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UNIVERSITY OF CALIFORNIA AGRICULTURAL ISSUES CENTER


AIC I SSUES BRIEF
Number Two July 1997

A Measure of Subsidy to California Agriculture

Daniel A. Sumner and David S. Hart*

As elsewhere, agriculture in California is heavily influenced by government policy. Most farm programs and other policies that affect agriculture in the rest of the United States apply in California, and the state has responsibility for several additional agricultural programs.

California agriculture is diverse and complex; it is impossible to consider here each of the policies or programs that may be important for individual commodities. Our approach instead is to summarize and measure government transfers to agriculture by commodity and by policy tool. We limit ourselves to programs with a specific agricultural focus. Further, we do not deal with farm labor, environmental, or food safety regulations, or general tax policy.

To provide a summary measure, we describe, calculate and discuss a Producer Subsidy Equivalent (PSE) for California agriculture.

A Producer Subsidy Equivalent for California

The Producer Subsidy Equivalent has often been used to measure agricultural policy impacts elsewhere. Our work represents the first attempt to apply the concept to California. A PSE measures the explicit or implicit revenue transfer to agriculture from government policy. A PSE aggregates such policies as direct payments, import barriers and government research outlays. When calculated as a ratio of total transfer to total industry revenue, the PSE is a rough guide that may be compared across commodities, time and national or other geographic boundaries. When these comparisons are interpreted with care, they provide useful indicators of the impact of policy.

The table shows the contribution of individual policy instruments to the aggregate PSE for California for the 1994-1996 period. Based on the most recent data available, the total Producer Subsidy Equivalent associated with agricultural policies in California is $2,344 million annually. This represents about 10.6 percent of 1995 gross agricultural receipts in the state. As shown in the table, import barriers account for $857 million in subsidy equivalent (37 percent of the total state PSE), followed by input assistance (19 percent). Water subsidies, which apply to most crops, contribute $236 million per year. Direct payments under the Federal Agricultural Improvement and Reform (FAIR) Act of 1996 apply to cotton, rice, wheat and feed grains and are worth about $205 million per year, with almost half going to rice. Agricultural research accounts for about $161 million per year. The remainder of the subsidy equivalent is comprised of export assistance, marketing regulation or assistance, and various other policies.

The Producer Subsidy Equivalent is not a measure of production subsidy, since it measures all transfers to an industry, including those that may do little to stimulate output. Nor is the PSE a reliable measure of import protection or export stimulant, though it is related to such policies. Further, the PSE does not measure producer benefit from government programs. Program outlays or other measures that enter the PSE may do little for net revenue or producer profit. The PSE is simply a convenient summary of a variety of agricultural programs that does not require a full analysis of each industry.

A change in the PSE is itself not an indicator of policy change. In particular, the movement of market prices may cause the PSE to change even if policy parameters are constant over time. This means also that a PSE for a specific year may not reflect accurately the degree of government support for a commodity in other years. Even with these limitations, we believe that the PSE provides a useful summary of subsidy associated with government policies affecting California agriculture.

For the California PSE calculations, we use a large number of sources related to budget outlays, domestic and international prices, quantities and other data. In some cases, we measure a portion of the government subsidy as an average for recent years. For broad-based indirect input subsidies, we use national data and allocate a share of the national total to California based on its share of national receipts. We then allocate the California total to commodities within the state by their share of California agricultural receipts. In other categories, we use California budget data for 1994 or 1995, as available. For direct commodity payments from the federal government, we updated the payment rates to reflect the FAIR Act of 1996.

Contribution of Policy Instruments to California PSE

Policy Instruments Producer Subsidy
Equivalent ($millions)
Percent
Import Barriers 857 37
Dairy
781 33
Sugar
56 3
Cattle & Calves
20 1
Export Assistance 88 4
Export Subsidy
47 2
FMD/MPP
41 2
Government Payment 237 10
FAIR Act Direct Payment 205 9
Disaster Payment 31 1
Input Assistance 456 19
Water 236 10
Farm Credit 156 7
Crop Insurance 33 1
Fuel Excise Tax 1 0
Pest and Disease Control 23 1
Grazing Fees 2 0
Emergency Feed 5 0
Dairy Marketing Order 154 7
Other Marketing 265 11
Advisory 24 1
Inspection 121 5
Processing and Marketing 1205
Research 161 7
Infrastructure/Land Improvements 34 1
Economy-wide Policies 92 4
Taxation 73 3
Transportation 19 1
Total 2,344 100

