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Plowshares and Pork Barrels
The Political Economy of Agriculture
By E. C. Pasour Jr., Randal R. Rucker
The Independent InstituteCopyright © 2005 The Independent Institute
All rights reserved.
The Role of Economics in Agricultural Policy Analysis
Agriculture in the United States and in other countries has been heavily regulated for many decades. During the past two decades, however, important changes have occurred in agricultural policies throughout the world. There is growing awareness that protectionist farm programs are expensive and inimical to economic progress, that they have little effect on long-run profitability of production, and that different programs frequently work at cross purposes. The inconsistencies between U.S. farm programs and free trade have been highlighted both in recent international trade agreements (for example, the General Agreement on Tariffs and Trade [GATT] and the North American Free Trade Agreement [NAFTA]) and in the two most recent U.S. farm bills — the Federal Agriculture Improvement and Reform (FAIR) Act of 1996 and the Farm Security and Rural Investment Act of 2002 (in this book referred to as the 1996 farm bill and the 2002 farm bill, respectively).
The 1996 farm bill was hailed by some as representing a major change in U.S. commodity programs. This so-called Freedom to Farm bill, which was in effect for seven years, largely dismantled the costliest price-support programs for farm commodities and permitted farmers to produce program crops with few planting restrictions. Some suggested that the FAIR Act marked the beginning of the end of government involvement in U.S. agriculture. The experience of U.S. agriculture under the FAIR Act, however, was not consistent with its advance billing. Farmers did gain increased flexibility in their planting decisions. In part because of low market prices for several major commodities, however, annual ad hoc appropriations for emergency aid were made in several recent years, and the costs to U.S. taxpayers turned out to be much larger than predicted when the 1996 farm bill was enacted.
The recently enacted 2002 farm bill (the Farm Security and Rural Investment Act) largely retains the flexibility in planting decisions implemented in the FAIR Act. Beyond that, however, the 2002 bill in many ways reverts to pre-FAIR policies. Target prices have been reinstituted, allocations for many FAIR programs have been substantially expanded, new producer groups are designated to receive government payments, and expectations are widespread that taxpayer costs will be the largest ever incurred under U.S. farm programs.
Recent trade agreements and policy changes, described throughout this book, mean that U.S. agriculture is now more closely linked than in the past to other sectors of the domestic economy and to world markets for farm products. Indeed, the effects of international trade along with the monetary and fiscal policies of the federal government may now be more important to U.S. farmers than policies designed specifically for agriculture.
In short, the farm sector cannot be considered in isolation. In many respects, the agricultural economy can be viewed as a microcosm of the entire economy. That is, economic activities in agriculture are similar to those in other sectors of the economy. Consequently, in any evaluation of the effects of various agricultural policies, it is necessary to understand how economic activity is coordinated in a market economy. First, we should consider the functions that must be performed in any type of economic system and the ways of performing these functions in a modern economy.
FUNCTIONS OF AN ECONOMIC SYSTEM
The functions of an economic system are quite general, regardless of political system and economic organization. First, there is a problem of product mix. That is, the amounts to be produced of corn, wheat, milk, beef, textiles, autos, steel, and all other products must be determined. Second, and closely related, land, labor, and capital resources must be allocated to the production of the various products. In agriculture, the production of crop and livestock products is rarely restricted to a single technology. Grain producers, for example, can reduce the amount of tillage by using more herbicides and pesticides. Moreover, even with a given technology, the most profitable amount of any input generally hinges on relative prices of inputs.
Third, the economic pie must be divided, or income must be distributed in some way. It should be emphasized, however, that wealth is not merely given, nor is there a fixed amount of income to be distributed. Instead, in free societies, individuals create wealth through labor, cooperation, and ingenuity. Income distribution is not a separate activity, but rather an integral part of the production process — individuals respond to incentive systems that reward extra effort.
Fourth, if economic progress is to occur, capital facilities must be maintained, updated, and possibly expanded. If the expected receipts from a capital-intensive activity are less than the costs, productive facilities are likely to be depleted. And if new goods and services are to be made available, incentives must be sufficient to induce producers to assume the risks. Because productivity depends on the amount of capital investment per worker, the maintenance and expansion of capital facilities is closely related to economic growth.
Finally, goods and services must be "rationed" in the sense of adjusting consumption, both at a particular moment and over time, to the available stock. Some goods such as agricultural crops are produced seasonally and must be stored if the goods are to be available throughout the year. Regardless of whether production is seasonal or occurs throughout the year, however, the very nature of economic goods means that they are scarce and must be rationed at any point in time.
