WORLD BANK TECHNICAL PAPER NO. 465 (hma~ Europe and Central Asia Environmentally and Socially Sustainable W) Development Series WTP465 Work in progres for public discussion April 2000 Structural Change in the Farming Sectors in Central and Eastern Europe Lessons for E UAccession-Second World Bank/FAO Workshop, June 27-29, 1999 Edited by Csaba Csaki Zvi Lerman Recent World Bank Technical Papers No. 392 Felker, Chaudhuri, Gy6rgy, and Goldman, The Pharmaceutical Industry in India and Hungary: Policies, Institutions, and Technological Development No. 393 Mohan, ed., Bibliography of Publications: Africa Region, 1990-97 No. 394 Hill and Shields, Incentivesfor Joint Forest Management in India: Analytical Methods and Case Studies No. 395 Saleth and Dinar, Satisfying Urban Thirst: Water Supply Augmentation and Pricing Policy in Hyderabad City, India No. 396 Kikeri, Privatization and Labor: What Happens to Workers When Governments Divest? 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Mark Blackden and Chitra Bhanu, Gender, Growth, and Poverty Reduction: Special Program of Assistance for Africa, 1998 Status Report on Poverty in Sub-Saharan Africa (List continues on the inside back cover) WORLD BANK TECHNICAL. PAPER NO. 465 Europe and Central Asia Environmentally and Socially Sustainable Development Series Structu:ral Change in the Farmning Sectors in Central and Eastern Europe Lessonsfor E UAccession-Second World Bank/FAQ W,rkshop, June 27-29, 1999 Edited by Csaba Csaki Zvi Lerman The WorldBank Washingon, D.C. Copyright © 2000 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 April 2000 Technical Papers are published to communicate the results of the Bank's work to the development community with the least possible delay. 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The material in this publication is copyrighted. The World Bank encourages dissemination of its work and will normally grant permission promptly. Permission to photocopy items for internal or personal use, for the internal or personal use of specific clients, or for educational classroom use is granted by the World Bank, provided that the appropriate fee is paid directly to Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, U.S.A., telephone 978-750-8400, fax 978-750-4470. Please contact the Copyright Clearance Center before photocopying items. For permission to reprint individual articles or chapters, please fax your request with complete information to the Republication Department, Copyright Clearance Center, fax 978-750-4470. All other queries on rights and licenses should be addressed to the World Bank at the address above or faxed to 202-522-2422. ISBN: 0-8213-4733-0 ISSN: 0253-7494 Cover photo: Corn field in Northeast Hungary, Peter Szabo. Csaba Csaki is lead agricultural adviser in the Environmentally and Socially Sustainable Development unit of the World Bank's Europe and Central Asia Region. Zvi Lerman is a professor at the Hebrew University of Jerusalem and a consultant for the World Bank's Development Economics Research Group. Library of Congress Cataloging-in-Publication Data has been applied for. Contents Forevword ....................................................................... v Abstract ....................................................................... vi Preface ....... ................................................................ vii Country Abbreviations and Symbols in Tables and Figures ................................................................... viii Contributors ...... ................................................................. ix Summary of Workshop Deliberations - C. Csaki, Z. Lerman, and D. Bontempo .............. ...................... xi Part One: Evolving Farm Structures and Competitiveness of Agriculture Status of Land Ref orm and Farm Restructuring in Central and Eastern Europe: A Regional Overview - Z. Lerman .......................................................................... 3 Major Features of the New Farming Structures in Central and Eastern Europe - E. Mathijs and J. Swinnen .......................................................................... 22 Competitiveness of Farming in Countries Associated with the EU under the Common Agricultural Policy - K Frohberg .......................................................................... 39 Impact of Foreign Direct Investment on Agriculture and Agro-Industry in Transition Economies - H. Gow and J. Swinnen .......................................................................... 66 Part Two: Land Laws and Legal Institutions fDr Development of Land Markets and Farm Restructuriing Emerging Lanid Markets in Central and Eastern Europe - P. Dale and R.Baldwin ............ .................... 81 Review of the Legal Basis for Agricultural Land Markets in Lithuania, Poland, and Romania - R. Prosterman and L. Rolfes, Jr ........................................................................... 110 Agricultural Land Leases and Development of Effective Land Registration Systems in Central and Eastern Europe - J. Riddell .......................................................................... 140 The Impact of Land Laws and Legal Institutions on the Development of Land Markets and Farm Restructuring in Hungary, Lithuania, Poland, and Roman a - S. Tanic ................... ............................. 150 iii Part Three: Development of Farm Services for Improved Competitiveness Evolving Commercial Farrn Services for the New Farm Structure - D. Gisselquist ............ .................. 157 Farm-Level Agribusiness Trade and Services in Selected EU Countries - J. Cordier ........... ............... 174 Survey of Farmers, Agribusinesses, and Machinery Owners in Bulgaria - A. Georgieva .......... .......... 186 Extension and Research for Farm Competitiveness - K. Brent and G. Adams .............. ....................... 208 Restructuring of Extension and Advisory Services in Estonia: Expectations and Outcomes - 0. Kreen ...... .............................................................. 230 Workshop Program .................................................................... 245 List of Country Studies The following country studies presented at the Workshop are being published separately in the World Bank's Environmentally and Socially Sustainable Development Working Paper Series. Copies of the country studies volume can be obtained by e-mailing Ms. Christin Cogley (ccogley@worldbank.org) or Mr. David Bontempo (dbontempo@worldbank.org). The country studies (except East Germany) were commissioned and sponsored by FAO. Part One: Country Experiences in Adjustment of Farm Structures Bulgaria - T. Morrison and H. Bachev Czech Republic - T. Ratinger, 1. Foltyn, L. Zednicjkov6, A. Matthews, Z Tou§ek, and J. Ulmanova Slovenia - S. Tanic The Evolving Farm Structure in East Germany - U. Koester Part Two: The Impact of Land Laws and Related Institutions on the Development of Land Markets and Farm Restructuring Lithuania - S. Cironka Hungary - E. Tanka Poland - T. Hunek Romania - V. Florian, M. Popescu, F. Toderoiu, M. Rusu, and C. Stefanescu iv Foreword The Wor]ld Bank's Strategic Compact Initiative includes a set of coordinated activities that leverage the World Bank's comparative advantage in economic analysis and world-wide development experience to help the ten EU accession countries achieve EU membership. Activities include studies designed. to facilitate the implementation of policy and institutional reform in preparation for accession. The studies are followed by workshops and seminars to disseminate the results and imrrprove the analytical skills and policy analysis capabilities in the respective countries. The First EU Accession Workshop, held in Budapest in June 1998, related regional and international trade policy issues to experiences with regional trading agreements. The workshop discussed the implications of Central and Eastern European Free Trade Agreement (CEFTA) and World Trade COrganization (WTO) membership for EU accession countries. The Second EU Workshop, held in Warsaw in June 1999, focused on how ifarmn structures and supporting institutions will need to evolve in order to enable the transition countries to withstand the competitive pressures of accession. The sessions at the Workshop dealt with an assessment of the current farming structure in the EU accession countries and explored the changes in land laws, land market institutions, and provision of farm services that are necessary for market-led restructuring and improvement of agriculture's productive efficiency. The discussion of these issues was facilitated by the presentation of studies that had been especially prepared for the Workshop as part of the work program of the World Bank and the FAO Subregional Office in Budapest. We hope that the publication of the major findings of this Workshop in the present volume wvill assist the countries in the process of preparing for EU accession. The volume will also serve as a useful information resource for organizations and individuals interested in issues of EU accession in the rural sector. Kevin Cleaver Jaroslav Suchman Director FAO Subregional Representative Environmentally and Socially Sustainable for Central and Eastern Europe Development, Europe and Central Asia Budapest The World Bank v Abstract This volume examines the reforms and policy changes necessary in the food and agriculture sectors of the ten countries that have started the accession process for eventual membership in the European Union (Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia). The papers in this volume cae selected from the presentations at the Second World Bank/FAO EU Accession Workshop held in Warsaw, Poland, on June 27-29, 1999, and are organized around three topics: (l[) Evolving Farm Structures and Competitiveness in Agriculture; (II) Land Laws and Legal Institutions for Development of Land Markets and Farm Restructuring; and (111[) Development of Farm Services for Improved Competitiveness. This volume is intended for agricultural policy makers and government officials in the candidate countries, EUJ officials, World Bank and FAO staff, development scholars, and all others interested in the process of agricultural reform in Central Eastern Europe. vi Preface The World Bank, under its Rural Sector EU Accession Initiative, sponsored the Second EU Accession Workshop in Warsaw, Polarnd, between June 27-29, 1999. The Workshop was organized in cooperation with FAO and in close coordination with the European Commnission and the Polish Ministry of Agriculture. The Workshop participants included over 70 key government officials (among them three former ministers), all deeply involved in ttheir countries' preparation for EU accession negotiations in the rural sector. In addition, fifteen experts and academics from both EU member countries and EU accession candidates participated in the Workshop. The participants came from all ten accession countries: Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia. Angel Carro-Castrillo represented the Directorate-General for Agriculture (DG-VI) of the European Commission in Brussels. Kevin Cleaver, Director of World Bank's Europe and Central Asia Environmentally and Socially Sustainable Development Unit, and Gershon, Feder, Manager in the World Bank's Development Economics Research Group, actively participated in the seminar, together with seven additional World Bank staff members. The FAO delegation included Jim Riddell, Chief of FAO Land Tenure Service in Rome, Jaroslav Suchmann, the FAO Subregional Representative for Central and Eastern Europe in Budapest, and five additional FAO headquarters and subregional office staff. The organization of the Workshop was coordinated by Csaba Csaki from the World Bank and Zbigniew Karnicki, former FAO Subregional Representative in Budapest. Administrative support was provided by Courtney Smothers and David Bontempo from the World B3ank headquarters in Washington, ancL by Stjepan Tanic from the FAO Subregional Office in Budapest. This proceedings volume presents a selection of papers from the Workshop and a summary of the deliberations. In addition to the papers published in this volume, a rich variety of country case studies were also presented and discussed at the Workshop. These case studies are published in a separate volume in the World Bank's Environmentally and Socially Sustainable Development Working Paper Series. This Workshop proceedings volume was compiled by Csaba Csaki and Zvi Lerman and processed for publication by Christin Cogley and Alan Zuschlag under the guidance of the editors. The assistance and support provided by the Polish Ministry of Agriculture for this Workshop is greatly appreciated. vii Country Abbreviations and Symbols in Tables and Figures Bu Bulgaria P1 Poland Bul Bulgaria Pol Poland Cz Czech Republic Ro Romania Est Estonia Rom Romania Hu Hungary Sk Slovakia Hun Hungary Svk Slovakia Lat Latvia Si Slovenia Lit Lithuania Sn Slovenia Lv Latvia Svn Slovenia Dashes in tables (-, -, --, ---) denote zero or negligibly small value viii Contributors Geoffrey Adams - IJN Food and Agriculture Organization, Rome, Italy Richard Baldwin - Independent consultant, UK David Bontempo - Environmentally and Socially Su;tainable Development Unit, Europe and Central Asia Region, The World Bank, Washington, DC Keith Brent - UN Food and Agriculture Organization, Rome, Italy Jean Cordier - Ecole Nationale Superieure Agronornique, Rennes, France Csaba Csaki - Environmentally and Socially Sustainable Development Unit, Europe and Central Asia Region, The World Bank, Washington, DC Peter Dale - Department of Geomatic Engineering, UTniversity College, London, UK Klaus Frohberg - IAMO-Institute of Agricultural Development in Central and Eastern Europe, Halle, Germany Anna Georgievai - Agra Analytica, Sofia, Bulgaria David Gisselquist -- Environmentally and Socially Sustainable Development Unit, Europe and Central Asia Region, The World Bank, Washington, DC Hamish Gowv - Department of Agricultural and Consumer Economics, University of Illinois at Champaign-Urbana, USA and Policy Research Group, Department of Agricultural and Environmental Economics, Katholicke Uniiversiteit Leuven, Belgium Olav Kreen - Rural. Development Department, Ministry of Agriculture, Tallin, Estonia Zvi Lerman - Department of Agricultural Economics and Management, The Hebrew University, Rehovot, Israel and Development Econornics R'esearch Group, The World Bank., Washington, DC Erik Mathijs - Policy Research Group, Department of Agricultural and Environmental Economics, Katholieke Universiteit Leuven, Belgium Roy L. Prostermnant - University of Washington School of Law and Rural Development Institute, Seattle, Washington Jim Riddell - Land Tenure Service, UN Food and Agriculture Organization, Rome, Italy Leonard Rolfes, Jr. - Rural Development Institute, Seattle, Washington Johan Swinnen - Directorate-General for Economic and Financial Affairs (DG II), European Commission, Brussels and Policy Research Group, Department of Agricultura]L and Environmental Economics, Katholieke Universiteit Leuven, Belgium Stjepan Tanic - Farming Systems Development, FAO Subregional Office for Central and Eastern Europe, Budapest, Hungary. x Structural Chlange in the Fanrming Sectors of Central anld Easteni Europe Second EU Accession Workshop in the Rural Sector, WVarsaw, Poland, June 27-29, 1999 Summary of Workshop Deliberations Csaba Csaki Zvi Lerman David Bontempo The 1999 Warsaw workshop, building on the success of the first workshop in Budapest in 1998, continued the World Bank's efforts to prepare accession candidates for full membership in the European Union. Thiis second workshop focused on the structural changes in the farming sector in Central and Eastern Europe (CEE) associated with thie transition to a market economy, and the lessons and implications of these changes for the accession countries. The workshop deliberations clearly show that farm structures in CEE today cover a whole spectrum of fonns, which include small subsistence-oriented household plots, medium-sized commercial family farm,s, and large corporations. The agricultural sector in CEE definitely has not embraced the family farm as the dominant farming structure, thus confounding the original expectations of Western experts. On the other hand, agriculture did not collapse because of fragmentation and piivatization, as predicted by conservative doomsayers. The amount of land controlled by the individual sector is unlikely to shrink in the future. Yet market forces will probably continue Ito produce significant internal restructuring in the individual sector, encouraging consolidation through transfer of land resources from very small units to more efficient mid-sized farms with commercial orientation and greater earning potential. The large corporate farms are also there to stay, yet market forces and efficiency considerations will probably sustain the downsizing trend that has been generally observed so far. Consolidation of mid-sized family farmns and downsizing of very large corporations will ensure that the CEE farm structure continues to move toward the market distribution pattern. The workshop concluded that there has been significant progress toward the goals of market-oriented agriculture, but the structural change in the farming sector in CEE has not been completed. Several of the initial tasks of transforming the inherited structure into a system based on market principles and private ownership have not been fully accomplished in some countries. These uncompleted tasks include land privatization, lanid titling and registration, restructuring and consolidation of the new farming units, and more. Significant further changes can be expected in the pre-accession period, and although the main directions of change are foreseeable, the specific outcome of the changes in the farming structure is uncertain in detail. xi xii C. Csaki, Z. Lerman, and D. Bontempo It was apparent from the workshop that government policies in this period should be aimed at facilitating further smooth evolution of farm structure led by market forces. The workshop specifically discussed issues related to land markets and concluded that it will be important to eliminate restrictions on leasing, which is expected to play an especially important role during the period of underdevelopment of land sales markets, as well as land ownership. Enhancement of competitiveness and efficiency were identified as the most important tasks for government policies in the farming sector during the pre-accession period. Efforts to respond to current social problems, or avoid future problems, have recently led in several countries to government actions which undermine this objective. The political importance of these social issues was recognized by all workshop participants. However, it was agreed that the responrse to the social problems should also be based on a clear understanding of the economic costs and benefits of these alternative policy options. The workshop recognized several other issues of critical importance to agricultu:re and agro-industry that are of more general relevance to the economy. These include especia:Lly the institutional framework, such as titling, property registration, contract enforcement, provision of public goods, taxation policy, etc. The countries need to make more efforts to understand the new tendencies and developments in the EU and in the global economy, and to develop their own strategies and farm policies in that context. Agriculture remains important for the rural population in CEE, as the welfare oi rural families increases with the increase in their land endowment. However, the future of the rural population must be considered in a broader context of rural development, including creation of alternative jobs in rural areas that will facilitate the exit of surplus agricultural labor without involving the undesirable option of rural-to-urban migration. The countries should. take advantage of the adjustments required for EU accession to broaden the scope of reform and to include rural development issues in their agenda in addition to the traditional agricultural topics of land privatization and farm restructuring. OVERVIEW OF WORKSHOP PRESENTATIONS The Warsaw workshop was organized around three main sessions: i) evolving farm structures in Central and Eastern Europe (CEE) in light of potential EU accession and. farm competitiveness; ii) land laws and related legal institutions to support development of land markets and farm restructuring; and iii) farm services to support improved competitiveness of new farming structures. Each session combined regional analyses with individual country case studies. The workshop concluded with presentations by individual country participants on where they stand in the accession process. The World Bank discussed its role in assisting the cou.ntries achieve their accession goals, and the EU provided further details on timelines for each country's accession negotiations. The main issues addressed in these sessions are summarized below. The rest of the volume provides a selection of presentations delivered at the workshop. Summary of Workshop L)eliberations xiii Session It: Evolving Farm Structures in CEE in Light of Potential EU Accession and Farm Competitiveness What do the new CEE farms look like? How many people are employed by them? What size are they now, and what size should they be in order to compete with western Europe? The first session was opened by Zvi Lerman with a description of the current status of land reform and farmL restructuring in CEE. Breakup of the socialist-era collective and state farms, with consequent expansion of individual cultivation, is one of the most significant factors affecting agriculture in CE,E. The emergent farm structure is characterized by a large number of relatively small farms, while at the other extreme very large farms persist, controlling a disproportionate amount of land. As a result, the distribution of farm sizes in some CEE countries retains the highly dual pattern reminiscent of socialist agriculture, which is strikingly different from the farm size distributions observed in market economies. Neithzr the excessive fragmentation nor the extreme concentration of land is probably sustainab]e, anl[d future processes will include strengthening of mid-sized farms at the expense of very small and very large units. Continuing firom this general overview, Johan Swijnnen presented results of recent survey work in CEEI that sought to analyze the major features of the new farm structures. Evidence suggests that iamily farms are more efficient than cooperatives, and the least efficient structures are most like:ly to go out of business in the future. Breakup of the cooperatives has created a large pool of surplus labor, and the three countries with the most success in restructuring (Czech Republic, Hungary, and Slovakia) are those in which rural labor has found alternative employment outside agriculture. Liberalization policies that support labor mobility are required to achieve outflow of redundant labor from agriculture. Klaus Frohberg examined the expected competitiveness of CEE farms under EU conditions. The CEE countries have some of the resources required for competitiveness. These include abundant land and high-quality, well-trained labor. Capital, on the other hand, may be a problem due to outdated machinery, and general lack of access to credit. Accession cannot be expected to give a big boost to CEE agriculture in general, particularly since prices for many goods (except mi-lk, beef, and sugar) are either ahead or very near EU prices. Hamish Gow discussed the impact of Foreign D)irect Investment (FDI) on the development of a properly functioning system of contracr.s. Because of lax contract enforcement, payment delays to producers are very common in transition countries, particularly among downstream processors. FDI, in addition to providing an important source of financial and human capital, can help establish private contract enforcement mechanisms. Following takeover by a foreign firm, a sugar processor in Slovakia with a notoriously bad payment record to producers undertook a range of activities stimulating sugar-beet farmers to increase their production and resume deliveries to the company. By creating a transparent contract, the foreign- controlled processor has forced all other sugar processcrs to do the same while competing for inputs, and the entire system has been improved. xiv C. Csaki, Z. Lerman, and D. Bon tempo Country Case Studies on Farm Restructuring: East Germany, Bulgaria, Czech Republic, Slovenia Following the more general discussions above, four country case studies were presented (East Germany, Bulgaria, Czech Republic, and Slovenia). Ulrich Koester provided an overview of the experience with farm policy in East Germany following unification. The most striking feature of agricultural adjustment in East Germany is the huge out-migration of labor from agriculture. Generally, single-owner farms have fared best, whereas cooperatives have fared least well. Many East German are not sustainable, and a similar situation would prevail for the CEE cooperatives under EU conditions. Agriculture should strive to be successful not through government policies, but rather through technology, open markets, better management, and flexible land markets. Tom Morrison discussed the experience of Bulgaria. The government policy on machinery provides grants and credits to the large, inefficient farms, while offering no options to make machinery available to small farmers. The assets of government-owned machinery services should be quickly auctioned, and the market should be allowed to determine the right size for hire companies. In addition, a new advisory service is needed to provide farmers with technical advice and farm management skills, and to assist in organization of water user associations and marketing cooperatives. The experience in the Czech Republic was described by Tomas Ratinger. There has been a certain contraction of farm size, although very large farms continue to exist. Labor productivity has improved, particularly on family farms of less than 100 hectare. Farms larger thanL this, especially cooperatives, show lower labor productivity, but this is partly due to the social consideration of not laying off more workers. However, for most commodities, no overall efficiency differences have been observed among the different farm types. Thus, settlement of property rights has been more important to structural change in farms than efficiency considerations. In 2005 under the EU, competitiveness of some traditional commodities, such as cereals, rapeseed, sugar, and livestock could be maintained but only if costs were reduced substantially. The farm restructuring experience of Slovenia was presented by Stjepan Tanic. Early on, farm structure was recognized as the most important factor in determining efficiency. The structural changes have been geared toward the enlargement of the very small family farms, as opposed to other CEE countries, where the policies aimed to decrease the average farm size. The main constraint to further farm adjustment is the incomplete land market. However, agricultural activity is not a very important source of household income in rural areas, and an overall shift toward part-time farming is observed. Summary of Workshop,Deliberations xv Session 2: Land Laws and Related Legal Institutions to Support Development of Land Markets and Farm Restructuring The importance of well-functioning land markets was clearly identified by the presenters in Session 1, ancd Session 2 explored this issue in more detail. Land transactions are much easier to conduct in the EU than in transition economies, and consequently there is much greater turnover of land in the EU. Yet the transition countries have a, great need for land transaction in order to move tow,ard optimal farm sizes ensuring improved productivity, efficiency, and profitability. As the CEE' countries approach EU accession, governments must have clear policies to accelerate the development of active land markets in which market forces will determine the best farm structures. The session vwas opened by Leonard Rolfes, who reviewed the legal basis for agricultural land marlkets with special emphasis on Lithuania, Poland., and Romania. The legal framework for land markets encompasses several dimensions, which include private ownership of agricultural land, full owner control over use and disposition of land, land use regulations, the transaction regime, land mortgage, land registration, and taxation of land and land transactions. The country case studies for Lithuania, Poland, and Romania show that the three countries are reasonably advanced in all relevant dimensions, although some delays are observed in the areas of transition to private land ownership (privatization and restitution of land) and land mortgage legislation. Richard Baldwiin and Peter Dale presented a paper on emerging land markets in CEE, providing a set of indicators for comparative cross-country assessments. Their study, supported by the EU's ACE program, involved detailed investigations of rural land markets in the Czech Republic, Hungary, ]Latvia, Poland, Slovakia, and Slovenia. Land market development involves three main components: 1) land registration and cadastre (ensuring secure title and rights); 2) land valuation (by market forces); and 3) financial services (providing capital and credit). Each pillar consists of a numnber of elements that get a higher score as they advance toward an efficiently functioning land market. Taking the status of these components in the EU as 100, the case countries scored between 20 and 45, indicating that substantial progress still must be made prior to harmonization to EU standards. Specific action recommendations were made to achieve further progress. Jim Riddiell elaborated on the option of leasing land as a method for increasing farm sizes. The creation of formal land tenure institutions, such as modern cadastres and land registries, is just as relevant for the lease market as for the market in land sales. The basic characteristics of good land leases worldwide are i) simplicity; ii) minimum cost (if it is too expensive, the infonnal market prevails); iii) certainty and security; iv) sustainability; v) equity and fairness; vi) transparency (critical requirement to attract outside capital); vii) preservation of legal interest in property; viii) flexibility in markets, especially in view of unknown future; and ix) a minimum of government regulation and intervention. In general, leases should be short- term, to allow both parties some flexibility as market or cther conditions change. xvi C. Csaki, Z. Lerman, and D. Bontempo Country Case Studies on Land Markets: Hungary, Lithuania, Poland, Romania Session 2 concluded with four country case studies describing the development status of legal institutions and land laws in Hungary, Lithuania, Poland, and Romania. The four countries have followed different land privatization strategies, which have produced different farm structures during transition. Yet the case studies show that all these countries, through their laws and related legal institutions, have a solid base for the development of an active land market. The lease market is already fairly developed in all countries, and although land sale markets are not yet very active, this is changing and the frequency of buy-and-sell transactions will increase as the countries move closer to EU accession. The development of land markets is highly important for adjustment of farm sizes to more efficient operation, because small farms are usually regarded in these countries as an inadequate source of household income, and farmers must have ways and means to increase the size of their holdings. Session 3: Farm Services to Support Improved Competitiveness of CEECs' New Farming Structures Market-oriented farm services from outside providers are no less important for agricultural competitiveness than farm structure and farm management. The third session of the workshop accordingly focused on the need for improving agricultural support services. In addition to more general discussions on this topic, two examples were presented of integrated food processing chains. David Gisselquist reviewed the changes in agribusiness and processing during transition, based on a survey of chambers of commerce and other business organizations in the pre- accession countries. The surveys found a working business community everywhere, even, at the village level, where many "chambers of commerce" are active and a strong private sector of small agricultural entrepreneurs is emerging. The surveys did not find corruption or law enforcement to be much of a problem. An unfair tax system penalizes smaller processors or farmers and thus puts them at a significant competitive disadvantage compared to larger firms. This clearly is a deterrent to the establishment of a fair formal market for agricultural goods. Jean Cordier discussed the changing nature of European agribusiness, with an emphasis on the increasing need for fully integrated food chains. Because of the new emphasis on qulality, consumers no longer trust an individual food firm, and instead look for quality from the entire chain that delivers the final food product. The best way for farmers and processors to compete in this new environment is by assuring quality at each level of the food production system through extensive coordination among the various agents in the system. An example of a dairy processing chain in France showed that a strong competitive position could be developed by creating a system for product tracking and monitoring from the dairy farmer to the final processor. Simon Barry discussed the possibilities of integrated production chains in the presentation on Farmer Controlled Businesses (FCBs) in Scotland. Similar to farmers' service cooperatives but with a strong profit orientation, FCBs achieve economies of scale not available to Summary of Workshop Deliberations xvii individuals. They constitute an effective organizational form for meeting the challenges of a competitive market, while maintaining farmers' control of production and supporting a vibrant rural economy. I[ighland Grain Limited, the FCB given as an example, processes, quality-tests, and markets malting barley on behalf of 75 member-farmers, while also maintaining a large machinery ring, a rural training agency, and an input supply service. This integrated chain helps member-farmer control their costs for better competitiveness. The FCB also acts to find new market niches anid develop new value-added products, a tas:k that is essential for improving profitability and is yet beyond the means of individual fanners. Anna Georgieva presented the results of a survey of farm services conducted among farmers, agribusinesses, and farm machinery owners in Bulgaria. While farm services are generally available in rural areas, lack of demand du. to declining purchasing power and unavailability of creclit is identified as a major problem. The tax system and the registration requirements are judged cumbersome and not entirely fair. Excessive fragmentation of land holdings is identified as one of the factors responsible for limited use of farm machinery and high cost of machinery services. Kalim Qainar presented a paper by Geoffrey Adtams and Keith Brent on the role of research and extension in farm competitiveness. Techno]ogy transfer needs to change from the centralized, government-run methodology of the past to a methodology that emphasizes private sector involvement, and appropriate policies must be in place to allow this to happen. A large share of financingr the research and extension system must continue to come from the government budget, but private sector providers of these services should also have an opportunity to emerge. The research and extension system needs to play a strong role to ensure that farmers hear about the most appropriate technologies and market opportunities and learn to judge for themselves what activities best suit their interests. After a few years of acljusting to the open market, CEE farmers will be quite competitive with western Europe, because they will have learned the harder lessons of farming wiithout the EU's high levels of protection. Olav Kreen reviewed the experience with the restructuring of the extension and advisory service in Estonia. The "bottom-up" Soviet system with extension experts in each farm enterprise served the needs of the large collective and state farms. Since independence, it has become clear that the needs of small farmers are not being met, and Estonia lhas been working to transform the extension system in three main ways: i) by creating new institutions for provision of extension and advisory services; ii) by focusing on creation of a client-oriented system; and iii) by initiating a "free market" for advisory services. The new extensior, service is still not oriented enough to the needs of the rural society, or to finding innovative so:Lutions to problems. These deficiencies should be corrected in the nearest future. The government has to be more proactive in disseminating information that affects the lower levels in the system, particularly with reference to decisions related to EU accession. xviii C. Csaki, Z. Lerman, and D. Bontempo SUMMARY SESSION AND CONCLUSIONS In the summary session, the country teams were given an opportunity to make an assessment of the proceedings and to speak on any topic important to them which may not have been covered by previous speakers. One of the more contentious issues in all countries is that of allowing foreign ownership of agricultural land, and many representatives emphasized that this option was not acceptable to their governments. There is a concern that the low prices for agricultural land associated with generally low farm profitability will allow foreign buyers to "grab" the most fertile land for speculative purposes. This land would then not be available to local farmers when their profitability and earnings recover in the future. This issue has implications for EU accession due to the EU requirements that prohibit discrimination among citizens of member nations. Responding to the concerns of the country representatives, John Nash from the World Bank pointed out that as productivity and profits increase in the luture, land prices will also rise, and countries should not worry so much about ownership changing into foreign hands for speculative reasons. Another issue of concern to many representatives involved compensation payments to farmers under an EU accession scenario. Representatives stressed the need for subsidies to ensure that farms in CEE countries earn higher returns to land. Angel Carro-Castrillo, speaking for the European Commission, responded that the countries should focus on competing for market share, and not for subsidy shares. The subsidies will be gone, or certainly diminished over time, and maintaining competitiveness to protect market share is vitally important. Subsidies from the EU should only be used to eliminate bottlenecks to better market function, and to strengthen market systems. Unfortunately, most of the subsidies requested are not of this ty,pe. Representatives from Bulgaria noted that government policy should not be designed to support any particular farm structure, but rather allow easy access to factor markets. Competitiveness can be achieved only if farmers get the best advice from the research and extension system, and the government has a very important role in ensuring that high-quality advice reaches every farmer. Another important aspect of competitiveness is creation of formal associations by farmers to increase their bargaining and political power. Representatives from the Czech Republic discussed the importance of farm size to success, noting that in their country larger farms had performed best. However, the large joint stock companies and cooperatives employ an excess of labor and capital, and must release some of these resources to become truly competitive. Government policy should focus on removing the barriers in factor markets to allow these adjustments to occur. Representatives from Estonia noted that they had had a free market for quite a long time, and to some extent competition had been bad for farmers. A new focus needs to placed on orienting agriculture to consumers, and finding off-farm opportunities for people displaced from their farns. The country needs more knowledge sharing, possibly through twinning arrangements with the EU. Summarty of Workshop Deliberations xix Representatives from Lithuania voiced some concern about whether their country's agriculture could be competitive in world markets without further privatization of land and restructuring of industry. There is also a need for further chanige in the production structure and techniques to modernize the sector. Agriculture still suffers from redundant labor, and government policies must assist with the development of off-farm employment. Representatives from Poland indicated that farmers must realize that in the new environment they are not simply agriculturists, but also managers, marketers, and salesmen. While government appears to be shifting its priorities away from agriculture, this sector has shown about the same rate of growth as the economy overall. Polish agriculture is fairly efficient relative to other sectors, and incentives to agriculture will not have any negative effect on the rest of the economy. In Romania, land regulations are still a problem, and some of the solutions proposed in the workshop could assist in refining them. The farm s:.ze appears to depend on the manager's ability to attract capital, and the most appropriate farm sizes will be sorted out naturally by the market. Romania lacks a strategy for restructuring the agricultural research system. There is a need for a more comprehensive public policy on rural developmnent. Slovakiai's agriculture is characterized by a seemingly permanent liquidity crisis, adverse terms of trade, and outflow of capital from agriculture. However, agriculture is only a small part of the national economy, and its difficulties are refleclions of the overall economic situation. Competitive private structures in agriculture cannot d-velop without access to land through functioning markets. While numerous private input suppliers exist in Slovakia, there is no transparency in the system, and farmers cannot get price lists to compare different suppliers. Slovakia has inherited a good research and extension system, but it is seriously underfunded. The challenge is to re-orient the system so that it serves farmers, and not the extension agents. Slovenia is different from the other CEE countries in that 90% of the farms are part-time, and overall rura,l development policies are therefore more important than strictly agricultural policies. There is an immediate need for better education and further restructuring of the sector, to create off-farm employment possibilities for the many rural residents who cannot rely on the farm for their livelihood. The workshop concluded with remarks by Kevin Cleaver of the World Bank. With the inevitable further integr-ation of CEE agriculture into the world market, it will be difficult, or impossible, to protect the agricultural sector from competitive pressures. Self-sufficiency is not realistic; instead, full integration into the world market should be the goal. Although the World Bank favors fully open markets for land, in most countries, other objectives, particularly regarding social protection, prevent this from being possible. Fully open land markets are also prevented due to distortions in other markets, most notably credit. With regard to the controversy over foreign ownership of agricultural land, we should note there is a continuing evolution in the world market for agricultural products. In order for countries to be competitive in this evolving market, much new entry into the system is needed, and public policy should facilitate this new entry, including foreign businesses. The workshop heard an argument against foreign ownership, xx C. Csaki, Z. Lerman, and D. Bontempo especially as it affects the non-economic objectives in country policies. However, a restrictive regulatory environment will diminish any country's ability to be competitive. In keeping with the Budapest precedent, the participants discussed the topic and the venue for the third EU Accession Workshop to be held in June 2000. It was agreed that next workslhop would deal with comprehensive rural development strategies for transition countries and would be held in Sofia, Bulgaria. Part One E.volving Farm Structures and Coimpetitiveness of Agriculture Structutral Change in the Farming Sectors of Central and Eastern Europe Second EU Accession Workshop in the Rural Sector, WVarsaw, Poland, June 27-29, 1999 Status of Land Reform and Farm R,estructuring in Central and Eastern ]Europe: A Regional COverview Zvi Lerman Agriculture has been at the center of attention of politicians and policy makers in Central Eastern Europe (CSEE) since the beginning of transition. This is attributable, at least in part, to the relatively high importance of the agricultural sector in this region as measured both by its share in GDP and, perhaps most significantly, by its share in total employment. Thus, during the 1980s, the last decade before transition, agriculture contributed nearly 20% of GDP and employed more than 20% of the labor force in most CEE countries. Czechoslcovakia and Slovenia were the only exceptions, but even in these "non-agrarian" countries the agriculture's share was around 10% of GDP and total ernployment. To put these numbers in perspective, they should be compared with the 15 EU countries, wlhere the share of agriculture during the same decade was around 4% of GDP and 8% of employment. And yet the lobbying powe:r of EU farmers is such that agricultural policy is always in the limelight of EU politics. Because of the special role of agriculture in CEE and the political prominence of this sector in the EU, it is appropriate to carry out an assessment of the changes in the structure of the farm sector in transition countries. Because of agriculture's large share in the economy and especially in rural employment, improvements in agricultural productivity through market-oriented reforms were originally expected to act as an engine of change and growth for all sectors in the CEE countries. The transition of agriculture from plan to market is a complex multidimensional process. Land reform and restructuring of large socialized farms - the topic of our pa3per - are perhaps the most visible and widely discussed components of this process. Yet agricultural transition includes other essential dimensions, such as development of functioning market services (both upstream for input supply and downstream for product marketing and processing), reduction of government intervention, emergence of rural credit institutions, technological improvement, new capital investment patterns, agricultural labor adjustment. These dimensions of change are both affected by, and impact on, the process of land reform and farm restructuring. They are moreover interrelated with poliltical forces, democratization of society, and other profound adjustments that accompany the transition from the pre-1990 reality to t]ne world of the 21st century. Many of these dimensions are discussed by other authors in this volume. The present paper provides a status report of land reform and farm restructuring in teii CEE countries that are candidates for accession to the EIJ in the near future and, at the end, briefly examines the intriguing interrelationships between land reform, growth, and political factors. 3 4 Z. Lerman THE INHERITED SYSTEM The CEE countries embarked in 1989 on a program of land reform and farm restructuring as a part of an overall strategy of transition to the market. Table 1 lists the main features of the inherited socialist system in agriculture, which set it apart from market-oriented agriculture and were responsible for its chronic inefficiency. Figure 1 illustrates the structure of land holdings in the socialist farm sector, clearly highlighting the dominance of collective and state farms and the low share of individual farming (except in Poland). The CEE farming structure on the eve of transition sharply deviated from that observed in market economies, where individual farms dominate and corporate farms are substantially smaller than the socialist collectives. Thus, in the USA, individual or family farms control 80% of agricultural land. Moreover, 90% of corporate farms are classified as family-held corporations, i.e., extensions of family farms incorporated mainly for tax reasons. The average farm size in the USA is less than 200 hectare, and the corporate farms (about 5% of all farming units) average about 600 hectare. The farm sizes in the EU are much smaller, with farms in the UK (the EU country with by far the largest farms) averaging 70 hectare. Table 1. Inherited Features of Socialist Agriculture Attribute Shortcomings Confused ownership of land Private ownership without real property rights; dominant state and cooperative ownership Collective organization of inefficient due to free riding, moral hazard, lack of individual incentives production Large farms (2,000 ha, 500 Inefficient due to high monitoring costs, anonymity, lack of transparency workers) Lifetime employment policy Inefficient due to inability to control costs by adjusting labor for farm members Centrally prescribed Inefficient due to lack of consumer orientation, insensitivity to market signals production targets Soft budget constraints Inefficient due to lack of profit orientation, reliance on writeoffs and subsidies The structure and organization of socialist agriculture were thus basically incompatible with a market-oriented economy. The main economic goal was to transform the agricultural sector from a centrally planned command system to a more efficient market-oriented system. This involved the need for macroeconomic and sectoral adjustments including elimination of central controls and introduction of hard budget constraints, as well as privatization of land ownership, a shift from collective to individual agriculture, and general downsizing of farms in line with the evidence of farm organization and farm sizes in market economies. In fact, the reform program was driven by a mixture of economic and political objectives. The purely economic goal of efficiency improvement was augmented by a set of political objectives, which were motivated by the desire to break with the Soviet-dominated past and do justice to the former owners, who lost their property rights after World War II. Both sets of objectives predicated a transition from collective agriculture managed through central planning to agriculture based on private property, where producers control their farming decisions in response to market incentives. The economic objectives focused on restructuring cf the Status of Land Reform anidl Farm Restructuring in Central and Eastern E.urope S traditional large farms. The political objectives, in addition to justifying the elimination of collective and state farms, tilted the land privatizatiori straLtegy toward restitution to former owners (rather ihan distribution to workers). The CEE land reform program thus involved two intertwined strands of privatization and farm restructuring, which were expected to improve the efficiency and productivity of agriculture and at the sarne time wipe out the main features of a politically undesirable fheritage. PRIVATIZATION O' LAND Private land ownership did not cease in most CEE countries after Structure of Land Holdings: Pre-1990 World War II. The only exceptions were the three Baltic states, where land was fully nationalized when Estonia, 100% Latvia, and Lithuania vvere absorbed in 80% the Soviet Uinion. (Albania also nationalized the land by its 1952 60% constitution, but this country remains 40% outside the scope of our discussion.) Yet even in countries outside the Baltic 20% states, the land wvas predominantly =% cultivated by cooperatives and state 0 Pol Czs Hun Rom Lit Lat Est Bul farms all through the socialist era (see -state farms oCooperatives 01ndvduaI Figure 1). Despite collective Figure I cultivation, much of the land (outside F the Baltics) remained nominally in private ownership, and the owners' property was actually registered in the old caclastre, which survived the war and the socialist takeover. Some of the land reverted to cooperative ownership as former owners or thleir heirs left the cooperative and moved to the cit-y (this phenomenon was particularly common in Hungary). Some of the land - primarily the land controlled by state farms - was nationalized through expropriation from large estates, the Church, Nazi collaborators, or other politically suspect individuals. Privatiza,tion of land was one of the first items on the reform agenda of all CEE governments after 1989. Who may own agricultural land in CEE? All countries allow private ownership of land by individuals, i.e., physical persons who are nationals of the country in question. Some CEE] countries (Estonia, Lithuania, Hungary) prohibit land ownership by legal entities. Cooperatives, corporations, and other private companies may own non-land assets, but must lease their land resources from individual land owners or the state. Finally, most countries prohibit ownership of agricultural land by foreign residents, or severely restrict the ownership rights of foreigners. This restriction of foreign ownership is a serious obstacle in the process of EU accession, as EU laws require that there can be no discrimination in land ownership rights for all nationals of member states. 6 Z. Ler7nan The CEE countries chose to privatize land mainly by restitution to former owners. F'oland is an exception to the restitution strategy, as the previous post-World War II land reform in this country distributed most of the estate lands to smallholders. Any demand for the Polish smallholders to give up their allotments in favor of former large estate owners would be politically and socially untenable, and the state accordingly focused on privatizing, through auctions and sale, the 20% of land that had been nationalized and transferred to state farms. For similar social reasons, the CEE countries did not extend their restitution programs to ownership rights before World War II and accepted the outcomes of the land reform that was implenmiented immediately following the liberation from Nazi occupation after World War II. Among the CEE countries with a restitution agenda, only Hungary and Romania recognized the rights o-f the current tiller who was not a former land owner and thus was not eligible to restitution: in the interest of social equity, land from cooperative and state reserves was also distributed without payment to agricultural workers in these two countries. In all other CEE countries, the current tillers had to pay for land, although they received "first-refusal" rights to the land that they were cultivating at the time. Restitution affected land that had shifted after World War II to cooperative or state ownership. It did not affect land that had always remained in private ownership. The actual restitution strategies differed among countries, ranging from flexible restitution in the form of transferrable value-denominated certificates in Hungary to rigid restitution of the original physical plots in Estonia. Yet in all countries the restitution process ran into considerable delays due to technical difficulties of identifying the claims, registering the privatized plots, and issuing titles to beneficiaries. Political indecisiveness and frequent course changes in some of the countries were not conducive to smooth progress of restitution either. At the end of the decade, the restitution process has been largely completed in practice, although final ownership titles have been issued to a relatively small proportion of claimants. In some cases, much of the state- owned land have not been claimed by former owners, and governments have targets for f urther reduction of state land reserves through continuing privatization (Table 2). Even in PoLand, where more than three-quarters of land remained privately owned after World War II ancd only about 20% in total had to be privatized, the progress with privatization has been less than satisfactory and the state still owns 15% of land. Table 2. Privatization of Agricultural Land in Selected CEE Countries (1997-1998 status) Privatized (final title) State-owned Lithuania 37% 63% Estonia 57% 43% (target 36%) Romania 71% 29% Czech Rep. 81% 19% (target 9%) Poland 85% 15% Despite the lack of formal titles and deficiencies in registration of ownership, all countries have procedures that allow users to lease plots from the large pool of state-owned land. Many corporations take advantage of this option by leasing land from the state. Many indivi,duals use land that they have received through the restitution process although they still do not have a final title to this land and it is not counted as privatized in the official statistics. The available figures for privatization of agricultural land (Table 2) therefore understate the actual use of land Status of Land Rejfrm and Farn Restructuring in Central and Eas,tern Evrope 7 by private producers. It is quite clear that, at present, state-owned land is not cultivated by the state. Most of the land still registered as state-owned is in fact cultivated by private individuals and private corporate farmrs (companies), because the formerly powerful state farms have been dismantled or transformed into private organizations. INDIVIDUALIZATION OF AGRICULTURE There is a sharp distinction between ownership of land and tenure or use of land. This distinction applies everywhere in the world, but especially in the context of transition, where land privatization suffers from technical and political delays, while use of land continues. To differentiate between the processes associated with these two distinct concepts in transition economies we use two terms, "privatization of land" to describe transfer of land into private (as opposed to state or collective) ownership, regardless of its use, and "individualization of farming" to describe transition to individual (as opposed to collective) cultivation, regardless of the ownership of cultivated land. Farming companies and corporate farms, even if run as private businesses with private ownership of land and assets, are not regarded as individual farms, primarily because of their management and share-ownership structure. Individual agriculture is possible without land privatization, and land privatization does not necessarily create individual farmers. Restitution usually involves allocation of physical land plots to beneficiaries (heirs of original owners), either through direct assignment or ultimately through auction mechanisms. Yet whether or not the physical allocation of plots leads to individualization of farming depends on what the owners decide to do with their newly recovered land. Some land owners - mainly rural residents - may take possession of their land and switch from collective to individual farming. Other individuals may lease their land to large corporate farms or enterprising farmers. Different motivations are possible for the mutually exclusive decisions to cultivate privately owned land individually or lease it out. Individual risk preferences provide one explanation: some land owners prefer the safety of the collective or corporate umbrella, with its professional management, to the unfamiliar risks of individual farming. Another explanation is that many beneficiaries left farming long ago and now have jobs and property in urban areas. Some restitution claimants may even hiave left the country: Hungary, for instance, recognizes the rights of heir of former owners who live abroad. All these individuals have no inmmediate personal use for their restituted land, and entrusting it to a larger corporation or cooperative mrakes good economic sense. These new land owners, of course, also have the option of leasing their land to other individuals who are actively engaged in farming and seek to increase their holdings. Leasing to private individuals, however, may look more risky than leasing to a large organization, which is regarded as a more reliable source of lease payments. Individually cultivated land has increased dramatically in all countries of the region since the beginning of transition (Figure 2). In Slovenia, Poland, anid Latvia practically all land is in individua:l tenure and there are no large collective or -orporate farms. The change has been particularly striking in Latvia, where, prior to 1990, less than 5% of agricultural land was in individual tenure (Slovenia and Poland never had a large collective farm sector). In most other CEE countries, the share of individually cultivated land is around 50%-60%, up from 5%-10% 8 Z. Lerman before 1990 (only the two Land in Individual Cultivation: 1990-1997 components of former Czechoslovakia lag in this 100 respect). Overall, the available data show that 65% of 80 agricultural land across the CEE 60 countries is in individual tenure (as of 1997). 