Econ Focus

The 2002 farm bill, signed into law in May, authorizes $118 billion in funding over the next six years. Billy Stephenson, chairman of Spring Meadow Farms Inc. of Smithfield, N.C., and a member of the Federal Reserve Bank of Richmond's Small Business and Agriculture Advisory Council, says, "The farm bill is like Santa Claus' bag at Christmas. It has a little something for everyone."

Farm policy has not always been so expensive. The annual cost of farm programs was relatively low during a period of rapid growth in agricultural exports in the late 1970s and early 1980s, and the prosperity of the mid-1990s led Congress to consider putting an end to some subsidies. In 1996, the Freedom to Farm Act made two important market-oriented changes to agricultural policy:

• Farmers were given greater discretion over which crops to grow, and the Department of Agriculture lost the authority to order annual acreage idling;
• A seven-year, $36 billion stream of fixed-income payments replaced countercyclical payments that went to farmers when the market price for a commodity fell below a target price. This program was designed to effectively end subsidies for program crops.

Despite those changes, payments to farmers began to rise in 1998, as Congress passed emergency appropriations in response to dropping world agriculture prices and a series of weather problems that affected domestic production.

Still, the 2002 farm bill is "a big move backwards in farm policy — a step away from market orientation," says Russell Lamb, an agricultural economist at North Carolina State University. The legislation extends the temporary fixed payments, reinstates countercyclical payments, and boosts loan rates (or price guarantees) for nearly every program crop. What's more, it threatens to stall negotiations aimed at liberalizing international trade in farm goods. Jeffrey Schott, senior fellow at the Institute for International Economics, recently stated in a conference in Rome that the "reorientation of U.S. policy away from market-driven policies could complicate efforts by European officials to reform their own trade-distorting subsidies under the Common Agricultural Policy. Ironically, these are the very subsidies that the United States has been complaining about for decades and still hopes to winnow down in the Doha Round [of World Trade Organization talks]."

Payments for program crops — such as corn, soybeans, grain sorghum, barley, wheat, cotton, rice, and oats — will be about $16.5 billion this year, or two-thirds higher than if the 1996 farm bill were still in effect. Payments for program crops to Fifth District states will climb even faster and are likely to be 80 percent higher than under the earlier legislation. Tobacco, a mainstay of the Fifth District's agricultural sector, receives its subsidies separately and is not affected by the farm bill (see sidebar below).

The three commodities programs work in the 2002 farm bill as follows. Consider a farmer with 1,000 base acres of corn enrolled in the program. He can plant nearly any crop he wishes on those acres because the 1996 bill removed most government planting restrictions, but his subsidies for the year will be based on the corn payment rates. For simplicity's sake, let's say that the farmer plants corn; the average market price for corn next year is low at $1.90 a bushel; the farmer has a program payment yield of 105 bushels per acre (based on historical yields); and his actual yield this year is 140 bushels per acre. The farmer sells his 140,000 bushels of corn for $266,000 on the open market, and he receives an $11,200 loan deficiency payment from the government to compensate for the difference between the market price ($1.90) and the $1.98 loan rate. The farmer also receives a $30,345 countercyclical payment based on a $2.60 per bushel target price for corn, as well as a $24,990 direct (fixed) payment of $0.28 per bushel for 85 percent of base acres at a program payment yield of 105 bushels per acre. All told, government payments boost the farmer's compensation to $332,535, or 25 percent more than the market value of his crop.

The farm bill nominally limits each individual to a $360,000 combined payout from the three programs. But that limit has a loophole. Participants can receive "commodity certificates" — funds used to repay a loan for which a commodity is collateral — that are not counted toward that program's effective payment limitation. Although other limits affect the amount of funding available to high-income recipients with a large share of income from sources outside agriculture, "the cap on loan deficiency payments for someone working in agriculture is not a cap at all," says Barry Goodwin, professor of agricultural marketing, trade, and policy at Ohio State University.

Farmers not planting program crops can benefit from other changes in the commodities title that provide a variety of new, expanded, or resurrected subsidies for goods such as dairy products, lentils, chickpeas, honey, wool, and mohair. Changes in the peanut program are particularly important to the Fifth District, which produces about 16 percent of the U.S. peanut crop and will receive about 20 percent of peanut-quota buyout funds.

Peanuts are effectively recast as a program crop, with loan deficiency payments that provide a price floor of $355 a ton, countercyclical payments at prices below $495 a ton, and direct (fixed) payments. Until this year, marketing quotas guaranteed a price of $610 a ton for peanuts grown under owned or rented quotas, but cheaper peanuts imported under the North American Free Trade Agreement and other trade pacts were undermining the price support.

