St. Paul, Minn. — The United States farm problem is rooted in a number of important, interrelated factors. The farm economy's integration into the international economy has come at the very time the structure of the international economy has changed dramatically the economics of agriculture.
The general integration of the international economy has far outpaced its political integration, making it difficult, if not impossible, to manage the international economy.
And US monetary, fiscal, trade, and exchange rate policies have far more influence on agriculture than do the commodity programs, yet the agricultural committees in Congress have jurisdiction only over the commodity programs. Hence they are unable to influence the policies that really matter to agriculture.
Changes in the international economy provide the context needed to understand the current problems of agriculture.
Four of these changes are of particular significance to commodity markets and to commodity programs.
1. The world has become increasingly dependent on trade. Contrary to expectations at the end of World War II, international trade has grown faster than the world's gross national product in most years in the postwar period.
That means that most countries of the world have become more dependent on trade. Or as economists like to put it, most economies have become more ''open'' to trade.
Some of these openings are truly dramatic. The openness of the US economy as a whole approximately doubled from 1970 to 1979. If the period is pushed back to 1965, the openness of the US economy roughly tripled. Agriculture experienced this same degree of change. By 1981, approximately 30 percent of the cash earned from marketing farm products were due to exports, and the output of two out of every five acres - or 40 percent of our cropland - was sold abroad.
The significance of increased dependence on trade is that the US economy increasingly exceeds the reach of domestic policy. Agriculture perhaps epitomizes this problem. But it is a source of frustration more generally in our economy.
2. A well-integrated international capital market emerged.
Developments here have also been dramatic. At the end of World War II there was virtually no such thing as an international capital market. There were some transfers of capital among countries, but it was mostly from one government to another and we called it foreign aid.
During the 1960s the Eurodollar market emerged as European banks sought to relend the dollars they had on deposit. This market expanded rapidly, eventually evolving into a Eurocurrency market as the banks lent other currencies in addition to the dollar. The international energy crisis of the 1970s added further impetus to this market as banks were enjoined to recycle the petrodollars - which they did, sometimes to a fault.
This international capital market is now huge and is every bit as important a link among countries as is international trade. In some cases it is more important, because it serves to link economic policies together. And almost all countries use this market, ranging from the less-developed nations through the centrally planned economies to the industrialized countries.
3. Countries shifted from fixed to flexible exchange rates.
At the Bretton Woods Conference in 1944, the countries of the world agreed to base the exchange rate of their currency on the value of the US dollar, which was pegged to a fixed price for gold. The nations agreed to change their exchange rates only under dire circumstances and in consultation with other countries. Devaluations were not to be used to restore balance in the foreign trade accounts, nor were they to be used to dump domestic problems abroad. Instead, domestic monetary and fiscal policy were to be used to restore balance in the external accounts and to control inflation or unemployment in the domestic economy.
President Nixon changed all that in 1973 when he devalued the dollar for the second time in an 18-month period and eventually forced the world to shift to a system of flexible exchange rates (which might better be called a system of bloc floating). There was little recognition at the time that he also changed in a very important way the mechanism by which monetary and fiscal policy affects the US economy.
With a system of flexible exchange rates and well-integrated international capital markets, changes in monetary policy are reflected in the export- and import-competing sectors.
For example, a restrictive monetary policy, raising US interest rates, induces a shift into dollar assets in the international economy. This increases the value of the dollar against foreign currencies. The rise in the value of the dollar chokes off American exports, while at the same time reducing the domestic price of imports. Less expensive imports dampen the domestic sectors that compete with imports (such as automobiles, steel, textiles, etc.).
A decision to stimulate the domestic economy operates in just the opposite way. As domestic interest rates decline in response to a stimulative monetary policy, there is a shift out of dollar assets. The value of the dollar declines, our export sectors become more competitive, and the domestic price of imports rises. The result is an expansion of the domestic economy.
In either case, monetary authorities (in the US, the Federal Reserve Board) accomplish what they want to, but the export- and import-competing sectors bear the adjustment.
The significance of this is that prior to changes in the international economic system, agriculture bore little of the consequences of changes in domestic monetary policy. Instead, these adjustments were borne in large part by interest rate-sensitive industries like housing, construction, and durable goods. With the new international structure, agriculture as an export sector has joined those bearing the adjustment, together with other export- and import-competing sectors.
4. Monetary instability increased.
An important part of agriculture's difficulties is due to the fact that at the very time that financial markets and commodity markets became more well-integrated through the exchange-rate mechanism, monetary instability increased significantly. This instability has imposed large shocks on agriculture as well as on other export sectors and the import-competing sectors like the automobile, steel, and the textile industries.
