What Is Meant by Decoupling?
When commodity program payments are tied to current production or net returns, they can introduce market distortions by influencing planting decisions, overall production, and market prices. In contrast to such "coupled" programs, benefits from "decoupled" programs do not depend on the farmer's production choices, output levels, or market conditions. By severing the link between payments and production decisions, decoupled payments provide a way to support farm incomes that is less distorting to commodity markets.
Under the 1996, 2002, and 2008 Farm Acts, producers of selected field crops could qualify for fixed payments tied to historical plantings base acreage. These payments are considered "historical entitlements" that are unrelated to current production. For example, farmers with corn base acres do not need to grow corn to receive the payment, which is fixed by legislation. Indeed, they do not need to plant anything--although they have to keep base acres in approved agricultural use. (For more details on current U.S. commodity programs, see the Program Provisions chapter).
Is This a Step in The Right Direction?
For most of the 20th Century, U.S. commodity programs attempted to support farm incomes through interventions in commodity markets. Price supports, in combination with supply controls, were features of farm bills for at least a half century. (See Farm Program Effects on Agricultural Production: Coupled and Decoupled Payments, November 2004, for more information.) Two important drawbacks of this approach are the following:
- Inefficiency through market distortions. By obscuring market signals, coupled programs can lead to economic inefficiency. That is, producers can supply too much, or too little, of specific commodities because of government programs.
- Variability in federal budget exposure. When support to producers is linked to market prices, budgetary costs can vary significantly from year to year.
Decoupled programs can address both concerns. Many economic studies support the view that decoupled payments provide a more efficient basis for income transfer and give rise to fewer market distortions than coupled programs. However, no programs are completely free of distortion, and there is growing interest in identifying and evaluating the effects of decoupled programs, such as those implemented under recent farm acts.
Economists have approached the topic from different directions, using different methodologies and assumptions in their analyses. Some studies have been based on producer surveys. Others have used theoretical models of farm-level decisions. Statistical analyses have focused on the effects of government payments on crop acreage, labor and investment, and land markets. Each approach has different strengths and weaknesses. Not surprisingly, published studies are not in full agreement about the net effects of decoupled payments on the U.S. agricultural sector. A Review of Empirical Studies of the Acreage and Production Response to U.S. Production Flexibility Contract Payments Under the FAIR Act and Related Payments under Supplementary Legislation (March 2005) presents an overview of many of the studies.
The Term "Decoupled" Has Been Used in Different Ways
One way refers to implementation criteria, as explained above. For example, a payment is considered decoupled if it does not depend on current production or market conditions. Another way focuses on the economic effects, or the degree to which these payments affect production. Used in this sense, "decoupled" is a matter of degree, since effects on production are possible for any form of producer support. Later sections of this chapter discuss how payments that are "decoupled" in terms of implementation criteria might still influence production and markets.
Some programs have been described as "partially decoupled." An example is the counter-cyclical payment (CCP) program that was introduced in the 2002 Farm Act. CCPs are tied to historical base acres and fixed program yields. For this reason, individual producers cannot affect their CCPs through current production decisions. However, CCPs depend on market conditions: payments rise (up to a limit) in response to a lower national average price. The link to current prices means that CCPs are not fully decoupled in terms of their implementation criteria.
Background and Driving Forces
Changes in U.S. commodity programs. Fixed payments were introduced in the 1996 Farm Act, part of a package of reforms designed to improve the market orientation of U.S. commodity programs while limiting the cost to taxpayers. This was the culmination of policy reforms that began in the mid-1980s. (See The 1996 Farm Act Increases Market Orientation, August 1996, and, for a longer term historical perspective, The 20th Century Transformation of U.S. Agriculture and Farm Policy, June 2005). The 1996 Farm Act eliminated nearly all supply controls and planting restrictions for program crops and introduced fixed payments--called Production Flexibility Contract (PFC) payments-which promised farmers a known level of support without reference to current production or market prices.
