Developing Vietnam: Studies in Rural and Sustainable Development

Transcription

1

2 Developing Vietnam: Studies in Rural and Sustainable Development Edited by Joost Buurman Adam McCarty Scott Robertson

3 Joost Buurman, Adam McCarty and Scott Robertson (Eds.) Developing Vietnam: Studies in Rural and Sustainable Development Centre for the Study of Transition and Development (CESTRAD) Institute of Social Studies The Hague, Hanoi ISBN: Copyright: 2004 by the authors All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission of the copyright owners. Further copies may be purchased through CESTRAD,

4 CESTRAD Series on Transition and Development 1. The First Decade and After: Albania's Democratic Transition and Consolidation in the Context of Southeast Europe Edited by Fatos Tarifa and Max Spoor 2. The Breakdown of State Socialism and the Emerging Post-Socialist Order Edited by Fatos Tarifa 3. Developing Vietnam: Studies in Rural and Sustainable Development Edited by Joost Buurman, Adam McCarty and Scott Robertson

5

6 Contents Introduction 1 Part A: Setting the Scene Chapter 1: Analysing the Income Gap between Rural and Urban Areas in Vietnam Introduction Measuring the rural-urban gap in Vietnam Determinants of the rural-urban gap: an econometric decomposition Government influence on the rural-urban gap Conclusion 27 Chapter 2: Social Safety Nets: Identifying the Poor Introduction The social safety net of Vietnam Benefit incidence analysis of Vietnam s social safety net Proxy means tests for targeting social transfers Conclusions and recommendations 57 Chapter 3: The Impact of Income and Price on the Nutritional Status in Vietnam Introduction Theoretical overview Nutritional status in Vietnam The impact of income and price on the nutritional status Conclusions and recommendations 88 Part B: Production in Rural Areas Chapter 4: Vietnam and the international market for rice exports Introduction The international rice market The competitors of Vietnam in the international rice market 106

7 4.4 The competitiveness of Vietnamese rice exports Conclusions and policy recommendations 119 Chapter 5: Impact of Price Fluctuations on Coffee Producers: a Case Study of Dak Lak Province Introduction Commodity price fluctuations An overview of the coffee market The structure of the coffee industry in Vietnam The impact of coffee price fluctuations on producers in Dak Lak province Conclusions and policy recommendations 143 Chapter 6: Structural change in the sugar cane industry: the case of Lam Son Introduction Behaviour of farmers and agricultural production Transforming to cash crop production: sugar cane in Lam Son The impact of a change towards sugar cane production Assessing the comparative advantage of Lam Son in producing sugar cane Conclusions and Recommendations 167 Chapter 7: Agro-forestry household system Introduction Key factors of production in Yen Bai province Market structure of log products Sustainable land use Conclusions and recommendations 197 Chapter 8: Specialised non-farm villages in the Red River Delta Introduction Non-farm activities in rural development Analysis of SMVs in the Red River Delta Constraints and opportunities for SMVs in the Red River Delta Conclusion 228

8 Acknowledgements This book was funded by the Neys-van Hoogstraten Foundation. The Neys-van Hoogstraten Foundation was founded in 1989 by the late Dr. Karel Neys in honour of his parents. Dr. Neys was born on February 17, 1920 in Klaten, Indonesia. Most of his life Dr. Neys worked in the field of development cooperation for the United Nations. In his last will he bequeathed his fortune to the Foundation. He passed away on March 3, The main objective of the Neys-van Hoogstraten Foundation is to strengthen and stimulate socioeconomic research in the field of household budgets and family nutrition in Indonesia and other (Southeast) Asian countries. By providing financial and technical support the Neysvan Hoogstraten Foundation aims at enhancing the quality and quantity of research in this field. Research results should be published. We would also like to thank the Spanish Embassy for additional financial support for the publication of this book. The studies in this book are based upon the work of the students of the Vietnam- Netherlands Masters Programme in Development Economics (MDE), which was set up with support of the government of The Netherlands and implemented by the Institute of Social Studies, The Hague at the National Economics University, Hanoi, and the University of Economics, Ho Chi Minh City. The editors of this book wish to thank the students who have carried out the research: Le Trung Kien, Le Duc Truong, Phan Hoai Duong, Nguyen Thi Thu Hang, Nguyen Thu Duyen, Luong Thi Ngoc Oanh, Nguyen Quoc Toan and Doan Hong Da. In addition, we would like to thank Lee-Anne Molony for initial editing of theses. Also thanks to Mekong Economics for providing support and a work space. This book is dedicated to Nguyen Ngoc Luu, the MDE staff member who passed away, and Professor Vu Thieu, who has led and developed the MDE programme since 1994.

9 Neys-van Hoogstraten Foundation External Secretariat NHF c/o Span Consultants Bezuidenhoutseweg AB The Hague The Netherlands telephone: fax: office@neys-vanhoogstraten.nl website: National Economics University Vietnam-Netherlands Masters in Development Economics (MDE) 4 th floor, building 10 Giai Phong Road Hanoi Vietnam telephone: fax: thucanhmde@yahoo.com Spanish Embassy in Hanoi Daeha Business Centre 360 Kim Ma Street Hanoi Vietnam telephone: fax: embespvn@mail.mae.es Institute of Social Studies Centre for the Study of Transition and Development (CESTRAD) P.O. Box LT The Hague The Netherlands telephone: fax: cestrad@iss.nl website: Mekong Economics 24 Tran Vu Hanoi Vietnam telephone: fax: mekongeconomics@hn.vnn.vn website:

