Economics of Food and Agriculture in International Development Week 9 March 23, 2004 Policy and Poli

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Economics of Food and Agriculturein
International Development Week 9 March 23,
2004 Policy and Political Economy
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The development paradoxCountries tend to tax
agriculture when they are poor, and increasingly
subsidize it as they get richer.
Source Real GDP per capita is from the Penn
World Tables (http//pwt.econ.upenn.edu), and
percentage PSE estimates are from the USDA
Economics and Statistics System
(http//usda.mannlib.cornell.edu). Countries are
Argentina, Australia, Bangladesh, Brazil, Canada,
Chile, China, Colombia, Slovak Rep, France,
Egypt, Hungary, India, Jamaica, Japan, Kenya,
Mexico, Nigeria, New Zealand, S. Africa, Senegal,
Turkey, USA, Venezuela, Zambia, Zimbabwe.
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This pattern of farm subsidies is plainly
inefficient and unfair across countries
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and its pretty bad within countries as well.
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How might we understand, explain and perhaps
reform agricultural policy?

• In poorer countries,
• agriculture generally
• employs a large fraction of workers,
• consumes a large fraction of expenditure, and
• supplies a large fraction of exports (but often
  net food imports)
• while governments generally
• have few tax instruments, so rely on trade
  tariffs for revenue-- taxing trade taxes
  agriculture as an unintentional by-product
• have few democratic institutions, so respond to
  lobbying--farmers are poor and dispersed so
  cannot counter-lobby
• have falling land per farmer, often a rising real
  cost of food--governments seeking stability may
  try to keep food prices at past levels.

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Meanwhile,

• In richer countries
• agriculture generally
• accounts for a small fraction of expenditure and
  trade and
• employs a small number of workers on a fixed land
  base
• field crops are dominated by self-employed
  family farmers, whose farm profits are
  capitalized into the value of farmland, which
  active farmers rent or buy from ex-farmers
  their heirs
• and farm lobbying groups generally
• can field a large number of geographically
  dispersed, similarly motivated activists, who can
  appeal to a common history of relative
  deprivation but whose land makes them now
  wealthy
• also, each farmer can gain large benefits by
  investing in politics, at little cost to each
  non-farmer (who therefore doesnt counter-lobby),
  with assurance that free-riding entrants will not
  dissipate policy rents.

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Kym Anderson, Lobbying Incentives and the
Pattern of Protection (EDCC, 1995)

• Anderson begins with the following motivation
• Why is it that price and trade policies in poor
  countries typically protect the infant industrial
  sector at the expense of agriculture, while the
  policy regime in rich countries typically favors
  farmers relative to industrialists? This pattern
  seems paradoxical, since the distribution of
  aggregate votes and wealth has the opposite
  sectoral bias. (paragraph 1)
• and he concludes that
• a distortion of the agricultural/industrial
  product price ratio has vastly different effects
  on the real incomes of different groups in rich
  as compared with poor countries. Indeed, those
  differences are so large that it seems hardly
  necessary to consider the relative costs of
  collective action by different groups as an
  explanator of policy choices. (paragraph 4)

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Andersons model three sectors, in two kinds of
countries
(Agric.)
(Manuf.)
(Serv.)
(Agric.)
(Manuf.)
(Serv.)
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Andersons results elasticities of response
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A deeper analysis of policy-making

• In Andersons model, the economy acts like a
  lever, concentrating gains or spreading them out
• in poor countries, taxing ag. imposes a small
  cost
• on many farmers but gives big gains to a few
• in rich countries, subsidizing ag. imposes a
  small cost
• on many non-farmers, but gives big gains to a
  few.
• This explains a lot, but there is a deeper
  literature here
• why dont the many triumph over the few?
• To ask what explains policy, we could use
  history, sociology, politics, anthropology,
  psychology, etc., but increasingly we can also
  use economics
• assume that policy-makers are optimizers, and
• explain policy choices as an equilibrium among
  optimizers.

