22142z UNDP-WORLD BANK May 1990

TRADE EXPANSION PROGRAM My19OCCASIONAL PAPER 6

WHY AND HOW TOSTABILIZE

PRODUCER PRICESFOR EXPORT CROPS

IN DEVELOPINGCOUNTRIES

Patrick Guillaumontand

Silviane Guillaumont

The Center for Studies and Researchin International Development

This occasior" paper is a prof toe pint UNDPNVorld Bank Trade Expansin Proarn whrh pvidos edical and pok ady IDaxirries indrg g reform tiere regmes. Tte views connedherein are toseof teautrsanddonotrnsary efectoseofth Uriied Natons Devepnent Program or te Wold Bank

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UNDP-World Bank Trade Expansion Program

Occasional Paper 6

Why and How- Sb -ib.-ze.Producer PrIces for-Export Crops---

-in Developing Countries.

)::'I~~~~: Countri -- ---

by

PatickGAilatmont andS-:--:-ne ilatu:mont

-h:ne Cer for Stdies and Researchi-n InterationA Development

May 1990

Trade Policy DivisionThe World BankWashington, D.C.

Table of contents

Objectives of Agricultural Price Policy 2Primary objectives 2

Accordance with world price trends 2Contnbution to the national budget 2Stability of producer prices 3StabUity of budget receipts 4

Tradeoffs among objectives S

Alternative Policies 5Total stabilization 6Total pass-through 7Moderated stabilization or bounded pass-through 8Trend-based pass-through or adaptive stabilization 9

Marketing and Public Finance Implications of Price Policy 10Consistency between private marketing and public stabilization 10

Domestic marketing 11External marketing 12

Delinking the stabilization fund and the public treasury 12

Conclusions and Recommendations 14

Appendix. Simulation of Nominal and Real Producer Pricesand Unit Public Taxation in Madagascar 15

Notes 17

References 18

iii

Traditionally, most developing of real producer prices to real world prices.countries have attempted to stabilize the Public levies on export products have risenprices paid to producers of agricultural in periods of rising prices and the extraexport products. In large part, they have revenue has been allocated to finance publicdone so because of the marked instability of expenditures; as a result, funds have notworld agricultural prices and the belief that been available to support producer pricesthey could not rely on international attempts when prices were falling. Stabilizationto stabilize prices. systems, then, have often failed to fulfill

In trying to stabilize domestic producer their initial purpose and have resulted inprices, countries have followed one of two inadequate price incentives and mediocrebasic approaches. In some countries, a agricultural performance. More recently,public marketing agency buys from the following the sharp fall in world prices ofproducer (at an official price) and sells primary products and the inability of manyabroad. In other countries, private operators stabilization funds to sustain producercontinue to be responsible for marketing but prices, criticism has also focused on thethe government or a public agency has exorbitant cost of stabilization to the publicassumed financial responsibility for finances of countries striving to reduce theirstabilization, either directly (through budget deficit.taxation or subsidy) or through a Despite these problems, manystabilization fund. Various criticisms have developing country govemments continue tobeen leveled at both of these types of favor stabilization funds method. In contrast,interventions in agricultural export prices in many economists recommend passing worldrecent years. price fluctuations through to the producer

Large public marketing agencies, (see, for example, World Bank 1987). Thisresponsible for all domestic marketing issue is a major area of controversy foroperations and often for external marketing structural adjustment policy.as well (and, in many areas, for rural This paper examines whether it isextension or credit distribution) have proved appropriate to retain financial schemes forto be inefficient. Their inefficiency was one stabilizing producer prices for agriculturalcause of the growing tax burden on export products. To that end, the paperagriculture. Today, there is general looks at three questions:agreement on the need to promote more * What are the objectives of an agriculturalcompetitive marketing systems (except in price policy for export crops?certain agroindustrial sectors, such as cotton, * What are the main types of price policies,where this may be too difficult technically). and what are their advantages and

The financial stabilization agencies disadvantages in light of these objectives?have also been criticized for their methods m What are the implications of a particularof operation. It is true that they have policy for marketing and public finance?generally made producer prices less unstable Answers to these questions draw on countrythan world prices - in both nominal and real experiences, particularly in Africanterms (prices deflated by a price index). countries where agricultural export productsHowever, at least until the early 1980s, their are the main sources of foreign exchangepolicies generally led to a decline in the ratio earnings.

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Answers to these questions draw on country The objective of keeping producerexperiences, particularly in African prices aligned with world price trends andcountries where agricultural export products thereby maintaining their incentive value isare the main sources of foreign exchange justified by the price sensitivity of supply ofearnings. agricultural products. Many studies have

supported the view that the supply of manyObjectives of Agricultural Price Policy individual agricultural export products is an

increasing function of the level of realPinary objectives producer prices (Askari and Cummings

1977, Bond 1983, Lecaillon et al. 1987,Price policy for export crops of Bonjean and Marodon 1988), even though

developing countries should pursue four the aggregate agricultural supply priceobjectives. Frequently, the objectives are in elasticity is low (Chhibber 1988, Mellor andconflict, and tradeoffs are necessary among Ahmed 1988).them. When there is an acute shortage of

consumer goods in rural areas, however, aAccordance with world price trends. A rise in producer prices may not lead to an

