Instrumental Variables, IV, Policy, Agriculture, Subsidies, Production, Agribusiness, Agricultural and Food Policy, Farm Management, Land Economics/Use, Production Economics, Q1, Q12, Q15, Q18,

Key, Nigel D.

Kirwan, Barrett E.

Roberts, Michael J.

English

Research Papers in Economics

 
 
 
Production Effects of Decoupled Commodity Program Payments: 
An Instrumental Variables Approach 
  
 
 
PRELIMINARY—PLEASE DO NOT CITE, QUOTE, OR DISTRIBUTE 
 
 
 
Nigel Key 
USDA, Economic Research Service 
FAO 
 
Barrett E. Kirwan 
University of Maryland 
 
Michael J. Roberts 
North Carolina State University 
 
 
 
 
 
 
Selected Paper prepared for presentation at the Agricultural & Applied Economics 
Association’s 2009 AAEA & ACCI Joint Annual Meeting, Milwaukee, WI, July 26-28, 2009. 
 
 
 
 
 
 
 
 
 
Copyright 2009 by Nigel Key, Barrett Kirwan, and Michael Roberts. All rights reserved. Readers may make 
verbatim copies of this document for non-commercial purposes by any means, provided this copyright notice 
appears on all such copies.Introduction 
The 1996 Federal Agricultural Improvement and Reform (FAIR) Act removed most price-
contingent agricultural subsidies and replaced them with Production Flexibility Contracts (PFC) 
—lump sum payments with few ties to farmers’ production decisions or prices.  The payments 
were envisioned as a way to maintain income transfers to agricultural interests while minimizing 
production distortions.  The extent to which these lump-sum or “decoupled” payments affect 
production has been a significant dispute among academics and in recent World Trade 
Organization negotiations (FAO, 2005; Sumner, 2005). 
 
While a large and growing literature examines the relationship between agricultural production 
and the decoupled payments embodied in the PFC payments of the FAIR Act (see OECD, 2005 
for a review), several fundamental problems plague this literature. Because decoupled subsidies 
are essentially factor-specific subsidies to land, farmers chose the subsidy they now receive by 
historically choosing the amount and quality of land dedicated to program crops.  Thus, while 
PFC payments were largely decoupled from contemporaneous planting decisions, they were 
intimately tied to historical decisions, decisions that were tied as much (or more) to land 
attributes as to subsidy levels.  Research that ignores the simultaneity of these decisions 
attributes greater effect of subsidies than warranted because cross-sectional variation in subsidy 
payments cannot adequately control for unobserved heterogeneity (e.g., soil quality) that is 
closely associated with payment levels, leading to estimates that are almost surely biased too 
large.  A related critique is found in the joint determination of subsidies and production; as 
farmers alter the number of base acres they operate each year, e.g., through farmland rental or 
purchase, they simultaneously alter the total subsidy they receive and the total amount they produce.  This relationship is not causal however.  It is simply the by-product of the farmer’s 
decision to farm more or fewer base acres.  Conversely, measurement error in self-reported 
subsidy receipts results in finding a smaller-than-warranted effect. 
 
Empirical Strategy 
The data and methods of this paper overcome these sources of bias to estimate the true, causal 
effect of decoupled subsidies on production. Scientists use careful, experimental techniques to 
draw causal inference, often relying on randomization or case-control studies. Social scientists 
rarely have the opportunity to use markets as experimental laboratories. Consequently, existing 
studies highlighting the association between decoupled agricultural subsidies and crop 
production cannot make credible causal inferences without making strong assumptions about 
unobservable and/or mis-measured confounding factors. The contribution of this paper is to use 
an instrumental variables approach to isolate variation in decoupled subsidies that is unrelated to 
myriad confounding influences, such as a farmer’s entrepreneurial skill or farmland productivity 
(see Angrist and Krueger, 2001, for an excellent overview of the usefulness of instrumental 
variables in this context). The instrumental variables approach makes it credible to assert that an 
observed association between payments and agricultural production is a causal relationship 
rather than simply a correlation.   
 
Using random, weather-induce yield shocks, we isolate exogenous variation in decoupled 
subsidies that is unrelated to confounding influences on production. As is often the case in the 
program evaluation literature (Meyer, 1995; Angrist and Krueger, 2001), the policy details 
provide useful exogenous variation. In this case, it is found in the subsidy calculation. A farmer’s total decoupled subsidy receipt equals the product of the legislatively set subsidy rate, the 
number of subsidized (i.e., base) acres, and the farm’s program payment yield (PPY). This 
paper’s unique contribution can be found in the details of the PPY. A base acre’s PPY was 
determined in 1986 as the 5-year Olympic (dropping the highest and the lowest values) average 
of that acre’s yield from 1981-1985. The PPY used to determine subsidies in 1997 is thus a 
function of the idiosyncratic yield variation between 1981 and 1985.   
 
Data 
Using crop-specific, county-level yield data from the National Agricultural Statistical Service 
from as early as 1919, we calculate yield shocks as the deviation of the actual yield from the 
expected yield. Averaging the yield shocks between 1981 and 1985 provides a summary measure 
of the idiosyncratic component of the PPY, and thus the random component of decoupled 
subsidies. Administrative data obtained from the Farm Services Agency through a Freedom of 
Information Act Request ensure an accurate measurement of subsidy receipts tied to each 
commodity. 
 
