Why do farms need subsidies? [duplicate]

Question

The title is slightly misleading, farms need subsidies because it's difficult to make them financially viable, but...

Why do farms in developed countries require state subsidies (CAP in Europe, I believe there are similar schemes in the US)? Using my limited grasp of market economics, we all need to eat, so surely the supply / demand balance falls in the farms favour?

My train of thought is that it's a form of protectionism, preventing exposure to cheaper imports by making it artificially financially viable. Is this correct? If this is the case, why is it considered necessary to provide this level of support to farming rather than other industries? Security?

This may well be better at home on economics rather than politics, but I suspect the real answer straddles the two. 

Answer 1

Incorrect assumption. Farms don't need subsidies to make them viable. There are already plenty of farms that would be viable today without subsidies, and if subsidies would disappear only a few farms would need to close down before bulk food prices would rise to the level that others become profitable as well. Food has a fairly inelastic demand, with high margins after the farm (500% between farm and consumer is not unusual).

(Compare this to a closely related industry, flowers. Like grain, it's growing plants, also clearly profitable, but virtually without subsidies. )

So why are there big subsidies? Electoral reasons, of course. Farmers organisations historically had close ties to the influential Christian Democratic parties in Europe (Kaiser, "Christian Democracy and the Origins of European Union", 2007). Subsidizing food doesn't seem unreasonable to consumers, who'd expect that to result in lower prices for them (even though it doesn't - retail absorbs the margins). And arguments like "food independence" sound great even though there are sufficiently many suppliers to make it a non-issue.

Besides, if "food independence" would be an issue, you'd subsidize stand-by capacity. The EU CAP subsidies never took such a form, or any form that could be explained by reasonable economic policy. That is to say, a sane CAP would try to maximize a certain goal for a minimum number of euro's. No such goal has ever been discernible; the only goal appeared to be to maximize the number of euro's spent on farming.

One of the clearest examples is the Netherlands. In the early days of the EU, the Netherlands was very agricultural (not much industry), and a net receiver of EU funds due to CAP. Not coincidentally, the Dutch Christian Democrats were the dominant party, with wide support from Dutch farmers, and thus proponents of CAP. But they weren't the only Dutch party to support it: Founding Father of the European Union Sicco Mansholt was a Dutch socialist and credited with the invention of CAP.

But as the Netherlands moved to a services economy (still not very industrialized), they became a net contributor to the EU. The Dutch Christian Democrats all but disappeared, and support for CAP income support disappeared entirely: "[R]esponding better to global climate and food security challenges, increasing the effectiveness of existing greening measures, simplifying current CAP rules and focusing on SMEs, will be at the core of the [2016] Dutch EU presidency"

Answer 2

Suppose I live in a country where I can grow enough grain to feed my people. There will be a certain cost to grow this grain.

Now somewhere else, there's another country where they can grow a lot of grain, because of their size, the climate, etc. Furthermore, they can grow grain a lot cheaper than I can. This may have to do with the climate, local cost of labour, etc.

Now, a bakery in my country can buy local grain, or much cheaper grain from the other country. Guess which grain he will buy?

The farms producing grain in my country will fold. If nobody in my country buys their grain, nobody will want to buy it abroad either (because of the high price).

No problem, everybody still has food in my country.

But then something happens. The other country gets into a war, or for any other reason stops exporting grain to us. Now we have a famine on our hands.

That is why Western countries try to become and remain self-sufficient when it comes to primary commodities like food. Some countries are simply too small for that, which is why organisations like the E.U. develop such efforts on an international, yet localised, scale.

You can do that by making foreign grain more expensive (import duties) but that doesn't change your own farmer's position on the international market positively. Subsidizing your own farmers makes their produce cheaper, also improving their position on the international market.

Answer 3

Your comment:

My train of thought is that its a form of protectionism, preventing exposure to cheaper imports by making it artificially financially viable.

Is pretty much spot on

...why is it considered necessary to provide this level of support to farming rather than other industries? Security?

Yes.. security for the nutrition of the population. Maintaining production capability is important in event of crisis. Also, if you don't have production, you are vulnerable to extortion--having production reduces this threat.

Other industries are subsidized as well, but agriculture subsidies are more prevelent:

• food production independence is a tremendous strategic asset and governments invest in it
• seasonal weather causes boom/bust cycles; subsidies stabilize the producers year to year
• seasonal weather does not impact other industries so severely; subsidy is not need for year to year stability
• if an item is not strategic in nature, an importing country will often value lower cost more than it values protecting domestic producers (I believe this politically based reaction to most often be the case).
• some subsidies and tariffs are precluded by trade agreements, treaties etc. (NAFTA, EU, etc.)
• often cultural issues favor domestic products (Japan with rice comes to mind), so government uses uses subsidies or tariffs to protect domestic production (local politics)

Answer 4

The claimed reasons for subsidies in the United States relate to the twin issues of good and bad harvests.

