Chapter 11:National and International Commodity Price Impacts

Chapter 11-
National and International Commodity Price Impacts

by Earl O. Heady

Abstract

Reduced supplies and higher costs for water in the future will lead to higher food costs. However, these tendencies cannot be separated from other variables which also will cause higher prices for food. Major variables affecting food prices include world population, per capita income, and agricultural technology in developing countries.

Developing countries have capabilities to produce enough food to keep real prices at reasonable levels. These outcomes will overshadow U.S. water supplies in determining future food prices. Another condition of similar importance in food prices is the general level of agricultural technology in the United States. Some agriculturalists believe that crop yields are plateauing. If so, these yield limits would dominate water supplies in affecting food prices. However, other agricultural scientists foresee technological advances in crop and livestock production which will entirely offset water supplies in determining U.S. food prices over the next 30 years.

Statistical models to predict the impact of water supplies on food prices do not exist. However, a programming model providing a normative analysis indicated that reduced water supplies which cause a fourfold increase in water prices would increase food prices by 6 percent. Reduced water supplies in combination with restraints on land use and soil loss would cause much higher increases in real costs of food. Based on estimated food demand elasticities, each 1 percent decline in food supplies due to reduced water availability would increase food prices by 4 percent in terms of domestic conditions and .75 percent in terms of world markets.

The United States has had an abundance of land, and real food prices have declined over most of this century due to a number of planned conditions and favorable prices for resources. Some suggest that these conditions will not prevail in future because the

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suggest that these conditions will not prevail in future because the nation is approaching a plateau in per-acre yields. Agriculture increasingly competes with other sectors for surface water, is exhausting its groundwater supply, and is faced with increasing real prices for energy. We will return to these propositions at a later point. The extent to which these limits to food supplies and rising real costs of food will be realized depends on our ability to recreate conditions of the past, which allowed us to develop cheap substitutes for land and to increase farm output much faster than population growth.

Reduced supplies of water for irrigation in the western states, with subsequent restraints on supplies of food commodities, will have their impacts on domestic and international markets since the nation exports a large proportion of its grain production. Because of strong interdependence of U.S. agriculture with international commodity markets, food prices in the U.S. will be closely related to variables of food supply and demand the world over. Hence, generally we must relate water supplies of the West and their effect on food prices, to food production and consumption of the world. Domestically, the impact of changes in irrigation will be offset or augmented by future technological developments and factor prices for the rest of U.S. agriculture.

World Variables Affecting U.S. Commodity Prices

The future supply and real price of food depends on a complex set of variables and conditions-of which one is the U.S. supply price of water for agriculture. The real price of food will depend as much on demand variables as on those on the commodity and resource supply side-of which water is one element of a major set. Certainly two of the dominant demand variables are the rate of growth of population and per capita incomes in developing countries. Even with a reduction in their birth rate, total populations will still increase greatly since a large portion of these populations is still below child-producing age. But nearly as important are potentials in per capita income. The income elasticity of demand for food generally is high in developing countries. It is high even in relatively developed countries such as Eastern Europe and centrally planned economies where institutional restraints, rather than market demands, has limited use of meat and feed grains. The further release of these institutional

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restraints could mean a further heavy leverage in demand and prices for U.S. agricultural exports. In the 20 years from 1960 to 1979, we increased grain exports by 300 percent. In 1979, we exported the product of one-out-of-three acres of grain, including 33 percent of corn production, 57 percent of wheat production, 37 percent of soybean production, and 46 percent of all grains. Obviously, if it were not for this export demand, American agriculture would, given our technology and stock of natural resources, be an extremely depressed industry, and we would not be worried about domestic land and water supplies and strategies.

World export demand quantities are not, of course, independent of food supplies in the respective countries. Export demands of the future will depend on the ability of potential importing countries to increase their domestic supply of foods. The "supply variables" of other countries affecting the demand for U.S. exports include (a) improving technology through research and education, including high yielding and water-fertilizer-pesticide responsive varieties, (b) bringing more land under cultivation, (c) intensifying agriculture and land and water use through extended multiple cropping, (d) further development and better allocation of water supplies, (e) improving the laws and institutions governing the allocation and use of water, (f) improving livestock production, and (g) prevention of postharvest waste. These world variables and conditions relating to supplies directly, and through domestic supplies to demand for U.S. exports, are vast and complex and readily could offset or reinforce any impacts of limited U.S. water supplies on commodity prices. The fact that they have the potential of offsetting reduced U.S. water supplies over the next 30 years is evident: developing countries have 64 percent of the world's cereal acreage but produce only 40 percent of the total supply. In the period 1934-38 their average grain yield was 1.14 tons per hectare, compared to 1.15 tons for developed countries. However, by 1973-76, developed countries had increased per hectare yields to 3.0 tons, but developing countries to only 1.4 tons. If developing countries increase cereal yields only to the developed country level, even with currently known technologies, cereal production could be increased by 67 percent. And that is a modest possibility, since developing country locations roughly conform with the tropical area of the world, with much greater opportunity for multiple cropping and utilizing solar energy compared with the temperate climates of developing countries.

