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Morgan Rose

Paying for Farm Subsidies

Morgan Rose*

Farm subsidies were a hot topic of discussion toward the end of 2001. In November, the Environmental Working Group unveiled an online database that ranks the nation's farmers by name according to the amount of federal subsidies they each received over the past five years. This coincided with debates in the United States Senate on an overhaul of federal agricultural subsidies, debates that will resume once Congress returns to session later this month.1 In December, my local newspaper ran an article that showed the amounts of federal subsidies received by farmers in the St. Louis area.2 What was noteworthy in that article was the argument that farmers and local agricultural economists gave in defense of maintenance of the farm subsidy program. We'll get into that argument in a little while, after a discussion of subsidies more generally.
The Source of Subsidies

Subsidies are payments from a government for which it receives no goods or services in return. They are usually provided under the auspices of support for a specific group of people or industry that is seen to be in need of assistance. A subsidy usually consists of a fixed payment to a firm for every unit it sells. While in the past, American farm subsidies have coincided with price supports (federal guarantees of minimum prices for farmers' crops) and supply controls (payments for acreage that farmers kept out of productive use), since 1996 farm subsidies mainly have taken the form of fixed payments. Whatever the details of the program, though, the perception has been that crop prices are too low for many farmers to cover their costs, and without a helping hand from the government, thousands of farms would slip into bankruptcy. To prevent that, the government sends a bit of money from the public coffers to the struggling farmers. Seems like a generous thing for the government to do, doesn't it?

The problem, of course, is that it is easy to be generous with someone else's money, and all that any government has is someone else's money. As Ludwig von Mises, in paragraph 13 of the Epilogue to Socialism (1981, first pub. 1922), wrote:

The means for the subsidies have to be raised somewhere. They may be raised by collecting taxes. But the burden of such taxes has its effects on the public, not on the government collecting the tax. It is the market, and not the revenue department, which decides upon whom the burden of the tax falls and how it affects production and consumption. The market and its inescapable law are supreme.

The "burden of the tax" falls most obviously on the people who pay the taxes. Those who put the money into the public coffers might not enjoy being required to put in even more to provide for whatever group or industry the state chooses. While some people might welcome the opportunity to contribute voluntarily a portion of their well-being for that of others, for most people a government subsidy program entails compulsion rather than contribution. Frederic Bastiat put it this way in Chapter 2, paragraph L.101 of The Law (1850):

Nothing can enter the public treasury for the benefit of one citizen or one class unless other citizens and other classes have been forced to send it in.... The law can be an instrument of equalization only as it takes from some persons and gives to other persons. When the law does this, it is an instrument of plunder.

The Direct Effects—Wasted Resources

This critique against subsidies, that they can only occur using income extracted from a nation's taxpayers, can be used against any government spending program. To examine some of the particular effects of subsidies—that is, to bring to light some of the more subtle burdens associated with them—consider a simple community in which there is one farmer, Farmer Douglas, one consumer, Arnold, and no subsidies. Whatever costs Farmer Douglas incurs in order to raise his corn, he needs to earn back in the market price upon which he and Arnold agree.

Let's say that, with no subsidies or any other market interference, Arnold agrees to buy five bushels of corn from Farmer Douglas for ten dollars each. Arnold is not willing to buy a sixth bushel unless he can get corn at a cheaper price, say nine dollars. As for Farmer Douglas, the additional land, seed, fertilizer, and labor associated with raising a sixth bushel would cost him more than ten dollars, say eleven dollars. A sixth bushel of corn is worth less than ten dollars to Arnold, and it is worth more than ten dollars to Farmer Douglas, so a sixth bushel will not be raised or sold.

Now let's introduce a subsidy. Suppose that the government will give Farmer Douglas two dollars for every bushel of corn that he sells. Under this policy, Farmer Douglas and Arnold can reach an agreement on a sixth bushel. Farmer Douglas can charge Arnold nine dollars per bushel, making Arnold willing to buy the sixth one. With the nine dollars from Arnold plus the two dollars from the government, Farmer Douglas can cover the costs of raising a sixth bushel. (Note that there is no reason to believe that, in the case of a real world subsidy, the producer and consumer would each receive an equal share of the subsidy as described here. I picked these numbers for the sake of simplicity.)

From this example, we can see that the subsidy introduced a waste of resources into the community's economy. Without the subsidy, the last bushel sold, the fifth one, cost Farmer Douglas ten dollars to raise, and Arnold derived ten dollars of benefit or enjoyment out of it. With the subsidy, the additional bushel cost eleven dollars to raise, while it produced only nine dollars worth of enjoyment. The cost outweighs the benefit, so society as a whole is worse off as a result of the sale of the sixth bushel.

Note that neither Farmer Douglas nor Arnold is privately worse off. They each made a rational decision based on his own best interest in the light of the subsidy, and each acted voluntarily. It is only when we compare the benefit derived from the sixth bushel to the costs that went into producing it do we see that the transaction that was mutually privately beneficial was wasteful from society's point of view, and that it was the use of taxpayer resources that allowed this wasteful transaction to occur.

