In this segment and the next one we'll talk about some problems that can arise when agricultural policies are introduced. It doesn't always go smoothly. So amongst the problems that we'll talk about are that the policies don't always meet their objectives, policies sometimes cost more than they're worth, and they sometimes have costly or damaging unintended consequences. It's worth worrying about these problems when you're thinking about introducing a policy, because once bad policies are in place they can be very difficult indeed to repair them or remove them. So we need great care when policies are been designed and introduced, because we're going to be stuck with them for awhile, most likely. So I'm going to illustrate these problems with a couple of examples. And today we're going to talk about the example of price support, where the prices of agricultural products are increased above market levels. So if the prices of agricultural products are increased above market levels it prompts farmers to increase their production. Of course, we saw that with the supply curve. The higher the prices are the more supply there will be, the more production producers will choose to produce. The problem is that this results in excess production that cannot be solved at market prices. And then what are you going to do with that? And the most common solution is to store this excess production in the hope that at some future time it can be used or solved. Storage causes problems, it causes costs, it can cause wastage of product. And those costs are borne by the farmers, perhaps depending on the scheme, or by taxpayers. It can also reduce the market price for everybody if people in the market know that there is a huge stockpile of the product that might put a limit on how much they are willing to bid for the products because they know there's a lot there waiting to be sold. The must spectacular example of this problem in Australia's history was the wool crises. In the late 1980s, early 1990s, the Australian Wool Corporation operated a floor price. That means that they refused to allow wool to be sold if the market price, the price at auction, fell below a specified level. They set a floor price and then they enforced that by buying any wool which received a market price or an auction price that was below that floor price. Now the problem with that was that they set the floor price optimistically when demand was really booming and then refused to lower it when demand fell. What they should have done was set the price temporarily and then lower it once the demand fell. And because the process was set so very high, eventually far above the market price, farmers maintained very high levels of wool production, but most of it was passed in at auction and had to be purchased by the Wool Corporation which just put it into storage. So this is the situation in this graph. If the market had been allowed to operate without this sort of floor price you can see the point where the supply and demand curves intersect and from that you can see the level of production, the quantity of wool that would have been produced and purchased, and the price that it would've been sold for in the market. But what happened was, they set a much higher price, in this case 870 cents, and you can see that there's a much higher level of production, a much higher level of supply, and a much lower level of demand. So the vertical dotted lines coming down from the supply curve on the right or the demand curve on the left show the levels of supply and demand under this very high price of 870 cents. And so there's this huge gap. Not very much wool being purchased, an enormous amount being produced, and so the difference between those two amounts had to be put into storage in the hope that at some future time the price would rise and it could be sold at that floor price. It turned out that that was much too optimistic, it never happened. And eventually, after a couple of years of wool being accumulated, stockpiled, the amount of wool being stored reached almost a billion kilograms and it was incurring around $3 million a day in cost of storage and interest. Eventually, this Australian government stepped in and forced the scheme to be closed. The scheme was being run by an organization that was intending to operate for the benefit of farmers, but clearly they were actually doing a lot of damage to farmers because of the stupid design of the policy. The losses that occurred as a result of the policy were estimated to be around $12 billion. And the losses where shared amongst farmers, taxpayers, and wool processors around the world. There are plenty of other examples of similar disastrous price support schemes with varying flavors, varying systems of operation. So for example in the 1970s and 1980s, the New Zealand government had price supports on some of its main agricultural products. And because agriculture is a large proportion of the economy in New Zealand, these price supports and the subsidies that were provided to farmers became a massive burden on government. And eventually after a change of government they were removed, but that caused a lot of dislocation, a lot of pain to farmers who were used to receiving these subsidies. And it was very difficult for them to go through the transition to not receiving them. The European Common Agricultural Policy in the 1970s and 1980s also had prices that were well above market prices, and this led to very large stockpiles. There was a milk lake, a butter mountain, other big stockpiles of produce. This led almost to the collapse of the European Union budget in the 1980s and caused major cost to farmers in developing countries, because it reduced the world prices of agricultural products. And recently we had a similar scheme in Thailand to increase the price of rice. The Thai government set the price of rice for domestic producers at roughly double the world price, the world market price. And this caused massive problems with corruption, with rice being imported into Thailand from other countries so that unscrupulous people could sell it at double the market price, big wastage of produce that was being stored in not very good conditions. And overall, a cost to government in Thailand that's estimated to be about $19 billion US. Another one of these policies that really is very poorly designed, really stupid in fact. So the moral is, those who defy the markets will eventually lose. They may lose slowly or they may lose in a spectacular collapse, but they will lose. The solution is obvious. Governments shouldn't artificially inflate agricultural prices because the problems dramatically outweigh the benefits. If the government wishes to provide support to farmers, that's fine, but there are many other ways to do it. The assistance shouldn't be built into prices. So once they recognized this, the European Union went through a process of what was called decoupling. That means that the assistance that farmers received wasn't linked to prices. They now receive a payment that's not affected by how much output they produce, so they don't have the incentive to increase their production. There probably still is a bit of over production because of this, but it's much less dramatic than it was when the assistance was built into prices. So in summary, policies to increase prices for agricultural products to benefit farmers have been common historically and they still arise from time to time, but they cause numerous problems and massive costs. And they're probably the worst possible way to try and assist farmers. [MUSIC PLAYING]