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Are we already in the best of all possible
worlds?

• If everyone is optimizing, observed policies
  might maximize aggregate welfare. Three kinds of
  models in which this occurs are
• Benevolent dictator models
• (in which omnipotent leaders maximize their
  dynastic wealth)
• Median-voter models
• (in which entrepreneurial leaders seek policies
  that appeal to 501 voters)
• Tiebout-sorting models (from Tiebout 1956)
• (in which entrepreneurial leaders provide a set
  of options, and people move to jurisdictions
  where policies match their preferences)
• ...but these approaches dont work very well
  real governments dont do anything close their
  predictions.

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Modern political economyExplanations with
(political) market failure

• More successful models use a principal-agent
  approach, in which principals (the people) must
  use agents (leaders) to acquire public goods.
• With full information, costless transactions,
  etc., the losers from inefficient policy could
  always buy out the winners, leading to Pareto
  optimality.
• So modern models rely on transaction costs
• Rational ignorance (from Anthony Downs in a 1954
  book)
• Free-ridership (mainly from Mancur Olson in a
  1971 book)
• Rent-seeking (term coined by Anne Krueger in a
  1974 article)
• Time consistency (e.g. paper by McMillan and
  Masters 2003)

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Rational ignorance(Downs 1954)

• The basic idea of rational ignorance is that
• learning about and participating in political
  action is costly,
• so people wont, unless its worthwhile to do so
• Some implications of this model are that
• only those with relatively large stakes will
  participate in politics
• if people have similar and large stakes, they can
  lobby together
• the costs of participation can have a decisive
  influence
• if political information is easier to get, and
• if political participation is easier to do,
• then outcomes will be more economically efficient

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Free ridership in interest groups(Mancur Olson
1971 and others)

• The basic idea of the interest-group approach
  is that
• policy choices are inherently collective actions,
  
• so obtaining desired policies requires limiting
  free-ridership
• Some implications of the interest-group approach
  are that people will invest more in politics if
  they
• are few in number (so each is less likely to
  free-ride)
• are fixed in number (so newcomers wont
  free-ride)
• (Note that this latter effect has, to my
  knowledge, not yet been adequately exploited in
  the literature.)

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Rent-seeking by people and leaders(Krueger 1974
and others)

• Some basic ideas of the rent seeking approach
  are that
• people with access to power use it to earn
  policy rents
• people will use up policy rents in competitive
  lobbying
• Some implications of the rent-seeking approach
  are that
• welfare costs of intervention are Tullock
  trapezoids, not Harberger triangles, as policy
  rents are dissipated
• the structure of the political marketplace, in
  other words the institutions and technologies
  available to policy-makers, can have decisive
  influence. For example
• poorer countries use trade taxes, because they
  lack the enforcement capacity to collect income
  or property taxes
• poorer countries export farm goods and import
  nonfarm goods, because of comparative advantage
• this theory says their bias against agriculture
  could be unintended but self-perpetuating. as
  policy weakens ag. and strengthens nonag.
  lobbying groups.

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Time-consistency of policy choices(McMillan and
Masters 2003)

• The basic idea of time-consistency is that some
  peoples irreversible commitments are influenced
  by others recurrent choices
• this can cause market failure when a seemingly
  profitable investment is not made because, if it
  were, others would change behavior making it
  unprofitable
• in the situation of this paper, farmers will not
  invest in production without a guarantee of low
  taxes, and governments will not invest in RD
  without a guarantee of production
• the irreversible costs of production are
  relatively large for perennials, so tropical
  crops are more affected by this than
  temperate-zone crops
• This kind of policy trap is one of many
  explanations for why some governments choose
  paradoxically self-defeating policies, having
  both high tax rates and low RD investment.

