The following blog post by Travis McArthur appeared on Eyes on Trade, Public Citizen’s blog on globalization and trade here.

Earlier this week, the USDA released a report attempting to estimate the effects of the Korea, Colombia, and Panama FTAs upon U.S. agricultural trade. It also examined possible effects of the ASEAN-China and ASEAN-Australia-New Zealand FTAs upon the U.S.

Unfortunately, the USDA estimated the effects through a computable general equilibrium (CGE) model, which has a shoddy track record, to say the least. A 1999 U.S. International Trade Commission (USITC) study on the likely effects of China’s tariff offer for WTO accession used a CGE model to estimate that the U.S. trade deficit with China would increase by only $1 billion dollars due to China’s accession. In reality, the trade deficit with China skyrocketed by $167 billion between 2001 and 2008.

Similar studies on NAFTA were also way off the mark. An economist at the Federal Reserve concluded that a CGE-based study of NAFTA underestimated NAFTA’s impact upon U.S. imports by ten times the actual effect of NAFTA. He concluded his study with a recommendation: “If a modeling approach is not capable of reproducing what has happened, we should discard it.”

Not accounting for currency manipulation is a chief problem of CGE models, as Rob Scott at the Economic Policy Institute has demonstrated. The USDA’s report even acknowledges the devastating effect currency devaluation can have upon U.S. agricultural exports:

In 1997, U.S. apple exports to Southeast Asia peaked at 150,000 tons, just as the Asian financial crisis struck. The crisis led to sharp devaluations of Southeast Asian currencies that raised the prices of imported apples and income losses that further discouraged apple buying, triggering a dramatic decrease in U.S. apple exports to the region.

As we discuss in a factsheet, Korea is only one of three countries to have ever been placed on the Treasury Department’s list of currency manipulators, having repeatedly manipulated its currency in the past. The Korea FTA contains no prohibition against currency manipulation, so the Korean government could effectively negate the tariff cuts mandated under the FTA through currency manipulation. Despite the long history of Korea manipulating its currency, the USDA’s estimates do not attempt to account for the very real possibility of another devaluation, even though they could have done so through estimating alternative scenarios.

Given that fair trade opponents have touted beef as a major winner in the Korea FTA, a close examination of the USDA’s beef assumptions is warranted. The USDA assumes a very optimistic scenario for beef like the 2007 USITC study, although it is slightly less optimistic. (Who knows? Maybe the next study will have realistic expectations.) The 2007 USITC study assumed that U.S. beef exports would be unimpeded by current Korean regulations prohibiting the import of U.S. beef from cattle older than 30 months and it set the initial beef export level in the model at $1.1 billion, even though actual U.S. beef exports to Korea were tiny at the time the study was conducted. This USDA study assumes that the initial beef export level is $701 million. Actual 2010 U.S. beef exports to Korea amounted to about $350 million, far off the level of these optimistic scenarios. The initial level of exports is one of the primary determinants of the results of the CGE model, and higher initial exports result in greater predicted exports from tariff reductions. With the slightly lower initial beef export assumption, the USDA report projected increased beef exports to Korea of $563 million, compared to the USITC’s projection of $628-1,792 million greater beef exports. Realistic beef export data would result in even lower projected gains.

Finally, even though the report is some fifty pages, the USDA is highly stingy with its presentation of results. It presents the projections on the bilateral changes in trade flows with Korea and Colombia under the FTAs, but not how the FTAs will affect overall U.S. trade with the world. (The projected impact upon overall U.S. trade can be quite different from the bilateral results due to the trade diversion effects of bilateral trade pacts.) The decision to exclude the global results is especially puzzling given that the report focused on the effects of trade diversion in its assessment of the ASEAN-China and ASEAN-Australia-New Zealand FTAs.

It is likely that leaving the global results out of the report conceals the fact that the overall trade balance in several agricultural sectors is expected to worsen under the FTAs. The 2007 USITC report on the Korea FTA, which used the same model as the USDA study, did report both bilateral and global changes and found that several sectors expected to have improved bilateral trade balances would have worsening balances with the world, such as wheat, oilseeds, and miscellaneous crops. The global trade balance is what matters since it indicates the total effect of goods exiting and entering the U.S. upon farmers’ livelihoods. Thus, this USDA report does not contain sufficient information on projected imports and exports to evaluate the effect of the FTAs on U.S. farmers, even in terms of its own flawed CGE model.

In sum, at first glance this report projects significant gains for agriculture from the Korea, Colombia, and Panama FTAs, but a close examination reveals that methodological flaws render the report unreliable. Instead of these predicted gains, we could see a repeat of the NAFTA experience in which U.S. exports of beef and pork to Mexico in the first three years of NAFTA were 13 and 20 percent lower, respectively, than beef and pork exports in the three years before NAFTA was enacted, partly due to currency devaluation.

The following is from Policy Pennings and was written by Daryll E. Ray and Harwood D. Schaffer. Daryll E. Ray holds the Blasingame Chair of Excellence in Agricultural Policy, Institute of Agriculture, University of Tennessee, and is the Director of UT’s Agricultural Policy Analysis Center (APAC). Harwood D. Schaffer is a Research Assistant Professor at APAC.

The current concern over the US federal budget deficit will be a major factor in the formulation of the 2012 Farm Bill. An editorial in the Sunday, January 16, 2011 New York Times titled, “Here’s an easy one,” said “here is one big-ticket saving that all members of Congress should get behind: cutting the billions of dollars in farm subsidies that distort food prices, encourage overfarming and inflate the price of land.”

