Agribusiness News June 2023 – Management Matters

The farm adjustment problem

The cornerstone of micro-economics is that market forces efficiently allocate resources to their best use.  That is, the size of farms and the balance of labour, machinery, buildings, crops, and livestock on them will evolve based on the cost of inputs and price of outputs.  The trouble is that agriculture has a long-known ‘(resource) adjustment problem’, that in simple terms means that too many farmers persist in the industry and farmer incomes suffer as a result.

Meanwhile, some sectors point to growing labour shortages and the next generation complain about the lack of opportunities to farm.  What is going on?

Why do farmers keep on farming?

Farms have generally got bigger over time due to the cost-price squeeze and availability of new technologies.  However, when the annual farm income figures are released, the headlines typically highlight that farm incomes are low relative to other industries.  Of course, there is variation between agricultural sectors with dairying and crop farming consistently averaging higher incomes than beef and sheep farming.

Asset-fixity was the traditional explanation for low farm incomes.  In short, the labour and capital used in farming was difficult to reallocate to other industries because farm equipment and farmers’ skills and knowledge were not readily transferable.

As a result of this low asset salvage value, farmers keep on farming so long as what they sell covers the direct costs of production.  Often only forced to change when faced with a major reinvestment need like, for instance, the dairy complex becoming unmaintainable or failing compliance rules.

More recent research has revealed other important forces are at work.  Farms are often a base for more than farming (pluri-activity) plus off-farm income often bolsters farm household income.  Historical ties and joy of country living are also barriers to change.

Farming is also unique, owing to the importance of the land resource; yet the value of land generally far exceeds its agricultural productivity.

Favourable tax and policy support have been particularly influential.  Scottish, and British, agriculture that a century ago was largely farmed by tenants, is now mostly run by owner-occupiers with balance sheets anchored by land values.  With land now in demand for carbon farming this has inflated the value of upland and hill land considerably.

The term “asset-rich, cash poor”, still captures the essence of why farming on this island has evolved to its current structure.

What can government do?

Given that future Scottish agricultural policy is in the melting pot, what might government do to better help the industry adjust?

The emerging English agricultural policy appears to be supportive of letting market forces shape the adjustment process.  Area support payments are being phased out; indeed, farmers can speed up the process by selling their entitlements for an upfront lump sum.  Grant support will also be available to help transition via the Farm Investment and Skills & Training Funds.

For the dairy and cropping sectors where profitability is less dependent on the area payment, structural change is unlikely to differ much from the current trajectory with contract farming a key mechanism used to achieve business growth.  However, for the livestock rearing sector mainly in the hills and uplands, the loss of area support may prove a major disruptor.  Structural change in such farming areas could be more dependent on how environmental, diversification and socio-economic policy works.

The active farmer conundrum 

Scotland will not follow England in phasing out area payments.  Yet it is likely that a significant drop in this vital farm income stream is coming in Scotland given overall budget constraints and the need to fund environmental schemes.  As drystock farming is relatively more important north of the border, even a small drop-in direct support could trigger significant structural change.

In some areas, explicit socio-economic policy may be needed to prevent a breakdown in the agricultural eco-system.  But such is the extent of livestock rearing across Scotland, managing structural adjustment may be the best means of avoiding a destructive chain-reaction.  That may mean a more nuanced definition of “active farmers” than what many in the industry are calling for.

A good place to start would be to explore how to better connect “older” farmers with capital that wish to continue farming with younger farmers with drive and energy.  Like England, contract farming will have a place, but is there more scope to develop more flexible, joint-venture mechanisms like equity partnerships?

Kev Bevan, 07368 825877