Fixed payments were continued under the 2002 Farm Act. Two key changes in the program were to expand payment eligibility to include historical production of oilseeds and peanuts, and the option to update base acreage. (See the 2002 Farm Act Title I Side-by-Side Comparison for program details.) The payments were continued in the 2008 Farm Act.
Global reforms have played a role. International agreements have given the United States and other countries an important motivation for decoupling, because "minimally trade distorting" subsidies to producers were exempted from the limits on domestic support negotiated under the Uruguay Round Agreement on Agriculture. However, the interpretation of this criterion has been subject to much debate in both economic and legal terms.
International disciplines for domestic support remain under discussion. In the current Doha Round negotiations, developing countries have voiced concerns about decoupled forms of producer support. They question whether, given the size of program expenditures in developed countries, decoupled programs are truly minimally trade distorting. Interest has been heightened by a recent dispute before the World Trade Organization (WTO). In a case brought by Brazil against U.S. cotton subsidies, the WTO ruled that U.S. direct payments (DPs) (and former production flexibility contract (PFC) payments) do not meet established criteria for exempted (green box) support because of planting restrictions for fruit, vegetables and wild rice (see Eliminating Fruit and Vegetable Planting Restrictions: How Would Markets Be Affected?).
Decoupling is not limited to the United States. Reforms of the European Union's Common Agricultural Policy (CAP) have changed the basis for most producer supports in Europe, reducing the traditional emphasis on commodities in favor of single farm payments and more spending on rural development. (See European Union Adopts Significant Farm Reform, September 2004, for additional details.) Mexico now provides some support to producers through fixed payments, similar in concept to those offered in the United States. In Canada, recent reforms have focused on stabilizating farm incomes without reference to specific commodities. (For more information on these policies, see Recent Agricultural Policy Reforms in North America, April 2005).
U.S. Payments are Based on Historical Plantings of Specific Crops
Decoupled payments for U.S. farmers are linked to base acres that reflect historical plantings of specific program crops as defined in legislation. Payments are made for wheat, corn, grain sorghum, barley, oats, rice, upland cotton, soybeans, and peanuts and other oilseeds.
Producers have nearly complete planting flexibility (apart from restrictions on fruits, vegetables, and wild rice) without loss of program acreage or program benefits. Thus, current plantings are not constrained to a farmer's current allocation of base acres. For example, in 2003, plantings of all program crops represented about 95 percent of total base acreage. On this basis, one could argue that plantings are linked to base acreage. On a crop-specific basis, however, the ratios of planted acres to base acres have varied substantially, indicating that a significant amount of base acreage is not planted to the specific crop to which the base acreage is associated. (See Economic Analysis of Base Acre and Payment Yield Designations Under the 2002 U.S. Farm Act, September 2005, for more information. The associated Farm Program Atlas mapping tool (updated annually) contains maps showing the ratio of planted acres to base acres for corn, soybeans, wheat, rice, and upland cotton.)
Distribution of Payments
Fixed payments--called DPs under the 2002 Farm Act and PFC payments previously--have accounted for a substantial, but still variable, share of total government payments to U.S. producers in recent years. Decoupled payments declined somewhat over the course of the 1996 Farm Act, as determined by legislation, but the 2002 Farm Act raised expenditure levels on direct decoupled payments. They are projected to remain at $5.2 billion per year during the 2008 Farm Act.
The fixed nature of DPs limits potential variation in expenditures, but despite the introduction of decoupled payments, total expenditures on producer supports have continued to fluctuate over time. Year-to-year fluctuations are driven mainly by programs that continue to be linked to market conditions. These include CCPs and marketing loans.
How Can Decoupled Payments Distort Production?
