Risk management and trade in the new US farm legislation

30 May 2014

Abstract: As the risks of crop-damaging climate change increase, a shift towards insurance-based subsidies could be a source of tension in international trade.

Farming can be a risky business. Agricultural prices and yields can be quite volatile. Farmers do not know what price they will receive when they plant a crop and they cannot predict the weather during the season. Livestock farmers also face uncertainty about prices for their products and risks of losses due to weather or disease. Climate plays a key role in generating risk in farming, and the greater variability foreseen with climate change is likely to increase risk and uncertainty for the industry.

The latest version of agricultural legislation or "Farm Bill" in the United States - the Agricultural Act of 2014, signed into law by President Obama on February 7 - places a major emphasis on risk management. It authorises a range of farm programmes that address price and output risk, and the combined effect of these on revenues or on the margin between costs and returns. A key aim of the Act is to provide a safety net to protect farmers from the vagaries of the weather and market volatility.

Complex legislation

Because the issues are complex, the legislation is also complex. It took almost four years from the start of discussions to reach a compromise via legislation in the House and the Senate. The process was complicated by mandated reductions in federal spending and by the difficulty of obtaining consensus in an increasingly politically polarised Congress. One of the major sticky points was how much total projected expenditure would be reduced under the new legislation and how that reduction would be distributed. Farm legislation includes a range of provisions including commodity programmes that benefit farmers, domestic and international food assistance, and programmes promoted by environmental groups. Layered on top of structural complexity, farmers in different parts of the United States or those producing different products often have differing interests in the legislation. Balancing the wide range of competing interests poses a major challenge.

The new Act is a significant departure from earlier legislation and relatively few major provisions for commodities have been retained from the previous version of the Farm Bill. The most important survivor is the marketing assistance loan programme, which provides subsidies to farmers when prices of major crops fall below pre-determined levels. A programme that made payments to farmers regardless of prevailing market conditions - known as direct payments - was eliminated, primarily because of the difficulty of maintaining these under pressures to reduce federal spending.

Safety net provisions

The provision of a safety net for farmers is addressed through two different components of the Act - Title 1 covering commodity programmes and Title XI dealing with crop insurance. Crop insurance has become a much more prominent feature and the insurance concept has been extended to other areas, for example to milk production.

For the 2014/15 crop year farmers will have a choice of being covered under two different commodity programmes. The first is the price loss coverage (PLC) scheme - essentially a deficiency payments programme - in which payments are made if crop prices fall below predetermined levels. The second is the agricultural risk coverage (ARC) scheme, which provides payments to farmers when revenues fall below a benchmark figure calculated using country or farm average yields. Producers have the option to update the area and yield of crops on their farms used in determining payments when they enrol in the scheme of their choice.

Layered on top of these commodity provisions are a range of crop insurance options. Under the federal crop insurance programme, private companies market and manage the delivery of crop insurance policies covering yield or revenue risks. The Federal government provides reinsurance, and reimburses administrative and operating expense to the companies. It also subsidises premiums at rates varying between 38 to 80 percent, depending on the level of coverage and options chosen by producers. Proponents argue that high levels of subsidy are necessary to make the products affordable to producers. Opponents argue that the subsidy encourages producers to plant on land where production is risky.

There are several additions to the suite of insurance options in the new legislation. Beginning with the 2015 crop year, farmers who elect to participate in the PLC scheme will have a Supplemental Coverage Option (SCO) that provides area-based insurance based on county average yield or revenue. The subsidy rate for premiums is 65 percent. Cotton producers will have a special scheme called the Stacked Income Protection Plan (STAX) in place of PLC and ARC. The subsidy rate for premiums is 80 percent. An important feature of these insurance options is that unlike commodity programmes there are no payment limitations or eligibility restrictions based on income.

Insurance-based approach in the WTO context

The shift towards an insurance-based approach in the new Farm Bill is the most striking feature of the legislation, but the provisions are far removed from those allowed under Annex 2 - the green box - of the WTO Agreement on Agriculture for government participation in income insurance and safety-net programmes.

The small losses in revenue compensated through traditional crop insurance and new schemes such as SCO and STAX mean that these do not qualify for the green box as being minimally distorting for production and trade. Consequently, subsidies provided under US safety-net programmes must be notified to the WTO under the aggregate measurement of support (AMS). With high commodity prices in recent years notified support under the product-specific category of the AMS has been relatively low. For their part, insurance subsidies have accounted for virtually all of the US$9 billion of support notified under the non-product-specific AMS category. But that is substantially less than 5 percent threshold of the total value of agricultural production which would require such support to be counted against the US total AMS commitment of US$19.1 billion.

Many economists argue that risk management will become increasingly important for farmers as the effects of climate change become more pronounced, and that the use of insurance should be encouraged. But US programmes can be criticised for the high levels of subsidy that they provide and their potential impact on production and trade. Wealthy countries, such as the US, can afford to subsidise risk management options for farmers, but poorer countries may be unable to do so.

Brazil, which won a case at the WTO on US cotton support, may soon reopen its case on the basis that the new legislation continues to provide an unfair competitive advantage to US cotton producers. If commodity prices fall sharply, as they sometimes can, there is a risk that the United States will notify much higher levels of support to the WTO. This may not be a problem under the current ceiling on total support, but a proposed reduction to US$7.6 billion under the draft Doha Agreement on Agriculture could prove to be more problematic. More broadly, the issue of the extent to which governments should be involved in helping farmers to manage risks associated with climate change, and how much financial assistance they should provide seems likely to be heavily debated as the importance of the issue increases.

Author: David Blandford Professor of agricultural and environmental economics, Department of Agricultural Economics, Sociology and Education at the Pennsylvania State University. 

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