Cropland Conversion and Land Substitutes

A considerable proportion of the land which could be converted to crops has been shifted over the last three decades. FAO^[1] estimates that 125 million hectares over the world could be improved and irrigated in a decade, that food production could be increased by 3.8 percent per year to the year 2000, with 28 percent of the increase coming from added land. Exactly how much land could be converted at realistic costs remains somewhat uncertain. Some estimates^[2] suggest that of potentially arable land, only 22 percent in Africa, 11 percent in South America, and about 45 percent worldwide is now under cultivation. Others are even more optimistic. These estimates undoubtedly are too optimistic, and use of fragile lands would cause some environmental deterioration. However, there is still some land which can be converted to crops even in the United States. The 1977 SCS inventory (RNI) estimated that as much as 127 million acres^[3] could be converted to the equivalent of Class I and II land. But most researchers expect that world food supplies can be increased most readily by use of improved technology on land already cropped. While some estimates are pessimistic under any scenario, other estimates indicate that over the next 20 to 30 years world food supplies might push ahead enough to allow a worldwide increase in per capita consumption.^[4] Food production in developing countries probably could be increased by 3.5 percent per annum to the year 2000. (Existence of the potential does not guarantee implementation of policies to attain it, however.)

Yield Limits and Production Possibilities

In addition to those variables of world food demand and supply, another set of circumstances will either dampen or augment the price effects of reduced supplies of U.S. water for irrigation. These relate to future technological possibilities in U.S. agriculture generally. Over the last decade several agriculturists have proposed that U.S. yields are beginning to plateau. If this is true, then reduced water supplies would have a very significant effect in raising commodity prices. If, however, future productivity advances are as large as those of the recent past, the commodity price impact of reduced water supplies could be small. It is possible that the seeming emergence of yield limits in the

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mid-1970s was due to weather and the shift of somewhat marginal land into grain production out of former cropland set-aside. When observations for 1979-82, years of record U.S. crop yields, are included, a yield plateau cannot be statistically verified.^[5]

Some persons are optimistic about our ability to generate new technologies which can continue to increase productivity levels. Lu et al.^[6] estimate that if future additions to expenditures on agricultural research only offset inflation, productivity growth in agriculture will slow to 1 percent by 2000, while a real growth in research and development at 7 percent would increase it by a 1.3 percent rate. Whether diminishing returns to agricultural research investment will be encountered as efforts are turned to "exotic" technologies, as compared to the more conventional ones emphasized in the past, is unknown. Fuller^[7] believes that we already are at a point where diminishing returns to research can be expected. Wittwer, an optimist, says "far from achieving scientific and biological limits, the world has only begun to explore the capabilities of increasing agricultural production." He also states that "biological limits have not been achieved for productivity of any of the major food crops . . . a comparison of average world yields for every major crop shows a production ratio of three to one, with some records greater by a factor of six."^[8] In a later analysis, he suggests that the genetic potential of corn yield is 900 bushels per acre.^[9] Other scientists are optimistic in terms of possibilities in genetic engineering; increasing crop adaptation to stress conditions; improved irrigation technologies; hybrid wheat; increased protein content of corn; breaking the yield barrier of soybeans; improving photosynthetic efficiency of plants; developing nitrogen fixation by nonleguminous plants, and improved efficiency of those that now fix nitrogen in the soil; nontraditional approaches in genetics to more effectively use available genetic material; improving the efficiency of nutrient uptake of plants; developing appropriate technologies so that land not now cropped can be substituted for resources which are growing increasingly scarce; and a host of other innovations.^[10] Even more than in the past, the urgency is to induce a flow of technologies consistent with the relative supplies and prices of resources which will prevail in the future. With a systematic ordering of our research, I am optimistic about our ability to continue growth in agricultural productivity and food production.

Starting in the 1920s and abetted by both public and private investment in research and favorable real prices for energy and chemicals, we developed a vast set of new capital inputs (fertilizer-responsive crop varieties, improved chemical fertilizers,

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pesticides, etc.), which substituted for land. The supply of land was thus made less binding on food supplies, and the real price of food declined rather continuously up to recent times. Of course, during much of this same period, low energy prices and a favorable public pricing policy also caused water to be substituted for land as irrigated acreage increased. These substitutions were so vast that during times of the 1960s and early 1970s the nation paid farmers for holding up to 65 million acres out of production. Another indication of this substitution is the fact that total grain production in 1910 was 120 million tons on 193 million acres, but in 1979 was 316 million tons produced on 162 million acres. With the prevailing technologies of the 1960s and early 1970s, the nation's food supplies could have been maintained without important price impacts (except for specialized commodities adapted to specific climatic conditions) had we used the 60 million acres held out of production instead of any irrigated acreage. Again, in the future, the impact on commodity prices of reduced water supplies to agriculture will depend on the availability of water-substituting inputs and technologies. Their availability, in turn, will depend on the nation's agricultural research expenditures and the real price of the inputs. Whereas the real prices of chemicals and energy-based inputs declined in previous decades, the probability is that they will increase in the future along with energy prices. The public challenge is an induced research program which relates technologies to resource prices.

