Political Economy of Crop Insurance

by Levi Russell

Last week my (co-authored) article on the political economy of crop insurance in the next farm bill (coauthored with Art Barnaby of Kansas State University) was published in Choices Magazine. I thought I'd reproduce the theme overview here and link to all 4 articles for those who are interested.

The Farm Bill, passed every four or five years, is a large piece of legislation which includes agricultural, food, conservation, and rural development programs. The most recent bill, passed in 2014, made significant cuts to commodity programs and increased budgeted spending on crop insurance. This change shifts the focus of farm risk management toward crop insurance, making it an even more important part of a producer’s toolkit. Looking ahead to the next farm bill in 2018/2019, this focus on crop insurance will likely continue.

The articles in this issue anticipate three discussions surrounding crop insurance’s role in the next farm bill: the political economy of crop insurance by Barnaby and Russell, economic evaluation of crop insurance’s role in the safety net by Zacharias and Paggi, and crop insurance’s role in specialty crop agriculture by Paggi.

Barnaby and Russell examine three crop insurance alternatives which are likely to be proposed in the debate over the next farm bill:

 1. Replacing crop insurance with a free, area-based disaster program,
 2. Making modifications to existing policy which would significantly reduce support to  farmers and jeopardize the private delivery system, and
 3. Complete elimination of the safety net.

The article summarizes the political factors and their interaction with the economic effects of these proposals.

Zacharias and Paggi identify the key considerations for improving crop insurance’s role in the farm safety net. Among these are regional and commodity-specific considerations, government budget constraints, and interactions between crop insurance and other titles in the farm bill. They emphasize the importance of developing appropriate metrics for evaluating the simultaneous performance of crop insurance and commodity programs and conclude with a research agenda for examining these issues.

Paggi discusses the broader role of crop insurance as a risk management tool for specialty crop producers. Specialty crops are of interest due to the increase in specialty crops’ share of the total crop insurance liability over the last 15 years. Paggi details the connection between crop insurance and specialty crops and provides a discussion of factors affecting the future of this connection.

Finally, Woodard addresses the elasticity of demand for crop insurance issues.  This key value will determine the maximum achievable size of any cuts in USDA’s share of the crop insurance premium and still maintain a politically acceptable level of farmer participation in crop insurance needed to prevent any future ad hoc disaster program.  It is critical for policy makers to understand the impact of elasticity of demand to prevent unintended consequences by making Federal budget cuts to crop insurance.  All budget cuts are not equal so how those cuts, if any, are made is extremely important.

Given the important role of crop insurance in the future of the farm safety net, political and economic factors affecting policy decisions are particularly of interest. This issue provides a first look at the conversations policy makers, industry representatives, and academic economists will have leading up to the next farm bill.

Anti-Trust vs Regulation: The Case of Baysanto

by Levi Russell

Bayer's impending purchase of Monsanto is all over the news lately. As is typical in these situations, the conversation centers around concerns of increasing market power and monopoly profits. Regular readers might expect me to focus on the notion that industry concentration doesn't necessarily imply welfare losses, but I'm not.

It seems to me that the relationship between anti-trust legislation and regulation is an under-discussed issue in these cases. Agribusiness firms are heavily regulated by three of the most powerful regulators in the US: the FDA, the USDA, and the EPA. Many regulations function as fixed costs, implying that there are economies of scale in regulatory compliance. Thus, the greater the regulatory burden placed on firms in an industry, the greater the inducement to merge.

These regulatory economies of scale militate directly against the goals of anti-trust policy. The latter, perhaps as an unintended consequence, gives us fewer and larger firms while the latter attempts to reign in these cost-saving mergers in the name of competition. If we're going to seriously discuss regulation and anti-trust, we need to be cognizant of the interplay between them.

Of course, there are plenty of problems with the regulatory revolving door and other public choice issues to deal with as well. On this front, it seems fairly obvious that the incentive to rent-seek is positively correlated with the prize being offered. Perhaps this is an argument for less power vested in the administrative state and more power returned to the courts.