40 20 Our emphasis on the distinction between individual- Svn Pol Lat Lit Est Rom Hun Bul Cz Svk ECEG ization and privatization is tr1s9 E1 attributable to two main sets of Without Poland and Slovenia factors. First, individual farming is the dominant organizational Figure 2 form in market economies. As long as production is managed collectively or cooperatively, the organization is exposed to the dangers of moral hazard, shirking, and free-riding that may severely impair its economic performance. This is the standard argument against production cooperatives and collectives, which are seldom observed in market economies. Private companies and corporations, even when not organized as cooperatives, suffer from transaction costs associated with principal agent arrangements and labor monitoring difficulties, and their spread in market agricultures is also limited due to elusiveness of scale economies in farming. As noted previously, corporate farms control not more than 20% of agricultural land in USA, and only about one-tenth of these farms are true investor-owned corporations; the rest are basically family farms that incorporated for a variety of tax reasons. Second, farms in market economies are not restricted to operator's own land, and farmers increasingly rely on land that they lease in from others. Thus, in Belgium, France, and Germany, over 60% of land in farms is leased, and not owned by the farmer. On average across the 15 countries of the EU, farmers lease in 40% of land that they cultivate. In the USA, only one-third of farm land is fully owned by the operator, and this percentage has been declining steadily since 1950, while the percentage of leased land in farms has been increasing. Analysis of the EIJ data shows that individual farms using a higher percentage of leased land are on average larger: farms using more than 30% of leased land average 39 hectare across the 15 EU countries, while farms using less than 30% of leased land average only 18 hectare. In the USA, farms in which land is fully owned by the operator average about 100 hectare, while farms in which owned land is augmented by leased land are more than three times as large (340 hectare on average). Surveys conducted by the World Bank and Phare/ACE in some CEE countries also show that individual farms with leased land are significantly larger than farms using own land only. Thus, in Hungary individual farms that lease land average 20 hectare compared with 3 hectare for farms 'without leased land, in Bulgaria 5 hectare compared with 1 hectare, and in Romania 4 hectare comnpared with 3 hectare. The frequency of land leasing among individual farms in CEE countries, however, is still very low, much lower than the frequency of leasing among farms in E,U and USA. Status of Land Rejorm and Farm Restructuring in Central and Easiern Europe 9 Leasing, and not land ownership, appears to be the important mechanism for increasing farm sizes in market economies. Farms need not be constrained by the limited availability of own land: farm sizes can adjust through land leasing as long as fanners are guaranteed secure tenure and market institutions are available for reasonably smooth transfer of land use rights. Thus, there is no reason to be concerned about excessive fragmentation of land produced by various land reform strategies. Initial fragmentation that may arise through certain allocation and distribution procedures will be quickly corrected by market mechanisms if land markets are indeed allowed to function. RESTRUCTURING OF FARMS Prior to 1990, collective and state farms cultivatedl around 90% of Distribution of Farrn Land by Organizational Form agricultural land in the CEE countries (except Poland and Slovenia). After a 100% decade of transition the share of large 80% farms that succeeded the traditional socialized farm is down to 40% of 60% -Individual MMorporate agricultural land (Figure 3). The i o erate decline in the share of Land controlled 40% .-State by large farms lhas been accompanied 20% - by significant reorgatnization and restructuring of the sector. In addition 0% Pre-1990 Post-1990 to the significant increase in the amount of individually cultivated land, the Figure 3 process has led to virtual elimination of state farms, drastic reduction in the importance of cooperatives, and creation of a new category of private corporate farms (companies). The farms in all organizational categories are now substantially smaller than the former cooperatives and state farms. The individual farms, on the other hand, are larger (see Table 3 below). As the share of traditional collective and state farms declined through restitution and restructuring, new corporate farm structures began to emerge in the CEE countries. Unfortunately, no cornprehensive data are available on the operation and management of these new entities, but case studies suggest that in Hungary, the Czech Republic, and Estonia many of the large farms have transformed into market-driven corporations. In Romania, at least some of the large farms are new associations or cooperatives created voluntarily by individual landowners after the completion of land privatization. The large corForate or cooperative farms in CEE are now often forced to operate under hard budget constraints, with a real threat of bankruptcy proceedings in case of default. 10 Z. L,erman Figure 4 is a schematic diagram of farm restructuring in CEE, illustrating the processes that have led to the growth of the individual sector and the reorganization of the socializedc farm sector. The changes in farm structure are driven primarily by three processes: restitution of land ownership, privatization of state property, and reorganization of cooperatives into new private companies. Restitution is the main channel for the growth of the individual sector, as it shifts land resources from former cooperatives and state farms to new individual owners. Land not claimed by individuals remains in state ownership. Privatization of non-land assets of state farms through open auction and sale mechanisms (i.e., through channels other than restitution to former owners) leads to creation of new corporations or companies, which may be classified as state- controlled (with minority private interests) or private (with majority private shareholders). Finally, cooperatives may reorganize creating new private corporations or new, sometimes smaller cooperatives. In some countries (Estonia, Lithuania, Hungary), the various corporate forms ("legal bodies") cannot own land: they lease their land resources from physical persons. Initial structure New structure Adjustment by leasing State- controlled State farms Priatization of corporations Leasing to state property l egal entities Private Reor anization - corporations Cooperatives Cooperatives Non-farming Leasing from land owners non.farmers Restitution of land ownership Leasing to individuals Individual Individual farms Leasing among farms farmers Figure 4. Schematic Representation of the Farm Restructuring Process in CEE The transition from the initial inherited structure to a new structure is just the first stage in the overall process. The changes in farm structure continue as a dynamic adjustment of farm sizes through land transactions. These are mainly leasing transactions, as buying and selling of land is reported fairly seldom. Individual recipients of restituted land who are not interested in farming may lease their allotments to corporations or other individuals. On the other hand, enterprising individuals may seek to increase their holdings by leasing surplus land from Status of Land Rejfortn and Farm Restructuring in Central and Eastern Europe I1 cooperatives and corporations (in countries where corporate land ownership is allowed). Land markets thus sustain transfer of land resources to more active and more efficient producers, leading to gradual optimization of the farm sector through restructuring. EMERGING FARM STRUCTURE Large-scale collective or corporate farms continue to play an important role in agriculture in CEE outside Latvia, Poland, and Slovenia. In seven CEE countries (Hungary, Bulgaria, Romania., Czech Republic, Slovakia, Estonia, and Lithuania) about 40% of agricultural land is in large-scale non-individual farms. However, the diversity of large farm structures today is much greater than prior to 1990, when the Soviet-style cooperative and state farm were the only two organizational forms in socialist agriculture. While traditional cooperatives and state farms persist (in greatly reduced numbers), new corporate farming structures are registering as joint- stock societies, limited-liability partnerships, and private companies. The new large farms in some CEE countries, certainly those in Hungary and the Czech Republic, are profit-motivated business corporations with freedom to adjust their labor force to operating needs and to reward labor according to performance. Moreover, these farms operate under hard budget constraints that impose strict financial discipline and rule out reliance on government bailouts. Table 3. Average Farm Sizes by Organizational Form in CEE Countries (in hectares) C'ollective/cooperative State farms New Individual farms farms corporate = Pre-1I990 | Current Pre-1990 Currenl. Current Pre-1990 Current Bulgaria 4,000 637 1,615 735 -- 0.4 1.4 Czech Rep. 2,578 1,447 9,443 521 690 5.0 34.0 Slovakia 2,667 1,509 5,186 3,056 1,191 0.3 7.7 Hungary 4,179 833 7,138 7,779 204 0.3 3.0 Poland 335 222 3,140 620 333 6.6 7.0 Romania 2,374 451 5,001 3,657 -- 0.5 2.7 Estonia 4,060 - 4,206 - 449 0.2 19.8 Latvia 5,980 - 6,532 340 309 0.4 23.6 Lithuania# 2,380 - 1,880 - 310 0.5 7.6 Slovenia - - 470 371 -- 3.2 4.8 # Average size of collective, state, and corporate farms in Lithuania is based on unpublished OECD data. Source: Agricultural Sitiration and .Prospects in the Central and Eastern European Countries: Summary Report. European Commission, Directorate-General for Agriculture (DG VI). Brussels, 1998. Changes are also observed in the average farm size in CEE countries. We have noted previously that the socialized agriculture was characterized by substantially larger farms than the market economies. Although large farms continue to dominate the agriculture in most transition economies, a definite downsizing is observed since 1990. Large collectives, cooperatives, and state farms have been losing land through restitution and privatization. Internal restructuring of large farms in an attempt to achieve better market orientation has often led to division of the original enterprise into two or three smaller units. As a result of these processes, cooperatives and state farms in CEE are now substantially smaller than in the pre-1990 period (Table 3). The new corporate farms created in the process of farm transformation in CEE countries are also smaller 12 Z. Lerman on average than the traditional Downsizing of Large Farms During Transition cooperatives and state farms, although they are still large by the 6 thou. ha standards of market economy (Figure 5). Unfortunately, the ....2 . ..... . .0 available data make it impossible to 4 determine if the downsizing of large 3_ _ 1-,l Pre-1990 A-: ESi g x S S k -gS<-3-0 02:00 I EgPost-1990 farms is a continuing dynamic Post 190 phenomenon, or if it was a one-time adjustment. Experience in market economies definitely suggests that o L I further downsizing of large farm State Cooperative Corporate enterprises in CEE is desirable. Figure 5 While the very large socialist farms have become smaller, the average size of individual holdings, be it household plots or other family farms, has increased substantially across the region. The increase of individual iarms in CEE is clearly shown in Table 3. There is some evidence that the individual farms in CEE are gradually differentiating into two distinct groups: very small units cultivated by part-time farmers (successors of the subsistence-oriented household plots from the pre-1990 era) and larger commercially oriented full-time individual farms, which are in fact responsible for the observed increase of the average farm size in the individual sector in CEE. As a result of the opposing processes that reduce the size of collectives and augment the individual holdings, while creating a new intermediate layer of larger individual farms, the agriculture in transition economies may be gradually losing the sharply bimodal structure that traditionally characterized the farms in the socialist era. This in itself will be a change in the direction of greater compatibility with farm structures observed in market economies. To examine the extent of the adjustment in farm structures during transition, it is useful to compare the farm size distribution in CEE with that observed in market economies. In Figure 5, panel (a) shows the aggregated land concentration curve for farms in the 15 countries of the European Union (EU15), constructed from Eurostat data. Land concentration is presented by a standard "Lorenz inequality curve" in which the vertical axis gives the cumulative percentage of land used in farms and the horizontal axis gives the cumulative percentage of farms of all types, ranked by size. The straight diagonal line represents the situation of "ideal equality," when land is uniformly distributed over all farms so that 50% of farms, say, account for 50% of land. The downward-bulging curve reflects the actual farm structure in the EU, with land use distributed nonuniformly over small and large farms. From this curve, the bottom 50% of EU farms (the smallest farms by size) account for 10% of land use, while the top 10% of EU farms (the largest farms by size) account for 40% of land use. The land concentration curves for USA and Canada are virtually identical with the EU curve in Figure 6; this pattern of land concentration therefore may be accepted as representative of market economies. Status of Land Reform and Farm Restructuring in Central and EastErn Europe 13 (a) Concentration of Farm Land in the European Union (EU15) percent of land 100 60 - - - - - - - - /- - / 40 - / OS1 . C I . . 0 20 40 60 80 100 percent of farms (b) Bulgaria (c) Hungary 100 percent of land percent of 80 /---o 80 60 - - - -D - - - - - - -60 40 ~~~~~~~~-,40 20 ____ 20~~~~~~~~~~~~~~~~~~~~~ 0 - 0 20 40 60 80 100 0 20 40 60 80 100 percent of farms percent cf farms Based on 1.2 million farms (d) Slovakia (e) Czech Republic 10percent of land 80 - - - - - - -60 ------ 60~~~~~~~~~~~~~6 60 - - - - - - - -~~~~~~~~~~~~~6 0 20 0 20 40 60 80 100 0 20 40 60 80 100 percent of farms percent of farms Include. 500,000 household plots Figure 6. Concentration of farm land in 15 countries of the European Union (panel a) and in ten CEE countries (panels b-k). 14 Z. Lerman (f) Poland (g) Slovenia percent of land percent of land 100 1 00 ------- 40- ------- ----40---- 20- - - - - - -20- - - -- - - - - tO0 / I 0 Xl 0 20 40 60 80 100 0 20 40 60 80 100 percent of farms percent of farms Based on 3.1 million farms from 1996 census Based on 141,000 units, including estimated 50,000 household plots (h) Romania (i) Estonia t0o percent of land 100 percent of land 80 - - - - - 80 - - - 6 ~~~~~~~~~~~~~~~~~~~~ 0 - - - - - - - - -/ /-0 20 , . ,/, 0 20 0 0 20 40 60 80 100 0 20 40 60 80 100 percent of farms percent of farms Data by Kiusk and Elmet, Trtu Univ. () Lithuania (k) Latvia oo precent of land percent of land 80 - 80 - - - - - - - _ - - - 0 I I 40 0 20 40 60 80 100 0 20 40 60 80 100 percent of farms percent of farms Based on 220,000 private fans, 313,000 housshold plots Includes 156,000 household plont Figure 6 con't. Concentration of farm tland in 15 countries of the European Union (panel a) and in ten CE1E countries (panels b-k). Status of Land Rejbrm and Farm Restructuring in Central anid Eas'ern Eutrope 15 Other panels in Figure 6 present land concentration curves of the ten CEE countries. The CEE land concentration curves are based on available official statistical data on farm size distribution, which are unfortunately weak. In constructing these curves, we always tried to estimate the nurnber of farming units that control all agricultural land in each country. In this way, the distribution curves include household plots, semi-commercial and commercial family farms, and the larger corporate structures. The land concentration curves are based on the actual use of land, and are not directly related to land ownership. We should stress that the land concentration curves define "small" and "large" in strictly relative, and not absolute, terms; nor do they provide an indication of average farm sizes in different countries. The absolute size of farms varies across countries depending on the available land resources and the number of beneficiaries (i.e., the rural population). Land concentration curves abstract from these factors and only present the relative pattern of distribution of farm sizes. Table 4. Coicentratilon of Land: Percentage of Agricultuial Land in Top 10% of Largest Farms Country Percentage o Characterization of farm structure farm land _ Latvia 20 over-fragmented Lithuania 30 USA 35 Canada 38 EU1i 40 Slovenia 40 "nonnal" Poland 50 Romania 55 Estonia 60 Czech Republic 82 sharply dual Bulgaria 90 Hungary 92 Slovakia 97 The land concerntration curves in Figure 6 demonstrate the three main farm structure patterns observed in CE]E transition economies. Four countries - Bulgaria, Hungary, Czech Republic, and Slovakia - sharply deviates from the market pattern. Here 90% of farming units (the small household plots and family farms) control less than 10% of land, and the top 10% of farming units - the largest collective and corporate farms - control about 90% of land. This pattern is a manifestation of a sharply dual farm structure, with millions or hundreds of thousands of very small farms at the bottom end of the size scale and thousands or merely hundreds of very large farms at the top end. The sharply dual farm structure was a dominant feature of the Soviet model of agriculture in the pre-transition era, with an even more dramatic concentration of land than what we observe today: 98% of Soviet farms (the imillions of small household plots in the individual sector) controlled less than 2% of land, while 2%7o of the largest farm enterprises controlled 98% of lancl. The encouraging changes in farm structures discussed in previous paragraphs have measurably shifted the land concentration curves for the CEE countries, but they have been insufficient so far to produce a significant change in the sharply dual structure of traditionaLl socialist ajgriculture in the four countries of the first group. 16 Z. Lerman Romania and Estonia and representatives of the second group of land concentration patterns. These two countries, starting with a sharply dual Soviet pattern, have developed in the process of transition farm structures that are close to the market pattern of land concentration. Slovenia and Poland are also characterized by "normal" land concentration curves, although this probably is not a result of transition-related adjustment: the farm structure in these countries has always been characterized by predominance of small and medium-size farms and has not changed much since 1990. Latvia and Lithuania, on the other hand, seem to have overshot in the process of adjustment, and their farm structures today are over-fragmented compared with irmarket economies. Table 4 summarizes the differences in farm structures across CEE by presenting our land concentration measure - the percentage of agricultural land controlled by the top 10% of largest farms in each country. If we accept the market pattern in Figure 6(a) as an efficiency-optiinizing equilibrium farm structure, then countries with sharply dual farm structures - Bulgaria, Hungary, Czech Republic, Slovakia - can be expected to undergo further downsizing of large farm enterprises and simultaneous consolidation of the very small farming units. Countries with over- fragmented farm structure - Latvia, Lithuania - can be expected to go through a phase of farm consolidation, as very small farms adjust their holdings to operationally more efficient sizes and a certain proportion of new large farms are re-created under suitable conditions. In countries in the "normal" group the process of adjustment will probably continue as well, although less dramatically. These countries will probably gradually move toward stronger presence of mid- sized farms through consolidation of the smallest holdings and further fragmentation of the large successors of state farms and cooperatives. SECTORAL CHANGES DURING TRANSITION We started by reminding the audience of the relatively high Marginalization" of Agriculture importance of agriculture in CEE countries in the pre-transition era. share of agriculture in GDP/total employment, % During the last decade the situation has changed, and the CEE 20 - - - - agriculture is undergoing a process of "marginalization," similar to that observed in the EU. Alternativ 10 e ------------- sectors - especially services - are gaining prominence, and the share of........... agriculture in the economy isGE:GP E;lao EUGO E:lbr dropping, especially in GDP, less so CEE: GDP CEE: labor EU: GDP EU: labor E::Pre-1990 =IPost-1990 in labor (Figure 7). Yet despite Figure 7 these trends, agriculture remains a much more important sector in CEE than in the EU. It continues to be a major source of employment in rural areas, employing over Status of Land ReJiorm aind Farm Restructuring in Central and Eastern Europe 17 15% of the total labor force (compared to 5%-6% in the EU). The rural population is particularly dependent on agriculture in Bulgaria, Poland, Romania, Latviia, and Lithuania: in each of these countries the share of agriculturally employed is over 20%. Transition initially produced enormous dislocations and shocks in the economy in general and in agriculture in particular. The elimination of central planning, price liberalization, introduction of ]hard budget constraints - these were entirely novel rules of the game and the countries needed time to adjust. Both GD]P and GDP Indey for CEE: 1989-1997 agricultural production declined dramatically 140 during the first years of transition, between 1989 120 - --CZ and 1992-93. But as of 100 - - -Est 1993 we are witnessing a -___-Hun clear stabilization of both 80 - - -Liat indices. There are, of 60 -- - Pol course, variations across 40 - - --R-mvk countries, but as a regional -Svn average the GDP index is 20 - -CEE actually growing again, and 0 the agricultural product 1989 1990 1991 1992 1993 1994 1995 1996 1997 index has definitely stopped Figure 8 declining (Figure 8). The stabilization of agricultural production has Share of Livestock in Agricultural Product Before and During not been accornpaniedL by Transition dramatic changes in __ product mix or in yields. 80 Only the three Baltic states, 70 - and to a lesser extent 60 - - - X Hungary, have significantly 50 - - - - - I reduced the share of 4llPre-1990 40 livestock in their output 0 Post-1990 (Figure 9) and today 3 livestock procluction in 20 CEE countries is on a par 10 with the rest of the EU 0 (about half the total Bul Hun Pol Rom Cz Svk Est Lat Lit agricultural product).Wheat Figure 9 and milk yielcls in iCEE hardly changed durirng the last decade, and they continue to be substantially lower than in the EU, where technological progress is continuously driving the yields up (Figure 10). 18 Z. Lerman The decreasing role of agriculture in the CEE economy is reflected also in the decrease of absolute levels of agricultural employment. Five of the ten CEE countries (Hungary, Latvia, Slovakia, Czech Republic, and Estonia) registered sharp declines in agricultural employment since 1992 (Figure 11). In Lithuania and Slovenia the level of agricultural employment remained unchanged, and only Romania, Bulgaria, and Poland show significant increases in agricultural employment. Changes in gross Wheat and Milk Yields: CEE and EU agricultural output and Pre-1990 and Post-1990 agricultural employment lead to changes in productivity of labor 6 ton/ha or ton/cow in agriculture. Generally the decrease in agricultural 5 - - - - -- -- employment more than offset the decrease in GAO, and the 2t 9 g:JiJ U i k 1 R R X A A ¢>f~~~~~~~~~oPe-19902 productivity of labor tended to 3 EU: 990 ImPost-19i g-row. Five countries (Estonia, 2 Czech Republic, Slovakia, Hungary, and Slovenia) register 1 pronounced increases in productivity of labor in 0CEE: wheat EU: wheat CEE: milk EU: milk agriculture, and these are clearly attributable to the decline in Figure 10 agricultural employment (Table 5). In Bulgaria, Poland, and Agricultural Labor: Growth Rate 1992-1997 Romania, where agricultural employment actually increased, the productivity of labor has not Rom - declined because of matching Bul growth in agricultural product. PoL Only two countries, Latvia and LitQ ) Lithuania, show a decrease in the Svn(*) productivity of labor since 1992, Hun i mainly due to sharp decreases in Lat - GAO. Svk Czech [- Since physical yields have Est _______ii_____- not changed significantly during -15 -10 -5 0 5 0 the last decade and unfortunately (*) Change not significant at p=0.05 the last decade and unfortunately reliable information is not Fh!ure 11 available on the capital asset base in agriculture, changes in productivity of agricultural labor provide a good proxy to changes in the efficiency of agriculture in CEE countries. We may thus tentatively conclude that, during the last decade, the efficiency of agriculture has increased in the Czech Republic, Slovakia, Estonia, Hungary, and Slovenia (primarily due to decline in agricultural employment) and has not Status of Land Refonn and Farm Restructuring in Central and Eastern Europe 19 improved in Romaniia, Bulgaria, and Poland (where agricultural employment increased). Lithuania and Latvia still have not recovered from the negative shocks to production and output, and it is premature to evaluate the efficiency of their agricultural sector. Table 5. Chan es in l'roductivity of A ricultural Labor and Their Relationship to Reform Policy Index* State Change in gross Change in Change in Synthetic policy index agricultural agricultural productivi ty of product employment agriculturzl labor country values group averages Czech Rep. -2.19 -10.9 9.78 7.74 7.5 Slovakia 0.54 -6.34 7.35 6.82 Estonia -7.74 -13 6.05 6.89 Hungary 0.17 -3.91 4.25 7.92 Slovenia 4.89 0 3.76 7.88 Romania 4.1 4.27 -0.15 5.55 6.3 Poland 1.44 2.24 -0.78 7.49 Bulgaria 1.49 2.37 -0.86 5.50 Lithuania -3.18 0 -3.18 6.45 Latvia -11.49 -4 -11.49 6.47 * The changes are annual rates of change for 1992-97 calculated, in percent, from semi-logarithmiic growth regression. The synthetic policy index is on a scale of 1 to 10, with higher values corresponding to greater progress toNvard market environment. In addition to changes in GAO, changes in agricultural employment, and the resulting changes in productivity and efficiency of agriculture, Table 5 gives a synthetic policy index, which represents the curmulative progress of overall refonns in each country. Our synthetic policy index is the average of five policy indices available from intemnational sources. It combines three World Bank indices (the Country Policy and Institutional Assessment (CPIA) Index, the Liberalization Index, and the Environmentally and Socially Sustainable Development ECA Index), the Euromoney Creditworthiness Index, and the Freedom House Freedom Index. The CPIA Index is based on four groups of policy variables that are not directly related to agriculture: macroeconomic management and sustainability reforms; policies for sustainable and equitable growth; policies for reducing inequalities; and public sector management. The 20 variables collected in these four groups are assessed by a mixture of expert judgments and quantitative techniques to anive at at measure of progress in economic policy and institutional reforms. The ECA index is specifically geared to agricultural reforras in transition economies: it includes assessments (based on expert judgments) of the achieved. progress in several areas, such as price and market liberalization, privatization of agro-processing and input supply, rural financial systems, development of market-oriented institutional frameworks, and of course land reform. The three other indices, in addition to economic and financiaL dimensions, incorporate various measures of political freedoms and democratization that are an inevitable part of the transition to the market. For all indices, higher values correspond to greater progress toward a market environment. We see from Ta'ble 5 that, on a scale of 1 to 10, the countries showing an increase in the efficiency of agriculture have an average index value of 7.5, while the other countries, where the efficiency of agriculture has not improved, have a significantly lower average index value of 6.3. It thus seems that greater progress with general reforns, including macroeconomic policies, 20 Z. Lerman financial institutions, and democratization, is conducive to greater progress in agriculture, leading to noticeable changes in efficiency. Privatization and individualization of agriculture and changes in farm structures are necessary conditions for the recovery of agriculture. And yet they are probably not sufficient without an overall reform-minded environment and general reform- oriented policies and attitudes in government and society. WHERE TO FROM HERE? The course of transition during the last decade has displayed at least two surprising features. First, the process has been much slower than originally anticipated. And second, the actual outcomes meet neither the optimistic expectations of market liberals nor the dire predictions of conservatives. The transition from command economy to market has been a long-drawn process because of its intrinsic complexity, which was not fully appreciated at the start. Yet it is clear that, despite difficulties and delays, all CEE countries are moving steadily toward a market-oriented environment. The policy achievements vary across the region, largely depending on political and social forces, but as we see from Table 5 all countries have passed the half-way mark of 5.0 in their transition from command economy to market. The one attribute of the former system that has been totally and irrevocably abolished is central planning. This is probably the one attribute that has made the former economic and social structure possible. Now that it has been eliminated, many of the traditional accepted patterns of behavior and operation in agriculture and other sectors are unsustainable. There is no choice but to move forward with market reforms. The agricultural sector in CEE definitely has not embraced the family farm as the dominant farming structure. This is contrary to the original expectations of Western experts, who anticipated a quick and sweeping transition to individual farming as in market economies. Yet the individual sector has grown dramatically and it controls today 60% of agricultural land in CEE countries. Despite this strengthening of the smallholder sector at the expense of the large farms, agriculture did not collapse because of fragmentation and privatization, as predicted by conservative doomsayers. Farm structures in CEE today cover a spectrum of forms, which include small subsistence-oriented household plots, medium-sized commercial family farms, and large corporations. The amount of land controlled by the individual sector is unlikely to shrink in the future. Yet market forces will probably continue to produce significant internal restructuiing in the individual sector, encouraging consolidation through transfer of land resources fromn very small units to more efficient mid-sized farms with commercial orientation and greater earning potential. The large corporate farms are also there to stay, yet market forces and efficiency considerations will probably sustain the downsizing trend that has been generally observed so far. Consolidation of mid-sized family farms and downsizing of very large corporations will ensure that the CEE farm structure continues to move toward the market distribution pattern. Status of Land Reform and Farm Restructuring in Central and Eas,tern Eutrope 21 Finally, a,griculture does not seem to act as an engine olF growth in the CEE countries. The available evidence suggests a reverse causality: it is the general macroeconomic recovery stimulated by a progressive policy environment that encourages agricultural growth. Yet agriculture remains important for the rural population: empirical evidence clearly suggests that the welfare of rural families increases with the increase in their land endowment. However, the future of the rural popujlation must be considered in a broader context of rural development, including creation of alternative jobs in rural areas that will facilitate the exit of surplus agricultural labor without involving the undesirable option of rural-to-urban migration. The countries should take advantage of the adjustments required for EU accession to broaden the scope of reform and to include rural development issues in their agenda in addition to the traditional agricultural topics of land privatization and farm restructuring. A NOTE ON SOURCES OF DATA The most recent and up-to-date country-level information was obtained by direct correspondence with national research institutes and statistical organs in the ten countries participating in the conference. The willing and friendly cooperation of many individuals in these institutions is gratefially acknowledged. Without them, much of the latest data on agricultural transition would have remained unavailable. In addition to these direct contacts, we have used the data from a series of country studies commissioned by FAO for this workshop and by OECD for the Forum on Agricultural Policies in Non-Member Countries held in Paris in April 1999. Important data were obtained from the Directorate-Gieneral for Agriculture (DG VI), European Commission, Brussels. Specifically, we have made extensive use of the series of country and summary working documents published in 1998 under the general title of Agricultural Situation and Prospects in the Central and Eastern European Countries. Pre-1990 data for former Comecon member-countries were obtained from Statistical Yearbook of Member-Siates of the Council for Economic Mutual Assistance, regularly published in Russian in Mosccw up to 1990. The pre-1990 data for the Baltic states were collected from Soviet statistical yearbooks. Comparative data for market economies were obtained from Eurostat yearbooks (for EU countries) and from the 1997 USDA Census of Agriculture (for USA). Structural Change in the Farming Sectors of Central and Eastern Europe Second EU Accession Workshop in the Rural Sector, Warsaw, Poland, June 27-29, 1999 Major Features of the New Farming Structures in Cerntral and Eastern Europe Erik Mathijs Johan F.M. Swinnen FARM RESTRUCTURING A wide variety of farm organizations, such as (private) cooperatives, joint stock companies, limited liability companies, partnerships and individual farms have emerged during transition in Central and Eastern European countries (CEECs). Table 1 distinguishes between four production organizations: state farms, cooperatives, companies, and individual farms. Cooperatives and companies still use more than a quarter of total agricultural land (TAL) in Hungary, the Czech Republic, and Bulgaria. In Slovakia, they use more than half of TAL. Companies are most important in Slovakia (25%), Estonia (37%) and the Czech Republic (41%). The dynamics of farm restructuring is illustrated by the case of Hungary in Figiure 1, which shows that the share of companies was fairly stable over the period 1989-1996, while the share of cooperatives consistently declined, especially in the period 1991-1995. The relatively constant share of companies hides significant restructuring efforts among the farms in. this category, but Figure 1 clearly suggests that the importance of cooperatives as an organizational form of agricultural production is declining. Table 1. Share of different farm types in total agricultural land (in %) Individual farms Companies Cooperatives State farms Poland (1996) 82 8 3 7 Hungary (1996) 28 14 28 4 Czech Rep. (1998) 24 41 34 1 Slovenia (1997) 96 4 Estonia (1997) 63 37 Romania (1998) 65 18 17 Bulgaria (1995/6) 52 42 6 Slovakia (1998) 8 25 54 1 Lithuania (1996) 67 33 Latvia (1997) 95 4 1 I Source: European Commission (1998) and national institutes of agricultural economics in the Czech Republic, Slovakia, and Romania 22 Major Features of the New Farming Structures in CEE 23 -INDIVIDUALIZATION OF CEE FARMING The share of individual farming has increased continuously 100% since the beginning of transition, and90 - this increasing 'indiviclualization of 80% - - - - - - - - farming" is a common pattern in all 70% - - - - - - - - CEECs (Figure 2). T'he available data 60% - - l do not indicate any reversal of this 21 9 ; 400/ - trend so far. 30 200/-- Despite the simnilar trend in all 10% - . * - - - * countries. the differences in the 0% * -4 importance of indivi.ual fanning 1989 1990 1991 1992 1993 1994 1995 1996 among CEECs are enormous. Table 2 * ndividuaI farms oCo-operativs iCompanies presents our calculations of the farm Figure 1. Share oi land use by different farm types in individualization index (FIH), based on Hungary: 1989-1996 (%, of total agricultural land) the percentage of agricultural land used by individual farms adjusted for I _l _I the initial situation. FII varies between 100 3% and 95%. FII is lovv in countries 90 - - - - - - - where large-scale successor 80 organizations to the former state and 70 t - - - - - - - - - l collective farms still. donminate, such 60 - - - - - - - - ° polI as Slovakia (3%) and the Czech |50 - - - - hu 40 --a- ---- - ---C Republic (24%). FIT is highest in | - - - - -- - - sk Albania and Latvia (9:5%) where a 20 - K ro massive break-up of the collective 10 e bu farms resulted in dominance of small- 0 1 X ____£ ___v (_ snO scale production units. 89 90 91 92 93 94 95 While the b:reak-up of state Figure 2. Share or land use by individual farms: and collective farms into individual 1989-1995 (% of itotal agricultural land) farms is often associated with farm Legend: Poland (pol), Huingary (hu), Czech Republic (cz), fragmentation, this is not always the Slovakia (sk), Roniania (iro), Bulgaria (bu), Slovenia (sn) case. Some individual farms in I __ __I CEECs cover 100 hectares and more. An important factor explaining farm fragmentation is the size of the rural wor]k force: there is an almost perfect linear correlation (regression R2 = 0.92) between the share of TAL in farms less than 5 hectare, as a measure for fragmentation, and the share of agriculture in the economy (Mathijs and Swinnen 1998). 24 E. Mathijs and J. Swinnen Table 2. Farm Individualization Index (FII) Country FII Year Latvia 94.7 1997 Albania 94.2 1995 Lithuania 60.4 1996 Romania 60.2 1998 Hungary 51.1 1996 Slovenia 50.0 1997 Bulgaria 44.8 1995/6 Czech Republic 24.0 1998 Ukraine 14.1 1995 Russia 12.1 1995 Slovakia 3.2 1998 * The Flf is calculated by dividing the difference between the share of individual farms in total agricultural land in the most recent year (IND9X) and in 1989 (1ND89) by 100 minus the share of individual farms in total agricultural land in 1989: FJI=(IND9X-IND89)/(100- IND89). Data on land use are derived from European Commission (1998) and Mathijs and Swinnen (1998). FACTORS AFFECTING FARM RESTRUCTURING Farm restructuring depends on the pre-reform farm structure, on the design of the privatization and transformation policies (itself influenced by political economy factors), on the implementation of the policies, and on a series of factors, including the economic and social environment, all of which affect the restructuring process. Macro Evidence Based on a comparison of countries, Mathijs and Swinnen (1998) conclude that thel shift to individual tenures is stronger where: (a) more of the land was distributed to farm workers instead of being restituted to former owners; (b) the share of agriculture in employment is high; and (c) the costs involved in withdrawing assets from collective farms and starting up an individual farm (so-called "exit costs") are low. It is remarkable to see how the two countries at the extremes of the spectrum are exactly opposite by these three factors. Albania, where FIl is highest, distributed all the land to farm workers, and has a high share of agriculture in employment (around 50%), and low exit costs. Slovakia, where FIH is lowest, restituted ]Land to former owners, has a low share of agriculture in employment (around 8 %), and the exit costs are high. Additional factors have stimulated decollectivization in the Baltic countries, and especially in Latvia, where decollectivization was part of the independence strategy. Micro-Survey Evidence Based on 1996 household and farm survey data from Romania (Rizov et al. 1999) and 1998 survey data from Hungary (Rizov and Swinnen 1999), several conclusions can be drawn on the determinants of the shift to individual farming. In general, the process is affected by human capital and physical capital endowments of the household, reflected in factors such as age, Major Features of tl,e New Farming Structures in CEE 25 education, and expeirience, by regional social and economic conditions, and by the market structure. Some details of these findings are given below. 1. Education and age of the household members have a non-linear impact on the likelihood to start an individual farm. In Romania, younger people are more likely to start individual farming, while in Hungary there is a positive impact of agz on individual farmning up to the age of around 50 years, after which the relationship becomes also negative. In both countries, education is positively related with individual farming, but in Romnania only up to a certain point (8-10 years of education). More education than 8-10 years tends to induce individuals to leave agriculture, and continue at most part-time farming. 2. Experience in jfarming, but also previous experience in non-farming activities (e.g., working in urbani areas), has a positive impact on households using their land for individual farming. 3. Access to capital forms a major constraint to start up) an individual farm. The results show that direct access to capital inputs, such as agricultural machinery, buildings, and livestock, has a positive impact on individual farming. Furthermore, access to capital in the form of alternative sources of income, such as pensions or wages, also positively affects individual farming. Potential individual farmers find it difficult to secure external finance given market imperfections, and direct access to either capital inputs or alternative income sources stimulates the shift to individual farming. 4. Security of land' tenure has a positive impact on the development of individual farms: households will not invest in individual farming unless they iFeel secure that they can reap the results from their investments. FARM RESTRUCTURING AND EFFICIENCY: THEORY AND HYPOTHESES A key question is which farm organization is most efficient. In other words, can we say that in a liberalized economic environment individual hqarms (or small partnerships of family farms) are more efficient than former collective and state farms that have been transformed into private cooperatives or companies? We refer to cooperatives and companies jointly as "large- scale successor organizations" (LSOs). We distinguish between two concepts of efficiency, technical efficiency and scale efficiency. A farm is technically efficient if it produces on the boundary of the production possibilities set, that is, if it maximizes output with given inputs after having chosen a specific production technology. A farm is scale efficient if it is technically efficient and moreover produces at constant returns to scale, i.e., its input-output combination corresponds to the combination that would arise from a zero profit long-run competitive equilibrium situation (Fare, Grosskopf, and Lovell 1'985; Chavas and Aliber 1993). 26 E. Mathijs and J. Swinnen From the literature, one can summarize five hypotheses on technical and scale efficiency differences between farm organizations in transition countries. 1. Family farms are expected to have higher technical efficiency than LSOs. Family farms are expected to display higher levels of technical efficiency than LSOs because of the LSOs' inherent problems in solving principal-agent problems in labor contracting due to difficulties of linking effort in agricultural production to income (Schmitt 1991, 1993; Pollak 1985). Mletering effort in production is particularly difficult in agriculture because of its biological and sequential nature and spatial dimensions (Brewster 1950; Binswanger and Rosenzweig 1986). Family farms are argued to be more efficient than LSOs in this regard because family members maximize family welfare rather than individual welfare; consequently, they have no incentive to free-ride, and the costs of monitoring and controlling effort accordingly lower (Carter 1984). 2. The technical efficiency gap between family farms and LSOs depends on the specialization and the technology level. Problems of governance and worker supervision are less if activities can be monitored easily in terms of inputs or outputs: for example, if work gangs can be organized and supervised directly, or if output can be measured directly, so that workers can be paid on a piece-rate basis, e.g., as in harvesting (Pollak 1985). Furthermore, more labor intensive activities are more sensitive to problems with labor incentives and monitoring, ceteris paribus. Technological innovations (such as greenhouses and improved crop control techniques) may mitigate these problems by attenuating the stochastic factors and thus reducing the superiority of family farms as a transaction-cost-minimizing institution (Allen and Lueck 1998). 3. Companies are expected to have higher technical efficiency than cooperatives. In cooperatives, the management's capacity to make and enforce efficient decisions is restricted by the members' right of co-determination. As a result, transaction costs in companies, where the management has more autonomy in making decisions, are lower than those in producer cooperatives, mainly because of the organizational advantages of hierarchical versus democratic decision-making in firms (Schmitt 1993). 4. The efficiency gap between family farms and LSOs is expected to decline during transition. State and collective farms performed poorly not only because of the intrinsic problems with organization and management, but also because of extrinsic problems, such as bureaucratic controls and an extractive external environment (Putterman 1985; Lin 1990; Brada ancL King 1993). With the progress of transition, as these controls are removed and the environmlient is liberalized, the efficiency of the LSOs can be expected to improve. For example, LSOs will be able to solve their agency problems by setting up the right labor contract structure. The difficulty of monitoring in an agricultural production cooperative can be reduced by a self-enforcing contract, in which each member promises to discipline himself (Lin 1990). Such a self-enforcing contract can only be sustained in a free, voluntary cooperative, where each member has the right to exit and is thus committed to provide maximum effort as long as the decision is to remain in the cooperative. It is therefore more likely to be effective in a restructured organization operating in a liberalized environmnent. Major Features of the New Farming Structures in CEE 27 5. There are no scale economies in agriculture, excep3t for the very small family farms which hcave a lower scale efficiency. Scale economies would favor the largest organizations. However, many studies suggest that there are no increasing returns to size in agricultural production beyond a certain minimum size, which can be captured by (larger) family farms, both in developing countries (Berry and Cline 1979; Hayarni and Ruttan 1985) and in developed countries (Kislev and Peterson 1991; Peterson 1997). FARM lRES'TRUCTURING AND EFFICIENCY: EMPIRICAL EVIDENCE Empirical evidence on the relative efficiency of different farm organizations in CEECs is only now beginning to emerge. In this section, we review empirical results based on four studies, all using nonparametric Data Envelopment Analysis (DEA) to calculate technical and scale efficiency of farm organizations (for more methodological details see Fare, Grosskopf, and Lovell 1985; Chavas and Aliber 1993). The Dynamics of Farm Efficiency during Transition: Evidence from East Germany Analysis of thie efficiency of East German farms cluring 1991-1995 (Mathijs and Swinnen 1997) shows tha,t, consistently with the theoretical hypotheses, family farms were technically more efficient than LSOs, but only in certain specializations (i.e., livestock) and only in the beginning of transition. With progress in institutional reform, organizational restructuring, and liberalization of the external environment during transition, the gap in average efficiency of family farms and L',Os has disappeared. (The East German data do not allow to distinguish between cooperatives and companies; one should be caref ul interpreting the results - see further.) The improvernents in technical efficiency and governance of the LSOs are also reflected by the labor adjustments in LSOs. Employment was substantially reduced on all LSOs, but especially on livestock LSOs, where average employment decreased by 45% over the 1991-1995 period. Family farms have, on average, significantly lower scale efficiency than both partnerships and LSOs. In livestock production there is no difference in scale efficiency between partnerships and LSOs, while in crop production the largest farms (LSOs) have lower scale efficiency than partnerships. These results are consistent with hypothesis 5 that there are no positive scale effects beyond a certain minimum size. The results indicate that, on average, family farms are below this minimum size and that partnerships are at or above this minimum size. Furthermore, LSOs in crop production seemn to be too large, i.e., they display negative scale effects. Partnerships were, on average, the most efficient organizational form in former East German agriculture during transition. Partnerships combine lhigh levels of technical efficiency due to good managemnenit of labor, which is often family related and small in number, and full economies of scale by operating at larger farm sizes than average family farms. 28 E. Mathijs and J. Swinnen The Distribution of Farm Efficiency: Evidence from Survey Data for Hungary, Bulgaria and the Czech Republic We summarize here some key results from farm efficiency studies in three CEECs (the Czech Republic, Bulgaria, and Hungary), based on representative farm surveys comprising about 1,500 agricultural households and 400 LSOs (cooperatives and companies) in each country. For more details, we refer to Mathijs et al. (1998) and Mathijs and Vranken (1999). For reasons of comparability we only present and discuss results for crop farms. Figure 3 shows the frequency distribution of the total technical efficiency scores of all sample crop farms (regardless of organizational form) for the three countries (178 fa:rms in Hungary, 93 farms in Bulgaria, 55 farms in the Czech Republic). For comparison, Figure 4 is an example of a frequency distribution of technical efficiency scores of a sector in a well-developed market economy functioning with much less government intervention than in CEECs ('potato farms in the UK represent a sector relatively unaffected by subsidies under the CAP). Contrary to the distributions in Figure 3, the distribution of UK potato farms in Figure 4 is strongly skewed toward the efficiency frontier (technical efficiency score of 100%). The reason is that, in a competitive and well-functioning market, inefficient farms cannot compete and go bankrupt. Inefficient farms can only survive in the presence of various market imperfections or with the aid of farm subsidies. Reform measures to liberalize prices, to abolish subsidies, and to create competitive markets should increase the competitive pressures in agriculture and push farms to the efficiency frontier or alternatively drive them out of business (Sotnikov 1998). Hence, one should expect a gradual shift to a distribution as in Figure 4, unless government subsidies or market imperfections continue to shelter the inefficient farms from competitive pressures. At the present time, the technical efficiency distributions of the CEEC farms of Figure 3 are still far from the market-environment distribution of Figure 4. Figure 3 suggests a double- peaked distribution: in Hungary and the Czech Republic many farms are situated around, 40%- 50% of the highest observed efficiency level, and another peak is observed close to the frontier. In Bulgaria, most farms are situated around 20%-30% of the highest observed efficiency level, which suggests that Bulgarian crop farms are characterized by greater inefficiencies than their Hungarian and Czech counterparts. Another way of interpreting these figures is that there is still substantial room for improving the average efficiency of farms in CEECs. Impact of Organization on Efficiency The results of efficiency calculations by organizational form are presented in Table 3. Cooperatives (worker-controlled farms) have the lowest technical efficiency levels in all three countries. Companies (manager-controlled farms) are more efficient than procduction cooperatives. This is consistent with the theoretical hypotheses listed above and also with recent findings for insider-controlled firms, where manager-owned firms were observed to perform better than worker-owned firms (Jones 1997). Major Features of the New Farming Structures in CEE 29 20 0 15- gr 10 U- 0 ON~ 5 _ ILLt1 0-10 10-20 20-30 30-40 40-50 50-60 60-70 7C-80 80-90 90-100 Total Technical Efficiency, Hungary 20 CD 10- U- CD 5 .5 0-10 10-20 20-30 30-40 40-50 50-60 60-70 70-80 80-90 90-100 Total Technical Efficiency, Czech Republic 20 -6 15- U. 0C 7 0* 0-10 10-20 20-30 30-40 40-50 50-60 60-70 70-80 80-90 90-100 Total Technical Efficiency, Bulgaria Figure 3. Frequency distribution of (total) technical efficiency measur es from farm surveys in Hungary, the Czech Republic, and Bulgaria 30 E. Mathijs and J. Swinnen Table 3. Sunnmar ' Statistics and Average Total Efficiency Scores for Crop farms Cooperativesa Companiesa Individual farms Hungary Output ('000 HUF) 106,583 86,876 1,605 Land (ha) 1,645 1,282 26 Labor (AWU) 58 26 1.2 Capital ('000 HUF) 93,841 48,760 2,600 Intermediates (000 HUF) 69,506 57,490 123 Technical efficiencyb 44 50 58 Observations 63 40 75 Czech Republic Output ('000 CZK) 15,513 1,451 Land (ha) 1,037 91 Labor (AWU) 48 2 Capital ('000 CZK) 29,217 2,143 Technical efficiencyb 57 62 Observations 6 49 Bulgaria Output ('000 BUL) 400,172 4,871 Land (ha) 774 6 Labour (AWU) 38 1.2 Capital ('000 BUL) 370,531 17,996 Intermediates ('000 BUL) 48,306 651 Technical efficiencyb 44 44 Observations 54 39 aFor Czech Republic and Bulgaria, averages are given for the pooled sample of cooperatives and companies because of the small number of observations. bln Hungary, famiily farms are more efficient than cooperatives (at 1% level of significance) and companies (at 10% level of significance), while cooperatives and companies do not differ significantly by technical efficiency. For Bulgaria and the Czech Republic, the differences in technical efficiency between individual farms and cooperatives/companies are not statistically significant by the t-test. Source: Mathijs et al. (1998) and Mathijs and Vranken (1999) The comparison between family farms and companies does O 80 - not produce conclusive results: in Hungary, family farms have higher 60 - technical efficiency levels than companies; in the Czech Republic o there is no significant difference; . 