While we were able to develop technologies for land and water which allowed us to implement a large world food aid program even while holding over 60 million acres of cropland idle during the 1960s, surplus conditions of this extent are not likely to return in the future. Export demand is expected to continue to grow along with world population and per capita incomes, even if not as rapidly as in 1970-79. Aside from declining U.S. water supplies, I expect the real price of food to increase in the long run due to greater population and income, institutional changes which allow centrally planned and developing nations to participate in world grain markets, tightening restraints on limited resources worldwide, and, especially, rising energy prices. These rising energy prices will dampen somewhat the rate of development of agriculture through increased real prices for several categories of inputs and increasing costs of pumping groundwater.

If we had a closed economy where this complex set of demand, supply, and resource price variables had been operational for 40 years with carefully collected time series observations, we

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probably could predict or simulate the net impact of declining U.S. water supplies on commodity prices. However, with the prices of U.S. agricultural commodities increasingly linked to resource supplies, developmental and institutional changes, and food supply-demand variables in many countries, it is not possible in a few months to quantify a model which can give these net effects. There can be many possible combinations and permutations of these variables in the future. Their expected effect is to increase real prices for farm commodities, but the exact extent that reduced U.S. water supplies will add to this direction currently cannot be deciphered from this complex. If one set of variables dominates in direction and magnitude, they will offset the tendency of decreased U.S. water supplies to increase commodity prices; if another set dominates, a scarcity of U.S. irrigation water will augment their effect. Farmers, ranchers, and land owners collectively would be best off under the latter, consumers would be better off under the former.

Some Estimates of Commodity Supply Prices under Various Water Regimes and Other Scenarios

For the assignment undertaken in this chapter, it would be useful if we could pick out specific future dates, set all exogenous and some endogenous variables fixed at expected levels, vary (reduce) water supplies, and "read off" the resulting expected increases in commodity prices. Data for statistical, econometric and other methods or models for these types of predictions do not, however, exist. Nor are they likely to do so in the near future. Changes in the variables and institutions affecting water supplies and prices may change both gradually and discretely in the future. In the meantime, observations on all of these expected changes do not exist in time series data so that we can statistically predict their future impacts on prices. Many things which will affect water supplies and prices will only occur in the future. Thus our main opportunity to appraise a future of reduced supplies and higher prices in interaction with other events such as greater exports, soil conservation programs, changes in U.S. land use, technological developments, and conservation and environmental programs is to simulate the future. Some data are available, which we will summarize as one indication of potential impacts of water supplies and prices on commodity and food

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prices. While these are not perfect models, and have limitations that we know better than anyone else, they give probably the best data available to gauge the future in terms of our specific assignment.

For some years we have incorporated groundwater and surface water sectors for the 17 western states into large-scale interregional programming models of U.S. agriculture. Generally, these models allow transfer of certain land not now in crops to cropland, project future nonagricultural demand for water by regions, suppose a future reduction of groundwater supplies through use of water at only recharge rates, consider trend and other levels of yield improvement over time, and incorporate alternative population and export levels. These variants provide alternative scenarios for normative evaluations of potential changes in regional and national production and resource use in agriculture. A parallel analysis also is possible of resource returns and commodity supply or shadow prices under these scenarios. An early one of these analyses reduced use of groundwater to recharge rates by the year 2000, used trend levels of yield increase, and decreased surface water availability according to projected nonfarm and varied population levels by the year 2000.^[11]

Some alternatives in supply control and environmental enhancement also were considered. Only two levels of export demand were used and gave somewhat conservative estimates for 2000. However, since domestic and export demands were exogenous to the model, variations for them can be combined in a scenario which better represents current expectations of future exports. If we select a combination of domestic and export demand levels which approach current projections, suppose groundwater use only at recharge rates by the year 2000, and project a diversion of 16 million acre-feet of water from agriculture to other uses under trend technology, we discover real supply (shadow) price increases of about 10 percent for feed grains, 11 percent for food grains, 10 percent for oilseeds, and 20 percent for meat, as a result of the restricted water supply. Fruits, vegetables, and nuts were exogenous to the model and thus shadow or supply prices were not generated for them. Either dampened or accentuated trends in total demands and agricultural technology would, of course, change these normative supply prices-or even any set of price estimates that might represent econometric projections of equilibrium prices. In every case, it is not easy to isolate future price changes due alone to demand changes, technological changes, and reduced groundwater and

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surface water supplies for irrigation. In a system in which all of these and related variables were endogenous, a change in magnitude of one variable over time would induce, to an extent, compensating changes in other variables.

In models for the National Water Assessment (NWA), the Resources Conservation Act (RCA), and other national commissions or agencies, we generally have included land and water use, resource (land and water) returns, commodity shadow prices, and related variables on an endogenous basis. The dominating impact on farm commodity shadow prices results from the level of exports, the level of technological change assumed for all of U.S. agriculture, the amount of land included in the cropland base, and the tightness of restraints on soil loss. U.S. agriculture needs quite different amounts of water to meet specified commodity demands under various combinations of these variables or conditions. The shadow price of water and its relationship to the supply prices of agricultural commodities also differs greatly among these combinations or scenarios.

