Agricultural Pricing Policy in Eastern Africa Agricultural Pricing Policy in Eastern Africa Agricultural Pricing Policy in Eastern Africa A Macroeconomic Simulation for Kenya, Malawi, Tanzania, and Zambia Christopher D. Gerrard Greg D. Posehn Granville Ansong EDI Technical Materials The World Bank Washington, D.C. © 1993 The International Bank for Reconstruction and Development / THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing March 1993 Second printing October 1994 The Economic Development Institute (EDI) was established by the World Bank in 1955 to train officials concerned with development planning, policymaking, investment analysis, and project implementation in member developing countries. At present the substance of the EDI's work emphasizes macroeconomic and sectoral economic policy analysis. 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Some sources cited in this paper may be informal documents that are not readily available. The material in this publication is copyrighted. Requests for permission to reproduce portions of it should be sent to the Office of the Publisher at the address shown in the copyright notice above. The World Bank encourages dissemination of its work and will normally give permission promptly and, when the reproduction is for noncommercial purposes, without asking a fee. Permission to copy portions for classroom use is granted through the Copyright Clearance Center, Inc., Suite 910, 222 Rosewood Drive, Danvers, Massachusetts 01923, U.S.A. The complete backlist of publications from the World Bank is shown in the annual Index of Publications, which contains an alphabetical title list (with full ordering information) and indexes of subjects, authors, and countries Agricultural Pricing Policy in Eastern Africa 1 Agricultural Pricing Policy in Eastern Africa and regions. The latest edition is available free of charge from the Distribution Unit, Office of the Publisher, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from Publications, The World Bank, 66, avenue d'Iéna, 75116 Paris, France. Christopher D. Gerrard is professor of economics at the University of Saskatchewan in Canada. At the time of writing, Greg D. Posehn and Granville Ansong were graduate students in the department of economics at the University of Saskatchewan. Library of Congress Cataloging-in-Publication Data Gerard, Christopher D., 1951 Agricultural pricing policy in Eastern Africa : a macroeconomic simulation for Kenya, Malawi, Tanzania, and Zambia / Christopher D. Gerrard, Greg D. Posehn, Granville Ansong. p. cm. -- (EDI technical materials) Includes bibliographical references. ISBN 0-8213-1967-1 1. Agricultural prices--Government policy--Africa, Eastern--Simulation games. I. Posehn, Greg D., 1960 . II. Ansong, Granville, 1956 . III. Title. IV. Series. EDI Catalog No. 030/164 Contents Foreword link Acknowledgements link 1. Introduction: A Guide to Participants link 2. Historical Background link 3. Theoretical Background link Agricultural Development Policies link Economic Stabilization Policies link Trade and Macroeconomic Policies link Food and Agricultural Price Policy link Questions for Participants to Consider link 4. Establishing Macroeconomic and Agricultural Pricing Policies: link An Exercise in Small-group Decision-making The Current Crisis link Agenda link Descriptions of Roles link 5. Economic Policy and Performance in the Four Countries link Contents 2 Agricultural Pricing Policy in Eastern Africa Kenya link Malawi link Tanzania link Zambia link 6. Summary and Conclusion link Bibliography link Appendix: A Trainer's Guide link Foreword Agricultural Pricing Policies in Eastern Africa is a participatory simulation that provides seminar participants with the opportunity to experience vicariously the process of food and agricultural policymaking in a developing country. It explores the tensions that exist among such policy objectives as efficient economic development, economic stability, equitable distribution of income, food security, and nutritional well-being; and compares how successfully or unsuccessfully four countries in Eastern Africa have succeeded in resolving these tensions. This simulation has been tested repeatedly in courses and seminars delivered by the World Bank's Economic Development Institute. AMNON GOLAN, DIRECTOR ECONOMIC DEVELOPMENT INSTITUTE Acknowledgements The authors are grateful for the many constructive suggestions received from those who reviewed this text prior to publication by the Economic Development Institute (EDI) of the World Bank. It was possible to incorporate many of those suggestions without losing the essence of what has proved to be a straight-forward instrument for directed group study. Appreciation is also due for the careful incorporation of revisions into the text after each occasion on which it was used in its draft form. This task and the design of the document layout was the work of Mr. Patrick Lavey of the Agriculture and Rural Development Division of EDI. Finally, the opportunity to put the text to work in a series of EDI seminars on Agriculture Sector Policy in African countries has been a rewarding experience. 1-- Introduction: A Guide to Participants Governments may have a number of objectives with regard to agricultural pricing policy such as efficient economic development, economic stability, an equitable distribution of income, food security, and nutritional well-being. They may pursue these objectives, which are not necessarily compatible, in a number of ways such as investing in agricultural development, stabilizing agricultural producers' and consumers' incomes and expenditures, regulating input and output prices, directly controlling the marketing of food, establishing alternative marketing systems, and rationing. The purpose of this case study is (1) to explore, both theoretically Foreword 3 Agricultural Pricing Policy in Eastern Africa and practically, the inevitable tensions that exist among the above policy objectives in the context of less developed countries; and (2) to compare how successfully or unsuccessfully four such countries in Eastern Africa have succeeded in resolving these tensions. Kenya, Malawi, Tanzania, and Zambia are an economic laboratory for studying the impact of government food policies on their economies. The four countries have very similar economic and institutional structures, owing to a common geographical and historical legacy. However, their agricultural development experience has been rather different, with a particular dichotomy between Kenya and Malawi on the one hand, and Tanzania and Zambia on the other, while their agricultural pricing policies have been very similar. For instance, all have exercised domestic price controls on food grains that are enforced by quantity adjustments that equilibrate supply and demand in each year. A comparative case study provides valuable insights into agricultural policies in less developed African countries. This simulation is a participatory style of case study. Participants will have an opportunity to experience vicariously the process of food and agricultural policy-making in a less developed country. To begin with, you have been given Chapters 1, 2, and 3, which provide the historical and theoretical background for government agricultural pricing policies in the context of the four countries. You are expected to read these chapters before the first session. Chapter 4 provides materials for you to assume the role of policy-makers in key ministries in a hypothetical Eastern African country in the context of a small-group decision-making simulation. (The data provided are roughly representative of the four countries in this case study.) Chapter 5 compares the major decisions that the four countries actually made during the period 1965 to 1985 as well as some consequences of these decisions. Chapter 6 is a conclusion. 2-- Historical Background The purpose of the present chapter is to provide a brief historical background of the four countries in this study, focusing on those aspects of their political and economic history which are particularly relevant to the topic of this one-day seminar. In particular, it focuses on the economic structure of the four countries; agricultural production; agricultural exports; agricultural development policy; agricultural marketing, and exchange rate, monetary, and fiscal policies. Kenya, Malawi, Tanzania, and Zambia all achieved their political independence between 1961 and 1964. In 1965--that is, roughly at the time of independence--GDP per capita was $US 245 in Zambia, $US 107 in Kenya, $US 77 in Tanzania, and $US 63 in Malawi. (See Table 2-1.) GDP per capita was so much higher in Zambia because the country was rich in copper. All four countries were predominantly agricultural countries in 1965. The share of the population economically active in agriculture ranged from 81 percent in Zambia to 95 percent in Tanzania; the share of agricultural production in GDP ranged from 14 percent in Zambia to 61 percent in Malawi. (See Table 2-2.) Across the four countries, while the higher the per capita GDP, the lower was the share of the agricultural sector in the economy, agricultural production per capita was roughly the same in the four countries. Declining shares of the population engaged in agriculture were associated with increased agricultural productivity per person remaining in the agricultural sector. Although agricultural production is similar in the four countries, the structure of agriculture exhibits some significant differences among the four countries. Land use for sedentary agricultural purposes is of two general types: tropical highland and tropical savanna. The highland areas are generally characterized by (1) more precipitous topography more susceptible to erosion, (2) greater and more reliable rainfall, (3) more fertile soils, 2-- Historical Background 4 Agricultural Pricing Policy in Eastern Africa (4) colder temperatures that permit the growth of temperate crops like wheat but also restrict the growing season at higher altitudes; (5) more intensive cultivation of land; and (6) greater densities of population. Kenya has the most highland and the least savanna relative to the total amount of agricultural land -- that is, the most high potential land relative to total agricultural land -- followed in order by Malawi, Tanzania, and Zambia. Thus the technological requirements for sustained increases in agricultural productivity are slightly different in each country, being relatively land-augmenting in Kenya and Malawi and relatively labour-augmenting in Tanzania and Zambia. Agricultural production in all four countries is almost entirely rainfed. One important exception is the cultivation of rice under government-sponsored irrigation schemes in Kenya and Malawi. Agricultural production in the four countries comes overwhelmingly from hundreds of thousands of family farmers who cultivate small plots of land. The typical smallholder produces both food crops (such as maize and beans) and export crops. The most important small-farmer export crops are coffee and tea in Table 2-1 . Gross Domestic Product Per Capita, 1965 Kenya Malawi Tanzania Zambia GDP, 196466 average, 1015.19 247.62 914.78 906.28 1965 prices Population, millions 9.53 3.91 11.81 3.70 GDP per capita, $US 106.53 63.33 77.43 244.94 Source: IMF, International Financial Statistics , 1979 Yearbook. Table 2-2 . Contribution of Agriculture to GDP, 196466 Average Kenya Malawi Tanzania Zambia GDP per capita, $US 106 63 77 245 Share of agriculture in GDP 33 61 40 14 (percent) Share of population economically 88 91 95 81 active in agriculture (percent) Agricultural production per capita, 35 38.9 31 33.4 $US Sources: IMF, International Financial Statistics, 1978 Yearbook; and FAO, Production Yearbook, 1967. Kenya; coffee, cotton, and cashew-nuts in Tanzania; tobacco, groundnuts, and cotton in Malawi; and tobacco and groundnuts in Zambia. Large farms and/or plantations produce some maize, coffee, and tea and virtually all the wheat and sisal in Kenya; wheat and sisal in Tanzania; sugar, tea, and some tobacco in Malawi; and some maize and tobacco in Zambia. British colonial policy was very uniform throughout the four countries. Prior to World War II, the colonial administrations paid most attention to settler agriculture in order to generate a tax base to finance government services;1 they paid very little attention to the African small-farm group. After World War II, the colonial administrations finally 2-- Historical Background 5 Agricultural Pricing Policy in Eastern Africa 1 An Act of the British Parliament in 1924 required that all colonies should be self-financing. Table 2-3. Structure of Trade, 196466 Average Kenya Malawi Tanzania Zambia Merchandise Exports (percent 22 16 23 59 of GDP) Agricultural Exports (percent 59 92 82 2 of merchandise exports) Non-Food Exports (percent 77 89 83 72 of agricultural exports) Food Exports (percent of 23 11 17 28 agricultural exports) Merchandise Imports (percent 28 23 16 30 of GDP) Agricultural Imports (percent 17 18 9 11 of merchandise imports) Non-Food Imports (percent 53 51 24 29 of agricultural imports) Food Imports (percent of 47 49 76 71 agricultural imports) Cereal Imports (percent of 40 22 35 25 food imports) Value of Food Exports ($US 31.7 4.1 28.7 3.7 millions) Value of Food Imports ($US 23.7 5.1 9.7 22.0 millions) Source: FAO, Trade Yearbook, 1967. Note: Food exports and imports include those that are edible and contain nutrients. Coffee and tea are therefore excluded. began to pay some attention to this latter group. The major problem was thought to be that rapidly growing African populations in relation to the traditional slash and burn system of land use were creating problems of soil erosion. Efforts to correct this spawned a large number of administrative ordinances that attempted to govern cultivation practices, crops planted, and minimum acreages and that involved a considerable degree of compulsion particularly with regard to soil conservation practices. By the mid-1950s, these measures were judged insufficient and policy shifted towards increasing the intensity of land use in the high-potential areas (typically those of higher altitudes) by means of land consolidation and registration, the distribution of improved seeds and fertilizers, the introduction of cash crops, and price incentives. These measures produced a truly dramatic upsurge in agricultural production in 2-- Historical Background 6 Agricultural Pricing Policy in Eastern Africa Table 2-4. Agricultural Exports, 196466 Average Kenya Malawi Tanzania Zambia Maize (unmilled, 100 MT) -790.7 174.0 66.3 210.7 Value ($US 10,000) -581.7 85.0 27.7 125.7 Wheat & Wheat Flour (100 MT Wheat Equiv) 380.3 - - - Value ($US 10,000) 352.7 - - - Coffee (10 MT) 4519.3 - 3760.7 - Value ($US 10,000) 4521.7 - 3090.7 - Tea (MT) 18722.3 3523.7 4416.0 - Value($US 10,000) 2067.8 1066.4 420.7 - Groundnuts (10MT) 126.7 1622.7 738.7 - Value ($US 10,000) 30.0 372.5 156.3 - Tobacco (MT) - 14122.7 1353.3 9766.0 Value ($US 10,000) - 1244.3 153.3 702.7 Raw Cotton, (MT) 3403.3 4243.3 62493.3 255.0 Value ($US 10,000) 211.3 181.3 3695.0 62.5 Sisal & Other Agave Fibres (MT) 56886.7 377.5 208954.0 - Value ($US 10,000) 1232.1 11.1 4475.0 - Sugar, Raw Basis (MT) - - 1400.0 - Value ($US 10,000) - - 20.5 - Net Food And Agricultural Exports ($US 100,000) 890.7 276.3 n.a. -180.7 Net Merchandise Exports ($US 100,000) -561.3 -164.0 n.a. 2766.7 Source: FAO, Trade Yearbook , 1967. Note: MT stands for metric tonne. A negative sign represents net imports, rather than net exports. the late 1950s and early 1960s.2 They also brought about considerable 2 Zambia is a partial exception to this generalization. There, agricultural policy was conceived in terms of what agriculture could contribute to the rest of the economy, and in particular in terms of supplying food for workers in the copper mines. Agricultural development was concentrated along the line of rail connecting the major urban centers. 2-- Historical Background 7 Agricultural Pricing Policy in Eastern Africa inequalities in the level of development between different regions of each country.3 At independence, the four countries had a trade structure that is frequently associated with less developed countries. With the exception of Zambia, the countries were predominantly exporters of agricultural products, accounting for 59 percent of merchandise exports in Kenya, 92 percent in Malawi, and 82 percent in Tanzania. (See Table 2-3.) At independence, Tanzania had the most diversified agricultural sector, followed by Malawi, Kenya, and Zambia. (See Table 2-4.) Exports were primarily non-food products. All four countries had similar import structures. Non-agricultural products accounted for 82 to 91 percent of merchandise imports. Although imports of agricultural products were small, food imports constituted 47 to 76 percent of agricultural imports. Cereals accounted for 22 to 40 percent of food imports. All four countries inherited a system of government marketing boards for food crops from the colonial era. These generally began during the Great Depression or World War II as a means of protecting European settler farmers from low world prices and provided them with a guaranteed share of the domestic market. Not only low world prices but also (in the case of maize) competition from African farmers were driving many of them out of business. As the colonial governments were trying to encourage European settlement, they could not resist pressures from the settler community for higher and more stable prices. In response, they established government marketing boards that possessed statutory monopolies of the domestic marketing (including exporting and importing) of their respective crops in their respective colonies, and that paid guaranteed prices to producers upon delivery of their crops. For the remainder of the colonial period, the marketing boards were clearly designed to protect the interests of producers, among whom the European farmers were particularly articulate. Producer prices, adjusted at annual price reviews, were set at levels, generally above world prices, that ensured adequate supplies for the domestic market without resulting in surpluses that would have to be exported at a loss. Without exception, the four countries have maintained and expanded the functions of these marketing boards since independence. However, it is no longer clear that the boards still operate to protect the interests of domestic producers. The institutional arrangements for the marketing of export crops were more diverse, both within and among the four countries. For example, large private estates processed and sold their own produce at local auctions and exported directly to international markets. Smallholder coffee was marketed through small farmers' cooperatives in Kenya and 3 See, for example, in the case of Kenya, Judith Heyer (1975), ''The Origins of Regional Inequalities in Smallholder Agriculture in Kenya", East African Journal of Rural Development 8, pp. 142181. Tanzania. Smallholder tea was marketed through a government agency, the Kenya Tea Development Authority, in Kenya. Smallholder tobacco was marketed through the Farmers' Marketing Board in Malawi. All four countries also inherited from the colonial era a conduct of exchange rate, monetary, and fiscal policies which could generally be described as "Keynesian". Under the Bretton Woods agreement of 1944, the non-Communist countries of the world (including Great Britain and her colonies) adopted a system of fixed exchange rates, pegged to the US dollar, which was in turn pegged to gold at $US 35.00 per ounce of gold. Signatory governments pledged to maintain these fixed rates by supplying more domestic currency whenever there was upward pressure on their domestic currency and by demanding more domestic currency (i.e. by drawing down foreign currency reserves) whenever there was downward pressure. When the four countries became independent between 1961 and 1964, they continued this fixed exchange rate system for their newly established currencies -- the Kenyan and Tanzanian Shillings, and the Malawian and 2-- Historical Background 8 Agricultural Pricing Policy in Eastern Africa Zambian Kwachas. When Great Britain devalued the British pound in 1967, Kenya, Tanzania, and Zambia chose not to devalue their currencies at the same time (even though they had formerly been part of the Sterling area), but Malawi did devalue its Kwacha along with the British pound. When the Bretton Woods system of fixed exchange rates finally collapsed in 1971 and most developed countries adopted floating exchange rates, the four countries in this study, while they adjusted the value of their currencies somewhat in the wake of the US dollar devaluation, still maintained fixed exchange rates for their currencies. Until the early 1970s, most developed countries pursued Keynesian-type monetary policies also. Central banks targeted the domestic rate of interest rather than the domestic supply of money. They set the rate of interest at a relatively low nominal rate and supplied (i.e. accommodated) whatever demand for money resulted from these low interest rates. After independence, all four countries in this study also adopted similar monetary policies, partly because they were influenced by these Keynesian-type policies in the developed countries, but also because they wanted to make capital available for developmental purposes at low rates of interest. In summary, the outstanding difference in economic structure among the four countries at independence was that one country, Zambia, had a significant mineral-producing sector. Notwithstanding this difference, agricultural production per capita, food consumption per capita, and the structure of imports were all very similar, conditioned as they were by the stage of economic development in the four countries. A second important difference concerned the relative scarcity of land and labour as factors of production in agriculture. All four countries, with the partial exception of Zambia, experienced a rapid expansion and diversification of small-farm agricultural production in the last decade before independence. All four countries inherited a system of government marketing boards for major food crops from the colonial era, and a more diverse institutional structure for marketing export crops. All four countries also inherited Keynesian-type exchange-rate, monetary, and fiscal policies from the colonial era. 3-- Theoretical Background The purpose of this chapter is to discuss four kinds of government policies which affect the agricultural sector: (1) agricultural development policies; (2) economic stabilization policies; (3) trade and macroeconomic policies which affect the agricultural/industrial terms of trade; and (4) food and agricultural pricing policies that directly affect the production and the marketing of agricultural commodities. These provide the theoretical background for the small-group decision-making sessions of chapter 4. A major theme of the present chapter is that food and agricultural pricing policies per se cannot be separated from their macroeconomic context. Simply comparing domestic food and agricultural prices with world prices converted at the official foreign exchange rate does not indicate whether the government is taxing or subsidizing food and agricultural production on average. Also, simply increasing official food and agricultural prices does not completely negate the adverse impact on the agricultural sector of an overvalued exchange rate, an important substitution trade regime, or inflationary monetary and fiscal policies. Agricultural Development Policies Certainly in 1965, and still today, Kenya, Malawi, Tanzania and Zambia are predominantly agricultural economies. Clearly, agricultural development has a major role to play in their overall economic development. Agricultural development (1) supplies food for the growing non-agricultural population; (2) releases labour for non-agricultural production as labour productivity in the agricultural sector increases; (3) provides capital for non-agricultural investment; (4) earns foreign exchange from agricultural exports; and (5) expands the domestic market for the non-agricultural sector. 