In a year of a bad harvest, a farm doesn't produce enough food for sale to buy other things (mortgage, taxes, electricity, foods they don't grow, seeds, gasoline for planting, fertilizing, and harvesting next year's crops).

In a year of good harvests, too much food is produced and prices fall. If prices fall by more than the harvest increases, this means that the farm still doesn't produce enough money for other things. Worse, the incentives force the farmers to be even more aggressive about producing more crops. More crops make that farmer's situation better, but in aggregate, they make all the farmers worse off. So the government has systems in place to buy up excess harvests in good years and support farmers in bad years.

At its worst, during the Great Depression the government created artificial scarcity by paying farmers not to plant crops. My great grandfather used that program to fund his retirement. That program fell out of favor, but the stabilization programs continue.

We can run into some confusion about this. Some farms are profitable enough that with proper management they can save up enough to survive good and bad years. Another issue is that under the system farms behave differently.

When my great grandfather farmed, he had a vegetable garden for family consumption. He raised cows. Some produced milk, for family consumption. Some were slaughtered for family consumption. But the bulk of them were for sale. He also had grain fields for family consumption and for his cows. He probably had trees that he could cut for firewood.

Modern farms tend to have just one product. This better fits the subsidy system. Wheat or corn or beef or whatever. They don't have the same ability to eat their own crops exclusively and trade only for luxuries. They may eat their own immediate product but they add to it by purchasing other products from the store.

Another challenge is that farmers may be nominally rich by many statistics. For example, they own tens or hundreds of acres which have several buildings upon them. There is high value in their product. Even a small farm may have tens of thousands of dollars of crops to harvest, if not hundreds of thousands. But their expenses are high. They need to retain some of their product so as to produce more next year (seed or breeding stock). If they raise animals, they have to feed them year round. They have to put fuel in their tractors. They have to repair their machines or pay someone else to fix them.

The problem is that their expenses may exceed their revenues. But a farmer doesn't have the same opportunities as their more urban cousins to collect welfare in that situation. They have too much apparent wealth to get income support. If a farmer who is already on the edge faces a few bad years in a row, they may not be able to catch up even when their situation improves. They may use up too much of their capital.

In addition, big farmers have more political clout to get favorable treatment than do small farmers. So programs that are designed to help family farms are also used by large farms. After all, they produce the same product, so government purchases in abundant years have to help both.

All this said, it is not definite that farming as an industry requires subsidy. The system started in the Great Depression when the banking collapse spread to the farms, as banks would foreclose on farms. To avoid that, farmers would desperately try to sell as much as they could. But prices were falling and people couldn't pay the same prices as prior to the Great Depression. Meanwhile, the mortgages stayed the same.

Once the system was in place, farms adapted to it. Single crops rather than a mix for personal use and resale. The result was that farms became more dependent on the system. Moving away from the current system might be difficult, but it is not necessarily impossible. Some farms have already started doing this. Organic farms often have more of the mixed crops used by traditional farms. But they also have the advantage of being a luxury.

Answer 5

The CAP in particular is a modern solution to the ancient problem of "feast and famine". The politics is messy but underneath is a very real problem: agricultural overproduction in one year drives down prices, putting farmers out of business, potentially resulting in undersupply the next.

This is why the subsidies are usually combined with quotas, setting a maximum level of production as well. This also helps limit environmental damage (especially important for fishing quotas).

In a totally free market, many areas of Europe would have lost entire regional economies, with high social cost. It's been bad enough where concentrated heavy industries have gone; rendering farming uneconomic might ruin large areas for decades, a kind of rural Detroit

Answer 6

Answer relevant to Australia. Relevance elsewhere is unknown.

Farms need subsidies in certain years because farms get subsidies.

Generally, farms do not get substantial subsidies. They are subsidised to some degree with water being cheaper than supply/demand indicates it should be, cheaper diesel, and through government's spending more on services in the farming regions than they take in in tax.

But in a drought, farmers get given subsidies - tax concessions, interest free loans (which are a gift in real $ terms), forgiving people when they can't repay their loan, because any bank that confiscates farms due to non payment of debt gets targeted by the government.

So farmers, the effective capitalists that they are, overstock their paddocks in good years. They do not take sensible precautions such as diversifiying their crops, not over grazing, planting trees in paddocks and building sufficient infrastructure to cope with drought. They make a lot of money in the good years, because they aren't having to plan for the bad days ahead.

Then, the drought comes, and their farms fail. They hit up the media and plead for subsidies. One farm may not be significant. But because the vast majority of farmers mismanage their farms in the same way, and because food is important to us, they collectively are too big to fail.

They are bailed out. And what lesson do you think they learn? That it's best to use windfall gains in good years to prepare for bad years? Or that the taxpayer will bail them out when they need it?

Note: Any reference to farmers should be read as "most farmers". I do know at least two that do not, whose opinions form the vast majority of this post.

