Australian agriculture’s never-ending quest for ideal drought policies

Mick Keogh, Australian Farm Institute

Of all the agricultural issues that have vexed Australian policy-makers and farmers over the past 100 years, the one that has created most controversy and which has persisted as a ‘live’ issue during almost the entire period is drought policy. Yet despite what sometimes appears to be backward steps, there are signs that drought policy reforms are slowly resulting in better outcomes.

Despite their frequency, droughts have long been regarded as abnormal events in Australia which farmers were often ill-prepared for. This probably explains why the droughts of the last century had such a major impact on farm businesses, as the following highlights:

The first two decades of the new century were characterised by a series of droughts, each having a marked impact on livestock numbers. The ‘Great Drought’ from 1895 to 1903 was thought at the time to be the most widespread drought in the history of Australia… Sheep numbers, which had reached more than 100 million in the early 1890s, were reduced by half, and cattle numbers by more than 40%. In the nine years from 1895 the average wheat yield exceeded 8 bushels per acre (0.55 tonne per hectare) in only one year… (Pollard 2000)

The earliest government responses to drought were attempts to physically ‘drought proof’ the nation through the construction of water storages and irrigation systems. By the 1970s the focus had shifted to providing financial support to drought-affected farmers. Perhaps unsurprisingly, given the disastrous impact of droughts during the first half of the century, policy-makers equated droughts with natural disasters. They relied on a set of policies developed for natural disasters like floods and fires as an appropriate response to drought events, with the cost of that response borne by taxpayers.

It didn’t take long for both state politicians and farmers to realise that declaring a region to be in drought triggered funding from the Australian Government, and delivered mutual benefits. State governments effectively shifted the cost of drought to the national government, while at the same time securing the gratitude of grateful constituents. Farmers received the undoubted benefit of a range of different financial measures funded by taxpayers.

A review of these arrangements in 1989 identified many problems including the frequency of drought declarations and the related fact that government drought subsidies removed the incentive for farmers to better prepare for drought. This led to the introduction of new drought policy measures in 1992. The three principal objectives of that policy were to:

  • encourage primary producers and other sections of rural Australia to adopt self-reliant approaches to managing for climate variability
  • facilitate the maintenance and protection of Australia’s agricultural and environmental resources base during periods of climatic stress
  • facilitate the early recovery of agricultural and rural industries, consistent with long-term sustainable levels.

Support measures implemented to give effect to these objectives included farm household support payments and interest rate subsidies, both of which were triggered by the declaration of a drought to be an ‘Exceptional Circumstance’ event. This was defined as a one in 20 to 25 year climate event which impacted farm incomes over a period of more than 12 months, and which was not predictable or part of normal structural adjustment processes.

The rationale for interest rate subsidies as a drought support measure was that farmers who were in the early stages of their farming career or who had recently taken on more debt to expand their business were the ones most exposed to the risk of a drought event, and therefore interest rate subsidies ‘self-selected’ those farmers who needed help due to unlucky timing rather than bad management.

While the logic of that approach may have been reasonable at the time, a range of subsequent developments made it less so. Not the least of these was the progressive ‘normalisation’ of debt as a part of farm business operations, and the increasing concentration of debt amongst larger farm operations. For example, the Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) reports that average farm debt levels more than doubled in real terms between 2000 and 2009, with the debt predominantly used to fund farm expansion.

According to ABARES, around 70% of aggregate broadacre sector debt as at 30 June 2013 was held by just 12% of farms. On average, these were much larger farm businesses that in aggregate produced around 46% of the total value of broadacre farm production in 2012–13 (ABARES 2014).

Another major change that occurred in relation to the demographics of the farm sector was the growth in reliance of owners of small farms on off-farm wages to fund their farming ‘habit’. According to the Australian Bureau of Statistics (ABS), some 50% of farms generate less than $100,000 in annual farm output each year, and ABARES survey data for broadacre farms reveals that the owners of these farms now rely largely on off-farm wages for their annual income. In many respects, the owners of these farm businesses have ‘drought proofed’ themselves.

 

Figure 1:  Sources of income for owners of broadacre farms with less than $100,000 in annual agricultural output.
Source:  ABARES Agsurf database.