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Optimization and variables in the model

• In each period, farmers choose q (production) to
  maximize its net present value, given
• ? farmers discount rate
• Pf farmgate price
• csh ctotal costs, ssunk costs, hharvest cost
• ?(rdt-1) gain in productivity due to previous RD
• Meanwhile, government chooses rdt, and taxes to
  maximize its revenue producer surplus, given
• ßt govts discount rate
• Pw exogenous world price (taxesPw-Pf)
• a govts weight on prod.sur. (1 equal)
• If government taxes away farmers profits, they
• stop new plantings for k periods, but
• keep harvesting old trees for T periods.

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Equilibrium conditions andpredictions of the
model

• This model has two possible equilibria
• low growth high taxes, low RD
• high growth low taxes, high RD
• The high-growth equilibrium is sustained iff
• where expected effect on growth and RD is
• - for a, the governments (unobservable)
  preferences
• - for STC, the sunk-to-total cost ratio (s/c)
• for discounting factor, that depends on ?, T
  and k
• for profitability, that depends on Pw and ?

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ResultsPredation and Stagnation

• low tax (1) growth (2)
• STC ratio -4.72 -7.06
• Discount factor 0.19 0.04
• Profitability 0.53 0.33
• number of obs. 128 96
• LR test 19.94 20.97
• Dep.var. (1) low tax 1 if tltRMT
• (2) growth 1 if growthgt0
• Estimation method probit

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ResultsTax Rates, RD Investment and Growth

• tax rate(3) RD(4) growth(5)
• STC ratio -1.65 -0.016 -0.113
• Discount factor 0.005 0.000 -0.001
• Profitability 0.036 0.004 -0.004
• number of obs. 128 44 95
• Adj. R2 0.25 0.24 0.24
• Dep.var. (3) ave. NPC by crop
• (4) ave. per capita ag. RD
• (5) ave. real GDP gr. (5-yr. periods)
• Estimation method OLS

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ResultsPolicy Choice and Growth Rates

• long-run (6) short-run (7)
• RD 3.03 0.30
• taxes 6.28 0.94
• RD x taxes 1.18 0.015
• number of obs. 19 93
• Adj. R2 0.67 0.23
• Dep.var. (6) ave. real GDP gr., 1965-90
• (4) ave. real GDP gr. by 5-yr. per.
• Estimation method OLS

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Policy ImplicationsHow might outsiders
contribute to growth?

• Policy outcomes are sensitive to local
  institutions and ecological conditions
• Govt. commitment mechanisms (political parties,
  constitutions and rule of law, etc.)
• Farmer voice and retaliation (organizations,
  etc.)
• Technology and ecology (sunk costs,
  profitability)
• Exogenous influence may be limited
• forced policy reforms are likely to be
  short-lived,
• but exogenously-funded RD can change payoffs,
  so permanently improve policies and economic
  growth.

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What about the prospects for reform in
industrialized countries?
In the U.S. and other rich countries, agriculture
is still dominated by family farms, but they are
either part-time or very large
Source Economic Research Service, U.S.
Department of Agriculture
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Prospects for reform in industrialized countries
In the U.S. (and in other rich countries),
government payments are targeted to the major
field crops, not to agriculture as a whole
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Prospects for reform in industrialized countries
Its really all about land values if subsidies
were withdrawn, land values would fall, and
landowners would scream.
Source Economic Research Service, U.S.
Department of Agriculture
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Influence of rich-country reform on poor
countries
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A few conclusions

• There are very strong political-economy reasons
  why poorer countries tax agriculture, and richer
  countries subsidize it
• Moral outrage and exposure might not be enough to
  change the balance of power efforts to induce
  reform will probably have to change the
  institutional mechanisms available to
  governments
• in rich countries, to support land values and
  rural employment
• in poor countries, to reduce stabilize food
  prices for urban areas.
• Rich-country farm subsidies may be egregiously
  inefficient and inequitable, but they have little
  direct effect on poor-country farmers for them
  whats much more important is what happens within
  their countries.