Coase and Hog Cycles

by David Williamson

If you read this blog, then you're probably familiar with Ronald Coase's work on the importance of transaction costs. But did you know that Coase devoted a substantial portion of his early career to criticizing the Cobweb Model? He actually wrote 4 separate articles on the subject between 1935 and 1940, but not one makes Dylan Matthew's list of Coase's top-five papers. This work is actually really fascinating in the context of economic intellectual history, so here is a quick summary!  

The 1932 UK Reorganization Commission for Pigs and Pig Products Report

It all started when the UK Reorganization Commission for Pigs and Pig Products claimed in a 1932 report that government intervention was needed to stabilize prices in the hog industry. The Commission found that hog prices followed a 4-year cycle: two years rising and two years falling. The Commission explained this cyclical behavior using the Cobweb Model. In this model, products take time to produce. So, to know how much to produce, firms have to guess what the price will be when their product is ready to bring to the market. If producers are systematically mistaken about what prices will be, this could lead to predictable cycles in product spot prices.

The Cobweb Model

How forecasting errors can lead to cycles in product prices is illustrated in the figure below. Suppose we begin time at period 1 and hog producers bring Q1 to the market to sell. Supply is essentially fixed this period because producers can't produce more hogs on the spot, so the price that prevails on the market will be P1. Since this price exceeds the marginal cost of production (represented by S), the individual producers wish they had produced more. Now, when the producers go back home to produce more hogs, they have to guess that the price will be when their hogs are ready to sell. Suppose it will take 2 years to produce more hogs. The UK Reorganization Commission argued that hog producers will assume the price of hogs next period will be the same as it was this period (in other words that producers had "static" expectations about price). That means, in this context, hog producers think the price of hogs in 2 years will still be P1. So each producer will individually increase production accordingly. However, when the producers return to the market in 2 years, they will find that everyone else increased production too and that quantity supplied is now Q2. As a result, the price plummets to P2 and the producers actually lose money. Not learning their lesson, the hog producers will again go home and assume that the price next period will be P2 and collectively cut back their production to Q3. Hopefully you see where this is going, even if the hog producers don't. The price will go up again in 2 years and then down again in 2 more. Thus, we have a 4-year cycle in hog prices. How long will this cycle continue? That depends on the elasticities of supply and demand. If demand is less elastic than supply, as was believed to be the case in the hog market, then the price swings will continue forever and only get bigger as time goes on.

Source: Wikipedia

Coase Takes the Model to the Data

The Cobweb Model is really clever, but does it actually capture the reality of the hog market? Coase and his co-author Ronald Fowler tried to answer that question by evaluating the model's assumptions. First, are hog producer expectations truly static? Expectations cannot be observed directly, but Coase and Fowler (1935) used market prices to try and infer whether producer expectations were static. It didn't seem like they were. Second, does it really take 2 years for hog producers to respond to higher prices? Coase and Fowler (1935) spend a lot time discussing how hogs are actually produced. They found that the average age of a hog at slaughter is eight months and that the period of gestation is four months. So a producer could respond to unexpectedly higher hog prices in 12 months (possibly even sooner since there were short-run changes producers could also make to increase production). So why does it take 24 months for prices to complete their descent? Even if we assumed producers have static expectations, shouldn't we expect the hog cycle to be 2 years instead of 4?  

This evidence is hard to square with the Cobweb Model employed by Reorganization Commission, but Coase's critics were not convinced. After all, if it wasn't forecasting errors that were driving the Hog Cycle, then what was? "They have, in effect, tried to overthrow the existing explanation without putting anything in its place" wrote Cohen and Barker (1935). Coase and Fowler (1937) attempted to provide an explanation, but this question would continue to be debated for decades.

