The price of a liter of milk falls from 40 to 20 cents. The price of pork meat drops dramatically and now apparently follows the law which was once called the pig cycle. The cycle makes some happy, but many farmers, it is said, hang themselves. The editorials in newspapers deal with the price of milk day in day out and everybody is at a loss what to do (see here and here for example). Even those who sympathise with the farmers are afraid of serious consequences. Nobody raises the fundamental issue. This question is whether it is possible to introduce market mechanisms in an area where such things occur. The answer is a simple no!
Comically enough, none of the commentators ask why the price of cars never fall by half and what would presumably happen politically if such a tsunami would threaten to devastate the German automobile industry. No doubt, the industry would hire an army of journalists who would write articles night and day to make clear to society that enormous investments and millions of jobs are at risk. Do you think anyone would stand up and say that, while this may be regrettable, nothing can be done against it because this is the way in which a market economy functions?
The market must also fully play in agriculture, says the German orthodoxy these days. For forty or even fifty years, German and other ordo-liberal economists fought tooth and nail to destroy the terrible anti-market agrarian regime from Brussels that led to butter mountains and milk lakes. After decades of struggle, they finally succeeded: there will be no market ‚distortions‘ any longer and no more subsidies for the production and storage of products that simply cannot be sold at reasonable prices.
And now this. Farmers need for 40 cents for a liter of milk in order to cover their costs, but the price fell in a short time from forty to twenty cents. Why is that? It is easy to understand why this happens, but it will be impossible to remedy the problem with policy measures as long as the heads of mainstream economists are so full of ‚free market economy‘ that there is no longer any room left to think. Many point a finger at Aldi and Lidl, but the phenomenon is much older than both these supermarkets and its causes go much deeper.
The prices for milk and pigs meat, like that of most agricultural products, behave like raw materials and they indeed sharply fluctuate. The reason is that in such markets, the price elasticity of demand is low. Milk products are basically extremely similar to one another and consumers consistently consume a generous amount of milk, regardless of whether the price is twenty or forty cents per liter. Oil is similar. It is, in general, not consumed less when the price rises, but consumers sacrifice a portion of their income that they normally use for other goods. If the price falls, the consumer wins and enjoys a higher disposable real income.
The low elasticity of demand of many foodstuffs mean that even small fluctuations in the supply may have a major impact on the price. Exactly the opposite is true in a market where demand is extremely elastic. There every offered product is sold when it costs less. The low elasticity of demand creates the so-called pig cycle. Farmers raise many pigs when it seems favorable for them to do so, that is when the price is high. They invest in pens to raise more pigs. But inevitably the point of market saturation will arrive: the market cannot absorb more pork meat because consumers will not eat more of it, even if the price is much lower than before. When this happens, the price drops fast and dramatically. This is also because the product cannot be stored and the farmers keep a lot of pigs in their oversised pens that they cannot get rid of. The consequences are bankrupt enterprises. Farmers will now again systematically raise too few pigs, so the price will increase excessively. They will then raise more and more pigs and the insane cycle starts all over again.
It is now possible to explain why car prices are stable and only go up. In these markets, there is no distinct pig cycle because the reaction of consumers to price fluctuations is different. A drop in price by ten percent is certain to trigger a sales boom, because even those who only need a new car in a year from now would immediately buy one today. No one buys milk that he needs in a year from now. In addition, in markets for manufactured products, companies do everything to create product differentiation. They aim to please a specific customer base and hope that customers will remain faithful to the make in question.
Agriculture, on the other hand, can generally speaking differentiate its products only very little. They tried it by introducing the ‚organic‘ seal as a quality mark and with the direct marketing of dairy products. But milk ultimately remains milk. The majority of consumers does not distinguish between the several types of milk and even if they would, the fact remains that the product cannot be stored. Agriculture has become much more capital intensive during the last thirty or so years. Farming requires large investments. Still, the end products virtually remained unchanged.
The real problem lies therefore in the question of who under such volatile market conditions would be willing to invest a great deal of capital in a business, while at the same time all sorts of regulations regarding production, food safety, environmental and animal welfare standards and rural planning also need to be followed. Here, the answer is also simple: no reasonable person would do so. Anyway no one who needs agriculture to guarantee her or him a livelihood (and not just a hobby or farming on the side). Consequently, society gets everything that it expects from its agriculture, but not when it let the market economy run the agricultural sector. The introduction lead to huge factory farms that are sufficiently robust to deal with the price fluctuations I mentioned, because they produce an enormous range of products, but there will be no longer a peasantry that produces products in an artisanal way and no peasantry which takes care of the landscape.
The changes, both in practice and in mindset, that one demands so much of the farmers need instead to be demanded from policy-makers and economists. Anyone who wants an intelligently structured agricultural production with animal welfare, high product quality and a healthy environment has to realise the market cannot produce these outcomes. We can either return to the old agricultural markets with milk lakes and butter mountains. This is very dysfunctional, but it is better than farmers committing suicide. Or we can set up a series of governmental policies that compensate farmers for the maintenance of the landscape and the efficient and sustainable use of nature. Minimum prices are the bare minimum that farmers can ask from society. It has to be made clear that, in a market economy, no one invests if surprises in the price evolution of the final product cannot be ruled out. This is essential because such fluctuations can destroy economic existence within months. Farmers do us a service and they should be compensated in such a way that their livelihoods are not endangered when prices fall.