3-- Theoretical Background 9 Agricultural Pricing Policy in Eastern Africa But agricultural development is not inevitable; throughout recorded history, agricultural stagnation has been the most common lot of mankind. "Irrational" small farmers' preferences are not generally the reason for this stagnation. Small farmers may be poor, but on average they are as efficient as farmers in more developed countries, given the level of technology available to them and with due allowance for risk. Numerous field studies in Eastern Africa and elsewhere have now demonstrated that small farmers are responsive to economic opportunities to improve their standard of living. Such opportunities can arise from higher prices for their commodities, increased urban demand, lower transportation costs, or the availability of new, more productive technology. Rather, the problem is that farmers cannot improve their productivity and their income very much simply by reallocating traditional agricultural inputs such as land and labour in response to price changes. Land and labour are non-reproducible inputs in essentially fixed supply. To increase production, farmers must add new, more productive inputs like machinery and fertilizer to their traditional inputs in order to shift their production capabilities upwards and to increase the returns to their land and labour. Inputs like machinery and fertilizer are reproducible inputs which are reproduced year after year in the non-agricultural sector of the economy, and are therefore in more elastic supply. In a nutshell, agricultural development occurs when farmers increase their agricultural output by substituting reproducible inputs in elastic supply for non-reproducible inputs in inelastic supply.4 But some of the requirements for agricultural development -- such as agricultural research, agricultural education (including agricultural extension), and agricultural infrastructure such as roads, railways, and port facilities -- are in the nature of public goods. That is, the private market will generally fail to supply a socially optimal quantity of these goods. In the case of agricultural research, the social rates of return on investments commonly fall in the range of 30 to 60 percent per year,5 but the benefits are widespread among the farmers who adopt new techniques and consumers who pay lower prices for agricultural products. The private sector alone will not generally commit adequate resources to the research and development of new, more productive inputs for farmers because it cannot appropriate sufficient of the benefits to make the research profitable. Agricultural education and agricultural infrastructure also require government support in most cases. The role of the government in agricultural development is to promote the development of new technology and new institutions to the benefit of farmers, particularly where private enterprise is lacking. Again in the case of agricultural research, the government must institutionalize agricultural research stations capable of producing a continuos stream of ecologically adapted and economically efficient technology -- consistent with resource endowments and relative factor prices -- for each commodity of economic significance in each agricultural region,6 in order to support sustained productivity growth in agriculture. The government must also promote a suitable institutional framework for the activities of individuals. The institutional structure within which the private sector functions -- for example, in the market for land -- does not always emerge from the operation of market forces and so must be established by law.7 These 4 This characterization of small farmers in less developed countries can be attributed to T.W. Schultz (1964), Transforming Traditional Agriculture (New Haven: Yale University Press). The success of the green revolution in South Asia in increasing food production, starting in 1966, has led to the general acceptance of Schult'z approach to agricultural development. 5 See, for example, R. E. Evenson, P. E. Waggoner, and V. W. Ruttan (1979), "Economic Benefits from Research: An Example from Agriculture," Science, September 14, 1979, pp. 11011107, who analyze 32 studies of the economic benefits of public research in agriculture. 3-- Theoretical Background 10 Agricultural Pricing Policy in Eastern Africa 6 Vernon W. Ruttan (1975), "Integrated Rural Development Programs: A Skeptical Perspective", International Development Review. 7 P. T. Bauer (1976), Dissent on Development (Cambridge, Massachusetts: Harvard University Press), pp. 90-91. activities, while they can be construed as intervention in the market, are still consistent with economic efficiency. They alone represent a tall order; they stretch the capacity of most LDC governments. The development of new technology and increases in the rates of growth of agricultural production, alone, are not sufficient for overall economic development. In addition, Mellor and Johnston argue persuasively for (1) accelerated growth in employment in backward and forward linked industries, in addition to employment in agricultural production itself, which increases the rate of growth of the demand for food in spite of low price- and income-elasticities of the demand for food; and (2) increased demand by the agricultural sector for labour-intensive goods produced by the non-agricultural sector. The latter helps to offset the marked dualism associated with capital investment in many LDCs -- a small portion of the labour force operating with high capital intensity and a large portion with low capital intensity.8 Generally speaking, development economists now accept these important roles that the agricultural sector plays in the development process. Countries that have neglected their agricultural sector (in much of Africa, for example) have experienced continuing food bottlenecks to development, either in the form of rising domestic food prices or increasing food imports. Countries such as Taiwan and South Korea that did not neglect agriculture have used agricultural development as a springboard for industrialization based on labour-intensive industrial exports. India and the Philippines have not neglected agriculture either, but they have not benefited as much from their agricultural development as they might have. Their capital-intensive industrialization strategies with a strong import displacement component have failed to increase the demand for employment as rapidly as in Taiwan and South Korea. India even became self-sufficient in terms of the market demand for grain in the late 1970s and built up stocks to four times the level justified by optimal stocking policies because it has had such a bad record with respect to the growth of employment.9 Economic Stabilization Policies Let us now assume that the government has succeeded in promoting broadly-based agricultural development that is having a pervasive impact on the development of the entire economy. Agricultural production, both for domestic food consumption and for exports, is increasing. Agricultural productivity and incomes are increasing. Agricultural labour and capital are migrating to the non-agricultural sector. Agricultural demand for 8 Mellor and Johnston (1984). "The World Food Equation: Interrelations Among Development, Employment, and Food Consumption," and Mellor (1986), "Agriculture on the Road to Industrialization", in John P. Lewis and Valeriana Kallab (eds.), Development Strategies Reconsidered (New Brunswick, N.J.: Transactions Books for the Overseas Development Council). 9 Ibid., pp. 79 and 87. non-agricultural commodities is increasing. But, the real world is never so smooth. Such resource-based economic development is subject to two important kinds of fluctuations: (1) fluctuations originating from the international market, and (2) fluctuations originating from the domestic market. The most important fluctuations originating in the international market are demand-side fluctuations which directly affect the prices and quantities of developing countries' agricultural exports, their earnings of foreign Economic Stabilization Policies 11 Agricultural Pricing Policy in Eastern Africa exchange, and consequently, their capacity to import capital and intermediate goods for industrialization. The most important fluctuations originating in the domestic market are supply-side fluctuations such as drought-induced declines in agricultural production which affect both the quantity of agricultural exports and the quantity of agricultural food production. With respect to demand-side fluctuations originating from the international market, less developed countries can pursue one of two courses of action: (1) they can adjust domestic prices rapidly to the new international economic conditions and terms of trade; or (2) they can attempt to insulate to some degree the domestic economy from these fluctuations. The first policy transfers the burden of adjustment to domestic producers and consumers. A well-designed second policy would put the burden on the government. Two problems with the second type of policy are well known: (1) The government may not have the resources such as foreign exchange reserves to "ride out the storm"; and (2) the government may have difficulty distinguishing short-term fluctuations from long-term trends. Attempts to insulate the economy may result in increasingly costly distortions in the domestic economy while trying to offset an adverse long-term trend. Chapter 5 compares the experience of our four sample countries in responding to international disturbances, particularly those of the mid-1970s. Trade and Macroeconomic Policies Trade and macroeconomic policies are within the compass of national economic policy. In varying degrees and for various reasons, all four of the sample countries have adopted trade and macroeconomic policies that have distorted the agricultural/industrial terms of trade against the agricultural sector. The reasons for these policies have been a genuine, even if misguided, attempt to speed up the rate of development in their countries; a conscious, even if futile, attempt to mitigate the consequences of external or internal economic shocks; or a deliberate redistribution of income and wealth from the agricultural to the industrial sector.10 In this section, we will examine three such policies: 10 See Robert H. Bates (1980), "States and political intervention in markets: A Case Study from Africa," (Minneapolis: National Science Foundation Conference on Economic and Political Development) for a review of three approaches towards understanding why African governments have distorted the agricultural/industrial terms of trade against the agricultural sector. Trade and Macroeconomic Policies 12 Agricultural Pricing Policy in Eastern Africa Figure 1 Some Interrelationships Between Trade, Macroeconomic, and Agricultural Pricing Policies (1) Exchange rate policy, (2) commercial trade policy, and (3) fiscal and monetary policy. At the outset, we emphasize that the three types of policies are not independent of each other, but we analyze them separately in order to analyze as far as possible the separate consequences of each. Some of the relationships between the these three types of policies and food and agricultural pricing policy (to be discussed below) are illustrated in Figure 1. The diamonds in the four corners of the flowchart represent the different types of government policies; the rectangles in the center represent different policy objectives; and the ellipses represent some of the connections between policy and objectives. To keep the flowchart intelligible and useful, only some of the more important connections between policy and objectives, discussed below, are represented in the flowchart.11 11 This flowchart is consistent with Braverman and Hammer's multi-market methodology for analyzing agricultural pricing policies. "It is intended to be as simple as possible, while capturing the essential features of the country in question, in order to preserve the intuition a good economist should have in understanding and explaining the consequences of policy." See Avishay Braverman and Jeffrey S. Hammer, "Multi-Market Methodology for Analyzing Agricultural Pricing Policies in an Operational Context: A Background Note" (World Bank, Agriculture and Rural Development Department, June 1986), p. 3. The four policy objectives are economic growth, income distribution, the balance of payments, and inflation. Economic growth and income distribution are longer-term objectives, while the balance of payments and inflation are shorter-term objectives. Economic growth is concerned with both the rate and the style of economic growth, e.g., capital-intensive vs. labour-intensive, or import substitution vs. export promotion. Income distribution concerns the distribution of the benefits of economic development, e.g., rich vs. poor, or urban vs. rural. The balance of payments objective is to achieve a situation in which the country's balance (typically a deficit) on the current account of the balance of payments is exactly offset by the country's balance (typically a surplus) on the capital account -- what macroeconomists call "external balance". In other words, capital inflows of various kinds (such as grants, loans, and foreign direct investment) exactly offset on a more or less permanent basis the country's propensity to import more goods and services that it exports, so that the central bank's foreign exchange position is constant. The inflation objective is to achieve a situation in which the domestic rate of inflation in the economy is stable, as opposed to accelerating -- what macroeconomists call "internal balance". Accelerating inflation occurs whenever the public sector attempts to capture a larger share of the country's gross domestic product (e.g. as a result of capital investments, food subsidies, or military spending) without financing the expanded public sector outlays in a way that reduces the private demand for goods and services (e.g. by raising taxes or increasing interest rates). As a consequence, aggregate demand exceeds what the domestic economy is able to produce or supply with its available resources in the shor term, and inflation accelerates. The long-term and the short-term policy objectives are, of course, related. First , short-term balance is a pre-condition to the achievement of long-term goals. If the government is continually involved in short-term crisis management in response to external and internal imbalances, it will be unable to direct its attention to the achievement of long-term goals. Second , short-term imbalances have long-term impacts on the allocation of resources. For example, in the absence of external balance, and in particular with a persistent foreign exchange deficit, a country will be forced to adopt quantitative restrictions and controls on foreign exchange which, if more or less permanent, will adversely affect both the import and the export sectors of the economy. Similarly, a lack of Trade and Macroeconomic Policies 13 Agricultural Pricing Policy in Eastern Africa internal balance will lead to government policies, such as incomes' policies, which are reactions to the symptoms and not to the causes of the problem, and which, if more or less permanent, will adversely affect, among other things, the nature of private investment, since accelerating inflation discourages productive private investment when the returns to speculation begin to exceed the returns to production. This relationship between short- and long-term policy objectives is also parallel to the relationship between the "stabilization" and "structural adjustment" components of IMF and World Bank adjustment lending, and explains why both the IMF and the World Bank have become involved in adjustment lending since the early 1980s. While the IMF is more concerned with "stabilization" and the World Bank is more concerned in "structural adjustment", both components are integral parts of an adjustment lending program. Exchange Rate Policy As already explained in Chapter 2, all four countries in this study adopted, consistent with the Bretton Woods agreement of 1944, a fixed exchange rate system for their newly established currencies at independence. Even when the Bretton Woods agreement finally collapsed in 1971, all four countries, while they adjusted their currencies somewhat in the wake of the US dollar devaluation, still maintained fixed exchange rates for their currencies. Fixed exchange rates have been the rule -- and floating exchange rates the more recent exception -- throughout the post-independence period in the four countries. The foreign exchange rate represents the value of the domestic currency denominated in terms of some foreign currency, usually the US dollar. Under a floating exchange rate regime, the equilibrium value is determined by the intersection of the supply and demand for the domestic currency. The demand for the domestic currency arises from the country's exports and from capital inflows. The supply arises from imports and capital outflows. Under a fixed exchange rate regime, however, the government fixes the exchange rate at, above, or below the equilibrium value of the currency. At a rate below the equilibrium value, with the demand for domestic currency greater than the supply, the government will accumulate foreign exchange reserves. At a rate above the equilibrium value, the government will be forced to drawn down its foreign exchange reserves to the extent that it is able. If the fixed exchange rate remains above the equilibrium value for a sustained period of time, then, ultimately, the government will run out of foreign exchange reserves. It can respond to this situation either by a deliberate depreciation of its currency or by imposing exchange controls of various kinds. It can prohibit residents from owning foreign currency, in the form of notes or external accounts; it can require exporters to surrender all earnings of foreign exchange to the Central Bank immediately; and it can establish a licensing system for importers and for external travelers. All these actions reduce the demand for foreign exchange, while a licensing system rations the remaining excess demand for foreign currency according to some priority ranking. Typically, food and fuel are near the top of the priority list; luxuries are near the bottom. All four of the countries in this study have indeed adopted such an overvalued exchange rate and exchange controls of various kinds in order to maintain this overvalued rate, although to different degrees. This overvalued exchange rate represents an indirect tax on the export sector, including agricultural exports; and represents a subsidy to those import-competing industries that are fortunate enough to obtain licenses to import production inputs. Such subsidies are inherently discriminatory. Individuals and firms that obtain licenses experience windfall gains, and may find it worth their while to sell these licenses to the highest bidders rather than use them to import foreign commodities. If licenses become completely freely tradable, then the overvalued exchange rate no longer represents a subsidy to import- Exchange Rate Policy 14 Agricultural Pricing Policy in Eastern Africa competing industries, since the market value of the licenses becomes incorporated into the cost of all imports. In this case, the overvalued exchange rate no longer affects the demand for imports, just the distribution of income in favour of those who obtained the licenses in the first place. Commercial Trade Policy In a general way, less developed countries have the option of choosing one of two kinds of commercial policies with respect to international trade: export promotion or import substitution. Export-promotion policies are also variously referred to as outward-looking or free-trade policies. Import-substitution policies are variously referred to as inward-looking or protectionist policies. An import-substitution policy is a commercial policy in which the overall bias of incentives favours domestic production for sale in the domestic market, substituting domestic production for commodities that were previously imported.12 That is, the government systematically increases the domestic prices of those commodities (called importables) which compete against imports in the country's own domestic market relative to the domestic prices of those commodities (called exportables) which compete as exports in the markets of other countries. That is, the government systematically increases the domestic price ratio of importables to exportables compared to the international price ratio for the same commodities. The government typically implements such an import-substitution regime by means of tariffs or quotas on imported commodities. Conversely, an export-promotion policy is a commercial policy in which the overall bias of incentives favours domestic production for sale in the export market. The domestic price ratio of exportables to importables now exceeds the international price ratio for the same commodities. The government can implement an export-promotion policy by subsidizing production for export. The above definitions refer to the overall bias of incentives. An import-substitution regime may contain some "export-promotion" measures which offset some of the disincentives to production for export. An export-promotion regime may include some tariffs which are nonetheless smaller than the subsidies given to production for export. The above definitions are also qualitative; they say nothing about the degree of bias. In this respect, there exists an essential asymmetry between the two types of regimes. Tariffs are revenue-creating; the government can in practice implement an import-substitution regime with an extreme degree of bias. Subsidies are expenditure-using; the government cannot in practice implement an export promotion regime with very much bias at all 12 See Anne Krueger (1980), "The Role of the International Sector in Economic Development," (Minneapolis: National Science Foundation Conference on Economic and Political Development) for a more detailed discussion of the nature and consequences of import-substitution and export-promotion regimes. This paper summarizes an eleven-volume study of foreign trade regimes, edited by Anne Krueger and Jagdish Bhagwati, sponsored by the National Bureau of Economic Research. Commercial Trade Policy 15 Agricultural Pricing Policy in Eastern Africa Figure 2 The Short-term Impact of a Protective Tariff without threatening its own fiscal viability. In practice, an export-promotion regime is a regime in which domestic prices for all commodities are