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POLICY AND NON-POLICY SOURCES OF AGRICULTURAL PRICE DISTORTIONS:
EVIDENCE FROM THE MEASUREMENT OF SUPPORT IN SELECTED TRANSITION ECONOMIES
Olga Melyukhina*
Abstract
The OECD started computing PSEs/CSEs for transition economies at the beginning of the 1990s. This paper presents the PSE/CSE estimates for seven monitored countries: Bulgaria, Estonia, Latvia, Lithuania, Romania, Russia, and Slovenia. It then looks at the empirical issues of estimating support in transition economies, focusing specifically on the measurement of domestic price distortions.
Finally, some aspects concerning interpretation of support estimates for transition economies are discussed. PSEs/CSEs have proved to be useful tools for monitoring developments in the agricultural sectors of non-OECD transition economies. These measures help explain the scale of agricultural market distortions and the cost of these distortions to producers, consumers and taxpayers.
PSEs/CSEs can indicate the need for reform and point to areas where it is critical. However, while quantifying monetary transfers to producers from consumers and taxpayers, the PSE does not measure what effect these transfers have on farmers’ incomes. The PSE therefore needs to be complemented by other analytical instruments, in particular those estimating the various effects of policies applied.
Introduction
The OECD started applying its Producer Support Estimate/Consumer Support Estimate (PSE/CSE) analysis to transition economies at the beginning of the 1990s. Political developments in the central and eastern European countries (CEECs) and the Former Soviet Union opened the way to market transformation and closer integration of these countries into the world economy. This raised interest in the process of reforms in the region and their potential implications for OECD countries. In 1994 the OECD released its first comprehensive Agricultural Policy Review for Hungary. Similar studies followed on Poland (1995), the Czech Republic (1995), Estonia (1996), Latvia (1996), Lithuania (1996), the Slovak Republic (1997), Russia (1998), Romania (2000), Bulgaria (2000), and Slovenia (2001)1. PSE/CSE analysis was an important component of these studies.
Estimation of PSEs/CSEs is based on a comprehensive inventory of agricultural policies. The approach has three major strengths. First, the identification and classification exercise is itself a valuable contribution to policy analysis. Second, PSEs/CSEs provide a quantitative evaluation of policies based on a technique that is relatively simple and can be carried out on an annual basis. These estimates help provide an understanding of the scale of agricultural market distortions and the cost of
* OECD.
1. Four of these countries have become OECD members: the Czech Republic in 1995, Hungary in 1996, Poland in 1996, and the Slovak Republic in 2000.
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these distortions to food consumers and taxpayers. Third, PSEs/CSEs, representing aggregate tariff- equivalent measures of diverse policies, are well suited to cross-country comparisons (Cahill and Legg 1989/1990). Undertaken initially as part of one-time Agricultural Policy Reviews, PSE/CSE estimates have been updated each year. As with OECD member countries, PSE/CSE analysis has become an important feature of the annual monitoring of agricultural policies in several non-OECD economies.
This paper discusses the OECD experience of measuring PSEs/CSEs for non-OECD transition economies. It begins with the presentation of the PSE/CSE results for seven monitored countries:
Bulgaria, Estonia, Latvia, Lithuania, Romania, Russia, and Slovenia. It then deals with the practical aspects of estimating support, focusing specifically on the measurement of price distortions, which are the main source of producer support (taxation) in the analysed countries. Finally, some questions of interpretation of PSE/CSE estimates for transition economies are discussed.
One purpose of this paper is to demonstrate the potential of PSEs/CSEs for monitoring and analysing trade and domestic policy reform. Another is to highlight the key methodological features of the measurement of price distortions as part of the PSE/CSE analysis, as well as information required to carry it out. The paper also seeks to stimulate the feedback from the Forum participants on the usefulness of applying the PSE tool, or elements of the methodology, to developing economies.
Trends in agricultural support in non-OECD transition countries between 1986 and 2000
The OECD defines Producer Support Estimate (PSE) as an annual monetary value of gross transfers from consumers and taxpayers to agricultural producers, measured at the farm-gate level, arising from policy measures which support agriculture, regardless of their nature, objectives or impacts on farm production or income2. The Consumer Support Estimate (CSE), a PSE-related indicator, measures the cost of producer support to consumers of agricultural products3.
The PSE measures two types of transfers - market price support and budgetary payments to producers.
