Opinion: Rural debt issue not a market failure, but a policy failure

By Ben Rees23 Nov 2012

Ben ReesIn this opinion article economist Ben Rees, who was recently invited to present at the Federal Treasurer’s Rural Debt Round Table in Brisbane, outlines why he believes the debt crisis now gripping Australia’s rural sector is a consequence of long-tern rural policy failure. 

 

 

 

 

Rural debt and Net Value Farm Production. Chart: Ben Rees (Click on images below story to view charts in larger format)

 

On October 17, a Rural Debt Round Table was held in Brisbane.

It was an initiative of the Federal Treasurer Wayne Swann and northern Queensland independent MP, Bob Katter.

Farmers at the conference told of unserviceable debt levels, and, post GFC collapse in rural asset values. 

Combined with unserviceable loans and collapsed property values, some of Australia’s largest farmers now face the prospect of bank foreclosure and insolvency. 

As a consequence of financial distress, stories confirmed regular suicides among farming communities across the Australian agricultural landscape.

Debt is a symptom of a much deeper malaise in rural Australia.

The real problem is low farm income.

This can be directly attributed to economic theories that have structured industry reforms since 1983.

It is interesting to note that agro politicians cannot bring themselves to identify the problem of low farm income.

Instead they talk about low profitability.

This term is a “cop out”.

It does not explain the level of rural suicides and pending insolvencies of large farmers.

It sits uncomfortably besides trading accumulated tax losses discussed at the Round Table. 

Policy failure comprises three components: blind adherence to supply side economics, a changed financial system, and, a high level of monopoly power in both input and output markets facing agriculture.

Underwriting policy failure has been inept leadership at all levels of rural political representation.

This short article cannot discuss all three components; but, will concentrate on financial failure and underlying economic theory.

The Hawke Administration brought supply side economics to Australia in 1983.

Supply side economics relied upon asset inflation to deliver economic growth.

Deregulation of the financial sector and globalised capital markets were an important step in this theory.

Financial deregulation spawned a different banking system known as “originate to distribute”.

Under this model, banks lend and then securitise the mortgage which forms an asset pool underwriting securities sold into national and international capital markets.

The model became a “driver” of business and encouraged imprudent lending practises among financial institutions.

The rural sector became a target market for this banking model. Land prices inflated as debt equity lending became the norm.

The GFC brought an end to asset inflation.

Rural debut and secruritisation. Chart: Ben ReesPoor quality securitized assets became difficult to sell and market values fell.

Deflation of financial securities flowed back to the values of original real assets.

Lending based upon debt to equity ratios ceased.

Business was confronted with servicing loans from income.

Heavily indebted large farmers suddenly found insolvency a real possibility.

Supply side economic supply theory is based upon Jean Baptist Say’s 1803 Law of Markets, commonly referred to as ‘supply creates demand’.  This theory of supply and demand is unquestioned by all major political parties, industry leaders, and media commentators.

In 1995, “Beating the commodity price cycle”, the NFF restates Say’s Law of Markets in terms of aggregated demand for commodities and manufactures.

Under Say’s Law, there cannot be an oversupply of production.  All production provides income for producers which is expended on the production of others.   Say’s Law is essential for a belief in free trade.

Say’s Law implicitly relies upon one definition of economies of scale: constant returns to scale which underwrote the “get big or get out” policy.

Under constant returns to scale, production can continue infinitum maintaining the same level of profit. 

Real agricultural data not only refutes constant returns to scale; but, confirms another definition of economies of scale: declining returns to scale.

Under declining returns to scale, there exists a point beyond which further expansion becomes unprofitable. 

Blind adherence to Say’s Law of Markets and its flawed definition of economies of scale lies central to failed rural policy.

Say’s Law fails because it conflicts with another important law in economics: Engel’s Law.

In 1856 Ernst Engel empirically researched consumption of food at household level.

He postulated that as incomes rise in growing economies, the demand for food declines. 

In modern microeconomics Engel’s Law translates into the shift in a consumer budget preference away from food as incomes rise. 

A 2011 Massachusetts University research paper confirms that Engel’s Law is as relevant today as it was when it was first formulated in 1856.

The same cannot be said about Say’s Law of Markets.

Fundamental conflict in economic knowledge lies at the centre of agricultural policy failure.

Contemporary agricultural policy is based upon Say’s Law of Markets; and, assumes purely competitive markets.

Engel’s Law relates to changing consumer preference as incomes rise which affect the demand for food.

They cannot both hold true in the real world. 

