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What Does the Future Hold for U.S. Agricultural Subsidies?
The banking industry’s vulnerability to “stroke-of-the-pen” risk extends into the nation’s farm sector. Strong performance in the agricultural sector and among farm banks would be seriously challenged if an underpinning of this success, high levels of domestic government support payments, were to be scaled back because of the results of international trade negotiations or U.S. congressional budget debates. Should agricultural subsidies be lowered or phased out altogether, not only would farm income be hurt, but the value of farm land also could decline, and the financial condition of the nation’s farm banks could weaken. The effects of these policy changes would be significant and far-reaching and therefore warrant close scrutiny.

Performance of U.S. Agricultural Sector Remains Strong: Effect of Subsidies Is Clear
The U.S. agricultural sector is riding a wave of positive numbers. Net farm income of almost $74 billion set a record in 2004; this strong performance is expected to continue into 2005 with forecasted income of more than $64 billion.1 Relatively high livestock prices and substantial government support payments to farmers are compensating for low commodity prices (see Chart 1). In addition, farm real estate values have climbed rapidly in many areas, bolstering farmers’ balance sheets.

A key contributor to net farm income, government payments to farmers have exceeded $10 billion each year since 1997 (see Chart 1). Before 2002, these payments largely took the form of emergency assistance to help farmers through periods of low commodity prices. Since the enactment of the Farm Security and Rural Investment Act of 2002 (Farm Bill), the level of government support has been tied to commodity prices. As strong harvests for corn, soybeans, wheat, and cotton have dramatically lowered prices for these crops, government payments have helped fill the gap.

Pressures are building in Congress to scale back farm subsidies. In the longer term, the outcome of international trade negotiations may result in the U.S. government cutting or discontinuing many subsidy programs, possibly as soon as 2007, when the next farm bill will be negotiated. In the short term, Congress could cut farm subsidies to help close federal budget shortfalls. Any such reductions would be a blow to farmers’ cash flows and incomes and could affect farmland prices, as the expectation of continuing subsidies has been capitalized into land values. This article explores the events and pressures that could scale back farm subsidies and examines the implications for farmers, their lenders, and farmland values.

The World Trade Organization and U.S. Agricultural Subsidies
The United States is a member of the World Trade Organization (WTO), a forum for the negotiation of international trade rules that help lower trade barriers and improve the flow of goods.2 International trade negotiations from 1948 to 1994 reduced tariffs on manufactured goods from 38 percent to 4 percent, while total merchandise trade expanded an impressive 18-fold.3 Economic data show a strong link between free trade and economic growth, and liberal trade policies—those with fewer restrictions on the trade of goods and services—enhance competition and drive innovation.4

Chart 1

U.S. Net Farm Income and Government Payments Remain High

However, while most economists agree that a policy of free trade will maximize wealth and output globally, individual country leaders face political pressure at home to maintain policies that benefit particular interest groups. The agricultural sector, in particular, is characterized by strong special interests and has been governed by few trade rules until relatively recently. During the 1970s, the United States strongly supported liberalizing farm trade because it faced increasing competition in world markets. Consequently, during the trade negotiations that began in 1986, agricultural issues ranked high on the agenda.5 That round of negotiations, which concluded in 1994, resulted in the Agreement on Agriculture, the first significant multilateral treatment of farm sector issues.

Despite the 1994 agreement, however, tariff levels remain significantly higher on agricultural products than on nonagricultural products, and trade continues to be somewhat restricted. Similarly, export subsidies, which countries use to reduce the prices of their commodities and strengthen their competitiveness worldwide, remain widespread. Overall, though levels of agricultural subsidies declined shortly after the agreement’s implementation, low commodity prices since 1998 (attributed to strong crop harvests worldwide) have prompted an increase in domestic support payments in most industrialized countries, including the United States.6

The Doha Round: Developing versus industrialized countries and a pledge to reduce subsidies
A new round of WTO negotiations was launched in Doha, Qatar, in November 2001. This series of negotiations, known as the Doha Round, is intended to reduce trade barriers, export subsidies, and domestic support for many goods, with agricultural subsidies a key agenda item.

The Doha Round has sharpened the philosophical differences between developing and industrialized countries. International trade policies are hindering the ability of developing countries to realize the full benefit from their comparative advantages in the agricultural sector—low costs for farmland and labor. Industrialized countries, such as the United States and nations in the European Union, seek to support their agricultural producers through continued subsidy programs. Many economists maintain that agricultural subsidies in industrialized countries contribute to the overproduction of supported commodities and, in turn, depress world prices, hurting producers in developing countries.7

A turning point in the Doha Round occurred in August 2004, when industrialized countries agreed to “make substantial reductions in distorting supports, and those with higher levels are to make deeper cuts …”8 This statement reflects the first time the United States and the European Union committed to reduce domestic support levels. While no timetable has been set to curtail U.S. subsidy programs, the negotiation of the next Farm Bill will be an opportunity for this country to address farm subsidy payments.

