Should Governments Should Governments Subsidise Food Prices?Subsidise Food Prices?

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Neil FollandNeil Folland

• International agricultural markets directly influence the welfare of more than six billion people.

• The efficiency of agricultural markets, volumes of trade flows and the volatility of prices affect a number of interlinked issues. These are…

• Food security – at global, national and household levels.

• Real household income levels – due to share of household spending on food.

• Macroeconomic performance and price stability.

• Governments have intervened to keep food prices stable for hundreds of years.

• This was based on price stability and efficiency.

• Stability was provided through guaranteed prices and assured markets.

• UK Agricultural Act 1947 brought stability to UK market.

• After the UK joined the EU price stabilisation was determined by the Common Agricultural Policy which supported farmers through guaranteed prices.

• By 2003 CAP reform decoupled farm support from production.

• Now offers annual payment for basic agricultural and environmental maintenance of farmed land, with no requirement to produce.

• CAP is still the largest item in the EU budget accounting for about 45% of total expenditure.

• In 2008 EU agreed further reforms to shift subsidies away from production to take place from 2009-2013.

• Subsidies are considered harmful as they distort world markets and harm farmers in developing countries.

• Subsidies will now be transferred to conservation.

• The loss of arable set-aside subsidies is controversial as conservationists argue that this policy has helped wildlife.

• The countryside may become less attractive

• But the EU will become more competitive

• Money spent on subsidies can now go to technological and scientific research.

• Europe will probably end up importing more products that it cannot produce efficiently.

• As agriculture becomes more responsive to market forces there will be structural changes.

• There will be an exodus of farmers from the industry.

• Reform appears to be encouraging diversification rather than stimulating rapid agricultural restructuring.

• There is increasing polarisation between large and small farmers.

• Normally a food subsidy will reduce the market price of the subsidised good.

• This will increase the real income of consumers.

• It will also provide food security by keeping supply at a high level

• The subsidy shifts the supply curve out to the right.

• Market price falls from P to P1 and quantity increases from Q to Q1.

• This results in an increase in consumer surplus of PVWP1.

• Producer surplus increases as producers produce more and receive a higher price. (P1 + the subsidy RW).

• However, someone has to pay for the subsidy.

• The more that demand is inelastic the more of the subsidy producers will pass on to consumers in lower prices.

• Market distortion will depend on the amount of the subsidy and the length of time it is in place.

• We must also consider the opportunity cost of government spending on subsidies compared to alternatives foregone.

• Long-term commitment to a subsidy might lead to production inefficiencies.

• Subsidies may slow down industrial restructuring.

• As household incomes rise a declining share of total income is spent on food.

• Increasing economic growth and productivity in the non-farm sector will increase non-farm wages and draw labour away from agriculture.

• This in turn will lead to rises in agricultural wages.

• This will encourage the substitution of capital for labour with investment in machinery.

• Agricultural productivity will rise and optimum farm size will change.

• There is the possibility of government failure.

• The cost of processing a claim under the EU’s Single Payment Scheme often costs more to administer than the value of the claim itself.

• There have also been “unforeseen additional costs” and overpayments.

• Some might argue that this would apply to foods which are considered ‘essential’ or ‘healthy’.

• For example palm oil is now valued as an alternative to ‘trans fats’ which have been banned in certain places.

• Should the government decide what is good for us to eat?

• Financial support to back such a decision will distort price signals.

• They hurt the urban poor where food is the most expensive item in their budget.

• But benefit agricultural communities by increasing rewards and raising growth and employment.

• Higher food prices might make it possible to reduce subsidies with hurting incomes.

• If developed countries cut subsidies and lower other trade barriers this will promote world trade to the advantage of many of the world’s poor.

• The aim of intervention through farm price subsidy is often to provide price stability and food security but subsidies involve an opportunity cost.

• Subsidies have both micro and macro impacts and we must recognize economic efficiency as well as equity issues.

• Dismantling or reforming established farm support schemes can have far reaching consequences both beneficial and adverse.

• Economic analysis can determine welfare losses and gains from the introduction or removal of subsidies.

• Subsidies can result in both government failure and unintended consequences.

• To what extent do food subsidies contribute to a misallocation of resources?

• What arguments could a government employ to justify its use of food price subsidy?

• How would a reduction in agricultural subsidies affect the structure of the industry?