Agricultural Economics and Biofuels

March 4-5, 2010
Jeffrey Perloff, Organizer

Barry Goodwin, North Carolina State University; Ashok K. Mishra, LSU; and Francois Ortalo-Magne, University of Wisconsin, Madison
The Buck Stops Where? The Distribution of Agricultural Subsidies

The U.S. has a long history of providing generous support for the agricultural sector. A recent omnibus package of farm legislation, the 2008 Farm Bill (P.L. 110-246), will provide in excess of $284 billion in financial support to U.S. agriculture over the 2008-12 period. Commodity program payments account for $43.3 billion of this total. Goodwin, Mishra, and Ortalo-Magne study the distribution of these benefits. Farm subsidies make agricultural production more profitable by increasing and stabilizing farm prices and incomes. If these benefits are expected to persist, then farm land values should capture the subsidy benefits. The authors use a large sample of individual farm land values to investigate the extent of this capitalization of benefits. Their results confirm that subsidies have a very significant impact on farm land values and thus suggest that landowners are the real benefactors of farm programs. As land is exchanged, new owners will pay prices that reflect these benefits, leaving the benefits of farm programs in the hands of former owners who may be exiting production. Approximately 45 percent of U.S. farmland is operated by someone other than the owner. The researchers report that owners benefit not only from capital gains but also from lease rates, which incorporate a significant portion of agricultural payments even if the farm legislation mandates that benefits must be allocated to producers. Finally, they examine rental agreements for farmers that rent land on both a cash and share basis. They find that farm programs meant to stabilize farm prices provide a valuable insurance benefit.

Bruce Babcock, Iowa State University
The Politics and Economics of the U.S. Crop Insurance Program

Babcock estimates the demand for crop insurance, isolating the demand for risk reduction from the demand for expected returns, by constructing a dataset from which the farmer's response to actuarially fair contract offers can be estimated. His results indicate that more than half of CRC-insured acreage that was able to be insured at higher coverage levels at actuarially fair incremental premiums was so insured. This suggests that a large number of producers find that the risk reductions offered by revenue insurance generate significant value. It is also possible that some public support for crop insurance could be justified if private provision were infeasible because of a lack of reinsurance markets. These results also indicate that the stated motivation of Congress to offer large premium subsidies to induce farmers to buy increased amounts of insurance are not needed if farmers were offered actuarially fair contracts. An examination of the vested interest of groups that comprise the crop insurance industry offers an alternative explanation for why farmers receive large subsidies to induce them to buy more insurance. Great Plains farmers receive, in aggregate, large positive expected returns from the program. Crop insurance agents are the residual claimants of rents that accure to private industry. These two groups have been instrumental in pressuring Congress to expand the program and protect it from reform.

Rachel Goodhue, UC, Davis; and Carlo Russo, University of Cassino
Modeling Processor Market Power and the Incidence of Agricultural Policy: An Exploratory Approach to the Behavioral Model Selection Process

Goodhue and Russo examine the interactions between market power and agricultural policy in the U.S. wheat flour milling industry. They have two main objectives: to assess if the payments trigger a change in the underlying economic behavior of the milling industry, and to estimate if the spread between the price of wheat and the price of wheat flour is affected by the policy regime, holding everything else constant. They find that wheat millers alter their pricing behavior when the program is making payments, and that they are able to extract a rent from government intervention. These results are consistent with a collusion-maintaining price war model of millers' strategic behavior. In addition, millers alter their behavior in response to differences in political constraints.

John Beghin, Iowa State University; Anne-Celia Disdier and Stephan Marette, INRA France
The Economics and Potential Protectionism of Food Safety Standards and Inspections. An Application to the U.S. Shrimp Market

Beghin, Disdier, and Marette investigate the effects of a food inspection system that influences the food safety of foreign and domestic products in the domestic market. Consumers purchase both domestic and imported food and they value food safety. Potential protectionism can arise: inspection frequency imposed on foreign producers set by a domestic social planner would be higher than the corresponding policy set by a global social planner treating all producers as domestic. The domestic social planner tends to impose most, if not all, of the inspection on foreign producers; this improves food safety for consumers and limits the production loss for domestic producers. Despite this protectionist component, inspections address a potential consumption externality, such as health hazards in the domestic country, when unsafe food can enter the country undetected. The authors calibrate their analytical framework to the U.S. shrimp market, incorporating key stylized facts from this market. Identifying protectionist inspection requires much information on inspection, safety, damages, and costs. The researchers also investigate how to finance the inspection policy from a social-planner perspective. Financing instruments differ between the domestic and international welfare-maximizing objectives.

