INFLATION AND CANADIAN AGRICULTURE: EFFECTS ON EFFICIENCY, PRODUCTIVITY, AND EQUITY. Michele M. Veeman and Terrence S. Veemanl

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1 INFLATION AND CANADIAN AGRICULTURE: EFFECTS ON EFFICIENCY, PRODUCTIVITY, AND EQUITY Michele M. Veeman and Terrence S. Veemanl Since 1973, inflation has been a pervasive phenomenon affecting the agricultural sectors of most developed and developing countries. Despite its current significance, the issue of inflation and its impact on the agricultural sector is remarkably under-researched. In this paper we assess some of the economic impacts of inflation on Canadian agriculture in an attempt to isolate major influences and their effects. We consider effects on the prices of farmland, the increased risk and uncertainty affecting the industry, and a possible deterioration in the terms of trade between agriculture and the rest of the economy. We assess the effect of these and other inflation related influences on efficiency, productivity, and equity in the Canadian agricultural sector. The general conclusion of the paper is that the impacts of inflation on efficiency and productivity appear to have been minor compared to its distributional effects. Major Impacts of Inflation on Canadian Agriculture The most obvious impact of inflation on Canadian agriculture since 1973 has been on the prices of farmland. Compound annual growth rates reported in table 1 indicate that from 1962 to 1972, the growth rate in the nominal price per acre of Canadian farmland (including buildings) averaged 6.2 percent, slightly more than the annual average increase in the general price level (3.5 to 3. 7 percent as reflected, respectively, by the CPI and GNE deflator). In contrast, from 1973 to 1980 when the annual rate of increase in the general price level averaged 9.3 (GNE deflator) to 9.6 (CPI) percent, the annual rate of growth in nominal farmland values accelerated to 16.1 percent. These increases in the real prices of Canadian farmland which continued to mid-1981 reflect a reaction to increased levels of prices and revenues, particularly for grains and oilseeds, which coincided with increasing rates of inflation. However, the increased real prices for farmland also resulted from increased demand for farmland (whether by established, potential, or part-time farmers) based on recognition that this asset has been an effective hedge against inflation. It may be that, as Tweeten has argued, the rate of return on farmland (consisting both of productivity returns and capital gains) is invariant to the rate of inflation. This has not been tested for Canada. It is possible that part of the substantial increase in real prices of farmland in Canada from 1973 onwards arose because farmland was undervalued in the 1960s and very early 1970s. It is probable, too, that federal and provincial provision of concessional credit for agriculture and taxation benefits available to farmers contributed to the increased real prices of farmland as these features were capitalized into farmland prices. The increasing prices of land and other agricultural inputs have led to pressures for expansion of government provided concessional credit for new entrants to agriculture, and for farmers of marginal size to enlarge operations. The benefits of the lower rates of taxation which apply to all realized capital gains, and, in particular, the rollover provisions for postponement of capital gains taxes on intergenerational family farm transfers increased during periods of inflation and so are also expected to have contributed to the increased real prices of farmland that characterized Canadian agriculture during the period of inflation which has persisted since A second effect on agriculture apparently associated with inflation has been increased risk and uncertainty regarding prices and incomes. Output and input prices, and thus revenues and costs, have, except for their supply managed 45

