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BACKGROUNDER

U.S. Farm Subsidies andthe Farm Economy:

Myths, Realities, Alternatives

F O O D

F I R S T

INSTITUTE FOR FOOD AND DEVELOPMENT POLICY

BACKGROUNDER

SUMMER 2005 VOLUME 11 • NUMBER 3

ver the last five years, groups spanning the ideological spectrum have come out inopposition to US and EU farm support payments, or subsidies. Critics of US andEU farm policy claim that subsidies are a major cause of overproduction. Over-production depresses global prices, leading to a loss of economic viability andthe destruction of small-scale agriculture, both in the US and globally. While US farm policyis highly discriminatory against smaller farmers, the excessive focus on subsidies has served toobscure the deeper forces underlying the long-term decline in global farm commodity prices.This Backgrounder will argue that declining agricultural commodity prices are rooted in themarket’s lack of self-correcting mechanisms. Even in the absence of subsidies, commodity mar-kets do not tend to equilibrium or operate to ensure fair returns on farm labor. Recognizing thisreality is essential to any sound reform of US commodity policy.On the surface, the argument against subsidies is quite compelling. Reforms in US farm policyinstituted after 1996 established subsidy programs in which payments to farmers are triggeredonce prices fall below a floor price (the

loan rate

), which is set by Congress. While these subsidies

by Karl Beitel

†

Karl Beitel is a policy analyst at Food First/Institute for Food and Development Policy.

A wheat field outside of Pendleton,Oregon.

U S D A P h o t o b y S a r a W i l s o n

exports are either constant or falling foralmost all major US commodity groupssince the early 1980s—including theperiod after 1996.

Myth # 3: Removing USSubsidies Would BoostFarmer Incomes Worldwide

To support the claim that eliminating USsubsidies would boost both world com-modity prices and farmer incomes in thedeveloping world, critics cite studies thatmodel the effects of phasing out US andEU farm supports on global output andprices.

But since these models rest ondifferent assumptions, each yields differ-ent results—some estimating world priceincreases of 1.8 to 3.7 percent over tento fifteen years,

others, that prices woulddecrease up to 3 percent.

Even the bestcase would lead to modest price increasesand very limited benefits to select farmers.So if subsidies are not driving decliningcommodity prices, what is? If eliminatingsubsidies won’t really help poor farmers,what will?

The Perversity of theMarket

In most major industrial sectors, the mar-ket works basically like this: a few domi-nant firms exercise significant control overprice. Firms observe one another, gettingto know their competitors’ behavior. Theytend to avoid price competition, usingnon-price means to increase their marketshare. The farm sector is very different.Many individual farmers supply a givenmarket. No single farmer controls enoughof the total market to influence price byadjusting his or her own supply. Instead,farmers have to take the market price asgiven and adjust their output accordingly.To break even, farmers must at least be ableto cover their fixed costs. Therefore, theywill not, as a rule, respond to falling pricesby taking land out of production—that is,working to raise prices by limiting supply. Just the opposite: confronted with fallingprices, farmers will attempt to increase out-put in hopes of offsetting falling per-unitrevenues by a higher total volume of unitsales. Failure to do so will put them out of business—sooner rather than later.shelter US farms from risk, critics arguethat the floor prices encourage overpro-duction, generating surpluses that are thendumped on the international market atprices well below the cost of production.In fact, critics claim, the main beneficiariesof subsidy payments are not farmers, butlarge agribusiness firms, whose access toa steady supply of cheap farm commodi-ties reduces their costs and boosts theirprofits (as they don’t pass through full costsavings to consumers). This line of reason-ing leads to the assumption that reducingsubsidies would curb overproduction andboost prices. Critics further note, correctly,that US agricultural tariffs are higher thanthose levied by developing countries, andcall for their reduction.

Without question, the current US sub-sidy system discriminates systemati-cally against small farmers in the US andglobally. But two linked misconceptionspervade the present subsidy debate:that subsidies are a principal—even theprincipal—cause of overproduction andfalling prices; and, hence, that removingsubsidies (and cutting tariffs) will signifi-cantly boost incomes for poor farmers inthe developing world. Both these claimsare inaccurate, and serve to obscure ourunderstanding of the types of reformsthat are required to restore real equity andlong-term sustainability to the US andglobal farm economy.

Myth # 1: Subsidies Are aPrimary Cause of DecliningPrices

It is true that subsidies sustain produc-tion even as prices fall below the cost of production. But claims that subsidies area primary cause of declining prices areconfusing; the reality is more complex.In part, the present confusion over thereal effect of subsidies on price resultsfrom a failure to take a longer-term viewof the US farm sector. When we examinethe real, inflation-adjusted prices for sev-eral major US commodity crops over thelast sixty years, two facts stand out: thatthese prices have declined steadily oversixty years; and that the price declinesince 1996 has been far less severe thanin previous periods, such as the years1973 to 1986.

These two facts suggestthat other factors underlie the longer-term decline, and that we must be care-ful in attributing recent trends in pricechiefly to subsidies.Furthermore, a 1998 upsurge in subsidypayments was triggered in response tofalling prices, not the other way around.And prices fell not because of subsidies,but because the remaining vestiges of supply management programs werephased out in 1996, leading to increasedcompetitive pressures on the supply sideof the market.

