INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE

Agricultural input subsidies – conceptual reviewHiroyuki TakeshimaHak Lim LeeInternational Food Policy research InstitutePresented at the workshop in MaputoOctober 18, 2012

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Policy issues

Economics of subsidy and conventional wisdoms

Justification for subsidy & potential alternatives

Targeting Monitoring & Evaluations Exit strategy

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Subsidy

a payment reducing the buyer's price below the seller's price (Pindyck & Rubinfeld 2005)

A subsidy can be analyzed as a negative tax Agricultural input subsidies are paid with the

intention of lowering the prices of agricultural inputs (such as fertilizer, seeds, equipments) below their market prices

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Intended goals of agricultural input subsidy Affordability of agricultural inputs for

smallholder farmers Accessibility to inputs Develop the input-supply distribution system Sensitize farmers to the use of inputs Social protection for vulnerable groups Soil fertility Reduce social costs (rural-urban income

disparities etc) with broader goals of raising agricultural production and food security.

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Conventional wisdoms

Deadweight Loss= loss of economic

efficiency• misallocations of

resources • supplied at higher

cost than the value they create

• bought by those who extract less value from the goods than their costs (non-subsidized prices)

Input price

Supply curve (no subsidy)

Demand curve

Supply curve (Subsidy)

Deadweight Loss

Deadweight Loss, benefits to suppliers and farmers depend on Elasticity of input supply, demand

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Input use and supply

Deadweight loss, benefit distributions

Inelastic demand, elastic supply

- Reducing input cost => small DWL- Increasing inputs use => larger DWL

Elastic demand, inelastic supply

- Reducing input cost => large DWL- Increasing inputs use => small DWL

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Farmer benefits

Benefits to suppliers

Example of deadweight loss

Initial condition (Non-subsidized): Fertilizer supply (demand): 167,060 tons Farmgate price: $ 525 / ton Price elasticity

• Supply: 4 (Quizón & Binswanger 1986)• Demand: - 0.46 (estimated from Ricker-Gilbert et al. 2011)

=> With 25% subsidy

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Example of deadweight loss

Farmgate fertilizer price

(US$ / ton)

Subsidized price = 404

Government subsidizedfertilizer (1000 ton)

Supply curve

Demand curve

Source: Authors.

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(= actual demand)

Deadweight Loss = USD 1.2 million

Supplier price = 538

167

(= no subsidy)

Supplier price (no subsidy) = 525

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Example of deadweight loss

Benefits for• Farmers: $21.4 million (from lower price)• Suppliers: $ 2.3 million (from increased supply, higher price)• Total benefits => $23.7 million

Total subsidy cost: $24.9 million

Deadweight Loss = $1.2 million If subsidy budget of $24.9 million were allocated among

farmers and fertilizer suppliers, they could have benefited more

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Also, examples of inelastic demand, elastic supply caseReducing fertilizer cost is more efficient goal, than increasing fertilizer use

When may subsidy still make sense ?When conditions in competitive market do not hold Market failure (Information, Credit / insurance) Externality Public goods Economies of scale

Example: Farmers have imperfect knowledge, underestimate the benefits

of fertilizer Farmers may become more efficient in applying fertilizer over time Positive externality – better soil fertility for the future generation Reduce per unit costs due to economies of scale from increased

demand Subsidy may offset taxes for export crops (Kelly et al. 2003;

Holden 2003) Subsidies on ag inputs important in earlier stage of Green

Revolution (Fan et al. 2004; Djurfeldt et al. 2005)

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Potential alternatives to subsidy Public infrastructure, agricultural research &

extension Capacity building of various agents along input

value chains Fundamental cost reduction strategies without

subsidy • Kenya• fertilizer use ↑ (1990s ~ early 2000s)(Ariga & Jayne

2011)• Eliminated import licensing quotas• Fertilizer responsive crop varieties (=> higher demand

elasticity) De-regulation of package size (often regulated to reduce

adulteration risk (Dorward et al. 2011))• Reform in Kenya: repealing of law led to increase in

fertilizer purchase (Dorward et al. 2011)

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Potential alternatives to subsidy Input-supply distribution networks:

• Training rural retailers• Linking rural retailers, large input wholesalers, • Loan guarantee (cover part of the risk of wholesales of the

retailer defaulting)• Help input dealers organize, make bulk purchases with

joint collateral

Subsidy for supporting vulnerable groups• Transportation to remote areas - input subsidy costly • Social safety net, Food aid, Food for work, Conditional

cash transfer - if food market functions well Soil fertility in marginal area (Shalit & Binswanger 1984)

• Fallow in land abundant areas • Organic matter in more densely populated areas

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Targeting

Indicators of targeting performance Undercoverage: the share of intended beneficiaries who

end up not benefiting from the subsidy Leakage: the proportion of beneficiaries who are not

intended to benefit from the subsidy

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How to target ? -

Geographical targeting: provide subsidized inputs to all farmers in a particularly geographical area, exclude other areas

Community-based targeting: Indicator-based targeting:

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Community-based targeting

Rely on local authorities / community representatives to select beneficiaries

Pros• Can use local information about the beneficiaries -

often unobservable (Alatas et al. 2012) Cons

• Ineffective due to (Chinsinga 2005; Conning & Kevanne 2002) political favoritism misunderstanding

• Elite capture of vouchers in remote areas with unequal access to land within the community (Pan & Christiaensen 2012)

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Indicator-based targeting Based on household characteristics more cost-efficient if it were implemented for input subsidy

in Malawi (Houssou & Zeller 2011)• Household size• Wireless radio ownership• Floor of main dwelling is predominantly made of smoothed cement• Bicycle ownership• Lighting fuel is electricity• Highest education • Rubbish disposal facility is public heap... Etc

