The farm finance conundrum

Professor Alan Matthews writes: 'DG AGRI EU Agriculture and Food has published a news item 'Access to finance: unlocking investment for Europe’s next generation of farmers' which states that affordable credit is one of the biggest barriers to entering agriculture for younger farmers.

I am puzzled by some of the inconsistencies in the item. For example, it states that across Europe young farmers tend to operate smaller farms. This is factually incorrect, as is documented in the DG AGRI Analytical Brief No. 10 on young farmers in EU agriculture which makes clear that young farmers tend to operate larger farms than the average (an average of 26 ha compared to an average of 16 ha for other farmers) and that on average they are also bigger in economic size terms.

The news item also highlights that young farmers have higher debt ratios than older generations, a fact confirmed in the Analytical Brief. But this does not support the view that young farmers are necessarily shut out of the credit market - otherwise how would they become more indebted? 

I do not dispute that young farmers due to a lack of a credit history may find it difficult to obtain credit finance, and no doubt all businesses would like to see easier access to credit, but does the evidence suggest that young farmers have greater difficulty than other farmers? Of course, we all want to see more young farmers in the industry, but is this focus on credit a bit of a red herring when the real issue is the large number of older farmers beyond pension age continuing to farm and to draw down CAP payments?'

 

In the distant past (1994/5) I took part in a multi-country study of farm finance, contributing the coverage of the UK and the Republic of Ireland.  (The US, Canada, France and Germany also featured). I had some fascinating interviews with bankers, government officials, accountants and farm organisations and I wish we had published more from the study (I had a very able Irish research assistant who undertook a lot of archival work on the history of farm finance in the UK and Ireland.)

The interviews reports are lodged with the Modern Records Centre at Warwick University.

If I was to summarise the findings in one sentence I would say that farmers, or at least larger scale ones, had some pretty good financial deals (and tax concessions).

It is, of course, hard for younger farmers to break in, but that has much to do with older farmers clinging on, as I know from my own family.

Farmer debt pile grows

Farmers are building up record debts as they struggle to cope with a sharp drop in the price of wheat, milk and other commodities. Farmers borrowed £17.8bn in 2015, driven by cash flow problems, the NFU revealed at its annual conference in Birmingham.

NFU economist Anand Dosa said that agricultural borrowings had doubled in less than a decade. There had been a double digit rise in borrowings since 2012.

However, Allan Wilkinson, head of food and agriculture at HSBC, said that indebtedness remained 'very small' compared with the value of assets. Land values had remained relatively resilient.

The future of small farms

The president of the Agricultural Economics Society, Steve Wiggins, has written some interesting reflections on this enduring topic in their latest newsletter which I reproduce below.

'Small-scale family farms remain an enduring feature of agriculture across the world, and especially so in the developing world. Some 418 million farms in the developing world, 95%, have less than five hectares, according to broad estimates made by FAO from (inadequate) surveys and censuses. What's more, in most developing countries the average holding size still tends to fall with each decadal census.

Debates over the productivity of small farms and their likely evolution go back to the nineteenth century if not before. The end of the peasantry has been repeatedly announced, yet reality has proved otherwise. Concerns that smallholdings could not be efficient and would never allow sufficient increases in production to sustain development were voiced in the 1950s and early 1960s; but laid to rest when the green revolution showed what could be achieved on the small farms of Asia. Analyses confirmed that many smallholders ran efficient farms and responded to price incentives. Indeed, diseconomies of scale were apparent, since small farms could manage labour better than larger scale farms.

But like Malthusian pessimism, doubts about small farms periodically resurface. The latest bout began around the turn of the new century, inspired by observations of the new supply chains run by supermarkets and exporters springing up across the developing world. Small farmers would be at a definitive disadvantage in these chains, since they could not meet the exacting demands for standard, high quality production, to strict timetables, in large lots and preferably certified and traceable.

