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All Things Considered: July 2010

Down the Rabbit Hole


June 24, 2010
By Jim Knisley


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While I am loath to admit it, I am befuddled, bemused and confused.
This is not something someone who occupies space in a magazine should
admit. But it is when I decided to try and analyze Agriculture and
Agri-Food Canada’s (AAFC) farm income forecast for 2009 and 2010 that I
fell down a rabbit hole and am still trying to emerge.

While I am loath to admit it, I am befuddled, bemused and confused.

This is not something someone who occupies space in a magazine should admit. But it is when I decided to try and analyze Agriculture and Agri-Food Canada’s (AAFC) farm income forecast for 2009 and 2010 that I fell down a rabbit hole and am still trying to emerge.

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It all began in a normal way. AAFC (belatedly) released its forecast. I took a look, expecting the hog income figures to be horrific, beef income to be beastly, grain to be more or less OK and the poultry and egg industries to be boringly steady.

The hog, beef and grain figures were more or less as expected. But poultry and egg were a shock and prompted a classic “What the heck is going on?” response.

It’s not that the poultry and egg income numbers are awful, especially when compared with the beef and hog industries. Beef producers are on average expected to lose money this year on operations. If you throw in depreciation, things are worse.

Hog farmers are expected to generate slim net operating earnings (revenue minus expenses not including depreciation or changes in inventory). But the paltry earnings are thanks to government program payments. Without payments from the government programs the losses would be so steep that even the beef industry would look good by comparison.

On the poultry and egg side the ledgers are written in black ink. The producers are profitable. But the forecast indicates a steep drop in profitability over the last two years. Net operating incomes in 2010 are forecast to be down 29 per cent from 2008 and 18 per cent lower than the 2004 to 2008 average.

The average family net operating income for poultry farmers is expected to be $38,563 this year. That compares to $43,156 in 2009, $54,185 in 2008 and an average of $48,971 in 2004 to 2008.

Expenses are rising faster than revenues, a situation that is cutting into farmers’ bottom lines.

Under supply management this isn’t supposed to happen. The poultry and egg industries have sophisticated cost of production formulas designed to ensure that revenues from sales keep up with increases in costs. According to industry leaders, the formulas haven’t broken down and are still doing their job.

There also hasn’t been a massive revolt at the grassroots level, which would have been likely if incomes were falling as rapidly as AAFC forecasts. Quota prices don’t appear to have softened – something that would be expected if incomes were falling.

Another possibility was raised by Agriculture Minister Gerry Ritz when he spoke to radio reporters about the forecast. He said it represents a “worst-case scenario.”

That implies that AAFC, which has been doing these forecasts for decades, has recently changed its methodology. There is no evidence of this. It has changed the way the forecasts are presented, seemingly moving away from realized net farm income (which includes depreciation) and total net farm incomes (which includes changes in inventories as well as depreciation) and toward net operating income as the headline number. It also seems to be giving off-farm or non-farm income more prominence.
 
But if this year’s numbers are a worst-case scenario, the same must be said of forecasts for other years. For the 2010 numbers to be exceptional, this must be the worse, worst-case scenario.

Another possibility is that the forecast is wrong, but it would have to be very wrong. All forecasts are subject to revision. It is the nature of the beast. No forecasting model is perfect. They all include assumptions that are based on trends and foreseeable events. But sometimes events are unforeseeable. These events are frequently for the worse such as a drought, changes in the value of the dollar or disruptions of trade.

Maybe there was something wonky with the survey or other factors this time around – especially as it applies to both poultry and eggs.

While the forecast isn’t based on a poll, most people are familiar with the accuracy rate of plus or minus three per cent 19 times out of 20 statements. What most people don’t understand is that what this means is that there is a five per cent probability that a poll has a margin of error greater than plus or minus three per cent. While it is unlikely, it is possible that someone could do 20 polls and every one of them is wrong. That could be true of the AAFC forecast. Despite the care that goes into making it, maybe it overestimates costs and underestimates revenues. A small decrease in feed costs, for example, would have a big impact on income – especially net operating income. Likewise a small increase in revenue could have a significant impact.

The other thing I don’t understand is the off-farm income figures, especially for 2009. We were in the midst of a recession, unemployment in many rural areas was way up and yet the forecast shows only an insignificant impact on off-farm income.

I remain befuddled.


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