| Posted February
16, 2006: Announce the elimination of LDPs and corn
prices would jump immediately. With the Brazilian cotton case
looming large over WTO agricultural negotiations and thus
over US farm bill discussions, we have been using this column
to outline the arguments that could be used if one were called
upon to provide expert testimony before a WTO disputes panel
hearing a case against the US corn, soybean, wheat and rice
programs.
In the first column in this series, we identified the underlying
characteristics of crop agriculture. We then argued that looking
at subsidies isolated from these characteristics is like straining
at gnats while swallowing camels because numerous studies
have shown that eliminating subsidies are not likely to reduce
US aggregate crop production nor raise prices.
If the elimination of mailbox subsidies would not lead to
significantly decreased production and the expected increase
in the price of program crops, then why have prices been so
low? To a large extent it is because of the use of Loan Deficiency
Payments/Marketing Loan Gains (LDP/MLG).
In the mid-1990s, the non-recourse feature of the loan program
was rendered ineffective by the extension of LDP/MLGs to corn,
wheat and soybeans among other crops. Instead of forfeiting
ownership of a crop whose price fell below the loan rate to
the government in exchange for the government writing off
the decrease in collateral value, the LDP/MLG allowed the
farmer to retain ownership of the crop with the government
paying the farmer the amount it would have written off.
This shift in policy was seen as positive change. It saved
the government the cost of storage of forfeited grain, and
it allowed the farmer to capture any gain in value if the
price of the crop increased. In addition it was argued, the
use of LDP/MLGs would allowed the US price to match the world
price enabling US producers to recapture lost market share
in these crops. The logic behind this was based on the belief
that the US loan rate artificially held the US price above
the world price, resulting in lost marketing opportunities.
The belief was that the world price was set by international
supply and demand conditions apart from the US price. And
if the US rendered the loan rate ineffective in setting a
floor on prices, the US price would be the same as the world
price. This would allow the US share of the export market
to increase significantly because it was no longer locked
out by artificially high prices.
The problem with this line of reasoning is that it failed
to understand the role of US markets in setting the “world
price.” There is ample evidence to suggest that the
US is the oligopoly price leader for most temperate agricultural
crops.
Because of its control over a large portion of the supply,
the oligopoly price leader sets a virtual ceiling on prices
and all other competitors price off the leader. In most cases,
unless they offer a premium product, the price for competitors
is below that of the price leader.
As US prices fell from their 1996 highs, the prices of our
export competitors fell as well, staying below the US price
for the bulk of their sales. As the prices plunged below the
loan rate during the 1998 crop year, it was expected that
two things would happen: (1) our export competitors would
reduce their acreage or at least slow down their rate of acreage
expansion, and (2) the lower prices would enable us to capture
additional sales and our competitors would end up holding
additional year-ending stocks. Neither thing happened even
though prices stayed below the loan rate for the most of four
years.
In the absence of a supply crisis, once the price fell below
the loan rate, grain purchasers had little incentive to bid
the price up. From their perspective, as long as the price
stayed below the loan rate, the US government was in effect
subsidizing their purchases.
Farmers, too, had little incentive to see prices rise above
the loan rate because the lower the posted county price, the
greater the LDP/MLG they could capture. To make more than
the loan the farmer needed to wait to sell until the price
was greater than the posted county price when they took the
LDP. For farmers who had forward contracted their crop at
a higher price, it was like shooting fish in a barrel.
While LDP/MLGs provided little incentive for US farmers to
increase their aggregate plantings, they did protect them
from the ravages of sub-loan rate prices. Farmers in the rest
of the world were not so fortunate as they had to take the
lower prices; Thus, the charges of US dumping of crops at
prices below the cost of production.
We are not arguing that the US commodities were not sold
at prices below the cost of production. They were. What we
are arguing is that the problem is not farm program benefits
themselves, but rather the mechanism by which they are distributed.
If the US were to announce that it was going to scrap the
LDP/MLG programs at the end of the current crop year and allow
the non-recourse loan program to function, the impact would
be immediate. Corn prices would jump from their current local
prices in the $1.65-1.75 range to over $2.00.
Adhering to a faulty WTO-focused analysis and eliminating
all subsidies is like throwing the baby out with the bath
water. No one will be better off and many will be worse off.
A better solution would be to eliminate the offending LDP/MLG
program allowing the non-recourse loan rate program to set
price floors for US farmers and farmers around the world.
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