What's wrong with rural Australia

Whether one looks at protectionist policies of Europe and America or the free-market approach of Australia, rural sectors are in decline in mature economies. Orthodox economic theory appears unable to provide an analytical framework that can explain this phenomenon in the real world of mature growing economies.

For almost three decades Australia has pursued ad hoc rural policy underwritten by market economic theory advocating increased efficiency, rising productivity, and free international trade. The legacy of this policy approach is a battered and debilitated rural sector characterised by industry crises, volatile commodity prices, inadequate farm incomes, declining services, rising levels of poverty, suicide rates of international significance and population relocation.

To throw some light on how rural Australia has arrived at this sorry situation, we should eschew the rhetoric and do a reality check by shining the statistical spotlight on farm incomes; tracing rural policy development since the 1980s and examining an alternative analytical framework while recognising the reality of political economics. We might then be in a position to say what needs to be done for regional development.

Farm Incomes

The current improvement in cattle and wool prices is being heralded by the metropolitan media as evidence of a booming rural sector and the success of free-market policies. Analysis of purchasing power discloses that in terms of national income distribution, rural Australia is not booming. Indeed, real income of broadacre agriculture has markedly declined over time.

If one examines rural industry terms of trade (using figures from ABARE), the real net value of farm production and the consumer price index over the period from 1978 to 2001, it becomes obvious that farmers' terms of trade have declined markedly while prices in the wider community have risen i.e. prices for farm production have risen more slowly than prices measured by the CPI.

Looking at the relationship between costs, production, debt and nominal farm income for the same period, it can be deduced that costs drive production that is debt financed. Also demonstrated is that policy directed to increasing efficiency and rising productivity has made little difference to the value of farm income that remains in farm hands. The increasing divergence between gross value of farm production (GVFP) and net value of farm production (NVFP) confirms the rising proportion of farm production that is being redistributed to the wider community. In other words, policy directed to rising efficiency and increased productivity has not improved the relationship between GVFP and NVFP.

The policy response under market economics has been to reduce the number of farmers. This way NVFP is shared among fewer and fewer farmers. Mathematically, average farm income should rise. An alternative interpretation is that the increasing divergence between GVFP and NVFP represents discretionary policy redistributing income from the farm sector to underwrite incomes and living standards in the wider community.

Rural Policy

In 1994 Jonathan P. Sher and Katrina Rowe Sher published a paper in the Journal of Research in Rural Education. It was based upon work they had been commissioned to undertake for the Australian DPIE and was not so much an economic analysis as a narrative outlining their findings and conclusions drawn from wide international experience.

Sher and Sher had been asked to prepare a paper outlining a strategy for rural development based upon rural education and entrepreneurship. When they began to review existing Australian literature on the subject, they were astounded to find that very little was available. They found detailed material on specific rural places, rural groups and individual industries but they could not source a single convincing contribution that addressed the reality of life beyond cities and suburbs. They came to the conclusion that in 1993 for Australia, there existed no rural development strategy at all.

They changed their original task from rural education and entrepreneurship to one of writing a program for rural development. They used their experiences from OECD work and observations of applied empowerment strategies to compile their contribution to Australian rural development policy.

What is clear from their paper is that the Australian agro-political movement and major political parties enthusiastically embraced market theory from the early 1980s without a substantive rural development plan or understanding of likely outcomes. It appears ideology was the driving force.

According to Sher and Sher, empowerment should not be understood as a policy option in which government has no role. Empowerment of communities is based upon some central concepts - all involved parties agree on some important fundamentals and an operational strategy; each stakeholder must be empowered to contribute specific skills and the activity must be appropriately funded. It would be necessary for government to develop empowerment-promoting policies and accept a role as a partner in rural development.

Over the past three to five years, however, constructive discussion on rural policy appears to have waned and, in the name of empowering rural communities, politicians have effectively fragmented the rural voice and managed dissent by arguing that rural communities know best their own solutions.

The policy position that local communities are responsible for their own destiny carries a number of interesting implications. It would appear that rural policy accepts responsibility only for positive economic outcomes such as deregulated labour markets, competitive exchange rate, low inflation and interest rates, vibrant industries and communities that are growing. Negative economic outcomes affecting industries, communities and regions are not the consequence of policy. They are stand-alone situations determined somehow within communities lacking a sense of "community" and quality local or industry leadership.

Shifting responsibility for perverse policy outcomes back to community level makes individual communities feel somehow to blame for their plight. Consequently, every small community seeks to demonstrate responsibility for its situation by chasing individual solutions such as local tourism, retirement housing; local market days, and some promising industry. Effectively, each community competes against its neighbor to secure its own small portion of any available project or dollar.

This is an 'enclave theory' of rural renewal based upon a philosophical position.

The1999 Draft Report of the Productivity Commission tells us that the majority of small rural communities continue to grow. Overall, rural population is growing in absolute numbers - but the distribution is shifting, producing such phenomena as sponge cities and coastal drift. Population is declining in the 31 per cent of inland communities based upon grazing, wheat and mining. These towns comprise the service centres for major industries in inland rural Australia and herein lies the policy problem.

Graphical analysis of the monetary value of all farm assistance expressed as a percentage of farm gate revenue (%PSE) in OECD countries from 1997 to 1999 reveals that all member countries except Australia and NZ increased the %PSE. (Australia continued to reduce support from 7 per cnet to 6 per cent while NZ remained constant at 2 per cent). This suggests that OECD member nations considered farm revenue support a more important policy mechanism than empowerment.