As noted above, the total Producer Subsidy Equivalent for California agriculture represents $2,344 million or about 10.6 percent of total commodity receipts in California. This number may be compared to the PSE from elsewhere. The Organization for Economic Cooperation and Development (OECD) reports for a variety of countries PSEs for 12 field crops and livestock commodities. The national average PSEs range from about 3 percent of agricultural revenue for New Zealand to over 80 percent for Switzerland. Norway, Japan and Iceland all have PSEs over 70 percent. The OECD reports an average percentage PSE of 21 percent of revenue for the United States. Our figure for California is lower mainly because we use a broader set of commodities and because subsidy rates tends to be lower for fruits, vegetables and other horticultural commodities that are particularly important in California. On a commodity-by-commodity basis, California percentage PSEs roughly equal those for the US as a whole.

The Commodity Distribution of the California PSE

The figure on the next page illustrates substantial variation in PSE across commodities. At the high end, sugar has a PSE of about 69 percent. Rice is next at about 40 percent. Dairy has a PSE of about 34 percent and wheat and feed grains have an average PSE of about 35 percent. Cotton and alfalfa and other hay also have above-average PSEs. Among the horticultural crops, citrus and olives, avocados, walnuts and pistachios, and deciduous tree fruits all have PSEs in the 6.5 percent to 9 percent range. Other livestock, including poultry, and the remaining crop categories have PSEs between 3.4 percent and 6 percent. This low PSE group includes such important California crops as nursery and flowers, grapes, lettuce, tomatoes, almonds and strawberries.

Dairy is the largest single farm industry in California, accounting for more than 14 percent of California farm receipts. The dairy industry is also dominant in terms of government support; when summed across all policy instruments, about 45 percent of all Producer Subsidy Equivalent in California agriculture is provided to the dairy industry. On the other side, the two broad categories of horticultural crops, which include all tree crops, vegetables, and melons, berries and nursery crops, comprise well over half of all agricultural receipts in California, but receive a combined total of only 25 percent of the total PSE for the state.

Producer Subsidy Equivalent by Commodity in California

graph of producer subsidy equivalents by commodity

Discussion of Specific Policies

Certain policy categories warrant further discussion to better understand how we calculate their contribution to the California Producer Subsidy Equivalent. Water subsidy is discussed first. The policies affecting the dairy industry are summarized next. We then turn to direct payment programs and finally to the set of policies important to the horticultural commodities.

Irrigation Water. Irrigation is a key input for agriculture in California. In California, surface irrigation water is provided to some users at prices below cost and below potential market prices for the water.

Much of the reservoir and distribution system that serves agriculture was developed long ago. The federal government's Central Valley Project (CVP) and the California State Water Project (SWP) system of dams and canals are important providers of water. Almost half of the water available in the San Joaquin Valley comes from CVP or SWP sources. Of course, not all growers use project water, and as with other programs, our calculations are averages In addition, over 90 percent of Imperial Valley water comes directly or indirectly from federal or state projects.

Our PSE calculations are based on irrigation water usage by crop and estimates of the subsidy implicit in the state and federal water projects. For quantities of water, we calculate the share of project water by region multiplied by the applied water for that commodity in that region of California. For price subsidy, we use two subsidy rates based on some approximate calculations (by UC Davis Professor Richard Howitt) of transport costs and how a water market would develop if restrictions on water movement towards urban uses were eliminated. For the Sacramento River and Central Coast Regions we use an average subsidy rate of $15 per acre foot of water. These regions have low distribution costs and had substantial irrigation water supplies even before development of the major subsidized projects. For the San Joaquin, Tulare Lake, South Coast, Colorado River and South Lahontan regions, we use an average subsidy rate of $30 per acre foot of water. Overall we estimate that California agriculture producers receive approximately $236 million per year in subsidy from government water projects. This amounts to about one percent of the total value of California agriculture, and is distributed widely across crops. Alfalfa, important in dairy feed rations, receives the largest total water subsidy; about $70 million; more than ten percent of the value of the alfalfa.