Rural policy failure then becomes the consequence of a conflict in economic knowledge.

 

Ben Rees is a farmer and an economist. To visit his website click here

 

 

 

3 comments

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  • Gaucho Gill - 04 Dec 2012
    Asian corporatism, as described by Jonathan Unger and Anita Chan in their essay China, Corporatism, and the East Asian Model: "...at the national level the state recognizes one and only one organization (say, a national labour union, a business association, a farmers' association) as the sole representative of the sectoral interests of the individuals, enterprises or institutions that comprise that organization's assigned constituency. The state determines which organizations will be recognized as legitimate and forms an unequal partnership of sorts with such organizations. The associations sometimes even get channeled into the policy-making processes and often help implement state policy on the government's behalf." The Federal Government has set itself up as the arbitrator of legitimacy and assigning responsibility for a particular constituency (the Red Meat Industry) with one sole organization (RMAC), the Federal Government limits the number of players (by legislation) with which it must negotiate its policies and co-opts their leadership into policing their own members and enforcing the Government’s policy dressed up as “industry” policy. We must all fight to throw off the yoke of tyranny; you must all resign from your SFO and when you do, demand in writing back from them a document that states that they do not represent you anymore, and then join a non-aligned group. We want a privatized industry without Government ownership or intervention; to achieve that, the current structure must go and the current economic model must change so that we get financial benefit for our production, regain our equity and our independence.
  • John Mkichelmore - 01 Dec 2012
    The existing "free" market is not working; and farmers are no longer willing to or able to invest in Australian agriculture because the returns no longer sustain the current property valuations. Economics 101, if you can't make money, you sell up and get out, and you certainly don't invest. Governments continue to regulate and make everything compulsory, including farmer representation; in the belief that the few elite at the top of these "representative" organisations know best. The problem is we operate in a free market ( because of the free trade deals) , but there is nothing free about the internal Australian mechanisms of control, and thus agriculture is basically in its death throws for Australian farmers. While overseas investment continues, because the overseas investors have the money and are looking to feed their populations into the future, this option is the only way Australia can feed Asia, by selling the farm, allowing most cost effective overseas workers in, and allowing the overseas owners to ship the base food stuffs; grain, cattle, sheep, strawberries; unprocessed, back to the home land where the profits will be made. Whom is it that will ackowledge what Ben has put so well here, and do something about it:- 1) Banks- I don't think so; if the problem is acknowlegded by them , then their mortgages on what is mostly rented land which should be valued based on production capacity drops to less than half what they are now. Banks don't want to see or hear about the problems. 2) Governments- I don't think so; their income from leases, land tax, rates are all related to the overvaluation. To acknowledge a massive problem like this would highlight that Australian farmers can't feed Asia into the future, mostly farmers will be bankrupt , retired or doing something not related to agriculture in the future. Governments don't want to see or hear about these problems. Until they acknowledge the looming disaster valid longterm solutions will not be forthcoming. Hence the Asians will buy our land and assetts and feed themselves. Hopefully there will be enough food left for the Australian city populations, when there isn',t maybe the voting population will wake up. Government has no idea how to handle the catastrophy. 3) Farmers. Yes they know, they are selling up, advising there kids not to go farming, trying to let government and banks know there is a major problem, however if they have no voting power, the banks and government are in denial and haven't any idea about a solution, and the government levy funded representaive organisation are more concerned about power; what are famers supposed to do. Farmers cannot fix this disaster by themselves, where is the leadership we need. Maybe we need the Chinese running this country, we certainly aren't doing it for ourselves!!!
  • Rowell Walton - 24 Nov 2012
    Wayne Swan and Bob Katter gave a group of participants from most states an opportunity to show just what the economic health of their communities looks like. What became clear was that fro some life is very difficult indeed. The WA contingent indicated that in some districts every farm was for sale, while the northern cattle industry had approximately 30% of its operators insolvent. Of course for most communities a severe problem is approaching as capital values come under pressure. So the question left on every-bodies lips is what next. One may well ponder the future with adjustment upon us with no safety net. Governments it seems recognize agriculture plays a huge role in the national economy and they know if agriculture is healthy then it follows that we all benefit, but they seem to be unaware of the impending crisis. I agree with Wayne Swan when he stated that "we need new ways of doing things so we are still standing for the future". We need to bend our minds to find those methods and it seems the past performance has left us uncomfortably at risk of wholesale collapse.