It is tempting to view the position advocated in the editorial as an aberration, but we fear that it is merely a high profile example of the general media’s lack of understanding when it comes to the unique nature of crop agriculture. At the same time, there are elements of the current farm program that are hard to defend.

And, the Times editorial board quickly hits the most vulnerable element: “$5 billion in direct payments that are delivered regardless of what or even whether farmers plant.” What they don’t say is that the direct payments were established under the 1996 Farm Bill, known by its supporters as “Freedom to Farm” and its detractors as “Freedom to Fail.” As originally conceived, direct payments—which were originally called “Agricultural Market Transition Act (AMTA) Payments” in 1996 Farm Bill—were, as the name suggests, supposed to transition down to zero.

That didn’t happen because the 1996 Farm Bill was based on faulty premises. Two of which were that 1) the high crop prices at the time would continue because of ever expanding export markets—remember the growing Chinese middle class—and 2) should crop prices falter, farmers would—as opposed to historical experience—adjust production downward as needed and do so quickly.

But exports did not “ever expand,” they decreased. China’s couple-year period of importing corn prior to the 1996 Farm Bill turned out to be, like a head-fake in basketball, a false predictor of the future direction of play. In the years that followed, instead of becoming the US’s largest importer of corn, China became the US’s largest export competitor of corn. The US took the head-fake largely because we ignored China’s centuries-long policies of holding very large stocks of grain and the desire to be self-sufficient in grain.

So crop prices not only fell, they collapsed. But in addition to misreading China, framers of 1996 Farm Bill also misread other aspects of the grain markets. Basically, they offered up a fantasy world in which producers would react to lower crop prices by leaving fields idle and consumers would adjust to lower prices as they would to below-the-cost-of-production come-on sales on Black Friday following Thanksgiving.

Of course, neither is remotely realistic as evidenced by the severely depressed crop prices during the 1998 to 2001 crop years, but “new era” pronouncements can be very convincing. The framers of the 1996 Farm Bill were so convinced of this new way—that agricultural markets would react to low prices by reducing production—that they eliminated the very instruments designed to offset the fact that agricultural production and food consumption are different from producing and consuming about any other product you can mention.

Since there was no “buffer stock” program to absorb a portion of the “excess” production, nor a program to reduce production itself, there was a clamoring to do something for farmers when the price of all major-crop commodities fell well-below the cost of production of even the most efficient farm operators.

Given the path it had chosen with the 1996 Farm Bill, Congress suspended the idea of phasing-out the “transitional” AMTA payments in favor sending out “emergency payments” as a means of backfilling the lost revenue from the collapse in grain prices. In fact rather than continuing on with the phase-out, the emergency payments were computed as multiples of the AMTA payments. And as specified in the original AMTA legislation the payments that were sent to farmers “regardless of what or even whether farmers plant.” During the 1998 to 2001 crop years, the government sent out tens of billions of dollars to farmers to prevent the US farm economy from collapsing.

Because of erroneous perceptions of the future export market and the nature of crop agriculture, during the tenure of the 1996 Farm Bill crop, farmers were not “weaned off” of government payments as they “became more market oriented.” Instead, the 2002 Farm Bill institutionalized the emergency-payment enhanced AMTA payments, renaming them “Direct Payments.”

But direct payments have become the worst of all possible worlds of payments. They are given to farmers when prices are at record levels and well above production costs and they are not large enough under current cost conditions should prices plummet. And their major selling point, that they are “decoupled payments,” is not as convincing as it once was. Direct payments are said to not distort production since they were decoupled from production—farmers receive them whether they planted a crop or not. In a real sense they do not distort the level of production, because farmers reduce their production very little when prices decline—that is one of the unaddressed problems with the current farm program.

But AMTA/direct payments have affected the cost of production. As a guaranteed flow of cash, they have been incorporated into land rental rates and ultimately in the price of land. As a result, farmers have seen an increase in the cost of production directly attributable to the payments. At this point the payments are so integrated into the asset base/production system, that their abrupt removal coupled with a sudden future decline in crop prices could plunge rural areas into a freefall of land prices not seen since the 1980s. As a result there is strong resistance in the farm sector to any talk of reducing/redirecting/eliminating direct payments.

In the space of this column we are not able to challenge all of the misunderstandings the NYT editorial board exhibit in their “Here’s an easy one” editorial, but we cannot overlook their mischaracterization of the marketing loan program. They state that marketing loans “effectively set a floor on crop prices.” Many farmers that we know wish that that were true, but it is not.

While mechanisms were in place for decades to keep major-crop prices from going devastatingly low, the current marketing loan program DOES NOT put a floor under crop prices. Instead it backfills farm receipts with payments when crop prices fall below threshold levels, threshold levels that are now well below today’s variable costs of production, allowing the users of grain to purchase it at subsidized prices.

Without understanding why farm legislation was enacted in the first place and how it has morphed over time, it will be very difficult to design the 2012 Farm Bill in ways that will meet current budget constraints and still support a vibrant farm economy. We agree that relying on payments is the most expensive way to address price and income problems that beset crop agriculture, because it lacks the ability to quickly adjust production in line with the quantity demanded at reasonable prices. But that said, it is unrealistic to think that crop agriculture will do just fine without a safety net.