2 Table 1. Compound Annual Growth Rates of Key Variables Relating to Inflation and Canadian Agriculture, Selected Periods. Item % % Inflation level (1mpl1c1t GNE deflater) Ant1c1pated 1nflat1on level!distributed lag of GNE deflator) Inflation level (consumer price index) Prices received by farmers loff1c1al Laspeyres index) Prices paid by farmers (oft1c1al Laspeyres index) Terms of trade (Laspeyres based) Prices received by farmers (imputed D1v1s1a index) Prices paid by farmers (imputed D1v1s1a index) Terms of trade (D1v1s1a based) Total farm cash receipts Total farm operating expenses plus depreciation Net farm income Labor product1v1ty (output per man-hour) Total factor product1v1ty (D1v1s1a index) Nominal land prices per acre Nominal aggregate capital value of land Nominal value of machinery sales Agricultural implement selling price index Average farm size (acres) CPI, food items only Items 1 to 5, 10 to 13, and 15 to 20 are based on published Stat1st1cs Canada data series, items 7 to 9 and 14 are extensions of Islam ( 1982) commodities, been more variable since 1973, with consequent amplification of risk and uncertainty. A further possible impact of inflation on agriculture is on the terms of trade between agriculture and the rest of the economy. This is not a unique and invariant relationship. In terms of the general features of the demand for agricultural products, the cost structure and thus supply of these products, and the structure of the agricultural input supply and output markets, the economic pressures of inflation, particularly cost-push inflationary pressures, may accentuate declining terms of trade for agriculture. However, this could be overridden by other economic 'forces such as major expansions in export demand or institutional factors such as supply management. Table 1 reports compound growth rates for alternative measures of output and input prices and terms of trade for Canadian agriculture. Both of the terms of trade measures declined from 1962 to This decline was accentuated after We now turn to assessment of some implications of inflation on the agricultural sector in Canada in terms of the two dominant criteria for judging economic performance--efficiency and equity. It would seem that the major effects of escalation in farmland prices are on the level and distribution of net worth of those owning farmland. In contrast, the major effects of increased risk and uncertainty in agriculture are likely to be on efficiency and productivity in the sector. Finally, the impact of any inflation related decline in the terms of trade for agriculture would involve effects on both efficiency and income distribution in the agricultural sector. Effects of Inflation on Efficiency and Productivity The possible effects of inflation on static allocative efficiency as well as on dynamic technical efficiency (productivity) are of interest. A number of effects are possible-some may offset each other or be offset by other economic forces. On one hand, the increased risk and uncertainty which has accompanied inflation 46

3 might be expected to have deleterious effects on efficiency and productivity m agriculture. Distortions of resource allocation decisions might also be accentuated by cash flow and cost-price squeeze problems associated with inflation. These pressures might, for example, cause postponement of farm innovations and investments, particularly those which are highly capital using or those which are not risk reducing. However, the limited evidence of the growth rates reported in table 1 does not support the hypothesis of capital rationing, at least as judged by farm machinery sales. The value of machinery sales rose at a faster rate from 1973 to 1980 than from 1962 to 1972 and at a faster rate than the price increases for farm machinery. There is, however, also the possibility that longer run negative influences of inflation on productivity may arise from governments' efforts to counter inflation by reductions in real levels of government expenditures, including those on agricultural research and extension (Ruttan). General inflationary pressures on agribusiness could also be hypothesized to have adverse effects on the levels of private expenditures on agricultural research. Offsetting these short and long run negative influences of inflation on agricultural productivity, there is the possibility that there may be some positive influence on productivity arising from an inflation caused extension of the treadmill effect. Farmers may react to the increased uncertainties and risks and any inflation related intensification of the cost-price squeeze by more rapid adoption of available technological advances. This effect could be particularly pronounced for risk reducing and relatively low cost technological advances. Whether inflation has had a deleterious impact on agricultural productivity growth in Canada is an open question. The annual average productivity growth rate for the subperiod 1973 to 1980 (1.0 percent) is lower than that for the period 1962 to 1972 (1.9 percent), although much of this decline occurred in 1979 and for the shorter subperiod from 1973 to 1978, productivity grew at 2.7 percent. This issue was further explored by regressing a number of explanatory variables against total factor productivity--see table 2. The sign and significance of the estimated coefficients on the lagged terms of trade and rate of inflation variables are consistent with the hypothesis that inflationary pressures may have intensified a treadmill effect, encouraging the adoption of technological advances in Canadian agriculture. These results should be interpreted with caution. Many observers, including ourselves, would argue that continued long run "stagflation" is apt to have adverse repercussions for productivity performance in agriculture. Table 2. Regression Results: Possible Explanators of Total Factor Productivity in Canadian Agriculture, 1962 to Equation Dependent Variable Explanatory Variables X, R squared ** (0 055) 0017** (0003) 0003* ( X, -o 339** (0078) 0 016* (0 005) 0 003* (0001) ( X 1 = total factor product1v1ty, X, = terms of trade (D1v1s1a based) index lagged one year, X, = rate of 1nflat1on (% change in G N.E deflater); X, = average summer rainfall, 12 prairie centres, mm; X, = nominal federal agricultural research expenditures, millions of dollars, - and * denotes significance at the 1 % and 5% level, respectively 47

