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

Ben Rees, 23/11/2012

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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