Brazil’s challenge may strengthen the hand of developing countries.

In September 2002, the Brazilian government sued the United States in the WTO, challenging more than $3 billion in subsidies paid by the U.S. government to its cotton farmers. Brazil argued that the subsidies contributed to increased U.S. cotton output that depressed world cotton prices and undermined Brazilian farmers’ livelihoods. Brazil estimated that if U.S. cotton subsidies were eliminated, U.S. cotton exports would decline 41 percent, and worldwide production would fall 29 percent. This would boost world cotton prices more than 12 percent, benefiting cotton farmers in developing countries such as Brazil and West African nations.9

The WTO ruled in favor of Brazil in June 2004. The United States appealed the decision, but the WTO’s Appellate Body upheld most of the original ruling in May 2005. The decision marked the first time the WTO had ruled against any domestic agricultural support program. In another challenge, the WTO ruled in favor of Brazil against the European Union’s sugar subsidy program. Some observers believe the WTO’s cotton and sugar decisions could encourage Brazil or other developing countries to file similar complaints against other subsidy programs.

Although progress on international agricultural trade policy is typically very slow, the U.S. farm subsidy program appears to be vulnerable over the longer term. The outcome of the Doha Round negotiations, especially industrialized countries’ pledge to reduce domestic support payments to farmers, certainly is problematic. And the WTO cotton and sugar rulings fuel calls for scaling back government payments to farmers. These policy changes indeed have far-reaching consequences and will be carefully monitored by agricultural economists and policymakers.

U.S. Budget Pressures Could Prompt Cuts in Agricultural Subsidies
The 2002 Farm Bill was enacted during a time of federal budget surpluses. However, several key developments have occurred since that time: the extended war on terror, a weakening stock market, and growing budget deficits. Today we face a much different economic scenario, one that requires close scrutiny of all federal spending. In fact, as part of the 2006 budget reconciliation process, Congress must cut $70 billion by September 16, 2005. Of that amount, the House and Senate agricultural committees are tasked with trimming $3 billion in mandatory spending, most of which is for crop subsidies, food stamps, and other nutrition programs. Because the latter two are considered critical social programs, many observers believe crop subsidies will be targeted for cuts. In fact, the administration has proposed the following legislative changes to reduce agricultural subsidies or promote more efficient production decisions:

  • Reduce crop and dairy payments to farmers by 5 percent.
  • Scale back the commodity payment cap for individuals from the current $360,000 to $250,000.
  • Require the dairy price support program to curtail expenditures.
  • Base subsidies on historical production, allowing farmers to update their acreage according to what they actually grow.10

By far the most serious, the 5 percent across-the-board cut would affect many farmers and potentially strap highly leveraged farmers. The payment cap would be particularly problematic for larger farmers. The five states that stand to lose the most in agricultural subsidies are California, Texas, Kansas, Arkansas, and Nebraska; these states represent 51 percent of U.S. total reductions under the proposed cap.11 It is not certain that Congress will adopt these proposals; Congress traditionally has shown a bias against cutting agricultural subsidies. However, the potential fallout from these cuts should be anticipated and analyzed.

Reductions in Farm Subsidies Would Pose Significant Challenges for Farmers and Their Lenders
Since 1997, government subsidies of $120 billion have represented about one-third of the nation’s net farm income. About 40 percent of the nation’s farms receive government payments for one or more of these crops: wheat, corn, soybeans, cotton, sorghum, rice, barley, and oats. States that specialize in these crops would be disproportionately affected by subsidy cuts. For example, North Dakota, which is by far the most heavily subsidized state because of its concentration in wheat production, derived more than 71 percent of its net farm income from government payments from 1990 through 2003.12

In a related development, reductions in federal farm subsidies could depress farmland values. U.S. farm and ranch values have climbed in recent years because of strong farm income, increased demand for land for nonfarm uses, low interest rates, and tax advantages. According to Federal Reserve Agricultural Lender Surveys, land prices for good-quality (nonirrigated) farmland rose between 8.7 percent and 15.4 percent from 2003 to 2004. Ranchland values posted double-digit gains, primarily because of record cattle prices. The Real Estate Center at Texas A&M University reported that Texas land prices jumped 16 percent on average from 2003 to 2004, with some areas posting gains of more than 35 percent.13

Where the expectation of continued high government payments has been capitalized into real estate values, a scaling back of payments undoubtedly would place some downward pressure on land prices. Several studies indicate that government payments in recent years have contributed to higher U.S. farmland values; in fact, a study by economists at the University of Florida estimates that farmland values have increased 15 to 25 percent across the nation because of government payments.14 Although the impact on farmland values of lower payment levels would be widespread, the effects would not be felt uniformly across the country. Farmland values in areas that rely more heavily on subsidies slated for reduction would be expected to fall the most. An analysis by the U.S. Department of Agriculture estimated severe effects in the most heavily subsidized states. For example, in North Dakota, farmland values would decline 69 percent if government payments were removed altogether.15 While the elimination of government payments is highly unlikely, the study shows how closely farmland values and government payments are tied.

