Large farms receive large subsidy payments. This relationship is largely mechanical. Since the policy subsidizes production and land, farms with greater production and land will, consequently, receive more government payments. But the question arises whether subsidies enhance efficiency in agriculture.
An important way that subsidies enhance efficiency in agriculture is by providing farmers with greater access to capital. Numerous studies have concluded that U.S. farmers behave as though they have limited access to credit. Several empirical papers demonstrate a relationship between farm investment and the availability of internal funds. The findings all indicate credit constrained behavior among U.S. farmers. In other words, farmers face capital market imperfections. By solving such a market failure, government plays a key role in substantially increasing efficiency in the agricultural sector.
Researchers at the Department of Agriculture have closely investigated the impact of government payments on the structure of agriculture in the U.S. Their findings indicate that “government payments are strongly associated with subsequent concentration growth.” In other words, farms that receive large subsidies per acre grow faster. In similar work, Roberts and Key use quasi-experimental methods to examine the effect of government payments on farm concentration growth. Using farm-level data from the 1987-2002 quinquennial Census of Agriculture, they explore the relationship between per-acre subsidies and the growth in the size of the median farm in each zip code in the U.S. They find that per-acre government payments explain about half of the growth in farmland concentration. A plausible explanation of their findings is that government payments help farmers overcome liquidity constraints to exploit increasing returns to scale. In other words, government payments address capital market imperfections and in doing so they allow farmers to become increasingly efficient.
One way to measure the efficiency of U.S. agriculture is by the returns to investing in agriculture. Economists at the USDA’s Economic Research Service have shown that as farm-size increases, so does the return on equity. White and Hoppe show that, in 2009, farms with more than $1 million in sales achieved a 4.6 percent return on equity. In contrast, the average return on Treasury Inflation-Protected Securities was about 2.3 percent in 2009. The long-run average return on equity for the largest farms is about 6.5, which is comparable to the long-run return to the stock market.
When considering the justification for economic support for agriculture, one must carefully consider the economic benefits. Evidence suggests that farmers face capital market imperfections, which could lead to under investment in agriculture. Government payments overcome capital-market failings, and the economic returns appear to be quite high.
(Excerpted from Barrett Kirwan. 2014. “Economic Support for Agriculture,” in Public Economics: The Government’s Role in American Economics, edited by Steven Payson. Oxford UP: New York.)