Alternative Analytical Framework

Engel's Law states that as income grows, the demand for food grows less than proportionately. This is a Law of pervasive importance in economic growth. - Kindleberger

Its presence can be demonstrated whether considering the behavior of an individual, a nation or several nations, and it explains why as an economy grows and incomes increase, demand increasingly shifts away from food with low-income elasticities of demand e.g. grain and other staple foods. Consequently, the relative price of food declines compared to expenditure on manufactured goods and services. These effects of Engel's Law occur across both domestic and internationally traded goods and services.

In the real world, Engel's Law can help explain the structural realignment of agricultural sectors in economies as they grow over time. An important point is that Engel's Law does not disappear at some given level of economic maturity. It is a continuous process and mature economies such as Europe, America and Australia continue to experience ongoing structural realignment of agricultural sectors in their economies.

It is important to remember that while agriculture declines relatively in an economy, in absolute terms agricultural output continues to grow. Engel's Law directly challenges market economics and its belief in an international free-trade solution and establishes the case for managed trade. The political agenda that restricts Australian trade-policy debate to a position of either 'fortress Australia' or 'free trade' says more about the quality of politicians and ideology than about the breadth of economic theory.

Conventional supply -and-demand theory explains price determination under market forces through business-cycle activity. There is an optimum price level determined in the market when the level of supply equals the level of demand. From the price elasticity of demand for food implied in Engel's Law, it follows that production beyond the optimum level will see prices decline disproportionately to the increase in output.

Considered together, Engel's Law and conventional supply-and-demand theory mean that rural decline is a problem of structural realignment of a rural sector in a growing mature economy. Engel's law explains why under rising incomes food expenditure falls proportionately in overall expenditure patterns. Structurally, this implies rural production will decline as a proportion of overall aggregate output in a mature economy.

Supply-and-demand theory explains the volatility of the price over a trade/business cycle. Supply and demand theory also explains the oscillations of the terms-of-trade curve around the long-term trend curve at any given moment in time

Market economic theory with its emphasis upon increased efficiency and rising productivity cannot solve the long-term decline in real farm prices. Continued adherence to market theory is more likely to reinforce trade-cycle momentum than produce desired stability. Indeed, in time of international oversupply, increasing efficiency and rising productivity will have the perverse policy effect of exacerbating the oversupply problem and exert increasing downward pressure upon already inadequate prices.

The solution lies in management of structural realignment and not in increasing production.

Political Economics

Political economics would identify the Australian economy as a competitive capitalist system. All the major political parties easily meet the characteristics of contemporary conservatism. They all philosophically support low taxation, small government, free international trade, competition policy in some form and 'empowerment of rural communities' regional development strategies.

Party policy positions differ only in degree and rhetoric. In other words, their political orders are remarkably similar while their economic orders differ only at the margins.
Specific policy issues of rural income distribution, drought policies and regional development comply with the central tenets of contemporary conservatism and competitive capitalism.

The Universal Solution: Regional Development

The Productivity Commission Draft Report (May 1999) identified rural towns in decline as primarily support-centers for dryland grazing, wheat and mining industries. These major rural industries comprise broadacre agriculture accounting for approximately 60 per cent of gross value of agricultural output. In these towns, protracted commodity price dislocation and volatility has undermined income stability, saving, investment, industry confidence, regional development and stability.

Recently, commodity prices have recovered somewhat but, over time, purchasing power of commodity prices remains below real price movements in the wider community. Given the cyclical nature of commodity prices, it is uncertain how long the current relief will remain

Rural and regional development through infrastructure expenditure has become the solution slogan for politicians and market economists to address these underlying rural problems. Rural and regional development, however, implies establishment of new industries to rebuild declining towns or regions. Infrastructure by itself is only one aspect of the underlying problem.

Moreover, to attract industries to new locations, certain characteristics are required - a core population base necessary to deliver services, capacity to service markets and a skilled workforce. Competitive business does not welcome unnecessary hardships when selecting a new location. It is more likely to select towns offering established service centers and required work skills.

The rural workforce is poorly educated relative to urban workers where 15 per cent of breadwinners hold a university degree at pass or higher level compared to 8 per cent in rural areas (Productivity Commission Draft Report). Moreover, and according to the National Farmers' Federation, only 25 per cent of Australia's farm workforce have completed secondary school or hold a trade or tertiary qualification. The figure for New Zealand is 50 per cent and Europe 90 per cent.

Real-world industries looking to relocate are more likely to seek out vibrant and viable towns possessing the necessary attributes. While it is fine to include tourism and retirement industries in a balanced development program, over reliance on these low-income industries could prove self-defeating. Low-income, aged communities characterised by entrenched poverty traps are unlikely to attract modern expanding industries. Older type industries seeking low-wage workers to survive will transfer their own problems to debilitated towns.

What Needs to be Done

Economics is about choice - and market economics concentrating on efficiency and microeconomic reform is only one option. Solutions are available but they lie beyond narrow market theories and embrace income distribution, sustainable economic growth, full employment, rising standards of living and equality of opportunity. Solutions must be two-tiered: short term and long term. And the overall policy objective of rural and regional development must be broken into two major economic targets: stemming the disproportionate flow of GVFP to the wider community; and reality-based regional development for declining broadacre service towns

Development of a comprehensive regional development strategy will require a "sea change" from the popular empowerment thesis.

Political economics tells us that no directional change in rural policy will be possible without change in the established Australian political and economic orders. This will require a strong rural voice in the political process and the development of a third way for Australia, lying somewhere between competitive capitalism and over-zealous modern liberalism. Without a directional change in rural policy, substantive rural renewal will not take place. Established commodity price volatility will continue to undermine income stability, saving and investment patterns, industry confidence and regional stability and development.