Clearly, we cannot explainfalling prices and stressed conditionsin the global farm economy simply bypointing to the market-distorting effectsof US commodity subsidies.

Myth # 2: SubsidiesAre a Primary Cause ofOverproduction

By keeping afloat farms that currentlysell goods at below production costs,subsidies can indeed contribute to higheroverall supply. But they are not the pri-mary cause of overproduction; nor isexcess supply the primary cause of fallingprices and faltering farm incomes. Again,we need a more nuanced account of theactual causal effects.Overproduction refers to a situation inwhich current supply exceeds currentdemand. Excess inventories accumulate,and prices fall. If overproduction caused thelonger-term price decline, we would expectto see excess inventories rising as prices fall.

But inventories (in relation to usage) haveremained constant or fallen for all majorcommodity crops (corn, rice, wheat, soy,and cotton) since the early 1980s.

Thusfalling prices do not appear to be caused byoverproduction, either before or after the1996 subsidies were enacted. And (withthe possible exception of cotton), this dataoffers no compelling evidence that subsi-dies as such are causing stocks to rise.

Critics might argue that subsidy-fueledoverproduction is being exported, or“dumped” overseas, and that’s why wedon’t have climbing surpluses at home.The data don’t appear to support thistheory either: both the percentage of total domestic production that is exportedand the US’ overall share of total world

So the normal operation of the market— which aggregates the decisions of manyindividuals—is for lower prices to triggerhigher output, leading to even lower pric-es. The farmer’s imperative to cover fixedcosts, and the fact that farmers generallydo not coordinate their individual actionsprior to bringing their goods to market,gives rise to the seeming irrationality of farmers’ responding to falling prices bytrying to increase output.

And since thedemand for most food goods is relativelyunresponsive to price, a significant declinein price may be required to clear the mar-ket of excess supply. Thus the overall pricelevel tends consistently downwards—andbuyers’ expectations of what they will haveto pay adjust ever downward, too.One additional feature of the commodi-ties market is critical to understandingboth the downward trend in commodityprices and a likely effect of eliminatingUS farm subsidies. On average, it’s truethat farmers in the US regularly sell goodsat prices below their costs of production.But this doesn’t mean all farms in a givensector are operating at a loss. Detailedstudies by the USDA indicate that in mostmajor US commodity sectors, larger farmscontinued to post positive net returnsthrough 2001 (the last year for whichrelevant data is available). These produc-ers—the large commercial growers—setthe market standard for price: as theircosts fall, market prices can fall below theaverage US farmer’s cost.Large growers’ ability to “beat the mar-ket” means that removing subsidies couldactually improve their competitive advan-tage. Furthermore, though subsidy pay-ments favor large growers, many small- tomedium-sized commodity farmers dodepend on subsidies to survive. Cuttingsubsidies to these farmers would acceler-ate farm consolidation.

Alternatives

The commodities market by itself willnever guarantee farmers a price that willcover their costs, because it cannot correctitself in the ways other market sectors can.Deregulating this market further—whichis what eliminating subsidies wouldentail—will not and cannot defend theexistence of small- to medium-sized fam-ily farms, either in the US or abroad.The only way to stabilize farmers’ incomesand preserve a viable, diverse agriculturalsystem is through some combination of price supports and supply management.Government price supports are the mosteffective means of stabilizing price andoffsetting the negative consequences of rapidly falling prices: farmer bankruptcy,land loss, accelerated farm consolidation,and the competitive pressure to shift tomore input-intensive farming methods.Supply management programs, which allowthe government to mandate land set-asideswhen surpluses arise, can help compensatefor farmers’ lack of control over commodityprices; they can also be extended to embraceconservation initiatives and sustainable landmanagement practices, benefiting the envi-ronment as well.To be effective, price supports need to becomplemented by better tariff controlson imported farm goods. Such a policyprescription, of course, runs completelycounter to the entire neoliberal thrustof the last twenty-five years, and wouldeffectively remove US farm policy fromthe regulatory jurisdiction of the WTO,signaling the end of the WTO’s Agree-ment on Agriculture. This would, in our

P h o t o c o u r t e s y U S A I D / C h e m o n i c s / M . H e r r i c k

estimation, be a welcome development.If tied to complementary reforms of theinternational financial system that wouldallow developing countries to determineand direct their own internal develop-ment policies, this shift could open thepath to real alternatives that would allowsmall and mid-size farms to cover thieircosts and continue to serve as stewardsof the land.

Pursuing such alternatives is an urgentnecessity. Market liberalization does not,in itself, launch developing countries ona path of sustainable long-term growthcapable of lifting their populations out of poverty. In fact the market, left to operatefree from government intervention, willonly exacerbate economic pressures inlarge segments of the rural farm sector,both in the US and globally. The farmsector has historically been subjected toextensive regulatory controls, which areneeded to compensate for the market’sinherent failures. An alternative to crip-pling free market policies exists: what isrequired is the political will to bring itabout. Progressive agricultural and tradegroups North and South must movebeyond the subsidy debate and unite insupport of alternatives that will sustain theworld’s farmers and ecosystems.

Workers in Uganda bag maize seed.