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in the production decision of farmers in the Plains states. His models suggested that for every acre retired in the Conservation Reserve Program, another acre was put into production because of crop insurance and disaster payment transfers. To the extent that this is true the CRP and our risk management policies were working at cross-purposes. Once again, we had one foot on the brakes and the other on the accelerator.

Again, my conclusions are simple responses of the past have encouraged growers to take on additional risk and plant more marginal land. This places downward pressure on commodity prices but it also creates a damaging cycle that has more serious implications for the future. As you attempt to protect growers from the new risks they assume, they take on even more risk. In turn there will soon be more losses, more disasters from the same weather events, and more calls for a response. As long as the government creates incentives for people to take on more risk, they will do so.

Where to from Here?

The Congress took a bold step in 1996 with passage of new legislation designed to be a transition to a more market based economy. This Committee boldly asked if good public policy should provide the income necessary to allow growers to grow the same crops as their fathers and grandfathers. Public policy responses of the past favored producers who expanded production on their marginal land. Since there is more marginal land in the Great Plains, this region was favored. Therefore, it should have been expected that the policy changes that remove this incentive would hurt those producing on marginal land the most. The adjustments needed will continue to challenge not only the growers, but the agribusiness infrastructure as well.

Transition payments under the 1996 Act were designed to give growers the opportunity to adjust. In some cases, you must seriously ask if growers made the necessary adjustments. After over sixty years of public policy that took much of the risk out of agriculture, it was difficult to imagine a new regime. In many cases, the transition payments were simply used to buy new assets. This is the classic policy story of government subsidies being bid into land prices. Since only about half of the land farmed today is farmed by the owner, this has implications for those who gain and those who lose from such policies. Higher land prices mean higher rents paid to landlords. Higher rents increase the unit cost of production. These are basic principles. If growers believe they will be bailed out when disasters occur, you can expect these beliefs to be translated into rational decisions about investments. Risks that are real must be priced in the market if you don't want this to happen. This is not easy. While there is a significant safety net in place with the variety of risk management programs offered by private companies via Risk Management Agency programs, there are many missing pieces.

Neither futures markets nor the current RMA risk programs allow growers to protect themselves against the cycles of agriculture. Nearly all of the market-based alternatives available to growers only protect single year risk. Commodity programs of the past served to protect against the cycles that plague US agriculture. New initiatives in the private sector are needed to offer growers the opportunity to protect against prolonged downturns in the agricultural economy. Reducing the regulatory restrictions on trading off-exchange agricultural contracts may be an important part of facilitating such developments. Downturns in the agricultural economy will show up in asset values. Therefore, facilitating the development of privately traded land contracts allowing growers to insure against prolonged downturns may be a desirable long-run response.

If you wish to help agriculture in the transition to a market-based economy, you should consider the following:

✓ Stay the course on current transition payments.
✓ Resist the pressures to provide free disaster assistance.

Modify the rules so that private firms can develop more innovative risk management

alternatives that are indeed market-based (lower the regulatory hurdles). ✓ Encourage private development of multiple year contracts to manage the cyclical

risks that plague US agriculture. ✓ Encourage the development of a market to allow farmers to hedge asset price risks.

To a large extent, the best way to encourage private sector developments in risk sharing is to stay the course. Such developments will not occur if private interests think the Government is going to provide the same services at discounted prices.

Summary and Conclusions

Your responses to the current problems in selected agricultural regions will send important messages to US farmers across the nation. Understanding that you cannot eliminate risk in US agriculture is important as you consider an appropriate response. When you reduce the current level of risk, farmers will simply plant more on marginal land creating still more risk and resulting in more production and lower prices. Just as farmers drove faster and harder when roll bars were placed on tractors, they will take on more debt and take more risk if the government attempts to artificially reduce the risk in agriculture. There are no easy answers in moving to a market. Understanding why some farmers in particular will suffer in the short run will be important as you craft policy responses. Learning to take personal responsibility for the risk in agriculture will only come about if the Congress provides incentives for farmers to manage their own risks. The adjustments for many will not come easily.

KA 622

09.1

SUBMITTED BY THE HONORABLE EARL POMEROY

1996 FARM BLL:
QUESTIONABLE PREMISES LEADING TO UNREALISTIC EXPECTATIONS?

DARYLL E RAY, UNIVERSITY OF TENNBSSEE In years past many groups and individuals complained that farm programs was holding agriculture back since farmers could not fully respond to market forces. It was argued that the price and income stabilization aspects of farm programs would not be needed if farmers and markets were allowed to make adjustments on their own, upbampered by government interveation. Beginning with the 1985 Farm Bill and culminating with the 1996 Farm Bill, proponents of freeing agriculture have gotten most everything they have wished for.

