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Market Distortion and Farm Price Support Programs

June 10, 2013
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By Carl Zulauf, The Ohio State University
Courtesy of farmdocdaily

This article examines the potential for market distortions caused by the price support programs currently proposed in the House and Senate 2013 farm bills. It is common for discussion of market distortion to focus on the level of price supports, but the degree of distortion reflects the interaction of all of a program's parameters. One of the hot topics in business today is the role of product design. In many respects, this post is a discussion of policy design and the potential consequences of design decisions.

Comparison of Price Support Targets

Both the House and Senate farm bills propose price deficiency payment programs -- programs that make a payment when the market price is less than a target price. Both bills replace the historical term, target price, with a new term, reference price. Moreover, the House renames the counter-cyclical target price program the Price Loss Coverage program. The Senate renames it the Adverse Market Payment program. These changes likely reflect a decision that the existing names have either acquired a negative connotation or send an undesired message. Part of good product design is the appropriate naming of the product.

In a deficiency payment program, the setting of the support prices is a critical policy design feature. In general, the House and Senate take different philosophical approaches in designing the level of the reference prices. The Senate largely takes a market-oriented approach. Excluding peanuts and rice, the reference price is 55% of an Olympic average of the 5 most recent crop marketing year prices (an Olympic average removes the low and high values when calculating the average). In contrast, the House takes the usual, historical approach of setting the reference price at a value that is fixed for the life of the farm bill. Fixed prices are largely determined by budget constraints and the political desire to assist some crops more than others. Thus, fixed prices have the potential to create outcomes that differ from the market.

One conclusion from years of research by academics into price forecasting accuracy is that a reasonable, often the best, forecast of future price is the current market price. Moreover, market price is a key determinate of the use of resources. This market-determined use of resources may or may not be seen as acceptable by policy makers. Therefore, a reasonable initial comparison is to compare politically-determined prices with recent market prices.

Figures 1 and 2 present the reference prices in the proposed House and Senate Farm Bills as a percent of the Olympic average market price from 2008 through 2012. A value of 100% means the reference price equals the Olympic average market price. The higher the percent the more likely the reference price will offer support above the market level. Thus, the House reference prices favor peanuts, barley, and rice. The price ratio is smallest for corn, then soybeans. While the rationale is not known why these two crops having the lowest ratio, it is possible that this policy design decision reflects the fact corn has been the primary beneficiary of the renewable fuels mandate, with soybeans potentially becoming a beneficiary if and when the biodiesel market expands.

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The Senate reference prices favor peanuts and rice. Note that the Senate references prices have the same relationship to market price for all of the program crops except peanuts and rice, for which the Senate replaces its market-oriented formula with a fixed price.

The design decision to favor peanuts and rice in both bills is an attempt to address the concerns of southern farms about the loss of direct payments and their assessment that crop insurance does not provide adequate risk protection for them.

Other Program Design Considerations

Table 1 summarizes the key design parameters for the House and Senate proposed price support programs. Bolding is used to highlight key difference. Due to limited space, only one other design difference is discussed. Specifically, the House Farm Bill makes payments on 85% of planted acres while the Senate Farm Bill makes payments on 85% of historical program base acres. This difference can have substantial importance.

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