Dairy Policy. A substantial share of dairy revenue derives indirectly from several government programs. The total Producer Subsidy Equivalent for dairy in California is about one billion dollars. The California dairy industry participates in the US price support program and the industry benefits from US import barriers and export subsidies. California operates its own marketing order system that differs from the federal system.

Under the federal price support program for milk, whenever prices are too low, the USDA purchases butter, non-fat dry milk (NDM) and cheese from processors. However, the price support program contributed little to the dairy PSE in the 1994-1996 period, and the 1996 FAIR Act scheduled a gradual elimination of the program by 1999.

Import barriers are a fundamental feature of US dairy policy, accounting for more than 70 percent of the total dairy PSE in California. In general, imports of dairy products have been limited by tariff rate quotas to about 2 percent of US consumption. The PSE calculations attribute the difference between the domestic market price and the international market price for tradable dairy products (standardized for quality) to trade barriers.

As with the federal regulations that apply elsewhere, California milk marketing orders establish specific minimum prices according to the end use of the milk (classified pricing). A higher price is required for milk that is used for fluid products. California milk marketing orders include a program under which the additional revenue transferred from consumers by the classified pricing policy is provided to a subset of dairy farmers who own "pool quota." Recently, the amount transferred in this way has been about $154 million per year. This is our measure of the dairy industry subsidy due to the California milk marketing order system.

Direct Payments. Until the FAIR Act, federal deficiency payments were the major government program for rice, cotton, wheat and feed grains. Participants now receive direct payments each year based on a percentage of past deficiency payments. Producers are also relieved of requirements to idle land or plant specific crops. Payments to California participants totaled about $205 million in 1996.

Policies Affecting Fruits, Nuts, Vegetables, Melons, Nursery and Flowers. Commodities in these categories have little government intervention into their markets. The PSEs for these commodities range from about 3 percent to 8.5 percent of the revenue. This subsidy level is derived mainly from the broad based programs (inspection programs, research, farm credit) that support all of agriculture. While these commodities have no explicit export subsidies, they do benefit from small amounts of assistance for foreign market development. Crop insurance benefits and disaster payments are also a source of support for this group of commodities (only strawberries did not receive some income support from crop insurance or disaster payments during 1988-93). In the citrus industry, crop insurance and disaster payments comprise almost 30 percent of the total citrus PSE, based on a 1988-93 average. Large payments were made following a 1990 freeze that took a heavy toll on the California citrus industry.

All commodities in this group have a marketing order or related program. The marketing orders, which are supported largely by assessments, provide a small amount of the subsidy used for promotion or research. Of course, these commodities also are supported by state and federal research funding.

Conclusion

This AIC Issues Brief has described some key policies and provided a set of summary measures of government policy transfers to California agriculture. It is useful to re-emphasize here that the PSE does not necessarily measure net benefits to producers or net economic costs to consumers or taxpayers. Some of the policies benefit rural land owners who may not be active agricultural producers. Other policies may provide substantial benefits to consumers and some may provide net benefits to California as a whole. We emphasize that this study does not claim to have provided the analysis necessary to substantiate any claims about the overall effects of policy.

Because of its commodity mix, and the level and distribution of subsidy across commodities, California agriculture has an average percent PSE that is below the comparable figure in other places. The major horticultural industries in the state compete effectively with little direct subsidy and almost no commodity-specific support. These industries tend to welcome market-oriented policy reform of the sort, for example, that is being pursued in the World Trade Organization. Other California commodities such as dairy products and sugar continue to maintain relatively high import barriers and have traditionally resisted market opening and other policy reforms. However, even these segments of California agriculture expect to prosper as markets are opened and subsidies reduced on a world wide basis.


*Daniel A. Sumner is the Frank H. Buck, Jr., Professor in the Department of Agricultural and Resource Economics at UC Davis and the Director of the Agricultural Issues Center. David Hart is a recent graduate from UC Davis with a major in Agriculture and Managerial Economics. The full version of this research is published as a chapter in California Agriculture: Issues and Challenges, Jerome B. Siebert, Editor.

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