Lecture 3.
Agricultural policy objectives and the farm problem

What we want to learn about this topic

• What are the objectives of EU and Irish agricultural policy? How are they changing over time?
• What are the pressures for adjustment in agriculture? How does the 'farm problem model' explain these pressures?
• How can we explain a persistent falling-behind of farm incomes relative to nonfarm incomes
• What is the pattern of adjustment to these pressures in agriculture?

Short introduction to the issues

Agricultural policy objectives

Treaty of Rome Article 33 (ex 39) objectives; all highly desirable, but is government intervention justified?

• Some interventions arise due to imperfect markets or the absence of markets

  e.g. public goods, externalities, redressing market power, incomplete information, imperfect capital markets

• Other interventions directed towards correcting unsatisfactory market outcomes

  e.g. ensuring food security, preventing low farm incomes, maintaining rural communities

• Food policy objectives now changing rapidly

  e.g. more emphasis on food safety, animal welfare and environment which are not mentioned at all in Article 33 .

Agenda 2000 revised statement of EU agricultural policy objectives

• Suggestions that the InterGovernmental Committee preparing the Amsterdam Treaty should reformulate the agricultural policy objectives in Article 33 (ex 39) were not followed through.
• The 1997 Agenda 2000 document sets out a revised set of policy objectives as follows but these do not have legal standing
  • to improve the competitiveness of Union agriculture on both domestic and external markets
  • to guarantee the safety of food to consumers bothinside and outside the Union... and to support quality products
  • to safeguard the environmental friendliness of production methods and animal welfare
  • to ensure a fair standard of living for the agricultural community and to contribute to the stability of farm incomes
  • to develop the role farmers play in terms of the management of natural resources and landscape conservation
  • to create complementary or alternative income and employment opportunities for farmers and their families, on-farm and off-farm
  • to contribute to econmic cohesion within the Union
• Note that the farm income objective now appears as just one among a much wider range of objectives, including food safety, environmental and rural development goals.

The farm problem model

A common structural characteristic of developing and industrial country economies is the declining share of economic activity contributed by the agricultural sector, whether measured in terms of GDP or employment. This declining share implies that resources must be re-allocated from the farm to nonfarm sectors and, in a market economy, this implies that labour returns to agriculture will lag behind labour returns in the nonfarm economy to provide an incentive for this to happen. From a farm perspective, it is not surprising that the problem of low (and unstable) incomes is defined as a problem (the 'farm problem') but how justified is public intervention to raise farm returns? In this lecture we cover:

• assumptions of the farm problem model
• price instability in a supply-demand framework caused by low price elasticities of supply and demand. Coupled with the assumption of a lagged response by production to price changes, this can give rise to the 'cobweb' model of price and production cycles.
• agricultural adjustment in a supply-demand framework: the 'treadmill' of technical change together with Engel's Law drives food prices down and leaves farms unviable - evidence
• technological change and input substitution also encourage farm amalgamation and lower the demand for labour in agriculture
• farm problem model is developed in a partial equilibrium framework, meaning that it does not take account of developments in the nonfarm economy. However, extending the model to a general equilibrium framework does not change the basic conclusion, provided the assumptions are stated in relative terms (i.e. technical change in agriculture is high relative to non-agriculture, demand for food from agriculture grows relatively slower than demand for nonfood products).
• the farm problem model is developed in a closed economy framework. In principle, it might be possible for a single country to escape the demand constraints by developing export markets. However, the overall constraint re-emerges at the global level, leading to declining world market food prices over time.
• note that there is no inevitability that agricultural supply potential outruns effective demand. This is a historical fact but not an immutable economic law. On a global scale, there are a number of commentators (e.g. Lester Brown of the Worldwatch Institute) who make the Malthusian prediction that growing resource constraints on supply (the drying up of additional unutilised land, problems in expanding irrigated acreage, a slowdown in yield growth due to a lack of technological breakthroughs) imply that food prices will rise in real terms in the future.
• If food prices were to rise in real terms, would this imply an end to the farm problem? This depends on the operation of factor markets, and particularly the farm labour market.

Reasons why farm incomes may lag behind nonfarm incomes

• low farm incomes result from 'sticky' labour supply response. Possible explanations include:
  • barriers to exit and/or adjustment costs - only plausible in remoter rural areas where information on alternative opportunities may be limited or in periods of high unemployment
  • neoclassical human capital explanation - farmers on average are older, have lower education and a bundle of less valuable skills than non-farmers on average
  • fixed asset theory - helps to explain why farm resources, including labour, can become trapped in agriculture leading to overcapacity and low returns

The pattern of adjustment

• reduction in the agricultural workforce, accompanied by intensification in the use of land through the application of greater amounts of variable and capital inputs
• increased size of farm business and increased specialisation
• growing concentration of production and output on larger farms accompanied by the growing marginalisation of small-scale farming, leading to increased differentiation in farming...
• ...and differences in survival strategies depending on the resource base of the family farm and family circumstances.

Reading suggestions

Winters, A., (1990), The so-called non-economic objectives of agricultural support, OECD Economic Studies 13, pp. 237-266.
(surveys the usual arguments advanced to justify government support for agriculture in industrialised countries)

For a discussion of the farm problem model, see
Gardner, B., 1992, Changing economic perspectives on the farm problem, Jnl. Econ. Literature 30, March, pp. 62-101
(read first part of this article, pp. 62-85, ignore last section on US farm policy).

Supplementary readings

D. Blandford and B. Hill (eds.): Policy Reform and Adjustment in Agricultural Sectors of Developed Countries. Wallingford, Oxon.: CABI Publishing, 2006.
(concentrate on the early chapters describing the forces for change. Much of book is a set of national case studies, while concluding chapters examine policies to assist adjustment).

For discussion of the pattern of agricultural adjustment in Ireland over the past decade, see
Crowley, C., Meredith, D. and Walsh, J., 2004. Population And Agricultural Change In Rural Ireland, 1991 To 2002, Teagasc.