PART II: AGRICULTURAL POLICY AND AGRICULTURAL MARKETS
4 The role of the government in ensuring food security
Low-income families respond to even tiny price increases by reducing their consumption not only of ‘luxury’ foodstuffs such as meat and fish, but also of such necessary food staples as milk, bread, etc. This can be seen in figures 4a through 4d, which depict the relationships between income levels and consumption patterns in 1996, 1997 and 1999. As prices have increased, consumption by low-income families has declined while consumption by families whose money income is over 210 UAH per month has increased. Low-income families were forced to buy less of each product in 1999, compared to 1996 and 1997. Obviously, poor people substituted other food staples such as bread in order to survive. However, the price of bread increased over this period as well.
This wouldn’t be quite so serious if low-income families comprised only small share of total population. Unfortunately, this is not the case, as can be seen from figure 5. In 1997 49.8% of the population had an income of less than 90 UAH/month, while the cost of a minimum food basket was approximately 64 UAH. The figures for 1998 are even worse. As these income groups have to spend most of their income on food, they cannot afford proper medical treatment and have to sacrifice something else for each additional food item, or they have to sacrifice food to buy something else.
Luckily, many people can rely to some extent on home grown food products to help them survive.
Figure 5: Distribution of per capita money income in Ukraine 1997 and 1998
0 2 4 6 8 10 12 14 16
up to 20
20.1 -30
30.1 -60
60.1 -90
90.1 -120
120.1 -150
150.1 -180
180.1 -210
210.1 -240
240.1 -270
270.1 -300
more than 300 Income in UAH per month
Number of citizens (in million)
1997 1998
Source: STATE COMMITTEE FOR STATISTICS (b) (various issues).
One of the most vulnerable groups in Ukraine are the pensioners. With the small size of their pensions, many pensioners are not able to afford even a minimum food basket. Other social groups who must struggle to make ends meet are families with children and single mothers.
function-ing of the market. In this section, a wide variety of policies that might be employed to ensure food security will be discussed. It will be shown that some of the measures that look quite attractive at a first glance will actually fail to enhance food security, or they will be extremely expensive compared with other strategies. The question of food availability will be discussed first. Special attention will be given to the proper functioning of markets, to trade policies and to the question of self-sufficiency. In the second and third parts of this section we will discuss food aid and income, related aspects of the food security problem.
4.1 Functioning food markets
Price formation on food markets is not fundamentally different from price formation on other markets, provided they are liberalised. This price formation is presented in standard supply and de-mand diagrams (see below), which depict the relationships between the prices that prevail on the market, the quantities supplied by producers and the quantities demanded by consumers.
In economic cost-benefit analysis, a liberalised market without government intervention is often taken as the starting or 'reference' point. The imposition of export or import taxes or any other government intervention is then compared with the situation that would prevail in this reference situation. This in turn permits one to look at the question of who loses and who wins due to the pol-icy measure in question, and whether society in general wins or loses.
In the absence of trade barriers, the price of an internationally tradable product is determined by the world market price for that product. Domestic supply changes, caused by production varia-tions from year to year, or demand changes, caused by changes in available incomes or in tastes, do not affect domestic prices, provided one disregards some special effects that are not relevant to our investigation.2 The reason is obvious. Where no trade barriers exist, producers and traders have the option to either export their products or to sell them on the domestic market. Their decision will be based on the prices that are offered on these markets, and they will sell where they get the highest possible price. If this happens to be on the export market, the export of the product in question will reduce the domestic supply. Obviously, this will cause domestic prices to increase. Once they reach the world market price, however, it will no longer be profitable to export. Therefore, the market mechanism will ensure that domestic prices move together with world market prices, and the better the market functions, the better domestic and world market prices will be linked. This is commonly referred to as ‘market integration’. When price changes in one location (e.g. the world market) are transmitted to an other location (e.g. the domestic market), these markets are said to be integrated.
4.1.1 The effects of implicitly subsidised consumption
Implicit subsidies are those that are not directly paid from the state budget. Instead, the state establishes price limits, trade barriers or other measures that have an impact on domestic prices and thus, the same effect as subsidies. The export tax on sunflower seeds is an example of an implicit subsidy that benefits the oil-processing plants in Ukraine (and taxes oilseed producers).
Policies aimed at lowering the price of food products through market interventions, resulting in implicit subsidies for consumers, are used in many low-income countries, including Ukraine.
They include: non-competitive procurement of agricultural products from farmers, below-world-market food prices set by law, trade controls, and an overvalued domestic currency. These measures all have a price depressing effect on food products and, thus, on the prices agricultural producers receive for their products.