very much in line with international prices. All four of the countries in this study have implemented a protective tariff as part of an import-substitution regime. This protective tariff has both short-term and long-term effects. The short-term effect on the balance of payments is generally positive. The protective tariff reduces the domestic demand for imports without significantly affecting the supply of exports. In currency terms, the protective tariff shifts the supply curve for domestic currency backwards without significantly affecting the demand curve for domestic currency. (See Figure 2.) With a fluctuating exchange rate, the value of the domestic currency would appreciate from C to B; with a fixed exchange rate, the country accumulates foreign exchange reserves of AC. The long-term effect of the protective tariff on the balance of payments is generally negative, however. The tariff causes a change in the composition of a country's imports. The country imports fewer final consumer goods, owing to the establishment of such domestic industries behind the tariff wall, but imports more parts, components, intermediate goods, and raw materials which are necessary for these industries to operate. The new domestic industries tend to be high-cost industries which are unable to achieve economies of scale within the confines of a relatively small domestic market. Consequently, the import bill may actually increase; the foreign exchange required to purchase the parts, components, etc. can easily exceed the foreign exchange which was previously required to purchase the final consumer goods. At world prices, domestic value added may be negative. Overall, as a result of this changing composition of Commercial Trade Policy 16 Agricultural Pricing Policy in Eastern Africa Figure 3 The Long-term Impact of a Protective Tariff imports, the rate of growth of imports tends to exceed the rate of growth of GDP. On the other hand, the rate of growth of exports tends to be lower than the rate of growth of GDP, for the simple reason that the protective tariff favours domestic production for sale in the domestic market. The increase in the domestic prices of importables relative to the domestic prices of exportables causes resources such as labour and capital to migrate from the export sector of the economy to the import-competing sector of the economy. Other things being equal, the rate of growth of exports declines, including agricultural exports. The impact of import-substitution policies, in general, and a protective tariff, in particular, on agricultural exports is like the impact of rent controls on the supply of apartments. In the short term, the rent controls have virtually no impact on the supply of apartments in a given urban center, only on the revenues of apartment owners. The owners of apartments are unable to re-allocate the capital invested in apartments to alternative uses in the short term. But, in the long term, rent controls reduce the incentive for apartment owners to build new apartments and to maintain existing apartments, and therefore rent controls reduce the supply of apartments in the future. Similarly, import-substitution policies have little impact on the supply of agricultural exports in the short term, but they reduce the incentive for farmers to invest in agricultural exports in the long term. Thus the import-substitution policies cause a long-term deterioration in the country's balance of payments. In currency terms, as the demand for imports grows more rapidly than the supply of exports, the supply curve of the domestic currency will shift out more rapidly than the demand curve. (See Figure 3.) The government can respond to this situation in one of two ways. Either, it can allow the value of its currency to depreciate, say, from A to B to C to D. This will happen naturally under a floating exchange rate regime; it requires a deliberate act of policy under a fixed exchange rate regime. Or, as discussed in the previous section, the government can attempt to maintain the existing (now overvalued) exchange rate by imposing exchange controls of various kinds. Indeed, this is one of the major ways in which the exchange rates became overvalued in the four countries in this study, not as a deliberate act of policy, but as an attempt to maintain the existing value of the domestic currency against what was perceived to be only a short-term, rather than a long-term deterioration in the balance of payments. But once the exchange rate became overvalued, this reinforced the impact of the protective tariff and the degree of bias in the import-substitution regime. The two policies -- the protective tariff and the overvalued exchange rate -- fed on themselves and Commercial Trade Policy 17 Agricultural Pricing Policy in Eastern Africa made it more difficult for the government to extricate itself from the deteriorating situation. Fiscal and Monetary Policies Fiscal policy refers specifically to the government's revenues and expenditures, the sources of revenue, the allocation of expenditures, and the balance between revenue and expenditures. Monetary policy refers to the domestic supply of money and the impact of the supply of money on domestic credit, the exchange value of the domestic currency (or its degree of overvaluation), the level of interest rates, and the rate of inflation. Fiscal and monetary policy are interdependent, even in developed countries, but particularly in less developed countries. For example, a government deficit (revenues less than expenditures) must be financed either by borrowing from the non-bank private sector, borrowing from abroad, or borrowing from the Central Bank (otherwise known as printing money). But, among the two internal sources of funds, less developed countries with less developed financial markets have less capacity for financing the deficit by borrowing from the non-bank private sector. Consequently, the deficit is invariably monetized. The government's fiscal policy effectively dominates the central bank's monetary policy. Domestic financial markets are less developed in developing countries than in industrial countries for two reasons. First, it simply takes time and effort to develop these markets. But, second, as explained in Chapter 2, most less developed countries, including the four countries in this study, adopted Keynesian-type monetary policies in the post-war period which targeted the domestic rate of interest rather than the domestic supply of money. Partly because they were influenced by similar policies in the developed countries (up until the early 1970s), and partly because they wanted to make capital available for developmental purposes at low rates of interest, they chose to supply (i.e. to accommodate) whatever demand for money resulted from these low interest rates rather than raise interest rates in order to borrow from the non-bank private sector to finance the deficit. The low interest rates, themselves, discouraged the development of financial markets. Monetizing the deficit was, of course, inflationary. In a situation where the government lacked the administrative means to collect taxes at the same rate that it was increasing expenditures, this inflation tax was an effective means of financing development -- up to a point. Under a floating exchange rate regime, domestic inflation in excess of world inflation would lead to a continuous depreciation of the domestic currency, at essentially the same rate that domestic prices were rising faster than world prices. But under a fixed exchange rate regime, domestic inflation in excess of world inflation became unsustainable. It was guaranteed to produce a crisis -- at random but certain intervals -- because the government had in effect, created a game in which speculators (i.e. those who speculated against the domestic currency) could not lose. The overvalued exchange rate, the import-substitution trade regime, and the expansionary monetary and fiscal policies led not only to black markets, smuggling, and other illegal transactions, but also to mutual suspicion between the public and the private sectors of the economy. Private sector profitability became as much a function of obtaining licenses for foreign exchange as of economic efficiency in production. Among other things, the private sector had the incentive to overstate its requirements of foreign exchange; bureaucrats had reason to be suspicious of such applications. The public and private sectors became involved in frustrating each other rather than working cooperatively for shared developmental objectives. In all of this, the agricultural sector in which most of the people worked has been the most adversely affected. The protective tariff encouraged economic resources to move into the protected industrial sector. The overvalued exchange rate was an indirect tax on agricultural exports. Government capital expenditures generally favoured the urban-industrial sector. Low interest rates led to a chronic shortage of capital; non-market capital allocation Fiscal and Monetary Policies 18 Agricultural Pricing Policy in Eastern Africa mechanisms again favoured the industrial sector. These adverse impacts on the agricultural sector might not have been so bad had the industrial sector picked up the slack. But this did not generally happen. The import-substitution trade regime, the overvalued exchange rate, and the low interest rates encouraged a capital-intensive pattern of industrial development, notwithstanding the relative abundance of cheap labour. Companies that had access to foreign exchange typically obtained capital goods imports at negative real rates of interest. Industrial employment did not expand nearly as rapidly as industrial output. And import substitution became more and more difficult once the easy phase of non-durable mass consumer goods such as textiles, clothing, food products, and building materials was exhausted. In hindsight, it is remarkable that so many less developed countries, including the four countries in this study, made it into the 1980s without being forced to undertake significant structural adjustments before this time. Food and Agricultural Price Policy The four countries in this study tend to be exporters of non-food agricultural products13 such as coffee, tea, cotton, tobacco, and sisal, 13 Food products are those that are edible and contain nutrients. Coffee and tea, while (footnote continued on the next page) marginal net exporters or marginal net importers of their major staple, maize, and significant net importers of their secondary staple, wheat. Therefore, the governments have two major decisions to make: (1) the pricing of export crops, and (2) the pricing of food crops. The pricing of export crops is primarily concerned with domestic producer prices relative to international prices; the pricing of food crops is concerned with both domestic producer and consumer prices. Given the existing marketing systems in the four countries, both sets of decisions have immediate impacts on the government budget as well as on the welfare of the producers and consumers of agricultural commodities. At one extreme, the countries could adopt open trade policies in which domestic prices of both food and export crops were equal to world prices converted at the prevailing exchange rate.14 Then the countries would specialize according to their comparative advantage. They would probably increase their export of non-food agricultural commodities; some of the countries might end up exporting significant quantities of maize; all countries would almost certainly increase their imports of wheat. As we have seen, however, all four countries have adopted -- to a greater or to a lesser degree -- exchange rate policies, commercial trade policies, and fiscal and monetary policies which tax the agricultural sector indirectly. In this environment, government food and agricultural pricing policies are generally concerned with two issues: (1) whether to tax agricultural exports even more, but this time directly, by setting domestic prices below world prices converted at the official (overvalued) exchange rate; and (2) whether to subsidize food and/or export crop production directly in order to offset to some extent the adverse consequences of other policies. For example, the government could set domestic prices above world prices, or it could subsidize production inputs like fertilizer. One of the authors of this paper conducted an empirical analysis of food and agricultural pricing policies in the four countries of this study.15 He concluded that during the 1960s and 1970s the four countries did tax agricultural exports directly, but to different degrees. He also concluded that all four governments attempted to maintain a degree of self-sufficiency in domestic food grain production, particularly maize production. They (footnote continued from the previous page) Food and Agricultural Price Policy 19 Agricultural Pricing Policy in Eastern Africa edible, contain no nutrients. 14 The ''openness" of an economy is distinct from the "bias" of an economy discussed earlier in connection with import-substitution and export-promotion regimes. When import substitution is encouraged through nonprohibitive tariffs, the trade regime is biased towards import substitution, but open; when import substitution is encouraged through quotas, the trade regime is biased and closed. Export-promotion regimes are, of necessity, open. 15 C. D. Gerrard, "Government-Controlled Food Grain Markets, External Trade in Food Grains, and Agricultural Development: The Case of Four Countries in East Africa," Proceedings of the XVIII International Conference of Agricultural Economists (Held at Jakarta, Indonesia, 24 August to 2 September, 1982), pp. 560570; and C. D. Gerrard, "Government Commodity Policies in Domestic Food Grain Markets: The Case of Four Countries in East Africa" Canadian Journal of Agricultural Economics, Annual Meeting Proceedings (Held at Truro, Nova Scotia, July 1013, 1983). attempted to keep maize prices as low as possible to urban consumers consistent with self-sufficiency, i.e. supplying domestic markets from domestic production. They enforced these domestic food grain prices by means of a government monopoly of the marketing of food grains which entered urban markets and of international trade in food grains. They equilibrated supply and demand in each year at the government-decreed prices by quantity adjustments in government-held stocks and international trade. Consequently, all four countries were unstable participators in international trade in food grains, particularly maize during the 1960s and 1970s. They exported maize when the domestic harvest was good, and imported when the domestic harvest was bad. The four countries in this study are concerned about a number of other food and agricultural policies such as access to agricultural land; the relative sizes of the large and small farm sectors in their economies; bringing subsistence producers into the market economy; improving the nutritional status of low-income and vulnerable groups such as pregnant and lactating women and preschool children; and responding positively to the occasional threats of famine. But these latter policies pale in comparison with the previously mentioned policies in terms of the overall impact on the agricultural sector. Questions for Participants to Consider · Why must governments consider agricultural development and agricultural pricing policies in the context other government policies, in particular, trade, exchange rate, and macroeconomic policies? · Government policies such as protective tariffs have both short-term and long-term impacts. Are these always in the same direction? · To what extent can governments insulate their domestic economies from major international disturbances such as the four-fold increase in the price of petroleum in October 1973? What are the costs and benefits of attempting to do so? 4-- Establishing Macroeconomic and Agricultural Pricing Policies: An Exercise in Small-Group Decision-Making The President of a hypothetical country in Eastern Africa has convened a high level meeting to determine the government's response to a grave external shock to the domestic economy. Each person will receive documents Questions for Participants to Consider 20 Agricultural Pricing Policy in Eastern Africa that describe the nature of the current crisis, an agenda for the meeting, and an individual position paper describing his/her role at the meeting. The roles include president of the country, governor of the Central Bank, minister of finance and economic planning, minister of agriculture, minister of industry, and minister of trade. The group must forge a coherent set of exchange rate, fiscal, monetary, and agricultural pricing policies to respond to the crisis. The Current Crisis The time is December 1974. During the last decade, your country has enjoyed a sustained increase in prosperity. Real gross domestic product has grown at an average annual rate of 5 percent, while the population has grown at an average rate of 3 percent, and per capita output at a rate of 2 percent. Although agricultural incomes have risen, the growth has been concentrated in the industrial sector. Industrial output has grown in real terms at an average annual rate of 8 percent, compared to 3.5 percent in agriculture. Agriculture remains the dominant sector in the economy, however, accounting for 75 percent of all employment, and 40 percent of economic output. This growth is now threatened by the recent quadrupling of oil prices on world markets, and the concomitant decline in the external terms of trade. While the index of prices for your exports has increased by 15 percent in the last year, import prices have increased by 50 percent. Currently the commercial trade policies in your country are biased in favour of import-substitution industries. Tariffs are levied on products that compete directly with domestic industries, while capital goods enter without tariff restrictions. Revenue-creating export taxes are also levied on some agricultural products. An overvalued exchange rate discriminates against the export sector in favour of imports. However, importing is becoming increasingly difficult because of foreign exchange shortages. The official exchange rate has been held fixed relative to the US dollar since independence. The Central Bank estimates that the exchange rate was overvalued by 30 percent prior to the oil price increase, and now estimates the exchange rate to be overvalued by 60 percent. This overvaluation has been maintained through intervention in the foreign exchange markets by the Central Bank, and by restrictions on the purchase of foreign exchange by businesses and citizens. A licensing system has been used to allocate foreign exchange, and permits are now needed to import goods into your country. Adverse by-products of the foreign exchange rationing have been the development of illegal markets both for the foreign exchange licenses and for the domestic currency. Table 4-1: Government Budget - Initial Estimates, 1974 Units of domestic Percentage of total currency (millions) Current Revenue Tax Revenue 7888 90.7 Income 3062 35.2 Goods and 3034 34.9 Services Import Duties 1054 12.1 Export Taxes 630 7.2 Other 108 1.2 The Current Crisis 21 Agricultural Pricing Policy in Eastern Africa Non Tax Revenue 806 9.3 Total 8694 100.0 Expenditures General Public 774 7.5 Administration Defense 764 7.4 Education 2486 24.0 Health 830 8.0 Soc. Serv., Housing 140 1.4 Economic Services 3122 30.1 Agriculture 786 7.6 Industry 448 4.3 Transport, 1460 14.1 Commun. Other 428 4.1 Marketing Board Losses 622 6.0 Interest on Public Debt 1194 11.5 Other 426 4.1 Total 10358 100.0 Current Expenditures 8012 77.4 Capital Expenditures 2346 22.6 Total 10358 100.0 Total Expenditures 10358 119.1 Total Revenues 8694 100.0 Deficit 1664 19.1 Current Expenditures 8012 92.2 Total Revenues 8694 100.0 Current Surplus 682 7.8 Source : Ministry of Finance and Economic Planning The exchange rate overvaluation has been a mixed blessing for industry. While it has helped the import-competing industries to consolidate their position in the domestic markets and made imported capital inputs relatively cheap, the rationing has made it more difficult to obtain foreign currency to purchase the many inputs that are unavailable domestically. One key to being successful in business in your country has become the ability to obtain foreign exchange licenses. Export-oriented agricultural producers have been adversely affected by the overvaluation of the exchange rate. Not only have export crop earnings stagnated or declined, but also the availability of production inputs such as The Current Crisis 22 Agricultural Pricing Policy in Eastern Africa fertilizer has been curtailed. As these incentives to production continue to decline, output is expected to grow at a slower rate in the future. The production of food crops has not grown as rapidly as the production of export crops. The apparent policy of keeping food prices relatively low compared to border prices has caused the production of food crops to stagnate. A net exporter of food at independence, your country is now a net importer of food in an average year. Government expenditures have exceeded revenues by an average of 15 percent per year since independence. Although most of the budgetary shortfall has been financed through internal borrowing (that is, printing money), the external debt has risen to the equivalent of one year of GDP. Consequently any further increases in budgetary deficits will not be looked upon favorably by foreign lenders, and will invariably lead to an inflationary increase in domestic credit. Table 4-1 contains an outline of government revenues and expenditures for calendar year 1974. All figures are expressed in millions of units of the domestic currency. Two of the largest components of the government budget are the interest on the public debt (both internal and external), equal to 11.5 percent of total expenditures, and subsidies to cover the losses of the parastatal food marketing boards, equal to 6.0 percent of total expenditures. Operating costs and new investment in transportation infrastructure (such as roads, railways, and port facilities) together equalled 14.1 percent of government budgetary expenditures, while direct expenditures on agricultural development and industrial infrastructure received 7.6 and 4.3 percent of budgetary expenditures respectively. Excluding the interest on the public debt, wages and salaries represent about 70 percent of total current expenditures. In the absence of corrective action, the government's budgetary deficit is expected to increase from 19.1 to 25.4 percent of revenues in 1975. Increased prices of imported inputs and the reduced demand for exports have reduced the profitability of both import-competing and export sectors. Consequently, the government's ability to collect taxes from these sectors has declined, resulting in a forecasted decline in total budgetary revenues of 5 percent for the coming year. The continuing deceleration in the growth rate of the economy, and persistent balance of payments problems seem assured if current policies are maintained. While food imports are still small relative to domestic production, a crop failure could drastically change the import requirements and put a further strain on the balance of payments. Imported food would be more expensive, and would increase losses to the