Following the logic presented, farza price and income problems should be a thing of the past. Yet, here we are.

Profitability

The fact is that the profitability of major U.S. crops is at the lowest or nearly at the lowest level in 20 years (figure 1; table 1). Net returns above variable costs are at a 20-year low for the wheat sector while net returns per acre for wheat is lowest in 20 years except for one year. When adjusting for inflation wheat net returns are half what they were in the mid-80s. Per acte net returns for cotton, com and soybeans are all near 20-year lows. In our farm level budgeting work, are finding that for many typical farms in various parts of the country, net returns above variable costs do not cover the cash rent charge for tho land.

Contrary to the implied precaise the 1996 Parm Bill, more profitable crop mixes are not always available to farmers. Lo some parts of the country, there are literally no real crop alternatives. Also, if prices for all crop alternatives are low, having planting flexibility does not increase returns.

Exports

Over a decade ago, debate that contributed toward the passage of the 1985 Farm Bill suggested that high U.S. prices were limiting U.S. exports. But lowering support prices in 1985 farm bill and therefore crop prices did not lead to recovery of U.S. grain export market share and profitability. The reason this didn't occur, we were told, was that farmers, confined by previous farm programs, were unable to take advantage of export opportunities. Now with no supply control and complete planting flexibility, farmors can finally be free to produce for the export market and thus increase exports, export value and market share

Let's see what the data show. Grain exports are shocking low by any comparison, and especially given the expectations generated by setting agriculture free to produce for the export market. It is interesting to note that all-time record export lovels for each of the major crops occurred in the late 1970s and early 1980s -- a time when farm programs were in full force and included relatively 'high' support prices. Exports this year are projected to be over one-third below those nearly 20 year old record levels for com and wheat while cotton exports will be acarly half its top level(figure 2; table 2). Data clearly show that when prices decline, exports do not increase enough to increase export revenue. What about our export sbare for grains? The U.S. share of world grain exports bas not improved but bas declined over the last 20 years. Com export share has gone from 84 percent in 1979 to 60 percent in 1997. Grain export market shares are on their way to averaging lower during the tenure of the 1996 Farm Bill than any of the last five Farm Bills (table 2).

Variability Issues

An underlying premise of eliminating form programs was that the free market would help stabilize pricos and incomos as farmers freely adjusted supplies to meet market conditions. But most of the volatility in agriculture is due to weather-based variation in yields, something farmers have no control over. Parmers, unlike factory production managers, do not have the luxury of 'quickly' responding to prices caused by a low or high yield. If and when farmers do respond by changing acreage the next year, a low or high yield on that crop is just as likely to further destabilize the market as it is to stabilize it. Also, most of the variation of production in other countries and hence their ability to export or aced to import is also due to yield variation. And the same potential for further destabilization exists overseas.

Summary and Concluding Remarks

Agriculture, especially grain agriculture, is different from other sectors of the economy. And changing farm programas, reducing the number of farmers from millions to hundreds of thousands, using off-farm suppliers of inputs and processors, or moving toward increased importance of export markets does not change those inherent differences.

Since each farmer has no influonce over the price he receives, he does his best to lower costs by adopting the latest technology and spreading his costs over as much output as possible.

He has every incentive to produce at full tilt. • While farmers shift from one crop to another available crop when price changes dictate,

when all prices decline land tends to continue in production, even if the bank orders an auction. Thus, resources that would be shifted to another industry under depressed income circumstances in other sectors tend to remain in agriculture. Year-to-year variation in exports is influenced by changes in prices, policies of other countles, credit, trade policies, exchange rates, and other factors. But the overriding determinants of change in export demand in a single year are crop yield and production of

our export competitors and our export customers – not price. • Domestic as well as export demand change very little even with relatively large changos in

price.
Realistic Versus Unrealistic Expectations?

Increased planting flexibility is great but don't expect it to help farmers who have no

alternatives or face low pricos for all crops. • Doing away with set-aside removes an inconvenience for farmers but don't expect the

increased production to improve net revenues. • Doing away with buffer stocks reduces government cost but don't expect the market to carry

out stabilizing functions of buffer stocks. If doing away with government programs made grain demand and supply adjust quickly to lower prices, that would do it.....but that's not the

casc.

Do expoct periods of low prices and incomes and higher volatility that could lead to higher highs and lower lows.

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