Among the nation’s farm banks, the use of farmland real estate as collateral has increased in tandem with higher farmland values.16 At year-end 2004, loans secured by farmland represented 18.6 percent of total loans, a significant rise from 16.4 percent at year-end 2000. Much of this growth was reported among farm banks based in states where farmland prices have appreciated rapidly, such as Minnesota, Wisconsin, and Missouri.17 In these states, loans secured by farmland grew 69 percent from 1997 through 2002. By contrast, farm banks in areas characterized by less rapid price appreciation reported only a 10 percent hike in farmland loans.

However, heavy reliance on government payments would not necessarily contribute to declining farmland values in all cases. Certain mitigating factors, such as those described below, exist.

Vibrant economies: While many rural counties, particularly in the middle of the country, are losing population, some counties with strong employment opportunities are attracting more residents. Many of these counties also have strong retail bases. Farmland values in such counties likely would better withstand the adverse effects of subsidy cuts than counties with declining populations.

Natural amenities: Agricultural areas characterized by natural amenities, such as lakes, forests, or mountains, likely will fare better than other areas. As people consider relocating away from urban areas, anecdotal evidence suggests they are looking for land suitable for hunting, fishing, hiking, and camping. These areas are also popular for nonresidential purchases. In the past few years, the value of land used for recreational purposes has contributed significantly to the increase in farmland values.

Proximity to metropolitan areas: Approximately 17 percent of the nation’s farms are located near a major urban center, and many of these farms have benefited from higher farmland values because of residential and commercial development. Growing population in many urban centers has driven demand for residential housing, pushing rural land values higher.

Each of these factors could be spurring the appreciation in farmland prices that has occurred to date, reflecting the influence of nonagricultural uses on farmland value. These factors could mitigate the downside effects of future subsidy cuts. However, the absence of these factors also could exacerbate the effects of lower levels of government payments. In summary, where would we expect to find the greatest adverse impact on farmland values? Based on our analysis of the downside potential of these factors, we mapped the results, and Map 1 clearly shows the more vulnerable areas. Of particular concern are areas where government payments are “institutionalized,” meaning that during the past 35 years, high farm subsidies have been the norm.18 As the map shows, the middle of the nation, where heavily subsidized crops are typically grown, depends significantly on government support, as do the Mississippi Delta and the South. If payments are reduced, these areas would experience the greatest impact, both to farmers’ incomes and farmland values.

Map 1

Impact of Reductions in Subsidies on Farmland Values Is Determined by These Factors

The map also shows the Great Plains, Corn Belt, and Mississippi Delta are being hurt by depopulation.19 These areas likely do not have vibrant economies that could help sustain farmland values should government payments be reduced. In addition, many areas in the northern Great Plains and Midwest do not have natural amenities to support recreational demand for farmland. And finally, many counties are in remote, rural areas that are not close enough to urban areas for farmland values to benefit from development. These areas also may lack the employment opportunities benefiting areas closer to metropolitan areas.

Map 2

Confluence of Factors Shows Areas of Greatest Impact

Although the absence of or weakness in any factor indicates some vulnerability to reductions in government payments, the confluence of shortcomings across all factors represents the areas of greatest concern (see Map 2).20 Our analysis highlights 666 counties characterized by a relatively high dependence on government payments, adverse demographic trends, poor natural amenities, and distance from metropolitan areas. As a result, we would expect farmland values in these counties to be hurt the most should government payments be significantly curtailed.

The most vulnerable counties are in the nation’s midsection—the Great Plains states of North Dakota, Montana, South Dakota, Nebraska, and Kansas; Corn Belt states of Iowa, Minnesota, and Missouri; and the Mississippi Delta, stretching up the Mississippi River from Louisiana to Illinois. The crops produced in these areas (wheat, cotton, corn, and soybeans) are the most heavily subsidized, and as a result, farmers’ reliance on government payments is the greatest. These areas also do not benefit from positive demographic trends, natural amenities, or proximity to metropolitan areas.

A significant number of the nation’s farm banks (979 of 1,730 nationwide as of year-end 2004) are headquartered in these areas. Almost two-thirds of these institutions are in five states: Nebraska, Iowa, Kansas, Minnesota, and North Dakota. These farm banks (holding $71 billion in total assets) have performed well in recent years because of historically high levels of net farm income and government subsidies. In addition, these banks have increased farmland lending during the past few years; loans secured by agricultural real estate constituted 19.4 percent of total loans at year-end 2004, up from 16.9 percent four years earlier. Although farmland tends to be a strong form of collateral, these collateral positions could weaken should lower levels of farm subsidies depress real estate values.