A set of shadow prices generated for solutions of the RCA model for the year 2030 suggests the general interaction of these quantities.^[12] The "required water use" and shadow or supply prices are shown in Table 11.1 for (a) a base-1 solution (A) which uses a standard (380 million acre) cropland base, (b) a base-2 solution (B) which allows the additional 127 million acres inventoried by the Soil Conservation Service^[13] to be used in crop production, while technology is at trend levels and exports at levels of base-1, (c) a high technology scenario (C) with yields increasing 60 percent faster annually than trend, while the land base and exports are the same as base-2, (d) a low technology scenario (D) with yields increasing at about only 75 percent of trend, with the land base and exports the same as base-2, and (e) a maximum production scenario (E) where technology is at the high rate and the land base is the same as in base-2.

It should be remembered that these are shadow prices resulting from a programming model specified to allow analysis of the scenarios described. To my knowledge, no other quantities exist to suggest potential values for these resources and commodities under the conditions set forth. The prices for water represent the value of water, at the margin, to produce the nation's output under the combination of conditions outlined. The supply prices for the commodities show the levels necessary to attain the prescribed level of production under the resource and technology conditions summarized. (Domestic demand and exports are

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projected to 2030 in terms of population, per capita income, and export trends.)

The figures indicate that under trend technology and the potential of adding 127 million acres of land as inventoried by the SCS, water use could decline by 10 percent in comparison of base-2 with base-1. Water value would decline while commodity price would be 29-50 percent lower than in base-1, with a 33 percent smaller land base. Water use in the high technology-high land base decreases by 35 percent over base-1 solution. Supply prices for water and commodities also would be lower than in base-1. With a low technology but high land base (D), water use would increase by 9 percent over base-1, but production capacity, under high technology and the larger land base, would still be great enough that water value and commodity supply prices would be lower than in base-1. Hence, if water supplies for endogenous crops were reduced considerably below the D level, commodity prices could move upward considerably, exceeding those of base-1 which suppose only trend technology and exports.

The maximum production scenario explores the potential if production, under conditions of the high land base and high technology, were raised to the maximum level possible. To fully use this land would require 110 percent more acre-feet of water as

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compared to the base-1 scenario. It also would increase water shadow price by over 100 percent and commodity prices by an average of about 67 percent over the "normal" or base-1 scenario. The higher water and commodity prices are a function of the level of production, a complete use of land, and the potential of an enlarged water use under very high exports. If this amount of water available in 2030 was reduced, then commodity prices would be raised further-purely as a reflection of restrained water supplies. Unfortunately, we did not run the model under this scenario.

Another study organized to examine the potential of U.S. agriculture for meeting domestic and export demands for food, attaining soil and water conservation, and improving the environment, was the National Water Assessment (NWA) made for the Water Resources Council.^[14] It also was a study of potentials made by a normative interregional and national programming simulation model since (a) quantities to be examined were those which had not been experienced in the past and thus lacked time series observation for econometric or statistical prediction, and (b) scenarios were designed to examine the full capacity or potential of the nation's agricultural resources under full production and certain restraints on soil erosion and water availability. The analysis was made for the year 2000 and assumed exports at current levels projected to that year, use of groundwater at recharge rates by 2000, and trend level yield increases. Under this base scenario of high exports but no other restraints on land use and water availability, water use for the endogenous crops and livestock was 86.7 million acre-feet. Prices (in 1972 dollars) were $1.82 for corn and $3.84 for wheat. Another scenario was the same except that (a) soil loss per acre per year was restrained to t-levels, (b) no further development of wet lands for crops was allowed after 1975, (c) the water supply available for agricultural uses was reduced (to 64.6 million acre-feet) to allow minimum streamflow for maintenance of water quality and protection of fish and wildlife, and (d) livestock wastes could not accumulate but must be returned to the land. Under these conditions, prices (in 1972 dollars) increased to $2.89 for corn and $8.82 for wheat. Soybean and cotton prices increased similarly. When soil loss restraints alone were applied, commodity prices remained near the level of the base scenario. Hence, the above increases could be imputed mainly to the water restraint which was reduced (for endogenous crops) from 87.6 million acre-feet to 64.6 million acre-feet.

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Water Price Changes

Not all water prices have been subject to market forces. For some surface water, historically they have more or less been institutionalized at publicly subsidized rates. In recent times, some water previously used for agriculture has been purchased by other users and market transfers have taken place. However, the number of time series observations and the data base for these transfers is so sparse that statistical estimation of water demand functions, with their implied impact on commodity supplies and prices, is currently impossible. Accordingly, we made a normative analysis of demand for groundwater and surface water. While fully aware of the water rights, legal restraints and institutional arrangements which prevent sale, interfarm and interbasin movement of water, and market reflection of the marginal value productivity of water, we made some normative estimates of water demand under the premise that some knowledge is better than none.^[15]

In this programming study made up of 105 producing regions, we defined supplies of groundwater and surface water in each. We then set prices (costs for groundwater) at four levels for each. The initial price was the 1975 price; we then doubled, tripled, and quadrupled that, to give 16 price combinations of each, as illustrated in Table 11.2, where G1S1 is the initial level, G3 is groundwater price tripled, S3 is surface water tripled, and G4S4 represents both prices quadrupled.^[16] The programmed water demand responses show, as normative estimates, the price of water associated with each quantity used and, in a sense, also are proxy representations of the price of water which might exist at different levels of water availabilities-under the usual claim of the limitations which prevail under such models. (As mentioned before, we are entirely aware of the limitations of such models and the particular assumptions underlying them.)

