Farm Support Prices

Support prices, or guaranteed prices, also have been widely implemented. They are cousins of controlled prices; they attempt to control prices in the downward direction only, while allowing them to rise without restriction. They suffer from the same conceptual and practical limitations that administered prices do. In addition, support

72. Martha de Melo, Cevdet Denizer and Alan Gelb, 'Patterns of transition from plan to market', The World Bank Economic Review, 10(3), September 1996, p. 397.

prices are costly to the government budget, for usually they are designed to raise the price to producers above the market-clearing level while keeping prices for consumers at or below the market level. The government then pays the difference, or the inverse marketing margin.

Another source of budgetary expense arises from the network of collection points and storage facilities that governments feel obliged to construct and operate in order to manage a policy of farm support prices. Often these facilities are not managed effectively, which further increases the cost of the policy to the government. In China, for example, after a government policy review in 1998:

The grain stations were charged with: i) being too slow to change management mechanisms; ii) having surplus staff; iii) being poorly managed; and iv) having diverted funds designated for grain purchases into other uses.73

In Honduras, it was found that State-owned silos were operated on average at only 10% of capacity over a period of many years.74 In El Salvador, the government silos were effectively empty for a number of years before they were closed down.

In spite of these budgetary outlays, frequently there are not enough funds available to fulfill the commitment to purchase the crop at the guaranteed price, especially in years of abundant harvests. As a result, just when the guaranteed prices are most needed from the viewpoint of farmers, the government often cannot deliver them. In Russia, 'by 31 December 1995, only 1 million of the 8.6 million tonnes of grain due to be procured by the federal government had been bought. By 1 February 1996, only 1.6 million of the planned [amount] had been purchased A lack of budget funding . .. was blamed . . .'.75

Another common defect of these policies is that access to the guaranteed prices is biased in favor of the better-off farmers, who can truck their crop to the collection points or otherwise ensure favorable treatment. Statistical documentation of a strong bias in this sense, for the case of Honduras, is mentioned in Chapter 3.

A basic conceptual problem with support prices concerns the determination of their level. Even if it is accepted that they are not intended to be market-clearing prices, what should their level be? Often, the operational procedure is to try to set a support price at a level which covers the estimated cost of production of the crop concerned, and to raise the price from year to year as costs increase. However, this is equivalent to rewarding inefficiency.

In addition to this serious problem with the scheme, it may be asked: whose costs of production? After all, in reality a supply curve is composed of many thousands of points, each representing a different farmer and/or technology or region of production. Should the support price equal the average cost of production, the marginal cost, or some other cost? Setting it at the marginal cost would seem to favor inefficiency also, and provide rents to all producers save the least efficient one. Plus, in the heterogeneous real world of farms and their resource endowments, an average cost may be difficult to calculate with any degree of accuracy.

For all of these reasons, guaranteed prices are falling out of favor in an increasing number of countries, from Latin America to the Middle East to Sub-Saharan Africa. They have been more durable in South and East Asia, perhaps made more effective in their implementation by these countries' long traditions of public administration, and in Eastern and Western Europe. Nevertheless, the conceptual objections to the schemes hold in the Asian and European contexts as well, and so they are undergoing re-examination there also. Prices to farmers can be raised more effectively, and at a lower cost to the government, by eliminating tariff exemptions on food imports,

74. Secretaría de Recursos Naturales, Programa Nacional de Reactivación Agrícola: Desarrollo Compartido en el Agro, La Nueva Política de Comercialización de Granos Básicos, Tegucigalpa, Honduras, May 1991.

75. OECD, Agricultural Policies, Markets and Trade in Transition Economies: Monitoring and Evaluation, 1996, Organization for Economic Co-operation and Development, Paris, 1996.

ensuring the exchange rate is at an equilibrium level. For this reason, a lemma of an effective agricultural policy reform can be: moving from a controlled but penalized agricultural economy to a free but protected one. In Honduras in the early 1990s, effective protection rates went up for farmers after reforms to the tariff and exchange rate systems, even while trade was being freed and guaranteed prices were being dismantled.

The foregoing are powerful arguments against the use of farm support prices. However, in some cases policy makers may either remain unconvinced or feel that a commitment to such policies cannot be altered, at least in the near term. If that is the case, then two important guidelines are suggested:

• The number of instruments should not be greater than the number of objectives. This basic rule was first enunciated by Jan Tinbergen in the 1950s76 and still applies to economic policy. The cost of not heeding it is usually considerable economic inefficiency resulting from clashing policy instruments. In this case, the number of objectives is one - maintaining a floor price for the specified product. Hence, there should be one instrument - the support price. Adding the instrument of trade controls to tariffs can be counterproductive.

• The government purchasing agency should have adequate infrastructure and funding to carry out purchases at the support price as needed, in all parts of the country. Its management should be as professional as possible and endowed with clear operating guidelines.

The importance of observing these two guidelines is brought out by a comparison of the contrasting experiences of Sri Lanka and Indonesia, in a study by Frank Ellis, Piyadasa Senanayake and Marisol Smith:

This paper describes the food market intervention system in Sri Lanka, and poses the question whether the parastatal organizations that trade in rice and wheat play any useful role in contributing to food security and food price stability. Analysis of time-series price data for the rice market suggests that the private rice marketing system is competitive and efficient. . .. There is no reason to deduce that the domestic distribution of wheat flour could not similarly be performed efficiently by private sector agencies. ... It is interesting to compare the Sri Lankan case to that of Indonesia. .. . In the case of Indonesia, the annual setting of a floor price in advance of planting decisions; its effective defense at peak harvest by an active purchasing agency, Bulog; the stability of annual procurement levels by Bulog at around 4-6% of the harvest; and the historical reluctance by the government to import rice, meant that the floor price approach appeared the most effective and low-cost means of achieving domestic price stability. In Sri Lanka, by contrast, the erratic and intermittent setting of the [support price]; the widely varying procurement levels of PMB [the State procurement agency]; the deteriorating infrastructure of PMB; and the flexible use of rice or wheat imports to keep staple food markets in balance, means that the [paddy rice support] price is a redundant policy instrument.77

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