Xiaoguang Chen, Haixiao Huang, Madhu Khanna and Hayri Onal, University of Illinois,Urbana-Champaign
Meeting the Mandate for Biofuels: Implications for Land Use, Greenhouse Gas Emissions and Social Welfare

Biofuels have been promoted to achieve energy security and as a solution to reducing greenhouse gas (GHG) emissions from the transportation sector. Chen, Huang, Khanna, and Onal present a framework to examine the extent to which biofuel mandates and subsidies reduce gasoline consumption and GHG emissions and their implications for the food and fuel prices. A dynamic, multi-market equilibrium model, Biofuel and Environmental Policy Analysis Model (BEPAM), is used to estimate the welfare costs of these policies relative to a carbon tax and to analyze the incentives provided by alternative policies for the mix of biofuels from corn and various cellulosic feedstocks that are economically viable over the 2007-22 period. The provision of biofuel subsidies that accompany the mandate under the Renewable Fuel Standard (RFS) is found to significantly change this mix in favor of cellulosic biofuels produced from high yielding grasses and reduce the adverse impact of RFS alone on food prices. These policies also reduce GHG emissions by 1 percent relative to a carbon tax of $30 per ton of CO2e but at a welfare cost of $213 B relative to the tax.

Thomas Hertel, Purdue University; and Jayson Beckman, Department of Agriculture
Commodity Price Volatility in the Biofuel Era: An Examination of the Linkage between Energy and Agricultural Markets

Agricultural and energy commodity prices have traditionally exhibited relatively low - even negative correlation. However, the recent increases in biofuel production have altered the agriculture-energy energy relationship in a fundamental way. The amount of corn used for ethanol production in the United States has increased from 5 percent in 2001 to over 33 percent by the end of the decade. This increase has drawn corn previously sold to other uses (exports, food, feed), as well as acreage devoted to other crops (for example, oilseeds and other grains). In addition, there has been an increase in the demand for production inputs, especially fertilizers, which are heavily energy-intensive. In short, the previous "biofuel decade" has led to significant changes in the U.S. and indeed the global economy. In the next five years, the U.S. Renewable Fuels Standard (RFS) envisions a further boost of ethanol production to 15 billion gallons per year. This might be expected to further strengthen the link between energy prices and agricultural commodity markets. However, unless oil prices rise sharply, it is likely that the RFS will be binding in 2015 - that is, the amount of ethanol consumed will be determined by government mandates rather than by the relative price of oil versus corn-based ethanol. Under such a scenario, with an even larger share of corn production going to ethanol, and with that source of demand potentially becoming unresponsive to price, there is potential for significant increases in commodity market volatility. Indeed, Hertel and Beckman estimate that, in the presence of a binding RFS, the inherent volatility in the U.S. coarse grains market will rise by about 25 percent. And the volatility of the U.S. coarse grains price to supply side shocks in that market will rise by nearly 50 percent. Under a high oil price scenario, rather than the RFS binding, the binding constraint is likely to be the "blend wall", that is the legal percentage content of ethanol in gasoline used by regular automobiles. (This is currently set at 10 percent.) With a binding blend wall, similar, although somewhat smaller, increases in market volatility are anticipated. If both the RFS and the blend wall are simultaneously binding, then U.S. coarse grains price volatility in response to corn supply shocks is 57 percent higher than in the non-binding case, and world price volatility is boosted by 25 percent. In short, the authors envision a future in which agricultural price volatility - particularly for biofuel feedstocks - will depend critically on renewable energy policies. Indeed, these may dominate the traditional importance of agricultural commodity policies in many markets.