20-- - - - and in Bulgaria family farms have lower technical efficiency than < 0 companies. The latter may be due 10 20 30 40 50 60 70 80 9C0 100 to the heterogeneity of family Technical Efficiency farms participating in the survey. TechnicalEEfficien This category includes both small Figure 4. Frequency distribution of predicted technical (part-time) farms, which are less efficiencies of UK potato farms in 1992 (Wilson et al. 1998) efficient, and relatively large family farms, which are more efficient. Evidence from the Czech Republic based on profitability measures is consistent with this supposition. The data in Table 4 show that large individual farms are the most profitable, followed by companies, and then small individual farms. The Major Features of the New Farming Structures in CEE 31 Czech profitability data also confirm that cooperatives fall at the bottom of the ranking. In general, the survey results are consistent with the findings fDr East Germany, namely that the most efficient farms are those with a small number of workers, preferably family related, operating at a size that captures the most important scale economies. Table 4. Averag profit for farms of different organi ational form and size in the Czech Republic: 1996/97 Cooperatives Companies Individual farmrs Individual farms Individual farms 10-50 ha 51-200 ha >200 ha Profit/loss, -717 -185 -334 205 309 CZKIha 1 897 1352 31) 101 421 Average size, ha Source: Doucha (1999) Farm Restructutring and Agricultural Productivity Growthi In the previous section we have analyzed the relative efficiency of the various farm structures. However, concluding that organization Y is most efficient in country A does not necessarily say rnuch about the overall efficiency of the agricultural system. For example, while cooperatives and companies continue to dominate Czech and Slovak agriculture, agricultural labor productivity (ALP) increased by about 40% between 1989 and 1995 in the Czech Republic, Slovakia, and Hungary (CSH), while it declined in most other CEECs. In CSH, a strong decline in output coincided with an even stronger decline in agricultural labor inputs (Macours and Swinnen 1999). This suggests that there is no simple relationship between the shift to individual tenure and productivity growth. Instead, the optimal reform and adjustment path differs among CEECs because it depends on the structure and the technology of the agricultural system and on the overall economic development. The impact of the shift to individual tenure depends on the factor input and technology of the farms. In capital-intensive production systems, such as CSH, the costs from disrupting the capital stock and breaking up the large-scale technology may outweigh the benefits from improved supervision and labor effort on individual farms. In contrast, in labor-intensive agricultu:re, as ir Albania, the incentive problems are likely to outweigh the costs of technology disruption with the break-up of large-scale farms. Therefore, in labor-intensive production systems, productivity growth is more likely to come from. the shift to individual farming, while in capital-intensive systems, productivity improvements could also come from improved LSO management. Improvecd management requires effective organizational reforms, including hard budget constraints. In those CEECs where LSOs seem to function relatively efficiently, they have undergone substantial effective restructuring, including both management reform and operation adjustments. In contrast, Lerman and Csaki (1997) and Sedik (1996, 1997) report that, despite some downsizing in restructured farms, internal reorgan'ization has not produced deep results in countries such as Russia and Ukraine, where the collective framework has preserved most of its 32 E. Mathijs and J. Swinnen traditional functions. According to recent World Bank surveys in Ukraine and Russia, about half the employees of farm enterprises report that no real change has taken place so far in the 'reorganized' farms. These surveys confirm the intuitive insight that changes in large fanns in Russia and Ukraine have been mostly superficial. Also, most managers in these countries report that their farm enterprises continue to be committed to a lifetime employment policy for their members, and they do not acknowledge disguised unemployment on their farms. The only real change is the abolition of externally imposed production plans. However, because of informal dependency between large farms and local authorities, production plans continue to be influenced by district government. Managers cannot ignore the goals and objectives of district authorities, and, in this sense, they are not free to adjust their product mix completely in response to market signals (Lerman 1997). Because of this lack of meaningful restructuring, Sedik, Trueblood, and Arnade (1997) actually measured a decline in farm efficiency during transition in Russia. The Institutional Environment To achieve improvements in overall productivity, farm restructuring needs to be complemented by other institutional reforms that improve access to land, credit, technology, and information, and allow improved allocation of labor. Therefore, one needs to focus on more general measures and the rest of the economy to improve labor productivity of the farms. Agricultural employment has been influenced by price and trade liberalization, as well as by general reform policies that liberalized factor markets, privatized productive assets, and removed obstacles for improved factor allocation and mobility throughout the economy (Swinnen, Macours, and Dries 1999). Increased factor mobility and improved incentives stimulated the outflow of surplus labor from agriculture, contributing to an increase in APL. Credit constraints have been severe for all farms. In addition to 'normal' imperfections associated with asymmetric and costly information in all agricultural credit markets (Stiglitz 1993), a series of specific transition-related problems have constrained the financing of agriculture in CEECs since 1989. These transition-specific problems have to do with the role of credit in the economy, the institutional reforms occurring within the financial system, the low profitability in agriculture, accumulated debts, high inflation, risk and uncertainty, and collateral problems (Calomiris 1993; Swinnen and Gow 1999). The rural finance situation is improving in some CEECs due primarily to two factors: (a) improved profitability in agriculture since 1995; and (b) the emergence of institutional innovations, such as credit cooperatives, leasing, and various forms of contracting between farms and the upstream and downstream sectors, The contracts can take various forms, e.g., equipment leasing, forward contracting of cutput deliveries in return for inputs and working capital, producer loan guarantees backed by processing companies with delivery contracts, provision of commodity loans to contracted Ifarms by processors and input suppliers, warehouse receipts, etc. All these contractual arrangements address the loan collateral problem and strengthen the credibility of future cash flows for loan repayment. They thus play an important role in improving access to credit for farms. Foreign direct investment (FDI) in upstream and downstream sectors has also contributed to solving credit and contract enforcement problems at the farm level. In some cases FDI has Major Features of the New Farming Structures in CEE 33 induced dramatic increases in productivity, as it simultaneously tends to solve problems of access to credit, information, management advice, and technology (Gow and Swinnen 1998). Furthermore, once one company successfully introduces such institutional innovations, there is an important spiLlover effect to other enterprises and even other sectors. Complenmentary institutional reforms are necessary to facilitate access to credit, information, technology, and land for farms, which is a prerequisite for sustainable productivity growth. The forn of the institutional solutions - such as the rcile of leasing or of cooperatives for purchasing inpults, credit supply, and marketing - will dif'fer for the large-scale farms in CSH, the small fragmented holdings in Albania and Romania, and the part-time family farms in Poland and Slovenia. Not surprisingly, in those CEECs where ALP has increased most complementary institutional reform;s and innovations, such as leasing of land and equipment, forward contracting, etc., and also the inflow of FDI, have progressed nmost. The Impact of Land Reforms and Land Markets A key conditlion for growth is that land reform allocates strong and clear property rights in land to individuals. Furthermore, the nature of property rights is more important than their distribution, even in transition countries (Swinnen 1999). In fact, ALP growth is strongest in those countries where an important share of the land is allocated to individuals not active in agriculture. Sales markets ol land are unlikely to provide an zfficient solution to the demand for land exchange in CEIECs. They generally work imperfectly (Platteau 1992) and in transition countries land sales are further restricted or absent due to missing legislation or the unwillingness of many owners to part with their newly acquired land. However, improved resource allocation can be achieved through land tenancy contracts even when other markets are incomplete. Although land rental markets cannot completely eliminate structural impediments and produce a fully efficient. allocation of land in an economy, they car, go a long way toward bringing the operatiDnal distribution of holdings closer to optimum (Deininger and Feder 1999). Land leasing is a widespread phenomenon in Western market economies, and it is extensively used by the h'ghly efficient farms in Europe and the United States (Swinlen 1998; USDA/ERS 1998). The main benefits of land ownership vis-a-vis land renting are 'the privileges of wealth' and improved access to credit with the use of land as collateral (Sadoulet, Murgai, and de Janvry 1998). However, recent studies on land use and investment incentives in Asia and Africa indicate that secure land-use rights are sufficient conditions for efficient land use and optimal investment by farmers (Brasselle, Gaspart, and Platteau 1.998; Feder and Feeny 1991; Rozelle, Li, and Brandt 1998). Furthermore, in developed market2 economies the importance of land as collateral to get access to credit is limited by the availability of other assets and diverse institutional arrangements to secure loan repayment. During transition, land collateral has not played a significant role because land sales markets were thin, if functioning at all, making it 34 E. Mathijs and J. Swinnen unattractive for banks to accept land as collateral, and because land typically cannot be used as collateral for working capital and medium-term investment loans, which were the main financing objectives during transition (Swinnen and Gow 1999). Therefore, a key policy focus should be on land leasing and on how to regulate and enforce leasing contracts so that they provide sufficient security to tenants for making farm investments and sufficient incentives for land owners to lease their land to the best user. Survey Evidence from Hungary In Hungary, the land reform of 1991-92 allocated land to citizens in two main ways: land was restituted to former owners either directly or through a process called compensation; and land was granted to former collective farm workers who had not owned land in the past. Households also have access to "land owned before 1992." This is mainly their pre-reform private plots and gardens, which accounted for approximately 15% of total agricultural land in the pre-transition period. Results from the 1998 Phare/ACE farm survey in Hungary indicate that, on average for all households in the sample, land owned before 1992 is still the most important source of land for family farms (Table 4). Almost 60% of the respondents cultivate land that they owned before 1992, and this land represents 45% of all holdings by family farms in the sample. Restituted land makes up 26% of their holdings, about one-half from direct restitution and one-half through compensation. Family farms primarily use own land, and leased land accounts for about 6% of holdings. Table 5. Sources of Land Used by Hungarian Farms: 1998 Survey Source Family farms Enterprises Owned 94.2 6.3 Owned before 1992 45.4 Restituted directly 13.2 Restituted through compensation 12.6 Purchased 13.1 Inherited 10.1 Granted 1.0 Leased 5.8 93.7 from the state 8.8 from partners/members 54.8 from outsiders 30.3 Total 100.0 100.0 Source: Phare ACE Survey (1999) Major Features of the New Farming Structures in CEE 35 Table 6. C'onstraints Identified as Important Obstacles to Expanding Income Opportunities (in % of respondents) = -_________________ Family farms Enterprises Agriculture is not profitable 82.9 89.7 Producer costs are too hilgh 78.5 89.9 Producer prices are too low 68.3 71.9 Cannot sell producl. 35.4 Policy problems 30.7 47.7 Cannot obtain loan 27.3 24.3 Delayed payments 24.2 19.5 Problems with cooperative 17.1 Cannot find labour 15.1 4.1 Cannot obtain land 13.0 70.9 Source: Phare ACE Survey (1999) Farm enterprises do not own land. Their land is leased, mainly from the members (or partners, in the case of companies). Over 80% of all farm enterprises report that they cultivate land leased from members or partners, and this source represents about 55% of all land used by enterprises surveyed (Table 5). On average, enterprises lease 30% of their land from outside land owners and another 9% from the state. The data suggest that the market for land leasing has been quite dynamic and important over the past years. Among farm households in the survey, 16% lease out land to others and 8% lease in land frorn others. But land transactions in Hungary are not limited to leasing: 16% of all farm households surveyed actually report land purchases, and purchased land accounts for 13% of total holdings (Table 5). Despite these developments, land seems to remain an important constraint for Hungarian farms. While fully 78% of farm enterprises surveyed were planning to lease more land, 71% considered land a seriotus constraint (Table 6), and only 7% found it easier to lease land now than 5 years ago. In contrast, only 5% of family farms indicated that they intended to increase their land holdings in 1998, and 13% viewed land as a serious constraint. These differences in attitude to may reflect the fact that farm enterprises, unlike family farms, still have considerable slacks in capital and/or labor. CONCLUSION Significant restructuring of farms has taken place since 1989 in most CEECs, where the former large-scale collectives and state farms are undergroing substantive change. Farm restructuring difiers wiclely among CEECs and among regiorns and sub-sectors within CEECs. Thus, large conmpanies and cooperatives continue to dominate in Slovakia and the Czech Republic, while they have virtually disappeared in Latvia and Albania. Individual farming is growing and cooperatives continue to decline in all CEEC's. The development of individual farming is affected by the characteristics of the existing farms, such as technology and productivity, by government policies, such as land reforms, and by 36 E. Mathijs and J. Swinnen characteristics of the farm households. Individual farning is more likely for individuals who are younger, but still have some farming experience, are better educated (up to a certain point), have access to land and capital inputs, and where the household has off-farm income sources. Farm surveys indicate a much more dynamic land market than is generally argued. For example, in Hungary, large individual farms and companies rent large shares of the land they use and have purchased a significant part of their land. The most efficient among the emerging farm organizations are farms with a small numbers of workers, preferably family related, operating on a scale that captures the most important. scale economies. This group includes the larger family farms and some farming companies. Cooperatives are the least efficient among farm organizations. There is no simple relationship between the shift to individual farms and overall productivity growth in agriculture. The optimal reform and adjustment path differs among CEECs because it depends on the structure and the technology of the agricultural system and on the overall economic development. To achieve overall productivity gains, farm restructuring needs to be complemented by other institutional reforms that improve access to land, credit, technology, and information, and allow better allocation of labor. General reform policies liberalizing factor markets and removing obstacles for improved factor allocation are necessary to encourage outflow of surplus labor from agriculture and to stimulate inflow of external investment into the sector. ACKNOWLEDGMENTS The authors thank Karen Macours and Liesbeth Vranken for research assistance, Alexander Sarris, Tibor Ferenczi, Tomas Doucha, Dinu Gavrilescu, Diana Kopeva, and Hamish Gow for collaboration on the surveys and for many discussions. The European Commission (Project Phare ACE P96-6090-R) financed several surveys from which results are reported. The views expressed in the paper do not necessary reflect those of the European Commission. REFERENCES Allen, D.W. and Lueck, D., 1998. The Nature of the Farm. Journal of Law and Economics 41: 343-386. Berry, R.A. and W.R. Cline, 1979. Agrarian Structure and Production in Developing Countries. Baltimore, MD: Johns Hopkins University Press. Binswanger, H.P. and M.R. Rosenzweig, 1986. 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Incentives, Organizational Structures, and Contractual Choice in the Refior)m of Socialist Agriculture. In Braverman, A., K. Brooks and C. Csaki (eds.), The Agricultural Transition in Central and European Europe and the Former USSR., Washington DC: The World Bank, pp. 27-46. Sotnikov, S., 1998. Evaluating the effects of price and trade liberalisation on the technical efficiency of agricultural production in a transition economy: The case of Russia. ERAEconomics 25: 412-431. Swinnen, J., 1998. Land Leasing in Western Europe: A Historical Perspective. Policy Research Giroup Working Paper, K. U. Leuven. Swinnen, J., 1999. Political Economy of Land Reform Choices in Central and Eastern Europe. Economics of Transition, forthcoming. Swinnen, J. and H. Gow, 1999. Agricultural Credit Problems and Policies During the Transition. to a Market Economy in Central and Eastern Europe. Food Policy 24: 21-47. Swinnen, J., Macours, K. and L. Dries, 1999. Transition and Agricultural Labour. Unpublished w\orking paper, Policy Research Group, Katholieke Universiteit Leuven, Belgium. USDA/ERS, 1998. Report on US Farm Profitability. Washington DC. Wilson, P., Hadley, D., Ramsden, S. and I. Kaltsas, 1998. Measuring and Explaining Technical Efficiency in UK Potato Production. Journal ofAgricultural Economics 49(3): 294-305. Stru,^tural Change in the Farming Sectors of Central and Eastern Europe Second EU Accession Workshop in the Rural Sector, Warsaw, Poland, June 27-29, 1999 Competitiveness of Farming in Countries Associated with the EU under the Common Agricultural Policy Klaus Frohiberg The Central and Eastern European countries having association agreements with the EU (CEAs) will enter the union in the near future. How will agriculture and the food sector be affected by this important event? This paper tries to provide insight into this very complex issue. It assesses farming condlitions in the acceding countries after entering the EU. A better understanding of how agriculture and the food industry will perform once they are part of the EU is of great importance for implementing pre-accession but also post-accession policies. Preparation for accession is currently already under vway. T'he CEAs implement agricultural and food policies which more and more resemble those pursued by the EU in terms of instruments used and their levels as its Common Agricultural Policy (CAP). In addition, applicant countries have to gradually introduce the acquis communautaire. This is to ens-ure that after accession they will be able to administer the CAP and their products adhere to EU standarc,s. However, the CAP as specified in the Agenda 2000 is likely to change due to external and internal pressure beifore enlargement takes place. To the foimer belong the Millennium Round of the WTO which is likely to put pressure on the CAP asking to abolish the compensation payments. Internal pressure arisz for the same lreason. The internal pressure rests largely on the view that the compensation payments would be extended to the accession countries at the time of accession. This is a rather realistic assumption. Many arguments can be forwarded in support of it. The budgetary consequences for the current EU rnembers are quite substantial. It, therefcre, is rather likely that the CAP should be re-designed to align its instruments and their levels more with the policies currently found in the CEAs. This makes it interesting to also look into the question of how the CEAs' food industry and agriculture would perfor-m under those conditions. Therefore, current competitiveness is also investigated. Whal. is meant by competitiveness is not uniquely defined. In this paper, competitiveness is understood as referring to tlhe ability to supply goods and services at the time, place and form sought by buyers at prices as goodi or better than those of other potential suppliers while earning at least the opportunity cost of returns on resources employed. Many factors iniluence competitiveness. Clearly, they will be different when accession takes place. By how much they will vary in relation to conditions without joining the EU depends on what the CAP will look like thlen and the countries' pre-accession policies. 39 40 K. Frohberg DETERMINANTS OF COMPETITIVENESS AND THEIR DEVELOPMENT Macroeconomic Policies and Institutions Agriculture is influenced by the performance of the macroeconomy and the policies used to steer it. As far as agriculture in transition countries is concerned, exchange rate and monetary policies are quite important. All CEAs peg their nominal exchange rates to a basket of western currencies or to just a single one. Although this policy might be justified from the macroeconomic point of view it may have substantial effects on the real exchange rate. While the nominal exchange rate is the relative price of two currencies, the real exchange rate is defined as the ratio of two price indexes, the price index for tradable goods and that for nontradables. The real exchange rate is a good indicator of competitiveness, as it can be interpreted as reflecting the cost of producing tradables in the domestic economy.. Statistics do not offer sufficient data for calculating the real exchange rate in the precise way defined above. One alternative is to rely on the purchasing power parity (PPP). The PPP exchange rate is the nominal exchange rate times the ratio of foreign to domestic prices. Frohberg and Hartmann (1997a) used the consumer price index (CPI) for the respective CEA as the domestic price, and the one for Germany as the foreign price. Their results reveal that nominal devaluation in the CEAs had not been strong enough to fully compensate for different developments in the inflation rates between the respective CEA and Germany (which reflects the same exchange rate changes as most EU members), thus leading to a real appreciation in all countries during the period 1990 to 1997. This implicit appreciation of the CEA currency in the past years of transition has made it more difficult for all export industries in these countries to compete on the world market. Though exchange rate stability helped considerably to reduce inflation. If there is no change in this policies a serious impediment to agricultural growth might occur. This also reveals the paramount importance of the nominal exchange rate of these countries with the euro at the time of entering the EU. Domestic utilization of agricultural output depends not only on price changes and acljustments in habit, but to a large extent also on income growth. The development of the entire economy is, therefore, quite important for food consumption. In all CEAs economic growth occurs but at considerable different rates. Macroeconomic policies should further stabilize the economy and put it on a steady upward path. As income grows, food consumption may not change considerably in terms of more caloric intake, but rather in terms of quality and type. A shift toward higher quality food requires more refined processing. This will offer the processing industries in these countries the chance to develop. However, it should be noted that further restructuring of this sector will be essential in order to take advantage of this growth potential and not to lose it to foreign competitors. Some changes in consumer preference can also be expected. The demonstration effect is important in this respect. The increase in trade of the CEAs with western countries, the rising relevance of foreign direct investments in food processing and distribution of the countries, and the booming travelling abroad all strengthen this effect and is very likely to induce convergence of food consumption patterns between the CEAs and western countries (Elsner and Hartmann, 1997). Competitiveness of Farwing in Countries Associated With the EU under the CAP 41 Market liberalization was done rather swiftly after the beginning of transition. Trade was also conducted in a rather liberal spirit. However, other areas like social policies were neglected completed policies. In inany CEAs, institution building did also not progress as needed. This has led to severe economic and social probleims. While new owners of food processing and distribution companies with large market power gained influence and realized large profits unemployment has risen and poverty became a problem. IIigh inflation rates in the first half of the nineties often eroded the savings of large parts of the population dramatically. This is indicative of further need to improve economic conditions in these coun,tries for smoot]hening accession. Agricultural Policies and Privatization Policies in agriculture and the food market differ somewhat between the various CEAs. All of them implemented measures to stabilize domestic markets and enhance exports for agricultural and food products. The types ol policy instruments used vary largely. They include market interventions, export subsidies and import tariffs. In cases where domestic supply was severely interrupted, some of these countries also make use of export quotas to assure sufficient supplies for domestic consumers. Protection was generally recLuced immediately after the collapse of the communist system. In most of these coantries, import protection has increased over recent years. Together with export subsidies granted, this should have led to a positive impact on agricultural trade balances, but exactly the reverse has happened. Other factors such as the appreciation of real exchange rate mentioned above, lack of quality and insufficient sanitary and phytosanitary standards, as well as inefficiencies in the food industry have obviously overcompensated these effects (see also Frohberg and Hartmann 1997a). Except for Bulgaria and Hungary, all CEAs run trade deficits in agricultural and food products in 1997. All associated couantries joined free trade areas. Estonia, Latvia and Lithuania created the Baltic Free Trade Area (BFTA) which has a special component for agriculture (BAFTA). The remaining CEAs belong to the Central European Free Trade Area (CEFTA). Both have problems especially with regard to trade in agricultural products. This shows that the agreements do not cover sufficiently issues arising from the differences in competitiveness among their members. From the point of view of accession the advantage of these free trade areas is that policies arnong their members are harmonized, at least to some extent. Hence, joining countries will have less difference in their agricultural policies, making integration easieir. Privatization is well advanced in all CEAs. Farms are privatized in almost all of them. Only in Estonia and Poland, some larger share of land is still owned by the government. In the former, some of the land is not farmed at all because of lack of profitability. YIn the latter, land of large scale enterprises is leased to private farmers. Privatization of the food industry has not been advanced as much as of the farm sector. Romania and Bulgaria began to privatize only in recent years while in Hungary this is almost completed (Hartmann and Wandel 1999). In some countries, certain sectors still lack privatization like 42 K. Frohberg the sugar industry in Poland. More important than the stage of privatization is the form of privatization chosen. For those food sectors which are primary processors preference in ownership was often given to farmers. This has led to shortages in investments in these companies. Environmental problems related to farming are often neglected in the discussion on agricultural policies in the CEAs. This might be due to the fact that application of chemical inputs is rather low in these countries, and thus there is hardly any problem with regard to non-point source pollution. However, storage capacities of manure are often insufficient with regard to quantity and quality so that pollution can occur from this source. Lack of investment funds makes it difficult for farmers to improve this situation. In addition, governments will have to provide incentives to reduce soil erosion in relatively large areas of these countries. Soil compaction is also a problem in some areas. Farmers will generally have to adopt different cropping patterns and farming methods to reduce these environmental problems. This holds especially since environmental standards are expected to become more stringent in the future. Farming Conditions The current low labor costs impact positively on competitiveness of agriculture in dlie CEAs. However, wage rates are expected to rise relative to other input costs and output prices. This will increase costs of agricultural production and reduce profit margins and at the same time require investments, mainly in machinery, to substitute for labor. Yield levels in the CEAs are lower than they used to be under socialism and compared to the EU. Though differences among the CEAs are enormous with regard to the EU, they have reached about 80%. It is doubtful, however, whether these countries will reach yields in the medium term which are as high as in the EU, even if natural conditions would permit such yields. Because this would require considerable investment in human capital, new breeds and seed varieties. But financial -funds will remain scarce for agriculture for some time to come. In addition, environmental standards will also become more stringent in the future making it more difficult to reach yield increases similar to those achieved by EU farmers in the past. Yield levels provide some indication on how productive land or animals are. However, not too much should be read into these figures. Yields depend on many inputs not just a single one. Low yields might therefore be a sign of that it does not pay to apply other inputs very intensively. It is important that farmers use inputs efficiently; both from the technical point of view as well as that of prices. Farmers in CEAs are not used to risks. Necessary institutions are not yet established to a degree necessary to enable efficient risk spreading. In most of these countries, futures markets do not exist, forward contracting is also not well developed and it is not possible to insure against crop failure or animal diseases. In addition, farmers face risks due to insufficient possibilities of contract enforcement by the government. Delayed payments is a rather widespread phenomena in CEAs. All farmers can do is to adapt their farming practices to reduce risk to an optimal level. Off-farm risk reduction measures, though, would often be more efficient. Competitiveness of Farming in Countries Associated With the EU under the CAP 43 Determinants Affecting Changes in Farm Size Competitiveness is crucially affected by farm size. Production costs are lowest only if an optimal farn size has ibeen reached. Experiences from western countries show that farm sizes are consistently adjusted; usually increasing in size. In some of the CEAs still very large farms exist. It is conceivable that they might decline. Factors dete:rmining the scale of operation vary subs tantiaLly within a country. Therefore, many different structures of farms can be found. Moreover, these factors are shaped by forces changing over time and, hence, are qui,te dynamic. Consequently, farmers are in need of adjusting continuously their scale of operation. In the following these dynamic factors will be briefly discussed. In the CEAs, type and procedure of privatization had a strong influence on farm size. However, privatization was a one-time event. Natural conditions impact on the scale of operation but also do not change over time. Therefore, both of these factors do not get further attention. The order of listing these factors changing in the future does not resemble in any way their importance. Price Structure The relation among all prices determines farm types and their product mix as well as intensity of input use. In turn, allocation of land and other quasi-fixed factors is affected. As adjustments in the agricultural terms of trade are likely to occur with entry into EU, farm sizes have to be changed accordingly. This also is likely to affect farm labor. Experience from western countries shows that employment in agriculture iis going to decline absolutely and relatively to the total work force. Endowment with Fixed Factors With the growth of the economy income obtained from off-farm work is usually rising. This leads to higher opportunity costs of farm labor. Returns to labor employed in agriculture is under continuous pressure to rise in order to maintain income parity. ][n turn, (marginal) labor productivity must go up. Farmers resipond either by producing more or reducing employment. They seek to expand their activities by cultivating more land, increase livestock husbandry or intensify production through other ways. The latter, of course, assumes that there is sufficient capacity available in form of buildings and equipment. Small-scale farms especially need to make sure that fixed labor is fully employed throughout the year. Size of operation as well as production structures are to be determined to avoid peaks in labor use. Rather, smooth employment over the entire year should be reached. Among others, this explains why small farms are usually more diversified than large ones. They produce more labor intensive goods because endlowment with capital is also relatively low. Large-scale farms can better cope with the problem of utilizing ind:ivisible factors throughout the year such as labor and capital items like tractors, combines and buildings. 44 K. Frohberg Land Market In general, land markets are still to improve in the applicant countries. The problem with land is that it is physically immobile and hence can only be 'moving' between farms located in a certain region. In addition, an increase in the operation of a farm through enlarging acreage leads always to more transportation within the farm and, hence, pushes marginal costs up. Due to the outstanding role of land in agricultural production a properly functioning land market is of very high importance for competitiveness. If this market works perfectly land will always go to that farmer who makes the most efficient use of it. Leading to a Pareto-optimal situation. Properly functioning land markets are especially needed in the CEAs (and other transition countries as well) because the way privatization was carried out. Most of them used restitution as a, way for privatizing land. The only exceptions were Hungary and Romania which also distributed land to farm workers free of charge (Lerman 1999). It is impossible that these procedures of privatization led to a farm structure which was optimal. Privatization cannot be expected to have led to the mosit efficient 'initial' distribution of land. Hence, re-allocation of land is necessary to improve farm sizes from the viewpoint of efficiency which requires competitive markets. However, many impediments can be found in the CEAs making their land sales and lease markets deviate considerably from the ideal situation. The most important ones are legal conistraints. Also relatively high transaction costs can restrict selling or leasing land. A third group of factors hampering transactions of land are missing markets of other production factors; especially cf credits (Mathijs and Swinnen 1999). Labor, Capital, Input and Output Markets Not only a functioning land market is a prerequisite for changes in farm size acccrding to economic conditions. Labor and capital markets, as well as markets for farm inputs and oUltputs are also essential for farm size adjustment. Agricultural labor can adjust in two ways. It may quit working in agriculture or seek part-time off-farm jobs. In particular, the latter way requires work alternatives in close distance to farms. It is therefore paramount that alternative industries and services will be able to absorb labor released by agriculture. This is especially important in those areas in which restructuring of farms is very much needed due to small farm operations. Experience from western countries shows that farm labor adjusts gradually to changing economic conditions. Especially for small farms one should not assess labor allocations without addressing the issue of how a farm household organizes the entire labor capacity it has to offer. Such a farm household might be considered as a unit which offers labor both on-farm and off-farm. Privatization and restructuring of banks was very much needed for the establishment of capital markets. This has progressed considerably in most applicant countries. Capital markets for agriculture are not yet functioning as well as they should. As with land markets, this statement refers more to total Competitiveness of Fatming in (Countries Associated With the EU under the C,AP 45 turnover rather than gove]rnment regulations. Especially rural areas still suffer in some of these countries frcm insufficient developments of the banking system. For example, in Latvia, there is only one bank which provides loans to farmers and agricultural companies (Frohberg and Winter 1999). Credit unions are established in Lithuania. They must have at least 50 members. The capital share of them should exceed 15000 litas. More than a dozen credit unions had been established in different regions by the end of 1997 in this country. In Romania, bank organizations and operations are to be improved. "At the leve:L of the financial intermediaries, the re-engineering of the organization, the management and the adoption of innovative financial instruments are pertinent to increase the efficiency of financial intermediation" (Heidhues and Schrieder 1998, p. 171). In Poland, on the other hand, rural lending is handled by only few banks which operate a subsidiary in almost each village. For many farmers the problem of receiving loans is compounded by lack of collateral due to their high share of leased land. Some countries like Hungaiy established credit guaranty funds which overcome this worry. A third reason for the low turn over irL rural capital markets is the relatively low internal rate of return making it difficult for agriculture to compete for credit with other sectors of the economy. Finally, tlhe arnount of savings in the countryside is low because of the small income earned by the people living there. During the socialist era, inputs were provided by the cooperatives or state farms. With the transition, these services were taken over by private companies. Farmers had to establish new business relations for buying inputs. In some countries not all of these services are well established hampering the development of famrlily farms in particular. Input industry is not yet producing efficiently in all CEAs, which leads to high prices. A more competitive input industry would avoid the disadvantage due to imperfect market structure. Problems with selling farm products are similar to those with buying inputs. New market channels had to be established. Especially, for those family farms which had small quantities for sale this created problemrs. MWholesale markets were founded only with substantial time delay and often are not yet functioning properly. For some products like vegetables and fruits finding a buyer requires still today substantial effort. Large-scale farms are much better off in this respect, especially if they could retain their relations with food processors. Economies of Scale Replacement of machinery and equipment usually shifts tlheir optimal use outward, resulting in technical economies of scale. This explains why the optimal scale of operation of farms is to be adjusted, generally leading to an expansion of farm operations. New capital also substitutes for (some) labor. If that part of labor does not find off-farm employment, farm production has the capacity to increase, putting additional pressure on enlarging the farm size. Small-scale farms have often difficulties in exploiting the advantages of mechanical technical progress. Possibilities to overcome this are offered by sharinlg imachines among several farmers or by hiring customs service. But even in those cases the need arises to expand production if labor cannot adjust. 46 K. Frohberg Another form of technical economies of scale is associated with improvement in genetic resources (biological technical progress), which usually leads to higher yields or more efficient use of inputs. Large-scale farms are in a better position to take advantage of this type of technical progress because of better managerial skills. The organization of markets at which farmers are buyers and sellers is also relevant for restructuring farms, leading to so-called market economies of scale. The more the buyers of agricultural products and sellers of farm inputs have market power, the more difficult it is for small farmers to be able to enforce their economic interests. Large farms have an advantage under these circumstances. This is due to the higher quantities of equal quality these farms can offer. For reaching equal market conditions small farms have to cooperate in marketing their produce. Exploiting more market power results especially in better prices. In some cases, like at financial markets it may even be the only way to obtain a loan. Small farmers require only relatively small loans. High transaction costs accruing to the lender make these credits expensive. This often pushes total costs of the loan beyond the limit what the farmer can afford to pay. The farm size also affects possibilities to hedge against risks. Various forms exist to carry out these activities which is easier for larger farms than smaller ones. It was mentioned above that on-farm possibilities their optimal use to insure against various forms of risks but few off-farm ones exist. Economies of Scope Economies of scope usually arise if experience and skills gained in producing one good can be used in the production process of another one; an observation quite often found in agriculture. This positive effect gets re-enforced by the need of agriculture to diversify production in order to spread yield risks due to unforeseen natural events like hails, infestation etc. If economies of scope prevail the farmer is forced to produce many commodities for efficiency reasons. Hence, a certain size of operation is required to simultaneously exploit economies of scale. Inter-seasonal labor use 1has been mentioned above as another factor which makes especially small farms to produce relatively large number of commodities. Transaction Costs Transaction costs are those costs which arise due to the coordinating the interactions of human beings. They can be observed at various processes of economic and political decision making; the firm, the market and the political level. At the firm level, these are those costs related to controlling and measuring the work of labor (principal-agent problem) and to setting up contracts; i.e., to searching for partners and controlling and enforcing the contracts. Transaction costs gain in importance relative to those of production. It is obvi.ous, that transaction costs related to labor hardly accrue to family farms because they do not employ hired labor at all or only to a small extent. However, these farms are likely to also face transaction costs associated Competitiveness of Farming in Countries Associated With the EU under the CAP 47 with contracts for selling and buying activities and the like but these accrue to large scale operations as well. Williamson (1985) describes different ways of efficiently organizing the work of labor at a firm. He considers three determinants: a) the ease with which controlling and measuring can be achieved; b) the skill a certain task requires; and c) the frequency with which this task is to be done in the firm. For example, a task which is rarely to be carried out and requires very specific skills (high investments into human capital) should be done by specialists hired from outside the firm. Those jobs, however, which lead to measurement problems, do require many skills and are to be carried out relatively seldom might be better done by the farmer himself. Firm level transaction costs related to labor increase more than proportionate with the share of hired in total labor employed on a farm. This makes these transaction costs increase with farm size. On the other hand, it was shown above that larger farms have advantages in exploiting economies of scale. Managerial Skills Managerial skills are another if not the most decisive factor with respect to farm size and farm organization. Failure of farms are also occurring due to lack of managerial skills. It is not only the economic knowledge required for an optimal farm organization. The capability of inspiring farm workers to engage successfully in farm work is equally important. In summary, the optimal size and organization of a farm strongly depends on how all the determinants mentioned above play together. It is a very complicalted and complex interaction. This can be also seen from the fact t]hat farms in a country vary considerably in terms of size and organization at a given point in timne. Any prediction of future developments is made difficult by the uncertainty involved in foreseeing what path each of these determinant.s will follow. Nevertheless, both size and organization of farms will have to adapt in order to remain efficient. This process of adjustment is not unique for all farms. In the CEAs, many farms established in the early stages of transition will have to increase. Food Processing and Dlistiribution Processing and distribution of food, i.e., the food chain affects agriculture's competitiveness through the type and quality of products it buys from farmers and prices paid. In turn, agriculture impacts on the competitiveness of the food chain by supplying these goods at those prices. Competitiveness of the food processing and distribution industry is influenced by a number of additional factors. Only the most important can be mentioned in this section. These are the level of institution building, the progress with respect to privatization, links in the food chain, management and marketing capabilities, and external factors (for a detailed analysis see Eiteljorge and Hartmann 1999). The implementaition and enforcement of a bankruptcy law introduces full liability as an important constitutional principle of a market economy. Entrepreneurs are fully responsible for their 48 K. Frohberg activities and the government no longer covers or capitalizes debts, as it did in the centrally planned economy. Loss-making enterprises have to go out of business and resources freed to be allocated to those companies who can make better use of them. All CEAs implemented a bankruptcy law. Enforcement is not as rigorous as needed. For fear of high social costs, however, governments in some countries are reluctant to let enterprises of the food sector go bankrupt. Given the inherited monopsonistic and monopolistic structures in food processing and agro- service enterprises, antitrust regulations play an important role in enhancing competition. Most CEAs implemented appropriate anti-trust legislation, to which all companies, including those of the agro-food sector, are subjected. Anti-monopoly committees were established in some countries to monitor the situation in the commodity as well as service markets and to enforce the anti-trust law. In recent years, competition has become stiffer, due to both the legal framework and the emergence of many small- scale private enterprises. Opening up international trade also helps to stimulate competition. Establishing an appropriate market information system is very important for improving efficiency in agriculture and food processing. During the course of the transition to a market economy a large number of small-scale agricultural producers as well as of new private companies in the up- and downstream sectors started their business. They need information about market conditions, for an efficient response to market signals. Though systems for reporting regularly about markets were established deficiencies still exist in most CEAs. One major problem of the food industry in CEAs is poor quality of its products. In order to enhance competitiveness of the CEAs in food products quality standards and sanitary controls must be strengthened since they are not yet adequate at all levels in the food chain required for exporting to western countries. All CEAs are in the process of harmonizing their regulations with those of the EU. But this process still takes time till it is completed. As mentioned above, the banking sector had to be privatized and emerging local banks often lacked the competence and facilities to fulfil the tasks of money lending to entrepreneurs. I'he food industry has to compete with other borrowers for capital but it seems to be in a better position, than the farm sector is in. The methods of privatization applied in the food industry differ between CEAs. However, it is possible to identify some common features. In general, small enterprises have usually been privatized by being sold directly or auctioned to the highest bidder. Large enterprises have mostly been turned into joint stock companies, with a subsequent transfer of shares to various owners. In this case, preference has quite often been given to agricultural producers and/or to enterprise employees and managers. The former holds especially for the first stage food processing branches such as the dairy, milling and meat industries. The aim of granting preferential treatment to agricultural producers is to dilute monopsonistic power in the downstream sector and to guarantee the supply of processors with agricultural raw materials. This method has been used predominantly in the Baltic States, but also in Slovenia and Hungary. The degree of privatization achieved in the food industry differs between countries. In general it has often proven difficult to find suitable investors. Privatization of the food processing sector is most Competitiveness of Farming in Countries Associated With the EU under the CAP 49 advanced in countries such, as the Czech and Slovak Republics, hlungary, Poland and the Baltic States, although even these countries are experiencing problems in reducing excess capacities and privatizing the primary processing of agricultural products (e.g. mills, slaughterhouses and dairies). By the end of 1998, 85% of the fDod industry were planned to be privatized in Bulgaria, while Romania intended to have the privatization of this sector completed by that time (Agra-Europe 1998, p. 29). Among the CEAs Slovenia provides an exception since two property forms differing from the other CEAs are known: cooperative and so-called "corporaLte" property. The cooperatives are comparable to those common in the West, and a privatization is thus superfluous. The privatization of the processing plants in "corporate" ownership only started in 1994. At present privatization has been completed in about two thirds of the enterprises. In some sectors, however, it is just starting (wine, dairy, and vegetable oils). The degree of privatization differs not only between countries but also between sectors. While the privatization of some sectors of the food industry has been fully or nearly completed, in others progress has been slow. In general, sectors producing high-value finished products, such as vegetable oils, confectionery, tobacco and beer, were privatized quickly, often with foreign and multinational participation. Other product areas such as meats and dairy products have proved more difficult. A major obstacle for privatizing enterprises predominantly involved in primary processing activities might be the preferences given to agricultural producers in the acquisition of downstream industries. In Lithuania, for example, agricultural producers possessed in 1997 32% of the shares in the meat processing industry and 31% in the milk processing industry (EU Commission 1998, Lithuania, p. 35). It is by no means for sure that agricultural producers, who are generally having great difficulty surviving as viable primary producers and financing their own development, could take on the task of developing and running a successful processing enterprise. At best there would be a conflict of interests as regards the pricing of tlhe raw materials supplied by the producers to the processing enterprise. They might be tempted to increase producer returns, leaving capiLal without adequate reward. Also, where enterprises are dominated by employees, this could lead to a policy of maximizing employee benefits, thus awarding wages and salaries that are not related to productivity, and giving excessive preference to job security. Increasing horizontal integration in the food industry could be observed in recent years, as small-scale food processing enterprises merged into bigger units. At the same time badly performing enterprises go out of business, mainly because of their inability to meet the requirements of the changed laws on product quality and standardization as well as phytosanitary and sanitary regulations. LINKAGES BETWEEN AGRICULTURE AND OTHER RURAL INDUSTRIES AND SERVICES The development of rural regions in applicant countries is hampered by many problems. During socialist time, no special policies existed to support rural areas. Any assistance provided to these regions was part of farm policies. With the transition, support of agriculture drastically declined and, 50 K Frohberg hence, also of rural areas. Policies aiming at fostering development of these regions were not implemented for quite until recently. They are being established only now and even this is rather vaguely done. Urban development received considerably more attention in the CEAs. As a consequence, a decline of rural areas relative to urban ones occurred in all of these countries. The economies of these rural areas include various types of other industries and services of which agriculture is still the most important one in many regions of the CEAs. Besides its direct impact, agriculture also affects indirectly the development of the local economy. This occurs through the linkage which exist to its upstream industry providing inputs into agriculture and to its downstream sectors such as processing and distribution of agricultural output. In addition, the entire agro-food sector is linked to adjacent industries and services. Some of the latter connect again with agriculture. Therefore, forward and backward linkages exist between agriculture and the remaining local economy. Hence, agricultural and food policies still have an important bearing on rural economies even if it is reduced. The multiplier effects should also not be overlooked. Many functions for which formerly collective or state farms were responsible now are carried out by other industries. This also holds for construction work but also for organizing main social tasks like kindergartens and nurseries as well as medical and cultural services. They were provided in special, purpose-built facilities on state and collective farms which the village community has or had to take over. Some of the services also ceased to be provided. This is indicative of the substantial economic restructuring required in rural areas which takes time and needs many initiatives. On the other hand, it offers the chance of, at least partly, revitalizing the rural economies. Especially, processing industries could be established as well as marketing facilities and other services for agriculture in these regions. Development of rural economies might be enhanced by reallocating parts of the up stream but especially the down stream industry into the countryside. This can be accomplished simultaneously with restructuring these industries. Whether this will happen strongly depends on the quantity and type of raw material supplied by local or nearby agriculture. Some raw material cannot be hauled over too a large distance making factories which process these goods very dependent on sufficient local supply. Milk, live animals, fruits and vegetables belong to this group. Grain, however, is easily hatled over long distances making milling companies and bakeries independent of local and even domestic ;supply. In addition, the intensity of processing differs among farm commodities. Slaughterhouses and meat-packing and canning of fruits and vegetables require more inputs than milling. This also indicates that how agriculture develops can have varying impacts on supporting local economies. There are other examples showing that agriculture can enhance many economic activities in rural areas. Selling farm products or small scale processing is better organized if demand for the products is in close distance. On the other hand, development of farming also depends on industries not directly related to agriculture. Farmers often work only part time on their enterprise and earn a substantial part of their income from other industries and services. The problems in rural development may be seen in migration to and from urban areas. Though total net migration from rural to urban regions is relatively small the structure of these processes is more revealing. Young people move to cities and the elderly remain at or go to the countryside. Competitiveness of Fa,rming in Countries Associated With the EU under the CAP 51 Examples also exist that this process is reversible and young people return. New suggestions for development of rural communities are needed. More financial support may be helpful. But without any sustainable development the money given may be wasted. Physical Infrastructure in Rural Areas Upgrading the physical infrastructure and especially the iroad and railway systems seem to be unavoidable for keeping rural areas populated. This facilitates trade between regions and taking advantage of the particular amenities rural as well as urban areas offer. There are different ways to accomplish this. However, modern transportation systems just connecting large cities without stopping in the countryside are not facilitating this process. This holds for road, railway and air traffic. On the other hand, modern electronic networks also favor rural regions. Integrating the applicant countries into the EIU puts additional need for improving transportation. The benefits from enlargement can only be obtained if no artificial barriers like insufficient transport inifrastructure hampering trade exists. The EU Commission recognizes the crucial role of infiastructure in rural development and emphasizes the uipgrading of transport infrastructure including border crossing facilities (EU Comnmission 1997). The Rural Support Fund of Agenda 2000 has special programs targeted to diversification of the rural economy and the creation of additional and alternative jobs (EU Commission 1998). No agreement has yet been reached with regard to how the agricultural and structural policies of the EU will be implemented in applicant countries. As a matter of fact, opinions in this respect are still rather far apart the dividing line running between current and new members. Structural policies iin applicant countries supporting agriculture and rural development are still undergoing adjustments. For instance, in Slovenia they are likely to be altered towards measures which improve structural changes in ownership as well as in production, use of technology and setting up of marketing organizations. The development of a more market-oriented structure of agriculture is seen as a prerequisite to a successful adjustment of this sector. This appllies not only to expansion of farm size and yields, but also to the identification of not yet discovered "niche" markets and complementary income sources. A more efficient marketing and organization of producers are also needed. The state can play a key role in supporting market-oriented organizations - cooperatives for selling and/or buying, chambers of agriculture, sales points, marketing chains - and encouraging mergers. In some of the applicant countries, investment subsidies are available for less favorable areas (mainly for animal production on alpine pastures). Similar structural policies are implemented in other applicant countries as well. They can also be used to encourage the application of environmentally friendly production techniques. Where needed the use of pesticides and fertilizer as well as the livestock density can be reduced. Support may be directed toward organic farming and integrated food production systems. 