Tag Archives: Greg Mankiw

Why do almost all economists oppose U.S. farm policy?

There are many policies about which economists disagree. To read the news you might think that economists disagree about everything. In reality, there are plenty of areas in which the economics profession has reached a consensus. One is farm policy. Economists from Greg Mankiw to Paul Krugman oppose the “insane” (Mankiw’s word) and “grotesque” (Krugman’s) handouts to farmers that constitute U.S. farm policy. More broadly, Robert Whaples has found that more than 85 percent of surveyed economists oppose agricultural subsidies. (I’m willing to bet that many of the remaining 15 percent also oppose agriculture subsidies but are uncomfortable ending them cold-turkey).

Why is there so much agreement on this issue? Here are a few thoughts.

Subsidies and Price Supports Create Dead Weight Losses

U.S. farm policy is a grab bag of over 80 separate programs with confusing names like the “shallow loss program” and the “dairy indemnity program.” But for all the arcane language, the programs match pretty neatly to the simple microeconomic models that we teach undergraduate economics majors. They are price supports, they are subsidies, or they are barriers to trade. And whatever they are, they are inefficient.

Consider the Dairy Product Price Support Program. According to the CRS, it “specifies minimum purchase prices of: block cheese, $1.13/lb.; barrel cheese, $1.10/lb.; butter, $1.05/lb.; and nonfat dry milk, $0.80/lb.”

With the mandated price set above the market price, consumers gain less from exchange than they otherwise would and producers gain more than they otherwise would. Importantly, though, the simple economic model of a price floor (see below) tells us that consumers lose more than producers gain. Economists call this “dead-weight loss.”

Minimum PriceOr consider the Direct Payments program. According to the CRS, it pays growers of “wheat, corn, grain sorghum, barley, oats, upland cotton, rice, soybeans, and other oilseeds” a fixed subsidy that does not vary according to the market price. This effectively lowers the marginal cost of production, lowering the price and increasing the quantity sold. In this case, producers and consumers gain, but taxpayers lose. Moreover, the simple producer subsidy model tells us that taxpayers lose more than consumers and producers gain. Thus, this program too creates a dead-weight loss.

SubsidyNo Coherent Story of Market Failure or Imperfection

These interventions might be rationalized by some sort of story about market imperfection (externality, monopoly, asymmetric information, etc.). But as a commodity industry with so many producers and so many consumers, agriculture is much closer to the textbook ideal of a perfectly competitive industry than one plagued by market failure.

Safety Nets for People Not for Firms

“Well yes,” a champion of farm policy might reply, “but poor American farmers deserve a safety net.” Lots of economists (even Milton Friedman and F.A. Hayek) have conceded that publicly-funded social safety nets might be worthwhile. But these nets should catch people when they fall, not the firms that these people work for. The farm safety net makes even less sense when you dig into the numbers. As Vincent Smith has shown in his recent Mercatus paper, average household farm income is substantial greater than overall average income. Moreover, about 80 percent of direct payments go to the largest 15-20 percent of farms and a majority goes to the top 10 percent “whose owners, for the most part full-time farm operators, typically earn many times the national average household income.”

As Smith points out, many in the farm lobby claim that farmers need the safety net because they are in a particularly risky line of business. But, he says, this claim doesn’t stand up to scrutiny:

Farms fail at an annual rate of 0.5 percent: only one in every 200 farms goes out of business because of financial problems.24 By comparison, the annual business-failure rate is over 7 percent, 14 times greater. Among small nonfarm businesses, the companies most comparable to farms in terms of sales, the failure rate is about 14 percent, almost 30 times greater than among farms.

The farm safety net makes even less sense when you think about justice on a global scale. Daniel Sumner explains it well in his Agricultural Subsidy Program entry in the Concise Encyclopedia of Economics:

Some of the poorest countries in West Africa have traditionally been cotton exporters. In 2001 and 2002, they faced a world price of cotton ranging from thirty-five cents to forty-five cents per pound. Meanwhile, cotton growers in the United States, the world’s largest exporter, received seventy cents or more per pound from the subsidies plus the market price. Economists have estimated that U.S. exports of cotton would have been substantially lower, and the world price of cotton 10 to 15 percent higher, if U.S. cotton subsidies had been unavailable during this period. Reducing farm subsidies in the United States and other rich countries would help poor cotton growers and other farmers in poor countries, and, moreover, would begin a process of relying more on trade rather than aid for economic growth.

Given the near-consensus among economists, why does the U.S. continue this grotesque and insane experiment? I’ll explore this question in subsequent posts.

Yandle Redux

Yesterday I contra-posed Greg Mankiw’s view of stimulus spending against economic realities explained by Bruce Yandle. Last night I noticed this new video, from Reason.tv, in which Dr. Yandle explains in his own words the bootleggers and baptists theory, and talks about it in the context of other regulatory schemes.

