A reader asks:
Stiglitz said “The heavy subsidization of corn, for instance, means that many unhealthful foods are relatively cheap. So grocery shopping on a tight budget often means choosing foods that are not nutritious.”
Please correct me if I’m wrong. I’ve been telling [people] that farm subsidies make food more expensive, not cheaper (sugar is a really good example).
If you ask an economist, you shouldn’t be surprised when the answer is “it depends.”
Price-Decreasing Agricultural Subsidies
Letting p denote price, f(.) denote the production function, L denote how much labor is employed on the farm, and w denote the wage, we know that the producer maximizes profit by choosing how much labor L to employ on his farm, such that
pf(L) – wL,
where the first term is total revenue (price times quantity produced) and the second term is total cost (wage times labor), with the associated first-order condition (FOC)
pf’ – w = 0,
so at L*, i.e., the optimal quantity of labor, the value of the marginal product of labor (left-hand side) equals the marginal cost of labor (wage, or right-hand side).
If the state subsidizes labor by paying, say, 20% of each unit of labor, then the maximization problem becomes
pf(L) – 0.8wL,
because 0.2wL is paid for by the government. The associated FOC is then
pf’ – 0.8w = 0,
so L* is now such that the value of the marginal product of labor is much lower than it is in the unsubsidized case (since 0.8w < w). But because marginal product of labor is decreasing in L, this means that more output is produced, which leads to lower prices in the aggregate.
Price-Increasing Agricultural Subsidies
Now, that’s only one kind of subsidy. Another kind of subsidy is a price subsidy where the quantity produced is rationed — think of raisins in the US. In that case, if the quantity allowed is less than the optimal (i.e., market-clearing) quantity, what will happen is that prices will be artificially higher — the subsidy here is that each producer receives a higher price per unit, leading to extra-normal (i.e., above zero) profits.
The same can be accomplished by placing restrictions on how much of a commodity can be imported (e.g., sugar) by placing a tariff on it; this allows domestic producers to charge a price higher than marginal cost because of scarcity.
My understanding is that for corn, farmers directly receive money, which is more akin to my first example above and, as Stiglitz claimed, cheap corn-based foods (notice the presence of high-fructose corn syrup in almost every processed food) flooding the market instead of the other way around. Presumably, what drives the choice producers of specific commodities make (direct subsidies or trade restrictions) is whether a higher price and lower quantity demanded leads to higher profit, or whether a lower price and higher quantity demanded does (which goes through the price-elasticity of revenue, holding cost constant).
There are less direct subsidies, too. For example, a mandate for the purchase of farmers’ products. That would raise the price and thus the output level.
This is how the ethanol mandate impacts corn producers. The net effect on prices of a consumption mandate plus a direct subsidy is ambiguous, but the effect on quantity produced certainly isn’t!
The proliferation of low-cost high fructose corn syrup is more a reflection of the price-inflating import quotas on sugar than it is of the other forms of subsidies for corn production. At world sugar prices, high fructose corn syrup would become economically inefficient for most uses.
The old form of crop subsidy )different that you describe) was for the government to buy up ‘surplus’ production to achieve target prices–which were higher than would have been otherwise. So prior to the era of direct payments (which were intended to decouple subsidies and production levels), ag policy did increase the price of food pretty much across the board. Now, whether farm subsidies increase or decrease food prices depends entirely on the structure of the subsidy system, as you describe.
The system of subsidies is complex to be sure. As pointed out above, biofuel mandates have increased demand for corn (and to a lesser extent, soybeans for biodiesel), which increase prices for those commodities, which in some production areas means a shift in production that reduces supply of other commodities (thereby increasing their market prices).
And none of this touches tax-based subsidies that allow farm businesses to take more cash out of the business by accelerating depreciation on a wide range of items.