Erst objective is to link the producer price to increase in production. It may even have thethe long-term world price trend.' The trend reverse effect: when farmers have nothing toof producer prices, on which production buy with the additional income generated bydepends, must not deviate for long from that the price increase, they may work less toof the world price. If the producer price maintain their given level of consumer goodstends to fall below the world price, the purchases, assuming that the prices remaincountry can lose the advantage of increased fixed (see, for example, Berthelemy andproduction since the producer price will not Gagey 1984 and Guillaumont and Bonjeanprovide sufficient incentive. If the price 1988). This means that remunerative pricestends to deviate upward, the crop can absorb are necessary but not sufficient to increasetoo many productive resources, with production. Marketing and transportationexcessive production resulting; there is also a conditions must also be such that farmersrisk that this production will be unprofitable can acquire consumer goods, therebyand will have to be subsidized by the rest of conferring utility on supplemental monetarythe economy. income (see Azam and Faucher 1987, Azam

It is not, therefore, economically and Besley 1988, and Berthelemy andefficient for a country to allow the domestic Morrisson 1987).price relationships between its main crops todeviate from their world price relationships. Contribution to the national budget. AThis has often happened, however, as with second objective of price policy concerns thecoffee and rice in Madagascar (where rice contnbution to the budget of taxation ofmarketing has been deregulated) or cocoa agricultural exports. Since export cropsand coffee in C6te d'Ivoire (where the constitute a substantial part of economicproducer prices for both are the same even activity and are easy to tax, they are anthough the world price of coffee has been important source of revenue forabove that of cocoa for years). hard-pressed governments. However,

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taxation of exports may conflict with the production will be smuggled abroad, toprinciple that the tax system should not evade taxation.discourage exports. In particular, indirect Also important to consider is the impacttaxation based on export value should be that taxes on agricultural exports have onavoided in favor of direct taxation of income the tax base. A fall in exports due to a sharpfrom export-related activities. But it is rise in taxation is likely to reduce foreigndifficult to tax farmers directly, so exchange earnings, leading to procurementgovernment levies on agricultural exports difficulties for intermediate goods and,often represent a substitute for income tax.2 consequently, to a fall in production, which

There is a tradeoff, then, between the further reduces foreign exchange earnings.short-term financial objective, which leads to The impact of this vicious circle3 on totalan increase in the rate of taxation, and the income and on the tax base goes well beyondlong-term economic and financial objective the 'primary" impact of a fall in producerof raising the level of economic activity (and prices on the production of exportableconsequently the tax base). In any case, if the agricultural goods.tax rate is excessive, total revenue willdiminish because of the elasticity of Stability of producer prices. A thirdagricultural supply to prices. There exists a objective is to ensure some degree ofthreshold point beyond which further stability of producer prices and income. Thistaxation leads to more than a proportional objective rests on three hypotheses. The firstdiminution of the tax base (the Laffer curve is that stabilization of producer prices meanseffect). In other words, an increase in the tax stability of producer income. This hypothesisrate for agricultural export products does not hold good for all cases, however. Itincreases fiscal receipts only as long as the does not apply to a closed market (local foodrelationship between the producer price and products), where price variations are duethe world price does not fall below the level chiefly to fluctuations in the quantitiese/(1 + e), where e is the price elasticity of produced. In that case, prices are inverselysupply.2 In fact, the threshold is relatively proportional to quantity and help to stabilizelow, which seems to make a relatively high income.tax rate possible: with an elasticity of 0.5 to I Also, whether the hypothesis holds at(the most frequent estimates of short-term the country level and for export products,elasticity), the critical ratio of producer price depends on the country's influence on worldto international price is one-third to prices for a particular product. For exportone-half. products whose world price is independent

It is unlikely, however, that the tax of the production of the country concernedauthorities will be able to hold to the (a price-taker country, with only a smallguideline outlined above, for at least two share of the market), price instability isreasons. First, price elasticity of supply is independent of production volume and isgreater over the long term than the short therefore an autonomous factor in incometerm, and this raises the critical threshold instability. In some years, it may happen,leveL And second, if the tax rate is higher however, that exogenous factors such asthan that in neighboring countries, part of weather conditions fortuitously give rise to

contradictory movements of prices and

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quantities, so that the income effects offset marginal utility of income prevails, as iseach other. generally assumed, the more stable a given

The situation is less clear in a country average income the higher the utility. This isthat is a major or dominant producer and the basis of risk-aversive behavior. Thewhose export volume helps to determine the result is that, other things being equal,world price (a price-maker country). Price production of crops that yield unstablevariation may well be an income stabilization revenues will be less desirable thanfactor, but for this to be the case, the production of crops that yield stablevariation in the quantities produced by the revenues. This has two effects: farmers willcountry must be the chief cause of world allocate available time to the stable cropsprice fluctuations and the effect must be and they will seek ways to improve theirrapid. The outcome maybe different, productivity. Instability, by making farminghowever, for products for which demand investments and innovations riskier, alsoplays a dominant role, as illustrated by the diminishes recourse to crediL While thecases of cloves and vanilla in Madagascar. effect of risk aversion is difficult to captureAlthough Madagascar is an important world in an econometric analysis using time-seriesproducer of cloves, fluctuations in the world data,4 it is probable that economies whereprice of this product are influenced more by most producers are small farmers with lowvariations in production and imports in creditworthiness and limited capacity toIndonesia (the leading producer and cope with instability are particularly sensitiveimporter) than in Malagasy production. In to price instability.the case of vanilla, although Madagascar is But even if price instability exerted nothe leading exporter and producer and so effect on the average level or on the growthhas an appreciable impact on prices, price of production, it could have unfavorableinstability is also attributable to demand repercussions in the case of crops that arefluctuations due to the existence of a subject to industrial processing, such asdominant importer (the United States cotton or oilseeds. Since price instabilityaccounts for 40-60 percent of world imports) engenders production instability (a functionand of a synthetic close substitute for vanilla. of the elasticity of supply), and since plantNatural vanilla accounts for only a tiny size must be large enough to process thefraction (5 percent) of the world market for largest crops, price instability (of supply) canvanilla-based perfumes, so a small shift in the generate higher average processing costs.United States from natural to artificialvanilla leads to a relatively large change in Stability of budget receipts. A fourth,demand for natural vanilla. For these two often neglected, objective of price policy isproducts, then, stabilization of producer to avoid severe instability of fiscal (orprices relative to world prices apparently parafiscal) receipts. Once producer priceshelps to decrease rather than increase the are stabilized, government (in the broadinstability of producer income. sense) absorbs world price instability. If

The second hypothesis underlying the stabilization is achieved through taxation ofobjective of stabilization of real producer exports that contribute substantially to theprices is that income instability depresses budget, the effect is to make public revenueproduction. To the extent that a declining very unstable. This instability contnbutes to

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poor public management, as experience in imply tax rates that fluctuate in response tomany countries shows. If world agricultural world prices. But these last two objectivesprices collapse, an entire category of receipts can also be in conflict: in order to stabilizemay completely disappear, and the producer prices, tax rates have to vary in thegovernment may even have to resort to same direction as world prices whereas tomassive subsidies. Price booms also create stabilize government revenue, they have toproblems because of the difficulty of vary in the opposite direction. The problem,managing sudden surpluses. Decisions to therefore, is how best to reconcile theseincrease expenditures (for example, in the possibly conflicting objectives.form of civil service recruitment, poorlyprepared investments, and so forth) have Alternative Policiesoften been unwise or difficult to reverse, inmany cases leading to macroeconomic While many different price policies forimbalances that have necessitated the agricultural export products are possible,current round of adjustment policies (see each meeting the defined objectives to aGuillaumont and Demeocq 1988). different degree, they can be reduced to four

major types (table 1; also see the appendixTradeoffs among objectives for simulations of each type of system for the

case of coffee producer prices inSimultaneous achievement of all four Madagascar). These are examined below,

objectives is not possible. The need for after some preliminary remarks on the needtradeoffs is evident in the relationship that, to avoid misalignment of the real exchangeby definition, links the producer price (pD) to rate.the world price expressed in local currency The discussion of policies presented in(px), to the public taxation rate (t), and to the next few sections assumes that thethe unit marketing and unit processing cost official exchange rate is not overvalued and(c): can therefore be used to express world rices

in national currency. If the national currency(1) pp = px (1 - t) - c, is overvalued, then using the official

exchange rate results in an artificially lowwhere px = p*x e, * denotes a price in price in national currency, overvaluationforeign currency units, and e is the exchange constitutes implicit taxation of producers, torate (domestic currency relative to foreign the benefit of importers. Also, overvaluationcurrency). of the currency often forces a devaluation,

The first objective (alignment of generating a sudden change in the worldproducer prices with world prices) calls for price expressed in national currency thatstable and relatively low rates of taxation - should normally permit an increase in thein other words, protection rates near zero. real producer price. However, this resultThe second objective (funding of the actually occurs only if the share of the rise innational budget), however, implies relatively the export price in national currency that ishigh tax rates (low or negative protection passed through to the producer is more thanrates). The last two (stability of producer offset by the general price rise generated byprices and stability of government receipts) the devaluation (see P. Guillaumont 1988).

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Table 1. Major types of agricultural producer price policies for exportcrops

Pasaa zbfibz

Moderatd Two paniStabilzation szabilzaion

Absohbe Total ffloor and Trend-based systemFeawes stabiLizaton pass-vhrough ceilingpices) pass-through combied

GoalAdaptationto worldpnce trend No Yes No Yes Yes

Short-termproducerpricestability Yes No No Yes ?