 

 

 

Home 24 Apr 2014

Opinion: Rural debt issue not a market failure, but a policy failure

By Ben Rees23 Nov 2012

Ben ReesIn this opinion article economist Ben Rees, who was recently invited to present at the Federal Treasurer’s Rural Debt Round Table in Brisbane, outlines why he believes the debt crisis now gripping Australia’s rural sector is a consequence of long-tern rural policy failure. 

 

 

 

 

Rural debt and Net Value Farm Production. Chart: Ben Rees (Click on images below story to view charts in larger format)

 

On October 17, a Rural Debt Round Table was held in Brisbane.

It was an initiative of the Federal Treasurer Wayne Swann and northern Queensland independent MP, Bob Katter.

Farmers at the conference told of unserviceable debt levels, and, post GFC collapse in rural asset values. 

Combined with unserviceable loans and collapsed property values, some of Australia’s largest farmers now face the prospect of bank foreclosure and insolvency. 

As a consequence of financial distress, stories confirmed regular suicides among farming communities across the Australian agricultural landscape.

Debt is a symptom of a much deeper malaise in rural Australia.

The real problem is low farm income.

This can be directly attributed to economic theories that have structured industry reforms since 1983.

It is interesting to note that agro politicians cannot bring themselves to identify the problem of low farm income.

Instead they talk about low profitability.

This term is a “cop out”.

It does not explain the level of rural suicides and pending insolvencies of large farmers.

It sits uncomfortably besides trading accumulated tax losses discussed at the Round Table. 

Policy failure comprises three components: blind adherence to supply side economics, a changed financial system, and, a high level of monopoly power in both input and output markets facing agriculture.

Underwriting policy failure has been inept leadership at all levels of rural political representation.

This short article cannot discuss all three components; but, will concentrate on financial failure and underlying economic theory.

The Hawke Administration brought supply side economics to Australia in 1983.

Supply side economics relied upon asset inflation to deliver economic growth.

Deregulation of the financial sector and globalised capital markets were an important step in this theory.

Financial deregulation spawned a different banking system known as “originate to distribute”.

Under this model, banks lend and then securitise the mortgage which forms an asset pool underwriting securities sold into national and international capital markets.

The model became a “driver” of business and encouraged imprudent lending practises among financial institutions.

The rural sector became a target market for this banking model. Land prices inflated as debt equity lending became the norm.

The GFC brought an end to asset inflation.

Rural debut and secruritisation. Chart: Ben ReesPoor quality securitized assets became difficult to sell and market values fell.

Deflation of financial securities flowed back to the values of original real assets.

Lending based upon debt to equity ratios ceased.

Business was confronted with servicing loans from income.

Heavily indebted large farmers suddenly found insolvency a real possibility.

Supply side economic supply theory is based upon Jean Baptist Say’s 1803 Law of Markets, commonly referred to as ‘supply creates demand’.  This theory of supply and demand is unquestioned by all major political parties, industry leaders, and media commentators.

In 1995, “Beating the commodity price cycle”, the NFF restates Say’s Law of Markets in terms of aggregated demand for commodities and manufactures.

Under Say’s Law, there cannot be an oversupply of production.  All production provides income for producers which is expended on the production of others.   Say’s Law is essential for a belief in free trade.

Say’s Law implicitly relies upon one definition of economies of scale: constant returns to scale which underwrote the “get big or get out” policy.

Under constant returns to scale, production can continue infinitum maintaining the same level of profit. 

Real agricultural data not only refutes constant returns to scale; but, confirms another definition of economies of scale: declining returns to scale.

Under declining returns to scale, there exists a point beyond which further expansion becomes unprofitable. 

Blind adherence to Say’s Law of Markets and its flawed definition of economies of scale lies central to failed rural policy.

Say’s Law fails because it conflicts with another important law in economics: Engel’s Law.

In 1856 Ernst Engel empirically researched consumption of food at household level.

He postulated that as incomes rise in growing economies, the demand for food declines. 

In modern microeconomics Engel’s Law translates into the shift in a consumer budget preference away from food as incomes rise. 

A 2011 Massachusetts University research paper confirms that Engel’s Law is as relevant today as it was when it was first formulated in 1856.

The same cannot be said about Say’s Law of Markets.

Fundamental conflict in economic knowledge lies at the centre of agricultural policy failure.

Contemporary agricultural policy is based upon Say’s Law of Markets; and, assumes purely competitive markets.

Engel’s Law relates to changing consumer preference as incomes rise which affect the demand for food.

They cannot both hold true in the real world. 

Rural policy failure then becomes the consequence of a conflict in economic knowledge.

 

Ben Rees is a farmer and an economist. To visit his website click here

 

 

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