parastatal marketing boards. Agenda The objective of this meeting is to develop an appropriate set of exchange rate, fiscal, monetary, and agricultural pricing policies to deal with the current crisis. The person assigned to the role of President will chair the meeting for each decision-making group. In the time that is allocated, each group must make a series of decisions in accordance with the agenda outlined below. After each group has concluded its deliberations, each President will make a report of his group's decisions, and the reasons for those decisions to the entire group of seminar participants. Tables 4-3a and 4-3b are scoresheets provided for the purpose of recording the decisions made, the reasons for these decisions, and some consequences of these decisions. Agenda 23 Agricultural Pricing Policy in Eastern Africa Exchange Rate Policy There are three basic options available to you: you can maintain the current fixed exchange rate and increase the severity of controls in order to ration the available supply of foreign exchange; you can maintain the fixed exchange rate regime but devalue the official rate by 12.5 percent, 25 percent, or 37.5 percent; or you can adopt a floating exchange rate regime. The Central Bank has estimated that the exchange rate is presently overvalued by 60 percent. Either the devaluation of 37.5 percent or the floating exchange rate will eliminate this degree of overvaluation. As Table 4-2 shows, a 60 percent overvaluation only requires a 37.5 percent devaluation of the domestic currency relative to the US dollar in order to correct for the overvaluation because the percentage overvaluation is based on the equilibrium value of the exchange rate while the percentage devaluation is based upon the prevailing official exchange rate. Table 4-2: Relationship Between Overvaluation and Devaluation Percent overvaluation Devaluation necessary 14.29 12.50 33.33 25.00 60.00 37.50 While both the 37.5 percent devaluation and the floating exchange rate regime will restore equilibrium in the foreign exchange market in the short term, the floating exchange rate will permit immediate adjustments to changing supply and demand conditions in this market over the long term. A fixed exchange rate will ultimately become either undervalued or overvalued in the long term and will require further quantum adjustments in the future in order to restore equilibrium. The Governor of the Central Bank will provide the meeting with estimates of the impact of various levels of devaluation on the real rate of economic growth, imports, exports, the balance of payments, and the rate of inflation. Fiscal and Monetary Policies With respect to fiscal policy, the Minister of Finance and Economic Planning has projected that there will be a 5.0 percent decline in government revenues if no changes in tax rates occur. Because of the economic recession, the Cabinet has previously agreed not to increase tax rates this year, with the possible exception of export taxes. Therefore, your only options of dealing with the budget deficit are to reduce government expenditures to increase export taxes, or to reduce marketing board losses. This meeting must decide to reduce fiscal spending (apart from subsidies to food marketing boards) by 0 percent, 5 percent, 10 percent, or 15 percent next year. If you decide to reduce government expenditures, you should have some idea where these cuts in expenditures will take place. With respect to monetary policy, the Governor of the Central Bank and the Minister of Finance and Economic Planning concur that the budget deficit will have to be monetized if the current low interest rate of 6 percent is maintained. With low interest rates, the non-bank private sector will not be willing to lend sufficient funds to the government to cover its borrowing requirements. This meeting must decide to leave interest rates at 6 percent, or to increase interest rates to 8 percent, 10 percent, or 12 percent. Exchange Rate Policy 24 Agricultural Pricing Policy in Eastern Africa The Minister of Finance and Economic Planning will provide the meeting with estimates of the impact of fiscal and monetary policies on the budget deficit and the rate of inflation. Agricultural Pricing Policy There are three agricultural prices that you must consider: the producer price of export crops, the producer price of food crops, and the consumer price of food crops. For each of these prices, you must decide to increase real prices by -10 percent, -5 percent, 0 percent, 5 percent, or 10 percent. For the producer price of export crops, you may increase this by as much as 15 percent. The Minister of Agriculture will provide the meeting with estimates of the impact of changing agricultural prices on the government budget deficit (arising from changes in export taxes and marketing board losses), the balance of payments, and producers' incomes. Table 4-3a. Scoresheet for Cabinet Meeting: Policy Decisions Policy Decision Reasons Percent Devaluation 0.0 ___ 12.5 ___ 25.0 ___ 37.5 ___ Floating Rate ___ Percent Reduction in Government Expenditures 0.0 ___ 5.0 ___ 10.0 ___ 15.0 ___ Target Rate of Interest 6.0 ___ 8.0 ___ 10.0 ___ 12.0 ___ Percent Change in Producer Prices of Export Crops -10.0 ___ -5.0 ___ 0.0 ___ 5.0 ___ 10.0 ___ Agricultural Pricing Policy 25 Agricultural Pricing Policy in Eastern Africa 15.0 ___ Percent Change in Producer Prices of Food Crops -10.0 ___ -5.0 ___ 0.0 ___ 5.0 ___ 10.0 ___ Percent Change in Consumer Prices of Food Crops -10.0 ___ -5.0 ___ 0.0 ___ 5.0 ___ 10.0 ___ Table 4-3b . Scoresheet for Cabinet Meeting: Some Consequences 1974 Policy Variable (Initial 1975 (Projected) Decision Estimate) Government Budget Deficit (as a percentage of total revenues) Change in revenues: -5.0% ___(Table 4-7) Change in expenditures: ___ Subtract: Increase in export ___(Table 4.9) taxes Add: Increase in marketing ___(Table 4-12) board losses TOTAL 19.1% ___ Annual Inflation Rate1 (percentage points) Government budget deficit: ___ Interest rate ___ ___(Table 4-8) Percent devaluation ___ ___(Table 4-6) TOTAL 20% ___ Real Interest Rate Nominal interest rate 6% ___ Inflation rate 20% ___ Agricultural Pricing Policy 26 Agricultural Pricing Policy in Eastern Africa DIFFERENCE -14% ___ Balance of Payments Deficit2 (as a percentage of GDP) Percent devaluation: ___ ___(Table 4-5) Change in producer prices ___ ___(Table 4-10) of export crops Change in consumer prices ___ of food crops Change in producer prices ___(Table 4-13) of food crops TOTAL 4.71% ___ Notes: 1. Changes in fiscal and monetary policy affect the ongoing rate of inflation. The devaluation of the currency has a once-and-for-all impact on the rate of inflation for 1975 only. Thus the inflation rate should decrease substantially in 1976, and the real rate of interest should increase, without any further changes in policy. 2. A devaluation of the currency causes the balance of payments deficit to worsen in the first year (1975), but to improve in subsequent years, relative to no devaluation. Descriptions of Roles President You have recently been re-elected as President of your country, and you intend to build on your record of promoting and continuing the economic and industrial development process that began at independence ten years earlier. During the last ten years, your gross domestic product has increased at an average annual rate of 5.0 percent in real terms. This growth is now threatened by a dramatic reversal in the terms of trade of your country due to the shock of increased energy prices. The effects of this shock have been distributed to virtually all prices, causing a relative decline in the value of exported goods, and an increase in the price of imported goods. The realignment in the terms of trade has brought to light some structural weaknesses in your domestic economy. As President, you have the broadest agenda to which to attend. Your primary objective is to preserve domestic stability within your country. Consequently you must remain responsive to various pressure groups such as the military, organized labour, business leaders, and farmers; all of these groups have the potential to wield political power. Your country generally has cordial relations with all of your adjacent neighbors, although some border disputes with your northern neighbor occurred just subsequent to independence. For this reason, the armed forces continue to demand budgetary increases to maintain a modern army. There is some sympathy towards the military within the civil service. The Export Crop Producers Cooperative Association (ECPCA) has recently sent representatives to meet with you. They made a very forceful case that the best approach to agricultural development was to expand agricultural Descriptions of Roles 27 Agricultural Pricing Policy in Eastern Africa exports, while maintaining self-sufficiency in food crop production. They suggested that export prices should be realigned to reflect world prices better. The National Farmers Union (NFU) relayed a similar message to you regarding all agricultural prices. The NFU contends that if food prices paid to producers were equal to border equivalent prices, food self-sufficiency would be attained. They believe that higher producer prices could be offered without subsidizing or drastically increasing consumer prices, if the government food marketing boards could be made to operate more efficiently. Although you agree with the spirit of their arguments and recognize the need for foreign exchange earned from agricultural exports, you believe that the realignment in agricultural prices could be delayed in the short term without causing too much political damage to your government. You also doubt that prices could be increased without adversely affecting the government's net fiscal position. Moreover, you have also met recently with representatives of organized labour who have indicated in no uncertain terms that in light of all the increases in the cost of other consumer goods, an increase in consumer food prices would not be tolerated by workers. You take their position very seriously in light of a riot that occurred several years ago following an increase in food prices. In addition to mediating social pressures, you bear the ultimate responsibility for the overall success of the economic development process, in whatever forms it may take. Real growth in aggregate output is of primary importance. The nature of the economic growth is also important. It is recognized that the relative importance of agriculture must decline as development proceeds. Consequently, growth of industry is held to be a more important source of economic development. One of your personal aspirations is to be remembered as the President that led your country into the industrialized world. As the development process proceeds, the urban areas will continue to increase in size and importance. There is clearly a counter-dependency between the two populations, as the rural group looks to the urban areas for agricultural inputs and marketing infrastructure, while the urban group looks to the rural areas for food and surplus savings. The relative values of urban and rural incomes play a large role in determining the rate of growth of the two populations. On balance, low food prices and high real wages for urban dwellers are held to be more important than incentives for agricultural producers. Because of the potential for more focussed dissent among the urban population, you would prefer to placate their needs, while supporting a broader development process when the budget and economy warrant it. It is believed that in order to preserve domestic tranquility, an overall real growth rate in aggregate output of 2 percent per capita is necessary. Moreover, the lowest possible growth in real food prices must be assured. Governor of the Central Bank The relatively steady economic growth of your country during the last ten years is now threatened by a dramatic reversal in the international terms of trade due to the drastic increase in the world price of oil. Virtually all import prices have jumped relative to export prices. Both the import and export sectors are under stress. The strain on foreign exchange reserves is more acute than ever before. As Governor of the Central Bank, your primary objective is to ensure a sound macroeconomic environment within which all sectors of the economy can grow. For example, even a well-designed agricultural development strategy cannot succeed in a hostile macroeconomic setting. You are therefore concerned about the exchange rate system, a minimum level of foreign exchange reserves, fiscal responsibility, inflation, and interest rates. Governor of the Central Bank 28 Agricultural Pricing Policy in Eastern Africa Your research department now estimates that the exchange rate is overvalued by 60 percent. Since this overvaluation discourages exports and favours imports, the long term consequences are detrimental to the balance of payments and to the level of foreign exchange reserves. You have three basic options: you can maintain the current fixed exchange rate and increase the severity of controls in order to ration the available supply of foreign exchange; you can maintain the fixed exchange regime but devalue by 12.5 percent, 25 percent, or 37.5 percent; or you can adopt a floating exchange rate regime. You believe that the country should choose a realistic level for the exchange rate by devaluing the currency by 37.5 percent or adopting a floating exchange rate regime. Either course of action will restore equilibrium in the foreign exchange market in the short term. You are more partial to a fixed rather than a floating exchange rate regime, but you would prefer the floating regime rather than a devaluation of less than 37.5 percent. While the floating exchange rate permits immediate adjustments to changing supply and demand conditions in the foreign exchange market over the long term, this advantage comes at a cost in terms of uncertainty. Although you are not directly responsible for the budgetary operations of the government, your experience indicates that fiscal and monetary policies are not independent demand-management tools. The budget deficit is almost always monetized by the Central Bank since the government is not able to borrow from the non-bank private sector. Thus you intend to argue quite persuasively for fiscal responsibility. Chronic budget deficits lead ultimately to inflation. Indeed, your economy has been experiencing an upward trend in the rate of inflation for the past five years. The current crisis has exacerbated this trend. The rate of inflation is now 20 percent (in 1974) compared to an annual rate of 15 percent last year (1973). You take the position that the present inflationary trend cannot continue without jeopardizing the economic fabric of your country. Accelerating inflation destroys the incentive to save. It discourages productive private investment when the returns to speculation begin to exceed the returns to production. People attempt to avoid the effects of inflation by purchasing and hoarding land, buildings, and other tangible goods. Low interest rates have been a characteristic feature of domestic monetary policy since independence. While low interest rates make it less expensive for firms and individuals who have access to loanable funds to borrow for investment purposes, low interest rates also discourage the supply of loanable funds. The current situation with nominal interest rates of 6 percent and real interest rates of -14 percent has become ridiculous. This is aggravating the problem in your country of a lack of loanable funds from the private sector. You must make some long term plans to develop financial markets in your country, including more realistic real rates of interest, through which both the government and the private sector can borrow funds. Your research department has estimated the effects of various levels of devaluation on economic growth, imports, exports, the balance of payments, and inflation. The greater the devaluation, the greater will be the rate of growth of exports, the less the rate of growth of imports, and the greater the rate of growth of GDP. For example, a 37.5 percent devaluation or a floating rate is expected to cause GDP, exports, and imports to grow at average annual rates of 7.0 percent, 8.0 percent, and 4.0 percent over the next five years. In the first year, devaluation will worsen the balance of payments situation because it makes imports more expensive, but thereafter it improves the balance of payments because it causes the volume of exports to grow more rapidly and the volume of imports to grow less rapidly. Governor of the Central Bank 29 Agricultural Pricing Policy in Eastern Africa Devaluation also causes the measured rate of inflation to be higher in the first year after the devaluation since the devaluation increases once-and-for-all the domestic prices of all traded goods, both imports and exports. Table 4-4. Impact of Currency Devaluation on Real Economic Growth, Imports, and Exports (expected average annual growth rates, next five years, in percent) Percent GDP Exports Imports Devaluation 0.0% 4.0% 3.0% 6.0% 12.5% 5.0% 4.7% 5.3% 25.0% 6.0% 6.3% 4.7% 37.5% 7.0% 8.0% 4.0% Floating Rate 7.0% 8.0% 4.0% Table 4-5. Impact of Currency Devaluation on Balance of Payments Deficit (as a percentage of GDP) Percent 1975 1976 1977 1978 1979 1980 Devaluation 0.0% 4.71% 5.66% 6.62% 7.60% 8.58% 9.58% 12.5% 5.29% 5.52% 5.76% 5.99% 6.22% 6.45% 25.0% 5.88% 5.22% 4.56% 3.91% 3.27% 2.63% 37.5% 6.47% 4.75% 3.06% 1.41% -0.21% -1.80% Table 4-6 . Incremental Impact of Currency Devaluation on the Annual Inflation Rate, for 1975 only. (percentage points) Percent Devaluation Change in inflation rate 0.0% 0 12.5% 4 25.0% 8 37.5% 12 Minister of Finance and Economic Planning As Minister of Finance and Economic Planning, you are responsible for a wide range of economic matters. You are responsible for fiscal management, mobilization of internal revenues through tax measures, external borrowing by the government, the allocation of expenditures to the various sectors of the economy, and the coordination of economic decision-making in order to achieve a set of development objectives. The focus of your development program is on agriculture-based industrialization. In this respect, you would like the government to promote industrial ventures; at the same time, you do not want to neglect agriculture. Therefore Minister of Finance and Economic Planning 30 Agricultural Pricing Policy in Eastern Africa you have to allocate development expenditures between agriculture and industry in a way consistent with your overall development objectives. Your department has prepared initial estimates for 1974 which indicate the following pattern of expenditures for the last fiscal year: general public administration accounted for 7.5 percent of total expenditures; defence, 7.4 percent; education, 24 percent; health, 8 percent; social services and housing, 1.4 percent; agriculture, 7.6 percent; industry, 4.3 percent; transportation and communications, 14.1 percent; other economic services, 4.1 percent; losses to parastatal food marketing boards, 6.0 percent; interest on the public debt, 11.5 percent; and other expenditures, 4.1 percent. (See Table 4-1.) You are generally dissatisfied with the expenditure allocations for the previous fiscal year and it is your intention to effect some changes at this meeting. In particular, you consider military expenditures for the past five years have been unjustifiably high, in spite of the border disputes with your northern neighbor. Now that there seems to be a reasonable degree of tranquility between your two countries, you intend to bring up the issue of expenditure reduction in the military. The President may oppose any proposal to cut military expenditures since he is genuinely worried about the political risk of such a policy, but your inability to cut down in less important areas may mean less funds for more important economic sectors if you intend to restrain fiscal spending. You would also like to reduce losses to the parastatal food marketing boards even if this means higher food prices to urban consumers. Then your expenditures will be concentrated on what you consider to be the infrastructure for a modern society -- transportation and communications, power plants, water works, schools, and hospitals. On the revenue side, you realize that one of the reasons for the persistent budget deficit is the inability of revenues to keep up with the pace of economic development. You need to increase revenue collection from the tax system by various measures such as broadening the tax base and increasing the efficiency of tax collection. You would also like to deal with factors such as low real interest rates that reduce the incentive for households to save. You realize that your ability to curtail the growing deficit by increasing revenues is very limited in the short term. Indeed, the Cabinet has already decided not to increase tax rates for 1975. Given this limited ability to raise revenue in the short term, you must cut items in the budget that represent waste, extravagance and inefficient use of public funds. For instance, you have to address the problem of overstaffing state-owned enterprises, subsidies that affect certain favoured groups, and projects selected for political rather than economic returns. You will have to borrow from external sources to finance certain crucial investment projects. But your ability to obtain external funds will depend, among other things, on your program for economic recovery. Thus, there is a need to develop a restructuring program that will enable your country to generate internal funds for future investment. Table 4-7 shows the impact of expenditure changes (other than subsidies to marketing boards) on the budget deficit, expressed as a percentage of total revenue. For example, with the expected 5 percent decline in revenues in 1975 and an equivalent 5 percent decline in expenditures, the budget deficit would still be 19.1 percent of total revenues. Table 4-8 shows the projected impact of fiscal and monetary policies on inflation for 1975. The higher the rate of interest and the smaller the budget deficit (after incorporating changes in export taxes and marketing board losses, as well as the reductions in expenditures), the lower will be the rate of inflation. Minister of Finance and Economic Planning 31 Agricultural Pricing Policy in Eastern Africa Table 4-7. Impact of Revenue and Expenditure Changes on the Government Budget Deficit, 1975 Compared with 1974 (as a percentage of total revenues) Decreases in Expenditures Government Budget Deficit 0.0% 25.4% 5.0% 19.1% 10.0% 12.9% 15.0% 6.6% 20.0% 0.3% Note: It is assumed that government revenues will decline by 5.0 percent in 1975 compared to 1974. Table 4-8. Impact of Fiscal and Monetary Policies on the Annual Inflation Rate, 1975 (percentage points) Government Budget Deficit (as a percentage of revenues) Interest Rate 25.4% 19.1% 12.9% 6.6% 0.3% 6.0% 20.0% 16.0% 12.0% 8.0% 4.0% 8.0% 18.0% 14.3% 10.7% 7.0% 3.3% 10.0% 16.0% 12.7% 9.3% 6.0% 2.7% 12.0% 14.0% 11.0% 8.0% 5.0% 2.0% Minister of Agriculture As Minister of Agriculture, you are responsible for the largest sector of economic activity in the country. Over 40 percent of gross domestic product comes from agriculture, while 75 percent of the population is directly engaged in agricultural production. Despite the dominance of agriculture