Although decoupled payments are designed to be less distorting than traditional commodity-based programs, they could conceivably affect production decisions. This effect might occur for a variety of reasons that are best understood in the context of either the broader impacts on farm-household decision making (see Decoupled Payments as Income Transfers, February 2003, and Decoupled Payments in a Changing Policy Setting, November 2004, for more information), or more narrow impacts on farm business decision making. Decoupled payments can also influence production decisions through impacts on land values and farm structure and performance.
Effects on the Farm Household
In principle, a farm household can adjust its decisions in response to a fixed DP in many ways. When a household's income goes up, its expenditures also change--either through consumption, savings, or taxes. Consumption and savings decisions, in particular, can have implications for the farm business. The household may also change its allocation of labor among the farm business, off-farm activities, and leisure.
Consumption of goods and leisure. Consumption effects are often overlooked when assessing decoupled payments. To the extent that lump-sum payments are spent on goods and services, they should have no effect on production decisions. But households also consume leisure, and lump-sum payments may alter time allocations between leisure and labor. Both on-farm and off-farm labor have to be considered, and on-farm labor allocations would be expected to respond to higher farm returns. If decoupled payments did enhance the returns to farming, they might be expected to induce more on-farm labor. However, evidence on the effects for on-farm labor is somewhat limited. For large commercial farms, which account for the bulk of production of program commodities, the introduction of decoupled payments does not seem to have significantly altered on-farm labor allocations. (For additional details, see Decoupled and Coupled Payments Alter Household Labor Allocation, November 2004, and "Labor Supply by Farm Operators Under 'Decoupled' Farm Program Payments" by El-Osta, et al., in Review of Economics of the Household, Vol. 2, No. 3, 2004).
Savings and Investment Decisions. For any household-farm or non-farm, an increase in income and wealth generally makes it easier to save and invest and may also increase the household's access to credit. Households choose among investment options based on a comparison of their expected rates of return. Farm households may choose to increase on-farm investment, through purchases of equipment or other physical capital, if the expected returns to doing so are higher than the returns expected from off-farm investment opportunities. (See Farm Payments: Decoupled Payments Increase Households' Well-Being, Not Production, February 2003, for more information.)
Since fixed, lump-sum payments do not directly affect either on-farm or off-farm rates of return, they would not affect on-farm investment or production levels through capital market channels as long as these markets are efficient and households can access credit or capital. Instead, these payments provide farm households with increased purchasing power to allocate among a variety of uses, including financial investment and consumption.
In a paper presented at the 2005 annual meeting of the American Agricultural Economics Association, Goodwin and Mishra used data from the 2003 Agricultural Resource Management Survey (ARMS) to address how farmers have allocated their decoupled payments (e.g., to the farm operation or household expenditures). Farmers reported spending a large share of these payments on their farm operation, but it is unclear whether this spending was offset by reduced spending on the farm operation from other income sources.
Effects on the Farm Business
Within the context of the farm business, decoupled payments can affect production decisions through several other mechanisms.
Farmers' attitudes toward risk. Fixed DPs may alter a producer's tolerance for risk. If producers show less aversion to risk when their wealth increases, as assumed in some theoretical economic models, then a lump-sum payment may induce a change in output or crop mix. In short, the "wealth effect" associated with such payments may encourage farmers to absorb more risk, such as by producing crops with more variable yields and prices.
This rather subtle effect would depend on the risk attitudes of individual producers and on the size of decoupled payments relative to net worth. Empirical evidence on U.S. producers is mixed, with a wide range of risk attitudes reported in the literature. (See Decoupled Payments and Farmers' Production Decisions Under Risk, November 2004, for additional details.) For many large commercial farms, decoupled payments are small relative to net worth, suggesting that the wealth effects (in terms of production impacts) may be modest.
