FDIC OutlookWhat 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
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
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
The World Trade Organization and U.S. Agricultural
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
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
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.
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
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
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,
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.
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.
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
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.
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.