Capitalization of Farm Policy Benefits and the Rate of Return to Policy-Created Assets: Evidence from California Dairy Quota

Abstract

The rate of return to ownership of California dairy quota is about 27% per year-well above that of typical financial assets, but in line with other measured returns to agricultural quotas. Ownership of dairy quota does not contribute positively to total variation of typical portfolios, including those of dairy farm assets, and so contributes little or no portfolio risk. A plausible alternative hypothesis for the high rate of return is that quota owners see significant risk of policy change that would reduce future quota values. That is, they face default risk in quota ownership. T he capitalization of farm program benefits and the effects of policy on the rate of return to investments in farm assets have long been important to agricultural policy analysis. The issues arise in the context of the influence of policy on prices of farmland, other physical assets, and policy-created assets such as farm program quota. Basic economic principles tell us that the benefits of government programs will affect returns to and prices of resources connected to a program. The incidence of flow benefits depends, in part, on the elasticities of supply of these resources, with the prices of inelastic resources affected most. The capital prices of assets do not depend directly on past returns, but on expectations about future returns. Of course, in many practical cases, the history of past returns is a crucial source of information used to form expectations. Johnson assessed the literature on returns to farm quota, stating, Roughly speaking, the discount rate used to value future earnings from [farm-program created] quotas is approximately 25%. Thus, individuals who have recently