THE MARKET SYSTEM VERSUS CENTRAL DIRECTION
The economic functions just described must be performed in any type of economic system. There are basically only two methods of economic organization in a modern economy, the market system and central direction. Although the comprehensive application of planning as a coordinating principle, as shown later in this chapter, is utterly unworkable, every economic system of the modern world to varying degrees involves some level of central planning. There is, however, no substitute for competitive markets in discovering, coordinating, and transmitting information throughout the production and marketing system. For this reason, a modern economy requires economic freedom and market competition just as science requires freedom and intellectual competition to progress. Thus, as shown throughout this book, central planning, whether comprehensive or not, is more likely to create and protect monopoly power and privilege than it is to foster economic activity.
Abundant evidence shows that the type of political and economic system used to achieve economic and social cooperation has the potential to affect human welfare greatly. Economic incentives and private-property rights are as important in agriculture as in other activities. Prior to the breakup of the Soviet Union, for example, most of the state-owned land was organized as collective farms where the relationship between worker output and reward was tenuous at best. However, a highly disproportionate amount of food in the Soviet Union was produced on small plots of land leased to farmers by the state, on which the farmers were permitted to grow food and raise animals either for their own use or for sale. These private plots, which accounted for less than 1 percent of the agricultural land in the Soviet Union, were estimated to provide approximately one-third of total farm output.
This observed link between entrepreneurial incentives and productivity is not unique. Sven Rydenfelt analyzed the economic crises in fifteen socialist countries, including Cuba, Tanzania, China, and the Soviet Union. Rydenfelt showed how socialist policies, regardless of geography, population, or natural resources, undermine a nation's single most important economic resource, the entrepreneur.
In a market or private-property system, prices perform the economic coordination functions described in the previous section. Information about supply and demand conditions is coordinated and transmitted through market prices. When the expected price of soybeans increases relative to the price of corn, for example, farmers shift more land into soybean production. Similarly, changes in relative input prices bring about substitutions in input use. As the price of labor increases relative to prices of machinery and equipment, farmers substitute capital for labor. The substitution of capital for labor and land in U.S. agriculture has led to a significant increase in output per unit of labor used.
Individual incomes are determined both by one's control over productive resources and by the use made of the resources. The expectation of profits provides an inducement for individuals to engage in risky entrepreneurial activity, and the individual decision maker must frequently make choices involving trade-offs between income and risk. Resource uses yielding higher incomes in agricultural production and marketing, as in financial markets, generally involve more risk.
The present value of expected income in any future time period is determined by the discount rate. The higher the discount rate, the lower the present value of income received in a future time period. Thus, an increase in the discount rate reduces the market value of an asset yielding a given stream of expected income. For example, if the use of a particular machine increases profits by $100 per year, the market price of the machine will be lower the higher the discount rate. Thus, the interest rate — the price of credit — is a crucial variable in investment decisions affecting durable resources, including land and capital facilities.
The rationing of goods and services both in the current period and over time is also performed by the price system. U.S. agricultural programs have long been plagued by economic surpluses. The existence of a persistent economic surplus (or shortage) is evidence that the price mechanism is not allowed to perform the rationing function. Price is also important in rationing goods over time. The amount of corn stored at harvest, for example, hinges on the difference between harvest price and the expected price following storage. A farmer will store corn only if the expected increase in price is large enough to compensate for storage plus interest costs.
One of the most interesting features of the market system is that it is automatic and unconscious. The market mechanism was not deliberately created, and no one assigns market participants their roles or directs their functions. As Frank Knight puts it, "No one ever worked out a plan for such a system, or willed its existence; there is no plan of it anywhere, either on paper or in anybody's mind, and no one directs its operation." Stated differently by F. A. Hayek, markets, being spontaneous in origin, are the product of "human action but not of human design."
A key insight of Adam Smith's Wealth of Nations is that social cooperation is achieved by the price system in a decentralized market system as if by an "invisible hand." Economic cooperation occurs as individuals engage in mutually voluntary exchange. Without an order being issued, individuals are induced to use their knowledge and to cooperate with each other in ways that are broadly beneficial, but that allow individual market participants to make the "right" decision even though they may have very limited information. The New York City housewife, for example, reduces consumption of orange juice when price increases. Regardless of whether she knows that production was decreased by a Florida frost, she has the incentive to use the product more sparingly. Similarly, producers of oranges and individuals engaged in the production of inputs used in orange production and marketing are also induced to cooperate through mutually beneficial voluntary exchange. The theory of the decentralized market economy shows how an overall economic order is achieved that uses a large amount of information not concentrated in any one mind, but existing only as the separate knowledge of millions of different persons.
MARKET PRICES AND MARKET SOCIALISM
The alternative to this decentralized market system is socialism (defined as government ownership of the means of production) or some other variant of central planning that does not rely on market-price signals. If prices are not used as signals, some type of central direction involving coercion must be used to organize economic activity.
