Canadian Farm Income: Medium-term Outlook and Value-added Accounts

Wayne Jones and Mark Elward

Agriculture Canada, Ottawa, Ontario and Statistics Canada, Ottawa, Ontario

INTRODUCTION It is often said that there are two concerns in forecasting farm incomes. The first is that conditions are not going to return to normal. The second is that they already have. The suggestion is that recent conditions have been quite depressed relative to earlier periods and that this will be the norm for the foreseeable future. We argue that there is a bit of a misconception here.

Asked to characterize the most recent five-year period 1986-90, a common generalization might be one of low market receipts, rapid increase in operating costs and depressed farm incomes. In fact, average market receipts were above those of the previous five-year period 1981-85, operating costs increased much slower than the rate of inflation and farm incomes were at record high levels.

Of course these aggregates mask the problems in the grain sector and the massive infusion of government assistance. Nevertheless, in looking at the next five years, it is important to keep in mind that 'normal' in recent years has been a period of historically high farm incomes.

There are two parts to this paper. The first part presents the medium-term farm income outlook for Canadian agriculture and examines two factors that could significantly improve income prospects; namely the potential for reduc- tions in operating costs and the proposed new grain safety net program. The second part examines Statistics Canada's new agricultural value-added ac- count introduced this June on an experimental basis. The value-added account is designed to display the sources and allocation of farm income and as such portrays the economic conditions in the industry in a unique way.

MEDIUM-TERM FARM INCOME OUTLOOK Agriculture Canada will release a revised medium-term income forecast in August 1990 as part of its regular outlook program. The forecasts presented in this paper are preliminary results from that exercise. While the published forecasts may vary slightly from these presented here, the basic message will not. Only a brief summary of the farm income outlook is provided in this paper. For a more detailed discussion, the reader should obtain a copy of Agriculture Canada's publication entitled, Medium-term Outlook

Cash Receipts The medium-term outlook focuses on the 1991-95 period although 1990 is also still a forecast year. Looking at farm cash receipts first, total receipts are

Can. J. Agric. Econ. 38 (1990) 603-614 603

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Figure 1. Farm cash receipts.

forecast to rise slowly over the period from slightly below to well above the average of the previous five-year period 1986-90 (Figure 1). Market receipts from crops are expected to rise in the latter part of the outlook period from relatively stable levels in the earlier years. The major crops, grains and oilseeds, will contribute to higher receipts as production and export levels return to normal after recent droughts.

Livestock receipts are forecast to continue the gradual rise seen since the mid-1980s. Moderate increases in production and prices should result in higher cattle receipts until 1992. By 1993, however, lower prices are expected to more than offset higher production. Hog receipts should remain close to the level of the preceding five years, with fluctuations following the hog cycle. The next trough in the cycle is expected in 1993 with prices rising accordingly. Dairy receipts should remain close to current levels throughout the period given forecast weak demand and little gain in prices. Poultry receipts should show modest gains due to production increases and slight price rises while reduced egg production will be more than offset expected price increases.

Average market receipts for the 1991-95 period are forecast to be more than 10% above the previous five-year average, however, significantly lower pro- gram payments will act to neutralize this growth. Average annual cash receipts are expected to be very similar for the two periods 1986-90 and 1991-95. In the

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absence of any new government initiatives, direct program payments are expected to drop from an average of $2.9 billion over the 1986-90 period to the $l.lbillion range. This is primarilydue to the phasing-out of current ad hoc programs, such as the 1990 special income assistance program, combined with lower payouts under existing stabilization programs in response to improved market conditions (NTSP for hogs) and to declining support bases (WGSA for western grains).

Farm Expenses Farm operating expenses are forecast to remain relatively stable over the next couple of years as farmers take measures to reduce production expenditures in response to expected lower incomes (Figure 2). For the remainder of the forecast period, total expenses are forecast to increase by 2-3% annually, which

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Figure 2. Farm operating expenses.

is somewhat lower than the expected rate of general inflation in the economy. Cost pressures in the crop sector are expected to be greater than in the

livestock sector. Prices for fertilizer and pesticides are driven by U.S. markets where demand conditions may support price increases. Prices of animal pro- duction inputs are more likely to be stable given low and moderately rising feed grain prices combined with forecast falling feeder cattle prices.

