1. Agricultural input
subsidies – conceptual
review
Hiroyuki Takeshima
Hak Lim Lee
International Food Policy research Institute
Presented at the workshop in Maputo
October 18, 2012
INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE 1

2. Policy issues
 Economics of subsidy and conventional
wisdoms
 Justification for subsidy & potential
alternatives
 Targeting
 Monitoring & Evaluations
 Exit strategy
2

3. Subsidy
 a payment reducing the buyer's price below
the seller's price (Pindyck & Rubinfeld 2005)
 A subsidy can be analyzed as a negative tax
 Agricultural input subsidies are paid with the
intention of lowering the prices of agricultural
inputs (such as fertilizer, seeds, equipments)
below their market prices
3

4. Intended goals of agricultural input
subsidy
 Affordability of agricultural inputs for
smallholder farmers
 Accessibility to inputs
 Develop the input-supply distribution system
 Sensitize farmers to the use of inputs
 Social protection for vulnerable groups
 Soil fertility
 Reduce social costs (rural-urban income
disparities etc) with broader goals of raising
agricultural production and food security.
4

5. Conventional wisdoms
 Deadweight Loss Input
price Deadweight
= loss of economic Loss Supply curve
efficiency (no subsidy)
• misallocations of Supply curve
resources (Subsidy)
• supplied at higher Demand curve
cost than the value Input use and supply
they create
Deadweight Loss, benefits
• bought by those who
extract less value to suppliers and farmers
from the goods than depend on
their costs (non- Elasticity of input supply,
subsidized prices) demand
5

6. Deadweight loss, benefit
distributions
Benefits to
suppliers
Farmer benefits
Inelastic demand, elastic Elastic demand, inelastic
supply supply
- Reducing input cost - Reducing input cost
=> small DWL => large DWL
- Increasing inputs use - Increasing inputs use
=> larger DWL => small DWL
6

7. Example of deadweight loss
 Initial condition (Non-subsidized):
 Fertilizer supply (demand): 167,060 tons
 Farmgate price: $ 525 / ton
 Price elasticity
• Supply: 4 (Quizón & Binswanger 1986)
• Demand: - 0.46
(estimated from Ricker-Gilbert et al. 2011)
=> With 25% subsidy
7

8. Example of deadweight loss
Farmgate Deadweight Loss =
fertilizer price USD 1.2 million
(US$ / ton)
Supply
curve
Supplier price = 538
Supplier price (no subsidy) = 525
Subsidized price = 404 Demand
curve
Government 167 185
subsidized
(= no (= actual
fertilizer
Source: Authors. subsidy) demand)
(1000 ton)
8

9. Example of deadweight loss
 Benefits for
• Farmers: $21.4 million (from lower price)
• Suppliers: $ 2.3 million (from increased supply, higher price)
• Total benefits => $23.7 million
 Total subsidy cost: $24.9 million
Deadweight Loss = $1.2 million
 If subsidy budget of $24.9 million were allocated among
farmers and fertilizer suppliers, they could have benefited
more
Also, examples of inelastic demand, elastic supply case
Reducing fertilizer cost is more efficient goal, than increasing
fertilizer use
9

10. When may subsidy still make sense ?
When conditions in competitive market do not hold
 Market failure (Information, Credit / insurance)
 Externality
 Public goods
 Economies of scale
Example:
 Farmers have imperfect knowledge, underestimate the benefits
of fertilizer
 Farmers may become more efficient in applying fertilizer over time
 Positive externality – better soil fertility for the future generation
 Reduce per unit costs due to economies of scale from increased
demand
 Subsidy may offset taxes for export crops (Kelly et al. 2003;
Holden 2003)
 Subsidies on ag inputs important in earlier stage of Green
Revolution (Fan et al. 2004; Djurfeldt et al. 2005)
10