10 Introduction 1. Background and objectives This book presents eight studies that give an overview of problems and opportunities encountered in the development of rural areas in Vietnam. As the gap between rural and urban areas is growing (Chapter 1), more effort is needed to alleviate poverty and stimulate economic growth in rural areas. Although not the cause as such, fostering change in the structure of agricultural production is important in stimulating economic growth. In addition, alleviating poverty can be supported by policies such as a well-targeted social safety net and policies to combat malnutrition. This book differs from many other publications in that the studies on which the chapters are based have been carried out by Vietnamese students from the Masters Programme in Development Economics at the National Economics University in Hanoi. The chapters present a Vietnamese point-of-view from professionals at the beginning of their career, which still have an open mind towards the problems and challenges of a rapidly developing country. The students often undertake original research and carry out field research to obtain data. The student research was supervised and examined by senior Vietnamese economists and professionals, leading to sound studies appropriate for publication. 2. The Masters in Development Economics Programme All chapters in this book are based on theses from students of the Vietnam- Netherlands Masters Programme in Development Economics (MDE). The MDE is a twoyear full-time degree taught in English by Vietnamese lecturers who have been trained abroad and by visiting lecturers from abroad. The MDE curriculum focuses on applying economic theory to the policy challenges facing Vietnam. The programme was set up in 1994 with support of the Netherlands government, and with the aim to produce the first Masters in Development Economics degrees of international standard in Vietnam - one in the north (National Economics University - NEU) and one in the south (University of Economics Ho Chi Minh City - UOE). Eight years of teaching and other assistance by the Institute of Social Studies (ISS), based in The Hague, The Netherlands, has enabled the degree to achieve a high standard and deliver about thirty graduates each year. From 2003 onwards the program has become self-sustainable. Introduction 1

11 The focus of the MDE curriculum is applying economic theory to the Vietnamese context. In the second year of their study, students write a substantial thesis. The theses are based on original research, carried out by the students and supervised by senior academics and officials from universities, institutes, ministries, banks and international agencies. Research is usually based on data collection in the field or statistical data available at ministries and other governmental and non-governmental organisations. This results often in good studies, which can be of interest to a larger public. Based on quality, topic and relevance, eight theses from the past seven years have been selected for this book and edited into chapters. The chapters give a representative image of the students work at the MDE. For the future additional publications are planned, focusing on other topics such as macroeconomic developments. The Neys-van Hoogstraten Foundation has been so kind to support this publication. 1 The main objective of the Neys - van Hoogstraten Foundation is to strengthen and stimulate socio-economic research in the field of food and nutrition at household and community level in Indonesia and other Asian countries, in particular Southeast Asia and the Indian subcontinent. By providing financial and technical support the Neys - van Hoogstraten Foundation aims at enhancing the quality and quantity of research in this field. Additional financial support was provided by the Spanish Embassy in Hanoi. 3. Outline of the book This book contains eight chapters that are related to rural development in Vietnam and can be divided in two parts. Part A comprises the first three chapters that sketch the situation while highlighting three poverty issues. These chapters are based on data from the Vietnamese Living Standard Surveys (VLSS) of 1992/3 and 1997/8, and are rich in statistical analysis. Part B consists of the remaining five chapters that analyse developments in growing (cash) crops (rice, coffee, sugar cane and agro-forestry products) and in carrying out non-farm activities to raise income in rural areas. These studies are based on data collection in the field, data from statistical publications and reports. As the chapters represent students work from the past seven years, the editors have updated the chapters with new figures and recent information where possible. The first chapter starts with an analysis of the income gap between rural and urban areas. In Vietnam, poverty is for a large part concentrated in rural areas. Thirty-seven percent of the Vietnamese population lived below the poverty line in 1998, but in rural provinces this figure was 45 to 50 percent and could locally be as high as 77 percent (Baulch and Minot, 2002). One of the aims of the Vietnamese government is development with equitable distribution. However, as the chapter shows, the gap between rural areas and urban areas widened in the period Based on the Vietnamese Living Standard Surveys, the author uses a statistical approach to explain the causes of the rural-urban gap and the factors that cause the rural-urban gap to increase. Findings from the study are that a 1 External Secretariat Neys-van Hoogstraten Foundation, c/o SPAN Consultants, Bezuidenhoutseweg 1, 2594 AB The Hague, The Netherlands, 2 Introduction

12 little over one third of the gap between rural and urban areas can be explained by different characteristics (education, occupation, etc.), while the remainder is caused by policies that promote urban industrialisation, but hamper rural agriculture. Chapter 2 analyses the social safety net in Vietnam. Although not specifically focussing on rural areas, an important conclusion of the study is that the urban population has a better social safety net than the rural population. The social security system, which consumes the largest part of social benefits, targets employees of state-owned enterprises, which are not the most likely to be poor. The poorest people, mostly living in rural areas as Chapter 1 shows, receive the smallest benefits and are least covered. The study proposes a proxy means test as an alternative way to identify the poor that most need the social benefits. Reforms of the social security system could benefit by using methods such as the proxy means test. However, social security reforms are politically a sensitive topic, so extensive coverage of the rural population is not soon to be expected. Chapter 3 examines the impact of income and price on the nutritional status in Vietnam. Households have to make decisions on how to allocate their income, and which food items they want buy. The level of the income and the prices of different food items are important determinants in this decision making process. The study analyses the effects of changes in income and prices for different categories of households: rural versus urban, male headed versus female headed and poor versus non-poor. One of the findings is that the nutritional status of the population living in rural areas is more responsive to changes in income and prices than that of those living in urban areas. Price policies and macroeconomic policies can be used to improve this situation. Part B of the book discusses several subjects related to rural development in Vietnam. The chapters have a common focus on agricultural production. However, each chapter takes a different perspective. Chapter 4 analyses the rice market from the macro-perspective of international trade. Chapter 5 analyses the impact of fluctuating world coffee prices on coffee growing households. Chapter 6 takes a regional perspective when analysing the production of sugar-cane, while Chapter 7 analyses agro-forestry at the household level. After discussion of these different crops, Chapter 8 looks at non-farm production in rural areas. The five chapters each discus development issues that are important to improving the welfare of the rural population. Increasing the competitiveness of Vietnamese rice, coping with coffee price risks, a shift to sugar-cane production, agro-forestry, or non-farm production may all lead to increases in rural incomes. In detail, Chapter 4 discusses the crop that is being produced by the majority of the farmers in Vietnam: rice. The market for rice is strongly influenced by government policy. Although rice production in Vietnam has increased considerably since the start of the Doi Moi reforms in 1986, Vietnamese rice exports still face difficulties, such as prices lower than those of the competitors in the world market, and fluctuating prices creates volatility in export earnings. This study analyses trends in demand and supply of rice and assesses the competitiveness of Vietnamese rice in the global market. Chapter 5 analyses the situation of the coffee producers. Coffee production boomed in Vietnam in the late 1990s. Output increased strongly and even affected the world coffee Introduction 3