These changes led to questions by both policy-makers and farmers about the merits of policies such as interest rate subsidies. These questions were also exacerbated by the experiences of the ‘millennium drought’ extending from 2003 to 2010, and the observations that some regions of Australia had been declared to be experiencing an ‘exceptional circumstances drought’ for most of the period from the mid-1990s through until 2008. It was also the case that many recipients of drought support accessed that support repeatedly, with no strong evidence they were becoming more self-reliant.

 

Figure 2:  Frequency of Exceptional Circumstances drought declarations, 1992–2008.
Source:  ABARES (2012).

Starting in 2008, the Australian Government initiated a series of reviews of drought policy, examining the related financial, social and climatic issues. The conclusion of those reviews was that there needed to be a greater focus on family welfare and social support as part of drought policy; that the farm business support measures were poorly targeted and created perverse incentives in relation to drought preparedness; and that government support services were often poorly coordinated and targeted when drought events developed.

The outcome of these reviews and a trial of modified drought policies in Western Australia in 2010–11 was an intergovernmental agreement (IGA) on drought policy reform, which was finalised in April 2013 (effective from 1 July 2014). It resulted in a number of changes to existing drought policy. These included the cessation of drought declarations, a broadening of the availability of farm household welfare support, the removal of farm business support measures, and a focus on training and support to improve farmer’s business management skills and drought preparedness (see Box 1).

Box 1:    Five main elements of the intergovernmental agreement (IGA) April 2013:
  • Farm Household Allowance – provides eligible farmers and their partners who are experiencing financial hardship with assistance and support to improve their long-term financial situation. Support includes a fortnightly allowance payment at a rate equivalent to Newstart Allowance, a Health Care Card and support for a dedicated case manager to help recipients assess their financial situation and develop a plan for the future.
  • Farm Management Deposits – Farm Management Deposit (FMD) tax rules have been changed to increase to $100,000 the allowable deduction for FMDs from non-primary production income sources and to permit consolidation of existing FMD accounts held for more than 12 months.
  • Business management training – a national approach to farm business management training that will deliver courses to develop core competencies in the Farm Business Management Skill Set.
  • Social support services – a network of Drought Coordinators commenced on 1 April 2014, to assist with the delivery of mental health and social support services in drought-affected areas.
  • Tools and technologies to inform farmer decision-making – including seasonal rainfall outlooks and other climate reports by the Bureau of Meteorology.

In addition, Australian governments continued to fund the Rural Financial Counselling Service, and engaged in efforts to develop standard national farm debt mediation guidelines.

As is invariably the case when new drought policies are implemented in Australia, these changes coincided with events such as the intensification of drought conditions in northern New South Wales and Queensland, and a federal election. Despite the agreement, in the run up to the election the then Australian Government implemented a new drought support measure in the form of a concessional farm finance scheme, with the finance available even in states where drought was not occurring. These measures have subsequently been modified and refined, and a range of different support measures have also been implemented by state governments, including cash grants and transport subsidies.

Many of these measures appear to be contrary to the 2013 intergovernmental agreement, although governments argue that there was insufficient time to transition to the new policy arrangements, and hence the need for interim policy measures. Whether these measures are temporary, or become a permanent feature of the drought policy landscape is yet to be seen.

There are a number of lessons arising from the recent developments in drought policy in Australia.

The first is that enduring drought policy is necessarily a compromise between the economically ideal and the politically acceptable. While economists are able to come up with an economically sound set of policies largely based on the need to send farm businesses the right messages about appropriate risk management and preparation for drought as a normal feature of farm management, there is an innate tendency of politicians to respond to drought by ‘doing something’ – even when they know that the ‘something’ is largely ineffective.

In many respects, some farmers and politicians engage in mutually beneficial behaviour in response to drought – both knowing that if farmers make sufficient noise then politicians will act, and both may benefit as a consequence. Drought policy that ignores this reality is unlikely to succeed.

A second key lesson arising from changes in farm demographics is that unless a great deal of care is taken, industry-wide policy responses now have much less chance of being effective, due to the increasing diversity of farm businesses.
Demographic data highlight that changes over time have rendered the notion of the ‘average farmer’ obsolete. As can be observed in the following graph, while livestock and horticulture farm populations are dominated by small-scale farm businesses, sectors such as dairy and cropping have experienced major changes, and the intensive livestock sector is now dominated by very large-scale farms.