4 Effects of Inflation on Equity The effects of inflation on equity in the agricultural sector can be considered in terms of effects on the level and distribution of income and wealth in the sector. The effects on the level of income are not fully predictable. A possible tendency for the agricultural terms of trade to decline during inflation was discussed earlier. The continued increases in total factor productivity have served to partly offset declining terms of trade of the sector. The effect may vary with commodity, region, and time period considered. However, the aggregate effect on Canadian agriculture has been, as reported in table 1, a downward trend in aggregate net farm income from It is, however, inaccurate to view farm income as the sole source of income of farmers- taxfiler data indicate that off-farm income constituted 72 percent of net income of farm taxfilers and 23 percent of net income of full-time farmers in The effects of inflation on wealth in the agricultural sector have been striking. Substantial increases in the values of farm assets (particularly of land) and thus in farmers' net worth occurred duing the 1970s. For example, the real capital value of a Canadian farm increased from $65,756 in 1971 to $113,174 in 1976 and to $172,772 in There are only scanty data on which to assess the distributional impacts of inflation on Canadian agriculture. Table 3 provides a summary of a recent survey of Canadian farmers. It indicates that the large number (41 percent) of relatively smaller farms (with annual gross sales of less than $30,000) account for 5.5 percent of output and 15.5 percent of net worth of the agricultural sector. The relatively low incomes from farm sources of this group are at least partly offset by income from off-farm sources. This group of farmers includes part-time and hobby farmers for whom off-farm income is an appreciable or major source of income, but also includes farmers with very low levels of income and with limited resources and abilities to increase income, whether from farm or off-farm sources. In contrast, the largest farms (with gross sales in excess of $70,000) represent 30 percent of all farms and account for 75 percent of sales and 57 percent of net worth of the Canadian agricultural sector. Increases in wealth associated with inflation have been disproportionately greater for this group of larger commercial farmers. Table 3. Some Characteristics of Farms Classified by Gross Sales Categories, Canada, Gross Sales Under $30,000 $30,000 to $ Over $70,000 Percentage of Farms Average Net Worth $214,919 $385,951 $788,396 Percentage of Net Worth Average Gross Sales $13,974 $49,668 $191,694 Percentage of Sales Average Off-farm Income $15,437 $5,901 $3,966 Source Farm Credit Corporation, Farm Survey, Ottawa. Canada,

5 The possible structural implications of the impacts of inflation are of interest. Schertz and Harrington have suggested that in the United States, inflation related wealth and taxation effects lead to increases in farm size and declines in farm numbers. At first glance the limited data on average farm size in Canada, as reflected in the censuses and in annual Canadian Wheat Board information on permit holders, do not seem to confirm this tendency for Canada. These data suggest that the rate of increase in size of Canadian farms lessened somewhat over the 1970s as compared to the 1960s. However, it seems that a tendency for increasing size of the relatively larger and wealthy commercial farmers is offset by increasing numbers of relatively smaller farmers. Both these tendencies could be associated with inflation and the provisions of Canadian income tax legislation. To the extent that increasing numbers of hobby farmers have been attracted into agriculture by the prospects of capital gains and the (limited) tax advantages of part-time farming, there may be some divorce of farmland ownership from operation, though this tendency is not expected to be as extensive as in the United States. Summary and Conclusions The most obvious effects of inflation on Canadian agriculture in recent years have been the escalation in the real prices of farmland, increased risk and uncertainty, and intensification of the tendency for declining terms of trade of the agricultural sector. Increasing values of farmland have had major effects on the level and distribution of wealth in Canadian agriculture since The effects of inflation on efficiency and productivity of Canadian agriculture are less clear. In the short run, these effects may not be as deleterious as some have feared. Despite the substantial capital gains of landowners over the 1970s, it is too simplistic to conclude that Canadian farmers have benefited from inflation. The real wealth of many farmers has increased substantially (though the distribution of these benefits has been skewed). The sector has also suffered the problems of increased market risks and cost-price squeeze pressures. Public policy for agriculture has responded to these two problems with increased emphasis on commodity based market stabilization and support programmes. The effects of some of these programs on both efficiency and equity may, however, be questioned. There is a need for further research to be directed at the complex and important problems which inflation creates for agriculture. Note 1 Departments of Rural Economy and Economics, University of Alberta, Edmonton, Alberta, Canada. We gratefully acknowledge the computation and typing assistance of Michael Austin, Jim Copeland, and Judy Warren. References Islam, T. S., "Input Substitution and Productivity Change in Canadian Agricutlure," Ph.D. thesis, University of Alberta, Ruttan, V. W., "Inflation and Productivity," American Journal of Agricultural Economics, Vol. 61, Dec Schertz, L. and Harrington, D. H., "Inflation and Agriculture," Agricultural Food Policy Review: Perspectives for the 1980s," USDA-ESS, AFPR-4, Washington, D.C., April Tweeten, L., "A Review of the Impact of Inflation on Agriculture," Policy Research Notes, USDA-ESS, Washington, D.C., Nov