in the economy, you are often frustrated by policies which seem to be geared towards promoting growth in industry at the expense of agriculture. Nevertheless, you feel that your primary goal should be to continue the output growth and diversification that the agricultural sector has experienced since independence. The success of the industrialization program is dependent upon a thriving agricultural sector to finance it. Since the country is small relative to world markets, export farmers are price-takers. Consequently, your objective is to produce the maximum level of output possible in any given year. While there are many factors beyond the control of both the producer or the government, it is clear that prices affect both the land area cultivated and the intensity of cultivation. Consequently, as Minister of Agriculture you are in favour of higher prices for agricultural output, as near to border equivalent prices as possible. At the present time, the prices of both food and export crops are below world prices, which constitutes a de facto tax on export crops, and a subsidy to domestic consumers of food crops. Food crops are deemed to be of more political importance than export crops, and self-sufficiency in staple foods such as maize is a goal. Most recently, the costs of the industry-oriented economic development policies have become painfully apparent as the exchange rate becomes increasingly overvalued. In the last five years the relative prices offered to export crop producers have fallen by 25 percent in real terms on average, and investment in perennial crops has fallen off. Although export crop output has continued to grow until now, you believe that future growth is threatened. Minister of Agriculture 32 Agricultural Pricing Policy in Eastern Africa While this might be expected to cause a shift toward food crop production, the price incentives have been only marginally better (an average real decline in producer food prices of 18 percent), and in many cases the land is not very suitable to such substitution. Despite the improvements in agricultural productivity, your country has now moved toward being a net food importer compared to being self-sufficient at independence. You believe that a realignment of the prices paid to producers is necessary to restore the agricultural sector to good health; food self-sufficiency is a goal. You are committed to improving the productivity of the crop marketing system. The loss last year of a substantial portion of the bumper maize crop, because of inadequate storage and transportation facilities, was an embarassment to your ministry. The President has indicated to you that he fails to see the benefit of increasing producer crop prices when any surplus goes to waste. You must convince the president that a more comprehensive approach to growth in the agricultural sector is necessary. Parastatal food marketing boards have a monopoly on the purchase of the major crops, and are responsible for transportation, milling and distribution. These boards constitute a persistent drain on the government treasury. Because the government sets the prices that the marketing boards pay to producers, as well as the prices at which they can offer food to the consumers, much of the marketing losses are the direct result of government policy. At the present time, losses incurred by the food marketing boards constitute 6.0 percent of total government expenditures. While you believe that the prices paid to producers should be increased for all crops, you also believe that the consumer price should be increased to offset some of the marketing board losses. While you have received some pressure from business people to open up crop marketing to private sector competition, you believe that such competition would only obtain for the highly lucrative crops in central areas, leaving the remote and unprifitable areas for the parastatals. This would increase the losses to the parastatal marketing boards. In your opinion, the best way to improve the productivity of the parastatal marketing boards would be to invest in more modern transportation, storage and milling facilities. While price and production are important, the provision of public goods and services and the production and distribution of agricultural products is also your responsibility as Minister of Agriculture. Gaining greater access to the government budget for capital funding of agricultural research and extension as well as building up the transportation infrastructure is important. Similarly, you believe that the funding of agricultural credit institutions must come from government. A net increase of at least 10 percent in capital appropriations for agricultural development is needed to begin improving services. This would bring agricultural expenditures up to 8.5 percent of total expenditures. You see your ministry as having a broader role to play in the development process than merely providing food to industrial workers. In order to accelerate industrial development, the surplus earnings of agricultural producers are needed to finance the purchase of capital goods. Similarly, food self-sufficiency, and a growing trade in export crops will serve to provide foreign exchange for such capital purchases. A thriving agricultural sector is a prerequisite for broadly-based economic development. Increases in both producer prices and consumer prices would aid in this process, and would also retard the overwhelming rate of labour migration to the cities from the rural areas. Your ministerial staff have estimated some of the impacts of agricultural pricing policies on the government budget, the balance of payments, and producers' incomes. Table 4-9 describes how changes in export crop prices influence the government's budget surplus. At the present time the government is extracting a tax on export crops of 630 million units of domestic currency, equal to 7.2 percent of the governments revenues. This tax is equal to the difference between the revenues and the costs of the export crop marketing agencies. Devaluation and changes Minister of Agriculture 33 Agricultural Pricing Policy in Eastern Africa in real producer prices affect both the agencies' revenues and costs. A devaluation increases the prices received by the marketing agencies denominated in the domestic currency and therefore increases their revenues. A change in the real producer price has two effects on their costs: first, by changing the producers' incentives, it influences the volumes of crops that are marketed; second, it affects the nominal prices that the agencies must pay for each unit purchased. For example, it is estimated that a devaluation of 12.5 percent coupled with a real decline in producer prices of 5.0 percent will lead to an increase in export taxes equal to 4.1 percent of total government revenues during the next year. That is, the export tax will increase from 7.2 to 11.3 percent of government revenues. Table 4-10 describes how changes in export crop prices influence the balance of payments in much the same as they influence the government's budget surplus. A 37.5 percent devaluation of the currency, in conjunction with an increase in the real producer price of 5.0 percent, will lead to a decrease in the balance of payments deficit (or increase in the surplus) equal to 0.61 percent of GDP. Table 4-11 describes the incremental impact of real price changes on the real value of export crop producers' gross income from the production of export crops. This is an incremental impact; in general the percentage change in gross income is larger than the percentage change in prices, because volumes supplied by farmers will change in the same direction as prices. If the real price of producers' export crop price were to drop by 5 percent, it is estimated that producers' income from this source would drop by 7.4 percent. Tables 4-12 and 4-13 are analogous to Tables 4-9 and 4-10, but deal with the impacts of food, rather than export crop price changes. The parastatal food marketing boards must consider prices that pertain to the consumer as well as to the producer; consumer prices affect the quantity demanded, while producer prices affect the quantity supplied. Because consumer prices relative to producer prices do not cover the marketing costs, the food marketing boards will incur losses of 622 million units of domestic currency in 1974, equal to 6 percent of total government expenditures. An increase in both producer and consumer food prices of 5 percent for 1975 would lead to an increase in marketing board losses equal to 0.3 percent of total government revenues, and a decrease in the balance of payments deficit equal to 0.8 percent of GDP. While the effects of changes in agricultural prices on the government's budget and on the balance of payments have been calculated in terms of changes in real prices after allowing for inflation, the actual changes in agricultural prices will be announced to the public in nominal terms. Table 4-14 assists you in converting changes in real prices to changes in nominal prices. Table 4-9. Incremental Impact of Currency Devaluation and Export Crop Pricing Policy on Export Taxes, 1975. (increase in export taxes as a percentage of total government revenues) Real Change in Percent Devaluation Producer 0.0% 12.5% 25.0% 37.5% Prices -10.0% 2.3% 5.2% 8.1% 11.0% -5.0% 1.2% 4.1% 7.0% 9.9% 0.0% 0.0% 2.9% 5.8% 8.7% 5.0% -1.3% 1.6% 4.5% 7.4% Minister of Agriculture 34 Agricultural Pricing Policy in Eastern Africa 10.0% -2.7% 0.2% 3.1% 6.0% 15.0% -4.2% -1.3% 1.6% 4.5% Note: Export taxes are presently 7.2 percent of total government revenues. Table 4-10. Incremental Impact of Currency Devaluation and Export Crop Pricing Policy on the Balance of Payments Deficit, 1975 (increase in deficit as a percentage of GDP) Real Change in Percent Devaluation Producer Prices 0.0% 12.5% 25.0% 37.5% -10.0% 0.88% 0.99% 1.10% 1.21% -5.0% 0.44% 0.50% 0.55% 0.61% 0.0% 0.00% 0.00% 0.00% 0.00% 5.0% -0.44% -0.50% -0.55% -0.61% 10.0% -0.88% -0.99% -1.10% -1.21% 15.0% -1.32% -1.49% -1.65% -1.82% Table 4-11. Incremental Impact of Export Crop Pricing Policy on Export Producers' Gross Income, 1975 (in percentage) Real Change in Producer Change in Gross Income Prices -10.0% -14.5% -5.0% -7.4% 0.0% 0.0% 5.0% 7.6% 10.0% 15.5% 15.0% 23.7% Table 4-12. Incremental Impact of Food Pricing Policy on Marketing Board Losses, 1975(increases in marketing board losses as a percentage of total government revenues) Real Change in Real Change in Consumer Prices Producer Prices -10.0% -5.0% 0.0% 5.0% 10.0% -10.0% -0.8% -2.3% -3.8% -5.1% -6.5% -5.0% 1.1% -0.5% -2.0% -3.3% -4.7% 0.0% 3.0% 1.5% 0.0% -1.5% -2.9% 5.0% 5.0% 3.3% 1.8% 0.3% -1.1% 10.0% 6.9% 5.3% 3.8% 2.3% 0.8% Minister of Agriculture 35 Agricultural Pricing Policy in Eastern Africa Note: Marketing board losses presently account for 6.0 percent of total government revenues. Table 4-13. Incremental Impact of Food Pricing Policy on the Balance of Payments Deficit, 1975 (increases in deficit as a percentage of GDP) Real Change in Real Change in Consumer Prices Producer Prices -10.0% -5.0% 0.0% 5.0% 10.0% -10.0% 1.74% 1.43% 1.21% 1.02% 0.85% -5.0% 1.09% 0.82% 0.61% 0.41% 0.20% 0.0% 0.45% 0.21% 0.00% -0.21% -0.45% 5.0% -0.20% -0.41% -0.61% -0.82% -1.09% 10.0% -0.85% -1.02% -1.21% -1.43% -1.74% Table 4-14. Impact of the Government's Macroeconomic Policies and Agricultural Pricing Policies on the Nominal Agricultural Prices 1975 Real Changes Annual Inflation Rate Agricultural Prices 15.0% 20.0% 25.0% 30.0% 35.0% -10.0% 5.0% 10.0% 15.0% 20.0% 25.0% -5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 0.0% 15.0% 20.0% 25.0% 30.0% 35.0% 5.0% 20.0% 25.0% 30.0% 35.0% 40.0% 10.0% 25.0% 30.0% 35.0% 40.0% 45.0% 15.0% 30.0% 35.0% 40.0% 45.0% 50.0% Minister of Industry You fill a key portfolio in the economic development of your country. While agriculture is still the dominant sector in terms of employment and economic output, it is only through industrialization that real progress in development can take place. You feel that this development is by no means automatic; some impetus must be provided. Your ministry must serve to provide that impetus. Your ministry has helped to foster a manufacturing industry in a number of ways. By providing for public works in the urban areas, in conjunction with the investment in education and medical services by your government, your ministry has helped to lay the foundation for an industrial society. More directly, large commitments have been made to individual businesses through direct investment and the provision of credit. While your ministry can provide support directly to business, a suitable macroeconomic environment is also necessary. You are satisfied with the current trade policies of your government which place relatively low tariffs on primary inputs and intermediate capital goods, but provide substantial protection for the consumer goods that are manufactured in your country. You also feel that any devaluation in the value of your country's currency relative to the rest of the world would undermine the investment that your government has made in industrial development, by making your own industries less competitive with foreign suppliers. Similarly, devaluation would make the importation of capital that is necessary for industrialization more difficult. Minister of Industry 36 Agricultural Pricing Policy in Eastern Africa The recent quadrupling of oil prices has had a devastating effect on industry, causing a severe profit squeeze as costs rise and revenues stagnate. While prices of imported capital have risen, the quantity of foreign exchange available to industry has not risen apace. This has caused some rethinking of the priorities in your ministry. Some of the more ambitious projects are being deferred, while those projects that are less dependent on foreign suppliers are being promoted. In light of the problems that your country faces in gaining access to foreign exchange, you believe that the government should allocate more to industry, so that needed capital can be imported. You are very upset to observe some foreign exchange being allocated to consumer goods imports, when these goods can be manufactured within the country, and are clearly diverting precious foreign exchange away from capital importation. You are aware that the government, and your ministry in particular has been putting more resources into industry to date than it has been getting out. Consequently, you personally take some responsibility for the persistent budget deficit that has been incurred. The alternative to this is a long term stagnation in economic activity, as your country would remain caught in a vicious circle, with no investment in development because there are no savings to invest. You believe that the government must actively help industry, even if it must borrow money to do so. One of the key inputs to industry is labour, and you are particularly proud of your government's record in encouraging the training of industrial workers and encouraging their fair compensation. Since a relatively large portion of the wages earned by labour is committed to feeding them and their families, you are concerned that the current economic problems may result in food price increases. If food prices increase, labour is certain to increase their wage demands. This would come at a time when profits are already in decline, and would inevitably result in some business failures. At the same time, you believe that the government should support the agricultural sector in providing some incentives to production. A maize shortage several years ago convinced you that the country was better off producing its own food, rather than importing it from abroad. Minister of Trade During the last decade, there has been a persistent balance of payments deficit. While import prices have been rising faster than export prices, the volume of imports has also been growing faster than the volume of exports. In addition, the domestic currency has been overvalued for the past five years by about 30 percent, further favouring imports and discouraging exports. The current crisis, due to the quadrupling of the world price of oil, has suddenly increased import prices by about 50 percent while export prices have increased by merely 15 percent. The degree of currency overvaluation has increased to 60 percent; this, combined with the reversal in the terms of trade exerts enormous pressure on the balance of payments to deteriorate even further. As Minister of Trade, you have the responsibility to reverse this trend by recommending appropriate trade and exchange rate policies. You need to influence decisions on the exchange rate policy that your country must pursue, given that you cannot change the basic tariff structure at this meeting. You should be aware of the various implications of the exchange rate policy that the Central Bank adopts. Indeed, it is your duty to influence the discussion of the appropriate choice of exchange rate policy that has to be adopted since the exchange rate regime will affect your ability to expand exports and earn foreign exchange. In your export promotion strategy, you are aware of the dangers of relying on a few export crops. Yet, export diversification and the expansion of markets for exports do not come easily. At the very minimum, an attempt Minister of Trade 37 Agricultural Pricing Policy in Eastern Africa should be made to reduce the battery of distortions that has created the bias towards import substitution. On the question of export subsidies and taxes, you must note that in the short run, the former is a drain on the treasury while the latter brings in revenue; in the long run, subsidies lead to increased export crop production while taxes discourage production. The scarcity of foreign exchange is not only due to the inadequate capacity of the economy to increase exports, but also due to the management of foreign exchange controls. Allocating scarce foreign exchange for the importation of nonessential items is not desirable. You recently had a meeting with the External Trade Association (ETA). This group contends that there is a great deal of inefficiency in the allocation of import licences. Many of the import licence allocations were resold to firms and individuals who did not qualify and thus the very items for which the import licences were issued were not imported. Their suggestions contained several considerations. For instance, they indicated their preference for using the market system to limit imports; this would entail currency devaluation. Alternatively, they suggested that if import quotas and licences were to be maintained, then the system must be streamlined with quantitative restrictions replaced by tariffs. While you may not necessarily agree with the ETA on every issue, the essential thrust of their concerns should be clear enough. You have also recently had a meeting with the National Agribusiness Association that represents both large and small private business and cooperatives that are involved primarily in the marketing of agricultural inputs to farmers, but also in the marketing of some agricultural outputs not marketed by government parastatals. They are acutely concerned about the availability of foreign exchange to import agricultural inputs. The National Agribusiness Association is more concerned about the availability of foreign exchange to import agricultural inputs than the c.i.f. prices of these inputs converted into domestic currency. That is, they would rather that your government devalue your domestic currency in order to purchase agricultural imports in the long run rather than maintain an overvalued exchange rate and controls. The National Agribusiness Association argues that the devaluation of the domestic currency would have two other beneficial effects. First, it would increase the domestic price of agricultural exports making it possible for farmers to purchase the higher priced inputs. Second, by increasing the domestic price of agricultural inputs it would increase the international competitiveness and foster the long-run development of the domestic industry producing agricultural inputs. A final area of concern is the deterioration in internal transportation and port facilities. The inability to transport export crops easily from the producing areas to the ports partly accounts for the recent decline in the volume of export crops. Several thousand tons of crops have been destroyed because they remained in poor storage conditions before they were moved to the ports. Some were never transported at all. Of course, there is no point in encouraging farmers to increase production if produce can not be transported to the ports for export. Ships anchor for days at overcrowded ports, waiting for berthing space and accumulating demurrage charges that run to spectacular levels. You and the other Ministers should come out of this meeting with policies that will help the country develop the capacity to deal with external shocks in the future. In the present crisis, if you attempt to use short-term measures to insulate the economy artificially against the oil shock, you should be aware of the long-term implications of doing so. Minister of Trade 38 Agricultural Pricing Policy in Eastern Africa 5-- Economic Policy and Performance in the Four Countries In chapter 3, we reviewed the theoretical implications of four kinds of government policies which affect the agricultural sector. In particular, we showed that agricultural policy, however well-designed and intentioned, could accomplish very little in the context of an unfavorable macroeconomic environment. In chapter 4, we provided materials for participants to assume the role of policy-makers in key ministries in the context of a small-group decision-making simulation. The simulation illustrated the political as well as the economic dimension of food and agricultural policy. As a sequel to the small-group decision-making, this chapter briefly discusses the policy choices made in four countries in Eastern Africa and their consequences roughly during the period 1965 to 1985. We discuss agricultural pricing policies in the context of other major policies such as economic development policies, commercial and foreign exchange rate policies, and fiscal and monetary policies. Then we will compare the policies and experiences by looking at these countries in turn. The discussion of policies follows, generally speaking, the outline in chapter 3. Kenya The first decade after independence was, generally speaking, a decade of economic success for the Kenyan economy. Real GDP grew at an annual rate of 6.6 percent between 1965 and 1975; agriculture and industry grew roughly at 4.7 and 8.4 percent respectively. However, during the second decade, the economy did not perform as well. The annual growth rate of real GDP fell to 4.6 percent between 1975 and 1985; the growth rate of real GDP per capita fell even further to one tenth of 1.0 percent. Economic Development Policy The government focused its development efforts in the immediate post-independence era on industrialization. It actively promoted and participated in industrial ventures, it adopted a liberal attitude towards foreign investment, and granted high levels of protection to import-substituting industries. At the same time, the government did not neglect the agricultural sector. Hence, it achieved a certain degree of balance between agricultural and industrial development. The most striking feature of the