Figure 3:  Distribution of Australian farm businesses by value of agricultural output.
Source:  ABS. 

This highlights the very obvious difficulty inherent in attempting to develop drought support measures that treat participants in the sector in an equitable manner, let alone considering the need for effective policies that provide the right preparedness incentives.

A third key lesson is perhaps best summarised by the observation that ‘farm businesses are different’.

There has been a tendency in some drought policy reviews to draw parallels between the treatment of farm businesses and other small to medium sized businesses, and to question why farm support measures are different to those available to other similar-sized businesses in other sectors.

Part of the answer to this question lies in the fact that the level of revenue volatility or risk experienced by the owners of farm businesses in Australia is much higher than the level of risk experienced by businesses in other sectors of the economy, or indeed the level of risk faced by farm businesses in other nations.

Research results published by both the Productivity Commission and the Australian Farm Institute identified that annual revenue volatility in the farm sector is the highest of any sector, and more than double the ‘average’ for the entire economy. Similar research by the Australian Farm Institute comparing the volatility of returns for the farm sector in Australia with that of farm sectors in other nations revealed that the volatility experienced by Australian farm businesses is the second highest (behind only Uruguay) of any significant agricultural nation (Keogh 2012).

Given this, the potential exists that major drought events in Australia will result in severe industry and regional disruptions, which have the potential to impose significant costs on the community and necessitate extended recovery periods.

Exposure to this risk also limits the flexibility of farm business managers in making capital investment decisions aimed at improving farm productivity, and is the reason that equity levels of Australian farm businesses are frequently maintained at much higher levels than is the case for other, similar-sized businesses.

Government measures that assist farm business managers to better manage this risk exposure therefore appear to have some justification as part of drought policy, especially in situations where there is a degree of market failure hindering the development of commercial risk management options.

Given these lessons and the many and varied twists and turns that have occurred along the drought policy reform road, how adequate are current drought policies?

First and foremost, one of the most important developments in relation to drought policy over recent years has been the separation of farm household welfare support from farm business support, and changes that have made farm household welfare support more widely available.

Under the previous arrangements, it was not until an area was declared to be in Exceptional Circumstances that farm household welfare support was available – subject to meeting eligibility requirements. Under current arrangements, farm household welfare support has been made universally available to members of farm households (subject to them meeting income and net asset-test requirements), irrespective of whether an area has been declared to be in drought or not. This overcomes the inequity of previous arrangements, where a person on one side of a road may have been eligible for support, while a neighbour on the other side in identical circumstances was not. It also means that farm families experiencing low income due to non-drought related reasons (for example a storm wiping out an orchard, or a disease outbreak) can also access welfare assistance measures, without the need for special declarations or arrangements.

Perhaps the only negative aspect of this policy is the fact that payments made under this program are accounted for in the budget of the Department of Agriculture, rather than the normal social security budget. This creates the impression that this measure is ‘special’, rather than just a normalisation of farmers' access to the same welfare support that is available to the rest of the community.

It had long been an anomaly that someone owning a multi-million dollar house in Toorak or Point Piper who met the income test did not have to first sell their home (due to the exemption of the family home from the asset test) in order to access welfare, but that farm families were effectively required to dispose of their farm (which is also normally their home) before they could access the same welfare measures.

It is easy to underestimate the significance of this measure, and no doubt there will be some fine-tuning of eligibility requirements and application processes, before it is finally ‘settled’, but the Western Australian Drought Pilot of 2010–11 highlighted its significance in assisting farm families. Recipients spoke of the benefits of having regular cash income available to pay for groceries and things like children’s shoes and school fees, which was not the case when assistance was provided in the form of interest rate subsidies that went straight to the bank.

The decision to cease drought declarations and to stop farm business support in the form of interest rate subsidies has attracted criticism, but it is important to examine this decision in the light of evidence rather than rhetoric. This is a measure that only a relatively small proportion of farm businesses have been able to access in the past. Even during the extended millennium drought, 70% of broadacre and dairy farms in drought areas received no assistance at all for the duration of that event (Productivity Commission 2009).