52 K. Frohberg QUANTITATIVE INDICATORS OF COMPETITIVENESS Results of several recent studies, most of which were financially supported by the EU Commission, are used in this paper for assessing competitiveness of the CEAs under the CAP. Each study analyzed the effects of the EU East-Enlargement on the CEAs by using a host of different indicators. Jointly, the studies probably exhaust the current possibilities for measuring both quantitatively and qualitatively competitiveness of a sector and industry. The various indicators and the specific studies are listed in Appendix I. This overview provides an interesting insight into which of the measures were mostly preferred by the research teams. Many of these indicators can only be used for indicating past competitiveness. They are calculated based on statistics representing sector averages or farm level information. Just a few of the indicators measure development of competitiveness in the future or at a certain future date. But the latter characteristic and not the former is required for an assessment of how agriculture and the food industry in the CElAs may be able to hold on to or expand market shares after these countries joined the EU. Answers to this question are provided by using the domestic resource costs indicator (DRC) in some instances. Most often simulations with some kind of sector or national models are carried out for this purpose. The measures used vary also with regard to ease of calculation and their ability of depicting competitiveness. For example, factor endowment is not as good an indicator as is the DRC. As might be expected, there is a negative correlation between ease of calculation and data availability oil the one hand and ability to indicate the degree of competitiveness on the other. Those to be computed with little problems often do not have the strongest predictive capacity. Panel Al in Appendix I reveals that just a few measures regarding agriculture are used for all countries. These are the market share indicators and real exchange rates. The latter has special characteristics; it is an indicator calculated - at least in the studies analyzed for this overview - for the national level and not specific commodities or crops. Besides these two indicators the DRC is also employed for almost all countries. All other measures find only scattered application. Panel A2 lists quantitative indicators that have been employed for analyzing competitiveness of the food industry. Interestingly, they are fewer in number than those used for the agricultural sector. With the exception of market share indicators and protection levels they are not employed to assess competitiveness. This is likely caused by lack of data availability rather than suitability. The DRC or gross margin can equally well be used for indicating competitiveness of the food industry as for agriculture. In terns of model simulations, the food sector has quite a different market structure making it more difficult to depict it in a mathematical system. Lack of data may be another reason why so few models exist for the food industry. Besides quantitative also qualitative indicators are used for assessing competitiveness. Those employed in the studies considered in this evaluation are listed in panel A3 in Appendix I. All of them are rather difficult to compute and, therefore, might not have been calculated. Some of them such as foreign direct investment and effective protection could, however, have been filled with numbers. Nevertheless, they are not easy to interpret from the point of view of competitiveness. This holds for foreign direct investment especially since they occur due to a host of factors not all of which are closely Competitiveness of Farming in Coluntries Associated With the EU under the CAP 53 linked to competitiveness. On the other hand, if used these two mneasures are employed for almost all countries. One aspect is worth mentioning. All studies investigate separately competitiveness of agriculture from that of the food industry. An analysis of the entire food chain, i.e. from stable to table would be advantageous. Investigating competitiveness only For the farm sector leaves important aspects of the downstream sector out, even if the product is not farther processed by the domestic industry. Transportation and, marketing activities are not included which might turn the final verdict on competitiveness into opposition direction. On the other hand, including raw material into the analysis of the food processing industry's capacity to compete allows a more comprehensive investigation than without. Considering first ex post competitiveness, the exchange rate was (and still is) an important determinant of trade for the CEAs. Immediately after transition began all CEAs devalued their currencies against those of western countries. Thereafter, they tried to keep them constant with more or less success. Some of these exchange rates are fixed against one or several western currencies. For example, since the early period of transition Estonia ties its currency to the German mark. On the other hand, the inflation rates differ between transition and western countries. For some of the CEAs, the policy of keeping [he nonminal exchange rates rather fixed while differences in inflation rates were considerable led to rather strong changes in their real effective exchange rates. Figture 1 sh,ows - the development of this 200 - indicator between 1L995 and 1998 for nearly all 175 - of the CEAs. Earlier 160 163 years are exclujded 150 14 because of substantial 133 1 136 structural adjustments 125- 123119 3 2119 1 119 I20 which took place in lx 103 these countries. 100--1 However, as this figure aD countries -.xcluding Russia EU only depicts even over more recent years changes in [I Estonia E Latvia El Lithuania H Poland M Czech Rep. El Slovakia M Hungary the real effective exchange rate were still rather strong. The Baltic countries, experieed the l s Figure 1: Appreciation of Real Effective Exchange Rates of Some CEAs from 1995 to experienced the largest 1998 (1995 = 100). Calculations carried ou't by W.-R. Poganietz in three alternative appreciation during scenarios: considering all trading countries, excluding Russia, and including only the this period. This holds EU. No data for Bulgaria, Romania, and Slovenia. regardless whether al]L trading partners are considered in the calculation, Russia and other European countries of the Commonwealth of Independent States (CIS) are excluded, or only the EU is included. It is interesting to notice that for nnost CEAs the appreciation of the real effective exchange rate is strongest towards 54 K. Frohberg the EU and smallest when Russia and other European countries of the CIS are excluded in the calculations. This means that real effective appreciation of the currencies of CEAs was lowest towards the latter countries. In some 120.00 Estoniii cases even a depreciation occurred. Since the CEAs 110.00 Latvia trade only a small percentage 100.00 Lithuania of their goods with the CIS, so- ___-. x Poland changes in their bilateral 90.00 10' exchange rates enter the 80.00 Rep. calculation of the real 0 _b vakia effective exchange rate with - Hungy relatively low weights. 60.00 EU Hence, strong adjustments in 5000 these exchange rates have almost no impact. 40.00 30.00 The lowest 2 I appreciation of the real 20.00 1993 1994 1995 1996 1997 effective exchange rate took place in Slovakia and Figure 2: Aggregate Producer Price of Crop Products in Hungary. The appreciation in Selected CEAs Relative to the EU (EU=100). Poland and the Czech Republic is somewhat higher but still considerably less than | Figure 3: Aggregate Producer Price of Livestock Products in the appreciation in the Baltics. selected CEAs relative to the EU (EU=100) Nevertheless, real appreciation 12000 of 20% over a period of only 110.00 three years is fairly strong and constitutes a considerable 100.00 . Estonia deterrence to export. At the 90.00 - | Latvia same time, it improves import F L conditions. Both effects put 80.oo . -- Lithuania domestic production under 70.00 x - Poland severe pressure of adjustment 60_ *---A, Czech since the share of imported 60.00 - . ep. X Slovakia inputs is relatively small. 50.00 - . . t g Future developments 40.00 1 - -EU of exchange rate policies in the 30.00 - CEAs are likely to lead to 20.001 different developments which 1993 1994 1995 1996 1997 are expected to be more conducive for exports. Therefore, these policies will strengthen outward orientation of agriculture and the food industiy in the CEAs by strengthening their competitiveness. Competitiveness of Farming in Countries Associated With the EU under the C4P 55 Other important deterrminants of competitiveness are producer prices. At the beginning of transition they were considerably lower in the CEAs than those prevailing in the EU. Aggregate producer prices of crops and of livestock increased during the transition period relative to those of the EU in all those CEAs shiown in Figures 2 and 3. This holds for crops as well as for livestock products. In 1997, the difference of the aggregate prices of crops varied between 8% for Poland and 28% for Hungary. The price gap for animal products is, in general, somewhat larger. It ranges from 24% for Lithuania to 34% for Latvia. Besides the narrowing of the price gap between the EU and the CEAs it also is remarkable how close these aggregate prices becamre among the associated countries themselves. This is likely to be due to several factors among which the creation of free trade areas (CEFTA and BFTA) are quite important. It also makes the enlargement of the EU easier since prices are harmonized among the acceding countries to a considerable degree though at a different niveau than that of the EU. The aggregation of producer prices of livestock procLucts disguises an important fact. Beef and milk prices were all substantially lower in all years than the aggregate one while those for pork, poultry and eggs were above. This pattern is observable for all CEAs. In 1997, producer prices of ruminant products were about 50% below those in the EU. The other ones were at equal level or somewhat above. In some of these cotntries, the pork price exceeded that of the EU by 20% in that year. Agenda 2000 is likely to lead to lower prices for some agricultural products than those which prevailed in 1997 narrowing the price gap between the EU and the CEAs even more. Hence, at the time the associate countries will join the EU only a small price effect - if any - can be expected. As a consequence, competitiveness of agriculture in the CEAs will only be modestly strengthened due to increases in producer prices after accession. However, input costs matter as well. Prices of tradable inputs can be 20 , expected to adjust to E_U level. In 18 ,r" general, this will lead to an increase with x s 16 X a magnitude comparable to changes in producer prices. Ccsts of the nontradable 14 -_ _-- Latvia production factors land and labor remain 12 A__ , - Lithuania to be considered. Land is the residual - -Poland claimer and gets that remnuneration of r ...... what the other inpuits do not claim. Only 8Rep labor remains to be explained as a cost 6 ' Slovakia factor. Competitiveness of agriculture in 4w- Hungary the CEAs could consicderably weaken if -. - labor costs in these countries adjust to 2 _ X those prevailing in the EU. Figure 4 0 ° depicts the hourly wage rate to be paid 1993 1994 1995 1996 1997 1998 for agricultural labor- in the CEAs Figure 4: Hourly Wage Rate in Agriculture in Selected CEAs Relative to relative to that of the EU. As can be seen theEU(EU=IO0). from this figure the difference in wages 56 K Frohberg is still rather large though the gap is also narrowing. In Poland, Czech Republic and Hungary the difference was 80% in 1997 and in the Baltic countries 90%. An important question is 14000 E.stonia whether wage rates increased more than 13500 Latvia producer prices in the CEAs compared Al I to the EU. Figures 5 and 6 combine the 3000 Fo_and information contained in Figures 2 and Poland 3 respectively with that of Figure 4. 2500 - X Czech They depict ratios of a relative price in 2000 - Reo. the corresponding CEA to that in the EU. The relative price is the aggregate 1500 Fl ,. Hungary crop price (or livestock price) l- ___ normalized using the hourly wage rate. The graphs in Figures 5 and 6 reveal 500 - - - two aspects. First, the normalized producer prices are considerably higher 0 1993 194 19196 17 in the CEAs than in the EU. In 1997, the range run between 12 times in Figure 5: Ratio of Aggregate Crop Price to Wage Rate Lithuania and 5 in the Czech Republic for Selected CEAs Relative to the EU (EU=100). for the aggregate crop price and between 10 times in Lithuania and 4 in Poland for the aggregate livestock price. Second, for all associated countries considered but Hungary this ratio of the two normalized aggregate producer prices declined over time. The level of reduction is in general not very strong. Lithuania and Estonia, however, show a considerable decrease. This change implies that producer prices relative to the wage rate increased less in the CEAs than in the EU. Hungary is the only country for which this ratio increased from 1993 to 1997 indicating an improvement in relative producer 4000 prices as compared to the EU. -x- Emrua 3500 -___________________________ 35 Latvia This competitive advantage based 3000 L * Lithuania on relative prices has to be turned into -o one which considers costs. Low wage 2500 Fxoland rates do not imply small labor costs --i Czech because the level of labor productivity is x Slovakia usually reduced too. Since the two are 1500 . Hnngar closely related it is very likely that with 1000.... increasing wage rates labor productivity . x- will also go up. That means that labor 500 . _ costs may increase after the CEAs joined 0 the EU but less than wage rates. 1993 1994 1995 1996 1997 Figure 6: Ratio of Aggregate Livestock Price to Wage Rate Many of the indicators employed for Selected CEAs Relative to the EU (EU=100). need a large set of data, are based on past information and used for ex post analyses. Only a few methods exist which can be engaged for ex ante Competitiveness of Far.ning in Countries Associated With the EU under the CAP 57 assessments (Frohberg and Hartmann 1997b). Models belongl to the latter group. Some measures of the ex post type like DRC are now also taken to condense the information provided by rather broadly scoped models such as general or partial equilibrium ones to a single indicator. The advantage of doing this is obvious; it is easily seen whether a competitive advantage exists and to what degree. The discussion on competitiveness focuses first on ex post analyses. Ex ante evaluations will follow thereafter. As an irnportant determinant of competitiveness, production costs are explicitly considered in several inclicators; e.g. in the calculation of gross margins. However, the results of these calculations are rather depend on the underlying assumptions and data used. It is not unusual to see rather diverging statements or even conflicting results. Commonly, gross margins are calculated only at farm level. This hampers somewhat their use for international comparisons since important determinants like transportation and marketing costs are not explicitly taken into account in case if raw materials and, in addition, processing costs if food products are colnsidered. Gross margins are s]hown for the Baltic countries, Poland, Hungary, and Romania in Table 1. For comparison, gross margins are also depicted for two Scandinavian EU member states, Finland and Sweden. Quite large differences in those figures can be observed. For all Baltic countries only pork can be claimed competitive if compared to Sweden. The situation is quite different if evaluated relative to Finland since gross margins of the latter are substantially lower than those in Sweden (because, among other factors, direct transfers are not treated as revenue in Finland). Gross margins of farms in Poland and Hungary are indicative of a stronger competitiveness while those of Romania are generally low. Table 1. Gross Marginsa) for the Baltic Countries, Finlaind, and Sweden in 1996 (in euro per hectare or per animal) Estonia T Lal.via Lithuania Poland b),e Hurngary c) Romania c) | Finland Sweden Wheat 359 41 -19 139 46 39 280 445 Barley 113 -69 18 n.a. n.a. -152 -49 139 Sugar 29 138 48 219 100 -54 -349 102 Milk 359 -[17 -19 501 667 n.a. 280 445 Beef 29 3 48 n.a. n.a. n.a. -349 102 Pork 8 -62 32 n.a. n.a. n.a. -23 -10 a) Gross margins defined as revenue minus costs of variable inputs and labor.; b) Gross margins of small farms; c) Data for 1995 Source: Frohberg and Winter (1999) for the Baltics and Scandinavian countries, Schuele (1999) for the rest. These margins were calculated for the mid-90s. Their srnall levels are often caused by low producer prices rather than high production costs. Increasing producer prices (as has actually happened since then) could have lead to considerable improvements in competitiveness if prices of variable inputs increased less and/or productivity grew especially strong. As shown above wage rates tend to increase faster than other prices. This will erode the cost advantage these countries still have if productivity is not raised. Table 2 provides a summary assessment of various competitiveness indicators calculated in studies financially supported by the EU. The light shaded cells include commodities for which the results show competitiveness. The dark shaded cell point toward products that lack competitiveness. For cells not shaded and ce]ls with a plus/minus sign no conclusion could be reached. The latter is the one most often occurring. ODbviously, different indicators used for the same commodity often show 58 K Frohberg conflicting results. The table depicts two sets of indicators, ex post and ex ante. The former are based on observations made in the past while the latter assess competitiveness assuming conditions which are likely to prevail after accession to the EU. The ex post indicators include gross margins, DRC, private cost ratios (PCR), and two revealed comparative advantage measures, the relative export advantage index (RXA) and the relative trade advantage index (RTA). Ex ante indicators are results of simulations carried out with models. Berg et al. (1999) use farm level Linear Programming models, while Weber et al. (1999) employ econometric type sector models. The relative export advantage index, RXA, is defined as the ratio of a country's export share of a certain product in the world market to the same country's share in world export of all other commodities. The special feature of this measure is that the world "total" is always taken as the sum across all countries except the one studied. This avoids counting countries and commodities in both the numerator and the denominator. This aspect is especially relevant if a country is important in international trade, and/or if the commodity considered is important in total trade. In these cases, double counting would lead to biased index values. RXA values above unity suggest that the country reveals a competitive advantage in the considered product category whereas values below point to a competitive disadvantage. The relative trade advantage index, RTA, is the difference of two similar measures, the relative export advantage index, RXA, and the relative import penetration index, RMP. RMP is defined similarly to RXA using imports instead of exports. The competitive advantage revealed by RTA is implicitly weighted by the importance of the relative export and import advantages. Hence, it is not dominated by extremely small export or import values of the commodity considered. A positive RTA value indicates a competitive advantage, and a negative one a competitive disadvantage. The RTA and RXA measures go beyond those discussed so far in this section. 'rhey also include processed food. Hence, results of these two revealed comparative advantage measures are summarized which were obtained for several processing levels of each commodity. According to these indicators, Hungary seems to have competitive advantage. Similarly Estonia shows generally positive signs, especially for oilseeds and sugar beet, but not for meat products; the outcomes for milk are conflicting. Most CEAs do not have a strong advantage according to numbers based on trade figures. For Hungary and Slovenia DRC and PCR were also calculated. As can be seen froni Table 2, they are not always in agreement with the picture provided by the RTA and RXA measures. For Hungary, no differences can be discerned for wheat and oilseeds - all indicators show competitiveness, but for animal products they are substantial. Both DRC and PCR point to difficulties in being able to compete in milk and beef which the other two indicators assess to be rather the opposite. One explanation for this divergence is whether processed or unprocessed goods are considered. As mentioned above, this can be decisive for the outcome. A similar picture emerges when the D)RC and PCR figures of Slovenia are compared with the ones representing revealed comparative advantage. Again, only for wheat and oilseeds is there an agreement in the message. These two products are competitive. For all other products the measures produce conflicting results. Competitiveness of Faiming in Countries Associated With the EU under the CAP 59 Table 2. A Summary Assessment of Competitiveness for CEAs* Study Method/ Year wheat oilseeds sugarbeet milk beef pork Indicator'_ Estonia = ==_________ ______ __________ ex post = _ Eiteljorge RTA and RXA 1995 + . and 1996 +_ i I + Hartmann 1997 j Weber et aL Sector model 2007 4-i Latvia __________ ________ _________ ex post Eiteljorge RTA and RXA 1995 + + +- . . .±, -. - + - and 1996 - I- Hartmann 1997 Y6 I ± ex ante Weber et al. Sector model _ 2007 Lithuania __________ ________ ex post Eiteljorge RTA and RXA 1995 +- | |+- | +- and 1996 + i - ex ante Weber et al. Sector mc,del _ 2007 =tg 17 4S { + ________ ______ Poland ex post Eiteljorge RTA and RXA 1995 - + | + I - and 1996 1 0 _ | + Hartmann __1997_ _ | +.. - . . _ ~~~~~~~ex ante Berg et al. LPinodel 12007 e a I I : Weber et al. Sector model _ 2007 __ Czech Republic = - | ~~~~~~~ex post Eiteljorge RTA and RXA 1995 , and 1996 +- -+- r . + Hartmann __ -- 1997 -+ _________ _ ___ _____ _ |ex ante Weber etal. Sectormodel | 2007 Z;. -- 0 *) The + sign stands for competitive, +- for indecisive, and - for non-co:npetitive. ')DRC = domestic resource cost, PCR = private cost ratio, RXA = relative export advantage index, RTA = relative trad advantage index. 60 K. Frohberg Table 2 Continued Study Method/ Year wheat oilseeds sugarbeet milk beef pcrk lindicator'" I I__II Slovakia ex post Eiteljtirge and RTA and RXA 1995 I Hartmann1964 1997 +- + ex ante Berg et al. |LP model 2007 Weber et al. Sector model 2007 ^ Hungary ex post Banse et al. DRC 19945 1995 1996 w, l _S _ 1 PCR 994 gLl||| Eiteljorge and RTA and RXA 1995 fg>6>f R.fi.58<6RX.|X@' ,.o^ Hartmann 19 1997 .X. ex ante Berg et al. iLP model 2007 |Dn Weber et al. Sector model 2007 Slovenia ex post Bojnec |DRC | 1995 i O g E 5 |PCR | 1995 W}RgS ......- Eiteljorge and RTAandRXA 1995 1 +F- Hartmann 1996 Webe I et997 a St m 2007 Weber et al. I Sector model 1 2007 gx,RMO,;l'gg,g'"'"2' 7 %@'m'W Bulgaria l l l ~~~~~~~~~ex post Eiteljorge and |RTA and RXA 1995 7i>f - | + - 1 + ' Hartmann ||1996 + LjH+I -|4 1997 _ _ + | + | + | + | 4- | | | ~~~~~~~~~ex ante Weber et al. I|sector model |2007 | 8>8O8 ......... >f.1...+ xt568 i5j Competitiveness of Farming in (Countries Associated With the EU under the CAP 61 Hungary, Estonia and Slovenia are the countries for which the outcome of various analyses conducted with regard to assessing the impact of accession are mnore in agreement than for the other CEAs. No results could be found for Romania. Evaluations for Hungary show that crops are competitive but milk and beef not. Though in some years domestic resource costs point toward a lack of competitiveness for pork revealed comparative advantage indicators show mixed results or the opposite. It is remarkable that oilseeds and sugarbeet in Estonia are measured to be competitive while milk is not and for beef opposite outcomes were found. Continuing with the discussion of ex ante indicators, Munch (1999) and Weber et al. (1999) provide estirnates of production changes in the first round countries (Estonia, Poland, Czech Republic, Hungary and Slovenia) under different assumptions with regard to what kind of CAP might be adopted. The results indicate thalt besides changes in domestic prices also productivity changes such as yield levels play an important role in the responses simulated. In a scenario which excludes extension of compensation payments to acceding countries the studies find that price increases are sufficient to lead to expansion in cereal production in those countries and coarse grain exports will increase. Oilseed prcductioDn will decrease as prices in the first round countries fall to ElU levels. In the case direct payments for arable crops are granted for them, oilseed production decreases less as relatively more area is aLlocated to these crops in the analysis done by Munch (1999). Weber elt al. (1999) find that oilseed output will decline more if no compensation is paid than with. In the livestock sector two types of development take place. For pork, poultry and eggs prices in the first round countries are at or above those of the EU. Hence, joining the EU leads to a decline in output of these cornmodities and an increase in consumption. As a consequence, these countries become net importers of those products. Developments for rmilk and beef are quite different. For these commodities, the first round countries have prices substantially below EU levels. Hence, price increases are expected to occur with accession. Production wlill, therefore, increase, demand be reduced and net exports rise. Compensation will make production increases of beef even stronger but not milk since these countries will also be allocated a milk quota. T'his is expected to be binding already in the scenario without compensation. As mentioned above, efficiency of the food industry is crucial for the development of agriculture. Table 3 provides concentration ratios of the four largest firms for some food processing sectors in associatecl countries and EU member states. The latter are added for comparison. Hungary, Lithuania and Slovenia indicate relatively high concentration ratios for the entire food industry. Estonia and Latvia show them for the dairy industry. hn Poland, Czech Republic and Romania they are relatively low in general. Bulgaria provides a rather mixed picture. Though concentration in the food industry seems not anymore the most pressing problem in these countries, implementation and enforcement of appropriate antitrust rules is necessary to prevent a new occurrence of. concentration (Hartmann and Wandel I1999). 62 K. Frohberg Table 3. Concentration Ratios of the Four Largest Firms for Some Food Processing Sectors in Selected Accession Countries and Some EU Member States in 1996 (in %) Flour Bread Processed pork and beef Milk Estonia n.a. n.a. n.a. 573) Latvia n.a. n.a. n.a. 46" Lithuania 43.21) 43.21) 40.6 31 3 Poland 20.0 10.7 11.5 19.3 Czech Republic 18.0 n.a. 15.7 26.7 Hungary 30.0 23.0 40.02) 35.0 Slovenia 100.0 45.5 55.6 76.0 Romania 8.5 9.1 11.6 31.2 Bulgaria 47.6 6.9 15.12) 35.2 4 France 29.0 4.5 23.0 n.a. Germany 38.0 7.0 22.0 n.a. Italy 6.7 4.0 11.0 n.a. United Kingdom 76.0 58.0 n.a. n.a. i) grain processing; 2) pork only; ) dairy sector; 4) for 1995 Source: Adapted. from Gorton et al. (1999) and Hartmann and Wandel (1999). Another indication of how competitive the food sector is can be obtained from the price spread between farm and retail level. Farm gate prices as a percentage of retail prices are rather low in some of the first round countries such as the Czech Republic, Poland and Slovenia for wheat (Trable 4). Hungary's farmers receive a much higher share of the retail price for bread than their colleagues in other first round countries. In the second round countries listed in that table, Bulgaria and Romania, this share is even higher. Large variations also exist for the farm gate to retail price ratios of other commodities and for prices of processed goods. Table 4. Ratios of Prices at Farm gate and Different Processing Levels to Retail Prices in 1996 (in %) Bulgaria Czech Rep. Hungary Poland Romania Slovenia WheatlFlour/Bread Farm gate 36 13 32 13 37 19 Milling 54 21 49 39 81 29 Bakery 81 88 86 44 94 88 Milk Farm gate 50 63 64 30 72 55 Processing 78 82 84 39 83 86 Beef Farm gate 33 26 38 n.a. 67 37 Processing 74 82 72 n.a. 90 47 Pork Farm gate 28 27 38 32 57 27 Processor 53 39 72 77 82 31 Chicken Farm gate 32 40 45 56 50 33 Processing 57 83 92 n.a. 68 72 Source: Adapted from Table 5 of Gorton et al. (1999). Both processing and retailing receive direct or indirect support in some countries (Gorton et al. 1999). If this is going to be phased out after accession to the EU some sectors of the food industry might face profitability problems unless they cut costs. Considerably less information on Competitiveness of Farming in Countries Associated With the EU under the CAP 63 competitiveness exists for the second round countries. Thi, is due to the fact that at they were not as intensively studied as those in the first round. It holds less for Slovakia, Latvia and Lithuania but more for Bulgaria and especially for Romania. The latter received least attention in this respect. CONCLUSIONS The overview of farming conditions under EU economic and especially agricultural policies reveals that agriculture is likely to benefit from accession to the EU. However, the extent of this improvement is open to considerable variation. It depends on many determinants of which the development is quite uncertain and also can be influenced to a large degree by the accession countries themselves. Altogether., it is fair to say that production will strengthen but demand as well. The net trade position in agricultural and food products of the accession countries is expected to improve as well. Crucial to these outcomes are also factors which a:re shaped outside the EU and the joining countries. Among those, developments at the world markets for agricultural products are very important. REFERENCES Agra-Europe (1998), East, Europe, March. Banse, M. et al. (1999)., The Evolution of Competitiveness in Hungarian Agriculture: from Transition to Accession, listitute of Agricultural Economics, University of Goettingen, Working Paper No. 1/6. Berg, E., S. Davies, and !E. Majewski (1999), Einkommeniwirkungen unterschiedlicher agrarpolitischer zenarien auf landwirtschaftliche Betriebe in ausgewihli;en MOE- und EU-Laendern, Agrarwirtschaft, 48, Heft 8/9, pp. 331-338. Eiteljorge, U. and M. Hartmann (1999), Factors determining success or failure in the food chains of CEECs, in: ISMEA, The European Agro-food System and the Challenge of Global Competition, Rome. Elsner, K. and M. HartmaLnn (1997), Convergence of Food Consumption Patterns between Eastern and Western Eurepe, IAM'O Discussion Paper. EU Commission (1997), Agenda 2000 - Volume II - Communication: Reinforcing the Pre-accession Strategy, Coc97/7, Brussels, 15 July 1997. EU Commission (1998), Agricultural Situation and Prospects in Central and Eastern European Countries. Country Reports, Brussels. Frohberg, K. and M. Ilartmann (1997a), Promoting CEECs' Agricultural Exports through Association Agreements with the EU - Why It Does Not Work, IAMO Discussion Paper No. 1, Halle/Saale. Frohberg, K and M. Hartmann (1997b), Comparing Measures of Competitiveness, IAMO Discussion Paper No. 2, Halle, Germany. Frohberg, K. and E. Winter (1999), Competitiveness of the Baltic Agricultural and Food Sectors after Accession to the E,U. revised Final Report to the EU Commission, Institute of Agricultural Development in Central and Eastern Europe, Halle, Germany. Gorton, M., A. Buckwell and S. Davidova (1999), Transfers and Distortions Along CEEC Food Supply Chains, Wye College Working Paper 2/9. Hartmann, M. and J. Wandel (1999), Industrial Organisation of the Milk Processing Industry in the Baltic States: Results of an Expert Survey, Paper presented at the 66th EAAE Seminar on Bringing Baltic Sea Countries inlo the EUJ, Tallinn, May 20-22. Heidhues, F. and Schrieder, G. (1998), Transformation und land-liches Finazwesen. Agrarwirtschaft 67 (1998), Heft 3/4, p. 165-171. 64 K. Frohberg Lerman, Z. (1999), From Commonality to Divergence: How ECE and CIS Agriculture are Drifting apart, Paper Presented at the Seminar on Land Ownership, Land Markets and Their Influence on the Efficiency of Agricultural Production in Central and Eastern Europe, IAMO/FAO, Halle, Germany, May 9-11. Mathijs, E. and J. Swinnen (1999), Efficiency Effects of Land Reforms in East Central Europe and the Former Soviet union, Paper Presented at the Seminar on Land Ownership, Land Markets and Their Influence on the Efficiency of Agricultural Production in Central and Eastern Europe, IAMO/FA.O, Halle, Germany, May 9-11. Munch, W. (1999), Effects of CEC-EU Accession on Agricultural markets in the CEC and on Government Expenditure, Draft Final results of Task 4, Goettingen. Schuele, H. (1999), Analyse der Wettbewersfahigkeit der landwirtschaft ausgewahlter Laender Mittel- und Osteuropas, Agrarwirtschaft, 48, Heft 8/9, pp. 290-294. Weber, G., 0. Wahl, and E. Meinlschmidt (1999), Effects of EU-Eastenlargement on acceding countries, Discussion Paper, IAMO-Institute of Agricultural Development in Central and Eastern Europe, Halle, Germany. Williamson, 0. (1985), The Economic Institutions of Capitalism, New York. Competitiveness of Farming in Countries Associated With the EU under the CAP 65 APPENDIX I: Availability of Competitiveness lIndicators for CEAs in EU studies* Al. Quantitative indicators used for assessing the competitiveness or agriculture Estonia Latvia Lithuania Poland Czech Rep. Slovakia Hungary Slovenia Romania Bulgaria| Factor endowment X X X Gross margins X X X Total factor productivity x x x Farm income X Private cost ratio(PCR) X X Domestic resource costs (DRC) X X X Market share indicators (RXN,RTA) X X X X X X X X X X Model simulations X X X X X X X X Agricultural gross output (GOA) _ X X X X Real exchange rates _ X X X X X X X X X X Nominal protection rates (NPR) X X X X X X X X Producer subsidy equivalents (PSE) _ X X X X X X Price and income response = _ = X X X X A2. Quantitative indicators used for assessing the competitiveness of food processing industry E=stonia Latvia Lithuania Poland Czech Rep. Slovakia Hungary Slovenia Romania Bulgaria Concentration ratios X X X X X X X X X Foreign direct investment X X X X X X X X X X Market share indicators (RXA,RTA) X X X X X X X X X X Price margins in food chain X X X X X X Firms with exporl: license X X X X X X Firms with retail outlets X X X X Producer subsidy equivalents (PSE) _ X X X X X X A3. Qualitative indicators used for assessing the competitiveness of agriculture and food processing Estonia Latvia Lithuania Poland Czeh Rep. Slovakia Hungary Slovenia Romania Bulgaria Farm structure X X X X X X X Human capital X X X X X X X X X X Credit markets X X X X X X X X X Land markets X X X X Downstream sectors X x x | x x x x x Effective protection _ | X X X X X X Instability of agricultural policies I X X X *The indicators marked with X are available in the following studies funded by the EU Commission: 1. EU Integration Impacts on the Financial Situation of Farms in Selected Existing and Future Member States: Coordinator: E. M ewski (ACE P 95- 2180-R) 2. Agriculture and East-Wes: European Integration: Coordinator: Johan Swinnen (ACE F 95- 2022 -R) 3. Analysing Agricultural Pclicy Options Under Transition in Viewv of Future Accession to the EU; Coordinator: George Mergos (ACE P 96-6107) 4. Farm Restructuring in Central and Eastern Europe: Causes. Efficiency and Policy Inp lications; Coordinator: Johan Swinnen (ACE P 96- 6090- R) 5. Agriculture Implications of CEEC Accession to the EU; Coordinator: Stefan Tangerman (FAIR 1 CT 95- 0029) 6. Competitiveness of the Baltic Agricultural and Food Sectors after Accession to the EU; Coordinator: Klaus Frohberg (P 95 2198 R ) 7. Inefficiencies in the Food Industries of the Baltic States; Coordinator: Monika Hartmann (P 96 6055 R) Structural Change in the Farming Sectors of Central and Eastern Europe Second EU Accession Workshop in the Rural Sector, Warsaw, Poland, June 27-29, 1999 Impact of Foreign Direct Investment on Agriculture and Agro-Industry in Transition Economies Hamish R. Gow Johan F. M. Swinnen Total flows of foreign direct investment (FDI) into transition countries increased significantly during the early 1990. FDI has a positive impact on the industry in transition countries because it provides capital essential for restructuring and modernization, as well as bringing managerial and technological skills, which are in short supply within the region (OECD 1998). FDI in the agro-food sector accounted for a substantial share of total FDI. The bu[k of agro-food FDI has been directed to the agro-industry, and not to primary agriculture. However, despite the fact that very little FDI has gone to the farm level, FDI is having a major positive impact on primary agriculture. Agricultural transition has been characterized by declining output and decapitalizatiLon of the production system. One of the contributing factors to these negative development has been the break-up of the pre-reform system of contracting and contract enforcement in the agro-food chain, which formerly was strongly vertically integrated and centrally planned. With imperfectly developed market and legal institutions, enforcement problems within the agro-food sector[ have caused contractual disruptions. In the absence of credible and enforceable contractual arrangements, the opportunity exists for one of the parties involved in the contract to attempt to extract the appropriable quasi-rents accruing to the relationship-specific investmenlt by renegotiating the contractual terms ex post, that is "holding up the transaction" (Williarnson 1985). Hold-up is defined as "the general business problem in which each party to a contract worries about being forced to accept disadvantageous terms later, after it has sunk an investment, or worries that its investment may be devalued by others...." (Milgrom and Roberts 1992, p. [36). These hold-up problems cause under-investment in relationship-specific assets (Klein et al. 1978). In transition agriculture, hold-ups are usually observed in the form of delayed payments, due to a combination of agriculture-specific characteristics and transition-specific probl[ems (Gow and Swinnen 1998). Empirical observations suggest that FDI in upstream and/or downstream industries in transition countries has provided a solution to the contracting problems and has facilitated access to inputs for farms through private contract enforcement mechanisms induced by innovative vertical contracting. Our discussion of the impact of FDI in transition countries focuses specifically on opportunities for private contract enforcement and contractual convergence across 66 Impact of Foreign D)irect Investment on Agriculture and Agro-Industry 67 sectors, going beyond the traditional FDI-induced effects (Bende-Nabende and Ford 1998, Borensztein et al. 1998, Brenton and di Mauro 1999) and spillover to other sectors (Lall 1980, Watanabe 1983, ]3lonstrom and Kokko 1997). To explain the impact of FDI in transition countries, we use a new institutional contracting model basedl on Klein's (1996) model of contract enforcement and hold-ups. We show why the reforms have induced massive contract disruptions and how FDI-induced vertical contracting has been successful in providing private enforcement of contracts during the transition period. Empirical evidence is presented on FDI-induced vertical contracting, including a case study. The case study illustrates a potential aggregate inpact of FDI, including horizontal and vertical spillovers, on investments, productivity, output, and trade, both for the processed product and for the raw rmaterial. FDI IN TRANSITION COlJNTRIES Between 1991 and 1996, the amount of FDI into transition countries more than quintupled. The main beneficiary countries of foreign investments have been the Czech Republic, Hungary, Poland and Russia. These four countries together accounted for about 80% of total FDI flows to the region in 1996. The vast majority of investors are from OECD countries, with geographic proximity being a major determinant of investment. For example, German companies have been important investors in the Czech Republic and Poland, Scandinavian firms in the Baltic states, and Greek investors in Bulgaria (OECD 1998). The share of total FDI going to the agro-food sector ranged from 7% in Croatia to about 25% in Bulgaria l(Table l). On a per-capita basis, the Czech Republic, Hungary and Poland stand out as the recipient countries with the highest agro-food FDI. The bulk of agro-food FDI has been directed to agro-industry., and not to primary agriculture. lrn Ronmania and Ukraine, for instance, at most 2%-3% of total FDI has been directed to primary agriculture. Within agro-industry, most FDI has been directed into the sugar and confectionery, the tobacco, and the soft drink subsectors. Alcoholic beverages and milk and dairy production have also attracted substantial FDI. Meat processing, on the other hand, has received relatively little investment from foreign firms. The Impact of FDI: Direct Effects and Spillovers FDI provides much of the capital and managerial and technological skills needed for the restructuring and modernization of agro-industries in transition countries. Also tacit know-how can often be moire easily transferred by foreign managers than local managers who are not as familiar yet with the vorkings of private enterprise (Teece 1986). FDI not only has benefits for the recipient company, but can also have positive effects on the behavior and perfonnance of companies with whom the recipient company competes - so- called horizontal spillovers - or with whom it exchanges products as supplier or purchaser. For 68 H. Gow and J. Swinnen example, foreign-owned firms force local competitors to improve their operations, increase their managerial efforts, or adopt some of the marketing and contracting techniques, thus providing role models for the behavior of companies in other industries. The demonstration of new technologies increases know-how of local firms and, in combination with increased competition, forces them to operate more efficiently (Blomstrom and Kokko 1997). Table 1. Cumulative FDI Inflows for Food-Processing Industry and Selected Sub-Industries in Transition Countries, 1990-97 (millions US $) Sugar, Alcoholic Soft drinks Tobacco Total food Per capita, Share of confec- beverages processing US$ agro-food FDI tionery in total FDI, % Albania' - - 10.0 - 14.0 4.0 - Bulgaria' -18.6 37.0 40.9 0.9 191.0 22.7 25 Croatia - 33.0 31.2 - 68.0 15.1 7 Czech Rep. 23.0 157.0 237.0 420.0 997.0 96.8 3 Estonia - 16.0 15.0 17.0 85.0 57.4 lit Hungary' 173.0 123.9 21.8 32.0 832.2 80.8 - Lithuania 23.0 25.0 - 64.7 150.0 40.4 16 Poland 765.9 226.6 454.2 730.0 2,915.0 75.7 14 Romania' 42.4 166.0 321.0 - 239.9 10.6 18 Russia 692.7 121.9 294.2 90.0 1,459.4 9.9 14 Ukraine' 42.5 6.8 116.0 - 361.2 7.1 22 Total 1,781.1 913.2 1,251.3 1,354.6 7,312.8 24.2 - Estimates Source: OECD (1998) Some of the spillovers from FDI result from cooperation between the foreign affiliates of multi-national corporations (MNCs) and local firms, or from linkages between the affiliate and local suppliers, as suppliers are forced to meet the higher standards of quality, reliability, and speed of delivery (Watanabe 1983). Spillovers also occur when local firms benefit fromn the MNC affiliate's superior knowledge of product or process technologies or markets, without incurring the initial setup and development costs that may exhaust the gains frorm the improvement. MNCs can affect the economic welfare of input suppliers in three ways: (a) the quality of goods and services that they buy; (b) the influence they may exert on the terms of procurement; and (c) the impact they may have on the technological capability, managerial initiative, and organizational competence of their suppliers (Dunning 1993). Direct spillover effects come from MNCs who contribute to raising productivity and efficiency in local suppliers as they help prospective suppliers set up their production, provide technical assistance or information to raise the quality of suppliers' products or to facilitate innovations, provide or assist in purchasing of raw materials and intermediaries, provide training and help in management and organization, and assist suppliers diversifying by finding additional customers (Lall 1980). Empirical observations suggest that spillover effects are very important in transition countries. For example, whilst the bulk of agro-food FDI has been directed to the agro-irndustry levels of the supply chain, rather than to primary agricultural production level, FlI has nevertheless had a major positive impact on growth and efficiency at the farm level. The beneficial impact of FDI has resulted from vertical contracting between farmers and the foreign affiliates in the upstream and downstream industries. The inflow of FDI into the agro-food chain, Impact of Foreign Direct Investment on Agriculture and Agro-Industry 69 when accompanied by innovative vertical contracting ancd financing, has successfully reduced the financial constraints and stimulated investment and technology adoption at the farm level, resulting in substantial quality and yield improvements for contract producers (Gow and Swinnen 1998). Additionally, FDI spillovers have occurred through changing management and contracting practices both within the initially affected sector as welI as across adjacent sectors. Firms have been observed imitating these contractual relationships as they compete for the same primary producers and their fixed factor resources, i.e., land. TRANSITION AND CONTRAICT DISRUPTIONS Contracts are naturally incomplete, because agmnts find it difficult and expensive to foresee and plan for all possible contingencies, as well as enforce these contracts, especially when outcomes are unobservable or non-verifiable by a third party (Hart 1995). Contractual incompleteness oftern results in parties exposing themselves to ex-post costs and hazards related to their sunk investments in relationship-specific assets, that is the occurrence of hold-ups. There are two mechanisms to reduce the likelihood of a hold-up: private sanctions and legal (court) enforcement. Private sanctions include both the losses that result from termination or nonrenewal of the contract or relationship (i.e., the future quasi-rents of the relationship- specific investments) and the damage to the reputation of the party holding up the transaction. Because of damaged reputation, future transacting parties may impose an increased cost of doing business on the reneging party by demanding more explicit and/or favorable contractual terms and preferring written contracts to verbal promises. Traditional contract theory usually considers that court enforcement and private enforcement are alternatives. However, Klein (1996) emphasizes a fundamental complementarity between the two enforcement mechanisms. ContractuaL terms are used "to economize on the amount of private enforcement capital necessary to make a contractual relationship self-enforcing by merely 'getting close' to the desired performance in a wide variety of circumstances (without creating undue rigiclity) and to let the threat of private enforcement move performance the remainder of the way to the desired level" (pp. 455-456). It is sometimes not viable to use legal dispute mechanisms due to a combination of litigation costs, ineffective contract law, poor third party verifiability, and the potential loss of the only suitable trading partner for that commodity. This is especially true in transition economies. For exarrple, the agricultural processing sector is often characterized by geographical monopsonies. Therefore, the potential loss of their sole trading partner can impose high costs upon a production enterprise, especially when the relationship-specific investment has already been sunk. Further, the legal and judicial systems are still in their embryonic stages of development, hence outcomes of any court decision are highly uncertain and non-transparent. Firms may actually prefer incomplete contracts. Strict specification of the contractual terms may produce unwanted rigidity. For example, once contractual terms are written down, one of the parties may decide to hold up the transaction by enforcing the literal terms even if these run against the initial intentions of the contract (Klein el al. 1978, Klein 1996). With incomplete 70 H. Gow and J. Swinnen contracts, parties gain greater flexibility to opt out of the contractual arrangements if future market conditions deviate substantially from expectations. To avoid the danger of being locked into an adverse situation, transacting parties may intentionally elect to leave detailed specifications out of the contract, and opt to use private sanctions to enforce the contractual arrangements instead of the courts. When Do Hold-Ups Occur? At each point in time, both parties to a contract consider the costs and benefits of holding up the contract. A hold-up will occur when its benefits are greater than the costs to one party. Klein (1996) argues that transacting parties will only engage in a transaction if they expect that __B_/_I both parties will honor the (implicit) contract, i.e., PO P p if for both parties the cost of breaking the contract I / A is larger than the benefits. The main reason for hold-ups occurring is when unanticipated changes / in the external environment affect the cost/benefit / ratio sufficiently to make it optimal for one party KB to hold-up the contract. To illustrate this, consider the following example. A producer needs to invest in a Figure 1. The self-enforcing range in contracts production facility specific for a certain delivery to a processor. To prevent a hold-up by the processor after the producer makes the investment, both parties agree on a contract that specifies product characteristics ("quality"), quantity, and a fixed price. Assume that the price is set at the expected market price po. Once the contrac-t has been agreed upon, the actual market price, p, may deviate from the contracted price p0. If p > p0, the contract provides unanticipated rents to the processor, and the benefits of breaching the contract increase for the producer (the producer can get a higher price by selling his product in the market). As Figure 1 shows, the producer's benefits of breaching the contract (HA) increase with an increase in the wedge between the actual price and the contracted price. At some price PA, the benefits HA will become larger than the costs for the producer of breaching the contract, KA, which is the sum of reputation losses and capital costs. Analogously, PB represents the market price below which it is optimal for the processor to breach the contract and to buy his supplies in the market. If the market price stays within the price range PB - PA, the contract will be honored, otherwise not. The range PB - PA is therefore called the "self-enforcing range" of the contract (Klein 1996). The self-enforcing range measures the extent to which market conditions can change without precipitating a hold-up by either party. Changes in market conditions may alter the value of specific investments and thus the benefits of a hold-up, yet as long as the relationship