Agricultural Policy, Agribusiness, and Rent-Seeking Behaviour

Second Edition

ANDREW SCHMITZ CHARLES B. MOSS TROY G. SCHMITZ HARTLEY W. FURTAN H. CAROLE SCHMITZ

UNIVERSITY OF TORONTO PRESS Toronto Buffalo London Contents

List of Figures xiii List of Tables xvii Acknowledgments xxi List of Abbreviations xxiii

Introduction 3

1 Agricultural Policy: Agriculture and Agribusiness Environments 1.1 Agricultural Policy and Budgetary Outlay 9 1.2 Agriculture and Its.Changing Nature 13 1.3 Instability and Uncertainty in Agriculture 19 1.4 Boom-Bust Cycles: The Importance of Wealth 21 1.5 Agribusiness and Contract Farming 23 1.6 Lack of Countervailing Power 25 1.7 Farm Policy, Government Support Levels, and Effective Lobbying 26 1.8 Targeting Farm Subsidies 27 1.9 Rural Communities 28 ; 1.10 Commissioned Reports 29 1.11 Summary and Conclusions 30

2 Agricultural Policy: Institutions and Rent-Seeking Behaviour 31 2.1 Agricultural Policy 31 2.2 Political Institutions 37 vi Contents

2.3 Consequences of the Political Process 40 2.4 Rationale for Government Intervention in a Market 41 2.5 Government Failure and Policy Uncertainty 43 2.6 The Theory of Public Choice and Agricultural Policy 44 2.7 Rent-Seeking Behaviour 45 2.8 Coalitions and Logrolling 50 2.9 Farm Organizations 52 2.10 Summary and Conclusions 54

3 Theoretical Considerations 56 • —' 3.1 Economic Efficiency and Income Distribution 56 3.2 Income Transfers 61 3.3 The Harberger Tax and Monopoly Power 64 3.4 Efficiency of Income Transfers 66 3.5 The Economics of Information 70 3.6 The Theory of Regulation 72 3.7 The Search for Stability 73 3.8 Summary and Conclusions 78 Appendix 3A: Graphical Description of the Conditions for a Pareto Optimum 79 Appendix 3B: Consumer Surplus 83 Appendix 3C: Producer Surplus and Economic Rent 87 Appendix 3D: Starting from Second Best 88

4 Agricultural Trade and Macroeconomic Policies 89 4.1 Agricultural Trade 89 4.2 International Trade Theory 90 4.3 Trade Policy Instruments 95 4.4 Trade Distortions Caused by Market Power 101 4.5 Macroeconomics, Trade, and Exchange Rates 105 4.6 Summary and Conclusions 109 Appendix 4A: Negative Gains from Trade 110 Appendix 4B: Macroeconomics and Agricultural Policy 113

5 U.S. Agricultural Policy 122 5.1 U.S. Stabilization: Policies and Direct Farm Subsidies 122 5.2 U.S. Aggregate Farm Bill Expenditures 123 . 5.3 Early U.S. Farm Bills 124 5.4 The 1970 U.S. Farm Bill: Target Prices, Loan Rates, and Deficiency Payments 126 Contents vii

5.5 The 1996 U.S. Farm Bill: Agricultural Marketing Transition Act Payments (AMTAPs) 130 5.6 The 2002 and 2008 U.S. Farm Bills: Target Prices, Countercyclical Payments, and Direct Payments 131 5.7 Summary of 2002 U.S. Farm Bill Provisions 132 5.8 In Perspective: Three-Quarters of a Century of Price Floors 139 5.9 Conservation Reserve Program 142 5.10 Dairy, Sugar, Tobacco, and Peanut Programs 143 5.11 In Perspective 153 5.12 Summary and Conclusions 157 y - -- Appendix 5A: Stock Buildup and Managing Surpluses 158 Appendix 5B: Milk Program - A Two-Price Plan 163

6 Canadian Agricultural Programs 165 6.1 Agricultural Programs 165 6.2 Traditional Stabilization Programs 166 6.3 Provincial Policy and Program Differences 175 6.4 Transportation 178 6.5 Aggregate Treasury Support for Canadian Producers 179 6.6 Supply Management in Canada 180 6.7 Supply Management: An Economic Framework 183 6.8 International Trade 189 6.9 Summary and Conclusions 189

7 EU Agricultural Policy and Reforms 192 7.1 Growth of the European Common Market 192 7.2 Common Agricultural Policy 193 7.3 EU Cereals Policy 200 7.4 EU Oilseeds Policy 204 7.5 EU Sugar Policy 204 7.6 EU Dairy Policy 207 7.7 Fruits and Vegetables 212 7.8 The 2003 Single Farm Payment Scheme 212 7.9 High Commodity Prices and Double-Dipping 214 7.10 Summary and Conclusions 218 Appendix 7A: Welfare Analysis of EU Enlargement for a Net'Cereals Exporter 219

8 Insurance Mechanisms in Agriculture 222 8.1 Crop Insurance in the United States and Canada 222 viii Contents

8.2 History of Crop Insurance 223 8.3 Evolution of Crop Insurance in Canada 224 8.4 Evolution of Crop Insurance in the United States 225 8.5 Theory of Crop Insurance 227 8.6 Information Costs Associated with Crop Insurance Programs 239 8.7 Dealing with Adverse Selection and Moral Hazard 243 8.8 Crop Insurance Coverage Falls as Prices Fall 244 8.9 Summary and Conclusions 248 Appendix 8A: Value of Insurance under Risk Aversion 250 Appendix 8B: The Mechanics of GRIP 251 - - • Appendix 8C: An Adjustment Option (Jackson Offset) 252