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Comparison with U.S. farm expenses might suggest American farmers have made considerable strides in cost reduction relative to their Canadian coun- terparts. In fact, the low level of expenses in recent years were related to high set-aside levels for corn, wheat, rice and cotton as well as low soybean acreages. There is some evidence that U.S. producers made some adjustments in the early 1980s in response to income pressures (Figure 3). Farm machinery sales, for example, fell off in the US. while remaining relatively strong in Canada. This was in part due to a tightening credit market in the U.S. One more recent difference has been a much greater reduction in farm debt in the U.S.; about a 30% drop from the peak compared with about a 7% drop in Canada. However, forecast increases in total farm costs over the next five years are about the same.

I I 1 I I 1 I I 1 81 82 83 84 85 86 87 88 89 90

1.15 - Figure 3. Cash basis operating margins.

Cash Income Net cash income is forecast to be well below the record high levels of the 1987-89 period until 1993 (Figure 4). For the latter part of the outlook period, farm income is expected to improve when the anticipated growth in farmcash receipts begins to offset the generally lower program payments. Average cash income for 1991-95 is forecast at about 75% of the previous five-year average which included several years of high incomes.

Falling cash incomes in the grain and oilseed sector will account for virtually all of the decline in aggregate income. It is this sector that has relied most

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GRAINS AND OILSEEDS GOVERNMENT

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Figure 4. Net cash income.

heavily on special income assistance measures in recent years. Also grain prices are expected to weaken further from current levels before recovering towards the end of the period. In the grain and oilseed sector average cash income for 1991-95 is forecast at about 60% of the previous five-year average.

POTENTIAL FOR IMPROVED INCOME PROSPECTS The medium-term income prospects, especially for the grain and oilseed sector are not encouraging but there is always potential for a better-than-ex- pected outcome. Uncertainty surrounding the commodity markets has been dealt with by other papers in this session. R o additional areas that should be noted are the potential for reductions in farm operating costs and for increased support through improved safety nets for farm income.

Cost Reduction In examining the medium-term income outlook much of the emphasis is on commodity markets with little focus on farm operating costs; yet expenses are forecast to increase by more than $1 billion over the 1991-95 period. Compare this to cash income forecasts in the $5 billion range and the impact of rising costs on farm incomes becomes obvious. Given the weakcash income position implied in the forecast the pressures to reduce costs will be high. There are a number of factors that could contribute to such reductions in farm costs:

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Lower farm input prices brought on by declining interest rates, excess supplies in purchased inputs markets, less expensive generic chemical as patents expire or new government rebate programs. New technologiessuch as minimum-tillage practices or more efficient farm chemicals that reduce input utilization. Improved management skills which lower operating costs through more

efficient use of resources. Structural change within the industry that lowers aggregate costs as higher margin farms replace lower margin farms.

Cost reduction through the improvement of management skills or the structural shift to higher margin farms perhaps offers the greatest potential. Other papers presented at this conference in the symposium on farm manage- ment will examine this area in detail.wever, a brief comment is provided.

Farm level data collected by the University of Saskatchewan indicate the variation in costs on Saskatchewan grain farms and the impact on accrued farm income. Projected costs for 1990 on 173 farms show a range for wheat produc- tion from a low of $2.29 to a high of $6.19 per bushel (Figure 5). Similar data

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Figure 5. Cost of wheat per bushel; wheat on stubble, Saskatchewan, projected 1990.

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on actual costs and revenues for the three years 1987-89 show the difference in income per cropped acre between high margin (the top one-third of farms ranked by margins) and low margin farms (Figure 6). Based on data for 25-35 farms depending on the year, the average difference was $47 in 1987, $60 in 1988 and $69 in 1989. Variation in costs accounted for between 36% and 48% of the difference in income with variations in revenue accounting for the remainder. The questions raised (and the one to be addressed in the farm management symposium) is what are the sources of these variations and to what extent can they be reduced.

