4.4.1 Effects of border measures
4.4.2 Effects of domestic measures in an open economy
4.4.3 Effects of domestic measures in a closed economy
4.4.4 State agencies: inconsistent policies and informal markets
4.4.5 Relevant exercises
After identifying the policy instruments used by the government, the second step is to ascertain how the various market, price and trade policy instruments affect:
· prices and quantities at the producer level
· prices and quantities at the consumer level
· marketing margins
· quantities traded
· government expenditure or income.
A competitive tree market will be assumed as the point of reference. In order to simplify the discussion, we will also assume that world prices remain unaffected by the country's trading operations (i.e. the country under consideration is a small one in terms of external trade).
As a methodical basis for discussion, the effects of the following policy instruments commonly adopted by African governments and elsewhere will be described and analysed:
· border measures
· domestic measures in an open economy
· domestic measures in a closed economy
· state agencies: inconsistent policies and informal markets.
An import tariff raises the price of imports above international levels for both the producer and the consumer. The effect is to reduce imports and increase domestic prices, and hence domestic production, while consumption declines. Domestic producers therefore benefit but consumers suffer a welfare loss. Government revenue increases. Similar effects will occur when an import quota is used, except that such quotas do not increase government revenue. Instead, licensed traders will be able to earn a rent on their operations over and above the profit they would have made in a free market (unless the government auctions import licenses to the highest bidder). An import subsidy will have the opposite effects.
An export tax reduces exports and hence domestic prices, leading to lower domestic production and higher consumption (Figure 4.1). Producer welfare declines but consumer welfare improves. Government revenue again increases. Similar effects result from an export quota, while an export subsidy will have the opposite effects.
The marketing policies adopted by monopoly trade agencies will often have similar effects to tariffs, subsidies or quotas. Thus, when a state or parastatal monopoly import agency sells on the domestic market at prices above those on the world market (even with marketing costs taken into account), the effect will be similar to an import tariff. Likewise, if a monopoly export agency buys on the domestic market at prices below those on the world market, the effects on production and consumption will be analogous to those of an export tax.
Figure 4.1. Effects of an export tax
When a country's international trade is unrestricted by tariffs, licenses, quotas, foreign exchange controls or any other kind of barrier (including high transport costs) it is said to have an open economy. The expression open economy is relative. An economy with a non-prohibitive level of import tariff but no quantitative or foreign exchange controls is "fairly open". Conversely, when foreign exchange controls accompany the same level of tariffs, it is considered "rather closed".
In an open economy, domestic prices generally correspond to their border price equivalents. The border price equivalent for a given commodity in which a country trades is its border price, adjusted for marketing, handling and transport costs (but not taxes) between the border and the domestic market. The border price of a commodity is its international trade price, c.i.f. (costs, insurance, freight) at the country's own border in the case of imports, and f.o.b. (free on board) in the case of exports.
When applied in an open economy, a producer subsidy increases returns to the producer, raising the incentive to produce more. Consumers remain unaffected (Figure 4.2). Either imports are reduced or exports are increased. Government expenditure increases.
A deficiency payment scheme, where producers are compensated for reduced revenue caused either by falling prices or by falling output (or both) over a given time period, is one example of a producer subsidy. A floor price system, through which the government pays the producer a guaranteed price above the border price equivalent (while it sells to consumers at the lower free market level), has essentially the same effects. A producer tax will work in the opposite direction.
A consumer subsidy reduces the price paid by the consumer, thereby increasing domestic consumption. Producers remain unaffected. Either imports are increased or exports are reduced. Consumer welfare is improved. Again, government expenditure increases. A consumer tax will have the opposite effects.
Figure 4.2. Effects of a producer subsidy in an open economy.
The effects of tariffs/subsidies applied at the border can be expressed in terms of equivalent subsidies or taxes applied at the domestic level. For example, an export tax will have an effect equivalent to the combined effect of a producer tax and a consumer subsidy (Figure 4.1). The only major difference between border measures and equivalent domestic measures lies in their ease of administration. Whereas trade taxes and subsidies can be implemented conveniently at the border where the market channel is narrow and relatively easy to control, equivalent domestic measures require an elaborate institutional administrative framework for effective implementation. Border measures, however, will not work unless smuggling can be stopped.
