Farm Income Stability
What old-style CAP defenders claim
Prices for agricultural products are notoriously unstable and yields fluctuate. This justifies state intervention that stabilizes agricultural prices and incomes.
Farmers themselves have a variety of tools at their disposal in order to cope with risks.
- Farmers can diversify their income by producing different crops and livestock and by engaging in off-farm work or non-agricultural on-farm activities, such as tourism.
- They can share risks along the agricultural market chain through contractual long-term arrangements, for instance with supermarkets.
- They can rely on risk-pooling in producer cooperatives, on insurance and hedging on options/futures markets, and on capital and debt management.
Governmental intervention weakens farmers’ incentive to lower their income variability: the more the state takes care of them, the less they will take care of themselves. It is a typical case of ‘moral hazard’.
Many of the benefits of price stabilization do not go to poor farmers who suffer hardship in the wake of low prices. Large commercial farms also profit though they can be expected to use risk management instruments efficiently – or suffer the consequences like any other enterprise in a market economy. Similarly, households with significant off-farm earnings that are not dependent on their farm income gain from price stabilization. Finally, rich farmers and land owners take advantage. Since they are already well-off, there is no reason for the public to worry about the smoothness of their income stream.
Harm to poor consumers
A combination of tariffs, quotas, export subsidies and other market interventions is necessary to stabilize prices. More stable prices thus come at the cost of higher prices. This is particularly damaging to low-income households that spend a relatively high proportion of their income on food. For the quintile (20%) of EU households with the lowest income, food, beverages and tobacco constitute 25% of their expenditures, whereas this share is at only 15% for the quintile with the highest incomes. Therefore, poor consumers foot a disproportional share of the bill.
Destabilized world food markets
EU price stabilization undermines world markets. World market prices tend to be less volatile than domestic prices because the many national supply and demand shocks are only partly correlated: a drought in Australia can be off-set by a good harvest in Europe, and vice versa. The world market can thus act as a buffer. But many price stabilization policies undermine this function. If world prices fall, EU prices tend to fall as well, so that EU price stabilization policies, such as higher tariffs or export subsidies, kick in. This increases EU supply and decreases EU demand on the world market, further depressing world prices. Thus, many measures that stabilize EU prices destabilize the world market.
The instruments used to stabilize prices – such as tariffs, production quotas, export subsidies and subsidies to use food as animal fodder – have further undesirable side-effects. Quotas distort production especially strongly, export subsidies threaten foreign producers and weaken the global trading system, and animal feeding programs waste valuable food.
Stabilizing prices comes at a high cost. It weakens farmers’ own risk management, increases consumer prices, destabilizes the world market and involves the use of highly undesirable instruments. By contrast, the benefit for poor farm households who strongly depend on their agricultural income is small because many other farmers also profit.
More effective policies are available to help farmers cope with agricultural price risks. For instance, farmers in several member states can pay taxes on their multi-annual income average. They are thus less affected by the combination of volatile incomes and progressive income taxation. Another option is to allow farmers to put money into a special savings account and to pay taxes on this money only at the time they withdraw it and not when they earn it. Farmers can thus withdraw savings in years when they earn little and, accordingly, pay low income tax rates.
Governments may also consider instruments targeted at poor farm households strongly dependent on their agricultural income. Governments could assist such farmers in employing risk management tools and, if politically unavoidable, they could even insure their incomes. However, such special assistance should be narrowly circumscribed. Price fluctuation is a natural phenomenon of free markets and only such producers that can cope with these fluctuations should remain in business in the long run. This is an economically efficient solution that does not endanger food security.
By the way, long-term contracts for the delivery of public goods from agriculture are a reliable source of income for farmers. These contracts can cover ten years or more, and the payment does not depend on fluctuating prices or yields. Green subsidies thus have a positive social side effect.