11. Potential alternatives to subsidy
 Public infrastructure, agricultural research &
extension
 Capacity building of various agents along input
value chains
 Fundamental cost reduction strategies without
subsidy
• Kenya
• fertilizer use ↑ (1990s ~ early 2000s)(Ariga & Jayne
2011)
• Eliminated import licensing quotas
• Fertilizer responsive crop varieties (=> higher demand
elasticity)
 De-regulation of package size (often regulated to reduce
adulteration risk (Dorward et al. 2011))
• Reform in Kenya: repealing of law led to increase in
fertilizer purchase (Dorward et al. 2011)
11

12. Potential alternatives to subsidy
 Input-supply distribution networks:
• Training rural retailers
• Linking rural retailers, large input wholesalers,
• Loan guarantee (cover part of the risk of wholesales of the
retailer defaulting)
• Help input dealers organize, make bulk purchases with
joint collateral
 Subsidy for supporting vulnerable groups
• Transportation to remote areas - input subsidy costly
• Social safety net, Food aid, Food for work, Conditional
cash transfer - if food market functions well
 Soil fertility in marginal area (Shalit & Binswanger 1984)
• Fallow in land abundant areas
• Organic matter in more densely populated areas
12

13. Targeting
Indicators of targeting performance
 Undercoverage: the share of intended beneficiaries who
end up not benefiting from the subsidy
 Leakage: the proportion of beneficiaries who are not
intended to benefit from the subsidy
13

14. How to target ? -
 Geographical targeting: provide subsidized
inputs to all farmers in a particularly
geographical area, exclude other areas
 Community-based targeting:
 Indicator-based targeting:
14

15. Community-based targeting
 Rely on local authorities / community
representatives to select beneficiaries
 Pros
• Can use local information about the beneficiaries -
often unobservable (Alatas et al. 2012)
 Cons
• Ineffective due to (Chinsinga 2005; Conning &
Kevanne 2002)
 political favoritism
 misunderstanding
• Elite capture of vouchers in remote areas with
unequal access to land within the community (Pan
& Christiaensen 2012)
15

16. Indicator-based targeting
 Based on household characteristics
 more cost-efficient if it were implemented for input subsidy
in Malawi (Houssou & Zeller 2011)
• Household size
• Wireless radio ownership
• Floor of main dwelling is predominantly made of smoothed cement
• Bicycle ownership
• Lighting fuel is electricity
• Highest education
• Rubbish disposal facility is public heap
... Etc
=>
• Compared to community-based targeting systems,
 73% of transfers, instead of 50% of transfers, will reach the poor /
smallholder farmers
 Costs of leakage to the non-poor – more than 50% ↓
 Administrative costs – twice, but offset by the reduction in the cost
of leakages
16

17. Instruments
 Voucher
• Pros
 Added incentive, force farmers to buy the intended inputs -
unlike a cash transfer
• Cons
 sufficient stock of inputs at the agro-dealers at the time that
farmers require the inputs at the start of the cropping season
 must be redeemable without delay
• Electronic voucher - text messages to mobile phones, bank
cards, electronic “smart cards”
 costs for voucher distributions ↓ by 90% (EuropeAid 2012)
 Demonstration packs
• Starter Pack program - Malawi
• small quantity - discourage larger scale farmers who need not be
sensitized
• elite capture - still common, requires appropriate targeting method
(Morris et al. 2007)
17

18. Instruments
 Rationing subsidized inputs
• Reduce required budget
• Rent-seeking activity when ration < demand
 Well-connected individuals divert inputs for their own benefits (Dorward 2009)
• Inelastic demand - may aggravate the problem
 Passbook
• Enforced saving
• Cotton production in Tanzania (Poulton & Maro 2009)
• Cotton growers are given a savings passbook containing a credit equivalent to the
beneficiary subsidy at the harvesting season in exchange for the seed cotton that they
deliver. In the following planting season, they can use the funds in their passbook
savings account to obtain inputs such as seeds and agro-chemicals
• Differs from a voucher
=> Farmers decide to deliver the crop output in the first cropping season that entitles them
to receive a subsidy for the next season
 Timing
• Well ahead of planting
• Input subsidy at harvesting season
 Fertilizer subsidy in Kenya (Duflo et al. 2011) –
 at harvesting time, farmers have more cash and are more forward-looking –
willing to invest into modern inputs for the next season, than consumption
=> similar idea holds for passbook
18