remains within the self-enforcing range where each transactor's benefits of a hold-up Impact of Foreign Direct Investment on Agriculture and Agro-Indusnry 71 are less than the costs, a hiold-up will not take place. In this framework, hold-ups only occur when a sufficiently large unanticipated event shifts a contract outside the self-enforcing range. A hold-up would never occur in a fully anticipated world, If the transactor had anticipated the possible occurrence of the present market conditions and recognized the potential for hold-ups to occur, it is unlikely that he would have undertaken the ini.tial investment to begin with. Otherwise, he would have insisted upon different specifications in the contract. Altemnatively, since the magnitude of the private sanctions (reflected in HA and 1HB) affects the size of the self-enforcing range, a different distribution of private sanctions could also prevent a breach of contract. Transition Hold-Ups in the Agro-Food Chain Prior to the iinitial reforms in Box 1. Changes in the Processing Sector: The Case of the CEE most of the agro-food supply Slovak Republic chain was centrally planned and In the pre-reform era, both the upstream and downstream vertically integrated (see Box 1). The industries were composed of large state-owned companies, central authority routinely provided one per sector an(l in some cases the same firm on both sides contractual enforcement and transacting of the market, e.g., the Agricultural Supplies and transacti ng Procurement Organization (PZN). This enabled the state to parties faced a low (o:r zero) probability gain total control of the sector, while producers effectively of being held up. The reforms caused faced supply and marketing monopolies. Additionally, all several institutional changes, leading to production and resource allocation decisions, as well as widespread hold-ups. First, economic price targets, were set centrally by the state. The artificially reforms siplit the agro-food chain into low and administratively set commodity prices required heavy compensalion olf agriculture through an extensive autonomous enterprises. Second, menu of subsidies. Massive consumer subsidies were also contractual terns were no longer provided for basic foodstuffs. These factors stimulated enforced by the legal system or the excessive production and consumption of agricultural central planning authority, while new products, as well as the establishment of overcapacity in the legal enfoDrcemenit mlciechanisms were processing sector (OECD 1997). Beginning in 1991, the Czechoslovak (Later Slovak) govemment transformed the absent or ineffective. Thlird, since the integrated agro-food processing sector comprising 30 firms transacting parties had no previous and 188 processing plants into 197 separate and autonomous experience with hold-ups, private state-owned enterprises. Subsequently, these enterprises enforcement levels were left unchanged where either privatized during the first voucher privatization and producs continiued making or sold to selected strategic purchasers in the second stage and producers cotud mkg (OECD 1997). relationship-specific investments. Fourth, the refonns brought "unanticipated" shocks that dramatically changed market conditions shifting the processors outside of the self-enforcing range. As market conditions moved outside of the self-enforcing range, hold-ups were not prevented by couit actions. The lack of transparency or the absence of a suitable legal system has complicated court enforcement in transition economies. For example, in the Slovak Republic during 1994/95, delays in the payment for delivered milk by dairy companies were 6 months or 72 H. Gow and J. Swinnen longer, yet farmers continued to deliver milk to the processing plants without seeking any legal action. Some Central and Eastern European governments have drafted suitable legislation on contracting, e.g., prompt payment laws in the Slovak Republic and Slovenia, but it takes time for these laws to pass through parliament, and meanwhile the transacting parties have to rely upon other enforcement mechanisms. Once hold-ups occurred, the problem reinforced itself because the private enforcement capital of processors had declined as their reputation and relationship- specific investments decreased, further reducing the self-enforcing range. Within the agro-food chain these hold-ups have typically been characterized by long payment delays for delivered product, i.e., increase in accounts payable of downstream processors and accounts receivable of primary producers. Effectively these payment delays have provided processors with an interest free loan for the length of the delay while causing additional financial strain on already distressed producers. Thus, in the Slovak Republic the length of the delay is negatively correlated with farm profitability: in 1994-95, profitable farms had an average collection period of about 80 days, while unprofitable farms had to wait about 100 days to collect on their accounts receivable (OECD 1997). Delayed payments are not only an important constraint for farms, but also for other companies in the agro-food chain. A recent survey among food processors concluded that late payments were considered the single most important obstacle to company growth in the Czech Republic and Slovenia, and the third out of 12 obstacles in Hungary (Gorton, Buckwell, and Davidova 1999). Considering that these three transition countries are among the most adv.anced, one can imagine that the problem is at least as relevant in other transition countries. Indeed, the observed shift to barter trading in Russia and other former Soviet republics can be interpreted as an institutional response to extreme payment arrears existing in these countries (Melyukh-ina and Khramova 1999, Wandel 1999). Farms responded to payment delays by internalizing their exchange transactions through vertical integration, shifting exchange to spot markets, or terminating their activities in anticipation of better market conditions. These factors combined have contributed to the large falls in agricultural output, the decline in fertilizer use, and shrinking investment in livestock and tractors, although with minimal changes in the use of arable land (Gow and Swinnen 1998). FDI, Vertical Contracting, and Private Contract Enforcement Empirical observations suggest that FDI in upstream and/or downstream indusLiies in transition countries has provided a solution to the contracting problems and has facilitated access to inputs for farms through private contract enforcement mechanisms induced by innovative vertical contracting. More specifically, FDI has provided food processors with the ability and incentives to shift the self-enforcing range to better match the transacting parties' expectations of future market conditions, thereby sustaining the contracts. Through the provision of innovative and credible contracts with producers, enforced by private capital, such processors have been able to reduce the probability of a hold-up and stimulated increased relationship-specific investment by producers. Impact of F'oreign D)irect Investment on Agriculture and Agro-Indusfry 73 FDI-induced vertical contracting between agro-businesses and farms has taken many forms, but typically included conditions for product delivery and payments, as well as input support programs for farms. Tables 2 and 3 summarize programs implemented by various FDI- linked agro-businesses in Central and Eastern Europe and ithe former Soviet Union. These programs include pre--financing of inputs (chemicals, fertilizers, and seeds), interest subsidies on investment in machinery, and technical support for technology adoption and management. In the next section, we present empirical evidence and insights from a case study of one of these FDI-induced vertical contracting activities. The case study illustrates the principles of the vertical contracting mechanism, as well as its direct and spillover effects. CASE' STUDY OF A SLOVAK SUGAR PROCESSOR: JUHOCUKOR A.S. Juhocukor a.s., the largest sugar processing company in Slovakia, was taken over in 1993 by a British-French company (Eastern Sugar BV). Following the takeover, Juhocukor's sugar output increased by 212% and sugar beet deliveries by 157% between 1993 and 1997. This coincided with rmarked increases in investments, productivity, and output at the farm level, producing strong spillover effects to other sectors. In this section we explain how Eastern Sugar's FDI in Julhocukor reduced the probability of hold-ups and thereby induced these strong positive effects. Table 2. FDI-Induced Vertical Contracting and Support to Producers by Agro-Businesses in Central and Eastern Europe (Source: Own case studies) Foreign Investor British/French BritishSugarProcessor BelgiumBeerProducer BelgiumMalter European Sugar Processor Seed Merchant Loal Partner Local Sugar Processor Local Sugar Processor Local Brewery Local Malting Plant Foreign Food Oilseed Producer Manufacturers Activity Sugar Production Sugar Production Malting Malting Seed Merchandising Vegetable oil productio Countries of Investnrnt Hlungay Poland Ronania Croatia Central and Slovalda Czech Republic Hungary Eastern Europe Slovakia Producer Type Sugar Beets Sugar Beets Barley Barley Crops Rape and Sunflower Types of Support to Producers Production and Eo,uip. Training Yes Yes Yes Yes Yes Yes Credit Access Programs Yes Yes Yes Yes Yes Yes Input Provision and Facilitation Yes Yes Yes Yes Yes Yes Machinery Procurmenrpt Yes Yes -- --- Sometimes --- Agrononical Support Yes Yes Yes Yes Yes Yes Veterinary Support --- --- --- --- --- Harvest and Handling Support Yes Yes Yes Yes Yes Yes Quality Control Yes Yes Yes Yes Yes Yes Transportation Yes Yes Yes Yes Yes Yes Specialized Storage Yes Yes Yes Yes Yes Yes Bus. And Fm. Mgmt Support Yes Yes Yes Yes Yes Yes Market Access Yes Yes Yes Yes Yes Yes Tmrely Payments Yes Yes Yes Yes Yes Yes 74 H. Gow and J. Swinnen Before the takeover, Juhocukor was facing many problems. Besides the standard difficulties - such as financial constraints, underutilized processing facilities, poor quality control, outdated processing equipment, and low quality inputs - Juhocukor had gained a bad reputation for not paying farms within a reasonable time after delivery of sugar beets. These delayed payments had worsened the farms' strained cash flow and aggravated their profitability problems. As a consequence, farmers no longer wanted to invest in sugar beet production for Juhocukor: sugar beet deliveries to Juhocukor declined from 315,000 tons in 1990 to 214,000 tons by 1993, contracted hectares from 7,800 ha to 6,000 ha, and its sugar production from 32,000 tons to 24,000 tons. In the framework of our contract model, the reform-induced changes in the institutional and market environment and the erosion of Juhocukor's reputation by previous hold-ups had shifted the expected environment outside the self-enforcing range and made private contract Table 3. FDI-Induced Vertical Contracting and Support to Producers by Agro-Businesses in the Former Soviet Union (Source: Adapted from Foster 1999) Foreign Investor US Combine Producer Swiss Confectionery US Dairy Processor US Food Catering Firm US Nut Processor US Agri-Chemical Producer Mt nfacturer Local Partner Ag. Equipment Dealer Dairy Plant Dairy Plants Food Catering Enterprise Facilities Owners Ag. Input Distributors Activity Ag Equip. Leasing and Sales Confectionery Dairy products Fast Food Service Walnut processing Fertilizer and Pesticide Sales Countries of Investment Ukraine Russia Ukraine Russia Moldova Jlkraine Moldova Ukraine Russia Kazakhstan Producer Type Grain and Oilseed Dairy Producers Dairy producers Vegetable producers Walnut Growers Croj Producers Types of Support to Producers Production and Equip. Training Yes Yes Yes Yes Yes Yes Credit Access Programs Yes --- --- --- Yes Yes Input Provision and Facilitation Yes Yes Yes Yes Yes Yes Machinery Procurement --- --- Yes Yes Yes Yes Agronomical Support Yes Yes Yes Yes Yes Yes Veterinary Support --- Yes Yes --- --- --- Harvest and Handling Support Yes Yes Yes Yes Yes 'Yes Quality Control Yes Yes Yes Yes Yes Yes Transportation Yes Yes Yes Yes Yes Yes Specialized Storage Yes Yes Yes Yes Yes 'Yes Bus. And Fin. Mgmt Support Yes Yes Yes Yes Yes Yes Market Access Yes Yes Yes Yes Yes Yes Timely Payments Yes Yes Yes Yes Yes Yes enforcement impossible under the existing circumstances. To encourage farms to invest in high- quality beet production for delivery to the company after the FDI takeover, Juhocukor introduced several programs which were intended to make the contracts self-enforcing and red-uce the likelihood of a hold-up as perceived by the beet producers/ This involved restructuring the private enforcement capital, i.e., the distribution of costs and benefits in case of a contract hold- up, including assurances of easier access of producers to necessary inputs. First, to get rid of its bad reputation, the company started paying contracts at the time of product delivery to the factory (it was the only company in Slovakia providing timely payments to producers). Impact of Foreign Direct Investment on Agriculture and Agro-Industry 75 Second, an input provision and investment facilitation program assisted farmers in the purchasing of in.puts, such as seeds, fertilizer, chemicals, etc., and in accessing credit. The investment and financial facilitation packages were inihially provided on an ad hoc basis, but were in 1995 formalized into a specific program developed with Polnobanka (the main bank lending to agriculture in Slovakia) for financing investrnent in machinery and working capital. The program provided Polnobanka with a guarantee for the repayment of both the principal and interest on each loan and provided the contract growers with an interest rate subsidy between 3 and 7%. Through accepting the residual claim on these investments via the guarantees, Juhocukor effectively increased its own costs of not honoring the contracts, thereby making its honoring of the contracit more likely, and its promises to do so more credible. At the same time the program reduced the costs of a Juhocukor hold-up for producers. In the event of non-payment beet producers would not have to pay for their purchased inputs and only lose returns to their labor and personal capital contributions. By simultaneously reducing the likelihood of a hold-up by Juhocukor and lirniting the hold-up costs for producers, the program induced farms to invest in sugar beets. Third, a tech-nical support and extension program, which included agronomical support, soil testing, 1PMq, production and managerial advice, etc., expanded the amount of non- salvageable relationship-specific investment which Juhccukor had tied up in the contract. This increasecl the arrmount of' capital committed by Juhocukor and thereby enlarged the self-enforcing range of the contract. Finally, .Juhocukor attempted to restore its damaged reputation through an extensive media and public relations campaign. The campaign informed potential producers about the contracts and programs and signaled to producers that Juhocukor was willing to publicly risk its reputation to back these contracts. As its reputation grew over time so did the amount of private enforcement capital that Juhocukor had committed to the contract. Direct Effects and Spillovers The aggregaite impact of the Juhocukor FDI, including the horizontal and vertical spillovers, was quite dramatic. At the farm level, the programs instituted by Juhocukor after the FDI takeover induced large increases in productivity: average yields increased from 33 ton per hectare with 13%7c sugar content in 1993 to an estimated 45 ton per hectare with 16% sugar content for the 1997 season. After the introduction of the finance and investment programs in 1995, contractecl sugar-beet production increased from around 6,000 tons to 9,500 tons (this outcome cannot be attributed to price changes, as the termis of trade remained stable during 1993- 97). In combination, the increase in farm yields and contracted hectares resulted in an increase in Juhocukor's sugar output from 24,000 tons in 1993 to an estimated 75,000 tons in 1997. The impact on aggregate sugar production in Slovakia was even greater, because competition induced other domestic sugar companies (none of which were taken over by foreign investors until 1998) to imitate Juhocukor's contractual arraingements with some delay. As a result, other sugar companies and their suppliers also registered increases in output and 76 H. Gow and J. Swinnen productivity with a one or two Figure 2. Sugar production by processing company in Slovakia (from year delay (see Figure 2). Slovak Sugar Producers Association) Spillover effects began to manifest themselves after 1995, and aggregate sugar Sugar production (thousand tons) output in the Slovak Republic 70 increased from 140,000 tons 60 - to around 250,000 tons 50 - between 1995 and 1998 40 - (reversing the sharp decline 30 that accompanied the 40% fall in sugar beet production 10~ between 1989 and 1993). The 0 trade impacts were significant 1990 1991 1992 1993 1994 1995 1996 as sugar imports declined by -Juhocukor -Trnava -Trenc.Tepla -Sered 50% over this period (from |-SIdkovicovo -6-Surany -Rim.Sobota -Trebisov 75,000 tons to around 35,000 tons), despite a strong growth in recorded consumption from 210,000 tons to 275,000 tons. Contractual Convergence and Cross-Sector Spillovers Contracts tend to converge to a new equilibrium as additional firms begin to imitate the (initially experimental) contractual arrangements of pioneering firms once they are seern to be successful (Eggertsson 1990). Competition among contractual arrangements thus leads to a phenomenon of contractual convergence. In the Juhocukor case, firms competing for the same farm resources (land) were forced to offer similar contractual arrangements, thereby causing contractual convergence. Contractual convergence followed by new investment and technology adoption has not been confined to the directly affected commodity sector. Similar convergence and impacts have followed FDI in adjacent sectors, especially when there has been a requirement for high quality inputs by the downstream processing firms. For example, Palma-Tumys (Henkel) in the Slovak oilseed sector has provided similar contracts and associated programs with equal success. Other Slovak sectors that have been similarly affected include the brewing barley sector with Zlaty Bazant (Heineken), the corn starch and isoglycose sector with the Amylum group, and the dairy sector with Rajo (Schardinger) and Majcichov (Farmco). Another cross-sector spillover effect builds on the success of the contract-based lending scheme that Polnobanka (the main agricultural bank in Slovakia) developed with Juhocukor and Palma-Tumys. Polnobanka is now offering a standard range of credit lines that enable downstream enterprises to provide farmers with advance payments for contracted supplies. The schemes use draft loans with the future harvest acting as the collateral and operate in a similar way to the original Juhocukor scheme. Inmpact of Foreign Direct Investment on Agriculture and Agro-Induwtry 77 CONCLUSIONS FIX) in the agro-food sector has increased significantly since the beginning of reforms in transition countries. The impact of FDI on the agro-food sector in transition countries is significan,tly larger than is usually thought. Important effects on productivity, output, and trade are observed not only in, the upstream and downstream sectors where FDI actually takes place, but also at the farm level. The spillover to the farm level is the direct consequence of FDI- induced vertical contracting. As part of this vertical integration., many agro-businesses taken over by foreign companies have implemented producer support programs, including financial and investment assistance programs and extension support. In this paper, we have explained how these programs have contributed to growth of farm output and productivity. These programs provide so-called private enforcement capital to enforce contracts between the company and the farm. Contract disr-uptions and hold-up problems -- mostly in the form of payment delays -- have become pervasive in the agro-food sectors in transition countries, causing sub-optimal resource allocation, reduced investment, and decline of output and exports. In the absence of legal contract enforcement mechanisms due to transition problems., private enforcement mechanisms are crucial tc enforce contracts and provide credible incentives for investments. Vertical contracting and the associated support programs increase the costs of contract breaches -for the FDI-based company. This makes contract breach by the company less likely, and reduces the cost for the farms. The support programs therefore increase the private enforcement capital and improve incentives for farms to make contract-specific investments. At the same time, by providing guarantees to banks and companies supplying inputs to the farms, these programs increase the flow of farm inputs. Both factors combine to stimulated growth and productivity increases at the farm level. Emnpirical evidence from Central and Eastern Europe and the former Soviet Union suggest that the effect of FDI-induced vertical contracting may be quite strong. A case study of FDI in a Slovak company demonstrates the positive effects on output, yields, and quality. Empirical evidence furtlher indicates that the introduction of the contractual arrangements has caused spillover effects to other firms and even other sectors. Competing firms have imitated the successful contractual arrangements inducing positive impacts beyond the direct FDI-induced vertical contract. 78 H. Gow and J. Swinnen REFERENCES Bende-Nabende A. and J.L. Ford (1998) "FDI, Policy Adjustment and Endogenous Growth: Multiplier Effects from a Small Dynamic Model for Taiwan, 1959-1995", World Development 226(7):1315- 1330. Blomstrom, M. and Kokko, A. (1997). "How Foreign Investment Affects Host Countries", Policy Research Working Paper 1745. Washington D.C.: International Economics Department, World Bank. Borensztein, E., J. De Gregorio, and J.-W. Lee, 1998, "How does foreign direct investmenc affect economic growth?" Journal of International Economics 45: 115-135 Brenton, P. and F. Di Mauro, 1999, "The Potential Magnitude and Impact of FDI Flows to CE:ECs". Journal of Economic Integration, 14(1): 59-74. Dunning, J. (1993). Multinational Enterprises and the Global Economy. Reading: Addison-Wesley Publishing Co. Eggertsson, T., 1990, Economic Behaviour and Institutions, Cambridge, UK: Cambridge University Press. Foster, C., 1999, "The Impact of FDI in the Upstream and Downstream Sectors on Investb-ent in Agriculture in the NIS," in Agricultural Finance and Credit Infrastructure in Tranisition Economies, Proceedings of OECD Expert Meeting, Moscow, February 1999, OECD, Paris. Gorton, M., Buckwell, A., and S. Davidova, "Transfers and distortions along the CEEC food supply chains" paper presented at the FAIR conference on "Agricultural Implications of EUJ-CEEC Accession", March 1999, Leuven. Gow, H. and J. Swinnen, 1998, "Agribusiness Restructuring, Foreign Direct Investment, and Hold-Up Problems in Agricultural Transition", ERAE, 25(4):331-350. Hart, O., 1995, Firms, Contracts and Financial Structure, Oxford: Clarendon Press. Klein, B., 1996, "Why Hold-Ups Occur: The Self-Enforcing Range of Contractual Relationships," Economic Inquiry, 36 (July): 444-463. Klein, B., Crawford, R. G. and Alchian, A. A., 1978. Vertical Integration, Appropriable Rents, alad the Competitive Contracting Process. Journal of Law and Economics 24: 297-326. Lall, S., 1980. Vertical Interfirm Linkages in LDCs: AN Empirical Study. Oxford Bulletin of Economics and Statistics 42: 203-226. Melyukhina, 0. and Khramova, J., 1999, "New Players in the Food Marketing Chain in Russia", in Wehrheim P. and J. Von Braun (eds.) Russia's Food Economy: Towards Truly Functioning Markets, forthcoming OECD, 1997, Review of Agricultural Polices: Slovak Republic, Paris: Centre for Co-operatiorn with Economies in Transition, Organization for Economic Co-operation and Development. OECD, 1998. Agricultural Policies Markets and Trade in Transitional Economies: Monitoriig and Evaluation 1998. Paris: Centre for Co-operation with the Economies in Transition, Organ-isation for Economic Co-operation and Development. Wandel, J., 1999, "Vertical integration in the Russian Agro-Food Sector", in Wehrheim P. and J. Von Braun (eds.) Russia's Food Economy: Towards Truly Functioning Markets, forthcoming Watanabe, S., 1983. Technological Linkages through Subcontracting in Mexican Industries. In: S. Watanabe (Ed). Technology Marketing and Industrialization: Linkages between Small aned Large Enterprises. New Delhi: Macmillan. Williamson, 0. E., 1985. The Economic Institutions of Capitalism. New York: Free Press. Part Two Land Laws and Legal Ilnstitutions for Development of Land Markets and Farm Restructuring Structural Change in the Farming Sectors of Central Eastern Europe Second EU Accession Workshop in the Rural Sector, Warsaw, Poland, June 27-29, 1999 Emerging Land Markets in Central and Eastern Europe Peter Dale Richard Baldwin A study commissioned by the European Union in 1996 examined the progress of land market developrment in Central and Eastern Europe (CEE) and identified policies that would be useful in overcoming transition problems and in establishing a well-regulated functioning land market, especially during the period leading up to EU accession. Members of the study team are listed in the acknowledgments in Appendix A to this paper. The study sought to develop an understanding oF land markets in countries in economic transition and hence to identify ways in which they can be developed so that they meet the needs of the societies ithat they serve. In particular, the aim was to identify policies that should have a positive impact on the land market in a manner that enriches the common good, facilitates economic growth and strengthens democracy. By understanding the framework within which both urban and rural land markets operate, it should be possible to bring about a general improvement in the "quality of life" of citizens and hence provide greater social stability and economic growth. Policy recommendations also need to be consistent with the broad objectives of countries seeking eventual membership of the EU. It should be ermphasized that there is no such thing as a completely open land market since all countries have restrictions of one kind or another, especially in the agricultural sector. Many of these restrictions are more concerned with wh1o, and under what conditions, the land may be gainfully used, and with local social considerations, rather than with economics or law. For these reasons, the study did not seek a purely economic analysis of the land market, but rather sought to understand the broader political, social and historical factors that shape the attitudes of people. The focus throughout the study was primarily on rural land markets and on agricultural land rather than forest. Urban land markets in the transition countries are characterized by a lack of access to capital and credit in the domestic sector (mortgage banks are a recent introduction), whilst the privatization and restructuring of industry producecl a surplus of (relatively) low grade commercial premises. lnvestment has stimulated property development, and major growth has been experienced in sectors such as retailing, in response to. consumer demand. Generally, the urban markets are most buoyant in the capital cities, although they are still hampered by incomplete reform of the administration (such as technical delays in the land registration process). Property speculation is still perceived as high risk, especially where bankruptcy or 8] 82 P. Dale and R. Baldwin mortgage laws are considered inadequate to safeguard an investor's interest, or the valuation system is perceived as weak or inconsistent. Currently the land markets are much more active in urban areas than in rural. This is in part because in many countries rural land values are so low that owners are unwilling to sell and in part there are still major disincentives that arise owing to structural impediments in the market arising from the socialist legacy. THE TRANSITION AND LAND OWNERSHIP During the last fifty years, the countries of Central and Eastern Europe have experienced two profound changes in the dominant political ideology; a transition to a socialist command style of economy during the early 1950's, followed by a transition back to a market economny in the years following 1989. The socialist years had a significant impact on the socio-econowric and legal framework. The land policy that was practiced during this period may be characterized as one guided by an ideological belief in the common or social ownership of property; the allocation of resources according to centralized planning including state intervention processes; and the associated suppression of the individual private ownership rights of property. This policy had a powerful effect on the legal framework and especially on the relationships between land, prcperty and people and can be characterized by: * changes in the legal framework associated with the definition of property and rights of ownership, 3 concentration upon usage rights, as opposed to ownership rights, * passage of legislation which discouraged or inhibited trading in land and property, and the expansion of the state as owner/occupier or user of land. In terms of land, this led to the discouragement of private ownership with the result that the government organizations that had recorded land ownership focused on recording land utse. In several countries, agricultural land was either taken into state ownership, or the individual private farmers were forced to join co-operatives. Many citizens found that their propertv was expropriated by the state. Additionally, the pattern of agricultural land was changed so as to create large fields that were the optimum for agricultural production. The evidence of the boundaries of the earlier smaller plots then disappeared from the landscape. In the urban sector, new socialized building took place without regard to the historical underlying property rights, and the individual apartments and buildings were often not registered. There was no need. for a functioning land market in this environment. Calls for property restitution or compensation for loss of property followed the changes of 1989. There are interesting differences as to how these issues have been approached in the study countries, driven by the political aspirations and the mood of society in the country concerned. In Poland, there has been no large-scale restitution or compensation. Land taken into the possession of the state is subject to privatization; as of March 1998, of the estimated 4.6 million hectaLes in the possession of the state, less than 650,000 hectares have been sold (as reported by the State Agricultural Property Agency). In Latvia, Czech Republic, Slovak Republic, Slovenia, the Emergizg Land Markets in Centtral anzd Eastern Europe 83 restitution- of actual property has taken place where reasonable and possible. The claimants are limited to citizens of the countries concerned and compensation is paid where restitution of the actual property is not possible. In Hungary, the approach has been fundamentally different: rather than carry out large-sca]e property restitution, the state adopted a policy of compensation for all claimants. By June [998, more than 200,000 urban and 230,000 rural properties have been restituted in the Czech Republic and the process was more than 90% complete. There were approximately 60,000 cases in the Slovak Republic, and these are now rnore than 80% complete. By June 1998, Slovenia had settled more than 60% of the estimated 40,000 cases. In all countries the existing restitution is approaching completion. However, due to large scale border movements at the end of WWII (Poland) and mass migrations (Poland, Czech Republic, Latvia, Slovak Republic), there are still large groups of potential claimants who are unable to claim under existing legislation. In Hungary. land was awarded in a compensation process and also granted to the former workers in cooperatives ancl state farms. More than 2.1 million new land units have been created, and the total area subject to compensation is more than 5.6 million hectares (50% of the area of the country). A second major effect of the socialist period has been the impact upon field structure and the separation of usage and ownership. This problem is particularly acute in the Czech Republic and the 'Slovak Republic, where the owners lost their rights of disposal and independent farming and were forced to farm cooperatively. The effect on the land fabric was to eliminate the historic field boundaries. Today, there is no evidence in the field of these parcels, and they can only be registered in simplified Form (because there is no boundary data). This affects 9 million parcels in the Czech republic and 6 million parcels in the Slovak RFepublic (out of an estimated total of 23 million and 12 million respectively). The thircl major effect was to reduce the importance of the regulatory structures. Private financingr disappear ed, land valuation became oriented towards optimizing agricultural production through detailed soil ecological analysis, and thc land registers and cadastre were modified to reflect usage, not ownership, or were even inot updated at all. Financing was a state responsibility. LAND AS A COMMODITY Land has a number of characteristics that distinguish it from other goods and services that may be traded in the mnarket place. While the economist may view it as a commodity that is immovable and is strictly limited in supply, the landowner mnay not view it from an economic perspective but rather as a cultural heritage. Concerns by the Czechs over the ownership of real property in the Sudetenland, by the Poles over the areas once known as Prussia or by the Latvians over areas occupied by people of Russian origin add a climension to the land market. What may make short-termi economic sense, drawing investment back into a country, may be totally unacceptable for political and social reasons. There is an emotional element that enters into the ownership of lanid that constrains the land market and hence cannot be ignored. 84 P. Dale and R. Baldwin In many countries an informal market appears to have operated with transactions being agreed locally, for example over who should use the land and who should benefit from it. In all western communities there has been fragmentation in land management between the control of ownership and use rights, the former often being controlled at a central government level and the latter at the municipal or local authority level. This pattern is being repeated in many countries in transition. Confusion is compounded in the case of valuations that are sometimes a central government responsibility and sometimes a municipal task. Within the land market, tenure, value and use are inter-dependent and yet at the administrative level they are treated quite separately making a formal understanding of land markets more difficult to achieve. It is of course essential within market driven economies that land markets are supported by a clear legal basis that is administered by regulatory authorities who oversee the safe keeping and update of the legal title to property. Land and its associated buildings are traded according to their market value; they can be bought and sold, transferred from one owner to another or leased. The manner in which land or buildings may be used is, however, controlled by physical p] anning laws. Planning regulations affect the price that a purchaser will be willing to pay for any property since the permitted land use directly affects its market value. In looking at land markets, therefore, it is necessary to look at the factors that determine land values. These factors include matters particular to the individual land parcel such as the security of tenure and the nature of the use rights, and externalities such as the availability of credit. In most countries land and property are subject to taxation for occupation and usage. As the monetary value of land and property is high, it is usual to borrow capital in order to finance the purchase. The borrower needs security for the loan in the event of default and this will normally involve a charge upon the property. The various rights and privileges of the owner, the mortgagor, mortgagee, the lessor, the lessee and the occupier must all be defined in law. ODn the event of death of the owner, the inheritance must be settled and this often leads either to the fragmentation of parcels (with one farmer owning many small plots scattered over a wide area) or fragmentation of owners with many people having claim to a single piece of land. Parts of Poland provide an example of the former; a farmer may own fifteen fields each being less than two hectares and spread over an area of forty square kilometers. Slovakia offers an example of the latter where a single field of twenty hectares may have more than three hundred owners and over a thousand co-owners. In Slovakia changes in the law to prevent such multiplicity of ownership were rejected as they were judged to be contrary to basic human rights that in turn are protected by the Slovak Constitution. Any proposed land market model must take all these factors into account. It must also recognize that in mature markets there is the range of parties involved and a variety of goods and services. In the land market, this means there will be a range of participants, including plivate individuals, corporate investors, speculators and financial institutions. There will also be supporting services including valuation, estate management and a mechanism to put the buyers and sellers in contact with each other (real estate brokers). Each of, these contributes to the market and to the efficiency and effectiveness with which it operates. Emerging Land Markets in Central and Eastern Europe 85 A MODEL OF THE LAND MARKET There is a general consensus that development of a functioning land market requires: * clear definition and sound admninistration of property rights; * minimumrL restrictions on property use consistent vwith the common good; * maximum simplicity of the transfer of property rights; * transparency in all relevant matters; and * availability of capital and credit. These requirements are necessary but not sufficient to guarantee an efficient and effective land market. It is obvious that underpinning all land and property development there need to be clear and consistent land policies that operate within a slable institutional framework. In general under communism thle policy was clear and consistent since most matters were under central control. With the breakdown of communism new policies had to be developed and new legislation prepared. In the early days in Bulgaria, for example, there were at least thirteen versions of a proposed new cadastral law in circulation wlhile in several countries conflicts remain between different pieces of legislation introduced by different government ministries and departments. Because of the fragmented way in which land and property are administered, it is important that there is a national policy that is coordinated between the different Ministries. The market operates through participants buying and selling goods and services. These market operations need to be supported by three regulated sectors - land registration and the cadastre, valuation services, and financial services. The efficient functioning of these elements is essential if the land inarket is to operate smoothly and formnally. These supports may be regarded as the regulatory pillars that stand on the base of land policy. In the communist era, the first regulatory pillar (land registry and cadastre) was modified to focus on land use, the second regulatory pillar (valuation) reflected the potential use rather than market value of the land, while the third regulatory pillar (financial services) was almost non existent. Regulatory Pillar 1: Land Registration and Cadastre In all market economies the basic legal relationship between real property and its owner is officially documented in land registers that also record obligations or encumbrances that are charges upon the land. The official recording of this inf-ormation is normally carried out by the state administration although professionals in the private sector may be empowered to carry out some of the processes. In many countries there is, in addition to the land title registers a cadastre that was created to support land and property taxation. Unlike some land registers, the cadastre is map based, the plans recording precisely the physical extent of the property, including information about its boundaries. Many Central and Eastern European countries have followed the old Austrian practice of having the Land Register (the Land Book or Grundbuch) separate from the Cadastral Map. In some countries (e.g. I[ungary, the Czech Republic and the Slovak Republic) both the land register and the cadastral map are effectively integrated into one register and managed by a single 86 P. Dale and R. Baldwin authority. In others (e.g. Slovenia and Latvia), the land register and the cadastral map are maintained by separate authorities. Regulatory Pillar 2: Valuation In many of the land reform programs, great emphasis has been placed on cadastral reform and on computerizing the land records. Only when this began to gain momentum did the focus move towards property valuation; a process that aims to establish the connection between monetary value and the property itself by producing an estimate of the capital value of the asset. There are various ways used to calculate this capital value that may involve estimates of the income potential or the actual market value of the property. The methodology may need to take into account such factors as access, utilities, improvements and for agricultural land, the quality and permitted use of the land. In the case of the EU, an additional factor is the assignment of milk or wine quotas; if a land unit has an assigned milk quota then it may have a greater market value than a land unit that has no such quota. During the communist period, there was no need for an assessment of market value as agricultural land value was connected to its potential productivity. In all of the Central and Eastern European countries, a system of land quality indicators was developed that involved soil type and estimated productivity of that soil type for a particular crop. This was assessed within a particular district or region. Using this approach, the communists hoped to be able to optimize the agricultural production across the country. Valuation has suffered from a lack of expertise and a lack of data about market prices. Even today the methodology for valuation is weak in many of the transition countries and mass appraisals are based on 'cadastral' values that are calculated from land parcel areas, soil types and other objective criteria rather than on estimates or recordings of market price. In the early stages of land restitution several countries delayed the introduction cf land taxes, partly in order not to discourage land owners from reclaiming their rights. Now that the restitution programs are nearing completion the infrastructure for providing a valuation service and for the mass appraisal of real property is being put in place. In Latvia for example the mass appraisal that will form the basis of land taxes is itself based on the data gathered in the communist era since it can reflect the local comparative value between properties, even if in absolute terms it bears little relation to the market price. Where property taxes exist, there is a general consensus that the amount of tax paid should be proportional to the value and amount of land held by the landowner. More recently, land taxation has been viewed as a land mobilization tool, in that it can be used as a mechanism to promote good land management practices. By varying the tax rate the actual usage of the land can be influenced. In order to adopt this practice, up to date and accurate information is needed regarding the land occupancy and its actual (as opposed to intended or possible) usage. Emerging Land Markets in Central and Eastern Europe 87 In the cornmand economies, land value was a tool for the efficient allocation of resources through the planning process. In a market economy, land value supports the re-allocation of resources according to market forces (supply and demand). The land valuation practices that developed in the socialist countries did not produce transparent, reliable estimates of monetary value that are required for an efficient and secure land market. New valuation procedures are therefore being developed. Regulatory Pillar 3: Financial Services The third regulatory pillar that is needed to support the land market is the delivery and regulation of financial services. A market economy requires that adequate financing mechanisms are in place to support the buying, selling, leasing and development of property assets, and it is essential that these finan,cing mechanisms are regulated and supported by appropriate law. In the socialist economiy, land resources were controlled by direct allocation of resources, without regard to their monetary value, and hence, in all socialist countries, this pillar was largely absent. In market economies it is normal for the private sector to provide the products and services within a clearly regulated institutional structure. Thqe financing mechanisms needed by a market economy require that the investment into the property sector is going to give sufficient returns to warrant the risk and trouble of investment. In this, property financing has to compete with other forms of investment such as interest yields on deposits, stocks, government bonds and other securities. In the market economies, there is a range of financial services that can be used to support property investment. Different financial instruments tend to be used by different types of investor. Investors can be government, co-operative groups, individuals or companies. Typically they will invest for different reasons. Government will be concerned with infrastructure, establishing support services and housing. Companies may invest purely on the expectation of financial gain, or they may invest in order to use or develop the site. Individuals will normally invest in order to obtain secure living accommodation. For all investors who lack existing capital, the financing will come from loans or grants. Loans secured by charges upon the properties are mortgages and these are normally protected and regulated carefully by law. These form the principal financing mechanism available to the private investor and in countries such as the UJSA, mortgage and house savings funds can total mnore than 45% of the annual GDP. Raising capital for investment can also be obtained from the stock markets and capital markets and both of these require a secure and well- regulated financial sector, plus confidence on the partS of the institutions that make up this market. Where there is a loss of confidence, then the investors will stay away. Government may make development grrants available such as rural credit or rural guarantee funds in order to support policies and programs that it wishes to prioritize. 88 P. Dale and R. Baldwin The Three-Pillar Model: Comparative Analysis of the Reform Process The Three-Pillar Land Market Model is shown in Figure 1. The three regulatory pillars are constructed upon the legal framework of the country and are strongly shaped by the land policies adopted by government. Regulatory pillar one (land registration) provides the connection between land and property on the one hand, and people and legal entities on the other. Regulatory pillar two (valuation) provides the connection between land and property and -finance mechanisms, while the third regulatory pillar (financial services) establishes the connection between finance mechanisms and people and other legal entities. If government is able to adequately establish and support the pillars then the land market will provide a dynamic environment that includes: * the participants (land owners and tenants); * the goods and services (the land and its use); and * the financial instruments (mortgages, credit, capital financing, etc). Figd ureu. e l od of L Fiur 11. Tehr-Pllar MoXdels; ofLn akt An efficient and effective land market can be characterized in terms of the effectiveness of the regulatory pillars; the land policy; the regulatory framework; and the dynamnism of the market itself. Table 1 identifies those elements that are considered to have a significant impact. Where these elements are present, or are well supported, then this is a positive factor, while, if the elements are clearly inadequate or weak, then this is an inhibitory factor on the land miarket development. Emerging Land Markets in Central and Eastern Europe 89 Table 1. Characteristics of an Efficient and Erfective Land Market Elements characterizing an efficient and effective land market The Policy and Reguiatory Framework 1. Legal entities and all physical persons may own properties with equal rights. 2. Institutional structures are secure with well-regulated activities. 3. Clear policies create strong and clearly understood regulating authorities, a favorable environment for investment and strong motivation for individuals. 4. Agricultural and urban land management policies are clear. 5. Planning, environment, health and local administration polici-s clear. 6. Planning andl zoning controls are clearly understood and enforced. 7. Professional services exist, with basic assent and understanding from the public. 8. There are clnar policies about information management, intellectual property rights and the protection of investments in data. Market Assessment (Participants, Goods and Services, Finanicial Instruments) 1. Landowners and tenants exist and represent a range of different stakeholders. 2. There is a strong private sector (with individuals, companies & family units). 3. Large corporate players exist (including investment funds, pension funds). 4. All government held land is basically held for public purpose or social housing. 5. The construction secr.or is established and healthy. 6. There is a variety of assets available, apartments, residences (of various sizes), offices, commercial buildings and agricultural land holdings. 7. Information on real assets available for sale is widely known and reliable. 8. Mechanisms exist to create new assets where needed, (i.e. th- market is able to respond to rising demand by building more houses, etc.). Pillar 1: Land Registration a. d Cadastre 1. Sound legal basis for ownership and trading of property rights. 2. All necessary legal structures in place, especially inheritance. 3. Recording and registering systems are soundly implemented 4. There is no risk of unjustified expropriation. 5. Land and bLaildings can be traded and leased easily. 6. The quality of data held by regulators is good. Pillar 2: Valuation 1. Valuation is clear and well understood, based on market prices. 2. Valuations are accepted and used as basis for calculation of asset value. 3. The mechanism for offering real property for sale is clear. 4. Mortgage advice is available for residential property. 5. The quality of data held by regulators is good. Pillar 3: Financial Services 1. Cash sales are clear and supported. 2. Land and buildings can be used as security. 3. Special mcrtgages / credit facilities are available for agricultural land. 4. Bankruptc- and first charges on mortgages are supported. 5. Mortgages are available for residential property (up to a certain % of the value). 6. Financial products are tied to assets (e.g. pension funds can be used as security). 7. Taxation regimes ar e not subject to sudden change. 8. Tax implications for investments are clear. 9. Financing for in,vestments exists and venture capital is available. 