Ethan Ligon, UC, Berkeley
Demand for and Effects of Specialty Crop Insurance

Ligon's estimates of the demand for crop insurance produce two findings of interest. First, while higher value crops are more likely to have insurance products designed for them, demand for these insurance products is lower than for other crops, suggesting that reliance on a "high rank value" rule for developing crop insurance products may result in a misallocation of RMA resources. Second, larger subsidies are effective in increasing total liability per acre, but not in increasing total acres covered. The estimates regarding the e ffects of crop insurance on the supply of and demand for insured crops indicate a rather large effect on supply, although Ligon can't say whether this effect is principally due to more efficient production or substitution away from other crops. He finds that the effect of crop insurance on prices for insured crops is very close to zero. This last finding is consistent with the view that demand for such highly disaggregated commodities is likely to be highly elastic. A consequence is that crop insurance for these specialty crops has no significant benefit for consumers.

Michael J. Roberts, North Carolina State University; and Wolfram Schlenker, Columbia University and NBER
The U.S. Biofuel Mandate and World Food Prices: An Econometric Analysis of the Demand and Supply of Calories

Roberts and Schlenker show how yield shocks (deviations from a time trend), which are likely attributable to random weather fluctuations, can facilitate estimation of both demand and supply elasticities of agricultural commodities. They identify demand using current-period shocks that give rise to exogenous shifts in supply. They identify supply using past yield shocks, which affect expected price through inventory accretion or depletion. They use their estimated elasticities to evaluate the impact of ethanol subsidies and mandates on food commodity prices, quantities, and food consumers' surplus. The current U.S. ethanol mandate requires that about 5 percent of world caloric production from corn, wheat, rice, and soybeans be used for ethanol generation (assuming no recycling of the corn used in biofuels as feed stock). As a result, world food prices are predicted to increase by roughly 30 percent and global consumer surplus from food consumption is predicted to decrease by 155 billion dollars annually. If a third of the biofuel calories are recycled as feed stock for livestock, the predicted price increase scales back to 20 percent. The agricultural growing area is expected to increase, potentially offsetting the CO2 benefits from biofuels through increased land use change.

Jeffrey LaFrance, UC, Berkeley; Rulon Pope, Brigham Young University; and Jesse B. Tack,UC, Berkeley
Risk Response in Agriculture

Crop production is subject to supply shocks, and both expected and realized outputs, as well as output prices, are unknown when inputs are chosen. The process by which producers form expectations is difficult to model, especially when working with aggregate data. LaFrance, Pope, and Tack present a necessary and sufficient condition on cost and technology to allow variable input demand equations to be specified as functions of input prices, quasi-fixed inputs, and total variable cost. These are all observable when inputs are committed to production, so that ex ante demands can be estimated with observable data. The authors derive a flexible and economically regular model of variable input demands and apply it to aggregate U.S. agricultural data for the period 1960-99. They use the empirical results of this model to aid in the specification of a dynamic life-cycle model for agricultural producers facing output and output price risk, with investment in an off-farm, conditionally risk-free asset, risky financial assets, savings, consumption, and agricultural production opportunities. This framework admits a coherent, structural, econometric model of input use, output production, savings, investment, and consumption for agriculture. They then apply this model to U.S. data for the period 1960-99. Ongoing work focuses on updating the data set to the 21st century and applying both components of the model at the state-level.

Steven E. Sexton and David Zilberman,UC, Berkeley
The Economics of Agricultural Biotechnology Adoption: Implications for Biofuel Sustainability

Sexton and Zilberman provide new econometric analysis of GM crop impacts on farm yields, drawing on recent data and spatial and temporal variation in adoption to overcome both the limitations of earlier studies. They find that, on a global scale, agricultural biotechnology has boosted farm yields for the four crops in which it has been introduced. Furthermore, the yield gains are greatest in developing countries, which are generally characterized by high pest pressure and limited access to insecticides. While the magnitude of yield gains is significant, these findings are consistent with earlier work that has shown the GM yield advantage to reach 80 percent in a single season and average 60 percent over a four-year horizon.

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