Reduction in water use at the highest prices of water are only about half that at the lowest price of water in Table 11.3. These sizable reductions in water bring only modest increases in programmed commodity supply prices. In effect, these are changes in commodity prices reflecting reduced quantities of water used for irrigation (induced by higher water prices, but should parallel reductions in water use made through other means). The resulting commodity price increases in Table 11.3 are smaller than those resulting from a smaller (and somewhat similar pattern of) reduction for the NWA assessment which (a) assumes a higher level of exports, and (b) limits the amount of land which can be

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converted to crops. Similarly, the commodity price increases are less than those indicated in Table 11.1 for the RCA analysis, where added water use also is necessary^[17] for the maximum level of production and exports, because the RCA estimates also assume (a) much higher levels of exports, and (b) all available land is cropped. For the results in Table 11.3, the land base for the lowest price set is only 380 million acres. Hence, as less water is used, varying amounts of the 127 million potential crop acres indicated in the SCS inventory are able to substitute for reduced water use at a higher price. From this analysis, it would appear that over a considerable range (perhaps somewhat less than suggested in the above quantities) of reductions in water use could take place without causing large increases in commodity supply prices if (a) the level of exports is modest, (b) only a trend level of technology is supposed, and (c) a considerable amount of arable land is still available. However, the several sets of data suggest that with a high level of exports and complete use of the nation's potential cropland base, as might happen sometime in the future, declining water availability (due to diversion of water to other uses, higher energy prices, and depletion of groundwater) could cause considerable increases in commodity supply prices.

With sufficiently high energy prices, extended depletion of groundwater stocks, and diversion of water to other sectors from agriculture, water prices could be considerably higher than those used in Table 11.2. For the low price combination in Table 11.2, the average national prices are respectively only $9.80 and $7.83 for groundwater and surface water.^[18] For the highest combinations, these prices are quadrupled. But the possibility of much higher water prices is suggested by Ayer and Hoyt^[19] and by situations such as that quoted below:

"Ten years ago Colorado-Big Thompson water rights were selling for $240 an acre-foot and I thought that was really high," said Earl Phipps, director of the Northern Colorado Water Conservancy District. "Three years ago when the water rights were up to $850 per acre-foot, if you had told me the price would hit $2,000 by 1979, I'd have said you were crazy. That's where it is today. I still can't believe it! . . . Six weeks later the price had gone to $2,250. In 1947 it was $1.50."^[20]

Water prices considerably higher than those used in Table 11.2 could cause a drastic decline in water use and thus larger increases in commodity supply prices. Each further decrement in

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water use would have an increasing impact on agricultural production and commodity prices. It is possible that the "long run" aggregate commodity supply function potential in agriculture parallels is of this nature: over some range, it may remain highly elastic as opportunities remain to convert more land to crops and to further adjust the allocation and technology of water use. But eventually, with complete use of all potential cropland which can be converted at reasonable costs, higher prices and smaller supplies of water and exhaustion of reallocation possibilities for water, the supply elasticity may decline greatly with a sharp upturn in the commodity supply function. A good many persons suggest that we have already "turned the corner." My own estimate is that, for the reasons mentioned earlier, we will "turn the corner" into an era of rising real prices for food sometime in the next 20 years.

Changes in Institutional and Technical Possibilities

From the standpoint of irrigation water, possibilities of remaining on the flatter portion of the curve for some time rests on schemes which might remove institutional restraints in water allocation, application of improved water saving technologies, and improved distribution systems. Technological possibilities are numerous, including improved water delivery systems, water saving techniques such as laser or dead leveling of fields, trickle irrigation, greater pump efficiency, water scheduling, and others. There is even considerable evidence that farmers use water beyond profit maximizing levels, or even beyond yield maximizing levels, due to low administered prices of water.^[21] Since water response functions indicate diminishing marginal yields, use of given water on larger land areas also could help maintain commodity supplies under lowered water availability. Many of these technological changes would likely be induced under much smaller supplies of, and higher prices for, irrigation water. These conditions might also help cause removal of institutional restraints which stand in the way of the most productive use of water. If so, they would dampen the impact of reduced water supplies for agriculture on commodity prices.

The importance of other variables and conditions (export demand and related production in importing countries, land used in the U.S., domestic technology trends, energy prices, etc.)