The Next Chapter

Ultimately, John Muth (1961) proposed a model that assumed producers did not have systematically biased expectations about future prices (in other words that they had "rational" expectations). Muth argued this model yielded implications that were more consistent with the empirical results found by Coase and others. For example, rational expectations models generated cycles that lasted longer than models that assumed static or adaptive expectations. So a 4-year hog cycle no longer seemed as much of  a mystery. I'm not sure what happened to rational expectations after that. I hear they use it in Macro a bit.  Anyways, if you are interested in a more detailed summary of Coase's work on the Hog Cycle, then check out Evans and Guesnerie (2016). I found this article on Google while I was preparing this post and it looks very good.

References

Evans, George W., and Roger Guesnerie. "Revisiting Coase on anticipations and the cobweb model." The Elgar Companion to Ronald H. Coase (2016): 51.

Coase, Ronald H., and Ronald F. Fowler. "Bacon production and the pig-cycle in Great Britain." Economica 2, no. 6 (1935): 142-167.

Coase, Ronald H., and Ronald F. Fowler. "The pig-cycle in Great Britain: an explanation." Economica 4, no. 13 (1937): 55-82.

Cohen, Ruth, and J. D. Barker. "The pig cycle: a reply." Economica 2, no. 8 (1935): 408-422

Muth, John F. "Rational expectations and the theory of price movements."Econometrica: Journal of the Econometric Society (1961): 315-335.

Pigovian Prices

by Levi Russell

An interesting exchange occurred last month between two economists/bloggers. Stephen Gordon, an economics professor at Université Laval in Canada, wrote a column on the concept of a carbon tax price. In it, he argues:

As the Conservatives should really know by now, market-based approaches to reducing GHG emissions are more efficient than regulations. It’s better to let households and firms make their own priorities in response to price signals instead of having them imposed by the government. And the extra upside of market-based approaches like carbon taxes or cap-and-trade is that some of the costs of the policy are transformed into government revenues that can be used to compensate vulnerable groups or even to reduce other taxes.

So it seems that Professor Gordon equates a price with a tax. Hoover Institution economist David Henderson responded, taking Gordon to task for his apparent confusion of a price with a tax.

But carbon already has a price, or, more exactly, multiple prices. Natural gas has a price; oil has a price; coal has a price. And their prices are related to the valuable carbon component of those fuels because it’s carbon that makes those fuels valuable. Just as there’s no such thing as a free lunch, carbon is not free.

So why does Professor Gordon claim that taxing carbon means “putting a price on carbon?”

I can only speculate because I don’t know him, but here’s what I’m willing to bet dollars to doughnuts on: he calls a tax a price in order to lull the reader into thinking that it’s not a tax. Later in the piece he admits that it’s a tax but in his first mention, which sets the stage, he doesn’t.

Gordon later responded:

A market price is what a consumer has to pay in order to purchase a good or service. In contrast, a tax is, er, what a consumer has to pay in order to purchase a good or service.

This is one of those cases of a distinction without a difference. Unless you’re the sort of person who reads the fine print on the pumps at the gas station, you probably don’t know what the market price of gasoline is, and even if you do, you probably don’t care — at least as far as it affects how much gasoline you buy. What really matters is the total you have to pay. So when the focus is on how carbon taxes work to reduce greenhouse gas emissions — as mine was — then there’s not much point in using up column space to make the price-tax distinction. (Although if you want to play this game, think of a carbon tax as the price governments charge for degrading a communally owned resource.)

It's interesting to note here that neither Henderson nor Gordon are getting at the fundamental difference between prices and taxes. Prices, to one degree or another, transmit information about the relative scarcity of resources. If the price of a good rises, consumers of the good are incentivized to use it more frugally while producers are incentivized to produce more of it. It doesn't really matter whether the initial cause of the price rise was a reduction in supply or an increase in demand; what matters is the incentive the price change has on behavior.

One might be tempted to argue that a tax can be used to correct market prices when they don't reflect all relevant information. Indeed, this is the Pigovian paradigm that has existed in the profession for nearly 100 years. However, there have been significant challenges to this paradigm that are, in my mind, not fully appreciated. Though Henderson doesn't make this point in his final response to Gordon, I think it gets to the heart of the matter. Perhaps a tax on carbon is a sensible policy, but to simply assume that governments can get that price right ignores the reality that information and incentive problems present in markets are not absent from governments.