The advantages of such policies for the government are obvious: They result in only minor budgetary expenses. The government sets the price in the market below the level farmers would
2 An example of such a special effect is the domestic price shift that takes place when a country moves from a net im-port to a net exim-port position, or vice versa. This is discussed in detail in chapter 7 on Price Determination and Gov-ernment Policy on Ukrainian Grain Markets.
ceive without government intervention. As a consequence, agricultural producers lose. The differ-ence between the depressed price the farmer gets for his output and the world market price is a tax to the farmer.
Figure 6: The effects of price interventions and of explicit subsidies on the market
Quantity
P
demandsupply
P
wP
iQ
d1Q
d2Q
s2Q
s1a
c b
d e
f
Source: Own depiction.
In fact, implicit subsidies are even more expensive for the economy as a whole than direct subsidies, i.e. government expenditures. This is shown in figure 6. Suppose the government imposes an export tax on a product such as wheat. Domestic prices will fall from Pw (the world market price) to Pi (= Pw minus the export tax). As a result, farmers get less for what they produce. Instead of get-ting Pw for Qs2 they now only get Pi. Hence, their loss is the difference in prices (Pw – Pi) times the quantity produced (Qs2). In figure 6 this is the area PwabPi. Of course, the export tax will raise tax revenues equal to the quantity produced Qs2 minus the quantity consumed Qd2 times the export tax.
This is depicted by the area abcd in figure 6. Note that the effects we have been discussing so far are of a purely distributive nature. Income is taken from farmers and is given partly to consumers and partly to the state budget. If the objective of the government were to tax ‘rich’ producers and subsi-dise ‘poor’ consumers with the by-product of raising tax revenues, this policy would be appropriate.
However, this is not the entire story and several other effects need to be considered.
The first effect is that indirect taxation serves as a production disincentive. Since agricultural production is reduced from Qs1 to Qs2, farmers lose an additional amount of income equivalent to the area abe.3 Farmers will produce less because the price has fallen and they will prefer to shift re-sources to the production of other products. To illustrate this point, consider the export tax policy practised by the government of Argentina between 1940 and 1972. Among the consequences of this production-discouraging policy were that employment in agriculture declined and that agricultural productivity grew more slowly than in other countries, despite Argentina’s excellent agricultural soils and climate.
A second effect is that consumption increases from Qd1 to Qd2 as prices are depressed in the market and fall below the world market level. In fact, this is one of the desired results of the implicit subsidy, provided this additional consumption actually reaches the target group – the poor. Unfortu-nately, an implicit subsidy cannot be targeted at all. It is true that the poor will benefit from lower
3 Producers loose the additional amount abe only (not abfe), since the area bfe (the area under the supply curve) repre-sents the additional cost of producing the amount Qs1-Qs2. The total loss to producers is equal to PwebPi, which economists refer to as the change in 'producer surplus' that results from the export tax. Producer surplus is defined as the excess of revenue over cost. Detailed explanations can be found in standard micro-economic textbooks.
market prices for grain (i.e. bread), but so will the rich.4 Hence, for every additional Hryvnia of pur-chasing power that reaches the poor, producers must make sacrifices worth a multiple of that amount. Only a part of the cheaper grain is consumed by the poor, the balance is consumed by peo-ple not belonging to the target group.5
4.1.2 Explicit consumption subsidies
In contrast to implicit subsidies, explicit subsidies take the form of direct market interven-tions. For instance, the government buys grain on the domestic or international markets at the world market price Pw and then re-sells it at the domestic price Pi on the domestic market. In this admit-tedly simplified scenario, the price which producers receive is not influenced at all by the subsidy.
Hence, all production-discouraging effects are avoided. However, such a policy results in budget expenditure. The entire amount consumed domestically at the depressed price (Qd2 in figure 6) times the price difference between the world market price Pw and the domestic price Pi has to be financed by the government (area PwdcPi). Obviously, the distortions on the demand side remain: (a) not only the needy but all consumers are subsidised, and (b) consumers are encouraged to waste the subsi-dised product by its artificially low price. Furthermore, the government has to administer measures to ensure that the cheap products are not re-sold to on the world market, where prices are higher.
Due to the high budgetary expenditures, governments will hesitate to implement such policies, al-though they are less distortive than indirect subsidies.
