August 21, 2000
PROSPECTS FOR CONTINUED LOW PRICES
STIRS POLICY DEBATE
Prospects for record large corn
and soybean crops suggest that the two year period of extremely
low prices will continue for a while longer. In the near term,
pricing and marketing decisions will be centered around the use
of the marketing loan program. Specifically, producers will be
occupied with deciding when to establish loan deficiency payments,
how much of the crop to store unpriced, and whether or not to
take advantage of large premiums for post-harvest delivery.
With marketing moving to the back
burner, more attention is being focused on government programs
and proposals for policy change. A number of "plans"
are being proposed from a variety of sources. Many of the proposals
are without merit and/or are very short term in their approach.
The history of crop prices in the
U.S. suggests that high prices are an exception and that low prices
are the norm. The U.S. and world has the capacity to produce more
crops than can be sold at high prices for an extended period.
Efforts to increase demand can and have been successful, so that
more product can be sold at higher prices. These efforts, however,
tend to be gradual and demand has not improved faster than productivity
gains, so prices general remain low. This is the primary reason
that U.S. crop policy has historically had a supply control component.
Some writers appear surprised that
the current extended period of low prices has not resulted in
a voluntary supply reduction on the part of U.S. or world producers.
The reason that has not happened, of course, is that prices (prices
plus government payments in the case of some countries) continue
to exceed the variable cost of production. Budgets based on farm
records in Illinois, for example, show that the out of pocket
costs for producing corn may vary from about $1.20 to $1.50 per
bushel. All non-land costs may vary from $1.80 to $2.40 per bushel.
For soybeans, the out of pocket costs may range from $2.10 to
$2.50 per bushel, while all non-land costs may range from $3.90
to $4.70 per bushel. If price plus payments exceed out of pocket
costs and contribute to fixed costs, production will continue,
at least for a while. Current loan rates that are above the variable
cost of production, along with highly subsidized crop and revenue
insurance premiums, tend to encourage production.
Even though production is not discouraged,
low prices result in low or negative incomes for many producers
due to the high cost of renting or paying for farm land. Again,
budgets for Illinois show an "equivalent rent" cost
of land ranging from $.85 to $1.00 per bushel for corn and $2.00
to $2.80 per bushel for soybeans. Over time, low prices and low
incomes would likely result in lower land costs (values), bringing
the cost of production in line with the market price. However,
the short term impacts of land price devaluation are not generally
acceptable, so the government has made additional income payments
to producers in each of the last two years and will likely do
so again this year.
The effect of additional government
payments, then, is to support land values (costs) and keep the
total cost of production well above the normal market price. Since
payments go to producers, there continues to be keen competition
to own or rent land, driving values higher. The capitalization
of government payments into farm land values has been documented
by a number of academic studies and is generally understood by
farmers and many in government. However, there appears to be some
emerging frustration on the part of policy makers that government
payments drive up the cost of production which require more government
payments to support incomes during periods of low prices.
While the capitalization of government
payments into land values may be rational economic behavior, it
creates a policy dilemma discontinuing or reducing payments
could create widespread financial stress, while continuation of
large payments prevents the downward adjustment in costs that
appears to be needed. Expecting crop producers not to bid up the
value of land is like expecting hog producers not to expand production
when hog prices are over $50 it doesn't happen. The upcoming
policy debate should be interesting.
Issued by Darrel
University of Illinois