19. Monitoring & Evaluation - Ex-ante
 Elasticity
• Elasticity of demand for inputs:
 Will subsidy increase the use of inputs ?
 Will subsidy actually lower the input price?
• Choice experiment, conjoint analysis
 Willingness to pay (Holden & Lunduka
2010)
• Randomized control trials
19

20. Monitoring & Evaluation - Ex-post
 Various indicators
• Inputs use levels of target beneficiaries
• Crop yields
• Costs of input supply
• Farmer incomes, welfare (nutritional intake etc)
• Improved soil nutrient levels – nitrogen levels / soil
organic carbon
 Short-term & Long-term
 Distributional effects
• Regressive vs Pro-poor
• Efficiency vs Equity
20

21. Monitoring & Evaluation - Ex-post
 Private input sector development
 Reduced transaction costs per unit
 Increased volumes of economic activity by input
suppliers
 Crowding in / out of private input suppliers
 Crowding out - fertilizer subsidies in Malawi, Zambia
 Tanzania - better in not displacing private dealers
• Seed subsidies - crowding out of local informal seed
sector (emergency assistance through vouchers)
 Long-term growth potential
• Increased savings
 Providing beneficiaries with saving accounts –
impact evaluation in Mozambique
• Long-term investments made
=> Important for exit strategy
21

22. Monitoring & Evaluation -
Randomized control trials
 Randomly distribute or withhold subsidy benefits
 Why randomize ?
• Without randomization, difficult to measure the
impacts accurately
 Example:
• Village head disproportionately selects
beneficiaries among farmers with declining soil
fertility - usually known to the village residents but
not to outsiders
• Greater impacts among those beneficiaries
• False impression - similar subsidy could also work
elsewhere with the similar characteristics with
more fertile soil
22

23. Monitoring & Evaluation -
Randomized control trials
 Randomized experiment for evaluating subsidy
• Short-term, direct, localized impact
• Inappropriate for measuring indirect effect
 Food price
 Rural employment
 Historically, greater indirect benefits rather than direct effects
 Randomized experiment for ex-ante assessment
• With RCT, obtain certain information that is difficult to be obtained
from actual input market
 Choice experiment - random discount – use information of
their uptake to assess how demand will change depending on
the price
 Difficult without RCT – in real world, prices often don’t change
sufficiently within a short period of time
 Level of subsidy maximizing the uptake, minimizing the costs
23

24. Exit strategy
 Clear and feasible exit strategy needed from the beginning
 Removing subsidies - historically challenging
• Irrigation (Dinar 2007), Seed (Sperling et al. 2004),
Fertilizer (Smale et al. 2011)
 Long-lasting subsidy - problems
• Politically entrenched
• Encourage fraud / diversion of subsidies to other purposes
(Dorward 2009)
 Some options
• Seasonal credit provision (relates to passbook) (Poulton &
Dorward 2008)
 Gradually phase out subsidy while introducing a
seasonal credit structure (Poulton & Maro 2009)
• Saving programs – ongoing evaluation (Carter et al. 2010)
• Fertilizer subsidy to agro-forestry investments (de Schutter
& Vanloqueren 2011)
24

25. Key questions
 What are the strategic development objectives ?
• inputs use to food production
• poverty among smallholders
• private input supply network
• improve soil nutrients
• Altogether?
 What are the economic characteristics of the
agricultural inputs to be subsidized
• Will demand for inputs increase with subsidy ?
• Is there sufficient supply capacity?
 What are the intended outcomes - will they be
monitored and their impacts evaluated ?
 Is there ex-ante evidence ?
25

26. Key questions
 Who should be the beneficiaries?
• Large-scale commercial farmers ?
• Poorer smallholder farmers?
 How can they be targeted?
 What instruments can minimize leakage or
undercoverage of the subsidy program benefits?
 What is the plan for an exit strategy for subsidy ?
 How can subsidy help beneficiaries make long-
term investments ?
 What may be the alternative policies?
26

27. THANK YOU
INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE 27