The Indirect Effects—Wasted Opportunity

Having looked at some of the effects of subsidies on the behavior of producers and consumers, I now want to take up the argument I mentioned from the newspaper article about farm subsidies around St. Louis. It concerns the indirect winners and losers created by a farm subsidy program. That taxpayers lose out when the government subsidizes specific groups or industries is easy to see. But there are others who also suffer when subsidies are used, and those losses are no less important just because they are harder to see. Like the Mises and Bastiat quotes above, the following discussion could apply to any government spending program funded by taxpayers' resources, but the argument is brought up frequently in the context of farm subsidies, so it is worth addressing here.

Asked about the implications of eliminating farm subsidies, Rich Pottorf, chief economist with Doane Agricultural Services in St. Louis, said that "There's no doubt a removal of subsidies would cause a horrible upheaval in agriculture, that land prices would drop and rural areas would be in horrible pain."

Alan Libbra, a farmer from Madison County, Illinois, took the point further. "When people my size get pushed, the businesses they use get pushed out with them.... That just kills these little communities, kills the employment and kills the tax base."

Their point is that farm subsidies help more people than just the farmers who receive them. They also help those whose incomes and opportunities are tied to business done with those farmers. What is so interesting about this, and what is not acknowledged or apparent in the article, is that this same argument can be turned around to describe the people who are hurt by the subsidies.

When people have money taxed from them so the government can pay for farm subsidies, that money can no longer be spent on other things, things that taxpayers may value more than transfer payments to farmers. When that spending fails to occur, the firms that would have provided those other things are worse off than they would be if the subsidies did not happen. The extra business done by companies trading with farmers must be set against the business taken away from companies trading with everyone else.

Bastiat made just this point in his opposition to subsidies to support the theater and the arts in France. From paragraph 79 of "What Is Seen and What Is Not Seen," the first chapter in Selected Essays on Political Economy (1850):

In taking sixty thousand francs from the taxpayers, you reduce the wages of plowmen, ditchdiggers, carpenters, and blacksmiths, and you increase by the same amount the wages of singers, hairdressers, decorators, and costumers. Nothing proves that this latter class is more important than the other.... If [those supporting the subsidy] have seen on the one hand the wages earned by those who supply the needs of the actors, they should see on the other the earnings lost by those who supply the needs of the taxpayers; if they do not, they are open to ridicule for mistaking a reallocation for a gain.

To illustrate the point, let's make Farmer Douglas part of a larger community. Suppose that in order to give Farmer Douglas $100,000 in farm subsidies every year, the government taxes one thousand other people in town $100 each. Farmer Douglas spends his $100,000 per year on farm machinery and maintenance. As a result of the subsidy, then, the local John Deere outlet is substantially better off. With the extra business, maybe the manager there can afford to give his workers raises, or even hire more people. Sounds pretty good.

 

Adam Smith devoted Chapter 5 of Book IV of An Inquiry into the Nature and Causes of the Wealth of Nations (1904, first pub. 1776) to subsidies, called "bounties" in his time. Although he discussed bounties in the context of foreign trade, the main issues are the same. Paragraph 3 raises the point that subsidies that support otherwise nonviable industries divert resources away from more productive industries.

But let's say that if the other thousand people each had their $100 back, they would all buy an extra pizza each month. As a result of the subsidy, the pizza places in town sell one thousand fewer pizzas every month, twelve thousand every year. As a result, the managers of those businesses cannot hand out raises or hire more workers. Instead, they have to lay off some of their employees. Because the subsidy is in place, we never see the raises the pizza makers would have gotten or the extra jobs that would have been produced without the subsidy, but that they are still real costs that must be taken into account. Once all of its effects are considered, the subsidy does not sound quite as good.

Of course, it's not likely that every one of the thousand townspeople would spend their $100 on pizza. Some may buy more pizzas, but others might want some new clothes, others would spend an extra night in a hotel on their next vacation, still others would save it, maybe putting them one tiny step closer to the down payment on their first house. Different people would spend their money on different things, depending on their personal wants and needs. Forcing them to give up their money to pay for farm subsidies would divert resources away from activities that would yield them more benefits. As a result, society would have fewer jobs, lower wages, and less output in the industries society as a whole prefers.

Conclusion

The economic argument in favor of any given subsidies, then, rests on whether the total benefits, direct and indirect, of the subsidies outweigh the total costs. Ultimately, which way the scales will tilt depends on the preferences of the society under consideration. If people value the presence of small farmers like Farmer Douglas as something good in its own right, farm subsidies are more likely to be worthwhile. If they think that more people should have the chance to work in pizza places, then farm subsidies make less sense. Each society must choose for itself which industries, if any, are worth assisting using resources that its taxpayers individually might rather use in other ways.


Footnotes
1.

John Lancaster, "Democrats Pigeonhole Farm Bill Till 2002," WashingtonPost.com, 20 December 2001.

2.

Jim Getz, "Money Is the Issue in Farm Bill Debate," Post-Dispatch.com, 5 December 2001.


*Morgan Rose is a Ph.D. candidate in economics at Washington University in St. Louis, with research interests in industrial organization, corporate governance and economic history.

For more articles by Morgan Rose see the Archive.
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