The video shows both the depth and breadth of Dr. Yandle’s knowledge and insights, but also captures his gentle humility. It’s a privilege to work with him.

Like Taking Cyanide For A Headache

Greg Mankiw has a long article in National Affairs on the proper way to align incentives and stimulus spending:

Economists will no doubt long debate whether Cash for Clunkers passed a cost-benefit test. (Some early results, from Burton Abrams and George Parsons of the University of Delaware, suggest not.) But the fact that people responded to the incentive as they did — nearly 680,000 cars were purchased — suggests that a broader, more comprehensive program of incentives, such as an investment tax credit, might have stimulated spending even more.

Of course, not all tax cuts or credits are created equal, just as not all direct government spending is. One popular idea in recent years, for instance, has been a tax cut for businesses that make new hires. Indeed, the jobs bill signed by President Obama in March put in place a targeted payroll-tax exemption for some small businesses that hire people who have been unemployed for two months or more; several members of Congress have proposed broader tax cuts for businesses that hire new employees. The premise behind these policies is that, because unemployment is so high even as the economy begins to recover, we should create incentives for businesses to place unemployed workers into jobs.

There is a case to be made for a broad-based payroll-tax cut that might have this effect, but a narrower tax cut for new hires suffers from some major flaws. The basic problem is that we do not know how to properly define — or enforce a definition of — a “new hire.” Presumably we do not want a business to hire Peter by firing Paul and to then call Peter a new hire; this would cause a great deal of inefficient churning in the labor force (not to mention a great deal of unpleasantness for all the Pauls).

In this video from Mercatus’ Capitol Hill Campus, Dr. Bruce Yandle, Dean Emeritus at Clemson University’s College of Business and Behavioral Sciences, points out the faulty premise that stimulus spending increases demand. Instead, he shows that cash for clunkers and the recently expired first-time home-buyer credit simply shifted demand in time.

In short, for an incentive to actually stimulate an increase in demand, it would have to cost significantly more than the benefit created by increased economic activity. Mankiw himself explains that uncertainty is a recurring problem in economic planning:

The negative effects are even more challenging to trace. For example, if people observe the government issuing substantial debt (required to finance a stimulus), they may anticipate higher future taxes and therefore cut back on their current consumption. Increased government borrowing may also drive up long-term interest rates, which could make it difficult for people to borrow money and could therefore reduce spending today. Obviously, recovery.gov has no way to take account of these consequences, either.

Dr. Yandle presents the counter-point that economic uncertainty is not just an unfortunate side-effect of directed planning and incentives. Uncertainty is a prime driver of economic stagnation, both fiscally and psychologically. When economic rules and incentives change rapidly, private investors and business owners have to question their entire rational decision-making process.

Suddenly, planning a business is like building a house on quicksand. The point of stimulus spending is to offset a drop in aggregate demand, and hope that economic growth offsets the cost of the spending.

However, aggregate demand drops, as it did in 2008, because asset values become skewed. Aggregate demand needs time to reset, while consumers and producers determine the appropriate level of supply and demand under new conditions. The market seeks to correct uncertainty. By introducing new rules and incentives, stimulus spending time-shifts this realignment, but doesn’t supplement it. It adds more uncertainty to an already infuriatingly complex puzzle. That’s why such massive spending hasn’t had any noticeable effect on unemployment; it’s probable that Washington, with the best of intentions, has made hiring people more difficult for a longer period of time. It’s the same reason cash-for-clunkers was such a dismal failure, and the home-buyer credit shows the same symptoms.

Far from being a momentary side-effect of stimulus spending, uncertainty is a systemic problem with interventionist economic policy. The poison is worse than the medicine.

A brewing awareness

People don’t generally think about the governmental framework in which they live. It’s assumed like oxygen.  But change that framework drastically enough, and things learned and forgotten from history textbooks develop a live pulse.

Federalism, as a point of common discussion, is relegated to Constitutional Law, economics and political science journals. It’s the stuff policy people and academics pour over.  But not lately, as Randal Barnett writes at the Wall Street Journal, tea parties and sovereignty amendments speak to a growing awareness of profound structural change in the relationship between the federal government and the states.  The ceding of local and state control to the federal level is not a new story. The debate over this changing relationship dates to the 19th century, but given the size and kinds of spending in the last several years, rounded out by the stimulus and budget of recent weeks, and a threshold is perceived.

For three different policy takes: an interesting solution offered by Greg Mankiw back in October, would have given the governors more discretion in accepting funds – they could elect to pass it on to citizens, rather than expand programs. The Brookings Institute suggests following Germany, a federalist system, in applying transportation funds. Chris Edwards of CATO has done work on how federal aid erodes state budget autonomy.