13 market. With strongly decreasing prices near the end of the decade, many coffee producers face difficulties in earning a living and coping with debts. Better strategies are needed for households to cope with the highly volatile and low coffee prices. Chapter 6 addresses problems in the transformation to cash crop production, the impact of such a process, prospects for further development of commodity production, and recommendations relating to commodity production in Vietnam. In order to do this, the shift to sugar cane production by farmers in the province of Lam Son is analysed. The study finds that farmers have responded rationally to incentives created by the government to start growing sugar cane. In particular, announcing prices for sugar-cane proved to be a very strong incentive. A domestic resource costs analysis shows that sugar-cane production in Lam Son is competitive. Though difficult to assess, the region as a whole has benefited from the shift to sugar cane production. Chapter 7 looks at an ecologically sound way of increasing rural income. Agroforestry combines trees with agricultural crops. Though trees can bear fruits, this study particularly looks at wood production in privately managed agro-forestry farms in Yen Bai province. In this chapter, opportunities and constraints, as well as returns and effectiveness of investments are analysed. Privately managed agro-forestry farms are clearly a way of sustainable development, though land security problems exist and, related to this, investment capital is difficult to obtain. Problems in the markets for outputs, such as low prices and transportation difficulties, also hamper the development of ago-forestry. In the past few years it was increasingly recognised that non-farm production is needed to diversify production in rural areas. Non-farm production is the topic of Chapter 8. Non-farm production covers a wide range of activities; this chapter focuses on handicraft villages in the Red River Delta. It describes how the non-farm manufacturing economic system is organised, what the impact is of the transition to a market economy on the rural non-farm manufacturing sector in the Red River Delta, and the prospects of specialised manufacturing villages in economic development. It is not easy to give a single advise as production is diverse. Specific advantages should be utilised and market opportunities explored. Otherwise, for many products it will not be possible to compete with large-scale manufacturing. Reference Baulch, B. and Minot, N. (2002), The Spatial Distribution of Poverty in Vietnam and the Potential for Targeting, World Bank Working Paper, no. 2829, World Bank, Washington D.C. 4 Introduction

14 Part A Setting the Scene

15

16 Chapter 1. Analysing the Income Gap between Rural and Urban Areas in Vietnam Le Trung Kien 1.1 Introduction In Vietnam, economic development with equitable distribution is a basic principle of the development strategy. However, recent economic growth has not been equally distributed, according to the increase in the national Gini coefficient, which is a measure of inequality of income that lies between 0 (most equal) and 1. According to calculations based on the Vietnam Living Standards Surveys of 1993 and 1998, the Gini coefficient increased from to in the period Most of the increase in inequality can be explained by the widening gap between rural and urban areas. During the period , rural income increased by 30 percent, yet urban income did so twice as fast at 61 percent. Consequently, the per capita expenditure in cities increased faster than in rural areas, which is shown by an increase of the urban-rural per capita expenditure ratio from 1.81 to 2.21 (ibid). This chapter examines the degree of the rural-urban gap in Vietnam in the period , the role of various factors in explaining the gap, and the impact of government policies on these factors. The data source is the Vietnam Living Standards Survey (VLSS93) and (VLSS98), using a total number of observations of 4,000 households. The most important criteria distinguishing rural and urban areas is a 60 percent non-farm employment share of a household. Per capita expenditure figures were used to analyse the gap between rural and urban areas. This chapter follows a statistical approach to point out the causes for the rural-urban income gap and discusses the following topics. The next section analyses how the ruralurban income gap can be measured and shows the extent and dimensions of the gap in Vietnam. Section 1.3 applies an econometric decomposition to find the determinants of the rural-urban income gap. Section 1.4 discusses government influence on the rural-urban income gap and finally Section 1.5 contains the conclusions. 1.2 Measuring the rural-urban gap in Vietnam Poverty measures Before looking at the causes and explanations of the rural-urban gap in Vietnam, first ways to measure the rural-urban gap need to be discussed. The measurements give a Analysing the income gap between rural and urban areas 5