immediate post-independence agricultural development policies in Kenya has been their essential continuity with colonial policies. The emphasis has continued to be on individual land tenure, the promotion of entrepreneurial ability, and the continued expansion of services to the rural areas. British policy had created a rural middle class that took over the reins of power when Kenya became independent. This class, which had benefited from British policies before independence, continued them after independence. The new African government continued the policy of the colonial regime to diffuse crops and Table 5-1 Annual Rates of Growth of GDP and Population (in percent) Kenya Malawi Tanzania Zambia Real GDP 19651975 6.6 4.7 4.7 4.1 19751985 4.6 2.6 3.2 0.1 5-- Economic Policy and Performance in the Four Countries 39 Agricultural Pricing Policy in Eastern Africa Real GDP per capita 19651975 3.0 1.7 1.8 1.0 19751985 0.1 -0.5 0.0 -2.7 Population 19651975 3.5 2.9 2.9 3.0 19751985 4.5 3.0 3.2 2.8 Source : IMF, International Financial Statistics, various issues. practices suitable for small-scale farmers. Among food crops, the policy was particularly successful with respect to hybrid maize. These policies were mainly responsible for the high growth rates during the first decade after independence. There were other factors as well. First, immediately after independence, the government pursued a policy of redistributing large estates to small-scale farmers. Thus, some lands previously inaccessible to the peasant farmers became available to them. Second, the government lifted the remaining restrictions on activities such as coffee, tea and dairy production. As a result of these policies, smallholder output and income grew very significantly. One significant consequence of the rising incomes of the rural sector has been the expansion of domestic demand, which has provided the needed market for the growing industrial sector. As already indicated, the economy did not perform as well during the second decade. By the early 1970s, significant structural problems emerged, which made the high growth rates of the previous decade unsustainable. The major structural problems were a high population growth rate in the face of relative scarcity of land -- less than 20 percent of Kenya's area is arable -- and a slowdown in the rate of technological innovation. As Table 5-1 shows, the population growth rate increased from the already high level of 3.5 percent during 196575 to 4.5 percent during 197585. This combination of a limited supply of land and rapid population growth poses a fundamental problem for agricultural development in Kenya.16 With respect to the second structural problem, it should be noted 16 See World Bank Country Study (1984), Kenya: Growth and Structural Change, Vol. 1 and Vol. 2. that technological innovation comes in spurts. Each technological innovation takes agriculture to a higher plateau, and the country may remain in a particular plateau for an extended period of time. There were few new technological developments after the introduction of crops and practices suitable for small-scale farming. Similarly, after the redistribution of land holdings after independence and the resulting expansion of cultivated areas, there were few further opportunities in terms of unexploited agricultural land. But, while agricultural development was becoming more difficult because of the emerging structural problems, this is not sufficient to explain the declining rates of growth overall. International Disturbances The events on the international scene in the 1970s also contributed to the poor performance of the economy. This was a period of rising oil prices, international inflation and recession. For instance, with the increases in world prices of oil and other imports in 1974, the Kenyan economy experienced an unfavorable shift in the terms of trade. Import prices rose by 46 percent while export prices increased by only 12 percent, which resulted in an estimated loss of income equivalent to about 5 percent of domestic income. But to some extent, the deteriorating terms of trade only highlighted some structural weaknesses in the economy. International Disturbances 40 Agricultural Pricing Policy in Eastern Africa Trade and Exchange Rate Policies Since independence, the government has pursued a policy of import substitution in its industrialization program. Tariffs were imposed to protect competing local industries from external competition. The result was a divergence between the rate of growth of imports and exports, leading to a deterioration in the balance of payments. This divergence reflected an increasing bias in the trade regime in favour of import substitution and against exporting. The tariffs resulted in substantially enhanced profits for import-substituting industries, rendering production for the home market more attractive than production for external markets. The government responded initially to these deteriorations by exchange controls and quantitative restrictions. This brought a further tax on exports and a further deterioration in the balance of payments. As the balance of payments problems worsened, the restrictions were broadened and tightened. The result of all this was the creation of a serious disincentive towards exports. Fiscal and Monetary Policies The fiscal and monetary policies of the government have also played a part in the performance of the economy. With respect to the government budgetary operations, there was a steady expansion of both revenues and expenditures relative to GDP from independence until the early 1970s. But this expansion was characterized by a widening deficit of expenditures relative to revenues. As discussed in chapter 3, the resulting budget deficits could, in principle, be financed in three ways: borrowing from the non-bank private sector, borrowing from abroad, and borrowing from the banking system. In practice, the government adopted a low interest rate policy which excluded the possibility of borrowing from the non-bank private sector. The deficits were therefore largely monetized. The result was a rapid expansion in the money supply, which manifested itself in high inflation, although part of the acceleration of inflation in the 1970s was also due to the increase in the prices of petroleum and other imports. Given the fixed exchange rate regime, the high inflation led to domestic currency overvaluation and a further indirect tax on exports. Agricultural Pricing Policy Food prices have been heavily regulated in Kenya while the export sector has been relatively less regulated. In fact, unlike the other three African countries in this study, Kenya has not heavily taxed its major exports directly. Although exports get squeezed by other policies previously discussed, such as the currency overvaluation, it has had only a small tax on coffee and tea and no direct tax on the other exports. With respect to food crops, the Kenyan government has pursued a policy of relative self-sufficiency in food grains.17 It has generally controlled domestic grain prices at the minimum level required to meet the domestic demand from domestic production in an average year. Over this period 19641978, this policy resulted in a small tax on maize production relative to world prices (converted at the official exchange rate) and a small subsidy on wheat production. Economic Policy and Performance, 19751985 The international disturbances of 1974 brought into focus the growing impact of the government's exchange rate, commercial, monetary and fiscal policies on economic development. Indeed, in 1975, the International Monetary Fund assessed the economy of Kenya as an economy suffering from serious balance of payments imbalance relating to structural maladjustments in production and trade. In view of this, the government made a deliberate attempt to break this vicious circle. In support of the government's remedial measures, the IMF approved Kenya's request for funds under the then newly created Extended Fund Facility, making Kenya the first country to avail itself of the new facility.18 With this assistance from the IMF, the government pursued a restructuring program which addressed four main Trade and Exchange Rate Policies 41 Agricultural Pricing Policy in Eastern Africa issues: improving the less capital-intensive agriculture, water development, land settlement, and cooperative development. There was a determined effort on the part of the government to restrain growth in both public and private consumption through a combination of tax measures. Stricter wage guidelines and incentives to savings were introduced. 17 C. D. Gerrard, ''Government-Controlled Food Grain Markets, External Trade in Food Grains, and Agricultural Development: The Case of Four Countries in East Africa," op.cit. 18 See IMF Survey, September 29, 1975. The government was able to maintain producer prices at levels which provided adequate profitability to agricultural producers and to grant additional credit to the agricultural sector, especially to small-scale farmers. The farmers responded positively to the new higher levels of producer prices, particularly in grain production. The economy was helped in other ways as well. The exceptionally good weather in 19771978 brought sharp increases in food production. Also, in 1976, the drop in coffee production in Brazil as a result of frost led to high coffee prices and a major improvement in Kenya's terms of trade. The result was large increases in rural incomes, government revenues, and foreign exchange reserves which spilled over to the other sectors of the economy. Thus the Kenyan economy rebounded strongly in that year. However, other problems arose. A second oil shock arising from the outbreak of the Iran-Iraq war occurred in 197980, and droughts in 197980 and 198384 brought sharp decreases in food production, since food crops are rain-fed. Growth in agricultural production has also been deterred by the gap that exists between planning and implementation of programs designed to raise agricultural output.19 When the World Bank initiated its structural adjustment lending program in 1980 in the wake of the second oil shock, Kenya was once again one of the early recipients of this new facility, receiving its first structural adjustment loan in 1980 and its second in 1982. The government devalued the currency in a major way in 1982, restoring the real effective exchange rate to its 1976 level; raised agricultural prices substantially, including the producer price of maize, the most important food crop in Kenya; reduced the budget deficit, mainly through cuts in development expenditures; increased real interest rates to positive levels; and brought inflation under control. These structural adjustments have been largely successful in restoring both external and internal balance, if only because they were unavoidable. In conclusion, the government has become increasingly aware of the significance of setting domestic prices more in line with world prices and allowing the economy to adjust to external shocks. Relative to other African countries, Kenya has tried to maintain realistic prices: they were willing to devalue when the terms of trade went against them. The actual exchange rate was not significantly higher than the "equilibrium exchange rate", and this small degree of currency overvaluation has not seriously handicapped agriculture.20 The government was willing to adjust to changing economic circumstances. The agricultural experiment had largely been successful which meant that the government could continue to extract resources from agriculture to support its industrialization 19 Pamela M. J. Cox, "Implementing Agricultural Development Policy in Kenya," Food Research Institute Studies 19, No.2, 1984 20 Paul Mosley, "Agricultural Performance in Kenya since 1970: Has the World Bank Got it Right?" Development and Change (SAGE, London, Beverly Hills and New Delhi), Vol.17 (1986), pp. 51330. Trade and Exchange Rate Policies 42 Agricultural Pricing Policy in Eastern Africa program. Finally, it should be recognized that Kenya is still a resource-based economy, subject to external and internal shocks which the government is unable to mitigate since these shocks are large relative to the size of the economy. What is significant, though, is the willingness and ability of the government to allow the economy to react to these shocks realistically instead of attempting to insulate the economy from these shocks artificially. Malawi Like Kenya, Malawi has been relatively successful in its economic performance, particularly during the first decade following independence. Real GDP grew at an annual rate of 4.7 percent between 1965 and 1975, but fell to an annual rate of 2.6 percent between 1975 and 1985. The relative success of the Malawian economy can be described as "a good example of how a small African country with little apparent industrial potential can enjoy a high rate of growth of manufacturing while following an agriculturally-oriented development strategy."21 Economic Development Policy In the immediate post-independence period, the government of Malawi chose peasant agriculture as the focus of its development strategy. The World Bank and other donors made funds available to the Malawi government to be used for the promotion of smallholder agriculture through the development of Integrated Rural Development Projects (IRDPs). But these were not very effective since the government changed the focus of its agricultural development policy shortly after independence in favour of estate agriculture. First, the government facilitated the gradual transfer of existing estates from European to African ownership. Second, the government promoted the development of new estates based on small-farm production and share-cropping. Much of the government expenditures involved land re-allocation, construction of roads connected to estate development in the northern region of the country, and provision of credits to estate farming. This style of agricultural development appears to have been reasonably efficient in terms of production. The growth rate of agricultural production has been approximately 4.0 percent per annum since independence, which is one of the highest rates of growth achieved in sub-Saharan Africa during this time period.22 But this growth in production appears to have been accompanied by increasing inequities within the agricultural sector. The expansion of estate agriculture has involved the transfer of resources from small farmers, both peasants and sharecroppers, to the owners of estates, largely through the medium of 21 The World Bank, (1981), Accelerated Development in Sub-Saharan Africa, An Agenda for Action (Washington, D.C.: World Bank), p. 92. 22 Ibid, p. 50. agricultural pricing policy. This development policy has tended to polarize agriculture into a dualistic farming structure with a relatively well developed estate sector on the one hand and a neglected peasant sector on the other. Much of the agricultural and export growth achieved in the first decade can be attributed to the expansion of estate agriculture. Tobacco, tea, and sugar exports were developed primarily as estate crops. The estate expansion set off a vigorous tobacco boom, but the benefits of the boom accrued mainly to the estate owners who were primarily "absentee farmers". Indeed, there appears to have been increased impoverishment among large segments of the peasant farmers. A major structural transformation has become apparent. The share of smallholder (peasant) agriculture in domestic exports fell from 44.5 to 18.3 percent between 1968 and 1980, while that of estate agriculture increased Malawi 43 Agricultural Pricing Policy in Eastern Africa from 44.3 to 68.2 percent during the same time period. This increased output from the estate sector has exacerbated the existing degree of inequity in the distribution of income. It is conceivable that the peasant sector could have performed just as well as the estate sector, if not even better, if the government had directed an equivalent promotional effort at the peasant sector that it directed at the estate sector, considering that the estates were based on small-farm production and share-cropping. Fiscal, Monetary, and Exchange Rate Policies The government pursued a markedly conservative fiscal policy during the first decade after independence. While there were some development expenditures, the government was careful in ensuring that it did not overspend its development funds. With respect to exchange rates, the government pursued a rather unique policy by the standards of sub-Saharan Africa; the government made a determined effort to resist an overvaluation of the Kwacha. The relatively sound macroeconomic policies pursued added further impetus to the boom that had been set off by the estate expansion. Both factors contributed to the relatively successful economic performance during the first decade. Agricultural Pricing Policy The Agricultural Development and Marketing Corporation (ADMARC) is the main organization responsible for marketing smallholder crops. It was initially concerned mainly with crop marketing, but soon after its inception, ADMARC grew quickly to become a major development finance institution. It raised funds mainly by paying farmers domestic prices that were less than world market prices, even allowing for internal transportation and marketing costs. Since ADMARC purchased crops mainly from the smallholder sector but not from the estates, the government, through ADMARC, effectively taxed smallholder farmers but not the owners of the estates. One result was that smallholder exports such as groundnuts and cotton began to decline. In recent times, however, the government has instructed ADMARC to pay the smallholder farmers more remunerative prices that represent greater incentives for increased production. Economic Policy and Performance, 19751985 The performance of the economy during the period 19751985 was not as good as during the previous decade. The government abandoned its restraint on fiscal spending, which resulted in large government deficits. The intensive use of imported inputs for the estate sector also exerted a great deal of pressure on the balance of payments. Structural problems emerged which proved critical when the economy was hit by the external disturbances of the middle and late 1970s. When the second oil shock, a falling terms of trade of trade, drought, and transport disruption hit the economy in 19781980, the country did not have the capacity to deal with these alone. However, these economic shocks convinced the government of the need for structural adjustments. In the early 1980s, the government embarked on a structural adjustment program to deal with, among other things, the heavy concentration of exports in a few estate-produced agricultural commodities, and to reduce the budget deficits. They signed their first structural adjustment loan with the World Bank in 1981 and their second in 1984. One result of the structural adjustment program has been improved prices for smallholder crops, which has been reflected in higher levels of cotton production and in maize becoming an increasingly important export crop. The budget deficit, while still high, has been reduced significantly. Like the government of Kenya, the government of Malawi has become increasingly aware of setting domestic agricultural prices more in line with world prices, of allowing the economy to adjust to external shocks, and of keeping the budget deficit under control. Fiscal, Monetary, and Exchange Rate Policies 44 Agricultural Pricing Policy in Eastern Africa Tanzania During the first decade following independence, roughly 19651975, Tanzania experienced an average annual growth of real GDP of 4.7 percent, or 1.8 percent per capita. The following ten years stand as a sharp contrast to that initial growth; during the period 1975 to 1985, real growth in GDP amounted to 3.2 percent per year, but was stagnant in per capita terms. Since 1980, real GDP has experienced an average decline of 2.1 percent per year. Real agricultural productivity per capita has also stagnated, growing at an average rate of 0.5 percent per year between 1975 and 1985. Economic Development Policy The initial success, while not spectacular, was an indication that the nation was continuing to move from a traditional economy to a trading economy. The agricultural policy pursued by the government was to transform traditional agriculture completely and radically into a mechanized capital-intensive and technologically advanced pursuit, rather than to improve current practices pragmatically. Areas planted, as well as yields to most export crops increased in the 1960s as large farms adopted more capital-intensive and technically advanced practices. It has also been suggested that the production increases were more associated with the national euphoria over independence than with the transformation of agriculture.23 By the late 1960s there were few real changes in farming practices among most peasant farmers other than an increasing willingness to produce non-food crops. The few success stories were among individual farmers that embraced new technology and that employed privately held capital more intensively. These successes and their reliance on individual initiative became increasingly at odds with the nationalist and egalitarian policies of the government, and the government began to seek other approaches to help implement its economic development. In 1967 the governing Tanganyika Africa National Union (TANU) party adopted a new comprehensive development policy which became known as the Arusha Declaration. The declaration proclaimed a number of economic and social policies concerning ownership of industry, equality of income, and development strategy. The economic and social development policy for the agricultural sector was centered around a "villagization" program, known as Ujamaa. Ujamaa was to be the tool by which a transformation of peasant agriculture would be implemented without creating a capitalist class. Farmers moved -- at first voluntarily but later involuntarily -- from rural areas adjacent to their plots into communal villages. By centralizing the population in villages the government hoped that it could provide social and extension services more efficiently, while encouraging more communal large-scale farming practices. Villagization failed to produce any increase in long-run efficiency as peasants did not adopt communal production even though they did move into rural villages. In the short run agricultural production declined precipitously, leading to large food imports in 1974 and 1975, and dependence on foreign aid during the shortfall.24 Like the other three countries in the study, a policy of self-reliance led the government of Tanzania to foster and develop an import-substitution industrial sector through its tariff policy. Exemplified by the nationalization of the manufacturing industry, the government's industrial policy was an extension of the socialist political ideology of the governing party. It was ironic that the majority of manufacturing enterprises involved primarily the last stage of the manufacturing process, such that the use of imported inputs increased so dramatically that the policy of self-reliance led to greater reliance on foreign suppliers. Even more ironic was the fact that, although the industrial strategy strongly discriminated against agriculture, it resulted in agriculture's share of 23 A. Coulson (1982), Tanzania - A Political Economy (Oxford: Clarendon Press), pp. 16667. Tanzania 45 Agricultural Pricing Policy in Eastern Africa 24 One cannot determine what proportion of the decline in production can be attributed to the drought experienced in areas of Tanzania in 1974 and 1975, and what proportion can be attributed to the disruption associated with Ujamaa. For two conflicting viewpoints see Knut Odegaard (1985), "Cash Crop Versus Food Crop Production in Tanzania: An Assessment of the Major Post-Colonial Trends" (Lund, Sweden: Lund Economic Studies, No. 33), p. 50, and A. Coulson (1982), op.cit., pp. 26061. GDP rising at the expense of industry.25 Fiscal and Monetary Policies A relatively conservative fiscal policy was pursued during the first decade following independence. While the government consistently experienced budget deficits during this period, they were justified as necessary for economic development and were not excessive. The deficits were financed primarily by internal borrowing from the central bank and the commercial banking system, leading to an expansion in domestic credit. The size of the deficits were stable during the first decade following independence, leading to relatively moderate inflation rates. Agricultural Pricing Policy The agricultural pricing policy was a relatively passive component of the overall agricultural and development policies during the first decade.26 Prices for many commodities -- both producer and consumer goods -- were set by government authorities, but the producer prices were more reflective of the efficiency or inefficiency of parastatal marketing organizations than of conscious manipulation of prices to extract rents from the agricultural sector, or to promote specific crops. Producer prices set by the parastatal marketing organizations were typically determined residually after selling prices had been determined, (i.e. domestic consumer food prices had been set or export prices had been estimated), and processing and transportation costs had been covered. The operating costs of the marketing boards were passed on to the producer, so that farm prices only vaguely reflected world prices.27 International Disturbances The poor performance in the second decade has both internal and external sources. Increases in energy prices, resulting from the two oil shocks of 197374 and 197980, resulted in a substantial deterioration in the external terms of trade. From 1977 to 1982 the average price of imported goods increased by 87.3 percent, while the average price of exports declined by 3.1 percent. Invasion of northern areas of Tanzania by Uganda in 1978 led to large increases in defence expenditures, all of which were financed internally. Drought conditions led to crop failure in some areas. Economic Policy and Performance, 19751985 While policy makers have no control over external events, sound 25 Uma Lele and L. Richard Meyers (1987), Growth and Structural Change in East Africa: Domestic Policies, Agricultural Performance and World Bank Assistance, 19631986, Part I (Washington D.C.: World Bank, Managing Agricultural Development in Africa (MADIA), Research Report #1), p. 8. 