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besides declining water supplies, also is emphasized in another study using the Ogallala Aquifer area in an interregional and national programming model.^[22] This study indicated that rising energy prices are likely to be as important as groundwater mining and greater pumping depth in increasing water costs by the year 2000. With exports at higher levels in 2000 (corn at 5,424 million bushels, wheat at 3,213 million bushels, soybeans at 1,890 million bushels, and cotton at 4,743 thousand bales), an increase in energy prices from moderate to high levels would raise corn supply price from $2.45 to $3.31, wheat from $4.55 to $6.24, soybeans from $5.63 to $7.42, and cotton from $207 to $267 (1979 dollars). The increased supply prices result not only from higher costs of water due to both greater prices and greater pumping depths, and thus the use of less water, but also from the high level of demand, expansion of crop acreage to less productive land, and some reduced use of fertilizer.

Mainly, I have been discussing major basic feed, cereal, and fiber crops as their production and prices are reflected in the quantitative analysis. They, along with pork, beef, and dairy products, are treated as endogenous to the models. Other irrigated crops and poultry are included, but on an exogenous basis, supposing that they will be produced in the projected amounts (based on consumption trends and per capita incomes and food competition). Of the 60.7 million irrigated acres (including pasture) in 1977 estimated by the NRI,^[23] 55.7 million acres were in cropland, 5.0 million acres were in pasture, and 50.2 million acres were in the 17 western states. The large acreage of cropland not vegetables, fruits or nuts, and the 5 million acres of irrigated pasture are included in the above models. (Because of the use of irrigated land for high value crops in the West, about 25 percent of the value of crops grown in the United States is attributable to irrigation. About 13 percent of U.S. cropland and 11 percent of land, including pasture, is irrigated.) The high value crops (fruits, vegetables, nuts) are a small portion of irrigated acreage and total cropland acreage in the United States. They are, however, a large proportion of specialized crop acreage, particularly in the West. In general, their high value would give them comparative advantage over other crops in the claim to water. However, their prices would be especially affected by increased water prices stemming from reduced water supplies. Whereas dryland production would dilute the price effect of smaller water supplies for grains, cotton, hay, and pasture, it would not do so as greatly for specialized high-value vegetable crops grown in multiple-

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cropping systems. Thus, we would expect the price effects to be relatively larger under reduced water supplies than those discussed above for conventional field crops.

Elasticity Impacts

Another potential means of evaluating the impact on commodity prices of reduced irrigation water would be to estimate reduction in food production due to restrained water supplies and relate it to price elasticities of demand for each commodity involved. To do so, we would need to know the reduction in water drawn away from each crop, estimate its decline in production (for otherwise "normal" conditions), and effectively apply its price elasticity of demand to the change. Aside from programming models which can normatively estimate such reallocations relative to a stated objective function, there is no ready quantitative or statistical means to predict the pattern of these reallocations at a future time when higher energy prices and increased pumping depths reduce groundwater supplies while competing sectors reduce surface supplies. Hence, there may be little reason, in a predictive sense, to spend any great time on expected price changes for individual commodities.

Most of the price elasticities of demand estimated for food in aggregate in the United States over the last 40 years range from –.20 to –.33, with –.25 being somewhat the "central tendency."^[24] Hence, we might expect that each 1 percent reduction in domestic food supply resulting from reduced water supplies would increase food price by about 4 percent-other things remaining equal, on both the supply and demand sides.^[25] This would be the more expected level of price change if grain export markets paralleled those of the 1950s and 1960s. At that time, supply controls were in effect. U.S. exports were modest, and the overwhelming outlet for major export crops was the domestic market, with exports moving particularly under public assistance. However, since export markets have grown greatly over the past decade, foreign (world) demand elasticities for U.S. exports now may be most relevant in gauging the effect of reduced U.S. water supplies on commodity prices. Estimates of these elasticities are available for only a few major export commodities, cover a wide range of numerical values, and are greatly tempered by the supply elasticities of the importing countries.^[26] They are expected to be larger than domestic elasticities, and, as

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an average, are probably about –1.33 for grains which are the major U.S. export commodities. In these terms, a 1 percent reduction in output due to a reduction in water supplies to produce grain would increase price by about .75 percent.

Distribution and Equity Aspects

Reduced supplies and higher prices for water would likely bring about increases in the marginal productivity of water, thus dampening somewhat the impact of reduced supplies on commodity prices. A complex of water rights and institutional restraints now stands in the way of prices in allocating water more nearly in line with its marginal productivity. These rights and institutional arrangements have value to the users; to abolish them would force a capital loss on farmers to whom they attach. Hence, compensation to these farmers through better access to markets for their water, or by other means, is necessary if improved allocations of water are to be realized. These means may not be created soon, even though they would lessen the impact of reduced water supplies on food prices. However, with the proportion of farmers in the population tending towards zero, a means may be more readily created if the real price of food advances rapidly.

Discussion:
Kenneth R. Farrell

In his inimitable style, Heady has dealt competently and comprehensively with a very complex subject. As he correctly points out, there can be no unequivocal empirical determination of commodity price impacts from a decline in western irrigated agriculture. The region is but a part of a large system of national and international markets for agricultural commodities-markets in which numerous economic, technological, and institutional variables interact in complex, dynamic ways in the course of highly uncertain future events. Nevertheless, Heady has given us some possible "boundary" outcomes to reflect upon in our speculations and planning for the future.

