Decoupled payments and agricultural output: A dynamic optimization model for a credit-constrained farming household

The influence of the domestic agricultural support granted by developed nations to their farmers on the developing countries' agriculture and welfare is at the top of the controversy in multilateral trade negotiations. Decoupled payments have emerged as an alternative to traditional agricultural subsidies --which are coupled to production decisions--in order to minimize the distorting impacts of domestic agricultural policy. However, when farmers face imperfections in key markets--such as those for financial services and insurance--even direct payments, disentangled from current production choices, may end up inducing increases in agricultural output, with the consequent impact on international prices--when the country possesses market power.; This dissertation explores these issues for the case of corn farming households in the United States. It develops a deterministic dynamic optimization model for a representative credit-constrained corn farming household. Every year, the farming household receives a government payment that is decoupled from its choices of current and future land ownership and production. The farmer is credit-constrained in that the interest rate on loans is increasing in the debt-to-asset ratio. Corn prices and land prices are assumed to be given to the farmer and time-invariant.; The model is parameterized using data from the Agricultural Resource Management Survey (ARMS) of the United States Department of Agriculture (USDA), which collects comprehensive information about production decisions for a representative sample of farmers that have received decoupled payments since the beginning of the program in 1996. Estimated production function coefficients and parameter values derived from this dataset are used in the solution of the dynamic optimization model. Simulations with different values for the decoupled payments and key parameters shed light on the extent to which this presumably neutral policy instrument may end up influencing the farming households' production decisions.; The exercise allows the identification of three potential effects of decoupled payments. First, the results of the simulations suggest that, when a single corn farming household faces imperfections in the credit market that limit its access to credit, access to additional liquidity through decoupled payments (liquidity effect) increases its land holdings and output transitorily (i.e., along the optimal path) rather than permanently (i.e., in the steady state). Second, the increased farming household's creditworthiness, brought about by the decoupled payments, may shift the supply of credit, reducing the cost of access to debt (creditworthiness effect). This effect not only accelerates and reinforces the transitory direct impact of decoupled payments, but it also increases farm size and output permanently. Third, when the actions of the representative farming household are replicated by all of them, there may be an increase in land prices (land price effect). This price effect leads the representative corn farming household to reduce its holdings of land and output, both along the optimal path and in the steady state, thereby mitigating somewhat the expansionary impact of the other two effects.; In practice, the net effect of decoupled payments on output will depend on the final balance among these three effects, namely, the liquidity impact from the decoupled payment itself, the potential increase in creditworthiness, and the increase in land prices. Innovations in financial markets (the first-best policy) that improve the evaluation of creditworthiness of farming households would have equivalent impacts on the demand for land and on output, without creating other distortions. The three effects of decoupled payments identified in this dissertation go beyond any effects associated with attitudes towards risk, already found in the literature, and beyond the potential impact of expectations that future allocations of the payments m...