The issue of whether socialism is a viable alternative to private enterprise was hotly disputed among economic theorists for much of the twentieth century. In the 1930s, socialist theorists Oskar Lange and Abba Lerner and prominent economists argued that central planners can determine economically rational product and factor prices and the efficient pattern of production in the absence of private property. They demonstrated that if given crucial data on available resources, production possibilities, and consumer preferences, a central planning board can emulate market prices and determine the most appropriate pattern of production. Ludwig von Mises and F. A. Hayek, however, demonstrated that although market socialism may not be logically contradictory, it is practically impossible because of information problems. Central planning to simulate market activity, they argued, is not operational because the necessary data cannot be obtained. The market socialism approach merely assumes away a crucial economic problem — the discovery and efficient use of knowledge. In reality, the necessary information to implement this type of central planning is not given to planners. Moreover, as the arguments presented later demonstrate, there is no known way that the information can be obtained through central direction.
The Mises-Hayek insights were not incorporated into mainstream economic theory, and even Nobel laureate economists failed for many years to recognize the Achilles' heel of collectivism — information. These insights about central planners' inability to cope with information problems are no less relevant today than they were a half-century ago. Furthermore, information problems are just as important for piecemeal regulation, as of the farm sector, as they are for central direction of the entire economy — where the empirical evidence leaves little doubt that such problems are insurmountable.
The Cold War's nuclear standoff allowed "history's grandest economic experiment" to run virtually undisturbed for five decades. The East, where collectivism was forcibly imposed, was the "experimental group," and the West, with its private-property system, constituted the control group. By the end of the 1980s, even Robert Heilbroner, the well-known proponent of democratic socialism, conceded that in the debate over the feasibility of socialism, Mises and Hayek were correct. There is now a consensus that successful planning is impossible without private property and the associated market prices. Without these signals, there is no possibility of calculating costs or revenues and no way of determining the most highly valued products.
The death of socialism has discredited "politics in the large," or central planning at the national level, but it has not reduced the appeal of "politics in the small," or piecemeal economic planning. Before further consideration of the problems with regard to the acquisition and use of knowledge that are inherent in noncomprehensive planning, let us first briefly review the marginal efficiency conditions of conventional welfare economics.
MARGINAL EFFICIENCY CONDITIONS AND PUBLIC POLICY
The marginal efficiency conditions of welfare economics describe the relationships that must prevail to maximize social welfare. These conditions typically are derived under the assumption of perfect competition — which requires price-taking behavior on both sides of the market, "perfect markets" with costless transactions and communication, and instantaneous information and equilibriums. Price takers are market participants who do not buy or sell enough of a good or service to influence the market price. The model of perfect competition assumes away various "market imperfections," including monopoly, imperfect information, and externalities. Under these highly idealized conditions, optimizing behavior by individuals and firms brings about the most productive pattern of resource use for the entire economy.
The standard marginal efficiency conditions describe the relationships that must exist among consumers, for input use among firms, and in output markets. These efficiency conditions have the potential to be useful to decision makers in agriculture and other areas as a "logic of choice." The principles are relevant, for example, in farm-management problems such as finding the most profitable amount of nitrogen per acre to use in corn production or determining the least-cost combination of grain and silage to obtain (say) one hundred pounds of milk from dairy cows. A great deal of applied work by agricultural economists deals with these marginal efficiency conditions, and the usefulness of these optimizing principles has been demonstrated in many different production and marketing contexts.
Excerpted from Plowshares and Pork Barrels by E. C. Pasour Jr., Randal R. Rucker. Copyright © 2005 The Independent Institute. Excerpted by permission of The Independent Institute.
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Table of Contents
ContentsForeword by Bruce L. Gardner,
1 The Role of Economics in Agricultural Policy Analysis,
2 Economic Efficiency and Equity in U.S. Agriculture,
3 Government and the Economy: Private versus Collective Choice,
4 Public Choice: The Economics of the Political Process,
5 Implications of Public-Choice Theory for Agricultural Policy,
6 The Farm Problem and Economic Justice,
7 The Role of Government in U.S. Agriculture,
8 Price Supports, Parity, and Cost of Production,
9 History and Overview of Production Controls and Marketing Quotas,
10 Production Controls, Price Supports, and Current Farm Programs,
11 Cooperatives and Marketing Orders,
12 Effects of Agricultural Commodity Programs,
13 Subsidized Food Programs,
14 International Trade and Trade Restrictions,
15 Crop Insurance, Market Stabilization, and Risk Management,
16 Subsidized Credit in U.S. Agriculture,
17 Conservation and "Protection" of Natural Resources,
18 Agricultural Research and Extension Activities,
19 Taxation in Agriculture,
20 The Effects of Government Farm Programs,
Appendix The Farm Security and Rural Investment Act of 2002: How It Updated Existing Law,
About the Authors,