Bruce L. Gardner, University of Maryland

July 30, 1998

Mr. Chairman and Members of the Committee, my remarks are addressed to the causes of the difficult economic situation in agriculture that triggered this hearing and to what policies make sense in dealing with them. There are two main problems, which are quite different: emergency conditions due to crop failures in some areas, and a more widespread problem of low prices. With respect to crop failures the emergency is principally a matter of natural causes and the immediate policy issue is what can and should be done to remedy the losses. The problem of low prices, however, emerges from the working of the agricultural economy. Here the causes are more complicated and so is the choice of policy response.

In analyzing the problem of low prices, it is important to distinguish between temporarily low prices this year and low prices that will prevail over a longer time. And, there are important differences among individual farmers’ situations. All feel the pinch of low prices. But for some who have little debt and who sold part of their crop forward when prices were higher, the economic threat is less serious than for others who are heavily indebted and whose losses at current prices threaten to put them out of business. The policy issue is how to find a remedy appropriate to each situation. It is important to distinguish the differences because you are unlikely to find a single remedy for all.

First I want to consider today’s prices in a longer-term perspective, focusing on wheat and corn. Figures 1 and 2 show the real prices received by farmers since 1960 for wheat and corn. "Real" means adjusted for inflation. Since the price level today is almost 5 times its level of 1960, you have to multiply the 1960 price by 5 to get that price expressed in today’s dollars. Both wheat and corn have experienced persistent long-term real price declines, and the mid-points of USDA’s current projections for 1998-crop prices are the lowest of any of the historical data. USDA’s forecast range is also consistent with recent new-crop futures prices.

What lies behind the trend of declining prices? Of the many causal factors in play, two seem to me most important: decreasing real costs of producing wheat and corn, and market competition. U.S. grain producers with the help of continual technological advances have been able to produce more output with given inputs. Farm productivity has been rising at a rate of 1½ to 2 percent annually. This means that real costs per bushel are cut in half over a period of about 40 years, and this is roughly the trend rate of decline in prices that Figures 1 and 2 show. Competition forces these prices down over time as farm productivity improves, because any prospects of profit generate increased production and this extra production only clears the market at prices near the marginal cost of production. In this situation it is fortunate that a third causal force has been positive over the last several decades, namely expanding world demand for grain. Otherwise millions of acres of U.S. cropland would become redundant and farmers would face a further long-term threat to survival in marginal producing areas.

The downside of reliance on the export market is that it amplifies the competitive environment, a situation that more and more U.S. industries face in the global economy, and it makes U.S. agriculture vulnerable to other countries’ protectionist policies. Under global competition, U.S. agriculture is fortunate to be able to produce at lower real cost over time ¾ otherwise we would not be able to sell profitably in the world market.

What explains the short-run drop in prices that is happening this year? The way was prepared by the worldwide production response to the high grain prices of 1995-96. In the last two years world wheat and coarse grain production rose by 12% and 8% respectively from the two preceding years. It’s happening now because despite weather problems, the prospects are for big crops here and abroad again this year, at the same time the demand for a big crop isn’t there because of weak foreign demand, particularly in Asia where our commodities cost so much more now that currencies in Asian countries have fallen, and the real incomes of our foreign buyers have stopped growing.

What steps does it make sense for Congress to take in this situation, either with respect to the long-term trend, or this year’s especially low prices? First, placing international political considerations to the side, it is definitely in our economic interest to keep shipping farm products to willing buyers in China, India, Pakistan and elsewhere, and indeed to promote these sales and the reliability of the United States as a supplier. Second, with the longer term in view it is important to keep the pressure on for better access to foreign markets and reduced subsidies of foreign producers of grains by their governments. This requires intensive work both at the bilateral level and in multinational organizations such as the WTO and the World Bank. Both of these organizations have continually pressed countries around the world to reduce trade restrictions and subsidies. Congress should strongly support the efforts of these organizations. Unfortunately we get too caught up in reacting to objections expressed through such organizations to our own subsidies and trade restrictions. Third, it is crucial to keep investing in the scientific advances and infrastructure that give us the technological muscle to maintain our pre-eminence in world agriculture.

With respect to this year’s low prices, what about the CCC loan program? Two aspects are important. One is the credit provided so that farmers don’t have to sell their crop at low prices immediately to pay their production bills. The second is the price protection resulting from the government’s obligation to accept the commodity at the price given by the CCC loan rate or to make equivalent loan deficiency payments. Harvest-time credit provision is a task that USDA has been able to carry out expeditiously and efficiently, and may be helpful to many producers this year. But the idea of raising the CCC loan rate to increase the price guarantee for producers is a bad idea. Assistance to farmers who are in desperate straits is a worthy objective. But this should be done by a mechanism that targets the assistance at those who are in desperate straits and does not foster future economic difficulties for those individuals or for agriculture as a whole.

In looking at the economic condition of farmers in detail what is most striking is the extraordinary diversity of their situations. For example, go back to 1990/91, the previous period of low wheat prices. USDA did a detailed survey of farmers’ economic condition in 1991, the source of data they use to prepare the Family Farm Report that Congress requires each year. USDA estimated that 340,000 cash grain farms had an average farm-related net income of $9,700. Of these farms, 142,000 (41%) were estimated to have negative incomes. At the same time, 27,000 farms earned a net income of over $50,000. These latter tend to be the larger operations that are ready and able to reallocate their resources in search of profitable opportunities.

One problem with raising loan rates is that you will be allocating a lot of the benefits to people who are not in economic trouble, and this is on top of $4.5 billion each year that USDA will already be paying out in production flexibility contracts to wheat and feed grain producers in FY 1998 and 1999. Of course, deficiency payments formerly did the same thing despite payment limitations and payment bases. A more important problem is the economic production signals sent by higher loan rates. It is true that many grain producers, especially Plains wheat producers, have only limited options available for using their land. But some do have options to increase their acreage and increasing the guaranteed price is going to cause them to produce more wheat. It is such price responses that led to fixed bases and set-asides under pre-1996 programs. Without these restraints, raising loan rates now is going to create the potential for an even bigger price problem next year.

It is better for Congress to focus its efforts on creating a long-term regulatory, technological, and trade environment in which farmers can operate efficiently and compete effectively. The 1996 Farm Act promotes the idea of farmers using risk management tools that they control themselves, notably forward sales or put options. Farmers who bought put options or sold part of their 1998 wheat or corn forward have avoided the worst of the low prices this year and can generally smooth out the short-term swings that have always characterized commodity markets no matter what the policy regime. Even now corn can be sold basis March Chicago for $2.35 to $2.40 per bushel and wheat can be sold basis March Kansas City for $3.00 per bushel. Considering the usual basis between these futures prices and the average U.S. farm price, and the contract payments, producers can still lock in returns not far from what they would have been if the pre-1996 programs had been left in place.