In a study of acreage planted to program crops in the Corn Belt, Goodwin and Mishra found that decoupled payments led to some increase in the production of soybeans, but effects were modest ("Another Look at Decoupling: Additional Evidence on the Production Effects of Direct Payments," American Journal of Agricultural Economics, Vol. 87, No. 5, November 2005). Effects on corn and soybeans were also attributed to Market Loss Assistance "emergency" payments, with impacts again estimated to be modest. Other recent evidence suggests that government payments are less important than crop rotation, input costs, and expected crop prices in influencing acreage decisions (See "Farm Operator Decisions," pp. 42-46, in the 2004 issue of Agricultural Income and Finance Outlook ).
Capital market imperfections. Capital markets are sometimes characterized by imperfections that can induce creditors to restrict producers' access to capital or credit. In such cases, farm households that have limited access to credit may use fixed DPs to increase on-farm investment. (See discussion in Decoupled Payments to Farmers, Capital Markets, and Supply Effects, November 2004.) However, farm investment patterns do not rely on farm cash income--which includes government payments--except in relatively rare circumstances, both for the sector as a whole and for individual farms.
Furthermore, evidence suggests that capital constraints have not been an important determinant of U.S. production of program commodities in recent (nonrecessionary) years. However, if there is a "credit crunch" associated with farm recessions, for example, then fixed DPs may raise on-farm investment to more efficient levels.
Impacts on land values and rents. Because fixed DPs are assigned to base acres, the expected value of these payments should be reflected in land values through a process called capitalization.
Owners of base acres are clear beneficiaries in terms of asset values. But fixed DPs are made to farm operators rather than farmland owners, and most base acres are rented, according to available data from ARMS. What does this mean for the distribution of program benefits? To the extent that rental rates for cropland adjust upward to reflect the value of payments on base acres, the value of fixed payments is transferred, at least in part, from operators to the owners of base acres.
According to ERS research, producers who rented cropland (on a cash rental basis) in 1992 paid on average a 21-cent premium per dollar of government payments received. They paid a 33-cent premium in 1997, 1 year after the PFC program went into effect. These findings suggest that government payments had a stronger influence on land rental rates in the later period, after the introduction of decoupled payments. However, the rise in land rents did not fully reflect the amount of government payments received by renter-operators. (See the discussion in Effects of Government Payments on Land Rents, Distribution of Payments Benefits, and Production, November 2004.)
Knowledge about ownership patterns of program acres is incomplete. However, data on the ownership of U.S. cropland show that only 35 percent of rented acres are rented from one active farmer to another, while 65 percent are rented from non-farming landlords. Although these data suggest that a large share of benefits ultimately leave the farm sector, many of these non-farming landlords have a relationship to farming in that they are retired farmers, surviving spouses, or heirs. Nonfamily corporations or other types of business organizations own less than 10 percent of rented farmland.
Impacts on Farm Structure and Performance
A study by Key and Roberts, Do Government Payments Influence Farm Business Survival? (July 2005), used Census of Agriculture data to examine how program participation has affected growth in farm size. Results indicate that, after accounting for various farm characteristics, farms of commodity program participants tended to grow faster than those of nonparticipants--even after decoupled programs have been in effect.
Ahearn, et al., in "Effects of Differing Farm Policies on Farm Structure and Dynamics" (American Journal of Agricultural Economics, Vol. 87, No. 5, November 2005) also considered the effects of commodity programs on farm size and survivability. In general, their results support the notion that farmers who participated in programs expanded their farm size by buying additional farmland.
What Can We Conclude?
Conceptually, payments that are "decoupled" in terms of their implementation criteria could affect agricultural production in several ways. While results are not always consistent, most empirical studies conclude that the impacts of U.S. fixed direct payments are relatively modest. Among economists, there is general agreement that that these payments exert less influence on production decisions than traditional "coupled" forms of producer support.
Decoupled payments were intended, in part, to reduce variability in federal expenditures for commodity programs. Although expenditures on fixed payments are determined by legislation and not subject to market uncertainties, they are only one component of U.S. commodity programs. Other forms of support, including marketing loans and CCPs, continue to drive year-to-year variation in expenditures.