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More on Agricultural Subsidies

I've written about agricultural subsidies a few times already but it's time to say more, because SDB has written about them — at length, as usual, and linking the subject with the War Against Terrorism, as usual. :)

Happily, he links to the Environmental Working Group which has an online database of U.S. agricultural subsidies. They have charts that show U.S. subsidy spending since 1995. Total subsidy spending 1995-2002 was $114,024,265,743.

(Yes yes, it's Shocking! Outrageous!)

Unfortunately, I have to disagree with SDB a little.

He argues that there aren't many industries where poor nations can compete with rich ones because they lack both the capital and the educated workforce to enter those industries. A comparative advantage of poor nations is their cheap unskilled labor, which can be used in industries like farming. All of this is certainly true. But then he goes on to say:

[Our subsidies have] put a lot of farmers out of business in those nations, and it means those nations are paying hard currency for grain imports instead of using local currency for domestic supplies. In the short run it's cheaper, but in the long run it helps perpetuate their overall poverty, because it means they cannot use that same hard currency for capital improvements. [Or for paying off foreign debts, mentioned in his previous paragraph.]

The currency doesn't matter. Look at the goods first, and the money second.

Our subsidies are good for poor nations in the short run, and so long as the subsidies last — i.e., into the long run — their food remains cheaper, so they still benefit. (This applies to the poor nation only. To the world as a whole, subsidies are harmful because they distort the market and cause too much food to be produced at the expense of other things.) In the poor nation, domestic food production becomes more expensive than importing, freeing up the labor that had gone into farming and allowing it to be put to other uses, producing things that otherwise would not have existed. The fundamental scarcity of labor guarantees this.

That covers the goods, now what about the money? My analysis will be in terms of a single world money, but individual national currencies don't add much complexity. To think of it in those terms, substitute net inflows or outflows of money for changes in exchange rates below.

A nation that increases its imports will, ceteris paribus, experience a net outflow of money which will have a mild deflationary impact on that nation. The money flow stabilizes as prices and wages fall, which operate to make that nation's exports more competitive. A nation in debt will find it more difficult to pay that debt due to its smaller quantity of money.

So where is my disagreement with SDB?

First of all, the poor nations have been in an agricultural subsidy environment for a long time, so the adjustment I described has already taken place. Debt acquired after the deflation is not more difficult to pay off.

The second objection is that the condition of ceteris paribus does not hold, so the adjustment doesn't apply so straightforwardly. The labor in the poor nation no longer used to produce food is now used to produce other things (maybe for export, maybe not) and the net gain from this labor (the value of its new output minus the cost of imported food) causes the economy to grow faster than it otherwise would have. In particular, the available labor could be used in education, which would open new industries to the poor nation.

The increased rate of economic growth in the poor nation makes foreign debt repayment easier in (at least) three ways: (1) it will be richer sooner, easing its debt burden, (2) increased growth encourages increased foreign investment, supplying foreign currency in the short run, and (3) a consequence of Say's Law is that each nation tends to have a quantity of money in proportion to its total production, so an economy growing faster than others will attract money and keep it in the long run.

In short, I believe subsidies cause economic growth in the poor nation, not economic stagnation. The common sense proposition that cheaper food is good, not bad, is true. (Remember Adam Smith's words, What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom.)

So why have so many poor nations failed to prosper? Their governments are not creating the conditions necessary for capitalism to thrive. Whether it be through corruption or war or socialism or failure to protect contracts or failure to protect property rights, they are thwarting capitalism. Capitalism should not be blamed for the failings of government.

I also need to pick on Russell Nelson (The Angry Economist) for a minute. He writes in response to SDB:

We should immediately abolish subsidies and quotas for the very same reason that you should stop hitting yourself with a hammer. The pain doesn't go away immediately, but the healing starts right away, and you stop doing damage to yourself. [source]

I agree that agricultural subsidies should be ended, but it is important to acknowledge that some people would be hurt by ending them. The citizens of poorer nations as well as domestic agribusiness would be hurt. (Foreign agribusiness and domestic citizens would gain.) All large-scale economic changes have disaffected parties.

Sometimes the economic improvement would be so dramatic that it justifies an immediate and complete conversion. Other times allowing for a period of adjustment and implementing the change more gradually would be prudent. The control of agricultural subsidies rests with government, so this becomes a political issue, not an economic one. It is probably politically impossible to remove subsidies all at once, so supporting a gradual elimination is the next best thing.

How's this: Starting in five years (allowing time for planning), phase out subsidies over the subsequent five years. In year 6 the value of subsidies would be decreased to 80% of present, in year 7 it would be 60%, etc., until in year 10 they would be totally eliminated.

UPDATE 2003-09-29 05:42:12 UTC: Brick writes, The multi year phase out gives the loosing parties enough time to log roll the politicians. Indeed so. Given 10 years and solid incentives, the screams from the lobbyists would be deafening. Sudden termination of subsidies would change their argument from "why subsidies shouldn't be reduced" to "why subsidies should be reinstated", and the latter is politically easier to counter. Perhaps quitting cold turkey is more likely to succeed despite being more painful.

Tiny Island