Beef Trade and the TPP

by Levi Russell

As one of my colleagues recently pointed out at an Extension meeting, both major-party candidates are (at least claiming to be) anti-international-trade. It's true that trade restrictions would be harmful to many segments of the U.S. agriculture sector, including beef. I ran across a great article in Beef Magazine last month that shows the U.S.' top trade partners. The chart below is lifted from the article.

As you can see, Australia is responsible for a substantial proportion of beef (not cattle) imports into the U.S. Our exports go primarily to Asian markets and our geographical neighbors. The article goes into some detail about the recent change in fresh beef imports from Brazil. The new policy is a tariff-rate-quota; details are available in the article and in this video.

Since I strive to tell the other side of the story as fairly as possible, I thought I'd link to what I believe is the most sophisticated argument against the Trans Pacific Partnership I've read. I recommend reading it, even if you are pro-TPP.

Remembering Ronald Coase

by Levi Russell

The third year anniversary of Ronald Coase's death was last Friday. My Facebook and Twitter were alive with remembrances of this great economist, so I thought I'd put a few articles/videos/podcasts related to Coase for FH readers.

Though Coase is most famous for his work on transaction costs, what I find most interesting about his is his unique approach to economics in general. In the opening of this video interview, Coase says "Economics has become a theory-driven subject and I believe the approach should be empirical. You study the system as it is, understand why it works the way it does, and consider what changes could be made and what effects they would have." Coase derisively referred to abstract theoretical economics as "blackboard economics." In reading his work, the reader gets the sense that Coase is looking at the behavior of real people and trying to determine the underlying causal mechanisms. This is what makes Coase a great economist.

Here's an article on Coase that gives his background and surveys his most popular work. Here's a video featuring lectures on Coase's contributions by other well-known economists.

The video I linked to above, as well as this blog post of mine featuring Deirdre McCloskey, corrects the record on "the Coase Theorem." Speaking of my blog posts, here's another one that provides a summary of one of Coase's lesser-known, but no less fantastic, papers.

Finally, this post of mine summarizes a point by Bryan Caplan that, given his stated perspective on economic theory, I think Coase would have appreciated. It's a simple empirical observation that fundamentally challenges typical applications of standard monopoly theory.

Rent-Seeking and Regulation are Inseparable

Over at Marginal Revolution, Alex Tabarrok links to a piece by Tim Carney on a move by the Securities and Exchange Commission to continue requiring mutual fund companies to send mostly-worthless documents to their clients. I've reproduced the Marginal Revolution post below (Carney indented, Tabarrok in italics):

Five years ago, a new quirky-sounding consumer-rights group set up shop in a sleepy corner of Capitol Hill. “Consumers for Paper Options is a group of individuals and organizations who believe paper-based communications are critically important for millions of Americans,” the group explained in a press release, “especially those who are not yet part of the online community.”

This week, Consumers for Paper Options scored a big win, according to the Wall Street Journal. Securities and Exchange Commission chairman Mary Jo White has abandoned her plan to loosen rules about the need to mail paper documents to investors in mutual funds.

Mutual funds were lobbying for more freedom when it came to mailing prospectuses — those exhaustive, bulky, trash-can-bound explanations of the contents of your fund. In short, the funds wanted to be free to make electronic delivery the default, while allowing investors to insist on paper delivery. This is an obvious common-sense reform which would save whole forests of trees.

You won’t be surprised to lean that Consumers for Paper Options is funded by paper mills, timber firms and the Envelope Manufacturers Association.

What bothers me about these stories is not the rent-seeking–that is to be expected. What bothers me is that there is a law that prescribes how mutual funds must inform their customers. Why must every aspect of commercial life be governed by a gun? And this is where I expect pushback–the mutual funds will rip us off if we don’t have these laws, blah, blah, blah. Fine, believe that if you must, but then you have no cause to complain about rent seeking. You created the conditions for its existence.