Box 2: Price intervention in the sugar market
As in Soviet times, queues were seen in front of sugar shops in Ukraine during the second quarter of 1999. According to government data, the average sugar price had increased by 25 to 40% in May 1999 (even more in the Autonomous Republic of Crimea), and on average people had to pay 2 to 2.3 UAH/kg (in the Autonomous Republic of Crimea even 3 UAH/kg) for sugar. Wholesalers believed this price rise to be due to the fact that the stocks built up during 1998 were slowly depleting. This is just part of the story. In contrast to the official explanation, it was actually government intervention that caused prices to rise. A liberal trade regime without any import and export restrictions would have en-sured stable or even falling prices in Ukraine as world market prices were much lower and world mar-ket supplies plentiful. The depletion of stocks would not have influenced the price if there had not been an earlier government intervention in the market place.
This sugar market intervention is a very illustrative example of a poorly designed policy. First, some local administrators declared that ‘speculators’ had driven up prices. Therefore, the government felt compelled to set a price ceiling for sugar. On December 12, 1998 the Kyiv City administration passed Resolution №2440, according to which sugar for ‘privileged categories of the population’ was to be de-livered from the state’s reserves to city shops at 0.95 UAH per kilogram. The maximum retail price for sugar in the commercial network was set at 1.10 UAH/kg. On April 9, 1999 the Kyiv City administra-tion passed a second resoluadministra-tion, №530 “On providing the populaadministra-tion of Kyiv City with sugar and but-ter”. In it the government set the sugar price at 0.95 UAH/kg for ‘privileged categories of the popula-tion’ and at 1.15 UAH/kg for the commercial network. Legal entities were not permitted to dispose sugar at higher prices.
One would think that this measure could have led to the desired result, since it was taken with the in-tention of keeping the sugar market stable, and combating speculators and monopolists to protect the consumer. However, at this time the real procurement price from sugar plants was 1.19 UAH/kg. Since factory prices were higher than the legislated retail sugar prices (at which sugar had to be sold), the government agreed to provide everyone who ‘desired to sell sugar’ with sugar from the state’s reserve
4 It has to be noted that grain only accounts a part of the cost of bread. Thus, reducing grain prices will not reduce bread prices by the same percentage. Depending on the structures of the milling, baking and retailing sectors, part of the cost reduction resulting from purchases of cheaper grain may simply be absorbed in larger margins between millers and consumers.
5 This experience was made in many socialist countries in the past. As consumer prices were depressed to artificially low levels via implicit subsidies for consumers, food (for example bread) was often used animal feed. The result was a massive waste of resources. Hence, implicit subsidies are a very inefficient means of increasing food security.
at a price of 0.90 UAH/kg. To limit its exposure, the city administration limited the total amount to no more than 3,000 t of sugar by decreeing that that was all that was needed for the next half-year.
This led to two major problems. First, in order to buy sugar from the state reserve at 0.90 UAH/kg, every shop manager had to apply to the local administration. Since the sugar could be sold at the retail level for 1.15 UAH/kg, the trade margin amounted to some 27%, which was very attractive. It was de-cided to limit the number of shops that could take advantage of this opportunity in every district. All the shops that were not included on these ‘sugar lists’ were cut off from the sugar supply and disap-peared from the market. Second, Resolution No. 530 was binding for legal entities only. Private per-sons were allowed to dispose of sugar on the market at any price below 1.50 UAH/kg. Of course, there-fore, not all ‘preferential sugar’ ended up being sold over the shop counter. Traders who had access to
‘preferential sugar’ had an incentive to sell it privately for between 1.30 and 1.50 UAH/kg.
Hence, the government intervention on the sugar market did not change the price in the market place at all, and therefore, didn’t change the access of the poor to sugar. It must have been very expensive for the authorities first to have bought the sugar and then to have re-sold it at lower prices, and on top of that to have incurred all the costs of distribution and administration.
4.1.3 Self-sufficiency
Very often, food security is equated with self-sufficiency, i.e. the ability of a country to pro-duce 100% of what it consumes domestically. In Ukraine, for example, some fear that the country cannot feed its citizens if the agricultural sector falls short of producing enough food grain for the population or cannot provide 1.5 mill. t of sugar every year. Clearly, the real catastrophe is that Ukraine has so far failed to produce much more grain than it consumes on its fantastic black soils, thus forgoing huge potential export revenues. On the other hand, self-sufficiency itself is very ques-tionable goal. In fact, self-sufficiency does not ensure food security. The reasons are the follow-ing:
1. As we have discussed above, the fact that a country can produce the required aggregate amount of a certain food item for its own consumption does not ensure that all its citizens can afford to buy enough of that food item.
