Ebook Agricultural Arbitrage, Adjustment Costs, and the Intensive Margin
The United States Department of Agriculture-s Economic Research Service (ERS) reports that near2record harvests in 2008, coupled with improved farm product demand and high commodity prices, should result in increased spending on farm real estate and capital investment. Since 2000, holdings of these assets at the national level has more than doubled from $1.03 trillion to $2.16 trillion, and currently represent 92% of all farm assets. These figures indicate that farmland and capital are an important and rapidly expanding component of the agricultural economy.
Empirical evidence suggests that farmland and capital are quasi2fixed in that adjustment costs are incurred when holdings are altered. A paper by de Fontnouvelle and Lence (2002) states that transaction costs for buying/selling farmland are as high as 15% of the land price to cover brokerage fees, legal fees, appraisals, and surveys.( Research analyzing the quasi2fixity of capital is common in the agricultural production literature (e.g. Vasavada and Chambers, 1986; Oude Lansink and Stefanou, 1997; and Gardebroek and Oude Lansink, 2004), where examples of adjustment costs include lending fees, learning costs, building and environmental licensing fees, and the value of time spent preparing investments. As a fraction of investment expenditures for a sample of Dutch pig farms, Gardebroek and Oude Lansink (2004) find that adjustment costs for buildings and machinery are as high as 1.6% and 5.1%, respectively.
There is considerable interest in the rate of return for investing in an acre of farmland. From 196021999, sample data suggests that this return has averaged 6.2% in the United States. Compared to the 2.9% average return on a relatively riskless security over the same period, this implies an equity premium just over 3%. While not as large as the premium for investing in the S&P index, it has attracted attention from investors outside of the agricultural sector. A recent New York Times article titled ]Food is Gold, so Billions Invested in Farming,( reports that huge investment funds have poured hundreds of billions of dollars into commodity markets and big private investors are buying farmland. However, an important question that has not been addressed is how the presence of adjustment costs might affect the farmland rate of return.
Answering this question is not as simple as with other investment opportunities, where the rate of return is determined exogenously (i.e. stocks, bonds, etc.). Investment in agriculture is composed of many simultaneous decisions such as how much land to hold, how much capital and variable inputs to use, and what farm products to produce. Additionally, farmers make these decision with an eye toward smooth wealth accumulation over time (Jensen and Pope, 2004), and the costs and benefits of farming likely include many latent measures that are not observable to the researcher. These include the marginal effects of land, capital, and outputs on total variable inputs (intensive margin effects), and adjustment costs associated with quasi2fixed inputs.
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