9 Policy Decoupling, GATT, and the WTO 254 9.1 Policy and Decoupled Production 254 9.2 Policy Categories and Decoupling 255 9.3 Economics of Input and Output Subsidies 257 9.4 U.S. Cotton Subsidies: Drawing a Fine Line on the Degree of Decoupling 262 9.5 Summary and Conclusions 270

10 Farmland Markets: Politics, Policy, and Urbanization 272 10.1 Farm Payments and Land Values 272 10.2 U.S. Land Values 274 10.3 The Theory of Land Markets 274 10.4 Empirical Background 278 10.5 Canadian and U.S. Land Values 280 10.6 Boom-Bust Cycles and Farmer Wealth 286 10.7 Urban Growth and U.S. Farmland Values 287 10.8 Land Values and the Solvency of the Farm Sector 289 10.9 Land Values, Urban Development, and Trade 291 10.10 Productivity and Farmland Values 295 10.11 Multinationals: Capital Movements and Product Trade 295 10.12 Summary and Conclusions 297 Appendix 10A: U.S. Land Values and Decoupled Farm Programs 298 Appendix 10B: Land Rents - Price Supports and Technological Change 301

11 Agricultural Productivity and R&D Policy 302 11.1 Investing in Agricultural Research 302 11.2 Measuring Productivity and Productivity Growth 303 Contents ix

11.3 Research Expenditures in Agriculture 304 11.4 Evaluation of Research Expenditures 306 11.5 Estimated Returns to Agricultural Research 309 11.6 Effects of Government Subsidies and Trade on R&D 309 11.7 Agricultural Research: Who Benefits? 311 11.8 Regulation and Agricultural Research 318 11.9 Research Institutions and Intellectual Property Rights 319 11.10 Summary and Conclusions 322 Appendix 11 A: Gains from Research under Distorted Trade 323

12 The Economics of Biofuels 326 12.1 Gas Prices and Biofuels 326 12.2 The Economics of Biodiesel 328 12.3 The Economics of Ethanol 329 12.4 Food Concerns: No Free Lunch 346 12.5 Livestock 348 12.6 Impact Analysis: Limitations 350 12.7 Summary and Conclusions .351

13 Multifunctionality in Agriculture: Externalities and Non-traded Goods 353 13.1 Arguments for Protectionism 353 13.2 Externalities 354 13.3 Non-traded Goods 359 13.4 Identifying Positive and Negative Externalities 362 13.5 Regulations 364 13.6 Targeting Externalities 365 13.7 Summary and Conclusions 367

14 Input Use and Changing Farm Structure 370 14.1 Effect of Agricultural Policies on Input Use 370 14.2 Outputs Used as Inputs 372 14.3 Derived Demand for Inputs 372 14.4 Uncertainty and Input Demand 374 14.5 Simultaneous Changes in Input and Output Prices 376 14.6 Inputs: Fertilizer, Water, and Credit 377 14.7 Summary and Conclusions 392 Appendix 14A: Water Rights 394 Appendix 14B: Imperfect Competition 395 x Contents

Appendix 14C: Farm Equipment Markets 397 Appendix 14D: Interaction between the Input and Credit Markets 399

15 Genetically Modified Organisms 404 15.1 Different Plant Species 404 15.2 Regulatory Framework 406 15.3 Consumer Confidence and Producer Profitability 409 15.4 Economic Framework 411 15.5 Case Studies 413 15.6 StarLink™ Corn 421 ' '" 15.7 Summary and Conclusions 424 Appendix 15A: Non-adopters of GMOs 424 Appendix 15B: Modelling Market Segregation for Corn 425 Appendix 15C: Product Quality 427

16 Food Quality and Safety 428 16.1 Food Quality and Safety 428 16.2 Government Involvement in Domestic Food Safety 430 16.3 Inspection and Grading 434 16.4 Greater Role for the Private Sector 438 16.5 Regulation of Genetically Modified Foods 438 16.6 International Institutions for Food Regulation 441 16.7 Country of Origin Labelling: Producers and Consumers 444 16.8 Regulations and Information 447 16.9 Reputation Effect 450 16.10 Costs and Benefits of Regulation 450 16.11 A Positive View of Biotechnology 454 16.12 Nutrition, Obesity, and Agricultural Policy 455 16.13 Animal Rights and Humane Slaughter 459 16.14 Summary and Conclusions 462 Appendix 16A: The Household Production Model and Food Demand 463

17 Conclusions and Future Directions 468 17.1 Public Choice and Rent-Seeking Behaviour 468 17.2 Vertical Markets and Agribusiness 469 17.3 Goals and Objectives of Policy 469 17.4 Lament for Dying Communities 470 17.5 Targeting Support 470 17.6 Costs and Benefits of Agricultural Programs 471 Contents xi

17.7 The Pareto and Compensation Principles 472 17.8 GMOs, Biofuels, and the Environment 473 17.9 International Trade Concerns 473 17.10 Food Safety 474 17.11 Future Policy Options 475

References All Index 509