ModalitiesGuaranteedLo.b. price Yes No No Yes No

Subsidypossibility Yes No Yes Yes Yes

A good agricultural price policy, Total stbiliadonwhatever the type adopted, is thus easier toimplement if it is accompanied by an A policy of total stabilization of realeconomic policy that avoids overvaluation of producer prices involves defining athe national currency. In the opposite case, production objective for each export cropwhere the currency is likely to experience and determining the price that will induceperiods of high overvaluation and large farmers to produce the desired amounts. Indevaluations, the world price in national principle, the price is arrived at by examiningcurrency has to be measured using a the price elasticity of supply or by"reference" or equiibrium exchange rate. determining the marginal cost of production.Also, where inflation is high and variable and A policy of this type implies indexing thethe exchange rate is allowed to float (as in guaranteed nominal price of each crop to athe African and Latin American countries in suitable consumer price index. A guaranteedwhich foreign exchange is sold at auction), f.o.b. price is arrived at by adding unitadministered prices are very difficult to marketing cost to this price. Public taxationmanage. In this case, an agricultural price- is then equal to the difference between thesetting policy for export crops may not be export price realized and the guaranteedpossible. Thus, a policy of administered f.o.b. price.agricultural prices implies some degree of This system totally severs the linkstability of the nominal and real exchange between producer prices and world pricesrates. and is likely to lead to severe resource

misallocation. Moreover, it makes the level

6

of public taxation unpredictable and places it countries, as in others, instability of publicat the mercy of variations in world prices. revenue has been a root cause ofNot only is the average rate of taxation questionable investment choices anduncertain, but the entire burden of world macroeconomic disequilibria.price instability is borne by public finance (inthe broad sense). This destabilizing effect on Totpass-tlmughpublic revenue is intensified in manydeveloping countries where taxation of At the opposite extreme areexport products accounts for a high share of agricultural export price schemes thatpublic revenue. transmit all world price fluctuations to the

In practice, most stabilization fund producer. In this type of system, the tax rateschemes that appear to be similar to the remains constant and, when applied tosystem described above are really quite export value, produces revenue that variesdifferent. They have operated with all the with the world price.drawbacks of such a total stabilization If the tax rate is relatively low, the firstscheme but without its advantages. Producer objective (alignment with world prices) isprices have not generally been indexed to achieved. A relatively low rate reflects thethe price of consumer goods but have been tradeoff between the objective ofadjusted at irregular intervals. This has remunerative prices and the need for publicresulted in instability of the real price and revenues. A system in which taxation isoften in a declining long-run trend. The proportionate to export value is logicallyeffects of such schemes in two countries as reflected in a relatively low level of taxationdifferent as C6te d'Ivoire and Madagascar in relation to world prices. Since farmersare illustrative of this experience. The bear the entire price risk, it is appropriate tofollowing data show average level and allow them the means to do so in the form ofvariability of the real producer price index of incomes that are higher on average thancoffee during 1970-85 (1970 = 100) for they would be under a scheme that includedthese two countries (based on CERDI the possibility of subsidies when prices were1988): very low.

In a system in which world priceC6e d'lvoirc Madagascar movements are fully passed through, the

Avcrage 96B 93.7 objective of stabilization of producer pricesStandard is by definition abandoned. With nodeviation 11.9 22.1 guaranteed fob. price or official producerCoefficient of price, producers do not know at the start ofvariation (%) 12 24 the season what price they will receive. How

great the disadvantages of such a system areThe history of coffee in Madagascar, in depends on the magnitude of the

particular, exemplifies the risk of a sharp fluctuations to which export product pricesdownward trend of the real prce over the are exposed. Also, farmers' ability to copelong term. Moreover, the cases of Cote with such fluctuations depends on the naturedfIvoire and Madagascar demonstrate how and size of their land holdings and on theirdifficult it is for govemnments to manage traditional practices. While the assumptionfluctuations in resource inflows: in these

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is that farmers will learn how to manage a macroeconomic instability and to the well-volatile income, this learning process is known Dutch disease phenomenon. Indifficult for small, marginal farmers with no Kenya, the extra income earned wheneffective way to invest or to borrow. For this international prices were high was investedreason, it is desirable to complement such mostly in real estate. The effect was topass-through policies with policies that relax increase the relative price of nontradedthe investment and borrowing constraints. capital goods, which favored owners of

It should also be noted that pass- capital, who were largely urban dwellersthrough schemes with ad valorem taxation (Bevan et al. 1987). This caused the real(even at a fixed rate) do not protect public exchange rate to appreciate, which adverselyfinance against instability. They do, however, affected the incentives for the production ofmake public revenue appreciably less tradables relative to nontradables.unstable than under stabilization schemessince the instability merely reflects that of Moderated4stabalion orboundedworld prices. However, to the extent that pass-i trughunit marketing costs remain constant,producer prices are a little more unstable Between the two systems sketchedthan world prices (see equation 1). Also, it above are two hybrid partial stabilizationhas proved politically difficult to apply a schemes. One, moderated stabilization,constant rate of taxation regardless of the reduces the price rigidity of totalworld price leveL stabilization, while the second, attenuated

Coffee and tea policy in Kenya is an pass-through, reduces the price uncertaintyexample of a pass-through type of system. that results from a total pass-through system.However, Kenyan policy deviated from total These two systems meet the price policypass-through during the export commodity objectives defined earlier to differentprice boom of 1977. Since then, some degrees.progressivity has been introduced into the With the moderated stabilizationtax rate based on the world price level, which scheme, a number of variations are possible.contributes some stabilization to producer Their common feature is that they are basedprices. The system, which has not hindered on reference prices fixed in advance as athe growth of production in Kenya, may not function of production or social objectives.be appropriate in other countries, however. These prices do not change automatically asKenyan farmers have had decades of world prices change, although they may beexperience learning to adjust to producer modified as the international climate (andprice instability. They have been able to do the production objective) changes. Theso because their farms are fairly large, are principal types of moderated stabilizationconnected by a network of cooperatives, and system work as follows:are fairly well integrated into the monetary * The reference price is a guaranteedsystem. Increased price instability in minimum price (or floor price); when thecountries where conditions are different world price falls below that price,might affect production negatively. government subsidies make up the

The Kenyan experience also shows that difference.a pass-through system can lead to

8

* The reference price represents a whereas the lower the floor price, the moremaximum (ceiling) price; when the world likely it is to have no real impact. And, whereprice rises above that price, the the floor price is not indexed to domesticgovernment levies a tax equivalent to the prices, its impact will decline progressivelywhole of the difference. under the effect of monetary erosion. The

* Both a floor and ceiling price are set, and ceiling price exhlbits the same ambiguity. theworld price fluctuations are passed on in higher it is, the more likely it is to have nofull within the zone marked by the two practical significance, but the lower it is, theprices. more likely it is to lead to excessive taxation

* A proportionate or progressive of farmers and dissociation from the worldtax/subsidy system that goes into effect market price. And here too the risk ofwhen the world price rises above or falls erosion is high if the ceiling price is notbelow the reference price.5 indexed.

Combinations of these four systems are The floor price and ceiling price systemsalso possible, with the most common being do not, therefore, appear to be based on athe guarantee of a minimum price coupled valid analysis of the economic disadvantageswith progressive taxation above that price. of producer price instability. These systemsThis is the strategy that is used in some Latin ensure neither the short-term stability ofAmerican countries. producer prices nor their alignment with the

The moderated stabilization system world price trend. In brief, the risks are thedistributes the burden of world price same as those for which the two polarinstability between government and schemes are criticized. But moderatedproducers, with the nature of the stabilization/bounded pass-through systemsdistnbution depending on the modalities and reassure the opponents of the two polarrates applied. As a result, depending on systems and find a sort of moral justificationwhere the emphasis is placed, this type of in the refusal to pay farmers either "notsystem approaches, more or less closely, one enough" or "too much." Thus they representor the other of the two polar systems a sort of political or moral compromise(perfect stabilization and total pass-through between the two polar approaches.of instability). And the more such systemsapproach the polar types - for example, the Trend-basedpass-durugh or adtvemore producer prices are stabilized - the stabilzationmore they share the weaknesses of thosetypes of systems - in this case, the greater A second way to achieve partialthe risk of dissociating domestic from world stabilization without the pitfalls of theprices. moderated stabilization system is to avoid

This can be illustrated, first, by the floor creating lasting distortions in domestic pricesprice case, which is often proposed as an relative to world prices by defining aintermediate solution between total guaranteed Lob. price based on the worldstabilization and total pass-through. The price trend. Since estimating future prices ishigher the floor price is set, the more it little more than guesswork, the surest way tostabilizes the producer price but the more it tie producer prices to world prices is to basealso dissociates it from the world price, producer prices on past world price trends.

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This can be achieved using a "past trend pass-through of world price fluctuations tovalue,' expressed in constant local currency6 producer prices within the zone defined byand calculated simply as the moving average floor or ceiling prices, but this system carriesof previous year prices. the risk of dissociating prices in the medium

To avoid excessive government and long term. In contrast, this second typetaxation, an average tax rate is defined (as in of partial stabilization has a low immediatethe total pass-through scheme). This rate pass-through of world price variations butexpresses a long-term tradeoff between minimizes the risk of dissociation in theadequate remuneration of producers and medium term.satisfaction of the financial needs of the The two partial stabilization schemesstate. The average tax rate, applied to the can of course be combined. For example,world price trend level, determines the government taxation (or subsidy) can beamount of unit taxation and, when this is applied to only a certain portion of thededucted from the trend value, gives the spread between export price and referenceguaranteed f.ob. price; deducting average price, itself defined as a function of themarketing cost from the guaranteed £o.b. previous export price trend. This kind ofprice then gives the producer price. scheme is applied, under complex rules, to

In principle, the producer each year coffee and cocoa in Papua-New Guinea,receives the equivalent of the trend value of probably because the moving average isthe world price, reduced by marketing costs calculated over such a long period (10 years)and an amount of taxes calculated at a that, in the absence of a modulatedconstant rate. As a result, the effective rate taxation/subsidy rate, it would result inof taxation differs from the theoretical rate almost total price stabilization. A simpleras a function of the gap between the method - and one more in line with theeffective and the trend level of the world price policy objective of producer priceprice;7 it can even become negative (a alignment with world prices - would be tosubsidy). diminish the degree of stabilization by

The producer price is thus partially shortening the period on which thestabilized: it evolves from year to year in guaranteed price is based.accordance with the moving average worldprice expressed in national currency. Marketing and Public FinanceStabilization is only partial, and the burden Implications of Price Policyof instability is shared between producersand government.8 This is also the case in The choice of a price policy cannot bemany so-called stabilization schemes, but in based solely on how well a policy meets itsthis case the sharing is more rational since predetermined objectives. It has to take intothe world price trend is respected, and account the country's economic structurestabilization, which follows an automatic and the management capacity of the variousrule, no longer serves as an opportunity for participants in the production and exportexcessive taxation of producers. sectors; that is, it must take into account the

The other type of partial stabilization, marketing and taxation managementmoderated stabilization or bounded implications.pass-through, entails an immediate

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In the past, marketing boards and the realized export price. Marketing marginsstabilization funds have traditionally are undoubtedly also affected by the natureperformed three functions: of the producer price-setting system. The* Producer price stabilization, a function question, then, is whether a system of

that has been exercised only partially guaranteed £o.b. prices can increase orbecause real producer pnces have decrease these margins.generally remained unstable, and In pricing systems with a guaranteedstabilization funds have rarely subsidized fo.b. sales price or guaranteed export priceproducers when world prices fell; in other (total stabilization and trend-based pass-words, the funds' main effect has been on through systems), the guaranteed price ischanges in the tax rate levied on equal to the sum of the official producerproducers. price plus processing, transportation, and

* Control of domestic and external marketing costs, which are provided for in amarketing (sometimes even monopoly scale or a price list. Some believe that thiscontrol). system opens the govemment to pressure

* Management of part of the proceeds. from dealers and leads to overestimation ofThese three functions are not marketing costs. Moreover, whatever the

independent. Each producer price policy precautions taken to ensure competitionoption (total, zero, or partial stabilization among dealers, one cannot be sure of therelative to world prices) has repercussions price actually received by producers: in otheron marketing methods and public finance words, a guaranteed Eo.b. price does notmanagement. Price policy must take into imply a guaranteed price to the farmer.account these repercussions, and In countries such as Madagascar, whereconsistency must be ensured between marketing costs vary by region andfunctions. competition is imperfect, nothing ensures

that the official purchase price to theComcy btween private marketing and producer, which is tied to the differential,pubLic stabilaion will be respected. But where the guaranteed

f.o.b. price is linked through an establishedPrice policy has implications for both mark-up to a producer price, it is possible, as

domestic and external product marketing. in Cote d'Ivoire, to officiaUy announce theamount of the 'normal" producer price at

Domestic marketing. Everyone agrees the start of the season, well beforethat the private sector should have a major collection, and to publicize it widely. Thisrole in domestic product marketing, except procedure increases the likelihood that theperhaps in integrated agroindustrial sectors price will in fact obtain as long as marketingwhere the objective should be management credit is available, as was the case in C6tethat is independent of the government and d'Ivoire until 1987. Advance notification of ain accordance with free market principles. price also facilitates one-time payments toPrivate sector participation introduces farmers for their harvest.competition and so helps to ensure the In systems without a guaranteed fJo.b.lowest cost for marketing and to prevent price, there can be no official season-longproducers from losing too large a share of purchase price because the purchase price

11

depends on the export sale price, which is public export monopoly is compatible withdetermined only when export contracts are the various price policy objectivesconcluded. Publicizing the 'normal" distinguished earlier, it has the disadvantageproducer price is more difficult when the that export marketing efficiency cannot beprice is variable and is not known at the start assessed by comparing the performances ofof the season. Moreover, farmers may different operators. It may also give rise toreceive only a payment on account at the directly unproductive rent-seeking activitiestime of delivery instead of a final payment, as by those who operate the export facility. Forhappens in Kenya The farmers' confidence that reason, competition among privateabout receiving the remainder of the operators is often preferred. This secondpayment then depends on their confidence solution is consistent with the policies ofin the dealers or cooperatives that act as total pass-through of world priceintermediaries and, more generally, on the fluctuations or moderated stabilization,quality of credit facilities. This type of system neither of which is based on a guaranteedseems not to be well-suited to the poorer f.o.b. price.developing countries in Africa, given the Where price policy guarantees an fo.b.many obstacles to its smooth functioning price, marketing enterprises are likely toeven where conditions seem favorable (as in have little incentive for getting the bestKenya, with its large farms, cooperatives, possible sales terms since the entire profitcommunication and credit facilities, dynamic goes to the state. To meet this objection,private business sector, and rapid incentives can be introduced to motivate thedissemination of information about world marketing enterprises to try to get the bestprice data). price - for example, basing their

An alternative approach, where the remuneration on proceeds from sales andmarketing board or the stabilization fund is not on the guaranteed Lo.b. price, whichresponsible for export sales, would be to means that their profit margin does not formdetermine a definitive producer price based part of the established mark-up.on the expected or estimated export price.The board or fund would then bear the risk Delnking the stabilization fimd and theof any fluctuation in world prices between public aeaswycollection and export. Futures markets couldprovide some assistance in setting prices, but There are three methods of managingthey do no exist for all products. Generally public levies on export crops: in thespeaking, the assumption of this price risk is framework of the national budget, through aan incremental cost that will be passed on to stabilization fund, and some combination ofthe producer. the two, which can take several different

forms. The need to choose among theseExternal marketing. Foreign sales are arises only if the policy aims to stabilize

handled either by a public agency with producer prices and involves the possibilitymonopoly power, such as a stabilization of a subsidy. In the absence of a pricefund, or by private enterprises, which, stabilization objective, levies consisting ofdepending on the country, are controlled taxes normally go to the national budgetand competitive to varying degrees. While a

12

In practice, stabilization schemes have The problem of sharing the funds ariseshad serious drawbacks because the funds when the price scheme is aimed at total orthey accumulated when prices were high partial stabilization of producer prices andwere used to finance public spending and so involves the possibility of subsidies. In thewere not available to finance subsidies when case of total stabilization schemes, fiscalprices were low. Stabilization schemes have revenue could be stabilized by setting analso had two negative consequences for appropriate budget levy that reflects thepublic spending policy. sector's normal expected contnbution to

First, the schemes violated the public expenditure financing. To stabilizetraditional rules of public finance the real value of these public receipts, theconcerning budget unity and universality, levy must be proportionate to theaccording to which the whole of public guaranteed f.o.b. price rather than to theexpenditure should be contained in a single realized export price. In the case of partialdocument and the fiscal receipts should not stabilization schemes, which tax/subsidizebe allocated to particular spending items. the spread between the world price and aThese rules are expected to equalize the reference price, it is also necessary to definesocial marginal utility of the various the budget levy rate as a function of thecategories of public expenditures and so to reference price rather than the realizedguarantee the rationality of public choices. price in order to stabilize revenue. The issue

Second, allocating most of the levies to of sharing stabilization funds does not arisepublic finance leads to revenue instability. in the case of policies based on the totalRevenue instability can contnbute to poor pass-through of world price fluctuations.spending choices since expenditure Nor does it arise in the case of trend-baseddecisions during periods of sharp price rises pass-through schemes, which by definitionare often made quickly and with less care include an average fiscal levy rate defined asthan at other times. Moreover, since public a function of the trend price, which makesexpenditures tend to rise more when sharing between the budget and the fundreceipts are rising than they fall when automatic.receipts are falling, increased instability In all cases where a normal budget levycontnrbutes to budget imbalance. is set, the stabilization resources managed by

What is needed is a clear and rational the fund stabilize both real producer pricesdivision of responsibilities between the and the budget levies on the subsector.national budget and the stabilization fund. Rwanda's Equalization Fund is an exampleThe government can be responsible for of this type of system. The advantage ofmanaging fiscal-type resources levied to stabilization on the trend world price is thatfinance public expenditures, including those it does not freeze the volume ofintended to promote the production of export-based budget receipts but indexes theagricultural export products, and the fund amount of unit taxation allocated to thecan be responsible for managing the budget to the trend of the real world price.revenues raised for stabilization. Where producer price stabilization is

The modalities of the sharing of levy the objective, resources managed by theproceeds are not independent of stabilization fund need to be invested instabilization policy. ways that conserve their real value and

13

permit them to be mobilized quickly. The four objectives: respects the trend of worldmacroeconomic consequences of the prices and ensures incentives for producers,investment decision must also be considered. contnbutes to the financing of publicFor both these reasons, placing the funds expenditures, ensures some degree ofwith the treasury should be avoided because, stabilization of real producer prices, andas experience has often shown, they would ensures at least moderate stability of budgetthen be used to finance public expenditures. receipts. Of the policies that meet theseTheir liquidity would become uncertain and objectives to varying degrees, thethey would still contribute to expenditure trend-based pass-through or adaptiveinstability. stabilization scheme comes closest to

To facilitate the coordination of fund reconciling the objectives. First, it ensuresresource management and monetary policy, some stability of real producer prices whilefunds ought to be placed in the central also linkdng changes in those prices tobank - assuming the bank is independent of changes in real world prices. Second,the treasury - rather than in commercial guaranteeing an f.o.b. price makes it possiblebanks. In this way, part of the money created to set and publicly announce an officialas the counterpart of export receipts would producer price before the season starts,be sterilized during a period of rising prices thereby increasing the likelihood thatand rapid growth of exports; conversely, in a producers will not receive a significantlyperiod of falling prices, drawings on this lower price- provided that the marketingaccount would result in incremental money system is competitive; moreover, a producercreation. The central bank should of course price set for an entire season and announcedbe authorized to pay interest on the deposits before the season starts is a greater incentiveof the fund at not less than the inflation rate to producers than an uncertain price.in order to conserve their real value. It Finally, the system's automatic character andwould also be desirable for the fund to have the tying of its tax rate to the guaranteedthe legal capacity to borrow in the event of f.o.b. price ensure a stable tradeoff betweenexhaustion of its resources. the objectives of adequate remuneration of

Another solution, practiced by some producers and adequate public expenditurestabilization funds in the past, is to place the financing. It consequently avoids the chiefstabilization funds abroad. Theoretically, drawback of traditional stabilizationthis solution has the advantage of helping to schemes, which have favored budgetstabilize not only domestic money creation financing to the detriment of incentives tobut also foreign exchange receipts. It also producers.allows the fund to conserve the real value of To avoid this system's tendency towardits holdings. Despite its many benefits, marked instability of public receipts, somehowever, this solution may meet with operating rule needs to be established forpolitical opposition. distnbuting levies between the stabilization

fund and the public budget. One way to doConclusions and Recommendations this is to assign to the national budget the

receipts from a levy calculated as a certainThis paper has sought to define an constant percentage of the guaranteed £o.b.

agricultural export price policy that meets price; the fund would then receive a variable

14

levy (or pay the subsidy) equal to the (moderated stabilization scheme) equalrealized export price minus the guaranteed to 50 percent;f.o.b. price, the budget levy, and, perhaps, * Trend world price (trend-based pass-the marketing margin. In this way, the through scheme) calculated on anpricing policy serves to stabilize both average of seven years;producer prices and budget receipts. * The instability of the price measured by