Results 
Preliminary results indicate the strength of this instrument (see table 1). Early-1980’s yield 
shocks alone explain 25 percent of the 1997 rice PFC payment variation and 15 percent of the 
cotton subsidy variation. The instrument explains 10 percent of the corn subsidy variation in the 
Heartlands and 13-percent of the corn subsidy variation in the Northern Great Plains. Across all 
other program crops there is good statistical evidence of this instrument’s ability to explain 
decoupled subsidy variation.  
For the second-stage, we consider several production measures:  the share of cropland dedicated 
to the specific program crop, the share of cropland dedicated to any program crop, and total sales 
per acre of farmland.  Preliminary 2
nd-stage results indicate modest positive production effects 
for the share of acreage dedicated to the subsidized crop, but little or no effect on other program 
crops or on total agricultural sales.  The level of the effects estimated for 1992 (well before 
policy makers seriously considered decoupled payments), are similar to those estimated for 1997, 
and 2002 (one and six years after the policy change).  While decoupled payments appear to have 
significant if modest effects on production, effects stemming from the 1996 FAIR Act appear 
minimal. 
 References 
Angrist, J. D., & Krueger, A. B. (2001). Instrumental Variables and the Search for Identification: 
From Supply and Demand to Natural Experiments. Journal of Economic Perspectives, 
15(4), 69-85. 
 
Food and Agriculture Organization. (2005) “The effect of direct payments of the OECD 
countries in world agricultural markets. Evidence from partial and general equilibrium 
frameworks” FAO Commodity and Trade Policy Research Working Paper No. 12.   
August. 
 
Meyer Bruce, D. (1995). Natural and Quasi-Experiments in Economics “. Journal of Business 
and Economic Statistics, 13(2), 151-161. 
 
OECD.  (2003) A Review of Empirical Studies of the Acreage and Production Response to US 
Production Flexibility Contract Payments under The Fair Act and Related Payments 
under Supplementary Legislation, Directorate For Food, Agriculture And Fisheries 
Committee For Agriculture, Available at: 
http://www.oecd.org/dataoecd/15/15/34997377.pdf March 2005. 
 
Sumner, D. (2005) “Boxed In: Conflicts Between U.S. Farm Policies and WTO Obligations” 
Trade Policy Analysis No. 32. CATO Institute. Table 1 - First-Stage 
Instrument: 1981-1985 Average Yield Shock 
Commodity     U.S.  Heartland 
Northern 
Crescent 
Northern 
Great 
Plains 
Prarie 
Gateway 
Eastern 
Uplands 
Southern 
Seaboard 
Fruitful 
Rim 
Basin 
and 
Range 
Mississippi 
Portal 
Wheat F  27.56  0.7 5.97  7.41  19.79  1.26  10.28  8.79  2.68 1.25 
R
2 0.0109  0.0014  0.0207  0.0409  0.0492  0.0047  0.024  0.053  0.0192  0.0086 
Corn F  0.93  58.14  1  24.84  3.1  0.32  38.35  3.55  1.37  3.57 
R
2 0.0004  0.0972  0.003  0.1344  0.011  0.0009  0.0819  0.024  0.0252  0.0235 
Barley F  2.95  0.43 7.1 0.18  0  0.24  0.03  2.85  8.43  -- 
R
2 0.0025  0.0047  0.0302  0.0011  0  0.0046  0.0002  0.025  0.0572  -- 
Oats F  0.94  9.42  5.96  7.94  0.93  0.96  2.48  1.64  0.6  0.51 
R
2 0.0006  0.0218  0.0203  0.0722  0.0057  0.009  0.0104  0.0183  0.0066  0.0326 Sorghum F  42.6  0.83  --  13  0.49  8.2  8.52  0.14  0.01  13.23 
R
2 0.0283  0.0025  --  0.1625  0.0013  0.0671  0.0247  0.0018  0.0013  0.0887 
Cotton F  95.84  0.01  --  -- 74.13  3.87  39.03  0.09  0.19  46.63 
R
2 0.1473  0.0022  --  --  0.3511  0.0996  0.1613  0.0016  0.0599  0.3116 
Rice F  41.06  0.1 -- --  18.04  0.23  3.66  43.33  -- 3.3 
R
2 0.2598  0.0497  --  --  0.9475  0.0206  0.3432  0.6161  --  0.0538 
Notes: Dependent variable = County-level 1997 PFC payment per Base acre.  Explanatory variable = 1981 - 1985 Average Yield 
Deviation from linear trend. 
 

Instrumental Variables and the Search for Identification: From Supply and Demand to Natural Experiments.

Natural and Quasi-Experiments in Economics “.

The effect of direct payments of the OECD countries in world agricultural markets. Evidence from partial and general equilibrium frameworks” FAO Commodity and Trade Policy Research Working Paper No.

Production Effects of Decoupled Commodity Program Payments: An Instrumental Variables Approach

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics