ideas for increasing rural incomes: what does the theory tell us? richard j. sexton
Post on 03-Jan-2016
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A classification scheme for income-generating ideas
Ideas that expand the size of the pie Ideas that increase the share of the pie going
to producers and rural communities
Ideas that expand the pie
New product introductions Organic production Eco friendly and animal friendly production Geographic designations Brand labels and other means of product
differentiation Niche markets such as products targeted to specific
ethnic groups.
Ideas that increase the share of the pie going to producers and rural communities
Downstream integration into “value-added production”
Vertical coordination with downstream marketers Bargaining and other forms of collective action
intended to increase producer market power Legislation intended to increase competition and the
balance of power in agricultural markets
Some key stylized facts
Demand U.S. and European consumers demands for food are
very inelastic, and many of these consumers are willing to pay a lot to consume the “right” foods. Tastes are heterogeneous.
The fastest growth markets are in developing countries, and these demands are more elastic and place less emphasis on quality and differentiation.
Some key stylized facts
Production Barriers to entry into agricultural production are
usually low or nonexistent. The main barrier to entry is the lag time from planting
to harvest for perennial crops or the conversion process required for organic certification.
Do geographic designations create a meaningful barrier to entry?
Pursuing a product differentiation and niche marketing strategy will involve higher per-unit production costs.
Some key stylized facts
Marketing New and better food products may create substantial
short-run rents, but if downstream markets are not competitive, a large share of these rents may not be captured by producers.
Producer-marketer vertical coordination may improve market efficiency and improve information flow, but there may also be unintended market-power consequences.
Some alternative market morphologies and their consequences
The traditional competitive food marketing sector and spot markets– short run profits or losses, but the long-run
equilibrium is zero profits– Probably no modern agricultural market fits this
paradigm, i.e., market power, product differentiation, and information issues are integral elements of these markets nowadays.
Add product differentiation to the competitive market model
Differentiation may be either vertical or horizontal Preserve large numbers of agents and free entry,
and we have some form of monopolistic competitionQualitative predictions of monopolistic competition for profits
are the same as perfect competition: short-run profits or loses but zero profits in the long-run
Long-run equilibrium is achieved in these models through brand proliferation, leading to saturation of the product space, so that incumbent firms are earning nonnegative profits but no profitable entry opportunity can be found
Example of geographic designations as product differentiation
The designation provides an immutable barrier to entry outside the designated region
Free entry within the designated region But designation can attempt to impose supply controls
—how successfully remains an open question Producers outside of the designated region can
respond by creating their own designations, thereby saturating the product space and creating in the long run a classic zero-profit, long-run monopolistically competitive equilibrium
Geographic designations (cont.)
Crespi notes 450 appellations for medium-priced French wines—entry is not just at the high end of the product space, an example of the principle of maximum differentiation
Retailers generally only carry a few brands. Proliferation of brands gives retailers great power to use competition for shelf space and slotting decisions to capture rents from producers and marketers
Store brands can be used to counteract market power of shipper/processor brands
Organic production as an example of differentiation and niche markets
$555$555 BBILLION ILLION US US FFOOD OOD MMARKET ARKET inin
20032003 1.8% organic
Acres of organic commodities in Acres of organic commodities in CALIFORNIA 1992 - 2002CALIFORNIA 1992 - 2002
020406080
100120140160180200
1992 1994 1996 1998 2000 2002
1,0
00 A
cres
Nursery &flowers
livestock, poultry& products
field crops
Vegetables
fruit & nuts
Number of organic growers in CA: 1990-2002
0
500
1,000
1,500
2,000
2,500
3,000
3,500
1992 1994 1996 1998 2000 2002
Gro
wers
Nursery &flowers
livestock,poultry
field crops
Vegetables
fruit & nuts
Distribution of Organic Production by Income Category
42
10
21 22
7 4 3 31 1 4 612 14
55
9
$0-$4,999 $5,000-$9,999
$10,000-$49,999
$50,000-$99,999
$100,000-$249,999
$250,000-$499,000
$500,000-$999,999
$1,000,000and above
Pe
rce
nt
of
To
tal
Growers Sales
The bottom line from organic agriculture
Even a good niche, as organic has turned out to be, has a very small impact on the overall agricultural sector
Large-scale agriculture has come to dominate the organic sector, and many of the spillover benefits associated with organic are probably lost in the process
The vertical-control, contract-agriculture model
Principal-agent paradigm applies to this model: market power imbalances suggest designating marketing firms as principals and depicting producers as the agents.