Conclusion
Reductions in federal farm subsidy programs are becoming more likely as international trade negotiations and budget shortfalls pressure Congress to modify existing farm programs. If cuts do occur, farmers’ cash flows and profits would be hurt. In addition, farm real estate values, particularly in the middle of the country, could decline substantially. As farmland tends to be farmers’ most significant asset as well as valuable loan collateral, farmers and their lenders must continue to monitor the potential for payments to be scaled back through budget cuts or the outcome of international trade agreements.

John M. Anderlik, CFA, Regional Manager
Stephen L. Kiser, Regional Economist
Jeffrey Walser, Regional Economist

The authors acknowledge Jeffrey A. Ayres, Senior Financial Analyst, for his work with the geographic information system analysis.




Footnotes:
1. Economic Research Service, U.S. Department of Agriculture (USDA). Figures for 2004 and 2005 are forecasts.
2. The WTO was created January 1, 1995, as the successor of the General Agreement on Tariffs and Trade (GATT). International trade negotiations have been ongoing since the GATT was formed in 1948. In response to protectionist strategies pursued by several countries in the 1930s, which many believed contributed to the severity of the Great Depression, 32 countries formed the GATT in the postwar period as a forum for multilateral negotiations, initially to reduce tariffs on manufacturing goods. The WTO has similar goals but is wider in scope, with a stronger institutional base.
3. Ingco, Merlinda, and John Nash. 2004. What’s at Stake? Developing-Country Interests in the Doha Development Round. In Agriculture and the WTO: Creating a Trading System for Development. Washington, DC: The World Bank, 7.
4. World Trade Organization. 2005. Understanding the WTO. Geneva, Switzerland: WTO, 13. http://www.wto.org/english/thewto_e/whatis_e/tif_e/understanding_e.pdf 1,630kb (PDF Help).
5. Sheingate, Adam. 2001. The Rise of the Agricultural Welfare State. Princeton, NJ: Princeton University Press, 183.
6. Ingco, Merlinda, and John Croome. 2004. Trade Agreements: Achievements and Issues Ahead. In Agriculture and the WTO: Creating a Trading System for Development, 36.
7. Johnson, D. Gale. 1991. World Agriculture in Disarray. New York: St. Martin’s Press, 9.
8. World Trade Organization. December 2004. WTO Agriculture Negotiations: The Issues and Where We Are Now. Geneva, Switzerland: WTO, 58. http://www.wto.org/english/tratop_e/agric_e/agnegs_bkgrnd_e.pdf 730kb (PDF Help).
9. Benson, Todd. WTO Rules Against U.S. Cotton Subsidies. New York Times, June 19, 2004.
10. USDA. 2005. 2006 Budget Summary. http://www.usda.gov/agency/obpa/Budget-Summary/2006/FY06budsum.htm.
11. Report of the Commission on the Application of Payment Limitations for Agriculture, USDA, August 2003.
12. Economic Research Service, USDA. 2003 is the most recent year for which state data are available.
13. Novack, Nancy. June 2005. Agricultural Credit Conditions: Booming Farmland Values. The Main Street Economist.
14. Moss, Charles B., and Andrew Schmitz. 2003. Government Policy and Farmland Markets: The Maintenance of Farmer Wealth. Ames, Iowa: Iowa State Press.
15. Barnard, Charles, et al. 1997. Evidence of Capitalization of Direct Government Payments into U.S. Cropland Values. American Journal of Agricultural Economics 79:1646.
16. A farm bank is defined by the Federal Deposit Insurance Corporation as having at least 25 percent of its loans to farm operations or secured by farmland.
17. Areas of rapid farmland appreciation are defined as the top quintile of counties based on farmland price appreciation from 1997 through 2002.
18. The analysis of dependence on farm subsidies is based on Bureau of Economic Analysis county-level data for 1969 through 2003 for government payments and net farm income (NFI). If a county’s ratio of government payments to NFI ranked in the top quartile in at least half the years covered in our study, or if the ratio never fell into the bottom quartile during that period, the county’s reliance on government payments was considered “institutionalized.”
19. For definitions of the geographic terms and a detailed discussion of rural depopulation across the nation, refer to Walser, Jeffrey, and John M. Anderlik. 2004. Rural Depopulation: What Does It Mean for the Future Economic Health of Rural Areas and the Community Banks That Support Them? FDIC Banking Review 16:57.
20. This analysis is based on geographic information system software that allows for the comparison among factors. Each factor is given equal weight.


Last Updated 10/10/2005 insurance-research@fdic.gov