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For purposes of discussion although at the risk of oversimplifying Heady's conclusions, I have chosen to highlight three of his principal points.

(1) The future supply of water for irrigation in the western states will decline. I concur with this, but think it important to amplify in three respects. The first is to note that Heady is referring to the economic supply of water, i.e., for any given quantity of water, the price (unit cost) to agriculture will increase, for reasons he has cited (increased costs of pumping groundwater and increased competition from other areas). This is quite different from saying that agriculture will confront absolute physical constraints on water supply. Second, we should note that the economic supply of water now differs substantially among areas within the region, and that such differentials could well widen in the decades ahead, depending upon the rate of mining of underground supplies, the costs of energy, and the market or institutional arrangements by which water is allocated among competing uses. As Frederick has pointed out in a recent report, the locus of growth in irrigated agriculture in the West during the past 25 years has moved from south to north, and will so remain in the decades ahead.^[1] Finally, we should note that while competition for surface water will inevitably heighten, to the economic disadvantage of agriculture, the political-administrative institutions governing the allocation of that water are slow to change. Notwithstanding the imperatives of economics, agriculture may continue to muster sufficient political strength to defer major reallocation of supplies or major modifications in water prices for some time to come.

(2) ". . . the impact on commodity prices of reduced water supplies to agriculture will depend on the availability of water-substituting inputs and technologies." Such substitution includes the possibility of dryland farming of land now in irrigation, land now in other uses, and the adoption of current or new water-conserving management practices and technologies. As Heady notes, one of the public challenges we confront in the context of rising real costs of resources is that of inducing R and D programs which relate technologies to prospective resource prices.

With respect to the substitution of land for water, options differ widely within the West. In states such as California, the option is extremely limited. In the Great Plains states, the technical possibilities of shifting to dryland cropping are greater; but the economic costs of farm operators would be substantial. A recent study of the six-state Ogallala aquifer region concluded

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that, under conditions of crop prices and yield relationships of 1975-80 and with currently projected rates of groundwater depletion, a transition to dryland farming over the next 40 years would reduce gross farm income in the region by 25 to 50 percent.^[2] With respect to bringing land into crop production from other uses, the greatest possibilities would seem to be outside the region in the Southeast and in the upper Midwest.

Heady observes that there is a lack of knowledge of irrigation technologies and institutional changes which might be induced to improve and make more productive the use of water. It is frequently observed that application of water in agriculture is excessive from a technical or physiological point of view. What are the potential physical savings on water use given current technology? With new or improved technologies? What are the economically feasible savings of water under alternative technical and water-commodity price relationships? Such questions would be appropriate subjects for interdisciplinary research involving agronomists, irrigation scientists, and economists.

(3) The general conclusion which Heady appears to draw from the results of his several models is that water reductions could take place over a considerable range, without causing large increases in commodity supply prices, if the level of exports is modest, the trend level of technology is maintained, and the 127 million acres of cultivable land inventoried by SCS are available for conversion to cropland. Heady goes on to say, however, that at some point the commodity supply function could become quite inelastic, and that a combination of high exports and declining water availability could result in considerable increases in commodity supply prices. This conclusion is in accord with those of Crosson, and Crosson and Brubaker in their recently published reports.^[3] Heady's analysis illustrates clearly the sensitivity of American agriculture to export demand and in turn the economic "leverage" which exports could exert upon the price of commodities and use of resources in the United States. As he points out, there is great uncertainty concerning the future strength of that demand.

In conclusion, I would like to comment briefly on one of the premises of Heady's paper, indeed a premise of this entire volume-the need for additional information and research to narrow the bands of uncertainty concerning the basic issue, "Impacts of Limited Water for Agriculture in the Semiarid West." I have suggested a need for interdisciplinary research to better estimate the potential savings of water under alternative economic and technological scenarios. In addition, we need better,

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more complete estimates of the economic and social value of water in its alternative uses in the principal watersheds of the region and, within agriculture, better and more complete estimates of the value of water among alternative agricultural uses. Although a substantial body of such information is scattered among research institutions, it is of uneven quality and currency and probably not easily additive. The report to the National Water Commission in 1972 by Young and Gray provides an excellent conceptual framework within which to begin a coordinated regional or national effort to construct such estimates.^[4]

Finally, I would urge my fellow economists to seek more effective research alliances with other disciplines, particularly law, to examine and analyze the institutions which govern the use of water, to document the social costs and benefits, and the respective distributions of each under current, alternative, or modified institutions. As social scientists, we have a responsibility to induce innovation by providing relevant, usable research results. The need is neither new nor revolutionary. It is simply more pressing.

Discussion:
David L. Watt

This excellent chapter provides a long needed perspective on the relationship of agricultural resource problems in the U.S. to world commodity markets. Because many of the land-extensive commodities irrigated in the United States are grain crops, and the grain market is indeed a world market, we are attempting to measure the impacts of one possibility among many unknowns.

