Large farms are getting larger. This trend is well documented and will not be a surprise to anyone. But the reasons why farms are getting bigger may surprise many.
While most farmers would say the growth in farm size is simply because economics of scale mean farmers must get big to stay competitive, James MacDonald, chief of the agricultural structure and productivity branch of the USDA’s Economic Research Service, discounts this argument.
Instead, MacDonald believes that relative price factors, innovation, and government policy are much bigger drivers of the trend to larger farms than economies of scale.
Read Also
Riding the tariff rollercoaster
Farmers are accustomed to roller-coaster years. But the current geopolitical windstorm is something else entirely. On his cattle operation near…
If economies of scale were the reason for increasing farm size, MacDonald says we should also see a definite difference in the cost of production between large and mid-size farm operations.
However, while cost-of-production studies have consistently shown a wide variation in production costs between individual farms of all sizes, those studies haven’t found much difference in the averaged production costs of large versus mid-size commercial farms.
MacDonald sums it up in a few terse words: “Unit costs do not always fall as farm size increases.”
Part of the explanation for why agriculture doesn’t respond as readily as other industries to economies of scale is the “lumpiness” of capital equipment. Farm size can only be increased so much before additional equipment is required, MacDonald points out, and then production costs are high until enough land is farmed so the second set of equipment is fully utilized.
A second problem is the seasonality of agricultural production. Agriculture simply does not lend itself to the routines and procedures that contribute to economies of scale.
So MacDonald looked for other drivers that could explain the growth in farm size, and he found a very strong correlation between farm size and relative factor prices. Farms grew rapidly in size following the Second World War. This was also a time when wages in non-farm occupations grew quickly. The opportunity costs for farm labour increased and many farmers and family members of farmers chose higher-paying occupations over farming.
At the same time that people were leaving the farm for better-paying occupations, cost of capital was also decreasing, so business-savvy farmers substituted capital for labour. Then, further benefits were realized from innovations in equipment which enabled a farmer to increase the area that could be farmed with the same amount of labour.
This trend has continued to this day. Bigger and faster machines enabled an operator to seed 10 times as many acres per day and harvest seven times as many bushels in 2005 compared to 1970, and MacDonald points to work by Kislev and Peterson which found most of the growth in farm size between 1930 and 1970 is accounted for by substitution of capital for labour.
“Another driver of increasing farm size is government policy,” says MacDonald. As an example he points to peanuts and tobacco. Both crops were subject to quotas to limit production and support prices. Strict trading rules of quota ensured production stayed on small farms in the areas where these crops had traditionally been grown. As soon as these quotas were eliminated, production shifted to larger farms and lower-cost regions.
There can also be a strong correlation between farm size and government programs. Larger farms typically receive more total payments than smaller farms regardless of the cost of production. “This enables large farms to outbid smaller farms for land and have more resources available for growth,” MacDonald says. “As well, internal capital has a lower cost than external (borrowed) capital so larger payments received can be used to finance growth that would not be profitable if that growth had to be financed.”
“Even tax policy has an impact,” MacDonald adds. “Expensing and depreciation provisions benefit large farms over small farms.”
Studies by Key and Roberts in 2007 and 2008 concluded between one-half and three-quarters of the growth in the largest farms in the period 1987 to 2002 was a direct result of program payments.
The future
Many people fear that the trend to larger farms will threaten the family farm model which agriculture was built on. Will we see the demise of the family farm?
MacDonald says family farms still dominate U.S. agriculture. “Family farms account for 97 per cent of all U.S. farms and 84 per cent of production. The numbers imply that large farms are less likely to be family farms, but among those with $1 million to $5 million in sales, family farms accounted for 87 per cent of farms and 85 per cent of sales. The numbers fall off when sales rise above $5 million but family farms still accounted for 64 per cent of those farms and 57 per cent of sales.”
MacDonald also says that success in farming requires the precise timing and efficiency of tasks that are subject to weather and topographic conditions. A family farm operation tends to be much more nimble in decision-making than a corporate bureaucracy and can respond to change much more quickly. Furthermore, an owner-operator enterprise has a better incentive structure and therefore tends to be more efficient than bureaucratically organized farms.
However, family dynamics and management ability become increasingly important as farms grow in size and MacDonald outlines some strategies farm operations can and are using as their operations grow in size. They include:
- Employing custom service providers to meet equipment needs until the operation reaches a size where an additional line of equipment is justified.
- Using consultants to provide information which is needed to make good decisions.
- Including a non-family equity partner in the business.
- Hiring a professional manager for the farm operation.
- Assembling a number of farm operations together as an economic unit in order to capture bulk-buying opportunities of inputs and to capture marketing opportunities.
“There is no right size of farm,” MacDonald says. “There are a wide range of sizes that are viable.”
So why is all this important to Canadian growers?
In January, Farm Credit Canada released its 2011 Vision survey. Remarkably, 60 per cent of farmers indicated they intended to expand, diversify, or expand and diversify within the next five years. J.P. Gervais, senior agricultural economist with FCC says, “We do see the trend in farms getting bigger continuing. The industry is changing. We are losing the mid-size farmers and large farms continue to get bigger.”
At the same time, Gervais says, there are more and more small farms that are targeting specific market segments. “We are seeing a growing barbell pattern of farm sizes with increasing numbers of large farms and small farms and declining numbers of mid-size farms,” Gervais says.
If half or more of farmers do in fact expand production, this may lead to increased land and input costs. If this expansion was driven by economies of scale, those additional costs may be recaptured through lower production costs.
If MacDonald is right, however, and the real drivers of farm size are relative price factors, innovation and program payments, then expansion at this time could be risky.
After all, labour prices have stagnated for the past decade. The opportunity cost of leaving the farm for another occupation is declining. The economic slump and high unemployment rates, especially in the U.S., means more people may be looking for opportunities in agriculture than are exiting the sector. At some point the cost of labour may become lower than the capital cost of increasingly expensive bigger and faster machines.
We may also see a cut in the government transfers that have driven past expansions. Farmers must calculate whether expansion is a viable proposition without program payments.
Expansion will likely require borrowed capital. All-time-low interest rates may make expansion possible today but how long will rates stay at current levels?
The consensus is, farmers need to analyze whether expansion is really a good business decision or simply a quest to be bigger. Both are valid reasons for expansion, but only the first may be economically sound in the changing agricultural environment we are heading into. CG