17 detailed picture of the rural-urban gap in Vietnam. Table 1 presents a general picture of the rural-urban gap in Vietnam. While the majority of the Vietnamese population lived in rural areas (80.0 percent in 1993 and 76.5 percent in 1998), per capita expenditure and income in rural areas was much lower than those in urban areas for both 1993 and Share of rural population 80.0% 76.5% Per capita expenditure in urban areas 3,058,229 4,874,854 Per capita expenditure in rural areas 1,692,291 2,206,269 Urban-rural expenditure ratio Per capita income in urban areas 3,180,279 5,133,113 Per capita income in rural areas 1,656,874 2,352,494 Urban-rural income ratio Table 1: Average per capita expenditure and income (VND) in Vietnam. For measuring the rural-urban gap, inequality measures and poverty measures can be used. First, to measure inequality, the Theil T-index, or Theil inequality index, is often used. Theil s T-index is defined as follows: Theil ( T ) = Y Yi N ln Y = Y Y T Y ln N N i j j j j + i = 1 Y j j Y j Y Y N In this definition, Y is the total expenditure (or income) of the population, N is the total population, Y i is the expenditure (or income) of individual i, Y j is the total expenditure (or income) of group j, N j is the number of people in group j. If there is no inequality, the index is zero, the upper limit of the index depends on the size of the population. An advantage of Theil s T-index is that it is decomposable and can provide a measure for inequality not only within but also between rural and urban areas. Table 2 presents the results of the Theil inequality index calculation, and shows of which components the inequality exists. Within-rural inequality was, with a figure of about 0.13, lower than within-urban inequality, which has a Theil index of Thus, in urban areas on average a larger difference exists between poor and non-poor. Combined, the within-group component comprises a large proportion of total inequality (89 percent for 1993 and 83 percent for 1998), while remaining relatively stable over the period. In contrast, while comprising a small share of the total inequality (11 percent in 1993 and 17 percent in 1998), the between-group component recorded a very strong increase of 62 percent over the period. Dynamic inequality in Vietnam over the period can be mainly explained by the between-group component; another proof of the widening ruralurban income gap. 6 Analysing the income gap between rural and urban areas

18 % Change Within group component (%) 88.83% 83.18% Within-rural Within-urban Between group component (%) 11.17% 16.82% Between rural and urban Table 2: Decomposition of the Theil inequality index (T) for Vietnam, A second measure that can be used to assess the differences between rural and urban areas is the FGT (log variance) index (Foster, Greer and Thorbecke, 1984). This measure is widely used in poverty analysis. The index is defined as follows: P α = 1 N N α Z Y = i max 0, 1 Z i Here, Z is the poverty line; according to calculations of GSO (1999) and the World Bank (1999), the poverty line was 1,160,410 VND in 1993 and 1,789,871 VND in Y i is the income or expenditure level of individual i, N is the total number of individuals in the data, and α is the parameter that allows this index to vary its sensitivity to the depth of poverty. When α = 0, this formula becomes the headcount index or poverty incidence, which is completely insensitive to the depth of poverty. When α = 1 the index indicates the depth of poverty, which shows how much income must be transferred to poor people to allow them to reach the poverty line. When α = 2, the index indicates the severity of poverty (Ravallion, 1994). Table 3 presents the results of the FGT (log variance) index calculation and shows that poverty in Vietnam unambiguously decreased from 1993 to However poverty reduction was not equally distributed. In urban areas, the incidence of poverty fell strongly from 25.1 percent to 9.2 percent (a decrease of 63 percent), while in rural areas it only fell from 66.4 percent to 45.5 percent (a decrease of 31 percent). A similar situation was observed in poverty depth and poverty severity. This means that, despite Vietnam s rapid economic growth, nearly half the rural population (45.5 percent), constituting about 80 percent of the total population, were still poor in 1998 according to this measure. Analysing the income gap between rural and urban areas 7

19 Urban Rural Urban Rural Poverty incidence 25.1% 66.4% 9.2% 45.5% Poverty depth Poverty severity Table 3: Poverty incidence, depth and severity in Vietnam in rural and urban areas, Rural-urban gap by variable The rural-urban gap described by variable gives a more detailed picture than that presented above. Variables include region, economic activity, ethnicity, profession and educational level. Region Table 4 shows the rural-urban gap across the six regions of the VLSS that have sizeable cities. Every region recorded a significant rural-urban gap, as all urban-rural expenditure ratios are well above 1. The three richest regions in 1998 (Southeast, Red River and Central Coast) recorded the lowest increase in the gap between 1993 and 1998, while the three poorest regions recorded the highest increase in gap. This suggests that the ruralurban linkage worked quite well in the richer regions, but was quite weak in the poorer regions. Region Change in: Per capita Urban-rural Per capita Urban-rural Per capita Urban-rural expenditure expenditure expenditure expenditure expenditure expenditure ( 000 ratio ( 000 ratio (%) ratio (%) VND/year) VND/year) Southeast Red River Central Coast Mekong North-C Coast North Upland Table 4: Rural-urban gap in Vietnam by region, Economic activity The rural-urban gap by economic activity is presented in Table 5. In 1998, households with the head working in agriculture had the lowest per capita expenditure (2,088,690) and also recorded the lowest increase in expenditure (27.48 percent). 8 Analysing the income gap between rural and urban areas

20 Households with the head working in finance had the highest per capita expenditure (4,419,450) and the highest increase in expenditure (76.09 percent). From 1993 to 1998, all sectors recorded a growing increase in the gap. Economic activities Change in: Per capita Urban-rural Per capita Urban-rural Per capita Urban-rural expenditure expenditure expenditure expenditure expenditure expenditure ( 000 ratio ( 000 ratio (%) ratio (%) VND/year) VND/year) Agriculture Electricity & water Mining & extr. minerals Industry Transport & comm Other service categories Commerce Finance Table 5: Rural-urban gap by economic activities in Vietnam, Ethnic group Table 6 presents the results of rural-urban gap by ethnicity. Other minorities were the poorest and Chinese were the richest, with the rural-urban gap also being the lowest for other minorities and the highest for Chinese. All ethnic groups became better off over While both Chinese and Vietnamese recorded a significant increase in gap (62.95 percent and percent, respectively), other minorities recorded a slight decrease (-2.63 percent). Ethnicity Change in: Per capita Urban-rural Per capita Urban-rural Per capita Urban-rural expenditure expenditure expenditure expenditure expenditure expenditure ( 000 ratio ( 000 ratio (%) ratio (%) VND/year) VND/year) Other minorities Vietnamese Chinese Table 6: Rural-urban gap by ethnic group in Vietnam, Analysing the income gap between rural and urban areas 9

