Last night I was watching the kick-off of USDA's nationwide farm bill “listening tour” in Nashville. To me one of the most refreshing statements came from farmers that questioned the contribution of increasing exports of agricultural commodities, when the prices received do not cover the full cost of production. This is a very good indication that farmers are waking-up and figuring out that a call for competitiveness is a race to the bottom, and that it is only made possible thanks to the subsidies which keep farm income and rural economies from collapsing.

The 1996 Freedom to Farm, eliminated all mandatory set aside requirements and eliminated crop bases, which gave farmers complete control of planting decisions. Farmers then could produce as much as they decided of the crops they choose. The same farm bill also allowed for a more transparent transmission of market price signals to farmers, by eliminating the support price feature of the non-recourse loan rate.

These changes set the stage to drive prices down and become more competitive. Acreage that was in annual set aside was brought back into production as farmers made full use of all acreage
available to them. In the absence of a support price, commodity prices were driven down. When prices for all the crops that farmers could grow were going in the same downward direction, they realized that full planting flexibility was not of much use,. Only the intervention of Congress - through emergency payments and then, in 2002, through their institutionalization as counter
cyclical payments - avoided a collapse of farm incomes and rural economies.

Throughout this process the missing link was the lack of response of commodity exports to the drop in prices. To make a drop in prices worth it, the quantity of exports should have increased in a proportion larger than the drop in prices, so revenues would increase; but this did not happen. Moreover, as is usual in agriculture, the price increases of 2002 and 2003 were more the result of shortfalls in production in the US and abroad due to weather than price driven changes in production or export demand. But the theoretical increase in export demand never happened. Farmers in other countries are willing to receive a return close to zero on their land and labor before they stop farming, and even when they quit farming, the land resource and machinery remain in agriculture. Hence the production capacity of the sector is not affected significantly. Additionally, demand for commodities does not increase significantly as prices fall; once peoples need for food is satisfied, they are not compelled to buy more, even at lower prices. Even hunger and malnutrition have more to do with income and food distribution than with prices.

So for farmers, here and abroad, the picture is very bleak; prices are low, demand is not increasing significantly and therefore revenues are depressed. Only countries with significant government resources, like the US and EU, can provide massive subsidies so their farmers do not have to bear the full cost of the adjustment to the low prices.

But if farmers do not benefit, who are the true beneficiaries of low prices? Users benefit from these low prices, since US policy alters the normal requirement that the purchaser pay for the full cost of production. The users of US commodities are primarily large and often vertically integrated livestock operations, multinational agribusiness firms and importing countries (though it is often unclear whether importing country consumers directly benefit).

Government subsidies indirectly provide huge benefits to large and vertically integrated livestock producers, who purchase feed from the market at below production cost instead of growing it on-farm. This places small, diversified farmers at a competitive disadvantage, because they typically feed some crops to livestock on-farm. They thus absorb the full cost of production for the feed. In this way, low prices contribute to the growing pace of concentration in the livestock sector and the weakening position of small US farmers.

Large, multinational agribusiness firms are able to purchase agricultural commodities from the market at prices below the cost of production. At the same time, the absence of supply control mechanisms ensures traders and processors an unrestricted availability of commodities.
It also ensures input and machinery suppliers an inflated demand for their products, since the government no longer removes any acreage from production through set-asides.

Whether consumers directly benefit from the policies that have fostered persistent low prices depends on the ability of the marketing system to transfer the lower prices to them. In most cases, agribusinesses and middlemen are able to capture some or all of the benefits of low prices. In a study of the concentration and market power in U.S. food industry, researchers from the University of Connecticut found that in 32 food industries, the levels of concentration have resulted in cost efficiencies in one third of those industries. However output price increases, as result of increase in market power, were present in almost all of them(1).

This strategy of pursuing growth in the volume of exports, at the expense of driving prices below the cost of production can only exist in the presence of massive government subsidies, in
which the major beneficiaries are not farmers but agribusinesses. This is not a sustainable strategy as it is dependant on the ability of the federal government to continue to provide larger amounts of subsidies in a time when the fiscal deficit and the national debt continue to grow.
DTU

(1) Lopez, R.A., A. Azzam, and C. Lirón-España. "Market Power and/or Efficiency: A Structural Approach." Review of Industrial Organization 20(March 2002): 115-126.