26 World Bank (1984), Tanzania Country Economic Memorandum, p. 22. 27 Knut Odegaard (1985), op.cit., p. 112. Fiscal and Monetary Policies 46 Agricultural Pricing Policy in Eastern Africa policy formulation can help an economy to adjust to these shocks. Political and institutional forces in Tanzania prevented such a smooth adjustment. The adjustment to the external shocks was accommodated largely by reductions in import volume and declines in GDP growth, rather than by changes in currency valuation and relative prices. Despite the downward pressure on the currency, the official rate was maintained by the adoption of currency restrictions, and the allocation of import and foreign exchange licenses. The official rate remained above the black market rate by between 50 percent and 300 percent between 1975 and 1985, serving as a de facto tax on the agricultural sector. Consequently, the deterioration in the external terms of trade was especially manifest in a decline in the rural/urban terms of trade. At the same time, the government expenditures were taking an increasingly larger role in the economy, without an offsetting increase in revenues. The deficit grew to as large as 19.5 percent of GDP in 1979, and has remained in the range of 13 to 16 percent subsequently. While the external debt has been in excess of one half year of GDP, the vast majority of public debt has been financed by borrowing internally, thus fuelling inflation. During the second decade, the agricultural pricing process underwent a fundamental change. In the case of food crops, the marketing margin rather than the producer price became the residual in the pricing process.28 While prices for both food and cash crop prices fell below world levels, there was a relative shift of prices in favour of food crops, and a concomitant shift in production. This resulted in increased deliveries to the increasingly inefficient parastatal marketing boards with which they were unable to cope. The overvalued exchange rate further reduced incentives to cash crop production. It is ironic that while parastatal marketing boards were originally intended to stabilize producer prices, the prices realized by farmers in Tanzania have been more volatile than world prices; the marketing boards have tended to have a destabilizing influence on the domestic market.29 Much of the development progress that Tanzania had made in the first decade following independence was reversed in the second decade by a decline in real capital resources available in agriculture. Fiscal constraint led to neglect of transportation facilities such as roads and ports, and to rapid depreciation of crop milling and processing facilities, and irrigation equipment.30 Producers also ran down their capital resources: the average age of the stock of tree crops increased beyond peak yielding level of maturity; and the soil has eroded, which will make future agricultural productivity growth more difficult. Although the number of price-controlled 28 Ibid, p. 112. 29 Regression analysis and a variance ratio test supports the conclusion that price fluctuations in domestic producer prices have been larger than the fluctuations on world markets. 30 World Bank (1984), Tanzania Country Economic Memorandum, p. 18. commodities has declined as the costs of such controls have become apparent, most food prices are still controlled at both the consumer and producer levels. This price rigidity has reduced incentives to agricultural production in real terms, thus contributing to the decline in output. The initial reluctance to adjust to changing external conditions only compounded the problem; devaluation became inevitable as foreign exchange reserves became depleted, prices became liberalized because they could no longer be controlled, and production moved increasingly away from cash crops to lower value food crops. Of the four countries in this study, Tanzania was the country that attempted for the longest time to insulate its domestic economy from the cumulating external shocks beginning in 197374. Although the government made a few minor adjustments in the early 1980s, such as allocating more foreign exchange to agriculture, and liberalizing the grain market in 198384, not until June 1986 did the government bow to the inevitable and effect a major devaluation in the exchange rate. This action being interpreted by the donor community as a major commitment to reform, the World Bank approved a multisector Rehabilitation Credit in November 1986, Fiscal and Monetary Policies 47 Agricultural Pricing Policy in Eastern Africa involving commitments of $US 50 million from IDA and $US 46.2 from the Special African facility, in support of the government's structural adjustment program.31 Zambia The first decade following independence was marked by some growth in aggregate output. Real gross domestic product grew at a rate of 4.1 percent per year, corresponding to a real growth rate per capita of 1.0 percent. During the period 1975 to 1985 real GDP grew at a dismal rate of 0.1 percent, while real GDP per capita actually declined by 2.7 percent per year. Economic Development Policy Since independence, the fortunes of the Zambian economy have been inextricably linked to the fortunes of the copper industry. The mining sector contributed up to 45 percent of GDP in the first decade following independence. The government recognized early on that ore bodies were being depleted and that the mining sector would eventually need to be supplanted by some other industrial activity. Similarly, the government recognized that in the long run the agricultural industry would decline relatively as a result of economic development. The development policy was to protect and expand the import-substitution manufacturing industry; the mining and agricultural sectors were to serve as the source of rents to finance the industrial manufacturing sector.32 Above all it was the 31 Uma Lele and L. Richard Meyers (1987). Growth and Structural Change in East Africa: Domestic, Policies, Agricultural Performance and World Bank Assistance, 19631986, Part II (Washington, D.C.: World Bank, Managing Agricultural Development in Africa, Research Report 14), pp. 3739. 32 Doris Jansen Dodge (1977), "Agricultural Policy and Performance in Zambia" (footnote continued on the next page) availability of capital extracted from the copper industry that allowed Zambia to follow this independent course. In the first decade following independence the agricultural policy in Zambia was still largely a legacy of colonial times, tending to polarize farming into commercial and traditional producers. The government did not view the agricultural sector as a major source of economic growth in its own right, but in terms of the contribution that it could make to the copper mining industry. Because of the great distance from world markets, food self-sufficiency and food security for mine workers were important concerns. While the government did periodically attempt to articulate an agricultural policy, no coherent policy emerged. Experiments in a number of agricultural reforms were attempted but met with little success. Most of the benefits of the policy tended to flow to the commercial farmers (large private estates, and "emergent" smallholders that grew export crops and utilized more modern production practices), while traditional farmers received little benefit. Most of the commercial farmers were clustered along the line of rail that linked the copper industry to world markets. There was little diversification by the traditional farmers out of food crops, because of the remoteness of the farming areas. Fiscal and Monetary Policies Following independence Zambia pursued a conservative fiscal and monetary policy. Because of the abundance of tax revenue earned from the copper industry, Zambia was able to balance its government budget during the first decade following independence. Consequently there were few pressures on financial institutions to expand Zambia 48 Agricultural Pricing Policy in Eastern Africa domestic credit too rapidly. This situation changed in the second decade following independence as copper prices fell on world markets. Agricultural Pricing Policy Agricultural prices were set by a central marketing board with its origins in the colonial era. Policies that emerged were primarily geared toward estate and emergent farmers, and were largely irrelevant to the vast majority of traditional farmers.33 The criteria by which prices were set were conflicting; the price was intended to reflect both costs of production and "fairness" to consumers. Political realities suggest that fairness to urban consumers was the dominant criterion, and prices of major crops tended to fall below border price equivalents. The difference between consumer and producer prices were insufficient to cover marketing costs, and resulted in increasing government subsidies. While announced producer prices were of some importance to the traditional farmer, they were not always realized; only a small proportion (footnote continued from the previous page) (Berkeley, California: Institute of International Studies, Research Series No. 32), p. 54. 33 John C. de Wilde (1984), Agriculture, Marketing, and Pricing in Sub-Saharan Africa (Los Angeles: African Studies Center and African Studies Association), p. 77. of output by traditional farmers was marketed. There has been little diversification of Zambian farming into export crops. The limited agricultural research and extension performed has been of greatest value to the emergent and estate farmers; traditional farming practices have not changed substantially in the last 50 years. The sizable fertilizer subsidies are only of value to the commercial farmers, as the traditional farmers do not use chemical fertilizers. Economic Policy and Performance, 19751985 The dismal performance and negative real growth per capita during the last ten years can be partially attributed to external factors. The dramatic drop in copper prices (currently 50 percent below their peak in 1975) has resulted in a decline in output as many ore bodies have become uneconomic to mine, which has led to a decline in both employment income and government tax revenue from that source. In addition, trade routes were disrupted through Angola and Mozambique, and are becoming increasingly uncertain through South Africa. The government of Zambia has run a budget deficit since copper prices declined in 1975, and by 1985 faced a deficit equal to 19.8 percent of GDP. While most of the debt is financed internally, some has been financed externally, and by 1985 external debt constituted almost two years of GDP at 1985 rates. Foreign exchange earnings, of which over 90 percent are attributable to copper, have dropped in turn. Coupled with increases in energy prices, the terms of trade have deteriorated substantially. External factors have brought to light the inappropriate development policies that the government has pursued. While its copper wealth allowed Zambia to follow an independent development course of import substitution during the early years, the costs of the policy became apparent when the copper revenues declined. Despite the shocks on the economy, including the two oil shocks of 197374 and 197980, Zambia chose to retain an overvalued exchange rate to insulate the manufacturing industries at the expense of the agricultural and mining sectors. During the period 1975 to 1985 the official exchange rate was between 50 and 150 percent higher than the black market rate. In order to accommodate the fall in foreign exchange earnings, the government chose to cut Agricultural Pricing Policy 49 Agricultural Pricing Policy in Eastern Africa imports rather than devalue the currency. Available foreign exchange was rationed among importers by the allocation of foreign exchange licenses. Foreign exchange was only available to holders of licenses, typically to importers of essential consumer goods and of intermediate mining and manufacturing inputs. Ironically the overvalued exchange rate came to harm the manufacturing sector when it could no longer rely on the mining sector to provide the foreign exchange to purchase imported inputs. Until recently, agricultural policy has been one of neglect rather than active direction. While agricultural prices continued to fall below border price equivalents, consumer food prices were held below production and marketing costs, leading to an increasing subsidy to consumers, and an increasing implicit tax on producers. Since 1975 agricultural productivity per capita has declined at an annual rate of 1.7 percent. The alarming deterioration in government finances brought about by the decline in copper revenues finally forced an end to the consumer food subsidies and brought about a devaluation of the exchange rate. In October 1985, the government began a serious attempt to restructure the economy, the centerpiece of which was the establishment of a weekly foreign exchange auction, which resulted in an immediate 80 percent devaluation of the Kwacha. In addition, the government liberalized the import licensing system, reduced tariff rates, decontrolled interest rates through a Treasury bill auction, released producer prices of agricultural commodities to border price equivalents, and started the process of deregulating consumer prices. Initially, this structural adjustment program had its successes. Agricultural output expanded because of high producer prices and favorable weather, non-traditional exports expanded rapidly (albeit from a very low base), and capacity utilization in industry expanded due to increased availability of inputs and capital goods. However, these successes were short-lived. In the face of continuing downward pressures on the exchange rate and political pressures to contain the decline in living standards, the government abandoned the reform program in mid-1987. Since that time, real GDP has continued to decline, shortages of consumer goods have become more pronounced, inflation has accelerated, external debt has reached 4 times GDP, and debt service obligations have reached 70 percent of exports.34 Because the government waited so long to adjust to the cumulating external shocks starting in 197374, the adjustment experience has been and will continue to be more abrupt and more painful. 34 World Bank (1989), Adjustment Lending: An Evaluation of Ten Years of Experience (Washington, D.C.: World Bank, Country Economics Department, Policy and Research Series No. 1), p. 84. 6-- Summary and Conclusion The governments of Kenya, Malawi, Tanzania, and Zambia--like the governments of many less developed countries--have a number of objectives with regard to agricultural pricing policy such as efficient economic development, economic stability, an equitable distribution of income, and food security. They have pursued these objectives in a number of ways such as investing in agricultural development, insulating the domestic economy from external shocks, managing the foreign exchange rate, regulating input and output prices, and directly controlling the marketing of food. The purpose of this case study has been (1) to explore, both theoretically and practically, some of the inevitable tensions that exist among these agricultural policy objectives; and (2) to compare how successfully or unsuccessfully these four countries have succeeded in resolving these tensions. Purposefully, this case study has an agricultural focus. All four countries are predominantly agricultural countries. Consequently, broadly-based agricultural development has a major role to play in their overall economic development. The agricultural sector is not simply a holding sector, holding back a reserve army of 6-- Summary and Conclusion 50 Agricultural Pricing Policy in Eastern Africa underemployed workers until the growing urban-industrial sector can absorb them; the agricultural sector is a major source of economic growth in its own right. Broadly-based agricultural development will (1) supply food for the growing urban-industrial population; (2) release labour for urban-industrial production as labour productivity in the agricultural sector increases; (3) provide capital for urban-industrial investment; (4) earn foreign exchange from agricultural exports; and (5) expand the domestic market for the urban-industrial sector. A first conclusion of this case study is that agricultural development and agricultural pricing policies must be discussed in the context of other government policies, particularly, trade, exchange rate, and macroeconomic policies. For example, import-substitution policies, which increase the domestic prices of importables relative to the domestic prices of exportables, cause resources such as labour and capital to migrate from the export sector to the import-competing sector of the economy, and therefore tend to reduce the rate of growth of agricultural exports. An overvalued exchange rate also represents an indirect tax on agricultural exports, and represents a subsidy to those import-competing industries that are fortunate enough to obtain foreign exchange licenses to import production inputs. A government deficit that is monetized constitutes yet another tax on the export sector if it causes domestic prices to rise more rapidly than foreign prices. A simple comparison of domestic agricultural prices with border prices, converted at the official (overvalued) exchange rate, does not give an accurate picture of the effective government tax or subsidy on domestic agricultural production. On the surface, the government may appear to be subsidizing food and/or export crop production in order to guarantee adequate supplies of food to the cities or to earn foreign exchange; in actual fact, when all policies are taken into account, it may not be. A second conclusion of this case study is that government policies have both short-term and long-term impacts, often in the opposite direction. For example, the short-term effect of a protective tariff on the balance of payments is generally positive; the tariff reduces the domestic demand for imports without significantly affecting the supply of exports. But the long-term impact of a protective tariff on the balance of payments is generally negative; the country imports fewer consumer goods, owing to the establishment of consumer goods industries behind the tariff wall, but imports more parts, components, intermediate goods, and raw materials which are necessary for these industries to operate. The import bill may actually increase; the foreign exchange required to purchase the parts, components, etc. can easily exceed the foreign exchange which was previously required to purchase the final consumer goods. Conversely, government attempts to liberalize their trade policies tend to have negative short-term impacts and positive long-term impacts on the balance of payments. In the short-term, such policies tend to increase imports without significantly affecting exports. But in the long term, trade liberalization policies cause resources to migrate from the import-competing sector to the export sector of the economy, thereby increasing exports, including agricultural exports. A third conclusion of this study is that governments must ultimately adjust their domestic policies in response to major international disturbances. For example, the reversal which all four countries experienced in their international terms of trade between 1973 and 1975 represented a more or less permanent loss in real income. Kenya and Malawi adjusted their foreign exchange rates and their domestic prices relatively quickly to the new international economic conditions; they would appear to have benefited in the long term from doing so. Tanzania and Zambia postponed their adjustments for ten years; they would appear to have suffered from waiting so long. Eventually, they were forced to adjust; their attempts to insulate their economies were causing increasingly costly distortions. Essentially, the governments ran out of resources attempting to ''stabilize" an adverse long-term trend. Together, the three conclusions imply the following: Whether the government is trying to change its overall development strategy or whether the government is attempting to adjust to adverse international economic conditions, such changes