21 Profession Table 7 presents the results of rural-urban gap by profession. As expected, leaders and professionals had the highest per capita expenditure and the highest gap in 1998, and agricultural, forestry and fishery workers had the lowest per capita expenditure and the lowest gap in In terms of the changes from 1993 to 1998, the largest increase in both per capita expenditure and gap were observed in leaders and professionals (77.88 percent and percent respectively). All other professions also recorded a positive increase in expenditure and gap. Professions Change in: Per capita Urban-rural Per capita Urban-rural Per capita Urban-rural expenditure expenditure expenditure expenditure expenditure expenditure ( 000 ratio ( 000 ratio (%) ratio (%) VND/year) VND/year) Agricultural, forestry & fishery Unskilled workers Skilled manual workers Assemblers & machine operators Service & sales Leaders & professionals Table 7: Rural-urban gap by profession in Vietnam, Educational level In Table 8, per capita expenditure was lowest for those who had no education and highest for those who finished university or higher. Moreover, if excluding no education, a higher level of education was also associated with a higher rural-urban gap. In 1998, the largest gap was observed in university and higher (2.25) and the smallest gap was in primary education (1.86). This suggests that urban conditions are more favourable for higher levels of education than rural conditions. Higher levels of education were also associated with a higher change in expenditure; the lowest change was in no education (30 percent) and the largest change was in university or higher (122 percent). This suggests that economic growth mainly benefits those with a higher level of education. 10 Analysing the income gap between rural and urban areas

22 Education level Change in: Per capita Urban-rural Per capita Urban-rural Per capita Urban-rural expenditure expenditure expenditure expenditure expenditure expenditure ( 000 ratio ( 000 ratio (%) ratio (%) VND/year) VND/year) No education Primary Lower-secondary Upper-secondary University or higher Table 8: Rural-urban gap by educational level, Vietnam Concluding, irrespective of which variable is used to measure the rural-urban gap, there is always a significant gap between the two areas. Urban people are significantly better off than rural people across regions, economic activities, ethnic groups, professions and across educational levels. Also, the gap significantly widened in the period Moreover, as shown in the next section this gap is expected to increase further in the future Income structure An analysis of income structure may provide some insight into the future trend of the rural-urban gap. Total household income is divided into two categories: earned income including wage, agriculture and non-agricultural self-employment, and unearned income including pensions, remittances and others. Table 9 presents two items: percent receiving (the percentage of households receiving income from each source), and income share (the share of each source in total household income). Rural Urban Percent Income Percent Income receiving share receiving share Earned income Wage 49.2% 16.9% 69.0% 32.2% Agriculture 94.4% 44.0% 23.3% 3.5% Self-employment 40.9% 21.6% 66.7% 41.1% Unearned income Pensions 19.3% 3.9% 26.3% 4.3% Remittances 17.8% 4.6% 35.3% 10.7% Others 91.4% 9.1% 83.8% 8.3% Total 100.0% 100.0% Table 9: Income structure in rural and urban areas, Vietnam Analysing the income gap between rural and urban areas 11

23 It is clear that income sources varied significantly between the two areas in In urban areas, 69 percent of households had at least one member working for wages, and 67 percent received income from self-employment, while only 49 percent of rural households received a wage income and 41 percent received self-employment income. Obviously, the difference was even more marked in agricultural income: nearly all rural households (94 percent) received income from agriculture compared to 23 percent of urban households. Some 26 percent of households received income from pensions in urban areas, while only 19 percent (mainly demobilised soldiers) did in rural areas. The reason for this is that only individuals who hold government jobs are eligible for pensions, and these jobs are concentrated in urban areas. Overall, while urban households had diversified income sources (wage, self-employment and unearned income), rural households were more vulnerable to risk because income from agriculture, which an unstable operation as it is affected by weather and fluctuating market prices, accounted for as much as 44 percent of total income. Given the inevitable relative decline of agriculture in the economy (World Bank, 1999; UNDP, 1999), this income structure may have implications for the future trend of the rural-urban gap in Vietnam. Rural incomes can increase, but at a much lower rate than urban incomes. Most of the income increase in agriculture over the past years has derived from the new opportunities created by the reform package of , such as land and ownership reform (through de-collectivisation) and agriculture diversification (ibid). At present, not many opportunities from reforms are left for exploitation, so the pace of agricultural growth in the future will be much lower. 1.3 Determinants of the rural-urban gap: an econometric decomposition Introduction We now turn to some explanations for the rural-urban gap. The rural-urban gap may be explained by two main factors: the characteristics gap and discrimination. The characteristics gap refers to the Neo-Classical theory of the labour market: under competitive conditions, the same wage must be paid for a given grade of labour no matter where it is (Reder, 1971), therefore the rural-urban gap only reflects the difference in individual characteristics between the two areas (i.e., education and training). Discrimination refers to the Institutional view that many barriers hinder labour movement, so that the labour market is permanently divided into two distinct segments: the rural and urban sectors. Minimum wages, union power, sticky industrial wages, protected SOEs and various macro-economic policies keep urban wages at much higher levels than rural wages (McNabb and Ryan, 1990). Consequently, discrimination exists between the two segments, and urban people are offered a higher pay than rural people. Lipton (1977) goes further by arguing that urban-biased policies of government are the main agent behind this discrimination. If the rural-urban gap is decomposed into the two factors (the characteristics gap and discrimination), we can gain an understanding of the role of each factor in explaining the existing gap in Vietnam. This econometric decomposition of the 12 Analysing the income gap between rural and urban areas