Market Price Support (MPS) transfers emerge when there is a wedge between domestic prices for given agricultural products and the world prices for equivalent products. This price wedge occurs as a result of various government interventions, for example border measures, domestic price support (control), marketing regulations (restrictions), subsidised export, etc. In transition countries factors other than explicit government intervention may also have a strong impact on the price gap, as discussed later. The second component of the PSE, budgetary payments to producers, take either the form of actual payments to producers, or budgetary loss (i.e. forgiveness of debt on credit provided from the government resources) or budgetary income foregone (i.e. resulting from tax benefits granted to agricultural producers). The breakdown of the various categories of support is shown in Annex II.
The PSE/CSE estimates covering the period from the mid-1980s to 2001 demonstrate a general pattern of support in non-OECD transition countries: (i) a phase of very high support under the planned system (over 70% for the majority of analysed countries); (ii) a strong negative swing in support at the beginning of the transition period between 1991 and 1994; and (iii) modestly positive and moderately fluctuating PSEs between 1995 and 2001 (Figure 1).
2. For definitions and composition of OECD’s PSE/CSE and related indicators, see Annex I and II. A comprehensive explanation of OECD methodology is contained in OECD (2001b).
3. In the OECD methodology the consumer is understood as the first stage buyer of agricultural products.
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Figure 1. Percentage PSEs by country and OECD average, 1986-2001
-150 % -125 % -100 % -75 % -50 % -25 % 0 % 25 % 50 % 75 % 100 %
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000p 2001e
Bulgaria Estonia Latvia Lithuania Romania Russia Slovenia OECD
OECD average
OECD average
Source: OECD PSE/CSE database.
In general, the estimates for the pre-transition period reflect the significant isolation of domestic producers from international markets under the planned economy. High administered producer prices, large budgetary transfers, and exchange rate controls, all contributed to the high pre-transition PSE estimates. Economic liberalisation at the beginning of the 1990s, brought about significant falls in relative agricultural prices and a drastic reduction in budgetary support. This period was also marked by strong macro-economic shifts, leading to substantial weakening of the exchange rates in the monitored countries. Altogether, this caused a sharp fall in PSEs. The negative macroeconomic and sectoral trends of the early transition were reversed in the mid-1990s, with the result that PSEs recovered to positive levels during the second half of the decade. Since the mid-1990s, the annual PSE variations have become relatively moderate reflecting partly a greater integration of the monitored countries with world markets, as well as their relatively more stable macro-economic environment. In the majority of non-OECD countries support remained well below its pre-transition level, and below the OECD average. The estimates for 2001 indicate that PSEs ranged from 3% in Bulgaria to 24% in Romania compared to the OECD average of 31% (see Annex III and OECD 2002a). In the four OECD-member transition economies support was within the same range4. Out of all monitored transition countries, both OECD members and non-members, Slovenia represents a special case, with
4. The PSE trends in the Czech Republic, Hungary, Poland and the Slovak Republic generally exhibit the same pattern as in the non-OECD transition countries: high support before the transition, a reduction in the late 1980s and the first half of the 1990s, followed by some pick-up in 1998-1999, and a slight decline in the most recent years. In 2001, PSEs were estimated at 17% for the Czech Republic, 12% for Hungary, 10% for Poland and 11% for Slovakia (see Annex III). Market price support comprised 71% of producer support in Poland in 1999-2000, 63% in the Czech Republic and 59% in Hungary. Only in the Slovak Republic was this share relatively low, at 28%.
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a PSE at 40% exceeding the EU and OECD averages. It is worth noting, however, that the overall modest levels of producer support in the majority of monitored countries mask considerable differences across individual commodities. For example, in Bulgaria, the country with the lowest average %PSE in the monitored group at 3%, producer support ranged from 59% for sugar to minus 21% for barley.
The composition of PSEs indicates that Market Price Support and input subsidies dominate transfers to (from) producers in non-OECD economies. Thus, in 2001, Market Price Support (MPS) accounted for over one half of total PSE in Latvia, Lithuania, Russia and Slovenia, reaching as high as 87% in Romania and 89% in Bulgaria. Only in Estonia, with its liberal domestic market and border regime, does the MPS contribute a relatively small share to the total PSE (37%).
The budgetary component of the PSE in most countries was dominated by input payments. These are particularly important in Russia and Bulgaria, accounting for 66% and 73% of total direct budgetary payments respectively.5 While input subsidies continue to be an important component of support in the majority of monitored countries, a substantial shift to area and headage payments can be observed in recent years. Six out of seven monitored countries are candidates for accession to the European Union.
The increased emphasis on area and headage payments largely reflects the process of aligning domestic policies in these candidate countries with the Common Agricultural Policy of the European Union.
The Consumer Support Estimates (CSE) generally mirrored the PSEs in all monitored countries, with substantial producer support during the centrally planned period translating into an implicit tax on consumers.6 The situation radically reversed itself in the early transition years, with positive CSEs indicating that consumers were implicitly subsidised during this period. Starting from the mid-1990s, the pre-transition situation has been restored, however, with consumer taxation much lower than during the central planning years.
The Total Support Estimate (TSE), a broader indicator of support, complements the PSEs/CSEs. The TSE is the sum of transfers to agricultural producers (the PSE), expenditure for general services (GSSE), and budgetary transfers to consumers. Expressed as a percentage of GDP, the TSE indicates the burden that support to the agricultural sector places on the overall economy. In 2001, the percentage TSE in four of the monitored non-OECD countries remained above the OECD average of 1.3%, with Romania having the highest level of all monitored non-OECD countries (6.1% of its GDP).
Among the seven monitored countries, only in Russia, Bulgaria and Estonia were TSEs below the OECD average (Figure 2).
5. In some cases, e.g. Russia and Romania, sizeable amounts of input assistance were provided in the form of debt forgiveness.
6. However, in many monitored countries governments provided budgetary transfers to consumers to reduce this implicit taxation. Thus, grain elevators/milling plants, and milk and meat processors received direct budgetary compensation, which served as the principal instrument of maintaining high agricultural producer prices and low food prices.
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Figure 2. Total Support Estimate (TSE) by country and OECD average in 2000-2001 In per cent of GDP
0% 1% 2% 3% 4% 5% 6%
Bulgaria Russia Estonia OECD European Union Lithuania Latvia Slovenia Romania
2000 2001
Source: OECD PSE/CSE database.
A comparison of the PSE levels in transition countries with the OECD average suggests that less support to producers is provided in transition economies. But at the same time higher shares of total support in relation to GDP in many monitored countries mean that this support places a heavier burden on transition economies than in many OECD countries. This burden grows with the share of agriculture in GDP. Romania, a country with one of the largest shares of agriculture in GDP among the CEECs (11% in 2001), has the highest burden of all. Producer support (percentage PSE), roughly within the range of other CEECs, costs Romania more as a share of its national economy than any of these countries and more than twice what it costs OECD countries.
Estimating Market Price Support
Estimating MPS is the most challenging task when calculating PSE. One reason is the high weight of price transfers in the total measured support in the monitored countries. A second is the fact that the price gap captures the impacts of various implicit and non-transparent actions of the government, which affect agricultural prices. This point is essential for some transition countries, where the rapid evolution of macroeconomic and agricultural policy frameworks have often been associated with recourse to ad hoc interventions, various exemptions and special treatments within the formal regimes (e.g. trade tariff schedules), and non-transparent administrative controls of commodity flows. A final reason is that price gap estimation is data demanding. It requires external and domestic price data of reasonably good quality, as well as specific background information on individual commodities,
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notably, the link between primary, domestic wholesale and international markets, handling, processing margins and transportation costs.
i) Choice of a reference price
The measurement of price transfers requires an understanding of the opportunity cost of the country’s domestic production. In the case of a country that is a net exporter of a given product the opportunity cost would be the export price of the product; in the case of a net import, it would be the import price of the commodity in question. Therefore, as an initial step of domestic-to-international price comparison, an analysis of a country’s position vis-à-vis international markets is needed. For transition economies, this task has sometimes been complicated by the instability of their trade patterns during the past decade. A broader analysis of a country’s production and consumption conditions has often been needed to make a judgement on the most representative type of interaction with external markets and the underlying opportunity cost.
Once the question on whether to adopt an import or an export as a benchmark for comparison is answered, the appropriate import/export price has to be selected. The first approach at hand would be to use prices reported by national trade statistics (average import/export unit values7 or specific prices for major trading partners). However, for transition countries, this can rarely be considered the first- best choice. National data usually suffer from inconsistencies. All monitored countries went through a profound transformation from state monopoly to private trade. Trade registration systems and statistical methodologies have been changing as well. Hence, the national trade data for the pre- and early transition periods and most recent years are often weakly comparable. Second, the reported trade values are sometimes distorted due to barter trade, inter-governmental debt settlement agreements, food aid, etc. Therefore, the OECD practice to date has been to use the trade data of developed market economies, representing the major partners of monitored non-OECD countries. An additional practical consideration in favour of this approach relates to substantial time lags in the release of the national trade statistics in non-OECD countries. With such delays the usual timeliness of annual OECD policy monitoring would have become problematic.
For all seven monitored non-OECD economies a common set of international reference prices is currently applied. For the majority of PSE products, EU export f.o.b. unit values in extra-EU trade are used. The same prices are applied for calculation of the European Union’s own PSEs and those of some neighbouring countries. For milk, a New Zealand farm gate price is applied as an international reference, according to a procedure uniform for all OECD member countries. The choice of EU prices for almost all products is explained by a number of reasons. The monitored CEECs and Russia are net food importers of the majority of PSE products. The European Union is the main trader in the region, and the principal supplier-partner of the monitored countries. Hence, EU export prices can be assumed a reasonable indicator of the opportunity cost for these countries’ domestic production. For the six monitored CEECs, which all are in the process of accession to the European Union, EU prices take on additional significance as a benchmark for their future competitive position within the Union.
7. Import unit value is calculated as the total c.i.f. import value of a given commodity divided by the total volume of imports of the respective commodity, export unit value is calculated similarly, based on total f.o.b. export value and the corresponding exported volume.
125 ii) Price adjustments for farm-gate comparison
According to the OECD methodology, the price gap is measured at the farm-gate level. To be an adequate estimate of the opportunity cost for domestically produced commodities at the farm-gate level, the external (import or export) reference price should be adjusted for the relevant transportation and handling, as well as processing costs. The reference price should also be comparable with the domestic price in terms of quality. Adjustment of prices for quality may not be a particularly serious problem for a net exporter, as the f.o.b. price generally reflects the characteristics of the commodity produced domestically. However, in the case of a net importer, quality differences between domestic and purchased products may be substantial (OECD, 2001b). A quality correction should then be carried out for the external price. This is particularly relevant for transition economies, where the quality of domestic products is generally lower compared to imported products belonging to similar commodity groups8.
Measurement of the protection at the farm-gate level requires, therefore, a good understanding of domestic commodity markets and product-specific marketing systems. This calculation is also conditional on the availability of information on technical coefficients, marketing margins, transportation and handling costs. This partly explains why estimation of domestic-to-international price gaps is the most challenging component of PSE calculations. The challenge is particularly acute for transition economies, where consistent data series of this kind are rarely available and the quality of the existing information is sometimes limited. For this reason, some of the required adjustments are left out. An estimation error is certainly involved with this approach. However, this seems to be the most pragmatic solution given insufficient information for comprehensive adjustments and the fact that adjustments to some extent offset each other. At the same time, this is complemented by continuous efforts to improve the quality of the data and reduce estimation errors.
iii) Impediments to price transmission under the transition
Adjustments to the external reference price are needed to ensure that all differentials which are due to quality variations, marketing and transportation costs are eliminated from the measured gap between the two prices. Once these differentials are eliminated from the price gap, the remaining wedge is theoretically the result of government interventions preventing market forces from arbitraging away the price differences between domestic and external markets. “Theoretically” in particular means assuming a perfectly competitive market structure and that market agents can absorb information, make and implement new contractual arrangements in response to changed prices either immediately or within a short time. In real world these conditions rarely hold, as markets are usually characterised by various imperfections (asymmetric information, monopolistic structures, etc.), while market agents have to incur certain transaction costs. These factors, as well as the government policies impede the price arbitrage and contribute to the price gap between local and world markets. In transition countries, market imperfections and transactions costs can be a particularly important impediment to the transmission of world prices onto domestic markets. This to a large extent arises from the
“immaturity” of markets during the transition phase. Economies which begin their transformation from a centrally planned to a market system suffer inherent market deficiencies, particularly at the onset of reforms. All post-socialist countries inherited an underdeveloped physical and institutional infrastructure. Even those countries that can be considered as the most advanced in the group are far behind the mature market economies in terms of the development of transportation, storage and
8. For a more detailed discussion on adjustment of external reference prices for measuring the price distortions at the farm gate, see Tsakok (1990), Colman (1995), and OECD (2001b); Tomek and Robinson (1981) provide an in-depth analysis of spatial, value-added and quality price differences.