10. Foreign Direct Investment is encouraged and there is a low assessment of risk. 11. There is an understanding of how land and property taxes can affect land use. 12. The quality of data held by regulators is good. The elemmnts can be used as indicators of the current status of the land market. The land market can then be exarnined in terms of the elements identified in Table 1, and each element 90 P. Dale and R. Baldwin can be scored (minimum value 0, maximum value 5) as a land market indicator according to Table 2. Using this scoring methodology, it is possible to assess the state of development of each of the regulatory pillars; the policy and regulatory framework and the state of the market, and also produce an overall score for each of the study countries. On the basis of the scoring methodology put forward in Table 2, an overall score of less than 1.5 would indicate a very closed command economy with inadequate or missing regulatory pillars, communist style land policy and very little market activity. A score greater than 4 would be indicative of a market economy with adequate regulatory mechanisms of registration, valuation and finance, ancl a range of participants, goods and services, financing mechanisms and a favorable land policy. A Land Policy Framework Matrix (Table 3) is used to summarize the key issues that arise during the reform process, according to the land market indicator scores, for thle three regulatory pillars, the market activity and policy approach of the government and shows the current status of the reform process. The Policy Framework Matrix helps to show the overall progress that is needed in the reform of each of the land market sectors (land registration, valuation, financial services, market activity and land policy. The detailed case studies carried out as part of the ACE project enabled the study team to assign scores for each of the indicators of Table 1 for each of the six study countries. Although the numerical values are obtained from qualitative assessments and are therefore not rigorously derived, they should be consistent and provide a means of measuring a country's progress in comparison with other countries. In particular, when viewed through the Land Policy Fraiyiework Matrix they: * help to quantify the current land market status of the study country and illustrate the progress in the overall reform process; * identify and characterize the principal bottlenecks and inhibiting processes; * allow comparative analysis; and * facilitate the development of specific recommendations to support land inarket improvements. Table 2. Scoring for the Land Market Indicators of Table 1 Score Criteria 0 There is no evidence at all that this matter is being addressed I There is minimal evidence that the stated feature is present, but it is not clear that the requested functionality is provided 2 There are some major problems, the system cannot be said to work adequately, but the basic components are in place or being developed 3 The functionality is basically provided. There are some known problems, but things basically work 4 The system works smoothly and could be considered consistent with what one would fincd in another market economy 5 The feature or functionality offer performance levels consistent with that required for EU membership and with what one would expect in an EU member state and there are no outstanding or fundamental problems known Emerging Land Markcets in Central and Eastern Europe 91 Table 3. Land Policy Framework Matrix Showing-the Status of Land Market Reforms Command Economy -->I<------------------------Transition Economy-------------------------: |<-----------Market Economy------------->1<--- EU Member LMI score <1.5 1.5-1.90 2.0-2.4 2.5-2.9 2.0-3.4 3.5-3.9 >4.0 No government Weak political Inconsistent or Individual polic- Policies are All reforms are Clearly defined Policy Level support for land support for inadeqate policies ies sound. but coherent and complete and and integrated Frarnework market develop- objectives of leading to some difficulties preparations negotiations for land policies that ment & land market. No fragmented with policy coor- have started for accession are comply with EU individual broad political approach to land dination & infor- EU accession under way. regulations. property rights consenstis management. mation exchange Weak relation- Participation Participation Relationship Strong conn- Institutional Large range of Market ship of land and se verely restri - starting but interest between land and ection between investors and participants, goods assessment: people. Focus cted owing to limited due to people becoming land atnd There investment funds and services. Real Participants is on use rights unclear owner- structural problems clear. Growing is a range of are active in the Estate seen as and occupancy ship rights. and lack of market interest in land as participants and market. Risks in good safe long rather than Out-standing confidence. a marketable types of land real estate term investment ownership legal claims exist Information flows com-modity. for sale. investment seen as rights. Strong and are weak Inform-ation Infonnation low. Informa-tion informal sector. identification of flow still seen as flow is working completely Information owners, parcels limited. transparent unavailable or dif.ficult. unreliable No legal There is a legal Registers being Legal require- Land Registra- Records nearing System is effic- Pillar 1: require-ment requirement for recompiled, but ments for title tion System is completion. ient and supports Land for registration, registration but institutional registration are basically System works secondary market Registration insecure law there are arrangements and basically satis- working efficiently (except services. and Cadastre with respect to inconsistencies land law need factory but Problems with capital cities). significant private land ownership, in the law and strengthe-ning delays in land titling are Titles are regarded sector involvement inheritance and confusion over There is a lack of transactions mainly in large as secure. Land & cost recovery. disposal rights administrative title information. occur due to cities and in Reform completed Consistent 997r may be unclear. responsibilities Land reform technical and areas under and no title reliability of Regulating underway. organisational land reform. insecurity records. authorities not problems in place _ - Absence of any There is a Valuations are tied Systematic Valuattion Secure, reliable Complete valu- Pillar 2: accepted valuation metho- to market prices but valuation records system able to system support- ation data sets Valuation methodology delogy but little results are being compiled. support ing land trans- available that can for market accurate and up unreliable due to Valuations are property tax actions and fair be linked to other based to date data is lack of data from seen as neces- and market and efficient land valuations No available. low volumes of sary and able to values. property tax administration body tasked Valuation may transactions. No support market Regulatory collection records. Sienific- with valuation not be connected systematic reporting value. Real procedures are ant private sector to market prices Estate prices in place to involvement. volatile support data _ _ _ ~~~~~~~~~~~~~~~qualit:y. Pillar 3: Almost Czsh sales take Mortgage support is Mortgages have Mortgages Macroeconomic Pension funds. Financial complete place but the being introduced become more more widely stability promo-tes investment funds. Services absence of market is volatile but Foreign invest- accepted, and available, real estate life assurance financing with few trans- ment into real estate development interest rates investment and major investors. mechanisms actions and may be restricted financing is near to EU /G7 encourages Safe potentially rabid (high risk) emerging norm institutional sp.eculation - investors Land market Severe strategic There are major Reforms are System is A mature market The market is General operates imrpediments to impediments to a being implemen- basically is beginning to stable and secu-re Assessment through land market formal land market. ted but there are working and appear along with and real estate informal sector activity, reforms Reforms are still unresolved land rights are secondary markets seen as good safe outside progress very progressing but difficulties that seen as secure and transparent long term government slowly there are major inhibit and transferable land dealings investment authority difficulties at the development. policy level 92 P. Dale and R. Baldwin MEASURING PERFORMANCE While the earlier analysis indicates the state of development of the land market in the reform process, it takes little account of the actual performance as measured in terms of the actual amount of activity. Empirical evidence suggests that there is a direct correlation between progress in the transition towards the market economy and the level of market activity although as discussed earlier the performance is much stronger in urban rather than in rural areas. Table 4 identifies perfonnance indicators that may be used to assess the market activity. The performance indicators are compared with EU norms, obtained from examining the statistics of Five EU countries - Denmark, Finland, the Netherlands, Sweden, and the UK (reported in The Land Administration Inventory of Europe, Part 2, MOLA and the UK Land Registry). Based on the definitions in Table 4, a Land Market Performance Indicator of 100% would indicate a land market reaching the same level of market activity as that which imay be found within one of the more advanced EU member states. The Performance Indicator is dlefined in such a way that it reflects the availability of land that has clear title, with no regulatory impediments for sale, as well as the general market activity that includes inquiries, sales and mortgages. It is possible to develop this further and to include indicators based on area, land value and number of new constructions although this was not done in the present study. Table 4. Land Market Performance Indicators Land Market Performance Calculation method for particular country Expected figuires for Indicator EU member 1 How complete is the land CEC, = Total number of properties settled regularization/restitution Divided by EU1 = 100I%o process?' Total number of cases expected 2 How complete is the land title CEC2 = Total number of loaded titles database? Divided by EU2 =10%-. Total number of titles that exist 3 What is the level of annual CEC3 = Total number of annual enquiries queries of the land title Divided by EU3 =60% database? Total number of titles that exist 4 What is the level of annual CEC4 = Total number of annual transfers transfers of title? Divided by EU4 = 7% Total number of titles that exist 5 What is the level of annual CEC5 = Total number of new mortgages per year issue of mortgages? Divided by EU5 = 9% Total number of titles that exist Land Market Performance Indicator = (CECgEU1+CEC2JEU2+CEC3/EU3+CEC4IEU4+CEC5/EU5) * 100 100% 'This figure must take into account all matters connected with the full and correct registration of title (or deed) and full description of parcel data, i.e., it includes the completion or correction of problems such as restitution, compensation, missing property boundaries, mis-,ing owners, and all matters which detract from the completion. Emnerginig Land Ma rkets in Central and Eastem Europe 93 The overall Land Market Model has two distinct measurement domains: * Land Market Indicator measuring the overall status of the land market in its transition from the command to nmarket economy; and * Performance Indicator showing the overall level of activity in comparison with EU norms. A plot of the Land Market Indicator against the Plerformance Indicator should produce a diagram like that in Figure 2. A Performance Indicator of the order of 90-100% (Table 4) and a Land Market Indicator of 4.5 or 5 (Tables 1 and 2) correspond to the land market status in most developed EU states, while scores of <20% and <1.5 correspond to a closed command economy. In improving land markets the aim would be to increase both the market activity and the market reform, thus increasing the Land Market Indicator and the Performance Indicator towards their maximum values. The evidence gathered through the case studies suggests that it is possible to view the market in terms of three phases of development. PERFORMANCE INDICATOR MARKET ECONOMY (EU) 100% _ E 7, 7 80 _ 60 40 20 o - :'--2 3 4 COMMAND ECONOMY LAND MARKET INDICATOR Figure 2. Land Market Indicator anl Performance Indicator Phase A: Early Phase - Reform Driven. The land -market requires a certain amount of reform from its pre-]989 position before it can significantly develop. There must be a critical mass of property with clear title, secure boundaries and disposition rights. The legal basis must support private property, the regulating institutions must be ini place and there must be a critical mass of participants with access to suitable funding. This implies that this phase is dominated by initial legal, institutional and regulatory refonns. There will only be a slow increase in market activity, linked to improvements in the technical infrastructjre, once the initial conditions have been established. As the r eforms become more substantial, the access to disposable property and the amount of available property becomes clearer, the regulating institutions begin to work, the financial institutions develop and the risks are seen to reduce resulting in increased market activity. Phase B. Middle Phase - Market Driven. The land market now has most of the institutions in place and they are functioning. The data quality is good and the regulating institutions are sound. The credit facilities are available. The market becomres open to a wider range of participants and it is the dyniamic energy of these that drives the development. Significant increases in market 94 P. Dale and R. Baldwin activity take place for relatively little improvement in the institutional reform position. Land prices will rise significantly during this process and wealth creation is achieved. Phase C: Mature Phase - Harmonization Driven. The market is beginning to saturate as it approaches the levels consistent with market economies and the EU member states. In order to finally reach the EU levels, there is a further reform (or harmonization) of laws and regulations that are required. These are more concerned with environment and the creation of instruments to implement EU policies such as the CAP. Market activities will not be suddenly stimulated during this period unless significant distortions are introduced externally (e.g., the agricultural land market is suddenly liberalized overnight). PERFORMANCE INDICATOR MARKET ECONOMY (EU) 80 F Ta iti n by HarmonisatioC 40 3 s triven by Market 20 Driven by Reom/ CO!0 :::- 2 3 4 5 COMMAND EC, ~~~LAND MARKET INDICATOR Figure 3. The Transition Curve Figure 3 shows the development of a transition curve, which can be expected to represent the path of a transition country as it experiences the different phases and identifies the dominant forces during the transition from the command to market economy. THE CASE STUDY IN SIX CEE COUNTRIES The theoretical analysis outlined above was developed through the gathering of data and a series of workshops in which various ideas and components of the model were discussed. Tlhe model was then tested and scores evaluated both by members of the research team and by representatives of the six countries: the Czech Republic (CZ), Hungary (HU), Latvia (LV), Poland (PL), Slovakia (SK) and Slovenia (SI). The elements identified in Table 1 were quantified on the basis of the criteria that are given in Table 2. The results are presented in Table 5 and a summary is provided in Table 6. The scores are based on data gathered in 1997, and since then the markets have continued to progress. Some additional country details are given in Appendix B. In general, as can be seen from Tables 5 and 6, the market reforms have progressed fastest in the land registration and cadastral pillar and less quickly in Pillars 2 (Valuation) and 3 Emerging Lanid Markets in Central and Eastern Eutrope 95 (Financial Services). The reforms in Pillar 1 have received significant support from organizations such as EU PHARE and the World Bank and have enabled the land restitution and compensation programs to be largely completed. This has been both a political priority and an economic necessity in satisfying the aspirations of the former landowners, and reducing the role of the state as the principal landowner and land manager. The developmaent of the valuation pillar has been slower. The reasons for this are related to the lack of a hiistorical role for property valuers and tlhe lack of a central agency or institution charged with responsibility in this area. In addition, the relatively small number of commercial transactions during the early reform years and the lack of property taxes in most countries in the region have also cause(d progress to be slow. There is also a significant lack of information concerninig Valuation Roll and valuation has historically been concerned with productivity, rather than monetary value. The finalncial se.rvices are mostly provided by the private sector, so naturally this pillar will only strengthen as the market deepens and there is an increased demand for financial products and services. Necessary precursors for this include mortgage laws to protect the interests of the various parties and clear, strong foreclosurie and bankruptcy laws to lessen the risk of debtors defau'lting and creditors being unable to obtain possession of the property or adequate compensation. The generally higher level of interest rates in these countries will also restrict demand. The policy frarniework supports all these activities. Governments must adopt clear policies and priorities and provide a sound organizational structure. There are often conflicts between ministries concerning their respective areas of interest and this will influence the policy framework. The governments have had to develop transition policies for all sectors of the economy and it can be difficult to prioritize the aim of developing land markets in competition with other sectors. The completion of the land compensation program in Hlungary significantly increased the number of participants and brought in the new landowners before the market driven price increases took elffect. As a result, a relatively large number of' people have been able to share in the wealth creation process. Uncertainty has also been removed, as there are no further potential claimants. The state has no longer any significant holdings in land. All land units have certificates of title, mostl have marked boundaries in the l'ield and are registered. The information flows are available and the transaction and opportunity costs are low, with special incentives for voluntary consolidation (suspension of transfer tax, etc.). This is a response to consistent land policy or. the part of the state. In Poland the state remains as a imajor landholder, and in the Czech Republic, Slovakia, and Slovenia, large reserves of agricultural land are still held by State Land Funds. 96 P. Dale and R. Baldwin Table 5. Land Market Indicator Scoring for Six CEE Countries Elements of the Land Market Model CZ HU LV PL SK SI The Policy and Regulatory Framework 1. Legal entities and persons have equal rights. 1 1 1 1 1 4 2. Institutional structures are secure. 4 4 4 2 2 3 3. Strong regulating authorities. 1 3 2 2 1 2 4. Agricultural and urban land policies are clear. 2 3 1 2 2 2 5. Clear Planning, environment & health policies. 3 3 1 3 3 3 6. Planning & zoning understood and enforced. 3 3 3 3 3 3 7. Professional services exist & are supported. 3 3 2 3 3 3 8. There are clear policies on information. 3 3 2 2 3 3 Average 2.5 2.9 2.0 2.2 2.2 2,9 Market Assessment 1. Landowners and tenants exist. 3 4 3 3 3 3 2. There is a strong private sector. 2 3 2 3 2 3 3. Large corporate players exist. 2 2 2 2 1 1 4. All government held land used for public good. 2 3 3 2 1 2 5. Construction sector is established and healthy. 2 3 2 3 2 2 6. There is a variety of assets available. 3 3 3 3 3 3 7. Information on real assets readily available. 2 3 2 3 2 2 8. Mechanisms exist to create new assets. 2 2 2 2 2 2 Average 2.2 2.9 2.4 2.6 2.0 2.2 Pillar 1: Land Registration and Cadastre 1. Sound legal basis for ownership and trading. 4 4 3 4 3 4 2. All necessary legal structures in place. 3 3 3 3 3 3 3. Recording and registering systems are sound. 4 4 4 2 2 2 4. There is no risk of unjustified expropriation. 4 4 4 4 4 4 5. Land and buildings can be traded easily. 3 3 3 2 3 3 6. The quality of data held by regulators is good. 3 4 2 2 2 2 Average 3.5 3.7 3.2 2.8 2.8 3.0 Pillar 2: Valuation 1. Valuation is clear and based on market prices. 2 2 2 2 2 2 2. Valuations are accepted. 2 2 2 3 2 2 3. Mechanisms for property sales are clear. 2 2 2 3 2 2 4. Mortgage advice is available. 2 3 2 2 2 2 5. The quality of data held by regulators is good. 3 4 2 2 2 2 Average 2.2 2.6 2.0 2.4 2.0 2.0 Pillar 3: Financial Services 1. Cash sales are clear and supported. 4 4 3 3 4 4 2. Land and buildings can be used as security. 2 3 3 3 2 2 3. Mortgages/credit facilities for agricultural land. 2 3 2 2 1 1 4. Bankruptcy and mortgage charges supported. 2 3 3 3 2 2 5. Mortgages available for residential property. 2 2 2 2 2 2 6. Financial products are tied to assets. 1 1 1 1 1 1 7. Tax regimes are not subject to sudden change. 2 2 2 1 2 3 8. Tax implications for investments are clear. 2 3 2 2 2 2 9. Financing and venture capital available. 2 3 3 2 2 2 10. Foreign direct investment encouraged. 1 4 2 3 3 2 11. Impact of land and property taxes understood. 3 3 2 2 3 3 12. The quality of data held by regulators is good. 3 4 2 2 2 2 Average 2.2 2.9 2.2 2.2 2.2 2.2 Emerging Land Markeis in Central and Eastern Europe 97 Table 6. Oveirall Assessment of the Land Market Indicators for Six CEE Countries Sector of Land Market CZ HU LV P'L SK SI Mean Policy Framework 2.5 2.9 2.0 2.2 2.2 2.9 2.5 Market Assessmernt 2.2 2.9 2.4 2.6 2.0 2.2 2.4 Pillar 1: Land Registration 3.5 3.7 3.2 2.8 2.8 3.0 3.2 Pillar 2: Valuation 2.2 2.6 2.0 2.4 2.0 2.0 2.2 Pillar 3: Finance 2.2 2.9 2.2 2.2 2.2 2.2 2.3 Overall Assessment 2.5 3.0 2.4 2.5 2.2 2.5 2.5 Table 7. Land Market Performance Indicators for Six CEE Countries (calculated as in Table 4, in percent) EU Performance Indicator CZ HU LV I'L SK SI norm 1 How complete is the land 60 95 50 75 30 90 100 regularization/resitution process? 2 How complete is the land title 90 80 30 50 30 0 100 database? ___ 3 What is the level of annual 10 15 5 ]L0 10 10 60 queries of the land title database? 4 What is the level of annual 1 2.5 1 1 1 1 7 transfers of title? _- S What is the level of annual issue 0.1 0.2 0.05 0.05 0.1 0.1 9 of mortgages? Overall assessment (rounded to 35 45 20 30 20 25 100 nearest 5 %) PERF ORMANCE INDICATOR MARKET ECONOMY (EU) 100% 80 /Driven by Harmonisation 60 40 / t)riven by Market 20 Driven by Reforms K L Uv 0 L;;UM 2 3 4 5 COMMAND ECONOMY LAND MARKET INDICATOR Figure 4. Transition Curve for the Six CEE Countries. Land Policy FIamework matrices produced for eaclh of the six countries provided a profile of the overall reform and identified the major impediments at the time. The land market performance indicators described in Table 4 were calculated for the six countries, based on information gathered during the case study. The results are shown in Table 7. When applied to Figure 3, the position of each country on the transition curve becomes apparent (Figure 4). 98 P. Dale and R. Baldwini RECOMMENDATIONS In making recommendations, the study team have made certain assumptions, namely: * The basic reforms and market transition that are underway in the transition countries will continue and there will be no substantial change of political direction or orientation: * The process of EU accession will continue; and, * The governments of the transition countries are committed to open transparent land markets as a long-term objective. The policy recommendations concentrate on those aspects that will bring real sustainable benefits in the development and nurture of land markets. It is not the intention to make specific recommendations for the individual case study countries, as each has a specific set of circumstances and we are seeking to establish general policy level recommendations applicable to all transition countries. However, it is hoped that the recommendations on the following pages contain relevance for all of the case study countries. Recommendation 1: Completion of the Transition Process Background The relationship between the ownership and use of land and property was brok.en or suppressed during the socialist era, limiting the powers of disposal; in some cases the land itself was expropriated. Large socialist agricultural enterprises and co-operatives were created and in many cases, the evidence of the earlier field boundaries was destroyed. In some countries, the land ownership records were not updated, even in the case of inheritance. Land restitution programs have addressed the issue of expropriated property. In the case of eligible claimants in the Central and East European countries, the programs of restitution are largely complete though in some countries the problems of boundaries have not yet been addressed. Issue In several central and east European countries there are still substantial inconsistencies or inadequacies in the completion of the land registers owing to the "missing parcels" and "missing owners" resulting from the socialization of agriculture. The market mechanisms cannot work until the basic state directed reassignment of property relationships is complete and the records show a position that accords with reality. This does not mean that the old boundaries must be marked out in the field, but it does mean regularizing the new and old records in order that people can have clear title and also can see clearly where the properties are located. This will mark the completion of the state intervention into the rearrangement of land ownership relations. Recommendation It should be a policy objective of the government to complete the transition process in the land sector and establish the base conditions for market forces. This must include regularization of all titles and ownership relations and the settlement of any likely future claims as a prerequisite of completing the economic transition process. Emerging Land Markets, in Central and Eastern Europe 99 Implementation 1. Establish a national policy objective of regularizing all available land and property records, including the identification of owners and the identification (but not marking out) of the property boundaries. 2. Charge the relevant institutions with developing ways and means of achieving this objective within a realistic period and declare that the instnrments will include significant private sector involvcment. Success Indicators 1. All existing land ownership records are harmonized and accurately reflect the situation in reality. 2. There are no outstanding land claims by any disenfrarchised groups. 3. The quality of data of the land records is good (title data and boundary data). Recommendation 2: Establishment of a Coherent National Land Policy Backgromnd The establishment and operation of land administration systems and functioning land markets involves substantial cooperation from several different sectors of government. The transition, countries are characterized by a lack of institutional co-operation and an absence of "ownership" of lancl issues that can lead to politics operating in a vacuum. The particular circumstances are unique to every country and there are no two countries that exist with an identical land adrministration structure. Each transition country has to organize these matters in the best way it can. There is a real danger that wider issues become lost and specific issues are addressed only within the narrower confines of a single minisiterial brief. There are also dangers that policies in one sector will significantly impact on policies or ongoing programs in other sectors, therefore creating confusion and waste. Policy is important in considering the role of the state as landowner, the role of the state as land administrator and regulator, and the role of the state in supporting measures for land market development. These matters need a coherent approach. Issue There is a lack of a high level integrated policy in land matters and no formal mechanism for inter-ministerial debate. The activities of the regulatory pillars are not formally coordinated and there is not enough support for all of the regulatory functions necessary to support a transparent and openi land market. Without adequate regulation, there is no guarantee that the market will provide the right environment for the creation of economically and socially balanced structures able to serve the wider needs of society. 100 P. Dale and R. Baldwin Recommendation Governments should develop an integrated national Land Policy, including the identification and provision of the necessary supporting means and instruments that will allow high level political debate and the obtaining of broad inter-ministerial support. The retention, as far as possible, of a coherent integrated strategy in dealing in land and property should be a priority for both urban and rural land. Implementation 1. The government should consider the creation of a National Land Policy Forum which will include representatives from all ministries and agencies (including private sector representatives drawn from the professions) and act as a High Level Policy Committee in land matters. 2. The government should prepare a Land Policy Statement that sets out its immediate and near term policy objectives and identifies the roles and responsibilities of its executive agencies. The policy statement should explicitly consider the role of the state as landowner. 3. The government should establish a working group responsible to the Land Policy Forum, who will prepare a national strategic plan in accordance with the recognized needs and co- ordinate and harmonize the work of different ministries and agencies. This should explicitly strengthen the regulatory pillars, the monitoring of land market activity and establish targets for any remaining land privatization. Success Indicators 1. A clear and consistent policy statement concerning the land market 2. The establishment of an inter-ministerial forum for policy debate concerning land issues 3. The promotion of policies emphasizing broad sectoral issues and involving active cooperation of ministries and agencies Recommendation 3: EU Accession and Land Ownership Background The overriding political objective within the six Central and Eastern European countries is the EU accession and four of the six study countries (Poland, Czech Republic, Hungary and Slovenia) have been accepted for entry under the next round of enlargement. The EU has opened negotiations with all 11 applicant countries. The basic principles for enlargement were laid out at the 1993 Copenhagen European Council and the acquis communautaire is accepted as the definitive guide to the collective legislation that must be adopted in order to harmonize and be able to assume the obligations of membership. The Commission published its Opinion on the applicants ability to adopt the acquis in July 1997 and the basic assessment is that the countries are moving towards compliance An accession partnership is now being negotiated to address the matters raised in the Opinion. Emerging Lanid Markets in Central and Eastern Europe 101 Issue There is a fuindamental difficulty with respect to land that is not addressed in the acquis. In order for an applicant to enter the Union, the applicant country must constitute a functioning market economy, a prerequisite for which is the possession of an accepted method of registering private property. In all previous enlargements the app]icant countries already possessed such institutions. The topic therefore received no special atten-ion, other than creating an awareness of the need to address the broader objectives of the single market and to open up the land market to competitive forces from anywhere in the Union. The effect of this policy within the transition staltes is potentially catastrophic as most of the transition countrlies have significantly lower agricultujral land prices (one tenth, on average); as a result, large parts of the countryside could very quickly become foreign owned. This would be politically destabilizing and socially disruptive and would outweigh any gains in productivity that the new investment would bring. Unlike many other traded goods, the supply of land is strictly limited. This should be recognized and the applicant states should negotiate a transition period fCr fully opening up the agricultural land market. Recommendation It should be a policy objective of the applicant government to negotiate a transition period for the full liberalization of the agricultural land market. Given the start of the accession negotiations in 1998 and the planned accession in the next fevw years, these issues are of extreme importance at the present time. The urban land markets shaould be fully liberalized immniediately. Implemefitation 1. Establish nalionail policy objective as negotiating period of grace for full liberalization of the agricultural land market and signal this to the negotiating teams. 2. Allow full liberalization of the urban land market to proceed in line with the acquis. Change the law to allow any eligible EU national to have full ownership rights at the same level as a physical or legal entity of the applicant state for all land that is not designated as agricultural. Success Indicators 1. Agreement for a transition period in the liberalization of the agricultural land market. 2. EU legal and private persons are able to hold urban land with the same rights and privileges as state citizens. Recommendation 4: Land Administration - Institution Building Background The state is responsible for the legal and regulatory framework within which the land markets operate. The state also needs an efficient land administration capability in order to meet other national policy objectives, including justice and home affairs, revenue generation through tax policies, environmental controls, rural development, c:ross border issues and municipal 102 P. Dale and R. Baldwin administration. The impending EU membership places additional demands upon the land administration, especially in the adoption of the Common Agricultural Policy (CAP) and the implementation measures that include the Integrated Agricultural Control system (IACS). The socialist legacy of incomplete land records and uncertainty in title (including technical defects) need to be corrected. The structural pillars of the land registration and cadastre, valuation, and the supporting financial services must be secured and strengthened. Issue The land administration functions established in the transition economies have concentrated on the re-establishment of the necessary legal framework, the establishment of a services network and the registration of title to land and property, as well as the support for the property restitution and compensation (and similar) programs. In some cases it is recognized that the institutional arrangements may not be optimal for efficient land administration and in, other areas it is clear that the institutions face significant problems in introducing modem technology (and especially large-scale national information systems). They must also cope with the additional special demands of the compensation and restitution programs. Additional demllands will be imposed by the IACS. It is recognized that the information flows are currently weak and the processing time for transfers is too long in all of the capital cities. There are kniown difficulties in the legal definition of land and buildings and in the trading of use rights including leases. Most countries have inadequate valuation systems, while the financial sectors of some countries need legal support in dealing with mortgages, bankruptcy and foreclosures. These matters are all concerned with strengthening the legal framework, the regulatory authorities and improving the performance of the relevant institutions. Private sector involvement is almost completely restricted to contracting of routine technical activities (e.g. mapping). Recommendation There needs to be institutional strengthening of the land administration sector, which includes the three pillars of the regulatory authorities (registration, valuation, real estate financing) and the underlying legal framework. There is also a need to establish the technical systems needed to implement and provide a national level of service within reasonable time and with a high level of security and confidence. Implementation 1. The government should request the land administration agencies to draw up strategic plans for the step by step institution building, including budgetary, technical, legal and staff development, as well as the identification of performance indicators. 2. The government should encourage the land administration agencies to review and explore private sector involvement in the land administration sector. Success Indicators 1. Identification of institutional weaknesses and the establishment of corrective programs. 2. Identification and removal of excessive bureaucracy and purely institutional and administrative barriers to simple and effective transfer. Emerging Land Markets in Central and Eastern Europe 103 3. Support for the technical infrastructure and legal framework. 4. Increased capacity in the land administration sector and the elimination of backlogs. Recommendation 5: Land Market Support Measures Background The land markets in Central and Eastern Europe operate under many disincentives including punitive transfer taxes and notarial fees, the lack. of credit financing, inadequate valuation methodLs and a poor risk assessment of the market. Other disincentives arise in that the shape and position of many agricultural parcels are unviable as agricultural units, resulting from restitution of land andi parcellation that dates back more than 50 years. There is weakness in the availability of market based information including real valuations and market prices while the mechanism for connecting buyers and sellers is undeveloped. Agricultural support is an important aspect of rural development, yet it is not prioritized in some countries. Urban land markets are seen as subject to severe technical and legal delays in effecting transfers and there are serious weaknesses in the mortgage laws of some countries. The emergence of significant private investments driving insurance funds, building societies, savings and loan organizations or mortgage banks has not yet materialized. Institutional investors are still noticeably absent compared to EU countries and property (especially agricaltural) is not perceived as a safe long- term investment. Issue There are severe weaknesses in the land market that can be addressed through support measures aimed at creating the right environment for bottom up processes to be initiated by individual owners or groups of owners. This needs to be addressed not through direct state intervention, but by the identification and removal of obstacles to processes that will encourage the formation of viable agricultural units and stimulate the urban property market. This includes the removal of high transaction costs (notarial fees and some of the higher registration fees), the removal of entry barriers (parcels without adequate documentation) and establishing incentives for voluntary consolidation (waiver of transfer tax, etc.) and increasing the access to credit. Support measures can include measures aimed at improving the quality and availability of the goods (i.e. the land inits) and also supporting the entry of a wider range of participants into the market. Recommendation There needs to be a declared policy objective of liberalizing the agricultural and urban land markets through creating more open competition, providing support for information flows and removing entry barliers and disincentives. In addition there is a need to provide incentives for voluntary landl consolidation 104 P. Dale and R. Baldwin Implementation 1. Establish system of reporting for monitoring all land sales, including sales price, profile of investor, type and condition of real estate, to increase transparency and information flows. This could be implemented as part of a regional development policy. 2. Prepare a program in support of voluntary consolidation, including support measures and an information campaign. 3. Identify and remove specific entry barriers and excessive transaction costs. 4. Identify policy instruments in terms of land tax, transfer tax and fee levels, credit and mortgage support, and review leasehold law in order to liberalize markets sufficiently to promote growth. 5. Identify opportunities to support and promote voluntary consolidation. Success Indicators 1. Greater information flows and transparency. 2. Reduction of impediments and transaction cost. 3. Increased availability of incentives to encourage individuals and provide greater mobility. CONCLUSIONS The study identified a number of key policy issues relating to: * Land markets and the completion of the transition to the market economy; * The accession to the European Union; * The establishment of regulatory authorities - institution building; - Modernization of the technical infrastructure; and * Payment for cadastral services and the role of the state. Traditionally, the approach has been to put in place the legal framework, then ident[ify the necessary technical matters to carry out the mandated tasks. Given the close connection between the performance of this state sector and the impact on declared cabinet-level policy, land administration authorities cannot adopt a purely technical viewpoint and must consider the wider costs and benefits. Cabinet-level policy needs to address the market transition, open and transparent markets, EU membership, creation of a viable agricultural sector, efficiency in the administration, and promotion of the private sector. A number of policy-level recommendations formulated in the previous section are aimed at assisting with the development of effective and efficient land markets. The recommendations are not aimed at a particular country, but identify and address common problem areas that were identified during the study. The following specific issues need further study: 1. The economic objectives of land reform and the development of land markets. 2. The funding of land administration activities and the extent to which government agencies should seek full cost recovery. Emerging Land Markets in Central and Eastern Europe 105 3. The levels of cooperation between different governient agencies, especially with regard to land ownership; valuation and taxation of land and construction; control and management of land use; development control; land related information; agricultural policy. 4. The linkages between urban and rural land management. 5. The managenient ancd exploitation of land and property related information. 6. The balance between public sector and private sector activities. 7. The shortage of skilled managers in land administration. In conclusion, land policy must be emphasized. The land policy needs to be a response to the declared governmaent aims. It should involve active participation and discussion with all operators in the land sector including other government agencies, the regulating forces and the market participants. The introduction of the financing and valuation sectors that underpin the trade in goods and services heralds the transition to the market economy and completes the three regulatory pillars. Achieving a balance between the regulatory structures and the market forces will allow controlled growth and will be perceived as of general economic and social well being to the populace. REFERENCES ACE, 1998, The D)evelopmnent of Land Markets in Central and Eastern Europe, Final Report Project P2128R, 121 pages, ACE program, European Commission, Blrussels (unpublished). DTZ, 1997, European Commercial Property Markets Overviewv. EBRD, 1994. Measuring Transition: Extracts from the Transition Report, 1994. Economic Transition in eastern Europe andl the former Soviet Union. EBRD. UK. Euroconsult, 199.5. Farnm Restructuring and Land Tenure in -Reforming Socialist Economies: A Comparative Analysis of Eastern and Central Europe. World Bank Discussion Paper 268. The World Ban.k. W'ash,ington. Euroforum, 1997. Mortgages and Property Finance in Poland, Hungary and the Czech Republic. Proceedings of 2nd Annual Conference, May 27-28, Budapest, Euroforum, London. Euroforum, 1998. MortgaLges and Property Finance in Poland, Hungary and the Czech Republic. Proceedings of 3rd Annual Conference, March 31 -Apri [1, Warsaw, Euroforum, London. Gelb, A., and Gray, C.., 1991. The transformation of economios in Central and Eastern Europe, Policy, Research and External Affairs No 17, The World Bank, Washington. FIG, 1995. Statement on the Cadastre. FIG Bureau. Australia. Grossman, R.G., arnd Brussard, W., 1992. Agrarian Land Law in the Western World. CAB International. UK. Lerman, Z., Brooks, K., and Csaki, C., 1994. Land Reform and Restructuring in Ukraine. World Bank Discussion Paper 270. World Bank, Washington. OECD, 1992. Urban Land Markets: Policies for the 1990s, OECD, Paris. OECD. 1993. OECD Economic Surveys - Hungary, OECD, Paris. OECD. 1994. OEC'D Economic Surveys -The Czech and Slovak Republics, OECD, Paris. Riddell, J. (Ed), 1997, Private and Public Sector Cooperation in National Land Tenure Development in Central and Eastern Europe, FAO, In: Rivista Italiana di Telerilevamento, No. 10, May. Schwarz, A., D'Andrea Tyson, L., 1992., "Reprivatisation in eastern Europe: roundtable report," In: Reprivatisation in Central and Eastern Europe, Central and Eastern European Privatisation Network. 106 P. Dale and R. Baldwin Swinnen, J.F. (Ed), 1997. Political Economy of Agrarian Reform in Central and Eastern Europe. Ashgate. UK. UNECE, 1996. Land Administration Guidelines: with special reference to countries in transition. UN ECE Geneva. ECE/HBP/96. UNECE, 1997a. Land Administration Inventory in Europe (Parts ] & 2). UK Land Registry. UNECE, 1997b. Financing Land Administration Projects in Countries in Transition, May, Gene-va. UNECE, 1997c. Workshop on Definition and Numbering of Objects in Cadastres and Land Registers. MOLA ( Meeting of Officials on Land Administration), Oslo, June 16-17. UNCHS, The Habitat II Land initiative: access to land and security of tenure as conditions for sustainable urban development. UNCHS Vol 3 No 2. World Bank, 1996. "The 1997 Index of Economic Freedom," Transitions, Volume 7 No 11-12, pp. 22- 24. Zavadskas. E., Sloan. B., and Kaklauskus, A., 1997. Property Valuation and Investment in Central and Eastern Europe. Proceedings of International Conference, Gediminas Technical University, Vilnius, Lithuania. Emerging Land Markets in Central and Eastern Europe 107 APPENDIX A: Acknowledgments and ]List of Contributors Acknowledgmenlts This study was carried out with the financial support of the ACE program. The study could not have been possible without the help, advice, encouragement and participation of a large number of people who have alL kindly invested time and effort in the project. The principal list of contributors is containecl below, however it does not inc]ude all the people who have taken part in the meetings, interviews, review stages or have been a source of much needed encouragement. The group would like to particularly thank Ruzenka Zirnova. Jaroslav Vigner, Vaclav Slaboch and President J. Sima (Czech Republic), President I. Hornansky (Slovak Republic), Maria Toth, and Laszlo Niklasz (Hungary), Lars Lauridsen and Stig Enemark (Denmark), Elfriede Fendel (Netherlands) and Robin McLaren (Scotland). List of Contributors This study was undertaken by a group of researchers, consultants and academics who are actively working in the land imarket sector within the transition countries. A multidisciplinary approach has been adopted involving professionals from the fields of land registration, economics and agriculture drawn from both the EU member states and the countries in transition. The principal collaborators included thLe following: R. Baldwin (UK) Kinga Kovacs (Hungary) Andrej Udovc (Slovenia) P. Bielek (Slovak Republic) Bozena Lipej (Slovenia) J. Valis (Slovak Republic) T. Bogaerts (Netlierlands). Gyula Modos (Hungary) V. Voltr (Czech Republic) Csaba Csaki (Hungary) Gabor Remetry-Fulopp A. Zichy ( Austria) P. Dale (UK) (Hungary) Baiba Ziemele Andrzej Hopfer. (Polandi) V. Suchanek (Czech Sabina Zrobek Republic) APPE:ND.IX B: Land Policy Framework Indicators by Country The six country studies are documented fully within the ACE report Project P2128R: The development of land mzrkets in Central and Eastern Europe (ACE program, final report 1998). The report also contains the detailed Land Policy Framework Matrix for each country based on 1997 observationis, which has been used to produced the scorings in Tables 5 and 6 in this article. The following summaries provide a very brief assessment of the main findings. The Czech RepOblic is hampered in its developinent by four main factors. Firstly, there are the potential claims of the exiled Sudetenland Germans. Secondly, the agricultural land market faces high traLnsaction costs creating effective barriers through the lack of effective land units and the loss of the boundary data. Thirdly, the national agricultural policy is not conducive to investiment in this sector. Lastly, the lack of financial regulation has resulted in various banking and investment. funding scandals that have significantly reduced investment into the country. The institutional reforms have proceeded well in the land registration and cadastral 108 P. Dale and R. Baldwin sector but land valuation remains to be sorted out and an institutional framework with accurate and complete valuation information must be created. The financial pillar is handicapped by the poor financial regulation, but this is a priority problem for the government; significant pi-ogress should be expected over the next 2 or 3 years. The land market is still not yet established in a robust form. Hungary has virtually completed all of the land related transition activities and by passing through the compensation program, it has satisfied all outstanding land claims and there is no substantial group pressing for further land claims. It is also at the end of the three-year moratorium on land sales, following the compensation program and it is reported that agricultural land has increased in average sale price by 500% in the last year. Land Consolidation is now proceeding and is taking place both through a government-backed program and through voluntary sale and exchange. The compensation program created a large number of players who now have a chance to share in the increase of the capital value of the property. The agriculture produce sector has also been largely restructured and there is a willingness to invest in this sector. Hungary seems to have managed this process with relatively little institutional reform in the land registration and cadastral sector. It could be that some reform would become necessary as the market increases and the demand for services widens, especially concerned with va] uation. The financial pillar can be expected to grow significantly in the next 2 or 3 year period. The conclusion is that the land market is beginning to work in Hungary and the country is firmly in a market driven phase. In Latvia, the land market is developing in and around Riga but elsewhere, especially in the rural areas, the market price for land is still very low. Agricultural land that has been restituted is, in many cases, reverting to scrub or forest because the owners are unwilling to sell until the prices rise. Sensitivities over the status of long-term residents of Russian origin irLllibit a more open debate about land related issues. Awareness of land values is growing, part]y as a result of the mass appraisal that has placed a market price on the land. When property-based taxes are introduced in the year 2000 this awareness will increase further. In Poland, the land market is likewise hampered by the potential claims of groups, who were expelled and who wish to recover their families property. Consequently there has been no formal restitution or compensation law enacted. Large amounts of land (more than 4 -mlillion hectares) are still held by the state through its holding company and this is a significant damper on the market and can potentially overshadow private sector activity. This is having a depressing influence on land prices. The institutional structures in Poland are still confused and there is no single national land registration and cadastral authority as the responsibilities are split between different ministries and there has been interminable discussion about the future of the institutional structure. The administration is through the voivods and consequently there is a structural weakness that affects further progress. It seems from the case studies that the valLuation system is claimed to be more advanced in Poland than in any of the other study countries but the land market cannot yet be said to be working effectively. Slovakia is handicapped in its land market by the difficulties arising from the lack of updating during thie socialist years, resulting in large numbers of unknown owners as well as the Emerging Land Markets in Central and Eastern Europe 109 loss of boundary information (as in the Czech Republic). There is still a significant amount of land held by the state land fund and the restitution is still only two thirds completed. It therefore suffers from structural problems arising directly from the socialist legacy. A further complication (as in the Czech Republic) is the potential claims of evicted landholders who were expelled after the end of the Second World War. The regulatory authorities are also weak in that the land registration and cadastre sector is operated as part of the overall state administration and consequently there is a loss of executive control. Valuation and Financial services are still underdeveloped and there are weak information flows. hi order for the land market to begin to function, the owners and parcel data must be completed as a priority to complete the first stage transition. The institutional position of the regulating autlhorities also needs to be considered and the technical infrastructure is not yet in place. In Slovenia, the land market is noticeably less active thlen the other case study countries. It is too early to assess the impact of the liberalizatior of t]he market (it was opened to EU nationals in 1997) and this will only become clear over the next year or two. At the present time, the market suffers from a lack of technical infrastructure within the land registry. There is no large restitution program and there are no significant potential outstanding claims. The same families have been settled on the land for generations in small plots and these are not often offered for sale. While people like to be associated with the land, they are not so interested in the active use. The second and third pillars follow the same pattern as the other countries, though financial services have been even slower to develop in Slovenia, as the general economy has remained more closecd to outside companies. The chief impediments are considered to be the lack of technical infrastructure and lack of reliable information services from the Land Registry. The overall assessment shows that the reforms and institution building within the land registration sector (pillar one) have been more effective than the reforms in the valuation and financial services sector. There is a recognized weakness in policy formulation and coordinated institutional activities and a weakness in the establishment of a sufficient number and variety of participants in the land market itself, though Hungary has been noticeably successful in this area. Structural Change in the Farming Sectors of Central and Eastern Europe Second EU Accessioni Workshop in the Rural Sector, Warsaw, Poland, June 27-29, 1999 Review of the Legal Basis for Agricultural Land Markets in Lithuania, Poland, and Romania Roy L. Prosterman Leonard Rolfes, Jr. This report examines the legal basis for development of agricultural land markets in three of the ten Central and Eastern European countries seeking accession to the European Union (EU), with special reference to the requirements for accession. The three countries are: Lithuania, the Baltic country with the highest proportion of population in agriculture; Poland, the country currently engaged in accession negotiations with the highest proportion of its population in agriculture; and Romania, the country preparing for a later round of accession negotiations with the highest proportion of its population in agriculture. For each of the countries chosen, agriculture plays a significant role in their economies, and agricultural land is a resource (and an asset) on which more than one-fifth of their populations rely. Thus, the implications of the EU accession requirements with respect to agricultural land-market development are of considerable importance. This review is based largely on work done in Lithuania, Poland, and Romania in M4arch and April of 1999. In each country, meetings were held with senior government officials, government specialists, legislators, bankers, non-governmental organizations, other non- governmental specialists, lawyers, EU personnel, World Bank personnel, and other expatriate specialists knowledgeable about various aspects of rural land market development. The authors gathered and analyzed constitutions, laws, and other legal acts that have a bearing on the various aspects of land market development, and interviewed local officials, family farmers, and managers of larger farm enterprises about the status and development of the land market on the ground. RELEVANT EU ACCESSION REQUIREMENTS Two main requirements for accession to the EU have been identified as relevant to agricultural land. First, countries seeking accession must achieve a "functioning n market economy." This requirement was one of four accession criteria declared by the EU heads of 110 Review of the Legai Basis for Agrictldtural Land Markets 111 government at the Copenhagen European Council in June 1993.1 To meet this requirement, at the threslhold a country's laws must allow a market to ftnction for each of the major factors of production whichi make up a market economy. One of those factors of production is land. Thus, land must be substantially privately owned and capable of being bought and sold. In addition, this requirement carries implications for the legal rules gcverning processes of land privatization, including processes of land restitution to former owners. Further, the law must also provide the critical supporting structures for a land market, such as registration of land rights and mortgage financing of land transactions. Second, citizens and legal entities of EU member states should have the right to take up activities as self-employed persons, and to set up and rrmanage undertakings, on the territory of other EU member states.2 This right is known as the "freedomn of establishment," and includes specifically the iright to acquire and use land and buildings (Treaty Article 54(3)(e)).3 The "freedom of establishment" is significantly qualified, however, in at least two relevant ways: 1. When agricultural land or buildings are involved, iimplementation of the freedom to acquire land ancl buildings in another member state is made subject to the objectives of the common agricultural policy, which include taking account of the "social structure of agriculture," the "disparities between the various agricultural regions," and the need to make adjustments "by degrees" (Treaty, Articles 54(3)(e) and 39(2)). 2. The freedom-of-establishment principle only requires that an EU citizen be afforded treatment equal t[o "the conditions laid down for [a country's] own nationals" (Treaty, Article 52). Presumably, such conditions must also meet the separate "market economy" criterion laid down in Copenhagen. In plain language, a country can irmpose restrictions on certain activities if the restrictions apply equally to nationals and other EU citizens, and if the restnrctions still allow the country to meet thie nnarket economy criterion.4 1 European Council, Conclusions of the Presidency, Copenhagen, June 1993; see, e.g. Agenda 2000-Summary and Conclusions of the Opinions of Commissioni Concerning the Applications for Membership to the European Union Presented by the Candidate Countries, Strasbourg/Brussels, 15 July 1997 DOC/97/8. 2 See the Treaty Establishing the European Community (as Amended by ihe Treaty on European Union), Articles 52, 54. 58, 39. UNTS 11 (1957), and TEU amendments at O.J. C224/1 (1992) and 31 I.L.M. 247. A consolidated text of the Treaty can be fcund in George A. Bernann, et al., E!iropean Community Law Selected Documents (including Europear. Union Materials) 1998 Edition 5 (West 1997). 3See also 1961 Gener-al Programme for the Abolition of Restrictions on Freedom of Establishment, O.J. English Spec. Ed. 2nd series, IX 7 (Council of the EEC), Title III (A)(d) (second lettered sequence, following (a)-(j)). 4 See Commission v. Greece. Case 305/87, [1989] ECR 1461, in which the European Court of Justice held invalid under Article 52 Greek laws which had discriminatorily prevented natural or legal persons of other EU members from ownirng land ir border areas and on the Greek islands. See also General Programme, Title I, and III (A) and (B) (suggesting that treatment of other EU persons affording rights beyond national treatment may only be required if they are resident sAlf-ernployed natural persons). 112 R. Prosterman and L. Rolfes Key Legal and Policy Issues Related to Agricultural Land Markets in Lithuania, Poland, and Romania Issue Lithuania Poland Romainia 1. Private ownership of land - by citizens allowed allowed Allowed - by legal entities prohibited allowed Allowed - by foreign citizens prohibited allowed, but with Prohibited restrlctions - by foreign legal entities prohibited allowed, but with allowed only restrictions through Romanian legal entity subsidiary _ 2. Privatization of land (see also section 3) - main method(s) of privatization mostly by restitution to most land remained Restitution former owners, though privately owned during land also allocated for Communism; state-owned auxiliary plots and land being privatized private farms through sale to lessees - speed of privatization very slow very slow, but affects the mostly completed minority of land which is state-owned - intent to privatize clear intent to do so doubtful intent clear intent to do so - current use(s) of land leased to private farmers leased to farming cultivated by state remaining in state ownership or to citizens for use on corporations far smaller farms (this small plots than the predecessor state represents a farms minority of land; privatization expected soon) 3. Restitution of land _ - problems with restitution complex laws, competing no restitution program some prob] ams of claims, and excessive administrative hurdles parcelizatior 4. Farm restructuring (as it impacts marketability) - is collective and state farm land yes somewhat (most land Yes being transferred to the ownership remained privately owned) and use of individuals? - do restrictions exist on private no no No land transactions that discourage farm restructuring? 