24 rural-urban gap is explained in Appendix 1. Based on the results, the contribution of various factors to the rural-urban gap in Vietnam can be interpreted in two parts: the static decomposition, which decomposes the 1998 rural-urban gap, and the dynamic decomposition, which decomposes the change in the gap from 1993 to Appendix 2 explains the methodology of this decomposition. All results presented below (Tables 10-18) are based on regression results contained in Appendix Static decomposition Education People with higher levels of education usually have higher incomes. Table 10 shows that, as expected, returns to various grades of education are positive and significant, clearly reflecting the positive impact of education on per capita expenditure. Particularly, per capita expenditure of households having a primary education level is 12 percent higher than the benchmark of no education and this figure increases with higher grades of education. For upper-secondary levels of education a small gap (0.0818) exists between rural and urban areas, thus in education the return gap only slightly contributed to the rural-urban gap (2.76 percent), see Table 11. However, in education a large characteristics gap (difference in average value ) exists between rural and urban areas. While in urban areas, 25 percent completed upper-secondary education and 9 percent completed university or higher, the figure for rural areas are only 12 percent and 1 percent. The resulting characteristics gap contributed 7.53 percent to the overall gap. The combined effect for education of the return and characteristics gap to rural-urban gap was percent. Average value Return Rural Urban Rural Gap Urban Primary (12%) (12%) Lower-secondary (21%) (21%) Upper-secondary (37%) (49%) University or higher (73%) (73%) (No education) Σ=1.00 Σ=1.00 Table 10: Education of household head in Vietnam: average value and return to characteristics, Gap Gap value Percent in rural-urban gap Return % Characteristics % Σ= Σ=10.29% Table 11: Education of household head in Vietnam: contribution to rural-urban gap, Analysing the income gap between rural and urban areas 13

25 Occupation All occupations were significantly better off than the agricultural benchmark. Whitecollar workers had the highest return (58 percent for urban and 35 percent for rural), followed by blue-collar workers (38 percent and 12 percent), sales and services (35 percent and 11 percent), and non-working (34 percent and 6 percent), see Table 12. Returns to occupation were consistently higher in urban areas than in rural areas. As a result, the return gap in occupation contributed as much as percent to the rural-urban gap, see Table 13. The rural-urban gap was further aggravated by the concentration of rural people in agriculture, which is the lowest earning occupation: 63 percent in rural areas and only 12 percent in urban areas. For occupation, the characteristics gap contributed 9.37 percent to rural-urban gap. Overall, the characteristics and return gaps in occupation make a large contribution (33.46 percent) to the rural-urban gap in Vietnam. Average value Return Rural Urban Rural Gap Urban White-collar workers (35%) (58%) Blue-collar workers (12%) (38%) Sales and service (11%) (35%) Non-working (6%) (34%) (Agriculture) Σ=1.00 Σ=1.00 Table 12: Occupation in Vietnam: average value and return to characteristics, Gap Gap value Percent in rural-urban gap Return % Characteristics % Σ=0.24 Σ=33.46% Table 13: Occupation in Vietnam: contribution to rural-urban gap, Demographics Because it is almost impossible to estimate a credible adult equivalents scale, which should be used to compare households that are composed differently (see Deaton, 1997), one should be cautious when interpreting the coefficients on these variables. The effects of demographics are presented in Tables 14 and 15. Age of household head: It is normally expected that when people get older they will earn more income as they gain more knowledge and experience. However, this is not true in the urban areas of Vietnam as return on age of the household head is negative (-1 percent). As Vietnam s economy is in transition to a market economy, the young are 14 Analysing the income gap between rural and urban areas

26 usually more dynamic, neutralising the usual effect of age. However, in rural areas, not many opportunities are available for the young, thus the return on the head's age is still positive (3 percent). Average value Return Rural Urban Rural Gap Urban Age of the head (3%) (-1%) Sex of the head (-6%) (-6%) (Male=1, Female=0) Number of young children (-9%) (-9%) Number of adult (6%) (10%) Marriage status (7%) (7%) (Couple=1, Single=0) Number of children (-6%) (-10%) Table 14: Demographics in Vietnam: average value and return to characteristics, Gap Gap value Percent in rural-urban gap Return % Characteristics % Σ= Σ=-17.03% Table 15: Demographics: contribution to rural-urban gap. Number of children: A higher number of children in a family is associated with a lower level of per capita expenditure (-10 percent for urban and 6 percent for rural). Higher returns to rural children can be explained by the fact that urban children do usually not have to work, while rural children generally help their parents or directly participate in earning income. The negative side of this participation is the high drop-out rate from school among rural children, especially for poor households. In terms of household characteristics, rural households have more children than urban households. Number of young children and adults: More young children in a family leads to lower consumption (-9 percent), and more adults leads to higher consumption (10 percent for urban and 6 percent for rural). In terms of household characteristics, urban areas have more adults and fewer young children than rural areas. Sex and status of household head: Households headed by men have lower expenditure than those headed by women (-6 percent), although this was only marginally significant. This could imply that for this issue sex discrimination is not very significant in Vietnam. Households with couples have a higher consumption than single households (7 percent). Analysing the income gap between rural and urban areas 15

