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
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
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
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
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.