As we learned in Economics class, when supply gets burdensome, prices fall to disincentivize production. Lower production then increases prices, bringing the market back to equilibrium. The U.S. and South America have held burdensome corn and soybeans supplies during the last five years, leading to lower prices. If we go by theory, this year we should see rationing in the form of a steep decrease in global acreage…right?

Corn & soybean ending stocks in the U.S. & Brazil

Source: USDA, DTN

Well, not exactly. As it turns out crops such as corn and soybeans are not completely governed by the law of supply and demand. Farm subsidies play a big role, and in the case of these row crops, they result in production increasing year over year regardless of price or supply. Farm subsidies are an intricate part of most governmental policies around the world, making these markets much more complicated. During the last five years, prices for both corn and soybeans have been low. However, combined U.S. and Brazilian production has increased 8 percent in the case of corn and almost 6 percent for soybeans. Looking at how prices have fallen during this time, it seems logical that acreage reduction will occur soon—but that may not be the case, regardless of price.

Corn & Soybean Production in the U.S. & Brazil

Source: USDA, DTN

U.S. subsidies have evolved from simply paying farmers not to plant during times of oversupply to the more sophisticated crop insurance program. Crop insurance not only covers natural disasters but also secures a minimum price, and since the U.S. government covers crop insurance premiums, farmers are incentivized to plant. Crop revenue insurance pays farmers through a calculation of crop yield times crop price at harvest, so a farmer has no reason to plant less given the guarantee of income. As an example, in case of drought, futures prices will likely rise at harvest relative to normal production years. As a result, farmers will not only receive payments for lost crops, but those payments will be at higher prices as the payout is linked to the futures market.

An interesting thing about the crop insurance program is its structure. The U.S. government currently spends $2 billion a year paying premiums. This money goes to private insurance companies, but in case of disaster, the government absorbs losses that exceed total premiums. The government also covers the companies’ administrative and operating expenses. This raises the question of why the government is paying private insurance companies that amount of money when they do not seem to be incurring a great deal of risk. Why doesn’t the government self-insure? In the end, that is exactly what is occurring as the government pays for the premium and excess losses.

Farm subsidies also heavily favor certain crops. Approximately 90 percent of the budget goes to corn, soybeans, wheat, cotton, and rice. The low cost of these crops has resulted in what may be seen as excessive reliance on them in certain industries. For example, corn, as a low-cost carbohydrate, is used in three-quarters of all products sold in U.S. grocery stores. Though its extensive presence in our food supply might seem to be an incentive to keep prices low, the impact of high corn prices on the consumer is relatively minor, as a 50 percent increase in corn prices usually results in a 1 percent increase at the checkout counter.

There is a great deal of debate around farm subsidies, and while they secure jobs, there might be room for improvement, especially when it comes to efficiency. There is also debate about increasing subsidies for a broader range of crops, including organic.

This year, analysts estimate U.S. farmers will plant 90 million acres of corn and at least that many acres of soybeans. Planting is about to get started, and there are several uncertain factors for this season, such as if the weather will be favorable and where prices will go. As far as plantings, however, the structure of agricultural subsidies may be more relevant to acreage these other factors.

Posted by: Information Services
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