Deficiency Payments and Market Power: Effects of Imperfect Competition on Welfare Distribution and Decoupling

Despite the increasing importance of market power in the food industry, most policy models assume perfect competition. Ignoring market power may lead economists to make incorrect, or at least misleading, policy recommendations. In this paper I develop a theoretical model in which market power can alter conclusions regarding the welfare effects of a specific policy change: replacing deficiency payments with decoupled payments to farmers, and apply it to the U.S. wheat market and milling industry. The main conclusions of the theoretical model are that, middlemen's market power may cause i) an increase in public expenditure, ii) an extraction of policy rents from the taxpayers by the middlemen, and iii) a reduction of the social benefit from decoupling deficiency payments. I develop an econometric model to investigate if the U.S. wheat milling industry is gaining a rent from the federal loan deficiency payment program, using its market power. The results suggest that the wheat milling industry exhibit a moderate degree of oligopsony power and no oligopoly power. Due to the inelastic demand and supply, even a low level of market power has relevant effects. In the average year, the per-unit increase of public expenditure for the deficiency payments reaches 14.5% of the wheat price, and the potential benefits from removing the policy are reduced by 21.3%.