27 In summary, the return gap of demographics reduces the gap by percent while the characteristics gap increases the gap by percent. Overall, demographics reduces the rural-urban gap by percent. Ethnicity There is significant ethnic inequality in Vietnam. Chinese were the richest with a 71 percent higher per capita expenditure than the benchmark other minorities, followed by Vietnamese (33 percent), see Table 16. However, no return gap existed between rural and urban areas. In terms of household characteristics, Chinese concentrated in urban areas, while the other minorities concentrated in rural areas. As a result, the characteristics gap contributed 9.03 percent to rural-urban gap (Table 17). Average value Return Rural Urban Rural Gap Urban Chinese (71%) Vietnamese (33%) (Other minorities) Σ=1.00 Σ=1.00 Table 16: Ethnicity in Vietnam: average value and return to characteristics, Gap Gap value Percent in rural-urban gap Return % Characteristics % Σ= Σ=9.03% Table 17: Ethnicity in Vietnam: contribution to rural-urban gap, 1998 Table 18 presents the aggregate results for all factors. The characteristics gap contributes percent to rural-urban gap. This confirms the Neo-classical view that the higher standard of living of urban people is due to their higher level of education, their work in well-paid occupations, and having less children. The return gap actually reduced the rural-urban gap by 1.29 percent. The return gap was mostly observed in the categories of occupation and demographics. While occupation caused a widening of the gap (24.09 percent), demographics caused a reduction of the gap ( percent). The environment gap is the most important factor, contributing as much as percent to rural-urban gap. Because discrimination is the sum of the return and environment gaps, discrimination accounted for as much as 63 percent of the rural-urban gap in Vietnam in This result affirms the Institutional view that there is a high degree of discrimination between urban and rural areas. 16 Analysing the income gap between rural and urban areas

28 Gap value Percent in rural-urban gap Characteristics gap Ethnicity % Education % Occupation % Demographics % Σ= Σ=37.03% Return gap Ethnicity % Education % Occupation % Demographics % Σ= Σ=-1.29% Environment gap % Rural-urban gap Σ= Σ=100% Table 18: Decomposition of rural-urban gap into return, characteristics and environment gap: 1998 The decomposition results make clear that the argument that higher urban living standards are fair, since urban people are endowed with favourable characteristics such as high levels of education, working in high-productivity occupation and having fewer children, is not entirely correct. Arguments of this type merely reflected a third of the ruralurban gap (37.03 percent) with as much as percent being explained by discrimination Dynamic decomposition Discrimination is not only the main factor in explaining the (static) rural-urban gap in 1998, but also the main factor in explaining the increase in the rural-urban gap from 1993 to The results of the econometric analysis, using Equation 6 (Appendix 1) are presented in Table 19. The percentage share of each factor in the increase of the gap from 1993 to 1998 is provided in the right-hand column. The increase of the gap is explained by the increase in the characteristics gap, the return gap, and the environment gap. With respect to the characteristics gap, all categories made a positive contribution to the increase in gap, excluding ethnicity (-1 percent), with education recording the biggest increase of all (18 percent). Overall, the increase in the characteristics gap contributed 24 percent to the rural-urban gap increase. With a contribution of 72 percent, the increase in the return gap was the dominant factor in explaining the gap s increase. However, the role of each category in this factor was quite different. While ethnicity had no effect, education and demographics made a Analysing the income gap between rural and urban areas 17

29 negative contribution to the gap s increase (-7 percent for education and -17 percent for demographics). Most of the increase of the gap was explained in the occupation category, which was as high as 96 percent. This suggests that the gap in labour productivity between the two areas was widening extensively during the period. The contribution of the environment gap to the rural-urban gap s increase was small (4 percent); from 1993 to 1998, the macroeconomic environment was slightly biased in favour of urban areas. Overall, the increase in characteristics gap accounted for 24 percent of the gap s increase, while the remaining 76 percent was explained by the increase in discrimination. Most importantly, the widening productivity gap needs labour to move from low-productivity jobs in rural areas to highproductivity jobs in urban areas. This policy not only makes more efficient use of both labour and capital resources but also prevents the rural-urban gap from widening further Increase (2) (1) Percent increase of the gap (1) (2) Characteristics gap Ethnicity % Education % Occupation % Demographics % Σ= Σ= Σ= Σ=24% Return gap Ethnicity % Education % Occupation % Demographics % Σ= Σ= Σ= Σ=72% Environment gap % Rural-urban gap Σ= Σ= Σ= Σ=100% Table 19: Decomposition of the rural-urban gap increase into return, characteristics and environment gaps. Both the static and dynamic decompositions demonstrate that discrimination was the main factor in explaining both the 1998 rural-urban gap (62.97 percent) and the dynamic change in the gap from 1993 to 1998 (76 percent). According to the Institutional view and Lipton (1977), government policies are the main causes for this discrimination. The next section clarifies the impact of government policies on the rural-urban gap. 18 Analysing the income gap between rural and urban areas