The accompanying graph goes a long way to explain the crisis that agriculture now faces.
Recall that the 1970s were characterized by an unprecedented export boom in agriculture. At the time, many explanations were offered for this unusual performance: superior US technology and the free enterprise system; the weather; a Malthusian crisis in the third world; and changes in Soviet policies. However, as the chart indicates, the dramatic increase in our agricultural exports was closely associated with the decline in the value of the dollar. By the same token, the dramatic decline in our export performance in the early 1980s - a 20 percent decline from 1981 to 1983 - is also strongly associated with the dramatic rise in the value of the dollar in foreign exchange markets.
The question becomes: Why the large swings in the value of the dollar? Attempting to answer this is important because it helps explain how agriculture has become vulnerable to economic forces external to agriculture.
The weakness in the value of the dollar in the 1970s was due to a combination of a bad energy policy and inappropriate monetary and fiscal policies. Monetary policies were highly erratic and unstable during the 1970s, making the dollar undesirable as an asset to hold. In fact, real interest rates were significantly negative during some parts of this decade due to high rates of domestic inflation.
But our energy policies were probably equally at fault. Our unwillingness to permit high international petroleum prices to be reflected in the domestic economy caused us in effect to subsidize imports of petroleum at the very time that petroleum prices were going through the roof. As a consequence, our petroleum imports burgeoned, and this contributed to the weakness of the dollar.
In October 1979, the first step was taken to change this. Among other things, the Federal Reserve Board decided to stop monetizing the federal debt that resulted from the federal budget deficit. As a consequence, interest rates were permitted to rise so that capital markets could absorb the burgeoning debt. This rise in interest rates attracted capital from abroad. This, in turn, contributed importantly to a rise in the value of the dollar against foreign currencies, and the strong dollar choked off our foreign export markets. Recently, this capital from abroad has flowed into the US at an annual rate of $60 billion to $70 billion.
Next, President Reagan deregulated the petroleum industry. The rise in domestic prices and other adjustments caused our petroleum import bill to fall off dramatically. This contributed importantly to the strength of the dollar in the 1980s.
For its part, the agriculture sector performed famously in responding to the changed economic opportunities it faced as the export boom of the 1970s unfolded. For the first time in 50 years, there was a net inflow of resources into agriculture starting in the second half of the 1970s. This net increase in resources - on the order of 8 percent - together with continued increases in productivity enabled agriculture to respond to the burgeoning foreign demand without prejudicing the domestic market.
When the dollar started its unprecedented rise in 1980, however, agriculture did not respond to the changing economic conditions. Part of this was due to the rigidity in target and loan prices built into the 1981 farm bill. As the dollar strengthened in the 1980s, it should have caused agricultural prices to decline so as to signal the need to shift resources out of agriculture. To a significant degree these prices did decline. But at some point they came to rest on the loan levels, and as the dollar continued to rise, these loan prices were translated abroad as increasingly higher crop prices. As a result, producers in other countries took these higher prices as a signal to increase production, our own foreign demand was choked off, and a price umbrella opened in which other countries could undersell us in foreign markets. It would be difficult to imagine a better policy to lose market share!
In summary, the problems of our agricultural sector are rooted in our monetary policy, our fiscal policy, and our energy policy. For example, probably nothing would do more to improve the welfare of farmers than to balance the federal budget. This would lead to significantly lower interest rates, a weaker dollar, stronger export performance, and higher prices for farmers. Ironically, if we continue on our present deficit binge, an adjustment may come about inadvertently. If present trends continue, the US is expected to become a net debtor like Brazil, Mexico, and Argentina in about mid-1985. If we do become a net debtor, we can expect the dollar to weaken, other things being equal. If that occurs, agriculture will benefit from a significantly weakened domestic economy.
However, we are still faced with two challenges. First, congressional agricultural committees have little jurisdiction over the external factors that really matter to agriculture. Hence, they are likely to continue to tinker with the commodity programs. Will they have the wisdom and political courage to make these programs less of a barrier to adjustment? Or will they have the political clout to vote the export subsidies called for to offset the protection afforded the automobile, steel, textile, and other industries so that we make more efficient use of our national resources?
Second, will we muster the will to redesign and help implement new international institutions that recognize the greatly increased economic integration on the international scene? Or will we continue to act as though we are a closed economy and that our economy can be managed by strictly domestic policies?
These are the challenges policymakers face as we move toward the 1985 farm bill. If our policies toward agriculture are to be constructive rather than counterproductive, we greatly need to change our thinking about our role in the international economy and how we fit into it.