Woolly thinking

When trying to stabilise farm and food prices, it is important to get the price band right. It should not be too high or too low, too narrow or too wide. We have argued consistently that a system of buffer stocks, replenished when prices are low and released when prices are high, can help to prevent price volatility. Consumers are hurt by prices that are too high; farmers are hit by prices that are too low. But can we be sure of what is ‘too low’ or ‘too high’? The EU’s Common Agricultural Policy is an lesson in how not to interfere in agricultural markets. It accumulated more and more stocks of cereals, milk powder, butter and meat. There was never an opportunity to sell these back on to the European market and quell a rise in price. That’s because the market price never increased. The reason that the market price never increased was that there was never a bad harvest. The EU never had the opportunity to release its stocks of cereals, meat and so forth onto the European market during lean years. There never were any lean years. The fundamental problem of the Common Agricultural Problem was that the floor price had been set too high. It over-incentivised farmers to produce.

This failure of the EU to properly manage its markets can easily lead to the view that the system failed because it tried to reach an impossible judgement about an appropriate band within which prices should be kept. The conclusion is then that no one can know and that the whole enterprise simply illustrates what happens when anyone tries to anticipate market trends. In fact, the failure to set an appropriate floor price is more a matter of politics than economics. If the decision is left to agricultural interests – the farmers – the floor will be too high. Unfortunately, this policy mistake has been made on several occasions.

The clearest example is the Australian Wool Reserve Price Scheme. The scheme was introduced in the early 1970s and appeared to stabilise prices for more than a decade. But after 1987, the relevant Minister was removed from the price setting process and it became the responsibility of the Wool Council. Unsurprisingly, this body oversaw a 70% rise in the floor price over two years. Warehouses all over Australia were soon bursting with a massive and unsaleable wool stockpile. But the Australian Wool Council resolutely refused to consider any reduction in the floor price. The scheme collapsed at the start of the 1990s. Thereupon the price of wool fell like a stone. For some sheep farmers, it cost more to shear a sheep and transport the fleece to market than the fleece was worth. The wool stockpile was finally sold in 2001.

In principle, the Australian scheme was a good one. Wool is relatively easy to store and the importance of sheep to the Australian economy is well-known. It is true that demand is less inelastic with respect to price than in the case of certain essential foods. But this does not make it impossible to reach a sound estimate of future trends of wool supply and wool demand. There was plenty of economic evidence in Australia that could have suggested a lower floor price, but it was ignored because that price was effectively controlled by the farmers themselves. The lesson drawn from many at the time and since is that buffer stocks do not work; but a more appropriate lesson would be that buffer stocks need to be managed away from the farm interest groups that benefit from them.