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Figure 6. Difference in income between high and low margin grain farms, Saskatche- wan,1987,1988, and 1989. Source: Top Farm Management Data.

New Farm Safety Nets The need for large ad hoc income support programs in recent years raised concerns about the adequacy of existing stabilization programs to provide income protection to producers. In response to this concern federal and provincial governments and industry representatives are in the process of formulating proposals for new safety net programs. While no specific program details are available at present a proposal by the Grain Safety Net Task Force has been tabled for discussion. There are two components to the proposal; a

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Gross Revenue Insurance Plan (GRIP) and a Net Income Stabilization Ac- count (NISA). The two components would replace the current crop insurance plus price/income stabilization programs.

The NISA component is designed to provide an individual account that would enable producers to stabilize income by setting aside monies from good years. Based on the entire enterprise, the NISA would be funded by matching producer and government levies tied to net farm sales and subject to certain caps. Payouts would be triggered whenever the gross margin for the farm fell below its average for the previous five years or when net income fell below a specific amount; assuming there were sufficient funds in the account.

AGRICULTURAL VALUE-ADDED ACCOUNT The remainder of this paper deals with a new data series developed to improve our understanding of farm income. In June, 1990 Statistics Canada (AES. 1990) released a production income (value-added) account for Cana- dian agriculture. This was the first release of several accounts currently being developed as part of an alternative system of accounts for agriculture. The logic and concepts behind these accounts were developed in the thesis "An Alternative System of Financial Accounting for the Canadian Agricultural Production Sector" (Beelen, 1983). Much of what follows has been extracted from that thesis. A more detailed description of the production income (value-added) accounts concepts and the national level estimates for theyears 1981-89 is available from Statistics Canada, Agriculture Division.

The financial information system for the Canadian agricultural production sector serves public and private decision-makers, using information for a variety of purposes. Public policy-makers require information to monitor the financial situation of the sector and subsectors, and to develop and evaluate the effectiveness of policies and programs. Agricultural policies and programs have impacts on, among other things, the efficiency of production of agricul- tural products, the prices of those products, and the distribution of income to farmers, consumers, and others. Private sector decision-makers require infor- mation on the financial situation of the sector to anticipate the demand for inputs and the financing requirements of the sector. As well, information is required for general use to permit informed public debate on issues affecting agriculture and the country as a whole.

The financial accounting system for the Canadian agricultural production sector has become somewhat obsolete or inadequate as the information requirements of policy-makers, and the structure and organization of the sector have changed over time. Decision-makers require data which reflect the heterogeneous nature of the sector as policies tend to focus on specific commodities and subsectors in agriculture. Additionally, structural changes have created accounting inconsistencies and problems in the interpretation of the financial accounts. For example, changes in tax laws for wages paid to farm operator spouses and children have resulted in the inclusion of these wages in the wage expense series. This has changed the meaning of the farm net income

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measure since some income of farm operator families from farming operations is excluded from the farm net income measure.

The existing financial data system was developed in the 1930s and 1940s in response to pressures for financial information. Early agricultural policy in Canada concentrated on research and development in crop production and animal husbandry and on improving methods of marketing grain. With the onset of the Depression, there was a shift to policy designed to improve the income position of farmers and to increase their market power through centralized marketing. During World War 11, production maximization was emphasized. In the postwar period, policies concentrating on productivity, marketing, price stability and the adequacy of incomes were developed. Re- cently agricultural policy initiatives have expanded to include goals such as stable food prices with adequate supplies, stable and fair producer returns, and reduced disparities within agriculture, some other major policy concerns are: the quality of rural life, conservation of soil and other resources, environ- mental impacts, rural-urban balances, trade agreements, the impact of inter- national price wars and the fulfilment of international food supply responsibilities (Menzie, 1980).

It is argued that the aggregate farm financial data system can be improved with an expanded set of financial accounts. These accounts should result in better information and thus, facilitate better decisions by decision-makers. The experimental income account is the first of several integrated accounts which will form an alternative set of accounts for agriculture. The other proposed accounts include: balance sheet; cash flow; capital flow; farm capital value statement; and total incomes of farm operators account.