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The 1978 Census of Agriculture indicates that less than 11 percent of U.S. cropland is irrigated. The chapter points out appropriate evidence that there is great potential for improvement in the efficiency with which water is being used. Between 1949 and 1978 irrigated land in farms increased from 25 million acres to 50 million acres. This increase has been fostered by technological improvements in irrigation techniques-and by extensive expansion in international trade, particularly in the last 15 years.

Between 1967 and 1981 the annual average productivity growth of U.S. agriculture was 1.66. U.S. agricultural exports have increased at a rate of 6.7 percent per year, while aggregate farm output has increased only at a rate of 1.7 percent. Productivity growth has permitted the increase in output to be accomplished with a negligible increase in the quantity of inputs. However, changing relative prices have created significant change in the mix of the inputs used. For example, labor use declined by 35 percent during that period, while quantity of agricultural chemicals used increased by 74 percent.

If agricultural exports continue to grow at the same rate as during the last 15 years, and if domestic supply, demand, and productivity growth continue at trend levels, the increasing importance of exports as a demand for U.S. agricultural commodities will indeed cause real prices of U.S. commodities to increase, as indicated in the chapter. However, the impact of reduced water to produce grain is a long-term adjustment. With other countries having time to adjust to a changing situation, both in supply and demand, price impacts will be dampened much more than the amount estimated from currently accepted short-term world demand elasticities.

The availability of additional land and yield potentials for crops is handled well. The only conclusion is that sufficient land and yield technology is available to meet significant growth in demand. The question is simply, "What price will be required to fill future demand?" Expansion in demand will have its greatest impact on the quantity of irrigation.

It would be useful if we had enough knowledge about the future to justify statistical and econometric studies with reasonable prediction errors. It is essential for strategic planning by corporations and for capital investment decisions in the public sector to have an estimated future economic environment, including prices, on which to base decisions. Public Law 49-587, October 22, 1976, commissioned a study to determine the cost and

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benefits of reasonable options to ensure an adequate supply of food to the nation and promote the economic vitality of the High Plains region.^[1] In this study, commodity supply price estimates over the life of any policies which would be implemented were required to determine the benefits of alternative policy options. Also, the economic vitality of the High Plains region would be greatly affected by commodity supply prices. A baseline scenario was developed under the assumption that no explicit Congressional actions would be undertaken with respect to the declining water situation in the Ogallala.

For the baseline scenario, the productivity of the agricultural sector was assumed to grow at a 1.5 percent per year rate for the near term, and decline to 1.0 percent by the year 2020. Prices paid by farmers for production inputs were assumed to increase slightly faster than the price of all goods and services in the U.S. The projections for U.S. population and income growth, combined with the assumptions of growth in international demand, resulted in demand increasing by 1.75 percent per year in the near term and declining to 1.25 percent by the year 2020. These assumptions result in aggregate farm output measured as an index (1967 equals 100) rising to 210 by the year 2020. Prices received by farmers in this scenario experience a real growth rate of approximately .25 percent per year from the 1967 base. For this scenario, the total cropland harvested makes a gradual increase up to 388.5 million acres by the year 2000 and continues up to 435.1 million acres by the year 2020. Of the cropland harvested, 53 million acres are projected to be irrigated by the year 2000 and 61 million acres by the year 2020. These results imply that significant growth in agricultural production can be achieved without a large increase in irrigated acreage and only a slight increase in real prices received by farmers.

In the High Plains study, several management strategies were studied to determine their impacts.^[2] Of significant interest in looking at reductions in water use was management strategy 2, which looked at policies designed to force reduction in the amount of water pumped for irrigation. Researchers from the six states involved developed estimates of changes in production in each of their respective states from the baseline. The change in High Plains production was divided by the baseline U.S. production to reflect the percentage change in production caused by the new policy. The study showed that there are many factors which offset the reduction in available water for irrigation. Most descriptive and typical is the impact upon corn production. In

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management strategy 2 the percentage reduction in national production (with prices and other factors fixed) was 1 percent for 1990 and approximately 1.5 percent for both 2000 and 2020. When inserted into an aggregate model for the U.S. agricultural sector, the production impacts were partially offset by increased price effects and production increases in other parts of the U.S. The 1990 equilibrium production was reduced by only .5 percent, production by the 2000 was reduced by almost 1 percent, and production in 2020 was reduced by 1.25 percent. The price increase over baseline in this scenario was .75 percent in 1990, 1.8 percent for the year 2000, and only 1 percent by 2020. Thus, the net elasticity of change increases with the length this particular scenario is in effect. Net price elasticity is .66 in 1990 and rises to 1.20 by 2020.

Indeed, the distributional aspects are the most serious problems associated with reduced irrigation water in the West. The significance of this is highlighted when we recognize that reduced production of agricultural commodities in the West will result in higher net farm income for the agricultural sector at the national level. The most redeeming feature of the current problem is that increased attention is being directed toward determining more efficient ways of using water. We are also seeing significant improvements in the economic use of water in agriculture.