=> • Compared to community-based targeting systems,

73% of transfers, instead of 50% of transfers, will reach the poor / smallholder farmers

Costs of leakage to the non-poor – more than 50% ↓ Administrative costs – twice, but offset by the reduction in the cost of leakages 

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Instruments Voucher

• Pros Added incentive, force farmers to buy the intended inputs -

unlike a cash transfer • Cons

sufficient stock of inputs at the agro-dealers at the time that farmers require the inputs at the start of the cropping season

must be redeemable without delay• Electronic voucher - text messages to mobile phones, bank

cards, electronic “smart cards” costs for voucher distributions ↓ by 90% (EuropeAid 2012)

Demonstration packs• Starter Pack program - Malawi • small quantity - discourage larger scale farmers who need not be

sensitized• elite capture - still common, requires appropriate targeting method

(Morris et al. 2007)

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Instruments Rationing subsidized inputs

• Reduce required budget• Rent-seeking activity when ration < demand

Well-connected individuals divert inputs for their own benefits (Dorward 2009)• Inelastic demand - may aggravate the problem

Passbook• Enforced saving • Cotton production in Tanzania (Poulton & Maro 2009)• Cotton growers are given a savings passbook containing a credit equivalent to the

beneficiary subsidy at the harvesting season in exchange for the seed cotton that they deliver. In the following planting season, they can use the funds in their passbook savings account to obtain inputs such as seeds and agro-chemicals

• Differs from a voucher => Farmers decide to deliver the crop output in the first cropping season that entitles them

to receive a subsidy for the next season Timing

• Well ahead of planting• Input subsidy at harvesting season

Fertilizer subsidy in Kenya (Duflo et al. 2011) – at harvesting time, farmers have more cash and are more forward-looking –

willing to invest into modern inputs for the next season, than consumption=> similar idea holds for passbook

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Monitoring & Evaluation - Ex-ante

Elasticity• Elasticity of demand for inputs:

Will subsidy increase the use of inputs ?Will subsidy actually lower the input price?

• Choice experiment, conjoint analysisWillingness to pay (Holden & Lunduka

2010)• Randomized control trials

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Monitoring & Evaluation - Ex-post

Various indicators• Inputs use levels of target beneficiaries• Crop yields• Costs of input supply• Farmer incomes, welfare (nutritional intake etc)• Improved soil nutrient levels – nitrogen levels / soil

organic carbon Short-term & Long-term Distributional effects

• Regressive vs Pro-poor• Efficiency vs Equity

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Monitoring & Evaluation - Ex-post Private input sector development

Reduced transaction costs per unit Increased volumes of economic activity by input

suppliersCrowding in / out of private input suppliers

Crowding out - fertilizer subsidies in Malawi, Zambia Tanzania - better in not displacing private dealers

• Seed subsidies - crowding out of local informal seed sector (emergency assistance through vouchers)

Long-term growth potential• Increased savings

Providing beneficiaries with saving accounts –impact evaluation in Mozambique

• Long-term investments made => Important for exit strategy

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Monitoring & Evaluation -Randomized control trials Randomly distribute or withhold subsidy benefits Why randomize ?

• Without randomization, difficult to measure the impacts accurately

Example: • Village head disproportionately selects

beneficiaries among farmers with declining soil fertility - usually known to the village residents but not to outsiders

• Greater impacts among those beneficiaries• False impression - similar subsidy could also work

elsewhere with the similar characteristics with more fertile soil

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Monitoring & Evaluation -Randomized control trials Randomized experiment for evaluating subsidy

• Short-term, direct, localized impact• Inappropriate for measuring indirect effect

Food price Rural employment Historically, greater indirect benefits rather than direct effects

Randomized experiment for ex-ante assessment• With RCT, obtain certain information that is difficult to be obtained

from actual input market Choice experiment - random discount – use information of

their uptake to assess how demand will change depending on the price

Difficult without RCT – in real world, prices often don’t change sufficiently within a short period of time

Level of subsidy maximizing the uptake, minimizing the costs

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Exit strategy Clear and feasible exit strategy needed from the beginning Removing subsidies - historically challenging

• Irrigation (Dinar 2007), Seed (Sperling et al. 2004), Fertilizer (Smale et al. 2011)

Long-lasting subsidy - problems• Politically entrenched• Encourage fraud / diversion of subsidies to other purposes

(Dorward 2009) Some options

• Seasonal credit provision (relates to passbook) (Poulton & Dorward 2008) Gradually phase out subsidy while introducing a

seasonal credit structure (Poulton & Maro 2009)• Saving programs – ongoing evaluation (Carter et al. 2010)• Fertilizer subsidy to agro-forestry investments (de Schutter

& Vanloqueren 2011)

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Key questions What are the strategic development objectives ?

• inputs use to food production• poverty among smallholders• private input supply network• improve soil nutrients• Altogether?

What are the economic characteristics of the agricultural inputs to be subsidized• Will demand for inputs increase with subsidy ?• Is there sufficient supply capacity?

What are the intended outcomes - will they be monitored and their impacts evaluated ?

Is there ex-ante evidence ?

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Key questions

Who should be the beneficiaries?• Large-scale commercial farmers ?• Poorer smallholder farmers?

How can they be targeted? What instruments can minimize leakage or

undercoverage of the subsidy program benefits? What is the plan for an exit strategy for subsidy ? How can subsidy help beneficiaries make long-

term investments ? What may be the alternative policies?

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