5. Land-use regulation (as it affects marketability) - are "non-use" or "irrational use" no no sanction for non-use subject to sanctions? - are penalties for violation of land penalties do not appear penalties do not appear yes, land can be use excessive? excessive excessive seized without compensation in certain cases (though not currently in voked) Review of thie Legal Basisfor Agricuiltural Land Markets 113 Issue Lithuania Poland Romania 6. Transactions in land - may citizens and domestic legal only citizens, not legal yes Yes entities participate in purchase-sale entities transactions? - may citizens and legal entities yes, including foreigners yes, including foreigners yes, including participate in lease transactions? foreign legal entities. Foreign citizens may not lease land - do certain parties have pre- yes, the state has priority none identified yes, co-owners, emptive rights to buy or lease land? rights for very limited lessees, and lands (not for restituted neighboring farmers lands) have pre-emptive riehts (but strictly limited and not problematic) - are transaction costs (notarization, notary fees and survey fees seem high for notary fees seem survey, etc.) high? fees seem excessive transactions of small greatly excessive amounts of land - is there a moratorium on land no no No sales? - do size limits exist on the amount 150 hectare limit on r.o limits 200 hectare limit on of land that can be owned or leased? owned land; no limit on owned land; no limit the amount of land that on the amount of can be leased land that can be leased 7. Land M[ortgage _ = - is basic mortgage law sufficient? yes ves Yes - do restrictions exist on banks (i.e., yes, banks cannot own n10 yes, but not a lenders) owning land? land, even temporarily problem. Banks must dispose of foreclosed-upon _____________________ _ ______________________ land within one year. - are foreclosure rules fair and rules seem to excessively banks complain that rules seem fair and efficient? protect the lender, foreclosure is costly and efficient, but have although they rarely have slow been only minimally been applied in practice tested 8. Land Registration - does the registration law provide yes, but some yes, but much land is not overall yes, though adequate definition and protection of fragmentation into registered, with "sporadic" there some rights legal rights separate systems registration occurring for may not need to be transactions registered, causing ____________________ __uncertainty - is registration carried out in a some complaints as to no, long delays often occur registration seems timely manner the slowness of timely _____________ __ registration _ 114 R. Prosterman and L. Rolfes Issue Lithuania Poland Romania 9. Land Taxation - are land taxes too high so that they no yes, and distortion is No distort market activity? increased when combined with tax forgiveness for leased-out state lands 10. Compulsory Acquisition of Land - compulsory acquisition should be law is satisfactory law is.satisfactory law is sati sfactory allowed only to meet clear, limited, public purposes - just compensation should be paid market price is to be paid compensation standards are law provicles for when land is taken adequate "just compensation paid in advance" POTENTIAL IMPEDIMENTS TO LAND MARKET DEVELOPMENT This review of the current legal basis for agricultural land markets in Lithuania, Poland, and Romania was carried out against the background of the two relevant accession requirements stated in the previous section. Also, the review utilized a checklist of potential impediments relating to agricultural land markets that the Rural Development Institute had previously developed for the World Bank.5 These potential impediments fall under the following 10 broad categories: * Private ownership of agricultural land; * Privatization of agricultural land; * Land restitution; * Farm restructuring (as it impacts marketability); * Land-use regulation (as it impacts marketability); * Transactions in agricultural land; * Land mortgage; * Land registration; * Land taxation (as it impacts marketability); and * Compulsory acquisition of land (as it impacts marketability). The discussion of land markets in the three selected countries is organized according to these subject areas. Where significant problems are identified in the legal regime for land markets, we have offer brief "best practice" recommendations for their solution. The findi-ngs of the detailed country discussions are summarized in a matrix that presents in a comparative format the key legal and policy issues related to agricultural land markets in Lithuania, Poland, and Romania. The summary matrix is organized according to the same 10 broad categories of issues as the detailed country discussions. Roy Prosterman and Tim Hanstad, eds., Legal Impediments to Effective Rural Land Relations in Eastern E'urope and Central Asia: A Comparative Perspective (World Bank Technical Paper No. 436, 1999). Review of tlhe Legal Basis for Agricultural Land Markets 115 COUNTRY DISCUSS][ONS Lithuania Lithuaniaii law contains many of the needed provisions for a market economy in agricultural land to develop. Lithuanian citizens may ovvn land, and engage in the full range of transactions. Th,i law demonstrates a commitment to privatization of state-owned agricultural land, largely through the restitution process. Laws on land mortgage and land registration are sound. In addition, the law does not contain provisions allowing the government to over-regulate land rights, or to unacceptably terminate land rights, to any significant degree. Problems do persist, however. Transaction costs are high, the registration system is in danger of being fragmented throughout the government bureaucracy, and restitution is proceeding slow]y due to problems with the various laws and implementing regulations. Also, the Lithuanian Constitution prohibits foreign citizens from owning land, as well as prohibiting both domestic and foreign legal entities from owning agricultural land. These restrictions undoubtedly raise major issues regarding EU accession. Private Ownership ojfAgricultural Land Lithuania allows full private ownership of agricultural land by its citizens. Restrictions do exist, however, on private ownership by legal entities. Lithuania's Constitution allows agricultural land to be owned only by citizens and by the state. Thus, legal entities cannot own agricultur-al land., even if they are Lithuanian. This limitation could adversely impact the development of a market economy in two ways. First, by forbidding Lithuanian banks (which are legal entities) from owning land, the limitation might make mortgage financing of land purchase difficult or impossible. Second, forbidding land ownership by legal entities engaged in agricultural production may impair development of more com]petitive and efficient farms. Since a fundamental requirenment for accession to the EU is the existence of a functioning market economy, the restriction is problematic. Lithuanian law also proscribes ownership of agricultural land by foreign citizens and legal entitles. These issues are discussed in the section on 'Tansactions in Agricultural Land found below. It is widely expected that this constitutional restiction against ownership of agricultural land by legal entities will be removed (a similar restriction was removed for non-agricultural land in 1996). Some believe this change will occur before next year's parliamentary elections, while others believe the change will not occur until the restitution of agricultural land is substantially completed. Com ipletion of restitution could take several years, as discussed below. Privatization of Agricultural Land The primary question surrounding land privatization and its relationship to the development of a market economy is the amount of privatization that has in fact occurred. In 116 R. Prosterman and L. Rolfes Lithuania only 36.7 percent of agricultural land has been fully privatized; 63.3 percent remains in state ownership. However, several important facts make this statistic less gloomy. First, the Lithuanian government clearly intends to privatize a significant majority of its agricultural land. See the following section on Land Restitution. Second, over half of the state-owned agricultural land is leased to family farmers or used by citizens on auxiliary plots. Furthermore, while Lithuania has a far higher proportion of state-owned agricultural land than in Poland, for example, the administrators of such land appear more willing than in Poland to make it available in small and medium-sized parcels for lease to the family-farm sector. Privatization of land has occurred in three principal ways. The most significant method is restitution, a process still ongoing. The second way is through the allocation of 2-3 hectare auxiliary plots in use to citizens, who are then allowed to buy the plots out with vouchers or with money. The third way was through the allocation of land to peasant farms in 1989, at the beginning of the land reform. One obstacle to meaningful land privatization encountered in some transition economies is transferring land into so-called private ownership, but without the right to sell that land. This is not a problem in Lithuania: when land is transferred into private ownership, it is with -the full range of expected ownership rights. Also, the state has not exempted from privatization large amounts of land for specialized production, as has been the case in some other countries. Exemptions for high-quality seed and animal-breeding, research, and other specific purposes probably constitute one percent or less of agricultural land. Land Restitution The principal focus of Lithuania's agricultural-land privatization efforts is the restitution of land to Lithuanian citizens who were pre-World War II owners, or their successors. Restitution is, preferentially, to be of the specific land that the pre-war owners had cultivated. Unfortunately the process has gone slowly. The basic political will to carry out restitution exists, but the process has been plagued by problems with laws and implementing procedures. Thus, as mentioned above, only 36.7 percent of agricultural land has been formally transferred into private ownership, including final registration. The major problems with the restitution program are as follows: 1. Some land was allocated to peasant farmers in ownership under the 1989 law of the Lithuanian SSR "On Peasant Farming," before the restitution law was first adopted in 1991. As a result, unresolved conflicting claims exist between peasant farmers and restitution claimants. 2. The state allocated a substantial amount of land for use as auxiliary plots, and gave the users the right to buy out these plots (first with vouchers, and currently for a somewhat high ;state- determined price). Some of this land is now in private ownership, while most of it (an estimated 17.4 percent of all agricultural land) is still state-owned. This land was given out in 2-3 hectare allotments. As with the land allocated to the peasant farmers, much of the auxiliary plot land is subject to conflicting claims by restitution claimants. Reviews of dhe Legal Basisrfi Agrica1ltural Land Markets 117 3. The deadline for submitting restitution applications was extended in successive amended versions of the law. 4. The categories cf people who were given restitution rights were expanded in successive amended versions of the law, most recently in the 1997 law "On the Restoration of the Rights of Ownership to the Existing Real Property." Most notably, they were expanded to include grandchildren of the original pre-war owners. 5. Several different laws, and potentially several amerLded versions of the same law, may be applicable depending on the date a restitution claim was submitted. There also appears to be a lack of clear legal rules to resolve the conflicts between the claims of actual users and restitution claimants under (1) and (2). 6. Numerous administrative problems exist, such as the use of complex Soviet-era land valuation procedures rather than market values. Some of these problems, paradoxically, seem to arise from efforts to be scrupulously fair to restitution claimants. Complex rules and procedures contribute to indecision and gridlock. It is also worth pointing out that an estimated 50 percent of the c:laims for restitution of land in kind have novv been dealt with. However, as one person noted to us, "the last 30 percent are likely to be the hardest." * Recommendation: It would be very desirable to speed up the restitution process, but the issues are daunting and involve highly technical problems of administration and dispute resolution. The best tlhat can be suggested is that the Lithuanian government must recognize tlhat its present goal of completing restitution by 2000 is unrealistic, and that it cry to implement solutions to the problems outlined above. Unfortunately, from a legal perspective the problems described in (1) through (4) involve. rights which were granted, and thus cannot n1ow be taken away. Some clarificationis of ambiguities in the law may be possible under (5). The chief hope lies under (5) and (6), where initiatives to streamline administration and conflict resolution may be possible (improve training of officials who are tasked to work out solutions to conflicting land claims, use market valuations, etc.). Farm Restructuring The prirnary issue concerning farm restructuring and land markets is whether land traditionally used by collective and state farms is being transferred to the ownership and use of individuals. In Lithuania, transfer- of ownership has been slow due to difficulties with the restitution process. Nevertheless, most land is used by individuals, as follows: * Roughly 66 percent of agricultural land is used by family farmers or auxiliary plot holders. * Approxirnately 16 percent of agricultural land is used by the 1,650 agricultural companies which are the effective successors to (although much smaller than) the former collectives. Slightly more than half cf this 16 percent is leased from the state, and the rest is leased from private owners. 118 R. Prosterman and L. Rolfes * About 17 percent of agricultural land is unused, with the remainder used in miscellaneous small categories. The key factors leading to the relative smallness of the agricultural company sector have been government policy to transfer land to individuals, coupled with the prohibition in the Constitution on ownership of agricultural land by legal entities. Finally, Lithuania has not restricted transactions with privatized land in a way that discourages farm restructuring, as can be seen in some transition economies. A land share system (featuring a cosmetically reorganized state or collective farm using most of its traditional land base, but with the land held in common ownership by the farm members) does not exist in Lithuania. As to individual land plots, at one point restituted land not being used directly by its owner had to be leased to the agricultural companies. This obligation no longer exists, and most restituted land not used by its owner is apparently leased to family farmers. Land Use Regulation Severe penalties do not appear to be used for regulating land use. The 1994 law "On Land" requires that agricultural land not be used irrationally. No "non-use" provision exists, but the law prohibits allowing agricultural land to be overgrown with shrubs or forests. However, there is no clear specification of penalty, and no indication that loss of the land (with or without compensation) is a possible penalty. Certain legal issues arise when a landowner wants to change the use of his parcel from agriculture. If a town-planning document designates land as available for non-agricultural purposes, then the conversion can be easily made. Otherwise, it appears that a change in the town plan must be obtained under a rather complicated procedure. In addition, s;pecial compensation must be paid based on a multiple of the difference in profitability between the land as used for agriculture, and the land as used for non-agricultural purposes (i.e., a number of years of expected profit for the change must be surrendered up-front). Such conversions of land are rare, especially since land usually can be found which is already properly designated. Transactions in Agricultural Land 1. Sale and lease transactions. All private landowners have the right to sell, and to carry out other usual transactions, and the state has not imposed moratoria on land sales. Although the state does not produce standard forms for exercising transaction rights, private parties have developed and utilized their own forms (with guidance also from the Land Law). Land leasing is not restricted, except that under the 1993 law "On Leasing" of Land some leases may have to be for a three-year minimum term. One issue that still remains is, for agricultural land that has been sold by the state, as distinct from restitution land, the state has a priority right under the law "On Land Reform" to meet competing offers when the private owner subsequently offers that land for sale. Such a Review of the Legal Basis for Agricultural Land Markets 119 limited and straightforward priority right probably will not raise serious problems, although ideally there would be no such right. 2. Rights of foreigners. Regarding rights of foreign citizens and legal entities, the Lithuanian Constitution presently limits ownership of agricultural land to Lithuanian citizens and the state. Foreign oNvnership is thus precluded. The exclusion of foreign citizens and foreign legal entitzies from owvnership of agricultural land, compounded by the exclusion of Lithuanian legal entities, raises substantial problems for EU accession. Both the "freedom of establishment" issue and the "functioning market economy" issue appear to arise (see the discussion in the Relevant EU Accession Requirements section above). The "freedom of establishment" issue arises with respect to the ban on ownership by foreign citizens, although it may not arise with respect to the ban on foreign legal entities, since Lithuanian legal entities are also excluded from ownership, thus making the prohibition non-discrimrinatory. However, the potential problem must also be reviewed in light of the policy consideraticins integral to the common agricultural policy: taxking account of the "social structure of agriculture," the "disparities between the various agricultural regions," and the need to make adjustments "by degrees." (See Articles 54(3)(e) and 39(2) of the EU Trreaty.) The "functioning market economy" issue may arise with respect to the ban on agricultural land ownership by Lithuanian legal entities, both because they, a major class of likely market participants, are excluded from the market, and because Lithuanian banks, in particular, may be discouraged fronm mortgage lending if they cannot acquire lancd upon which they are foreclosing, even in the absence of other buyers. Thus, even Lithuaniain citizens may find it difficult or impossib:le to olbtain puarchase-money mortgages to finiance the buying of agricultural land, arguably an essential component of any functioning land jmarket. Lithuanians generally recognize the problems with restricting foreign ownership. We found fairly broad agreement that the prohibition on foreign ownership should be ended, although many people thought it would be best to complete the restitution process first. As a final matter, prices of agricultural land on the private market in Lithuania are clearly very low. They are estimated to be around 1,500 to 2,000 litas/hectare ($375 - $500/hectare). These prices are lowv not only in relation to EU market prices, but even relative to prices in neighboring Poland, where a realistic estimate of average market price may be as high as 7,000 zlotys/hectare (roughly $1,800/hectare). These great price differences suggest that unfettered foreign access to the land market could be highly disruptive, precisely what the Treaty policies quoted above are intended to avoid. In the previous round of EU accession, which involved a much more prosperous group of countries (Austria, Finland, and Sweden), even a restriction whose eLimination wvouild have involved far less potential social and economic dislocation (a restriction on foreign purchase of land for vacation homnes) 'was permitted to be retained for a five-year period after accession.6 6 See Act concerning the conditions of accession of the Republic of Austria, the Republic of Finland, and the Kingdom of Sweden, and the adjustments to the treaties on which the European Union is founded. O.J. C241, 29/08/94, Title III, Article 70. 120 R. Prosterman and L. Rolfes * Recommendation: The restriction on agricultural land ownership by Lithuanian legal entities, especially banks, appears highly vulnerable under the "functioning market economy" criterion, and should be quickly eliminated. This will require a constitutional amendment. As to ownership of agricultural land by EU citizens and legal entities, EU policy and precedent are deferential to the need for extended transition periods (including post-accession periods) to avoid dislocation. This approach should be applied in the Lithuanian context as well. 3. High transaction costs. High transaction costs are a major problem, especially for transactions involving small amounts of land. The two principal costs are notarial fees and surveying charges. Both notaries and surveyors are private, but the process either requires or encourages high charges. The Ministry of Justice approves the fee schedule for notaries, which starts with a fixed fee of 300 litas for all sales of immovable property with a value up to 30,000 litas (thereafter 0.7 percent of the price up to 100,000 litas, and so on). Surveyors are "approved" at the rayon (county) level and publish their fee schedule, which is anywhere from 150 r-o 500 litas/hectare for their work (equivalent to $37-$125/hectare), depending upon a variety of factors. One farmer we interviewed was buying four hectares for up to 3,000 litas/hectare and paying fees totaling 1,200 litas for redrafting the land plan and notarizing the sale. This amount is equal to 10 percent or more of the purchase price of the land. For the purchase of a one-hectare auxiliary plot of poor-quality land, surveying costs could be almost equal to the price of the land. * Recommendation: The minimum fee for notarization should probably be reduced. But, most importantly, competition among the private surveyors needs to be stimulated. It may be necessary to set nationally a maximum price for surveying (perhaps per parcel as well as per hectare) which should be substantially lower than the present fees. While the economic conditions are quite different, a situation of real competition among private surveyors in Moldova, for example, has led to a typical survey of one hectare divided into three separate parcels costing the equivalent of 32 litas. 4. Discrepancy in rent levels between state and private land. Another problem is the discrepancy between rent levels for state-owned land and privately-owned land. This discrepancy may be undermining the lease market, and possibly the sale market, for privately- owned land. Although private farmers we spoke with were leasing land from private parties as well as from the state, it was clear that rent levels for state-owned land were far lower. Rents on state-owned land are usually 1½/2 percent of a calculated "value" (an amount which is alsc equal to the normal level of land tax), typically now 20-30 litas per hectare. This is equal to roughly two to three percent of the average value of grain production per hectare. Rents on privately- owned land appear to be in the range of 120-150 litas per hectare (or equivalent in grain), although there are also cases where the owner leases the land for amounts described as "symbolic" or for payment by the lessee of the land tax. It seems highly likely that the availability of substantial amounts of state-owned land at comparatively very low rent levels is significantly undercutting both the private lease and private sale markets. Review of the Legal Basis for Agricultural Land Markets 121 * Recorrmendation: The solution is to finish the restitution process and get the state out of the business of owning and leasing out substantial amounts of agricultural land. 5. Size limits. Neither maximum nor minimum size limits unduly impede the development of Lithuaniia's land marlket. The maximum size limit on ownership of agricultural land by a family is 150 hectares, and was established under a series of laws, including the law "On Land Reform" as amerded through 1997. This does not appear to create a problem, although some thought must be given to possible adjustment if legal entities are given the right to own land. In addition, under the 1994 law "On Land," lower ownership limits could, theoretically, be set locally in accordance with local land-use planning documents. There is no maximum on the amount of leased land. Furthermore, under the law "On Land," it is theoretically possible for sub-division of private agricultural land holdings by transfer to be limited under local land-use plans. This appears to be the only respect in which a mini:mum size requirement could apply, and does not appear to be a problem in practice. Land Mortgage The legal rules, as to mortgage under the 1997 law "On Mortgage" and other laws appear to be adequate, with the important exception that legal persons (hence banks) cannot own agricultural land. Thus., if there is an inadequate bid, or no bid, at a foreclosure auction, a mortgagee bank cannot acquire ownership of the land itself, even temporarily. At a minimum, this probably will lead banks only to take mortgages on agricultural land which is clearly marketable and has value well in excess of the loan amount, so that sale to a third party at an acceptable price 'at a foreclosure auction would be virtually assured. We spoke with one bank that does, nonetheless,, make some loans on the collateral of agricultural land, but the restriction on bank ownership clearly is a constraint. * Recommendation: Unfortunately this is a constitutional issue, so a partial approach is very difficult. Ideally, however, an interim solution would allow banks to own land for a brief period of time, if that land was not successfully auctioned at a foreclosure sale. The law contains no express reference to purchase money mortgages, but this does not appear to create a problem. Excessive protection for the mortgagee may give rise to problems, although the practical experience with foreclosure is thus far very limited. The 1997 law "On Mortgage" appears to subject the debtor to a foreclosure auction within little more than a month after default, and we are not aware of any separate period-of-grace or special saving provisions. By world standards, such a rapid foreclosure procedure is fairly drastic. Land Registration The 1996 law "On the Real Property Register" appears basically adequate, although some improvement might be imagined. Registration is to be carried out by the "State Land Cadastre and Register." One ernerging problem is that there is now a separate Mortgage Registry, 122 R. Prosterman and L. Rolfes maintained in the courts by the Ministry of Justice. In addition, there is discussion about further fragmenting the registration system by turning over registration of other encumbrances or servitudes to the Ministry of Justice. * Recommendation: Every interest in land that is to be registered should be registered in one accessible place, whatever that place is. Rather than further fragmentation, re-combination of the Mortgage Registry with other registered information would be desirable. The law "On the Real Property Register" appears to require registration under its new procedures. Rights registered under earlier registration procedures are protected, however, until registered under the new procedures. The registry is open to the public. We heard complaints about the slowness of the process of registering landc sale transactions. The complex requirements found in the law "On the Real Property Register"' make it easy to understand the difficulties, even though that law also attempts to set some unrealistically short time-lines for various review steps in the registration process. Registration fees do not appear to be substantial, but notarization and, especially, survey costs for land sales are excessive. See discussion under Land Transactions above. Finally, initial privatization of agricultural land does not seem to be burdened by co]mplex requirements for legal land descriptions and surveys, but survey standards for subsequent private sales are more exacting. Even so, it does not appear to be the standards themselves, so mtuch as the excessive fees charged by surveyors for the work done, which are the problem. Land Taxation Land taxes are quite low. They usually amount to 1.5 percent of a state-calculated land value, and may be forgiven by local government. A tax of 1.5 percent of the calculatecd value would typically be around 20-30 litas per hectare, equal to perhaps 2-3 percent of the average value of grain production from a hectare of land. No sales tax is levied on the first deal for sale of a restituted land plot made per year; any additional deals are taxed at a rate of 20 percent of the contractual price. Compulsory Acquisition of Land The 1994 law "On Land" clearly and narrowly identifies the purposes for compulsory acquisition. The constitutional standard is "adequate compensation." The law "On Land" provides for payment of "the official land market price of that locality," with the right to appeal to a court. Whether "official" and actual market prices may differ significantly, or may come to differ significantly as a land market develops, is difficult to assess. At least at present, compensation for compulsory acquisition does not appear to be a problem. Review of the Legal Basisfor Agricultural Land Markets 123 Poland Poland has tlhe best-developed legal base for agricultural land markets of the three countries reviewed. Polish citizens may own land, and ciarry out the full range of transactions with that land. Registration and mortgage laws exist and are fanctioning, and land use rules are generally reasonable. Persistent problems include delays in privatizing some of the former state farm land, a process of registration that takes much too long, and restrictions on foreign ownership of land. Private Ownersh;ip ofjAgricultural Land Private ownership of both agricultural and nor-agricultural land is legal in Poland. Natural and legal persons may privately own land and enjoy the full range of expected ownership rights. Poland does, however, have significant administrative restrictions on acquisition of private land ownership by foreigners, which are addressed below. The right of legal persons to privately own agricultural land has not given rise to any problems of coerced contribution of individually-held land to charter capital of enterprises, as in some transition economies. In Poland, the state farm/cooperative sector only uses 20-25 percent of agricultural land (the r est is held in family farms). Privatizal-ion of ALgricultural Land Seventy-five percent of Poland's agricultural land. stayed in family farms throughout the communist period. I'his land remained privately owned and did not require privatization. With respect to the remaining land, certain issues exist as to full privatization. The Agricultural Property Agency (APA) is a state agency formed in 1992 under the 1991 law "On Administration of State Treasury-Owned Immovable Property." The APA took over roughly 4.6 million hectares of land, which had been occupied by state farms (3.7 million hectares), by the National Land Fund (600,000 hectares), or held in miscellaneous categories (300,000 hectares). The agricultural land in these categories represented 19% of Poland's total agricultural land base. The APA liquidated the state farms (average size 2,500 hectares), and distributed the three categories of land as follows: * 2.8 millicn hectares were leased, largely to 6,000 newly-created smaller farms (average size 450 hectares). These new farms are far smaller than the old state farms, but many of them are probably still closer in functioning to a "state farm" than to a "family farm." Although lacking some of the benefits of household-size private farms, these 6,000 farms do continue to employ mrany former state farm workers, a group that received no privatization benefits. * 728,000 hectares have been sold, apparently mostly to family farmers to expand their holdings; * 161,000 hectares have been transferred free of charge; * 330,000 hectares have been "redistributed" through "management," "perpetual usufruct," or "administration;" and 124 R. Prosterman and L. Rolfes * 616,000 hectares are officially awaiting disposal, but indications from the APA are that this land is of poor quality and will probably not be used. The most important issue related to privatization is the disposition of the 2.8 million hectares which have been leased out mostly to the 6,000 new farms created from the former state farms, usually under mid- to long-term lease (we encountered some 15-year leases), and at rather low lease rates. These 2.8 million hectares represent about 11 percent of all agricultural land. We were told by the APA that it is selling about 100,000 hectares of this land annually - probably nearly all to the lessees, who have a preemptive right to buy under the Civil Code. (The lessees are most likely buyers for another reason: a non-lessee buyer would be purchasing land a]ready leased for a long tern and at low rents to the lessee.) However, at the present rate it will take 20 to 30 years to fully privatize this land. Some observers believe the APA is attempting to extend its bureaucratic life rather than serve its intended function of privatizing state land by selling this 2.8 million hectares at such a slow pace. Others argue that, if a new law mandates rapid privatization of APA-held lancl, most of that land would go to the 6,000 smaller (but still rather large by Polish standards) farms vhich came out of the break-up of state farms, rather than to true family farmers. Several factors reinforce this possibility: the currently depressed state of agriculture; the location of much of this land away from areas of family farming; and the existence of the leases. * Recommendation: The land in the APA land fund should be transferred into private ownership. The APA should be given, by law, a fixed period (at most 5 years) to liquidate its "inventory" and close its doors. This may require much lower land prices than the APA presently offers, and probably - where the lessee does not want to buy or cannot meet another's offer - some preference for those local farmers who do exist. A second, lesser preference may also be needed for others who want to relocate to farm directly. Importantly, this land should be made available for purchase in single fields or units that are much smaller than the average size (450 hectares) of the 6,000 farms that are currently this land's principal lessees. * Recommendation: If APA-held land is to be fully privatized, the workers on the 6,000 successor enterprises to the state farms should receive 15 percent of the financial proceeds of privatization, equivalent to what workers in the non- agricultural sector received when their enterprises were privatized. Land Restitution A leading issue in transition economies concerning restitution is whether claims are being processed slowly or are not yet decided. Either a slow pace or potential overhanging claims could prevent the affected land from being presently marketable. (Restitution is not an EU requirement, but a "functioning market economy" is.) Review of the Legal Basis for Agricultural Land Markets 125 Poland does not currently have a restitution law, but successive drafts of such a law have been debated by the parliament through most of the 1990s. However, even if such a law eventually is adopted, it will affect a very small percentage of agricultural land. The only land affected will be APA--admninistered land -- land which the state expropriated from the aristocracy or large landlords after World War II and put into state farms. Most expropriated land under the post-war Land reform was given in ownership to family farmers; that distribution is universally considered legal and binding, and will not be affected in any way. At most, a restitution measure would return an estimnated 300,000 hectares to former owners. The APA has identified such former estates that had been swallowed by state farms, and has followed a policy only to lease this land and not to include it in any land being sold. Farm Restructuring As discussed above, the state now leases most of ihe land formerly held by state farms to some 6,000 farms operated by private enterprises or individuals which average about one-fifth the size of the former state farms. See the recommendation as to full privatization under Privatizat ion ofAgricultural Land above. Because Ploland does not have a land share system, the issue of "locking up" land in inefficient production inits through long-term lease of laLnd shares to large agricultural enterprises does not arise. The system of leasing out most former state farm land to 6,000 farms which are still rather large by Polish standards may tend, however, to lock up land in inefficient production units. The recommendation under Privatiza ion of Agricultural Land above would attempt to ameliorate this effect by offering this land for sale -- still subject to the existing lease, of course - in units muclh smaller than 450 hectares. Land Use Regulation We have found no provisions in Polish law threatening dire consequences for "irrational use" or "non-use." Nor have we found any indicaticn of draconian penalties for land-use violations. However, under the 1994 law "On Spatial Development" and related measures, a spatial development (zoning/land-use) plan must be complied with in order to get a valid construction permnit. This law actually goes dramatically, and indesirably, further than nearly all laws in the EU or North America, requiring compensation to the owner where a change in zoning reduces the value of his land. Following common practice, existing uses are also generally protected against zoning changes. Under the law "On Spatial Development," if a spatial-development plan which zones particular land for agricultural use has been approved by the gmina (village-level administrative body), a change to non-agricultural use requires a change in the plan (a change in zoning). This change necessitates a substantial procedure and approval process. This procedure and approval are carried out at the gmina level, however, and our discussions suggest that the actual difficulties of conversion may range from slight to severe, depending on the particular locality (and probably upon such factors as whether the change is to allow a substantial job-creating investment). Under ithe same law, it might be noted, if ihe beneficiary of a zoning change then 126 R. Prosterman and L. Rolfes sells the rezoned land, the gmina can impose a special fee equal to up to 30 percent of the increase in value of the property due to rezoning. However, this fee clearly does not represent a confiscatory level of taxation. A formula is used which probably reduces the impact still further compared to the actual price paid. Transactions in Agricultural Land 1. Sale transactions. Poland appears to have an active sales market in agricultural land. The APA, for example, estimated that 500,000 - 1,000,000 hectares are sold each year on the private land market (roughly 2-4% of agricultural land). As in many developed market economies, there are few or no official forms to be used in land transactions; private parties create their own forms to suit their needs. 2. Rights of foreigners. The Polish Constitution appears to permit, but not to require, restrictions on foreign purchase. It appears that foreign purchase of agricultural land in excess of one hectare or non-agricultural land in excess of 0.4 hectares currently requires permission from the Ministry of the Interior, pursuant to the 1920 Act on Acquisition of Real Estate by Foreign Persons (as amended in 1996). Leases apparently are permitted without limitation. As discussed in the Relevant EU Accession Requirements section above, restrictions on foreign ownership raise EU accession issues related to the "freedom of establishment." Although the prohibition of foreign ownership in Poland is not absolute, the need for administrative approval is, on its face, discriminatory and clearly sufficient to raise the freedom of estab] ishment issue. However, with respect to agricultural land in particular, the requirement as set fDrth in Articles 54(3)(e) and 39(2) of the EU's governing Treaty needs interpretation. The requirement states that any implementation of the right of foreigners to acquire agricultural land and buildings must be subject to the objectives of the common agricultural policy under Article 39,. taking account of the "social structure of agriculture," the "disparities between the various agricultural regions," and the need to make adjustments "by degrees." The issue of foreign ownership is one of considerable political and practical importance for Poland. On the political front, there is considerable resistance to possible foreign acquisition of tracts of agricultural land, especially by German citizens in the western areas that were at one time German territory and became part of Poland after World War II. On the practical front, Polish agricultural land presently sells for market prices that are far lower than prices for comparable agricultural land in the EU, and consequently could be easily bought up by w ealthier EU nationals. Also, it is argued that allowing foreign ownership would also tend to driveO up the price of agricultural land, and make it less affordable to Polish farmers. The differences in land prices between the EU and Poland appear to be substantial. We received estimates of the average price for agricultural land sold in private transactions in Poland ranging from around 3,000 zlotys/hectare ($790/hectare) to 7,000 zlotys/hectare ($1,850/hectare). By comparison, it was estimated that agricultural land in the western region of Germany sells for an average price of DM 15,000/hectare (about 32,000 zlotys/hectare), while such land in the Review of the Legal Basis fcr Agricultural Land Markets 127 eastern region of Germany sells for DM 7,000-9,000/hectare (about 15,000-19,000 zlotys/hectare). In sum, if Poland's agricultural land market is simply thrown open to bidding by EU citizens and enterprises, there could be adverse economic and political consequences of the sort that Article 39 of the E1J Treaty seeks to limit. a' Recommendation: Poland may end up needing a post-accession transition period to remove restrictions on ownership of agricultural land by EU citizens and enterprises. During the previous round of EU accessions Austria, Finland, and Sweden were each allowed to retain restrictions on foreign purchase of land for vacation homes for a five-year period after accession (see footnote 6). These restrictions, if immediately removed, would clearly have been far less disrLuptive to the local economies than the restrictions at issue in Poland. Moreover, foreigners already have a certain level of access to agricultural land in Poland, since they may lease such land. 3. Leasing. No restrictions exist in Poland on land leasing. Under the Civil Code, lessees who have leases of 3 years or more in length have a priority right to acquire the land they lease. They must meel: competing bids, however. Such a straightforward right restricted to lessees only does not seem to pose significant problems for a land market. One potential p:roblem regarding leasing is that APA lease rates for state-owned land are almost certainly below market. These rates currently average about 2.3 centners of wheat per hectare, which amounts to less than 10 percent of average production. While somewhat low, this rate is not nominal. The APA-held land, moreover, is usually leased out in large tracts and is largely located in ateas (in the north and west of Poland) where there are not a large number of family farms. In those settings, APA leases probably do not substantially undercut the private lease market. On the other hand, we also encountered APA leases of smaller tracts in settings where there are man,y smaller farmers. In such settings, private leasing very likely is undercut. In addition, low rents for APA land may discourage privatization. Currently the average sale price for one hectare of APA-owned land (2,700 zlotys) is equal to the price of 60-70 centners (6-7 tons) of wheat, while average lease payments to the APA are 2.3 centners per hectare. That is, APA sales prices average roughly 2(-30 times annual lease payments, which implicitly (and e.rroneously) assumes that a reasonable return on investment in that setting is less than 4 percent. Thus, a substantial disincentive to buy the land exists. Since lease payments are already fixed under generally long-term leases, this probably means that land prices will have to be drastically reduced if the APA land stock is to be rapidly privatized. * Recommendation: To solve these two problems (undercutting the private lease maLrket and discouraging land privatization', the APA should privatize its leased-out land at whatever prices are possible and go out of business (as suggested under Privatization of Agricultural Land above). This may depress 128 R. Prosterman and L. Rolfes the land market for a time, but thereafter a much healthier, and almost wholly private, land market will exist for both sale and lease of land. 4. Other transaction-related issues. Several other transaction-related issues deserve brief discussion. First, anecdotal evidence suggests that high transaction costs may hinder transac tions for very small land parcels. One farmer we interviewed, for example, said that last year he purchased 0.26 hectares of land for 500 zlotys. The fees related to the purchase were another 500 zlotys, including the notary fee, taxes, and the registration fee. He added, however, that the costs go down proportionally the larger the land plot being purchased. Second, Poland does not have upper limits restricting the amount of land private farms can own, as can be seen in other transitional economies. Subsidized loans are not granted to farms larger than 100 hectares, but this may well favor land markets at least in the short- to mid- term, and is indeed considered by bankers we spoke with to be favored by EU policies. Third, Poland does not have direct minimum-holding requirements for agricultural land, which can often restrict market allocation of land to its most profitable use. However, in Poland two rules exist whose combined effect probably increases artificially the desirability of farms of at least one hectare in size but less than two hectares in size. To be a "farm," a unit must be at least one hectare in size, and only persons with such a minimum holding can qualify for the heavily subsidized agricultural pensions (contributors pay in only an estimated 5-7% of what the agricultural pension system pays out). On the other hand, if someone who loses a non-farmn job also has a farm holding of two hectares or more, they do not qualify for unemployment benefits. Other impediments to land transactions found in some transition economies do not exist in the Polish context, such as rules allowing private "ownership" of land, but without the right to sell that land, or rules imposing heavy financial penalties for early sales of land. Land Mortgage A sufficient set of legal rules guides mortgage transactions in Poland, although some improvements might be helpful, as noted below. Significant numbers of loans using agricu[tural land as security are made by the BGZ Bank and by the cooperative banks. In 1998, the BGZ Bank made roughly 3,500 purchase-money mortgage loans for agricultural land (although these loans were subsidized by the government). As with land sale transactions, the private sector has developed its own forms for mortgage lending. Although Polish law contains no express reference to purchase money mortgages, the general mortgage rules are fully sufficient: purchase money mortgages are available from banks and are treated like any other mortgage. A number of technical mortgage-related issues should be mentioned. First, banks complain that foreclosure proceedings, which must be conducted through the courts, are very costly and slow. Second, under the Code of Civil Procedure, a mortgage lien had rather low priority relative to other creditors' claims (it stood sixth in order of priority, behind, most notably, workers' wage claims and tax claims). The banks we spoke with consider the problem largely solved by the law "On Mortgage Bonds and Mortgage Banks" (effective January 1, 1998). Review of the Legal Basis for Agricultural Land Markets 129 This law amends the Code of Civil Procedure to provide that mortgages issued by "mortgage banks" are third, in order of priority, preceded only by foreclosure costs and alimony claims. Many existing banks will probably set up new mortgage- bank affiliates. Third, registration of land rights, including mortgage rights, often takes a long time to complete. Since mortgages are not effective until notarized and registered, and banks are reluctant to disburse loan money without registered mortgage rights, mortgagors receive the loan money only after lengthy delays. This problem has been addressed by the appearance of private insurance coverage that will guaranty the bank's security interest during the period between notarization and actual registration, for a fee equal to about one percent of the mortgage loan. Banks can now disburse immediately after notarization. Of course, the optimum solution would be to speed up registration, as discussed in the Land Registration section below. Fourth, the law "On Mortgage Bonds and Mortgage Banks" appears to limit a mortgage loan, in most cases, to 60 percent of the value of the r:-al estate mortgaged. This protects the bank, but requires the borrower to have considerable cash, or non-mortgage financing. Regular commercial banks, h,owever, apparently can and general]y do loan 80 percent of the value of real estate when making mortgage loans. Fifth, in some countries concerns over bank lanc6 ownership and land speculation lead to severe restrictions on bank ownership of land, or to [he setting of unrealistically short time periods for bank.s to sell land. Restrictions of these types are not found in Poland. The law "On Mortgage Bonds and Mortgage Banks" allows the new mortgage banks to purchase real estate, aside from office space for bank use, "only in order to avoid losses resulting from lending of secured mortgage credits." This right to buy in order "to avoid losses" would seem to furnish adequate proteclion to banks. As a final mnatter, the greatest impediment to agricultural land mortgage may be social rather than legal in nature: many rural residents frown upon any bank foreclosure proceeding, and may be unwilling to buy their neighbor's land at a foreclosure sale. Land Registrati,sn The registration law seems basically sufficient, but major improvements could be made. While local lawyers claimed that registration of land rights provided "100 percent assurance," our own readin,g olf the 1982 Act on Perpetual Books ancd Mortgages (as amended through August 1997) leaves us doubtful. We suspect that private "title insurance" may eventually be offered to shore up registered rights (as it is in the United States, where the system is one of "deed registration" r ather than one of "title registration"). This can be an expensive solution. A big issue regarding registration is the treatment of unregistered rights. In Poland an estimated 30-40 percent of land is not registered, and these unregistered rights remain valid, as they should. When transactions (or mortgage) affecting unregistered land take place, the notary is required to submit an application to open a registration volume (perpetual book) for that land. With only such so-called "sporadic" registration, decad.-s may pass before all land is registered. 130 R. Prosterman and L. Rolfes Legal registration of unregistered land draws on a plethora of sources, including documents held by the right-claimant, notarial documents, and materials kept in offices (especially a land and building register) that are entirely separate from the legal registry. The perpetual books are open to the public. A more serious problem is that even sporadic registration is slow, is the subject of many complaints, and is a serious impediment to continued land market development. Typical cdelays run from a few months in the countryside to up to two years in Warsaw. The land and mortgage registers (the perpetual books) are kept by the nearly 300 district courts, and entries must be made by a judge. The system is thought to be seriously underfunded, and lacking adequate personnel. * Recommendation: At a minimum, the law should be amended to allow trained personnel who are not judges to make non-controversial entries in the perpetual book. Expand, if also needed, the number of judges. Pay for the system by setting fees to cover actual costs and by letting the Ministry of Justice retain those fees to maintain the land and mortgage registers. One problem seen in some transitional economies is that registration fees are high. thus discouraging transactions or use of the registration system. In Poland registration fees as such do not appear to be high. The main problem, we are told, is that the fees are not retained for the operation and improvement of the registry system; thus there is little value received for the fees paid. * Recommendation: Let the registration system charge necessary fees and keep them for its own operation and improvement. Land Taxation The land tax, averaging about 2.5 centners of rye per hectare, or roughly 9% of average production, is fairly high. The tax's potentially distorting effects may be amplified by the fact that the land tax is forgiven for the first 5 years of leases of state land made by the APA. This drives annual payments for APA land still further below market levels, and creates a further distortion in favor of leasing rather than buying such land. * Recommendation: End land-tax forgiveness for all future leases of APA land. Compulsory Acquisition of Land The purposes for compulsory acquisition are clearly identified by the 1985 law "On Land Use Management and Expropriation of Real Estate," as subsequently amended. This law sets forth adequate compensation standards, as well as the procedural rules in detail. Practices appear to be predictable. Review of the Legal Basis,for lgriciultural Land Markets 131 Romania Romanian law contains much policy supporting agricultural land market development. Most agricultural land is privately owned, and the government's intention seems to be to privatize much of what remains in state hands. Romanian citizens can freely sell, lease and conduct olher transactions, and can mortgage their land under the law. Several problems remain, however. Most notably. foreign citizens may not own or lease land. Foreign legal entities also may not own land, but can lease land under certain conditions. These restrictions are undoubtedly problematic under EU policy. In addition, land use rules contain some onerous provisions regarding confiscation of land in case of rules violations, and the land registration system faces difficulties. Private Ownership of Agricultural Land Rcmanian law provides for private ownership of land. Article 135 of the Romanian Constitution states that property, which clearly includes land, can be privately owned, and shall be inviolable. Article 41 states that private property shall be protected by law. These constitutional pronouncements on private ownership are supported by Romania's major law on land reform, the 1991 law "On Land Resources." This law states that land may be the subject of private ownership. Further support for private ownership rights can be found in the law "On Legal Circulation of Land." When viewing these laws together, combined with discussions with policymakers and field visits to farms, private ownership rights to agriculturall land extend to both Romanian citizens and Romnanian legal entities. However, ownership of agricultural land by foreign citizens and legal entities is restricted, and is discussed under the section on Transactions in Agricultural Landl. Privatization of A,gricultural Land As of 1998, of the 14.8 million hectares in Romania's agricultural land base, 10.5 million hectares have been privatized, the bulk of it through restitution. Roughly 75-80% of this privatized land has been fully registered and titled. 