Why farming defies the logic of supply and demand

Non-farming people often throw me a challenge. Telling me I was once an economist, they ask me why, when prices fall, farmers don’t do what any other business would do and produce less. They interpret the fact that farmers don’t do this as evidence the rest of the business world is much wiser than farmers, who ignore economic realities. The first of many times this was asked set me thinking, and the conclusion was depressing. That normal laws of supply and demand have been suspended in enterprises such as dairy and pigs is further evidence of just how bad things are in agriculture.

This adds to other examples where supply and demand don’t work in line with economic theory. That theory is built around price stabilising all markets – as milk and pork prices fall, people should buy more to drive up prices again. Equally, farmers should produce less, bringing the price back towards the balance point of supply and demand. Why that isn’t happening is partly that for food products there’s a limit on demand, and what happens is switching between competing products. Beyond that there’s a more fundamental, global problem in agriculture.

In a situation where prices have plunged, cash has become king. Farm businesses need cash flow to cover overheads and bills, so when prices fall and the incentive should be to produce less, they in fact produce more at low prices to maintain cash flow. They know this makes little economic sense and the industry needs a cut in production, but for their own business the need is to keep the bank at bay by generating cash. That’s why across Europe we’re still seeing milk production rising and why there’s not been a fall in sow numbers, despite the dire situation in that industry.

The economist’s term for this is ‘perverse’ because it goes against what should happen. Perverse economics are acting to prevent market recovery, particularly in the dairy sector. Forecast after forecast for when recovery would happen has been proved wrong, not helped by China’s faltering economy.

The hope is there’s a global limit to how sustainable it is to continually buck supply and demand logic, and production will finally plunge and drive prices up. That’s said more in hope than expectation; for now we seem locked into an era driven by perverse economics.

This isn’t helped by the pressure banks put on farm businesses with their hostile stance towards loans they deem ‘non-performing’ – capital ‘holidays’ where debt isn’t being reduced at the rate bank bosses want. Hopefully the European Investment Bank (EIB) will enter the scene with a move towards long-term farm loans, more akin to mortgages, with repayments linked to the price of the enterprise for which the loan was given.

But for now farmers need a lot of nerve. Things have come to a head as winter feed bills strain cash flows, made worse by the need to buy over-priced fertiliser.

So perverse economic outcomes are the answer to the question from those who think farmers are poor business people because they don’t do what economic theory says they should do. File the term away and next time you’re asked why livestock can’t be switched off like a machine in a factory, look someone in the eye and say it’s the outworking of perverse economics. Few will have the nerve to ask what you mean.

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