Under this principle, the fund remains the standard deviation.simply a stabilization fund, with no respon- All four schemes would have led oversibility for public expenditure choices - the period to an average real producer pricechoices that the government is in a better that was higher than the actual average priceposition to make within the budget (table A-1). Moreover, the partialframework. This solution also implies stabilization systems would have been moreplacing the fund's resources outside control favorable to producers than totalof the public treasury. stabilization, given the behavior of world

prices.Appendix Real price instability is of course at a

Simulation of Nominal and Real maximum in the case of the totalProducer Prices and Unit Public pass-through scheme and at a minimum

Taxation in Madagascar (zero) in the total stabilization scheme. Pricefluctuations under the moderated

In order to examine the specific stabilization scheme (at the rate of 50implications of the various pricing systems, percent) were between those for totalwe simulated the evolution of nominal and pass-through and those for trend-basedreal producer prices for coffee in pass-through schemes. Both partialMadagascar and of unit public taxation that stabilization formulas led to more markedwould have occurred between 1970 and 1986 instability than was found in the observedunder each system and compared these real price.situations with what actually occurred. The results for average level of unit real

The calculations were made on the taxation are the reverse of those for averagefollowing basis (see CERDI 1988): real price: taxation is maximum in the* Unit real marketing cost equal to observed actual situation and minimum in

effective cost; the case of total pass-through of price* Reference price (total stabilization and fluctuations.

moderated stabilization schemes) equal Instability of unit taxation is minimumto real 1970 price (the maximum real in the case of total pass-through andprice of the last 25 years) plus real maximum in the case of trend-basedmarketing cost; pass-through.

* Average tax rate (total pass-through and The trend-based pass-through schemetrend-based pass-through schemes) equal comes closest to reconciling the differentto 20 percent (approximately the rate at price policy objectives. However, it has thethe beginning of the 1970s); disadvantage that it entails marked

* Rate of taxation of the spread between instability of unit public taxation.world price and reference price

15

Table A-1. Comparison of simulation results for the four main producerprice policies for coffee in Madagascar, 1976-86(1975 Malagasy francs)

Realproducerpice Reapublc lvyfor coffee on coffe (per kg)

standard szaurdaveaage decaaon avaage decaton

Actual policy 129 273 224 1373

Total stabilization 196 0 157 148.7

Total pass-throughof intrnationalprice fluctuations 272 118.4 81 30.4

Moderated stabilization:tationlsubsidy of thespread betwee internationalprice and reference price,at a constant rate (50 %) 274 74A 78 74A

Adaptative stabilizationon the trend value of realinternational price(measured on 7 years) 245 50.4 107 175.0

Noze Producer prices and public levies were deflated by the 1975 consumer price index.

16

Notes

This article owes much to the discussions example, in the case of coffee inconducted in CERDI on agricultural price Madagascar (Guillaumont and Bonjeanpolicy among a team that included Jean-Paul 1988).Azam, Catherine Bonjean, G6rardChambas, Marielle Dem6ocq, Jean-Jacques 5. Whereas in the floor and ceiling systemsFaucher, and Regis Marodon. Many thanks with the simplest rules, the taxation (orare due to Jaime de Melo for his several subsidy) rates are equal to 0 or 1,pertinent remarks on a preliminary version. depending on the respective positions

of the world price and the reference1. It is understood here that the relevant price, it is possible to provide for rates

world relative prices are not current between 0 and 1 through eithercyclical prices but their foreseeable proportionate or progressive taxation ofaverage leveL For that reason, the difference between the world pricelong-term world market trends are and the reference price. In the case ofmore significant than short-term progressive taxation, it is appropriate tovariations. define not only a reference price but

also a scale -- also indexed -comprising2. Among those who accept the increasing rates by difference segments.

principle of the taxation of agricultural This system is illustrated fairly well byexports, see Mellor and Ahmed 1988. the Kenyan policy applied to coffee

since 1977, which includes slight3. See, for instance, Franco (1981) and progressivity in accordance with a scale

Nascimento and Raffinot (1985). expressed in current currency. WhereLet us call only taxation applies, the mean taxationR: public revenue levied on crop rate is logically lower than when it is

exports accompanied by subsidization since theq : the supply of export crops lack of compensation in the case of apx: the export price (less the marketing price fall implies limiting the taxation

costs) rate when prices are average or high.pp: the producer price For that reason, the mean taxation ratee : (6q/q)/6p,/pp) the elasticity of the in Kenya is low.

supply of export crops6. That is, of the world price converted

we have into national currency and deflated byR = (p -pp) the domestic consumer price index on

63R pq 6q the basis of the final year.bR = P P aq- uPxPX - PP -q 7. Note that the tax rate really reflects the

since 6ql6pp = e(q/pp) tradeoff between producers andsince 6q/3pp = e(q/pp) government only to the extent that the

6R = Px eq-q currency is not overvalued.= eq eq

Pp-p- Pp 8. The greater the number of years on6R which the average world price is

so > 0 when Px < e calculated, the more stable is thejpp Pp e,+1. producer price and the greater the

share of instability born by the4. The analysis is difficult, but not sharent.

impossible. It has been done, for govemnent

17

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