4.4 million hectares remain in state ownership. Its fate is discussed in this section, and in the section on Farm Restructuring found below. For land that has been privatized, full ownership rights have been transferred to private citizens. In order to gain a clear understanding of the significance of privatization, it is important to know not only how much land is privatized, but the extent to which privately-owned land is cultivated by small and medium size farmers. In Romaniia, roughly 15 percent of the privately- owned agricultural land has been joined together by the owners and is farmed in large associations averaging 409 hectares in size. Eighty-five percent is farmed in small and medium- sized units. When compared to the total agricultural land base, both private and state-owned, 132 R. Prosterman and L. Rolfes about 60 percent of this base is farmed in privately-owned small and medium-sized units. If state-owned communal pastures are excluded, the figure rises to about 68 percent. A related issue is the transfer of only lease rights or use rights into private hands., rather than full ownership. As mentioned above, privatization has meant the transfer of full ownership rights. However, the 1.8 million hectares on former state farms have been dealt with by an interim leasing scheme or have not been dealt with at all, rather than being privatized. The details of this scheme are discussed in the section on Farm Restructuring found below. Still another obstacle to land privatization sometimes seen in transitional economies is large amounts of land being categorized as important for research needs, for special plant breeding, and for other activities, and thus being exempted from privatization. In many cases these needs are used as an excuse to retain land that should be transferred to private ownership. This situation does not exist in Romania. The law "On Land Resources" requires a strict determination of which land should be retained for research and other purposes. The Ministry of Agriculture reported to us that, of the 150,000 hectares allocated for research purposes, only 80,000 hectares will be retained for such functions. This amount represents just over one-half of one percent of Romania's agricultural land base, and thus is not a problem. Land Restitution Restitution of pre-communist era land rights to private parties has been a major component of Romanian land reform. The vast majority of the 10.5 million hectares currently in private ownership was privatized through the restitution process. Roughly five million people have received land through this process. An important component of restitution is the timely registration and issuance of documents certifying private ownership. These processes can be delayed for a variety of reasons, such as difficulties in matching beneficiaries with land, various kinds of disputes, and administrative problems in registration and document issuance. While there are still delays, they do not appear to be primarily the fault of the legal rules, but rather reflect factual problems such as boundary disputes or disputes among heirs which are unavoidable during restitution. This is in contrast to the situation in Lithuania, where the law itself is the cause of many of the disputes. In any event (and despite the existence of up to 700,000 continuing disputes as compared to the five million beneficiaries), it is estimated that 75-80% of restitution beneficiaries have their rights registered and have received their documents. In some transitional economies concerns exist that restituted land owned by urban dwellers cannot be the subject of land transactions for a variety of reasons, such as problerms with registration or required government approval of transactions. These problems do not exist in Romania; urban dwellers who own agricultural land have typically leased most or all of their land to farmers. Since 40% of the new landowners live in towns, their ability to conllduct transactions is very important to the land market. Review of thle Legal Basisfor Agricultural Land Markets 133 Farm Restructuring The major issue when considering the relationship of farm restructuring to land markets is whether, as a result of- farm restructuring, land parcels are transferred to the ownership of individuals. During the communist period Romania had two major types of collectivized agricultural enterprises: agricultural production cooperatives (CAPs) and state farms (IASs). Under the 1991 law "On Land Resources," the vast majority of land used by the agricultural production cooperatives was privatized, primarily by restitution to prior owners or their heirs. Land used by agricultural production cooperatives that was not restituted was transferred to the management of local authorities. This land apparently is largely pasture land, and is used in common by rural residents. The failure to privatize this larnd will probably not have a major impact on the developrnent of the land market, and in any event would probably be strongly resisted. The forrner state farms continue to cultivate approximately 1.8 million hectares of agricultural land in Romania. Part of this land is already well along the process toward privatization. The law "On Land Resources," in conjunction with the 1994 law "On Lease" (as amended.), provide that people whose land had been taken and placed under the administration of a state farm could choose to be designated as "locators." If this option was chosen, they could conclude a five year lease with the agricultural company usinLg the land, after which the locator would be issuel an ownership document to a land parcel. I'hese five-year leases were largely concluded in 1994 and 1995, so will shortly begin to expire. The 1998 revisions to the law "On Land Resources" affirmnatively state that the locators, as well as shareholders in agricultural companies, are to receive ownership of the land. This process, once completed, will result in one million hectares of former state farm land being privatized. T'he remaining 800,000 hectares of former state farm land that will still be in state ownership consists of lands that were state property between the world wars, crown land, land under reclamation works, and land that no one was entitled to inherit by law. Discussions are currently underway concerning whether or not to privatze this land. Ideally this land would be privatized, but failure to do so would not be a serious blow to development of the land market, since this land represents only about five percent of Romania's agricultural land. Other ccncemns that have been raised regarding Farm restructuring in various transitional economies include failure to demarcate newly-privatized land rights; problems with land share systems (prevalent in the former Soviet Union); and improvident long-term leases to cosmetically reorganized collective farms. None of these problem appear in Romania: privatized land is demarcated; no lancl shiare system exists; and the former state farms lease land for at most five years. Land Use Regulation Three main problems with potential impacts on land-market activity have arisen regarding land-use regulation in transitional economies. The potential impacts come from undermining the owner's security of tenure, or reducing (or threatening to reduce) the land's value. First, laws 134 R. Prosterman and L. Rolfes may allow for confiscation of land for irrational use, non-use, or for other reasons. Second, violations of the land use regime may trigger overly severe penalties. Third, conversion of agricultural land to non-agricultural uses may be severely limited. In Romania the primary law dealing with land use regulation issues is the law "On Land Resources." This law requires holders of agricultural land to cultivate the land, to protect the land, and not to actively degrade the land. This legal requirement to cultivate the land is neither necessary nor helpful. The penalties for violation of the cultivation and protection norms are graduated, starting with requests for remediation by the local authorities, then fines, and finally loss of the use rights to the land. The requests and fines are reasonable responses, but the loss of use rights is clearly excessive, since it amounts essentially to an uncompensated expropriation. Fortunately the farmers with whom we spoke knew of no instances of this measure being invoked for land use violations. * Recommendation: The maximum penalty for land use violations should be forced public auction, with the net proceeds going to the land owner. In addition, the penalty for simple non-use should be eliminated, since the private owner is more likely than a government bureaucrat to make a rational decision on whether putting the land into production makes economic sense. Regarding conversion of agricultural land to non-agricultural uses, the law "On Land Resources" requires that such conversion be approved by the Ministry of Agriculture and Food. Locally developed land use plans also play a role. Field interviews indicated that conversion was difficult in practice. In addition, the law imposes a heavy tax on land that is converted, which ranges from two times to four times the sale price, depending on soil quality. * Recommendation: If conversion has been achieved through a planning process, it should not be subject to taxation of a punitive nature. A tax equal to a modest percentage of increase in value, or profit on sale, should be fully sufficient. Transactions in Agricultural Land 1. Sale, gift, and inheritance transactions. The main legislative act addressing agricultural land transactions is the 1998 law "On the Legal Circulation of Land." This law provides that Romanian citizens can acquire and dispose of extra-vilan agricultural land (land not in towns) in conjunction with the norms of civil law. Purchase-and-sale, gift, and inheritance transactions are thus sanctioned. Discussions with both policymakers and farmers indicated that no further legal measures, such as implementing regulations or model contracts, were needed for such transactions to be carried out between Romanian citizens. Dispositions of agricultural land are occurring in Romania. Anecdotally, the local administrative district of Prejmer (which is located near the city of Bra$ov in Transylvania) has Review of the Legal BasisjforAgricultural Land Markets 135 2,700 hectares of agricu:Ltural land. Prejmer has had 45 lancl sales, most of which were for agricultural land, through which 80-90 hectares of land has been sold. This represents a not- insignificant turncver ratio of about 3 percent, and has mostly occurred in the last year or so. The sales prices were 5-6, million lei/hectare ($333-400/hectare). Many farmers we interviewed indicated that they had purchased land. On a broader level, Ministry of Agriculture statistics indicate that, as of December 1998, 12,119 hectares of extra-vilan land have been disposed of in 12,438 separate transactions. Most of this land is certainly agricultural land. The rights of Ronmanian citizens to acquire and dispose of land are limited in two ways. First, a family may own rio more than 200 hectares of arable land. This limit is not a major land market impediment, especially since the average farm in lFomania cultivates only 2.2 hectares of land. Addlitionall-y, the 2,00 hectare restriction may help to prevent formation of latifundia. One problem that does remain, though, is that if a family acquires more than 200 hectares, then the amount, according to the law "On Legal Circulation of Agricultural Land," "shall be brought to the ceiling set by the law." How the family's land shall be brought to the ceiling is not specified. * Recommendation: The law should be clarified to provide that forced sale, not confiscation, will be used where a family exceeds the ceiling. Second, co-owners, neighbors, or lessees of extra-viltyn agricultural land have a pre- emptive right to buy such land if it is offered for sale. The law "On the Legal Circulation of Agricultural Land." clarified and narrowed the pre-emption rules. The owner of land offered for sale must notify the local administration, which publicizes the offer to sell for 45 days. Within this time period the pre-emptive rightholders have the opportunity to make an offer to buy the land. The seller must accept the offer if the price is satisfactory. If it is not, the seller may sell the land to anyone. While pre-emptive rights extend the time for concluding sale transactions, they are not a major impediment to land markets in the Rornanian context. Several farmers interviewed stated that they had bought land, and that the 45-day waiting period was not a significant obstacle to the transaction. 2. Rights of foreigners. Romanian law is much more restrictive regarding foreign acquisition of agricultural land. The Constitution explicitly prohibits foreigners and stateless persons from acqluiring ownership rights to land. This prohibition is also reflected in the law "On the Legal Circulation of Land." This law also says that foreign legal entities may not acquire land by way of a transaction with a person, but tien goes on to say that foreign rights to land which is the subject of foreign investment shal:L be governed by foreign investment legislation. The foreign investment legislation states that partly or fully foreign owned companies with Romanian legal entity status may acquire ownership to land in order to carry out their activities, but that the land must be disposed of if the Romanian legal entity liquidates. Thus, a foreign legal entity is able to acquire land for its activities through a Romanian legal entity. 136 R. Prosterman and L. Rolfes As discussed in the Relevant EU Accession Requirements section of this paper, restrictions on foreign ownership raise EU accession problems related to the "freedom of establishment" under Article 52 of the EU's governing Treaty. Since Romanian legal entities as well as Romanian citizens can own land, the prohibition covering legal entities and citizens of EU countries is clearly discriminatory. However, with respect to agricultural land, the requirement as set forth in Article 54(3)(e) and Article 39(2) of the Treaty requires interpretation. The requirement expressly makes room for policy considerations integral to the common agricultural policy under Article 39, taking account of the "social structure of agriculture," the "disparities between the various agricultural regions," and the need to make adjustments "by degrees." In a setting in which an estimated 37% of the Romanian population makes its piimary livelihood from the land, and in which market prices for agricultural land are low, the stanidards of Article 39(2) could, and probably should, be read to allow an extensive transitional period (even after accession) before sales of agricultural land to foreigners are required. Roirnanian agricultural land is incredibly cheap as compared with land in Germany, for example, and could not be thrown open to bidding by EU citizens and enterprises without a high risk of staggering economic and social dislocations. Such adverse impacts are precisely what the policies of Article 39 are intended to avoid. During the previous round of EU accessions Austria, Finland, and Sweden were each allowed to retain restrictions on foreign purchase of land for vacation homes for a five-year period after accession (see footnote 6). These restrictions, if immediately removed, would clearly have been far less disruptive to the local economies than the restrictions at issue in Romania. * Recommendation: Romania should be required to remove restrictions on EU citizen and enterprise ownership of non-agricultural land at an early date. With regard to agricultural land, EU policy and precedent provide the basis for a post-accession transition period for agricultural land, if such a transition period is ultimately needed. 3. Leasing. Leasing of agricultural land is common, both through written contracts and by oral agreement. Rents paid typically range from 10-30 percent of the crop. Leasing is particularly important since a high percentage of rural land owners live in the towns, and thus do not cultivate most or all of their land personally. The 1994 law "On Lease" allows Romanian citizens and legal entities to freely conclude lease contracts for agricultural land and to agree on the terms, most notably the duration of the lease and the amount of rent that the lessee shall pay. The law also adequately outlines the required contents of a lease, such as that the lease be in writing, contain the names and adclresses of the lessor and lessee, describe the real estate being leased, state the lease duration, and i nclude other responsibilities of the parties as they agree. Additionally, the law does not give the lessee a pre-emptive right to renew the lease. Such a pre-emptive right would restrict the lessor's right to use and dispose of his land as he chooses, and is often seen in the laws of transitional economies. The most significant lease restriction for European Union accession purposes is the requirement that lessees who are natural persons must be Romanian citizens. Natural persons Review of the Legal Basis for Agricultural Land Markets 137 who are not Romanian citizens cannot lease agricultural land under the law. Additionally, lessees which are legal entities must be "of Romanian nationality" and have a representative office in Romania. This provision may not seem a sericus problem, since it does not preclude Romanian legal entities controlled by foreign capital from leasing land, but it clearly raises "freedom of establishment" problems under the Treaty since it discriminates against EU legal entities. * Recommendation: There should be an early, but probably not complete, easing of the leasing restriction. Leases of agr-icultural land to EU citizens or legal entities might initially be limited to a medium term, such as a maximum of 5-7 years, with any renewal requiring negotiation. Two additional land market restrictions can be found in Romania's land lease legislation. First, sub-leasing of land is prohibited. While this restriction is not of major significance, ideally the law would allow the lessor and lessee to decide the question between themselves. Second, a lessee who is a physical person must have agricultural education, agricultural experience, or hold a certificate issued by the Ministry of Agriculture that testifies to the lessee's knowledge. This requirement adds a level of complexity to the lease transaction process, since the lessor must somehow determine that the lessee meets the standard. This requirement also manifests a lack of confidence in the workings of the market, which is premised upon private actors undertaking endeavors in which thiey believe they will be successful. 4. Other transaction-related issues. Another impediment to land transactions seen in some transitional econornies is a moratorium on sales. Romanlia had such a moratorium at one time, but it has been abrogated. Other potential problems, such as financial penalties for quick- turnaround sales, nomninal lease rates for government land undlercutting the private market, and minimum landholding size requirements, do not exist in Romania. Yet another set of problems in some transitional economies can arise from high transaction fees (notarization, surveying, registration, etc.). In Romania there seem to be problems related to high notary fees. Notary fees are ca]culated as a percentage of the value of the transaction, and can in practice reach as high as 30 percent of the declared purchase price of the land (as well as reaching a very substantial percentage of the, usually higher, actual purchase price). These high fees discourage otherwise willing sellers and buyers from carrying out land transactions. Reclucing these fees would clearly help development of the land market. Land Mortgage Tlhe legal rules for mortgage of agricultural land are sufficient, according to several bankers we interviewed. Mortgage is clearly allowed, the necessary procedures are adequately detailed, and banks and borrowers can decide for themselves what the loan funds secured by mortgage will be used for. With regard to purchase-money mortgage in particular, the general mortgage rules ar e sufficient to allow such mortgages. 138 R. Prosternian and L. Rolfes Foreclosure on mortgaged property for which the borrower defaults is governed by the Code of Civil Procedure. The Code contains a comprehensive procedure for adjudication of foreclosure claims, and for forced sale based upon a court judgment. The debtor can delay processing of the action by appealing to the court to use its discretion to grant up to one year of grace to pay all delinquent payments, or by appeal of an adverse court judgment. These rules seem adequate and do not seem to favor the mortgagor or the mortgagee, but they have not been significantly applied in practice. Countries transitioning to market economies sometimes prevent banks from owning agricultural land, especially as a-result of a foreclosure, for fear that banks will become large landowners and engage in land speculation. Rules such as these are often too restrictive and have the effect of discouraging mortgage lending. In Romania, the 1998 Banking Law forbids bank ownership of land, except for bank offices and for land "acquired as a result of the execution of the bank's claims," i.e. foreclosure, in which case the land must be disposed of within one year absent exceptional circumstances. This approach seems like a reasonable compromise. Finally, as a practical matter, almost no mortgage of agricultural land has taken place in Romania. Reasons given by bankers included low land values, unreliable land values, and difficulties in selling agricultural land. Land Registration Due to its history of being divided between the Austro-Hungarian and Ottoman empires, Romania has two different registration systems currently in use. These are the "land book" system and the "inscription-transcription" system. The 1996 law "On Cadastre and Real Estate Publicity," the primary legal act dealing with land registration, contemplates use of the land book system throughout Romania, and outlines the procedure for switching over from the inscription- transcription system. Rights under the latter system are protected under this law until each particular jurisdiction is ready to make the change. (There will be 170 land book offices, under each of the 170 local court offices.) A fundamental need in a land registration system is for the law to provide sufficient guidance on the system's major aspects. The law "On Cadastre and Real Estate Publicity" is on balance sufficient, addressing significant issues such as: * which agency shall maintain the land books. In Romania the law gives this function to the Ministry of Justice, and declares that the law courts shall have specialized land book bureaux; * describing the components of a land book. These are: (1) the description of the land parcel; (2) notations as to the land parcel itself, such as description of the owner, record of transfer of the land parcel, and easements; and (3) notations as to certain encumbrances, such as leases of more than three years, mortgage, and servitudes; * the evidence to be considered in making notations in the land book; * the procedure for making notations in the land book; * procedure for dealing with disputes; and * public access to the information contained in the land book. Review of the Legal BasisforAgricultural Land Markets 139 An additional vital component of the registration system is a clear statement as to the legal effect of registration. The land book system is, in. theo:ry, supposed to provide conclusive evidence of ownership and other registered rights. However, the description of the land book in the law r aises the possibility that the rights entered in the land book can be annulled in the future by court judgment. In addition, some rights, such as successions and rights obtained through court judgment, are enforceable even if not inscribed in the land book. These exceptions make it difficult for third parties to rely on the land book, since rights already entered in the land book can be overturned, or rights not entered may be enforceable. Thus, it is not correct to view Romania's land-book system as a conclusive system of "title registration" in contrast to a primarily notice-giving system of "deed registration." In practice, Romania's system probably falls somewhere between the two; private title insurance may arise in the future to fill the gaps, but at a price. Another potential problem is that the land book offices have little capacity to gather information; they rely on the local units of the National Office of Cadastre, Geodesy, and Cartography for all information upon which registration decisions are made. Unless these cadastre units are exceptionally responsive to requests from the land book offices, the land book offices rnay not be able to carry out registration activiries in a timely manner. Unfortunately, these local cadastre units are required to accomplish a mnyriad of cadastre-related activities, and thus it is possible that their most important task, supplying information to protect legal rights, will not receive the needed attention and resources. Land Taxation In transitional economies, high land taxes and taxes on transfer of land can adversely affect the agricultural land market and can trigger undesirable social or economic impacts. Fortunately, high land taxes for agricultural land are not a problem in Romania. (There is a tax- related problermi, however, when agricultural land is converted to non-agricultural uses, as discussed in the section on Land Use Regulation.) Compulsory Acquisition of Land Problems can arise for the private land market in transitional economies if security of tenure is undermined by inadequate rules for the forced acquisition of private land by the government for various supposed needs. Problems arise when the purposes for compulsorily acquiring land have not been clearly stated and limited, when the compensation provided is less than fair market value, and when the procedures for compulsory acquisition are unpredictable. Romania has had little, if any, experience with compulsory acquisition to date. Indications are that the law that is in place is satisfactory. Article 47(3) of the Constitution provides a good general standard, allowing compulsory acquisition only if for a public purpose, and only for "just compensation paid in advance." Structural Change in the Farming Sectors of Central and Eastern Europe Second EU Accession Workshop in the Rural Sector, Warsaw, Poland, June 27-29, 1999 Agricultural Land Leases and Development of Effectivie Land Registration Systems in Central and Eastern Europe Jim Riddell The focus of this paper is on the FAO member nations in Eastern and Central Europe that are the most likely to be admitted early into the European Union. There are vast differences between these countries and many FAO member nations in the CIS that are still defining the nature of land rights to carry them through the transition (see especially Lerrnan 1999). The workshop's emphasis on EU accession has circumscribed the scope of our coverage. LEASING AND PARTIAL INTEREST MARKETS IN LAND All successful agrarian systems recognize the need for adjustments in land use to reflect changes in local demographic profiles, labor and management availability, capital, opportunities and so forth. Consequently, we can take it for granted that there will be a number of institutional means available to almost any rural population for transacting among themselves the variety of partial tenure interests in agricultural land and related resources. Agricultural land tenure systems, of course, concern far more than just farmland. The value of agricultural land is also determined very much in line with available water resources, forests, orchards and other permanent crops, the suitability for commercial sites as well as buildings and other structures. Indeed, as the discussion of the multi-functional use of rural space takes on ever increasing importance in policy negotiation, the use of rural land for recreational facilities, scenic and public-purpose sites, and so forth can at times overshadow traditional agricultural land tenure concerns. In order to deal with this extensive inventory of competing uses and users of landed property, land tenure experts have traditionally chosen to regard "tenure" as a bundle of rights. This bundle can be separated and reassembled in a wide range of different rights configurations. Thus, each of the rights, recognized in the bundle, can be defined as to who has the right to do what (purpose and intensity of use), and for how long. Such rights in the use of the various interests that make up the bundle are norrmally institutionalized in terms of temporal interests (leasing, renting, share-renting, contractual license arrangements, etc.) and partial interests (such as, easements mineral rights, development rights, 140 Agricultural Land Leases aind Development of Effective Lanid Registration Systems 141 and so forth). The wide variety of terms applied to the kinds of partial and temporal rights arrangements (tenancy, license, fixed versus variable rents and so forth) underscores two competing tendencies. The first is the often particularislic character of such arrangements; the second is the need to institutionalize such arrangements. For instance, we normally discuss share tenancy in the context of under developed agricultural systemLs. Yet it is also very common in even the most rmodernized agricultural economies. It is popular, for example, for neighboring dairy farmners in Wisconsin (United States) to agree that one neighbor will use land of the other to plant and harvest a fodder crop. In exchange the two neighbors will share the resulting harvest. As long as there is no disagreement on the nature of the arrangement, the rest of society cares little about how this agreement was instituted. But because land matters are a traditional source of conflict, institutional means are created to reduce transaction and litigation costs. The need to deal with partial land tenure interests has been increasingly important as rural economies modernize. As the use of rural space has become increasingly multi-functional, there has developed an institutional means to deal with a variety of over-lapping and zoning needs. Indeed, there has been a whole sub-branch of land tenure that has emerged to study the evolving market in partial interests. For example, the European UJnion has established extensive environmental and ecological goals for its members. Thus, there has been, for instance, a renewed interest in preserving the rural character in peri-urban zones. Many jurisdictions in OECD countries have chosen to experiment with leasing or buying the development rights from agricultural property owners to preserve its use for environmental as well as recreational and aesthetic value. Of course, partial interests are not anything new. It has been part of the historical tradition in many of the countries participating in this Seminar to have a situation where the harvest rights (fructus) of certain fruit trees on land "owned" by one person belong to someone else. Indeed, it was quite remarkable during field visits to rural areas in Estonia, Lithuania, etc., during the early period of the restitution process, how often such rights were remembered in those situations where the trees were still standing. Old or new, the important point is that all advanced agrarian economies have highly-developed leasing and partial interests markets as a complement to existing land sales markets. Given the finite character of land resources and the irnportant political role of agrarian issues in any nation's political agenda, the value of rural land takes on a special characteristic. A surprising number of FAO Member nations do not have any expressed restrictions on the sale, lease or commercial interests of foreigners in urban property, but have imposed restrictions on rural holdings (FAO 1998). This raises the interesting point of how should one determine the value of these various partial and temporal land tenure interests. FAO has been organizing a world-wide analysis of this matter with our Member naticns (Melmed-Sanjak and Lastarria 1998; Ravenscroft et al., in press). There seems to be little doubt that land tenancies are most efficiently allocated when their value/cost is determined by the market. The emphasis here is on negotiated market transactions. That is, when all parties to the transaction of temporal or partial interests are able to negotiate the terms "at arms length", we find the lowest transaction and contract maintenance cost.s. Additionally we find the greatest access for new land use seekers in the areas of food production and rural development enterprises The macro as well as micro policy mechanisms needed to create good land tenure marketi are part of an on-going co-operative effort of a number of agencies, including FAO, IFAD, and the 'World Bank. 142 J. Riddell Leasing and partial interest markets are particularly suitable for Central and Eastern European countries (CEECs) at this point in the transition process. Those countries that have chosen to restitute properties that had been collectivized face the problem that the restituted parcels are located in reference to pre-World War II agrarian structures, markets and infrastructure. In most cases, these parcels are not suitable to current conditions. Other jurisdictions have simply divided the parcels out of the "whole cloth" of state farms and agro- industrial collectives without regard to their suitability for alternative farming systems. ][n both cases, some redefinition of agricultural enterprise boundaries is desirable (during the tranisition period, short terms leases of 10 years or less are probably preferable to keep large blocks of land from becoming prematurely defined). Land values for a sale market are yet to develop; ancd thus a lease market is an efficient way to get land into productive units that make sense under existing circumstances. This takes advantage of inherent flexibility and temporary nature of mnodern leasing arrangements. In a significant number of countries in transition, rural land, especially restituted farm property, has taken on a residual national/ethnic and/or cultural identity value that prevents it being a freely tradable capital asset for the foreseeable future. Formalized and institutionally supported leasing arrangements have the added value of clarifying and providing security to both the person leasing out as well as for the person leasing in. The partial or temporal interest, in contrast to alienation through sale, is much easier to constitute as a freely tradable produlction factor in the present circumstances, because leasing markets reflect the economic earning value of the land and are not as subject to speculative and other considerations. In addition, the CEE region has an industrialized, highly educated population that is not likely to seek traditional farming as a way of life. Available statistics indicate that primary owners of much of the newly created rural parcels are already pensioners or nearly so. Neither of these populations are prime candidates to create innovative rural production structures. Thus, there is a need for flexibility to experiment with alternative economic uses of rural real estSate, as well as to attract in new younger farmers who see agriculture's business potential. Furthermore, the countries in transition are entering simultaneously into both an expanded world economy in agricultural goods and services and into an increasingly integrated European agricultural and rural development policy environment. These evolving regional and international agricultural alliances suggest the need for several decades of adjustment and fine tuning of the rural land resource use and agrarian structures. CEE Member nations will be faced with sectoral competition for scarce capital resources. This is where the ability to integrate institutional developments in private property will become very important. For these and other reasons, leasing is an appropriate mechanism during this period of structural adjustment. It facilitates individual needs and aggregate responsiveness without requiring a fully articulated land market system. Agricultuiral Land Leases and Development of Effective Land Registration Systems 143 RURAL LEASING AND PARTIAL INTERESTS MARKETS AND LAND REGISTRATION Much has already been written on the shift frorn societal to private property as a key component in the transition process (see, for example, Csaki and Lerman 1996; Swinnen, Buckwell, and Mathijis 1997). If leasing and partial interest markets provide suitable land tenure arrangements for putting private property interests in land to use in CEECs, how formally do these arrangements need to be institutionalized in termis of both means and extent. It is our argument that temporal and partial interest markets in land are just as reliant on good land records as the land sales market. This section sets forth some of the reasons why land leasing will benefit from the extensive work currently underway 1o create fully modem cadastres, land registries and conveyancing institutions. CEECs have universally agreed that they will use modem cadastre and land registries as the institutional means for providing secure property rights in agrarian land and resources. The reasons normally given for creating these modem land tenure institutions hold just as valid for partial and temporal interests markets. * A well functioning land registry is an essential institution for private capital intensive investment on a general scale. The need for formal land tenure regularization is especially important for investment strategies for sustainable resource enhancement, on the one hand, and investment for entirely new uses of rural space or, the other. * Clarification and security of property rights through a good registry system encourages a favorable effort supply in land use activities (Deininger ancl Feder 1999). * Good land tenure re!gularization institutions are designed to reduce to a minimum the cost of defending use rights, whether permanent or temporal and partial. FAO experience has underscored the fact that far too often improved land use practices only encourage others to enter into litigation to gain access to property currently held by an innovator. We find that where property righits institutions do not function, non-innovative land use practices that do not attract attention are one of the best ways to hold on to current family parcels. * Good land record[s facilitate transfer of resources between users. * Modem land tenure institutions facilitate the development of financial services. Indeed, the relationship between the development of financial services and the land registry are historically very tight. As we have pointed out in recent work (Palmer 1999; Riddell, Nichols, and Toselli 1999), a study of modem land registries indicates that over 60% of the transactions that are recorded are financial and actual transifer of ownership is involved in less that 40% of total transactions. Financial institutions realize that they benefit from complete registration and in most advanced economies a prerequisite for any financial, lending or mortgaging operation will be a complete registration of all property interests involved. 144 J. Riddell There has been a growing sophistication in our analysis of when and where it is appropriate to formalize land tenure relations. A point that has often been raised during the FAO work on land leasing is why would most rural populations need formal land tenuTe regularization institutions like the registry and the cadastre at all. After all it is pointed out, they have been doing generally quite well without them since the Neolithic. In any agrarian system, we anticipate that under normal conditions, a majority of temporal and partial interest lettings will be informal, short term adjustments in labor, management and capital availability. Longer term arrangements and attraction of outside investments will necessitate transparency, security and low transaction costs. Therefore, in those situations where it is important to either attract financial support from outside the local community, the need is just as great for good LIS (land information systems) and regularization and conveying institutions for partial and temporal interest markets as for real estate sales. Should leases be entered into the land registry, and if so, when and under which circumstances? Most financial organizations in an advanced economy will insist on a legal recording of a lease when it involves a substantial amount of money and time. Short leases are often informal and unregistered. Yet it is common, even among friends to draw up a private recording instrument, to avoid any problems later on concerning memory of the details. '[t is important to remember that in advanced economies it is common to have generic leasing arrangements generally available at private businesses (e.g., stationary stores, attorneys offices, etc.) and/or public agencies. Fundamental to good contract and contract compliance is the secure knowledge of who has the rights to enter into obligations on specific parcels. That is, who can enter into legitimate negotiations over the letting of land. However, there are circumstances when registering short term arrangements is desirable. In cases where the negotiating power between the two parties is very unequal, having a public record of the transaction facilitates ensuring equity matters. Since a lease or the letting or selling of any of the partial interests (e.g., mineral rights) changes the legal nature of a property, most longer term leases are entered into the registry. In actual practice, this is usually done in OECD countries at the insistence of the financial agency involved in the investments in the property. This is part of the close relationship between financial institutions and the property records system of an advanced economy. It is important to remember that a majority of investments in the most advanced economies will be for enterprises, not property, and thus most financial institutions will likely have the larger proportion of their portfolio in enterprises using leased property. As such they are put at a certain greater risk of adverse selection (loaning to the wrong person or enterprise) and moral hazard (the borrower intends to default1). This is why lending agencies are more interested 'Though not commonly discussed in the literature, moral hazard is a common enough problem in situations where a favourable formal agricultural credit scheme requires agricultural land as collateral. In this kind of situation, the borrower buys up titles to rural properties with no intention of ever using ther, and indeed he may sell thern out again in the informal market. Once a suitable portfolio of properties is assembled, a loan is secured for an ambitious "agricultural project." The money is instead invested in urban property and the agricultural loan is defaultedl. The bank then attempts to resell the title on the market, but can only recuperate the land through very costly and conflictual means. The observed result is a "formal" market in paper titles and an informal market in land use and occupancy rights. Agricultural Land L,eases and Development of Effective Land Registration Systems 145 in the quality of the "business plan" of the enterprise than in the deed as collateral to counterbalance the costs of adverse selection and moral hazardl. Thus in all EU countries a good lease is sufficient for an investment loan, if the basic ente:rprise plan is judged sound. With the emphasis shifted to the types of investments to be made under the terms of the lease, the question of both the length of the lease and the rights of the lessee in the improvements takes on a dynamic as opposed to a fixed character. In these terms, there is no ideal lease term, but rather the Length of time, renewal provisions and so forth are contingent on the kinds of investments anticipated. In this sense, much discussion of the desirability for 99 year leases for countries with poorly ifunctioning real estate markets is misplaced. The idea has been proposed many times as ;a way to give the kind of security that one could have under full ownership, while waiting for the proper legislation and conveyancing institutions to develop. Indeed, for all the reasons given above, and further discussed below, at this time in the transition process, it is important that lease terms are based on the business plan, not ideology. An investor with a good business plan for an agricultural enterprise is not going to be attracted to a jurisdiction offering a 99 year lease, but with poor land tenure regularization irLstitutiions, as opposed to one with good institutional support but with a lease based on expected returns., amortization and etc. Rather than the idea of a very long lease being of foremost importance in investment strategy, such considerations such as ownership of improvements (indeed the types of improvements allowed are often a greater restriction to innovation), recovery of improved value of the property at the close of the lease should be given primary consideration. Another factor that is of more im,portance than having long terms (alwvays kceeping in mind the discussion at policy levels of 50--99 year leases) is the conditions of renewal and other ownership options. For example, many countries have found value in provisions on certain properties (often state-owned land) that the young farmer entering into agriculture wilL have the option of buying the land at a pre-set price after a certain trial period (e.g., five years). France's SAFER provides a good example of flexible arrangement to attract young, entrepreneurial farmers to developing agricultural enterprises. From all perspectives of agricultural growth and investment in rural development, good leasing requires good land registries both from the point of view of the entrepreneur as well as the financial investors. There are as many reasons to have short term leases as there are to have long terms ones. For the countries in transition, the questions is not which length of time is best, but rather the principles of good leasing that attract capital for sustainable investment, employnent generation and development. In the next section we will discuss what we think goes into such a strategy. THE BASICS OF GOOD LAND LEASES AND PARTIAL INTEREST LAND MARKETS FAO has been assisting its member countries since its founding on the ways of establishing good leasing practice. Recently there has been a concerted effort to provide some of the lessons learned in the form of a "Good Practice Guidelines for Private Sector Agricultural 146 J Riddell Leasing Arrangements (Ravenscroft, et al., in press). The present section will give a brief description of the main findings. To accord with the principles of good practice, policy, technical and operational areas governing and informing all lease arrangements should demonstrate the following characteristics: * Simplicity * Minimum cost of arrangement and operation * Certainty * Sustainability * Equity and fairness between the parties * Transparency * Preservation of the legal interests in property * Promotion of the leasehold sector as a means of promoting flexibility in the market * A minimum of state regulation and intervention. While these are considered essential elements in good leasing practice in a world-wvide perspective, the following paragraphs illustrate how they apply to CEE member nations. Simplicity. One of the temptations to be avoided in establishing sound leasing markets in member countries in transition is burdening the process with well intentioned but unneeded legislation. This is especially true where the search is for sustainable agricultural development that will require a great deal of flexibility as sound arrangements are worked out. Legislation and local law should not attempt to anticipate all possible outcomes and problems, but rather provide clear simple guidelines. FAO recommends the approach of the "model lease". The model lease can often be no more than a page in length. It sets out the essential elements of the lease, dealing only with the fundamental factors of the parties, the land, the commencement and termination dates and what are the payment (consideration) arrangements. The essential point is to prese:rve simplicity and to provide both parties with a good model. Minimizing transaction costs. Keeping procedures straightforward and simple is an important factor in reducing transaction costs. The more experts and specialists (notaries, attomeys, government agencies, etc.) involved, the greater the cost to the contracting parties. N4ot incidentally it also increases the opportunities for graft and hence the requirements for developing systems of professional ethics. Thus, from the point of view of the FAO group, the focus needs to be on the general area of contract law and procedures of contract enforcement. This will be particularly important in the CEE countries as rural modernization will depend on attracting investments. Good leasing contracts are an essential ingredient, but outside investors must be convinced of the overall contract environment in the country before choosing to invest in a particular jurisdiction. This is another way of saying that in the competition for investment funds needed to finance projects, jurisdictions with the ability to enforce contract compliance will have an important advantage. Certainty. Good land records are essential for having simple and cost effective leasing contracts. Thus, the current efforts to reconstruct or to create modern land registration systems must be completed as soon as possible to stimulate a leasing market as well as a real estate Agriculiural Land Leases and Development of Effective Land Regis 'ration Systems 147 market. An efficient land registry is essential in reducing the uncertainty that the person offering the land in lease or sale is the person with the right to do so and that no other is being sold the same right (adverse selection costs). It has been reported in several of the CEE countries that inefficiencies in the existing land registry offices, lack of co-ordination between the cadastre and the registry and comnplications in the conveyancing process have led to increasing reports of unscrupulous individuals being able to initiate simultaneous leasing and/or sales transactions with multiple parties. The degree to which the certainty of the participants (adverse selection concerns) and the actual situation of the property are in questicn will effect both the availability and cosl; of financial backing. As was argued above, the cDmpletion of effective land registries is also a major component in the development of much needed credit and other financial institutional resources at the rural level. Sustainability. Overriding social concerns have increasingly come to play a role in the use of rmral space. All of the CEE countries are working to bring their environmental and related policies and practices into co-ordination with those of the EU. Thus, sustainability becomes an issue in which the non-agricultural portion of the society takes not only a growing interest but also insists on the possibility of interventions. Thus, good leasing practice has to recognize that both the land owner and the tenant have responsibilities tD ensure sustainable land use practices. Thus, raost EU jurisdiction have insisted on what has been called "beneficial occupation" clauses. This is the requirement by the state that both the owner and the occupier of land have the duty to meet local enviionmental and related laws. Equity and fairness between the parties. Essential to good contract is that the policy, technical and operational instruments of land leasing preserve the equity and fairness between the parties. This requirement often flies in the face of the social reality of the different parties. Normally in FAO's work, it is the landlord who is powerful and the land seeker who is at a disadvantage. In the CEE countries it is often just the reverse. The land owner is often a pensioner who has to deal with a successor organization to the former collective. The latter, since it is the only effective agent has a monopsony in the leasing market and has been able to keep rental value well below economic value of agricultural land (see Schultze 1999). Competition will lead to a better fit between economic value of land and its rental price, but government will have to provide the appropriate policy environment to attract competition, in the first place. Transparency. Transparency is desirable in any agricultural contract, but is vital in CEE countries where the rehabilitation of the agricultural sector is dependent on attracting outside investmrent. This is part of the process reducing the transaction costs associated with adverse agent selection and moral hazards. Preservation? of the legal interests in property. CEE countries are particularly fortunate in being able to create modern use of rural space in an environment where the potential problems of inequality in land ownership have been largely solved by the restitution and land distribution processes. Leasing markets, as was argued above, provide a way of preserving this equality in land ownership on the one hand, while allowing for farm structure rationalization on the other. In addition, retaining the rights granted during restitution/distribution programs preserves the additiolal benefits of land ownership, such as credit wolthiness, community social status and so 148 J: Riddell forth to a very large proportion of the rural population. Good leasing law, policy and practice need to secure the rights of both the person leasing out as well and the person renting-in land. Such security of property relationships will also be an important factor in the creation of truly democratic forms of decentralization and local governance. Promotion of the leasehold sector as a means of promotingflexibility in the market. This point has already been discussed at length in the context of this paper. It need be added here only the point that rather than view the use of intermediary rights and interests in agricultural property as an indication of a poorly developed agrarian economy, policy makers in CEE countries should view it as a way of supporting a dynamic rural sector without the danger of prematurely stimulating one property structure over another (larger commercial farms versus small family farms). Minimizing state regulation and intervention. Good leasing policy and practice should be part of the processes leading to good governance. Government needs to ensure the fair and level playing field that allows the participants to negotiate the terms of the leasing contract in conformance with the reality of the prevailing market. Experience in FAO member countries has amply demonstrated that much well intentioned legislation designed to protect the weaker party only exacerbated an already bad situation. When the leasing contract becomes too burdensome, too complex, over regulated, and so forth, it is bypassed. This ends up defeating the whole purpose of providing land tenure regularization institutions, in the first place. Leasing contracts become too encumbered with adverse selection and moral hazard costs and the willingness to invest in rural enterprises declines. Thus, rather than trying to regulate leases; government policy should be to ensure open factor markets and the elimination of distortions caused by subsidized agricultural credit, machinery purchase by large enterprises and selective tax advantages that favor large commercial agricultural firms. Good land leasing practice and partial interest markets are part of the overall development of land tenure regularization institutions. While no one can predict the future with any accuracy, some trends are clearly evident for the kinds of challenges that will be faced by advanced industrialized economies like those of the CEE member nations when it comes to the future of agriculture and rural society. First and foremost, there will be an increasing emphasis on imulti- functional use of (and demands on) rural space. Primary agriculture will continue to become just one of an important set of economic activities. Secondly there will be new and unforeseen innovations in the use of rural space as the urban-rural distinction becomes ever more blurred. And thirdly, it can be anticipated that there will be a growing emphasis on temporal and partial interest markets as the most efficient way to allocate multiple uses of rural time and space. Agricultural Land Leases and Development of Effective Land Registration Systems 149 REFERENCES Csaki, Csaba and Zvi Lerman. 1996. "Agricultural Transition Revisited: Issues of Land Reform and Farm Restructuring in East Central Europe and the Former USSR," Quarterly Journal of International Agriculture, 25: 211-240. Deininger, Klaus and Gershon Feder. 1999. Land Policy. Working paper, The World Bank, Washington, DC. FAO. 1998. Working paper on foreign ownership of land in FAO member nations, Working papers series of FAO Legal Office, Development Law Service Lastarria-Comhie[, Susana and Jolyne Melmed-Sanjak (witlh the assistance of Beverly Philips). 1999. Land Tenancy in Asia, Africa and Latin America: A Look at the Past and a View to the Future. Land Tenure Center and FAO. In Press. Lerman, Zvi. 1999. "From Commonality to Divergence: How ECE and CIS Agricultures are Drifting Apart," In: Land Ownership, Land Markets and Their Influence on the Efficiency of Agricultural Production in Central and Eastern Europe, IAMO and FAO/REU, Halle. In press. Palmer, David. 1999. "Making Land Registration More Effective," Land Reform, Land Settl