2. The self-sufficiency of a country in a given year does not ensure that the country will be food secure in critical times. Modern agriculture depends heavily on internationally traded inputs (e.g. energy). If a country cannot guarantee a sufficient supply of these inputs in a critical situation, food self-sufficiency is not guaranteed either. In extreme embargo or war situa-tions, fuel and chemical imports could be halted, and overall domestic food production could shrink significantly. In fact, Ukraine is a prominent example of this situation. It depends heavily on Russian energy imports. Its agriculture would collapse without this energy, no matter what agricultural prices and measures the government might try to implement.
3. Countries that pursue food self-sufficiency to achieve food security incur large costs. They subsidise the production of certain products, although it would be more efficient (a) to con-centrate on producing goods for which the country possesses particular advantages and to export these, and (b) to buy those products on the world market which are in short supply domestically. In fact, with a liberal trade regime, farmers and traders would automatically re-act in this way. As JOHNSON (1996) has stated: “The only real assurances of food security are a liberal trading system for agricultural products, and peace”.
4.1.4 Buffer stocks
Some governments maintain buffer stocks in order to ensure the supply of foodstuffs. Again, this kind of policy at best ensures a stable supply of food, but not the ability of the poor to buy it.
Furthermore, maintaining large buffer stocks can be extremely expensive. First, this is due to the fact that in Ukraine physical storage losses are high compared with other countries. Second, storage costs depend heavily on prevailing interest rates. Storing 1 mill. t of grain, worth say 800 mUAH, for six month at an interest rate of 40% costs 160 mUAH. Under such conditions it might often be
less expensive to export grain at harvest time and to re-import it from the world market later in the year when it is needed for domestic consumption.6 Obviously, some food stocks may be necessary to smooth out seasonal variations: However, this can best be done by private market participants. Fur-thermore, long-term and large quantity storage of food reserves has proven not only to be very costly but also difficult to manage. As the size of stocks increases, their marginal benefit decreases and marginal costs rise sharply. There are several reasons for this. For buffer stocks to be effective they must be stored for several years; the amortisation costs of storage facilities must also be borne in years when they are not used; excess supply often cannot be stored because storage space is lim-ited. Again, if a high degree of stability is sought, large buffer stocks are unlikely to be effective compared with a flexible trade policy. Therefore, it is preferable to put in place and rely on appro-priate food production, distribution, and trade policies. Storage costs are far greater than the costs of borrowing or of carrying extra cash reserves so as to be able to import product when the occasion demands (REUTLINGER & VAN HOLST PELLEKAAN, 1996).
4.2 Food aid programs
Food aid has been an important form of assistance to reduce food shortages in developing and some transition countries. Humanitarian aid is a normal response to inadequate food supply and undernourishment in less fortunate countries.7 Food aid is granted for various purposes:
1. To alleviate the immediate consequences of food shortages. These can be due to natural dis-asters such as drought and emergencies such as war, or due to the negative consequences of ill-advised economic and agricultural policies.
2. To constitute an input into economic and social development programmes, in particular through labour-intensive public work projects and through nutritional programmes for vul-nerable groups.
Often food aid is provided to be sold in the recipient country. The proceeds can then be used to finance development projects, such as rural public infrastructure projects, or to target income as-sistance to the poor. In some cases, food aid is provided directly to workers employed in develop-ment projects in the form of so-called 'food-for-work' programs (see section 4.3.1 below).
The volume and composition of food aid is linked to the accumulation of surpluses of certain products in donor countries. That is, food aid tends to be given not only when and in the form that recipients require, but also when and in the form that is most suitable to donors who wish to dispose of surplus production. In recent years, new WTO regulations have restricted the use of export subsi-dies. Without export subsidies, countries such as the EU and the US find it difficult to dispose of their surplus production while simultaneously maintaining high domestic prices. In such a situation, food aid can represent a ‘loophole’ that provides a welcome means of disposing of surpluses.
4.2.1 The problems raised by food aid
Food aid has its pros and cons. Although food aid can play an important role in helping to meet urgent food requirements, it also raises a number of problems. It can have adverse effects on domestic agricultural production, on income distribution and even the food security of parts of the population. It can have adverse effects on international trade and it can lead to problems with man-agement, rent seeking and corruption (see OECD, 1974).
6 See chapter 7 on Price Determination and Government Policy on Ukrainian Grain Markets.
7 The low grain harvest in Ukraine in 2000 caused the Government of Ukraine (GoU) to consider requesting food aid. It was announced in May 2000 that Ukraine intended to ask the US Government to supply food aid in the form of 500,000 t of feed corn and 200,000 t of soybeans under its so-called PL-480 program. At the end of September 2000 it was announced that Ukraine planed to import 600,000-800,000 t of grain from the US under the US Government’s PL-480 and GSM-102 programmes. This application was rejected by the US government in January 2001.