Drought Policy

John Freebairn

Director of the Melbourne Institute of Applied Economic and Social Research at the University of Melbourne

Droughts are a recurring feature for the Australian rural sector. Clearly, most of eastern Australia is in the grip of a severe and prolonged drought, agricultural production will fall, farm incomes are down, and some families are in difficult financial circumstances. Not surprisingly, the lobby groups are seeking government support, and the Commonwealth and State governments are again reviewing their responses. It is useful to consider the arguments for government assistance for drought, and the form such assistance might take, in terms of direct income assistance to families to meet society equity goals and in terms of subsidies to farm businesses.

People who invest their capital and labour in agriculture do so as a voluntary decision. It is well known that industry fortunes fluctuate widely with seasonal conditions and with world commodity prices. From their own perspective, and this also would be the perspective of the best allocation of the nation’s scarce resources, people invest in agriculture only if on average the good times are expected to balance the bad times. Further, in the knowledge of the volatility of incomes, good managers also put in place a range of risk management and contingent strategies to carry them through the bad times, including droughts. Many current farmers, including some small operators, in fact make their decisions this way. In general, such farmers do not need to or seek special handouts in the event of drought.

However, inevitably there are some farmers who have based their decisions on over optimistic expectations, or have not made adequate contingency arrangements, or in some cases because of bad luck find themselves in a difficult financial situation when a severe drought arrives. It is not difficult for lobby groups, supported by some effective media shots, to paint a picture of hardship and to garner sympathy.

For those farm families who find themselves in poverty during a drought, the general income transfer system provides a basic safety net for all Australians. Social security support is subject to income and asset means tests, and in many cases to work tests. There seem to be no equity reasons why farm families should be given any different social security payments than other small business families, including many in the rural sector who are directly and sometimes more adversely affected by drought. Already there are some special exemptions for farm families with respect to more generous asset tests that are not available to other small business families. Proposals to exempt the non-farm income of a spouse for farmers when assessing eligibility for drought assistance is inconsistent with the inclusion of all sources of income in assessing the eligibility of other Australians for Newstart.

Consider next drought assistance to farm businesses in the form of, for example, interest rate subsidies, fodder subsidies and livestock transport subsidies. They are less direct and targeted forms of welfare support than already available direct income grants to families in need. In terms of decisions on the efficient allocation of the nation’s scarce resources, drought subsidies have the effects of first raising the average return to the subsidised industries and second of reducing the downside volatility of returns. In an important sense, drought subsidies reflect an industry policy of socialising some of the losses whilst retaining privatisation of the gains.

One effect of drought subsidies in an economy where most other industries do not receive subsidies, with the TCF and automobile industries being notable exceptions, is that too many scarce resources are attracted into the rural sector. In time, the subsidies become capitalised into higher land prices.

Assertions that one effect of the drought to be avoided is that farmers will exit the industry and future agricultural production will be put at risk are not supported by the facts. Sure, some farmers are forced out by droughts. But, other farmers, and usually those better adept at managing droughts, purchase the land and keep it in production. Ironically, drought assistance, particularly when it finds it way more to the less successful farmers, actually impedes the necessary and on going process of structural change in the sector. So long as land values do not fall to zero, there will be a buyer and a seller. Price to earnings ratios for good Australian farming land are well in excess of those found for blue chip shares, suggesting there is much optimism about the future of the sector. The historical trend for Australian agriculture has been one of doubling output every twenty to thirty years due to new technology and better management.

An undesirable and unintended side effect of drought subsidies is to increase environmental damage. The subsidies encourage overly optimistic operators to over-stock and to push cropping into fragile land.

While granting special assistance to farmers in the time of drought may have a good inner warm feel, it has adverse effects on the use of the nation’s resources, impedes the process of structural change, provides a disincentive to prudent management, increases environmental damage, and only postpones sustainable solutions to the inevitable next drought.