Contemporary Asia, where only a small fraction of farms exceed five hectares, provides some insights into changes and likely future trajectories. Even in rural areas well connected to cities, where supply chains are modernising for staples and not just high-value produce, family farms persist. These farms are, however, increasingly differentiated, as a minority specialise in farming and intensify their production; while most farms provide some income for rural households that increasingly rely on non-farm activities and remittances from migrants.

This throws up two challenges. One, land markets need the flexibility to permit some concentration of holdings in larger operating units, while rural households that want to retain ownership, but lack the means or inclination to cultivate, can do so. At issue are small-scale transfers, perhaps temporary arrangements, with rentals, share-crops and loans predominating over outright sale. Tenure policy needs to facilitate these exchanges.

Two, if small farms are to prosper they need to find ways to overcome the failures that typically apply in markets for inputs and credit. That can be done, of course by the state, but the costs can be (ruinously) high. The alternative is to look to private and collective institutional innovations - contracting, farmer associations, local agencies and franchises for inputs and finance, etc. - to overcome current market shortcomings. A plethora of such initiatives can be seen, even if most operate at limited scale. The challenge then is to learn from these, to find working models - not pilots - that can be replicated or adapted to wider circumstances.

Get these two things right and we can hope to see a gentle transition as most smallholders gradually leave farming on their own terms, while allowing specialising smallholders to expand their holdings.'

One might add that many family farms in countries like the US and the UK have become successful large-scale enterprises but that was dependent on a number of factors including: (i) a facilitating legal framework on inheritance; (ii) good infrastructure to get products cheaply and quickly to markets; (iii) mechanisms to learn about and adopt technological innovations; (iv) ready availability of credit at realistic rates; (v) some government financial support for modernisation. No doubt one could add to this list.

Finance for farmers

Back in the 1990s I was involved in a research project led by Will Coleman from Canada which looked at how farmers got their finance. I interviewed all the clearing banks in Britain and Ireland, plus a specialist institution called the Agricultural Mortgage Corporation which was set up by government in the 1920s but by then was being absorbed into the private sector.

The general pattern was for banks to have a specialist agricultural manager at head office who, with local managers, kept in touch with the farming community. Farmers were seen as a very safe bet. They rarely defaulted and, even if they did, you ultimately had the land as an asset, although banks were very reluctant to foreclose. In many ways it was a very traditional form of banking. A relative who is a farmer was tipped off by his bank manager about a suitable farm to buy to diversify his business.

There's still plenty of need for finance for land and capital equipment. Those who inherit a farm sometimes have to buy out siblings. They may also want to buy additional areas of land to secure economies of scale. Finance is important if agriculture is to meet the challenge of increasing and more sophisticated demand and relatively finite supply, particularly of land suitable for farming. Food production will need to rise by at least 60 per cent by 2050 to feed a rapidly growing world population that is increasingly able to demand more resource intensive foods such as meat which create additional demand for animal feed.

However, since the financial crisis banks have been cutting their loan books, while the price of land continues to rise, stimulated by the availability of subsidies, good long-term demand for food, tax breaks and, in parts of the UK, the dual use of farms for sporting purposes. However, new types of finance provider are emerging like Aquila Capital of Hamburg.

Aquila actually buys equity stakes in a farm which could be as much as 70 per cent. However, they claim that it works more like a debt. They receive a guaranteed 3 per cent a year, although there might be circumstances in which the farmer had to borrow to meet this requirement, increasing the debt burden. The farmer receives the next tranche of income and the remainder is split 70-30 in Aquila's favour. It is envisaged that such investments will yield pre-tax, post-free returns of 5-7 per cent a year which are attractive in current circumstances. Savings accounts are typically paying less than 2 per cent and relatively few companies pay dividends above 5 per cent (and may not be able to sustain them). 4 per cent would be a good return on an income fund, although you should be able to get over 5 per cent from a peer lender, depending on how much risk you might be able to take.

Whether it is a good deal for farmers is an interesting question, but needs must. Aquila also claim that after 15 years or so farmers will have accumulated enough capital to buy them out.