Recently the European farmers and Agri-worker organizations sent an open letter to the European Commission ‘demanding’ that the selling of farm produce at below input prices be added to the blacklist of practices defined in the Unfair Trading Practices (UTP) directive.1 Effectively, setting a price floor on farm produce. The stated intent of this request is to protect the future of European agriculture by providing reassurance to the younger generation that there is money to be made in this industry (paraphrasing is mine – the actual quote from Kjartan Poulsen, president of the European Milk Board, is more opaque).
Unfortunately, such a legislative move would be deeply misguided and significantly counterproductive to the financial well-being of European farmers. To understand why, let’s consider a few economic factors at play.
The letter focuses on pricing so let’s begin there. In a free market, prices are set by the laws of supply and demand. The greater the demand for a product, the more supply must rise to meet it. Should supply be unable to rise quickly enough, prices will rise instead in order to moderate demand to match what supply is able to meet (because price influcence behavior and decisions). In the inverse situation, if supply outstrips demand prices will fall to induce more demand. To farm is to sell a commodity, meaning there is no substantial differentiator between farm A’s corn and farm B’s corn. Price farm A’s corn higher than Farm B’s and Farm B will sell all of its corn before Farm A sells a single one.
However, when you begin to artificially adjust the pricing mechanism in the above formula, there are consequences for the other factors, supply and demand. To see one example of this, look at any country that has imposed price caps on food. The result is to have barren store shelves. Why? Because as demand remained constant, but supply became restricted due to stores being unable to charge more for the goods they were now having to pay more for from producers, stores were not able to continue purchasing from their suppliers. However, consumers continued to sustain the same level of demand. The inevitible and rapid result is barren store shelves and food scarcity.
So, what happens when you put a floor on prices, as this proposal from the EMB is effectively demanding? Regardless of supply and demand, prices are only unable to adjust upwards, but not downwards. If prices rise because supply falls or because demand soars, this isn’t a problem. However, if supply outstrips demand or demand declines relative to supply, this becomes a big problem. Rather than prices falling to induce greater demand for the surplus supply, they hit a floor below which they cannot fall. This means that rather than the surplus supply being able to sell at $0.90 on the Euro, it will simply not sell because no more buyers will be available who are willing to pay the price that is being asked. This means that rather than a farmer making a little less than their input costs, but still recouping some of their investment, they will loose their entire investment for all surplus goods because they will not be able to sell anything at below the fixed price floor.
This is the crux of the argument against a policy like this. By setting an artificial price floor, which is detached from the inputs of supply and demand, farmers in an oversupplied commodity market, will simply have to waste out their crops for which there is not enough demand for in the market. While selling below your input costs for any business is an unsustainable financial position, in the short term you can at least recoup some of your costs rather than none at all for each additional unit that exceeds demand.
There are other problems with this as well. It says the price floor can’t fall below ‘production costs’. The question then is, ‘who’s production costs’? The industries average as a whole? A sample group of farmers? Each individual farm? Each of these has their own problems.
To start with the last, each individual farm is virtually unenforceable. That means it can only be done retroactively when the farmer is filing taxes, by which time the sale will have long since taken place. If the goods were sold at below market price, who gets penalized? The farmer or the buyer? If the buyer, how are they supposed to know the farmers input cost for the good at the time of sale? The whole purpose of pricing is for the seller to communicate to the buyer the price for which they are willing and able to complete the trasaction. If the market price is below a particular farmers, but not all farmers, then is that farmer penalized for having higher production costs (legislatively, not by the market that is)? The deeper you dig into this scenario the more problematic questions that arise.
Next we have a sample group of farmers. What if the European Comission picks a sample group that have especially efficient operations relative to the rest of the industry? Then your price floor (per your stated purpose) will still be too low for most farmers to be profitable. But what if you pick a group of highly inefficient farms and set the price too high, crushing demand in the market and causing a far higher number of farmers to have to waste a good portion of their crops because no one will pay the required price?
Finally, if you take an industry average, then you disincentivize any individual farmer from innovating on their farm because even if they are able to lower their production costs, which would allow them to profitably sell their crops cheaper than other farms could, they will still be required to sell at the market price. While this would make them more profitable for what crops they did sell, it would still mean wasting 100% of the surplus if supply exceeds demand. This makes the ROI on any efficiency investment in a farm unappealing, leading to less efficient farms over the long run (due to a dearth of investment), which then leads to higher prices for consumers, while not making the farmers any more profitable.
Is it a problem that farmers aren’t making money on their farms? Absolutely! Does something need to be done to help farmers be more profitable? Yes! However, a price floor (just like rent freezes) are a bad idea economically. If you want to help farmers become more profitable, a great place to start is by removing the government programs that incentivize and encourage over production in the first place.
- Agriland; EU groups demand ‘blacklist’ for puchasing at prices below production cost, Louise Hickey, Oct. 7 2024 ↩︎
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