Contracts can solve information problems in market and provide efficient risk sharing, and thus expand the size of the pie, but . . .
Unless competitive forces are strong, contracts can be very effective devices for downstream firms to extract profits from producers, thereby generating zero profit equilibria in both the short and long run—participation constraints usually bind in these models
The prototype oligopoly/oligopsony model of an ag market
Put the focus on competition issues, and accordingly abstract away from issues of technology, product differentiation, and information
Assumptions Constant unit costs of marketing (zero profits under perfect
competition) Fixed proportions in converting farm product to a product at retailer Processors may possess oligopoly/oligopsony market power
Model - Main Assumptions
a measure of oligopsony power
0 1
Perfect Competition
Oligopsony or Oligopoly
Monopsony or Monopoly
a measure of oligopoly power
Key predictions from the model
Both oligopsony power and oligopoly power by downstream firms are bad for producers because they reduce output and, hence, income, employment, etc.
Marketing sector firms with market power can capture a large share of the surplus generated from a demand-expanding initiative
This means that even really good ideas that increase the size of the pie may not increase by much the income that flows back to farmers and rural communities
The Impact of Downstream Market Power on Producer Benefits from Advertising
0
0.002
0.004
0.006
0.008
0.01
0.012
0.014
0.016
0.018
0.02
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1
Market Power IndexOligopoly Oligopsony Oligopoly/Oligopsony
What about cooperatives and other forms of producer collective action?
Traditional agricultural marketing cooperatives have significant competitive disadvantages in modern markets
– Cooperatives that provide a ‘home’ to member production for the most part lose the power to influence price
– Cooperatives that market a single product face disadvantages in light of retailers preference for suppliers who can fill an entire product category.
– Cooperatives have a disadvantage in providing the quality and value-added dimensions critical in today’s market due to the horizon problem and difficulties raising investment capital and adverse selection problems created by pooling practices.
Can “advanced” forms of cooperation fare better?
New generation structure is intended to surmount many of the problems of traditional cooperatives: closed membership, delivery rights are tied to stock equity contributions, tradable equity shares, and delivery obligations.
Other “limited liability” corporations merge some ideas of cooperation with concepts of limited partnerships and subchapter S corporations—enable producers to capture appreciation in the value of the downstream enterprise
Are producers able to “cooperate” in even limited ways, such as funding advertising programs and supporting geographic designations?
Limitations on collective action of any form
Today’s agricultural producer is probably less ‘cooperative’ than predecessors.
– Concepts such as brands and monopolistic competition sharpen the focus of the other guy as a competitor and not a cooperator and are antithetical to traditional cooperation
– U.S. producers are having trouble cooperating in even limited ways, such as commodity promotion
– Would geographic designations be any different? Would success cause some producers to want to opt out?
Some pessimistic conclusions
Trend in nonsubsidized agriculture towards fewer and larger farms are likely to continue
Most production will involve substantial vertical coordination between the production stage and downstream stages—accordingly less “freedom to farm”, but greater efficiency and matching of production to consumer preferences.
Without substantial outside intervention, rural communities will continue to decay, involve substantial poverty, be populated mainly by those who work on the large-scale farms, and in general represent a societal problem
Some pessimistic conclusions
Grocery retailers will increasingly become the dominant players in the food marketing chain, with grains continuing to be dominated by powerful manufacturers
New ideas, concepts, and innovations may produce substantial short-term rents for small groups of producers but won’t have much impact on the aforementioned major trends
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