farmgate: How Should Congress Respond To The Cost-Price Squeeze In Agriculture?
Every farmer has felt the impact of the cost-price squeeze, and likewise has had a difficult time explaining it to his city cousins who ask challenging questions about tax-supported farm programs, the farm economy, and why farmers have so much trouble making money. They look at 2007 and 2008 commodity prices, assume every farmer is wealthy, and wonder why the dairy industry is in financial collapse. Congress, which is being asked for financial support for the livestock industry, has been given a new report from the Congressional Research Service which sets out a clear perspective of that cost-price squeeze.
Economist Dennis Shields of the Congressional Research Service (CRS) says the cost-price squeeze concept began in the early part of the last century, when farmers began purchasing commercial feeds, fertilizers, and other crop inputs, rather than using homegrown inputs. And he says livestock producers are currently facing low or negative returns based in part on feed prices, which have not fallen as fast as output prices. At the same time crop producers have had to deal with volatile costs of energy and fertilizer which affect their returns. He says crop inputs climbed after the commodity price boom of 2007 and 2008, and have not returned to prior levels, although grain prices have.
Shields has told Congress that after periods of higher commodity prices, production typically expands, followed by higher input prices. Once profitability is lost, production declines or farmers go out of business, if they cannot make up the income shortfall with part time employment. Other farmers try to reduce input costs by increasing the size of their operation and spreading out fixed costs, which creates many other issues.
One of the dynamics influencing the trend is rising productivity, which Shields says allows more output from less input. And that, says the CRS economist, puts economic pressure on smaller operators unable to take advantage of those inputs. He says the end result is declining farm prices resulting in the loss of some farmers. Shields suggests the need for a yardstick that will measure the cost-price squeeze, which could be the comparison of prices paid versus prices received, and for now, put the issue of technological developments on the back burner. Shields proceeds to compare milk prices to feed prices on a per pound basis and that the ratio is 2, which means the value of two pounds of milk is equivalent to two pounds of feed. Within the dairy industry two would be negative profitability and the likelihood of herd liquidation. Shields also says the cost-price squeeze could also be measured with an index of current prices received, divided by an index of prices paid, and if the ratio declines it indicates financial difficulty.
The CRS economist notes that using data collected by the National Agricultural Statistics Service would be a good source, but they will end up being industry averages, and some producers may be better off and others worse off than what the statistics suggest.
Using current data, Shields points to the dairy industry and says 2007 saw record high milk prices stemming from export demand, which increased the milk-feed price ratio. But once feed costs climbed higher in 2008, the ratio fell from 3.0 to 2.0 and weakened further. His charts all indicate that livestock to corn ratios are at the lowest levels of the decade, many of them below the point at which herds are liquidated. The crops ratio has been climbing, and after a peak, current prices are equivalent to 2007 prices.
When farm prices do not keep pace with production costs, Shields tells Congress that farmers have a variety of tools:
1) Marketing tools allow price risk to be managed, and management decisions can reduce input costs.
2) Low prices for certain commodities will result in fewer acres or head of that commodity will be produced. However, production cycles are so long that such responses take time to implement.
3) Farmers may be able to take advantage of some federal programs, but those are limited to a few program crops. Other programs include crop insurance and dairy price supports. However, the economist says farm programs distort production incentives that originate from consumers, and keep inefficient farms in business. Shields says, “The counterpoint to limited or no government intervention is that markets are, at times, too volatile and can unnecessarily destroy farms that otherwise benefit society.” And he notes that smaller farms which have higher production costs are better suited to carry out conservation and other environmental programs that benefit the long term productivity of the land.
4) Off farm income is one of the keys to survival seen by Shields, since for the past 20 years, off farm income as a share of total household income has been at least 80%, and some years over 90%.
Shields says the farm policy created in the Great Depression has helped farms weather financial difficulties, but technology has resulted in a transition from many high cost producers to a few low cost producers. Public opinion supports continuation of farm subsidies, but with payment targeted to smaller producers instead of larger ones. However, that is an incentive for some farmers to either grow to the point of not needing any farm program payments, or contracting in size and depending on farm program payments and off farm income. He says the US is not going to have a food shortage because land, labor, and capital will all continue to be available. But he rhetorically asks if federal farm policy should address the trend of large farms producing an increasing share of agricultural output; and should Congress let family farmers financially fail or help them toward a more economically efficient transition? Shields says farm policy used to be rural policy, but the growth of rural industries has reduced the importance of farming, so he says Congress must decide how does farm policy complement its goals for rural communities and rural life in important agricultural areas? He says some policy critics have suggested that current farm policy is reinforcing or accelerating trends in farm structure and making worse the cost-price squeeze.
Summary:
Much of agriculture, and particularly the livestock industry, is in the midst of a financial squeeze caused by rising costs and declining commodity prices. Farmers have several ways of relieving the pressure, including receiving farm program payments. However, Congress is challenged on how to structure those supports, both on amount and to whom they are paid. But in the end, are those payments keeping inefficient farms in business and exacerbating the cost-price squeeze.
Posted by Stu Ellis on August 17, 2009 12:47 AM to farmgate