Further, the availability of interest rate subsidies had long been an issue that divided farmers, with many of the view that the measure ‘rewarded’ poor farmers or those carrying too much debt, and actually penalised those who prepared adequately for drought by propping up land prices and slowing structural adjustment. In addition, the measure was generally not available to farmers in the intensive livestock and horticulture sub-sectors, despite the fact that these constitute almost 20% of all farm businesses.

The issue that is still contentious in relation to drought policy is what is referred to as ‘in-drought’ support. This was effectively what was provided by interest rate subsidies, and while many farmers and politicians recognise the shortcomings of that specific support measure, they are reluctant to go ‘cold turkey’ and to completely remove all in-drought support. To some extent this is being addressed at the moment through the availability of low interest drought and drought recovery finance packages, although they are a far-from-ideal measure that is expensive to administer, and which will require long-term management. They also create the possibility that at some time in the future it will be the government, rather than the banks, that will be involved in foreclosure actions in relation to farm businesses.

The dilemma, of course, is that these finance packages and all the forms of in-drought support available in the past invariably sent perverse messages about the need for drought preparedness, and also had a hidden cost in that they discouraged the development of commercial risk management options such as insurance products.

An alternative approach to in-drought support that is now attracting increasing attention is multi-peril insurance policies, with several trials of these products conducted over recent years. There are a number of different forms of these, with some based on defined meteorological events, and others based on realised farm income. These products are commonly available internationally (although almost invariably with premiums heavily subsidised by governments), and allow farmers to select and pay for the level of risk they are prepared to be exposed to. The multi-peril insurance products that have been trialled in Australia have generally been crop-specific, and have also been priced at a level that made them unattractive to many farmers. This is, in part, because the relatively low level of take-up meant that insurers needed to set high premium rates.

While there are many who question whether such products will ever gain wide acceptance in Australia, they certainly offer much more flexible and personalised drought risk management options for farmers, than will ever be achieved by a blanket government payment program, with all the inevitable eligibility criteria and policy changes that go with such arrangements.

There is potential for government to provide greater incentives for farmers to take up these policies through measures such as offering enhanced tax deductibility (for example 150%) for the cost of premiums paid by farmers for suitable insurance products. This would help to reduce the apparent cost of this insurance, while ensuring commercial providers remain competitive and tailor products to meet the different needs of the various sub-sectors of agriculture. It would also likely be close to revenue neutral for government, as any insurance payouts would be taxable income, in times when recipients would otherwise be unlikely to pay tax.

Governments could also assist the development of a commercial multi-peril insurance market by actions such as increasing the density of high quality weather stations across the landscape, a measure that also has additional benefits for weather forecasting and the management of bushfires and floods. The Western Australian Government did this several years ago, with the added benefit being that it improves the usefulness of computer models used by farmers to assist with management decisions.

The final lesson for government out of the long history of drought policy changes is that drought policy reform will not work unless it is widely communicated to, and understood by farmers and their advisors and financiers. It was very notable that subsequent to the signing of the IGA of 2013, there was virtually no effort made by any government to explain the changes or the rationale for them. It was therefore no surprise that several state governments very quickly pretended they knew nothing about the IGA as soon as drought conditions emerged. Unless the farm sector is fully engaged in future drought policy reforms, this will undoubtedly recur in the future.

References

Pollard, J (2000), One hundred years of agriculture, Australian Year Book 2000, ABS publication.
ABARES (2012), Drought in Australia: context, policy and management, ABARES report to client (GHD Pty Ltd) prepared for the Australia China Environment Development Partnership, Canberra, March.
ABARES (2014), Australian farm survey results 2011–12 to 2013–14, Australian Bureau of Agricultural and Resource Economics and Sciences, Canberra.
Keogh, M (2012), Including risk in enterprise decisions in Australia’s riskiest businesses, Farm Policy Journal, vol. 9, no. 1, Autumn, Australian Farm Institute.
Productivity Commission (2009), Government Drought Support, Report No. 46, Final Inquiry Report, Melbourne.
ABS (2013), ABS statistics report 7121.0, Agricultural Commodities Australia, 2012–13, Australian Bureau of Statistics, Canberra. 

Images:  Michael Coghlan, CSIRO, Denise Krebs, Dwayne Madden

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