A Description of the Production Income Account The account presented is designed to record the value of production in the sector in a time period. The incomes earned in this production are identified with the factors of production claiming them. The establishment concept is used as the basis of the account, recording primary and secondary production of farm establishments. The sources of income are identified as: (1) sales of agricultural products (2) sales of non-agricultural products, (3) other income sources and (4) own-account uses of production. Income sources are allocated to intermediate product expenditures and gross value added. Gross value added consists of: (1) indirect business taxes, (2) capital consumption allow- ances, and (3) net value added. Net value added represents incomes earned by factors used in production. This experimental account is conceptually consis- tent based on accounting principles for aggregate financial accounting.

The primary purpose of any sector financial account is to portray some aspects of the economic condition of an industry. The production income account is intended to identify factor incomes earned in agricultural produc- tion. Incomes earned in agricultural production accrue to many sector par- ticipants: farm operators, managers, hired labourers, corporate shareholders, landlords, financial institutions, and others. Consequently, policy decisions

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affect non-farm owners of resources employed in farm production. "Benefits from farm programs designed to improve incomes of farm people may be siphoned into non-farm sectors" (Carlin and Smith, 1973). Incomes earned by various groups of sector participants must be identified to permit valid analysis of the effects of policies on farm incomes as they affect different groups of sector participants. Valid linkages are established in the proposed accounts between sector income and those of the farm operator family "institutional" group through the specific identification of farm sector income accruing to farm operator family "institutional" group through the specific identification of farm sector income accruing to farm operator families.

The proposed establishment-based production income account relates to policy questions concerning efficiency, capacity and rates of returns to re- sources. The business orientation of this account should "deter the use of business information for drawing welfare implications of people involved in the sector" (Carlin and Handy, 1974). Welfare policy analyses are served by institutional accounts, such as the total income of farm operators account.

Initial Observations on the Production Income Account The most interesting information from these new accounts is in the estimation of income components hidden or excluded from the traditional income meas- ures and in the distribution of the net value-added among the various factors of production. Briefly, some of the highlights include (Figures 7 and 8):

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Figure 7. Net value added distribution, Canada

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Figure 8. Net value added vs. total net income for 1989.

Inter-farm sales and expenses ($3.2 billion in 1989) which are excluded from traditional income estimates.

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Identification of custom work ($508 million in 1989) and farm land rent to farm operators ($90 million in 1989) as other sources of farm income. Recognition that most of the land rent is paid to persons outside the farm sector (87% in 1989) and that the proportion is growing slowly. Corporation profits have increased sharply since 1981 ($704 million in

1989) as more larger farms become incorporated and a m u n t for a greater share of farm income. Wages to family members have increased more than twofold since 1981

($559 million in 1989). This increasingly important source of farm family income is masked in traditional measures of farm income. Regional differences in the value-added nature of the sector mean net

value-added measures give a different picture of economic performance from traditional income measures. For example, in 1989 total net income in Ontario and Saskatchewan were about equal while for the same year net value-added was almost 20% higher ($400 million).

Clearly, there is some valuable additional information on the economic performance of the sector that can be obtained from the production income (value-added) accounts.

REFERENCES Statistics Canada. 1990. Agricultural Economic Statistics ( A E S ) , catalogue No. 21-603, issue 90-001, May 1990. Beelen, G. 1983. An alternative system of FinancialAccounting for the Canadian Agricultural Production Sector. Masters thesis. Winnipeg: University of mani- toba. Menzie, E. 1980. Developments in Canadian Agricultural Policy, 1929-1979. Canadian Farm Economics 15: 15-19. Carlin,T. and Smith, A. 1979. A new approach in accounting for our nation's farm income. Agricultural Finance Review 33: 2-3. Carlin, T. and Handy, C. 1974. Concepts of the agricultural economy and economic accounting. American Journal OfAgn'cultural Economics 56: 969. Economic Commission for Europe. 1982. European Handbook of Economic Accounts for Agriculture. Statistics Canada. 1975. National income and expenditure accounts. Volume 3. A guide to the national income and expenditure accounts. September, 1975.