July 27, 2015
Changes in Capital Investment on U.S. Farms
By Brent Gloy
The U.S. farming system is capital intensive. As the agricultural sector adjusts to lower commodity prices many areas of the agricultural economy will adjust and it’s hard to imagine that capital expenditures will escape significant adjustment. We have looked at fertilizer prices, seed prices, land prices, and equipment investment in recent posts. With respect to machinery and equipment investment, David recently noted that both USDA and farm record keeping data indicated that these costs had not yet showed declines. We decided to take a further look at the main components of capital investment on U.S. farms and examine how they had changed over time.
The USDA’s Economic Research Service forecasts capital expenditures of roughly $37 billion in in 2015. This level is significantly higher than that reached before the commodity boom. From 2000 to 2006 capital expenditures ranged from a low of $18.7 to a high of $23.9 billion. As farm incomes come down one would expect that capital expenditures will adjust as well. To get a better feel for how capital expenditure levels have changed over the years, we calculated the annual percentage change in nominal farm capital expenditures from 1960 to 2015 (Figure 1).
Farm capital expenditures can experience large swings from year to year. Since 1960, there have been 24 years when investment increased or decreased by more than 10% from year-to-year. However, most of these larger changes have been on the upside. There are only 7 occasions since 1960 when farm capital investment fell by more than 10%. Three of these including the largest annual decline of 26% occurred in the 1980s.
The decade of the 1980’s was particularly rough on capital expenditures as they fell for seven consecutive years from 1979-1986. However, the third largest percentage decline in annual capital investment occurred more recently in 2009, when investment declined by 18%. In general, capital expenditures tend to be highly correlated with net farm income (correlation = 0.90) and gross value added (correlation = 0.93). This means that capital expenditures tend to move up and down with these two series.
As seen in Figure 2, in real terms (2009 dollars) annual capital expenditures did not approach anything close to the 1979 peak. Capital expenditures are forecast to decline, but they remain well above levels of even the mid 2000’s. One would expect that there is more room for these values to decline.
What Types of Capital Expenditures?
The ERS breaks capital expenditures into two major categories, 1) vehicles and other machinery and 2) buildings and land improvements. Of the two categories, vehicles and other machinery are by far the largest. In 2015 capital expenditures on vehicles and other machinery are forecast to be $26 billion versus $8 billion for buildings and land improvements.
How farmers have allocated their capital expenditures has changed over time. Figure 3 shows the percentage of total capital investment in each of the different subcategories over the time period 1960-2013 (forecasts for all subcategories were not available for 2014 and 2015). At the top of the graph one can see that the share of expenditures made on autos, once accounting for roughly 10% of total capital expenditures, has steadily declined over time.
The largest category is other equipment, which saw its share expand and then shrink, ending the time period at about the same proportion as it started. Tractors are the second largest category of capital expenditure. Their share of capital expenditures has generally increased over this time period and in 2013 accounted for 27% of total capital expenditures.
For the most part, the changes in the relative shares of capital expenditures reflect longer-term trends in agriculture. As autos have become less important in farming their share has shrunk. Tractors on the other hand have generally increased their share slowly over time. Other equipment has also held onto the strong majority of capital expenditures. These results likely mean that as capital expenditures slow, all categories of capital expenditures will shrink somewhat proportionately.
Wrapping it Up
The ERS is now forecasting that farm capital expenditures should begin to fall. This forecast comes after capital expenditures have reached a real (in 2009 dollars) level not seen since 1980, but well short of the 1979 peak. As economic conditions in the farm sector continue to deteriorate it is likely that capital expenditures will continue to decline. This should eventually help to reduce fixed cost expenses associated with equipment.
When looking at the individual components of capital expenditures, the largest category is investment in machinery other than tractors, trucks, and autos. The individual components of expenditures show few clear trends other than the fact that automobiles make up a consistently smaller portion of total capital investment. Additionally, it appears that tractors have recently made up an increasing share of capital expenditures. As overall capital expenditures decline it is likely that all categories of capital investment will be reduced.
The overall changes in capital expenditures can fluctuate widely with economic conditions in the farm sector. There have been several times when capital expenditures fell by more than 10% year-over-year, with 2006 and 2009 being the most recent examples. Such large changes in capital expenditures will likely challenge suppliers and retailers of capital goods, particularly those highly reliant on the farm sector. As we have pointed out before, it appears that farmers are well equipped and we would not be surprised to see another large pull back in farm capital expenditures if economic conditions do not improve.
Photo by Johnny Klemme