Edward Lotterman
It is a beautiful spring and farmers have been going gangbusters, not only here in Minnesota but across the nation. Moreover, drought maps show the best soil moisture conditions in key farm areas in years. The U.S. Department of Agriculture tabulates weekly Crop Progress reports for major crops such as corn, soybeans, wheat and cotton for our nation as a whole and for each major growing state. They are released each Monday showing progress as of the Sunday just before.
The last two weeks show that major crops are being planted early. The fraction of corn and soybean acres with seed in the ground by the end of April was higher than usual. As a result, the fraction that had emerged was one-fourth higher than a five-year average for the country as a whole. It was 40% ahead of average for the key state of Iowa and 67% for Minnesota.
Soybeans, nearly always planted after corn, show a similar pattern. The proportion with seed in the ground by the end of April was 80% higher than average including half-again higher for Illinois, twice as high for Iowa and three times as high for Minnesota.
Why is this important? Well, many adverse things can still happen. But early planting has a strong positive effect on both crops if conditions such as soil moisture and temperatures for both soil and air remain favorable. These are good so far this year.
The USDA and the National Oceanographic and Atmospheric Administration together with the University of Nebraska compile U.S. Drought Monitor maps. With the exception of an area in northeastern Iowa, virtually all of the major corn and soy areas show no moisture shortages at all and are the best in years.
So, all other things equal, we are on track to have high national output of these two major crops that are key to Minnesota agriculture. This is bad news for farmers.
What, you ask? How can a bountiful crop be bad?
Yes, high corn and soy output is good for the nation as a whole because vegetable oils and all of the meats produced using these crops will be cheaper. And yes, a bumper crop exhilarates farmers. But there is an important paradox. High production tends to reduce overall net incomes from growing these crops.
The problem is that high volumes harvested reduce prices. And the drop in price more than offsets the increase in quantity. Value of sales is lower while costs remain the same, so net income is down.
This brings us to a key economic variable that also affects who actually “pays” higher tariffs on imports or what portion of the half of FICA nominally paid by the employer actually comes from the employee.
This is “elasticity” and it applies to both supply and demand. It makes many students’ eyes glaze over but is vital to understanding everyday questions. If the price of eggs goes up, how many fewer eggs will consumers buy? If the price of gasoline falls, how much more will people use? What about toilet paper? Will a drop in price boost consumer purchases?
Formally, “elasticity of demand” refers to the percentage change in the quantity demanded divided by the percentage change in price. If the price of bread goes up 20% and the quantity bought drops 6%, the elasticity is -0.3. If this number is less than 1.0, demand is “inelastic.” This is usual. If it were greater than 1.0, it would be “elastic.”
Or, from the other end, if a 10% larger corn crop results in 20% lower market price, the elasticity is -0.5. Say that a farmer grows 100,000 bushels and sells them for $5 a bushel. Revenue is $500,000. If their crop were 110,000 bushels, up 10% and the price down to $4, revenue would be $440,000, a 12% drop. That is the sort of outcome that U.S. farmers may face this year, although, again, many other factors are at play including weather for the next five months, crops elsewhere in the world and overall demand.
The sort of adverse relationship for small producers in a large market is common because most elasticities are less than 1.0 and they cannot limit output. But the same sorts of elasticities apply for products that have only one producer or perhaps a few, as often is the case with medicines. Demand for insulin is very inelastic. Within a given range, producers can raise prices and the quantity insulin users buy drops little. Absent regulation of rates, the same is true for electricity.
The fact that reducing quantity sold raises net profits is obvious for products with any degree of monopoly power. Monopolists limit output to raise their incomes, they don’t increase it the way farmers or small businesses do. If there are a few large producers, they will collude to raise prices and thus net income, but they have to decide how much each cuts production. That has been the knotty problem for OPEC for decades.
So what about import tariffs or FICA taxes for Social Security and Medicare? How are elasticities involved?
Start with trade restrictions such as those proposed by Donald Trump. These are a subject that lead journalists into what logic profs call “the fallacy of the false dichotomy” or idea that the answer is entirely one thing or the other. Who would lose money with a 60% tariff on all U.S. imports from China: the U.S. or China, American consumers or U.S. producers?
The answer is both. U.S. consumers would pay more to buy the same amount of goods or would have to reduce quantities purchased. Chinese producers would sell less of their production or would have to slash their prices. The knotty problem is that the relative split of cost varies product by product.
One factor with a tariff specific to China is the degree to which other countries could ramp up their production if their behemoth competitor was at a big disadvantage relative to the rest. Bangladesh, the Philippines, Mexico, Honduras and many other countries could ramp up output of clothing and simple housewares and Chinese manufacturers would be hurt hard. Wages in many Chinese sectors would drop. U.S. consumers would not pay 60% more for these products And, to the degree that prices here went up, domestic U.S. clothing producers would have better sales. Output here would rise somewhat.
Anyone can see that the degree to which such adjustments would happen depend on time. In the short run, few changes can be implemented and the U.S. would face huge price increases. But as producers here and in the rest of the world ramped up, prices would drop.
Note also that there are not as many producers of smartphones, computers and solar panels outside of China as there are for clothing. So U.S. buyers would pay through the nose for a long time. U.S. output and employment would rise but costs here would be higher than in China and products would cost more.
Similar situations apply for excise taxes. The Bush 41 administration imposed a luxury tax on new high-priced pleasure boats. The result was that hundreds of skilled workers in specialty builders, largely on the Great Lakes, lost their jobs. The price of used yachts, to which the tax did not apply, rose sharply. Hardly any money went to the U.S. Treasury. Fat cats were inconvenienced but paid little.
What about FICA? That is a vital question as we talk about restructuring Social Security and Medicare. The quick answer is that the effects of higher FICA taxes, whether nominally on employer or employee, on the number of jobs and on pay levels would vary, industry by industry and job by job. But that vital deserves examination by itself.
St. Paul economist and writer Edward Lotterman can be reached at stpaul@edlotterman.com.
