Economic philosophy fails Australian agriculture

Hawke/Keating removed industry protection to reform Australian agricultural through exposure to foreign competition. International competition would force Australian agriculture to increase efficiency and raise productivity. Table 1 shows empirically how applied policy produced perverse outcomes of falling profits and rising debt as the number of farm units decline.

Because of available data, Table 1 is average calculations. The distribution of debt per farmer is the significant figure and that is not available in public published data. The seriousness of the debt crisis cannot be overstated. The populist urban "armchair" commentator's view of inefficient small scale farmers in trouble is nonsense. From our Rural Debt Round Table activities, this time it is large scale efficient mechanised farmers that are in serious financial difficulties. These are the farmers who "bought" the political spin of economies of scale as the pathway to profitability. As 20% of farmers produce 80% of national agricultural production, should these large farmers default on debt, then there is a national food production problem

The evidence is indisputable. As the level of debt rises, the value of output per dollar borrowed declines. The Table shows that in 1983, debt equalled 50% GVFP and each dollar borrowed supported $2.13 of output. By 2003 debt equalled 94.7% of GVFP, each dollar borrowed supported one dollar of output. From 2004, the value of output from a dollar borrowed falls to 74^c in 2012. Table 1 shows the dismal failure of applied policy that sought to build an internationally competitive and prosperous rural sector through deregulation, economies of scale, increased efficiency and rising productivity.

Why did banks continue to advance monies to farmers that were producing declining volumes of output relative to monies borrowed? There is no secret to that answer: debt to equity finance. As asset prices in the wider community rose, rural land prices increased also. Banks chasing market share ignored a long standing financial fundamental: capacity to repay debt form income.

When the GFC hit over 2008-09, rural finance changed. Capital market securities backed rural mortgage pools were no longer attractive to investors. Investors realized that underlying rural mortgage pools were overvalued. Capital markets effectively devalued rural mortgage pools by their reluctance to buy the securities based upon those pools.

The toxic nature of rural mortgage pools meant that debt to equity lending ceased. Farmers were asked to meet debt commitments from income. As loans were never designed to be repaid from income, heavily indebted farmers were seriously exposed the will of creditors. As finance dried up, forced sales created an oversupply of rural properties. Oversupply of properties for sale generated further downward pressure on rural land prices. Falling land values eroded formerly sound debt to equity positions. Consequently, the rate of insolvencies began to rise as banks sought to protect portfolios. Inevitably, rural suicides began to escalate as some farmers saw no other way out.

Pre GFC existing government farm finance programs were never designed to address consequences of a GFC type event. Widespread drought simultaneously compounds the financial positions of farmers whilst increasing pressure on State rural assistance programs. Rural Australia is a mess and the responsibility comes back to long term policy failure by successive governments besotted with elegant neoclassical mathematical models providing unquestioned advice to government.

4. Why did Rural Policy fail?

"Our criticism of the accepted classical theory of economics has consisted not so much in finding logical flaws in its analysis as in pointing out that its tacit assumptions are seldom or never satisfied, with the result that it cannot solve the economic problems of the actual world"  J.M.Keynes General Theory.p. 378

This excerpt from Keynes' General theory provides a clue to why neoclassical rural policy has failed to deliver a profitable farm sector for over three decades. Underlying assumptions of neoclassical theory do not reflect the real world of agricultural production

Firstly, the economies of scale solution implicitly assumed constant returns to scale. Table 1 demonstrates empirically that agriculture operates under declining returns to scale - not constant returns to scale. Consequently at some point, further expansion of a farm enterprise produces an unprofitable farm. Underlying assumptions implicit in the economies of scale policy not reflect the real world of agricultural production.