Answer 7

Speaking from a US perspective farms do not need subsidies. They would work just fine without them.

Historically speaking though there have been many reasons, but mostly it's because there were/are a great many farmers. Those farmers were/are a political force.

From a strictly economic sense, farm subsidies don't make a lot of sense. There are other ways and plans to help offset the costs of farming.

• Insurance, run by the USDA Risk Management Agency helps farms in times of poor crops and bad weather. This could be replaced by normal insurances, or even just saving money for lean years.

• ARC, essentially pays farmers if the price of the crop is too low. Unfortunately it also creates an artificial "we are higher then X so your good" boundary.

• PLC, pays farmers for the difference in the expected price and the actual price of the crops. This helps drive down and enforce the "we pay you enough" line. (hint: we don't pay farmers enough)

• Conservation programs, maybe the least evil of them all but in essence they pay farmers not to use their land to grow crops. Off seasons are needed to let the soil recover (very basic), and this helps ensure that farms aren't "forced" into running year after year on the same ground turning the area to a wasteland. A "better way" may be to regulate how an area is used and let prices adjust accordingly. But that is up for debate.

• "Marketing Loans", essentially are a loan given to farmers to not sell their crop now because of a low price. But it didn't really work out. It "morphed" into yet another instance of "we pay you enough so you don't need any more money". Specially at low cost crop times.

• Disaster aid, is exactly what it sounds like, and there are some "farmer only" programs that exist out there. Some are long term, and pay out no matter what. Some are in place after large disasters. These types of subsidies could use some reform but are probably OK, in general.

The problem

By using farm subsidies we artificially lower the cost of goods from the farm, which means we pay the farmer less. This is a hard cycle to break.

Let use a totally made up example.

John the farmer buys seed at $2.00 an acre. He grows his see and uses all the "best" techniques. That means in the course of the growing season he spends $42.00 an acre on growing that crop. It's time to sell, and it's a good year so he makes $38.00 an acre selling his crop. But that's ok, we pay John the farmer enough because with subsidies he makes $92.00 an acre.

The primary argument is that John can't afford to run his farm for $38 an acre. Which is true. But John's farm isn't rolling the money either at $92.00 an acre.

The alternative, is that John would just have to not sell his crops till people were willing to have him $92.00 an acre for his crop. And he could do this. But there are some serious side effects to consider.

1. The cost of food would go up. Meat and veggies both would sky rocket compared to the prices we have today. We would adjust, but it would be a shock.
2. Bigger farms can do it better. If John has a 100 acre farm, then he needs to make more per acre then someone with a 10,000 acre farm. The 10,000 acre farm can undercut him.

The debate

So the debate really comes down to is the US better with farm subsidies to help keep the costs of food down, or are we better to let the market run it's course. Farmers are a political group to be reckoned with. About 41% of the landmass of the US is farms (in one form or another) and about 5.5% our our GDP. Keep in mind that says nothing about what we consume internally. The US does not have to import very much food at all. We can grow most anything. There are exceptions, but the important part is the the US farm is a MAJOR player in the political and economic scene.

Answer 8

To add to the answers already posted, it helps that the broader public does not really care about agricultural politics, nor do they understand things like the farm bill. Combined this with the fact that it is just easier to maintain the status quo, legislators are able to please both groups. If the public actually cared about the issue of agriculture and put it on the list of priorities, then there might be some movement. Correct me if I'm wrong, but economists probably agree that farming should not be so heavily subsidized. Now if people/voters cared, then economists might gain some traction and have a more authoritative voice in the matter.

Answer 9

Using my limited grasp of market economics, we all need to eat, so surely the supply / demand balance falls in the farms favour?

You are correct that demand for food is largely inelastic. The purpose of subsidies falls strictly on the "supply" side of things.

Farm output fluctuates wildly from year to year, and often for reasons not under the farmer's control.

Consider what happens in a high-output year: the food available exceeds the demand, and the inelasticity of demand means that prices plummet. The market corrects just like it would with any other product, and next year, fewer farmers are growing crops on less land.

Consider what happens in a low-output year: there's less food available than people require, so prices rise. Since everyone needs to eat, they rise fast. The farmers are happy, because they're making huge profits, and the market corrects just like it would with any other product: next year more people are farming, and more land is planted. But the high prices mean that not everyone can afford enough food, so people starve to death.

Now, consider a high-output year followed by a low-output year. The low profits from the first year mean that less land is under cultivation the second year, when environmental factors cause the land to be less productive. You get a famine.

The purpose of farm subsidies is to average out these fluctuations. They ensure that during a high-output year, farmers remain in business, so that even during a low-output year, there's still enough food to go around, and year-to-year variations in prices are kept within reasonable limits.

Answer 10

Why do farms need subsidies?

They don't.

Why do farms get subsidies?

Because farmers are politically organized.

Further reading:

https://en.wikipedia.org/wiki/Agricultural_subsidy#Impact_of_subsidies