When a country's international trade is restricted by trade barriers, high transport costs or for other reasons, it is said to have a closed economy. In these circumstances, domestic subsidies/taxes have different effects. For example, a producer subsidy would increase the producer price, but it would also increase total supply (instead of merely displacing imports), in which case consumer prices would fall, such that both parties would benefit (Figure 4.3). In a closed economy, a producer subsidy would be similar in its effects to a consumer subsidy. The difference would depend on the relative elasticities of supply and demand.
Policies implemented through domestic state monopolies are analogous in effect to subsidies or taxes. For example, a monopoly marketing board, which pays a higher price to the producer than it charges the consumer (once marketing costs have been taken into account), is effectively implementing a policy to subsidise both parties.
State monopolies and other state or parastatal agencies often operate inefficiently, resulting in serious market distortions. Associated with such distortions is the emergence and growth of informal (and often illegal) markets, which circumvent monopolies and so erode their power. Under these circumstances, a fundamental condition for an efficient system, namely market transparency, is violated. Even where state agencies do not operate as total monopolies, their margins often exceed those of the private sector. As a result, the market share of the state body often declines, adversely affecting its marketing operations still further. When state agencies operate inefficiently, private traders may face reduced competition (if their numbers are restricted), enabling them to make excessive profits.
Figure 4.3. Effects of a producer subsidy in a closed economy.
Inconsistency results when a state agency is required to maintain an artificial price level (i.e. above or below equilibrium), but is unable to do so because of inadequate financial and/or policy support from government. A state monopoly with a responsibility to maintain consumer prices at levels below market equilibrium must be supported either by explicit government subsidies or by the provision of adequate financial resources to cover the losses it incurs.
Inconsistencies between the domestic operations of state agencies and the border measures taken by government are also common. For example, state monopolies are often required to purchase commodities at prices below export parity levels. (For a definition of parity price, see the footnote to Exercise 4.1.) When such agencies receive no support (or at least no effective support) in the form of an export tax, an informal/illegal export trade will tend to emerge which will compete with the official body.
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Box 4.1: The case of Alphabeta. In Alphabeta, a range of market, price and trade policy instruments have been applied. For beef and milk, prices at the producer, wholesale and retail levels are controlled through monopolies. A tax on exports is applied and the domestic price is held below the border price equivalent. Monopolies also exist for coffee, tea and pyrethrum, but a free market system operates for sheep and goats. The beef price policy adopted by the Meat Marketing Commission (MMC) has transferred income from producers to consumers. This has encouraged domestic beef consumption, particularly in urban areas, but production has suffered. Not surprisingly, exports have also declined. Another aspect of Alphabeta's beef marketing policy is that a price distortion has been introduced through the beef grading system. Because price differentials between grades have been kept narrow, deliveries of superior grades have declined in relative terms while domestic demand for them has risen sharply. This has adversely affected the country's exports of prime quality beef. Two factors have contributed to the growth of informal/illegal slaughtering and marketing of beef in Alphabeta. First, MMC's processing and marketing costs are higher than those of the private sector. The private sector has been able to pay a higher price to the producer and has commanded an increasing share of deliveries as a result. Second, MMC has attempted to keep the price of beef below the equilibrium level, but this has been done without the necessary government support. At set domestic sale prices, demand has exceeded MMC supply capacity. In order to increase supplies, MMC would have had to raise the prices offered to producers, but the necessary government financial support to do this has not been forthcoming. The intention to maintain low consumer prices has also failed since consumers have had to pay higher prices on informal markets. The situation is similar with dairy products. The market price of milk has been kept below export parity, simultaneously stimulating consumption and discouraging production. The export of dairy products has declined as a result, with Alphabeta becoming a net importer in recent years. The price policy adopted by the National Dairy Co-operative (NDC) has effectively resulted in a transfer of income from producers to consumers. The NDC is a commercial/co-operative agency whose prices are controlled by government. It operates as a parastatal marketing body and has been plagued by the problems and policy inconsistencies typical of such agencies. For example, seasonal and regional price structures have not reflected cost differentials since year five, resulting in serious distortions in the production and marketing of milk products. Production in remote areas has been encouraged and seasonal gluts and shortages have become common. Informal marketing has flourished. |
Exercise 4.1: Equivalent domestic and border policy instruments and the effects of state agencies.
Example: Let us consider the case of a wheat importing and producing country where the government has established a monopoly agency to import the commodity and to market both imported and domestic production. The following information on prices and margins is available for whole wheat:
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L$/t |
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Retail consumer price |
60.00 |
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Import parity price1 retail level |
50.00 |
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Transport and marketing margin (farm gate to retail level) |
8.00 |
1 The important parity price is the cost of imports (c.i.f.) adjusted by all other costs (e.g. marketing, handling, transport and taxes) incurred in getting the imports to the point of sale (in this case, the retail level). The export parity price is calculated in a similar way. The main difference between the import/export parity price and the border price equivalent is that the former includes adjustments for taxes.