in government policy must constitute a cohesive package--trade and macroeconomic 6-- Summary and Conclusion 51 Agricultural Pricing Policy in Eastern Africa policies as well as agricultural pricing policies--in order to be successful. In addition, such packages of policy changes will tend to result in short-term costs before they produce long-term benefits. The short-term losers can be expected to resist such changes, but the longer the government postpones the day of reckoning, the more difficult it will be to implement the required changes. It is generally easier for the government to implement a number of smaller changes over a period of time rather than a major change at the end of that same period of time. Credibility is also important for success. If the government's long-term commitment to a more liberal trade policy, for example, is in doubt, this will discourage the required movement of resources from the import- competing to the export sector of the economy necessary to make the more liberal trade policy a success. Moving too quickly, however, will impose large losses on the import-competing sector even if they do accept the government's commitment to trade liberalization but are unable to adapt to the policy change quickly enough. Moreover, a short term deterioration in the balance of payments may occur if imports grow faster than the domestic import-competing and export sectors. The government must move quickly enough to demonstrate its commitment to the new policy, but not so quickly that this generates sufficiently adverse economic and political pressure to block the reforms before their benefits are realized.35 35 Michael Mussa, "Macroeconomic Policy and Trade Liberalization: Some Guidelines," The World Bank Research Observer 2, no. 1, p. 62. As the title suggests, this article provides guidelines for the conduct of macroeconomic policy -- exchange rate policy, fiscal and monetary policy, wage policy, and credit policy -- which will complement a government's attempt to liberalize its trade policy. Bibliography Anthony, Kenneth R. M. et al. (1979). Agricultural Change in Tropical Africa . Ithaca and London: Cornell University Press. Bates, Robert H. (1980). States and Political Intervention in Markets: A Case Study from Africa . Minneapolis: National Science Foundation Conference on Economic and Political Development. Bauer, P. T. (1976). Dissent on Development . Cambridge, Massachusetts: Harvard University Press. Braverman, Avishay and Jeffrey S. Hammer (1986). "Multi-Market Methodology for Analyzing Agricultural Pricing Policies in an Operational Context: A Background Note". World Bank: Agriculture and Rural Development Department. Coulson, Andrew (1982). Tanzania - A Political Economy . Oxford: Clarendon Press. Coulson, Andrew (1978). "Agricultural Policies in Mainland Tanzania". Review of African Political Economy 10, pp. 74100. Cox, Pamela M. J. (1984). "Implementing Agricultural Development Policy in Kenya", Food Research Institute Studies 19, No. 2. de Wilde, John C. (1984). Agriculture, Marketing, and Pricing in Sub-Saharan Africa . Los Angeles: African Studies Center and African Studies Association. Dodge, Doris Jansen (1977). "Agricultural Policy and Performance in Zambia". Berkeley, California: Institute of Bibliography 52 Agricultural Pricing Policy in Eastern Africa International Studies, Research Series No. 32. Ellis, Frank (1982). "Agricultural Price Policy in Tanzania". World Development. Evenson, R. E., P. E. Waggoner, and V. W. Ruttan (1979). "Economic Benefits from Research: An Example from Agriculture", Science, September 14, 1979, pp. 11011107. Gerrard, C. D. (1982). "Government-Controlled Food Grain Markets, External Trade in Food Grains, and Agricultural Development: The Case of Four Countries in East Africa", Proceedings of the XVIII International Conference of Agricultural Economists. Jakarta, Indonesia: 24 August to 2 September, 1982. Gerrard, C. D. (1983). "Government Commodity Policies in Domestic Food Grain Markets: The Case of Food Countries in East Africa", Canadian Journal of Agricultural Economics: Annual Meeting Proceedings. Truro, Nova Scotia, July 1013, 1983. Heyer, Judith (1975). "The Origins of Regional Inequalities in Smallholder Agriculture in Kenya", East African Journal of Rural Development 8, pp. 142181. IMF Survey, September 29, 1975. Krueger, Anne (1980). "The Role of the International Sector in Economic Development". Minneapolis: National Science Foundation Conference on Economic and Political Development. Lele, Uma and L. Richard Meyers (1987). Growth and Structural Change in East Africa: Domestic, Policies, Agricultural Performance and World Bank Assistance, 19631986, Parts I and II. Washington, D.C.: World Bank, Managing Agricultural Development in Africa, Research Reports #1 and #14. Mellor, John and Bruce Johnston (1984). "The World Food Equation: Interrelations Among Development, Employment, and Food Consumption", Journal of Economic Literature 22, pp. 531574. Mellor, John (1986). "Agriculture on the Road to Industrialization", in John P. Lewis and Valeriana Kallab (eds.), Development Strategies Reconsidered . New Brunswick, N.J.: Transaction Books for the Overseas Development Council). Mosley, Paul (1986). "Agricultural Performance in Kenya since 1970: Has the World Bank Got it Right?" Development and Change 17, pp. 51330. Mussa, Michael (1987). "Macroeconomic Policy and Trade Liberalization: Some Guidelines", The World Bank Research Observer 2, no. 1, pp. 6177. Odegaard, Knut (1985). "Cash Crop Versus Food Crop Production in Tanzania: An Assessment of the Major Post-Colonial Trends." Lund, Sweden: Lund Economic Studies number 33. Vernon W. Ruttan (1975). "Integrated Rural Development Programs: A Skeptical Perspective", International Development Review . T. W. Schultz (1964). Transforming Traditional Agriculture . New Haven: Yale University Press. Stewart, Frances (1985). Economic Policies and Agricultural Performance: The Case of Tanzania . Paris: Organisation for Economic Co-operation and Development. Bibliography 53 Agricultural Pricing Policy in Eastern Africa Tod, W. H. W. (1984). "A Comparison of Smallholder Agricultural Development in Kenya and Malawi". Edinburgh University, Centre of African Studies, Occasional Papers No. 7. World Bank (1981). Accelerated Development in Sub-Saharan Africa . Washington, D.C.: World Bank. World Bank (1984). Kenya: Growth and Structural Change, Vol. 1 and Vol. 2. World Bank (1984). Tanzania Country Economic Memorandum . Washington, D.C.: World Bank East Africa Country Programs, Report No. 5019-TA. World Bank (1983). Tanzania Agriculture Sector Report . Washington, D.C.: World Bank East Africa Projects Department, Southern Agriculture Division, Report No. 4052-TA. World Bank (1989). Adjustment Lending: An Evaluation of Ten Years of Experience . Washington, D.C.: World Bank, Country Economics Department, Policy and Research Series No. 1. Appendix-- A Trainer's Guide Governments typically have a number of objectives with regard to agricultural pricing policy such as efficient economic development, economic stability, an equitable distribution of income, food security, and nutritional well-being. They may pursue these objectives, which are not necessarily compatible, in a number of ways such as investing in agricultural development, stabilizing agricultural producers' and consumers' incomes and expenditures, regulating input and output prices, directly controlling the marketing of food, establishing alternative marketing systems, and rationing. The purpose of this simulation is (1) to explore, both theoretically and practically, the inevitable tensions that exist among the above policy objectives in the context of less developed countries; and (2) to compare how successfully or unsuccessfully four such countries in Eastern Africa have succeeded in resolving these tensions. At the end of this simulation, we hope that the participants will have learned, among other things, the following lessons. First, agricultural pricing policies must be discussed in the context of other government policies, particularly, trade, exchange rate, and macroeconomic policies. Second, many of these policies have both short-term and long-term impacts, often in the opposite direction, which makes the achievement of the most appropriate long-term policies more difficult. Third, governments must ultimately adjust their domestic policies in response to major international disturbances such as a reversal in the country's international terms of trade. This simulation is participatory. It provides opportunities for participants to experience vicariously the process of food and agricultural policy-making in a developing country. The day before the simulation, the trainer should distribute chapters 1, 2, and 3 to all participants for them to read beforehand. The simulation itself is divided into three major parts: 1. Review by the trainer and group discussion of the material in Chapters 1, 2, and 3. 2. Small-group decision-making sessions, the participants being divided into groups of six, each participant taking on the role of one of six key individuals in the government, to decide how the government will respond to a grave economic crisis. 3. Reports of the small-group decision-making sessions and group discussion of these reports. Appendix-- A Trainer's Guide 54 Agricultural Pricing Policy in Eastern Africa Review of Chapters 1, 2, and 3 While this day-long simulation can stand alone, it is better conducted as part of a one or two week seminar on agricultural development policy or structural adjustment in African countries, in which case the major contribution of the simulation is to place agricultural policy, agricultural development, and the agricultural sector into an overall macroeconomic context. The agricultural sector is only one sector of the economy, albeit one of the most important sectors in the typical less developed African economy. Agricultural development takes place within the context of the entire economy; it affects and is affected by economic policy and economic events in the rest of the economy. Consequently, the meat of this review is contained in the second and third sections of Chapter 3: "Trade and Macroeconomic Policies" and "Food and Agricultural Price Policy." Most participants will be familiar with the material in the historical chapter, Chapter 2, with the possible exception of the material on the origins of the Keynesian-type exchange rate policies and fiscal and monetary policies pursued by Kenya, Malawi, Tanzania, and Zambia in the immediate postindependence period. As we will explain, these policies contributed to many of the structural adjustment problems these countries have today. But African countries can hardly be faulted for pusuing them in the 1960s and 1970s. At that time most countries in the world were doing the same. The first two sections of Chapter 3--on agricultural development policies and agricultural stabilization policies--are included in the document for reasons of completeness. When this simulation occurs as part of a one or two week seminar, other sessions will generally deal with this material in greater detail. The approach to agricultural development in these sections is neoclassical in perspective, following the work of Schultz, Ruttan, Johnston, Mellor, and Lele. The last paragraph under "Economic Stabilization Policies" is an important transitional paragraph. In many cases, African governments have to some degree attempted to insulate their domestic economies from external economic shocks. Lacking the resources to "ride out the storm", or mistaking short-term fluctuations for long-term trends, these attempts have proven increasingly costly. The trainer should spend considerable time explaining Figure 1, which depicts the major interrelationships between trade, macroeconomic, and agricultural pricing policies. The last paragraph on page 13 and the following four paragraphs on page 14--which discuss the four policy objectives of economic growth, income distribution, the balance of payments, and inflation--are extremely important paragraphs. The trainer should take considerable care in explaining precisely what the balance of payments and inflation objectives are; explaining the relationship between the short- and long-term objectives: and relating the short- and long-term objectives to the "stabilization" and "structural adjustment" components, respectively, of adjustment lending programs. This puts the subsequent discussion of exchange rate, commercial, and fiscal and monetary policies into a context to which most participants will be able to relate. Exchange rate policy is discussed first because commercial trade policy, and fiscal and monetary policies generally impact the economy through the exchange rate regime, whether fixed or floating. That is, other things being equal, an import-substitution policy and inflationary fiscal and monetary polices will cause a country's exchange rate to depreciate. But if the exchange rate is fixed, then the exchange rate will become increasingly overvalued. In this situation, the three types of policies reinforce each other in terms of their effects on the agricultural sector. The increasingly overvalued exchange rate represents an increasingly large tax on the export sector, including agricultural exports, and an increasingly large subsidy to those import-competing industries that are fortunate enough to obtain licenses to import production inputs, assuming that the licenses are not completely freely tradable. If the licenses become completely freely tradable, then the overvalued exchange rate no longer affects Review of Chapters 1, 2, and 3 55 Agricultural Pricing Policy in Eastern Africa the demand for imports, it just represents a windfall gain in favor of those who obtain the licenses in the first place. With respect to commercial trade policy, it is important to point out that the adverse impacts of an import-substitution policy on the agricultural sector may take a long time to occur. In the short term, farmers are unable to re-allocate their capital and their labour significantly in response to such a policy, but in the long term farmers have less incentive to continue investing their capital and labour in agricultural production, particularly production for export. With respect to fiscal and monetary policy, it is important to point out (1) how fiscal policy tends to dominate monetary policy in the typical less developed African country, and (2) how inflationary fiscal and monetary policies in the context of a fixed exchange rate regime are inherently unsustainable. This mixture of policies is guaranteed to produce a crisis-at random but certain intervals-because the government is creating a game in which speculators cannot lose. Finally, the trainer should emphasize again and again how food and agricultural price policy per se cannot be separated from its macroeconomic context. Simply comparing domestic food and agricultural prices with world prices converted at the official foreign exchange rate does not tell you whether the government is taxing or subsidizing food and agricultural production on average. Also, simply increasing official food and agricultural prices does not completely negate the adverse impact on the agricultural sector of an overvalued exchange rate, an import substitution trade regime, or inflationary fiscal and monetary policies. Small-Group Decision-Making Sessions The above review of macroeconomic and agricultural price policies represents a lot of material to digest in a short period of time. The purpose of the small-group decision-making sessions is for the participants to apply this material to a concrete situation similar to what many African countries actually experienced in 1974. While African countries have experienced adverse economic shocks in other years such as the second OPEC oil shock in 1979 and the U.S. dollar devaluation in 1981, the choice of 1974 is deliberate. It is because the period following 1974 illustrates the way in which delayed adjustment entails a heavy economic and social cost. In Chapter 5, in the review of economic policy and performance in the four countries, it turns out that Kenya was the first country to adjust to the 1974 oil shock with a major restructuring program in 197576. While Malawi did not respond with a structural adjustment program until 1981, Zambia and Tanzania attempted to insulate their economies from these shocks for even longer. Zambia did not bow to the inevitable until 1985 and Tanzania until 1986. However, this reason for choosing 1974 should not be shared with the participants until after the small-group decision-making sessions are completed. The trainer should divide the participants into groups of six, each participant taking on the role of one of six key individuals in the government: the President, the Governor of the Central Bank, the Minister of Finance and Economic Planning, the Minister of Agriculture, the Minister of Industry, and the Minister of Trade. Collectively, each group of six must forge a coherent set of exchange rate, fiscal, monetary, and agricultural pricing policies in response to a current economic crisis facing the country. The trainer should pay particular attention to the selection of the President of each group who will be called upon later in the day to summarize his/her group's economic policy decisions to all the participants in the simulation. As far as possible, the trainer should also assign individuals from different countries to each group. Small-Group Decision-Making Sessions 56 Agricultural Pricing Policy in Eastern Africa Then the trainer should distribute the first five pages of Chapter 4 to all participants, along with Tables 4-3a and 4-3b. This describes the current crisis in our hypothetical Eastern African country and the agenda for each small group. (The data provided are roughly representative of the four countries in this case study.) At the same time, the trainer should also distribute to each participant the brief description of the role that he will play in his small group. Each participant should keep these descriptions to himself. The participants playing the roles of Governor of the Central Bank, Minister of Finance and Economic Planning, and Minister of Agriculture will also be distributing copies of tables relating to their portfolios to all participants in their small groups. They should be provided with six copies of each table that appears in the section of the chapter on their role. Then the trainer should briefly review the current crisis and the agenda for the small groups as described in the first two sections of chapter 4. He should stress that each group must make a specific decision with regard to each of the six items on the agenda as set out in table 4-3a. Except for the fact that the President is the chairman of each group, how each group organizes its discussion and reaches its own conclusions is entirely up to each group. As chairman of the group, the president can exercise some leadership in the decision-making process. Each group will have approximately two hours to make its decisions. At the beginning of the small-group decision-making sessions, it is very important allow time for the participants to read and to digest what are their respective roles. The trainer should make himself available as a resource person to the various participants at this time if they, as individuals or groups, are having difficulty understanding some of the material given to them. Reports of the Small-Group Decision-Making Sessions and Group Discussion of These Reports. After the small groups have made their economic policy decisions, the President of each group will summarize and explain the group's decisions before all participants in the simulation. Then, drawing upon the decisions that the various groups have made, the trainer should lead a discussion of possible conclusions resulting from the exercise. These might include the following: · Compromises are necessary among conflicting interests. In the simulation, as in the real world, governments often select "second" or "third best" options. · The Minister of Agriculture generally wages an uphill battle in trying to get the overall Cabinet to agree to changes in trade and macroeconomic policies and to increases in agricultural prices, more conducive to agricultural production and agricultural development. · Agricultural pricing policies should not be considered in isolation from other government policies that affect agriculture. · While African governments have often looked upon agriculture as an important source of economic growth, they are less aware of the negative impact of certain policies, particularly the overvalued exchange rate, on the agricultural sector. · Some policies such as reducing food marketing board losses, while recognized as important, are very difficult to achieve within the framework of the existing economic structure. The only long-term solution may be to liberalize (i.e. privatize) food marketing systems. Reports of the Small-Group Decision-Making Sessions and Group Discussion of These Reports. 57 Agricultural Pricing Policy in Eastern Africa · Government policies have both short- and long-term impacts, often in the opposite direction. · Major economic crises such as the OPEC oil shock of 1974 have a way of revealing more clearly the negative long-term impact of previous policies, leading hopefully to a reassessment both of previous policies and of the style of economic development that the previous policies have been promoting. · Significant changes in the direction of government policies are likely to have negative short-term impacts before positive long-term benefits are realized. · In the simulation, as in major IMF/Bank adjustment lending programs, positive supply responses are assumed. In the real world, however, these supply responses are not so certain, which is one reason why governments frequently hedge their bets rather than go all-out for structural adjustment. · Governments must ultimately adjust their domestic policies to major international disturbances such as the OPEC oil shocks. They cannot insulate their economies from these shocks forever. At an appropriate time during the group discussion, the trainer should distribute and draw upon the material in Chapters 5 and 6, which briefly describes the actual economic policies that Kenya, Malawi, Tanzania, and Zambia pursued during the period 1965 to 1988. As previously explained, Kenya and Malawi responded to the 1974 oil shock before Tanzania and Zambia did. The participants are not expected, however, to read Chapter 5 and 6 until after the simulation is over. Suggested Timetable The following is a suggested timetable for the simulation: 9:159:30 Preliminaries. Overview of the entire seminar. 9:3010:15 Review Chapters 1, 2, and 3. 10:1510:45 Distribute Chapter 4. Allocate participants to groups. Explain what groups are to do. 10:4511:00 Coffee break. 11:0012:30 Small groups meet. 12:302:15 Lunch. 2:152:45 Small groups conclude. 2:453:45 Presidents of each group report. 3:454:00 Coffee break. 4:005:15 Discussion of small group reports and experience of four countries. Distribute Chapters 5 and 6. 5:155:30 Concluding remarks. Suggested Timetable 58 Agricultural Pricing Policy in Eastern Africa For a two-day simulation, more time can be allotted to discussions of chapter 3 and to small-group discussion. One session can deal with chapters 5 and 6. Suggested Timetable 59