Lower annual returns to peanut growers following the peanut-quota buyout are likely to shift some peanut production out of the Fifth District and toward states like Texas that already produce a lot of "additionals," or peanuts grown outside the subsidy system. Lamb notes, "The only reason to grow additionals is if your production cost is below the world peanut price."

The effects of the new peanut program are being felt already. Russell Schools, executive secretary of the Virginia Peanut Growers Association in Capron, says producers in his state reacted to the new farm bill by cutting acreage planted with peanuts by 22 percent this year. That cropland was planted instead with cotton, soybeans, or corn — all of which will provide less revenue than peanuts did under the quota system. Schools says revenue under the new peanut program will be "in the neighborhood of $500 per ton," and he notes that much of the quota-buyout money is likely to be spent or invested outside peanut farms because "two-thirds of the quota in Virginia is owned by people who don't farm it."

Texas is the top beneficiary of changes in the peanut program. One study on the subject was done by agricultural economists Walter Thurman, Blake Brown, and Jan Chvosta. The three researchers found that Texas peanut farms average a $7,987 gain from the combined effects of the quota elimination loss, the quota buyout gain, and the gains from countercyclical and direct payments. On the other hand, the changes result in an average loss of $1,448 per North Carolina peanut farm.

Outside the commodities title, the conservation title is the biggest winner in the 2002 farm bill, garnering an additional $17.1 billion in spending over the life of the bill spread across almost every existing agri-environmental program and some new ones. The new spending shifts away from programs that take land out of production and toward conservation spending on working lands.

Because restrictions on eligibility are few, conservation funding is one area where Fifth District farmers should be able to compete on a more even footing with the top commodities-subsidy recipients in the Midwest, Great Plains, and Deep South. Unlike the commodities programs, "the conservation programs do not require a program history in a crop or an unprofitable year," says James Pease, an agricultural economist at Virginia Polytechnic Institute and State University. The working-land conservation programs provide cost-sharing to help farmers add or maintain practices such as nutrient management and livestock waste handling. "If you don't qualify for one of these, you have no business being in farming," Pease notes humorously.

The other titles in the bill receive smaller increases in funding and at times address somewhat humdrum issues like expanding rural water and wastewater systems. One new program that has generated some interest among those concerned with agricultural exports are "technical barriers to trade" provisions. These combat backdoor efforts to keep agricultural products out of foreign markets through nontariff barriers such as health and safety regulations.

N.C. State's Lamb comments, "It's an incredibly small program at $6 million, but it's part of something that is going to be a trend. The World Trade Organization is working down tariffs and quota restrictions, and so making it harder for countries officially to lock out agricultural products. The Europeans in particular have a commitment to defending a structure of agriculture that is not cost-effective and are looking for ways to keep U.S. crops out."

Economists tend to frown on subsidies because they distort markets and lead to inefficient resource allocations, says Maurice McTigue, Distinguished Visiting Scholar at George Mason University's Mercatus Center and a former member of the New Zealand parliament, which effectively ended farm subsidies in that country in the mid-1980s (see sidebar above). "Up front, the money looks attractive even though in the long run the subsidies are quite damaging," McTigue says. "The policy process is too slow to respond to changes in the marketplace. If you subsidize exports, you're likely to be subsidizing either the wrong product or exporting into the wrong market."

Some economists have tried to put a number on the inefficiency costs of specific farm programs. Bruce Gardner, chair of the agricultural and resource economics department at the University of Maryland, cites a study he did that determined the crop-loan program causes "$1 billion per year in deadweight losses from misallocated resources." Loan benefits are based on current production, Gardner notes, so "the program induces overinvestment that drives down the market price and encourages overconsumption."

The farming community is more sanguine about the cost of subsidies. Spring Meadow Farms' Stephenson says, "I think that the price that the American consumer pays for a farm bill is cheap compared to the fact that it ensures a bountiful supply of the most wholesome food products in the world at a low price."

Whatever the cost of the subsidies, the failure of the 1996 free-market reforms likely signals that farm subsidies will be around for a while. "This bill contains everything the farm lobby could have wanted out of the 1996, 1990, and 1985 farm bills, plus there are no restrictions on producer behavior," Lamb says. "Whether this bill is sustainable or not is questionable. I think it's going to be a budget-buster down the road."