Under these conditions, the state agency would make a profit of L$ 10/t on its wheat imports. In the absence of such an agency, the equivalent border measure would be an import tariff of L$ 10/t, while the equivalent domestic measure would be a consumer tax of L$ 10/t combined with a domestic producer subsidy of L$ 1/t.
The domestic producer price is L$ 52/t (L$ 60 minus marketing costs of L$ 8/t). If government permitted competition by private traders and if their marketing costs were lower, (say L$ 5/t), the state agency would find it difficult to operate effectively and would tend to incur losses. Private traders could offer the domestic producer a price of L$ 55/t, and domestic wheat output would tend to be channelled through them, by-passing the government body.
Exercise: (estimated time required: 1 hour).
Read the parts of the central case study which describe the beef price policy adopted in Alphabeta. 2
Answer the questions below, given the following price/cost data2:
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L$/t |
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Farm-gate producer price |
340.00 |
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Export parity price at producer level (including MMC slaughtering costs) |
358.00 |
2 These data relate to fair average quality (FAQ) grade beef and are expressed in cold dressed weight (CDW) equivalents.
Box 4.2: Calculating beef prices at different market levels.
Assume a farm-gate price of L$ 0.20/kg live weight and a dressing out percentage of 50%. All prices and margins are expressed in L$/kg CDW:
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L$/kg |
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Farm-gate price, CDW equivalent (by-products included) |
0.40 |
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+ transport and marketing* (farm gate to wholesaler) |
0.01 |
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+ processing (slaughtering) |
0.03 |
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- value of by-products (hides, blood, bones etc) |
0.06 |
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= wholesale price, cut beef, CDW (by-products excluded) |
0.38 |
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+ transport and marketing (wholesaler to retailer) |
0.01 |
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= retail price, cut beef |
0.39 |
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Transport cost, farm gate to wholesale (slaughterhouse) |
9.00 |
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Value of by-products retrieved during processing (hides, blood, bones etc) |
56.00 |
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Transport and marketing margin, wholesale (slaughterhouse) to retail |
6.00 |
Question 1. Assume MMC is the sole export agency for beef and that private traders are prevented from exporting it. Does the MMC make a loss or a profit on its export sales? What is the size of this loss or profit/t CDW?Question 2. Assume that private traders are authorised to export beef. What type of border measure would be needed to maintain the producer price at its original level? What would be the level in L$/t CDW required for this measure?
Question 3. What would happen if the government did not apply the measure? What equivalent domestic measures could the government adopt instead (assuming that transport costs do not differ between MMC and private trade, but that slaughtering costs differ as in the central case study).
Question 4. Assume that the MMC and the private sector pay identical prices for beef to producers. What is the consumer price in L$/kg CDW for beef marketed through MMC and the private sector? What is the likely consequence of such a price difference? (With regard to transport and processing costs, make the same assumptions as in Question 2.)
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Important points (4.3-4.4) · In analysing the impact of market, price and trade policies oil commodity output levels and prices, the initial task would be to find out the nature of policy instruments being employed for the given commodity at various levels including international, wholesale, producer and retail. · Some of the important groups of market and trade policy instruments used by various governments in Africa are: - border measures · Among border measures, import tariffs reduce imports and domestic consumption but increase domestic prices and domestic production of the commodity, Government revenue also increases. An import subsidy will have the opposite effects. · An export tax reduces exports, domestic prices and domestic production but increases domestic consumption. Government revenue again increases. An expert subsidy will have the opposite effects. · A producer subsidy in all open economy increases production of the subsidised product with no effect on domestic consumption. Government expenditure is increased while imports are reduced. A tax on producers will work in the opposite direction. · A consumer subsidy reduces the price paid by, the consumer, thereby increasing domestic consumption. Imports tend to increase. Government expenditure increases There is no effect oil domestic production. A consumer tax will have opposite effect. · The effects from domestic subsidies/taxes ill a closed economy are different from those in all open economy. A producer subsidy would increase the producer price but it would also reduce the consumer price such that both parties would benefit. · Border measures are easier to administer than domestic measures. · State monopolies and other state or parastatal agencies often operate inefficiently, resulting in serious market distortions. |