30 1.4 Government influence on the rural-urban gap If econometric decomposition shows that discrimination exists, then according to the Institutional view, the policies of the government are the underlying cause. Following the approaches of Lipton (1977) and Bates (1981), the impact of government policies on the rural-urban gap are analysed here. In particular, the government s investment strategy (industry versus agriculture, heavy industry versus light industry, and infrastructure in urban areas versus in rural areas) and the government s manipulation of price incentives (tariff protection for industry and agriculture, exchange rates and export quotas for agricultural products). The analysis of government policies should focus on two questions. Firstly, does government intervention increase national output i.e., the sum of rural and urban output (efficiency)? Secondly, does government intervention reduce the rural-urban gap (equity)? Here we use Lipton s definitions of efficiency and equity to assess government policies in Vietnam. Discrimination mainly originates from urban-biased government policies, including both the government s investment strategy and the manipulation of price incentives Government s investment strategy As the Vietnamese government plays a crucial role in investment activity, the allocation of government investment has a strong impact on the rural-urban gap. The gap can be considered in terms of capital allocation between industry versus agriculture, heavy industry versus light industry, and the allocation of infrastructure. Industry versus agriculture Capital allocation between rural and urban areas plays a critical role in determining the gap between the two areas, as capital can be considered the scarcest factor of production in Vietnam. Agriculture versus industry can be used as a proxy for the rural-urban division to analyse capital allocation in Vietnam. Table 20 shows the allocation of capital between agriculture and industry over the period Agr. Ind. Agr/In Ratio Agr. Ind. Agr/Ind Ratio Agr. Ind. Agr/Ind Ratio GDP 51,282 57, ,539 65, ,895 75, Employment 24,765 4, ,775 4, ,814 4, Social Net investment 3,623 19, ,530 19, ,762 22, Table 20: GDP, Employment and Net Investment from 1995 to Source: General Statistical Office, various statistical yearbooks. Units: GDP in billion VND; Employment in thousand; Social net investment in billion VND Analysing the income gap between rural and urban areas 19

31 In 1998, while the agriculture/industry ratio of GDP was 0.74 and of employment 5.36, net investment in agriculture was much lower with a ratio of only As much investment was concentrated in industry, the law of diminishing returns implies that the return to that investment may be low, making investment inefficient. ICOR is the most widely used indicator to assess the efficiency of the above capital allocation: ICOR = K Y Where: Y is incremental output (annual GDP), K is incremental capital (social net investment per year). The results of the ICOR index are presented in Figure 1. As expected, too much government investment in industry has severely lowered the return to investment, raising the ICOR index in industry. Consequently, the ICOR for industry was more than four times higher than that for agriculture, meaning one unit of capital invested in agriculture could increase output fourfold, compared to one unit of investment in industry Government investment ICOR for Industry ICOR for agriculture industry agriculture industry agriculture industry agriculture Figure 1: ICOR and Government Investment Source: Government investment (billion VND) is from the General Statistical Office. ICOR is author s calculation based on Table 20. Following this analysis, by shifting capital investment from industry to agriculture the government can raise total national output. However, in practice the government shows a strong bias towards industry. In 1998, government investments in industry (especially heavy industry) was nearly double that of agriculture, and was usually justified by the dynamic efficiency hypothesis, (i.e. investment will lay the basis for long-term growth). However, this hypothesis is dubious given the deadweight efficiency and equity cost. Moreover, the long-term yield from such investment is quite uncertain in Vietnam. When 20 Analysing the income gap between rural and urban areas

32 investing in industry, the government has been influenced by group interest rather than dynamic efficiency (Dollar and Litvack, 1998). The consequence was that the development of industry (or urban areas) has come at the expense of efficiency for the whole economy, and agriculture (or rural areas) has suffered the most from such inefficient allocation. Heavy industry versus light industry At present, a shift in government investment from industry to agriculture will raise total output or economic growth in Vietnam. However, eventually agriculture must reach its limit, so such a shift cannot be considered a long-term policy to raise economic growth. According to Lewis dualistic theory (1954), long-term growth can only be achieved if there is continuous movement of surplus labour from rural agriculture to urban industry. During , while industrial output growth averaged 13 percent annually, industrial employment growth was only 4 percent; less than a third of the industrial output growth. This figure was as high as 80 percent for NIC countries (South Korea, Taiwan, Singapore) who pursued labour-intensive development in the 1970s and 1980s. So, despite rapid growth, industry has failed to absorb rural agricultural surplus labour. The growth pattern of industry is the main reason for this, as growth in industry concentrated on capital-intensive products rather than labour-intensive products. In its investment strategy, government has shown a strong preference for heavy industry rather than light industry. Table 21 provides a sectoral breakdown of top industrial projects which have been implemented in the period. All of the projects were in capitalintensive heavy industry, accounting for approximately 40 percent of total government investment in the industrial sector. Light industry, with a huge labour absorption capacity, was neglected. Sector Number of projects Total investment Top industrial projects Oil and gas Chemical and fertiliser Steel Cement Σ=20 Σ=79.98 Total investment in industrial sector Table 21: Government s top industrial projects: Source: Public Investment Program , June 1996 Unit: VND trillion. Government concentration of investment in heavy industry makes capital in the industrial sector less efficient, putting an upward pressure on the ICOR index. Urban workers are the main beneficiaries from this policy being equipped with more capital, resulting in higher labour productivity and higher wages. In contrast, rural farmers, which Analysing the income gap between rural and urban areas 21

33 are unable to move to industrial production, may struggle with one another for limited land and capital, keeping a low labour productivity, low income and low national output. Vietnam s comparative advantage lies in labour-intensive rather than capitalintensive products. Both the World Bank and UNDP are strongly urging the Vietnamese government to reverse its current policy focussing on capital-intensive products, claiming that this policy can only slow economic growth and widen the rural-urban gap (World Bank 1998b, UNDP 1999). Allocation of infrastructure While urban infrastructure is in rather good condition, rural infrastructure is generally underdeveloped, with most rural communities lacking access to even basic infrastructure. However, rural transportation, for example, seemed not to be a government priority in the recent past; the state investment program ( ) focused most transportation investment on the three developed centres of Vietnam (Hanoi-Hai Phong, Ho Chi Minh- Dong Nai-Vung Tau, and Quang Nam-Da Nang), leaving only 5 percent for investment in rural transportation. In recent years this situation has, however, improved as many roads and highways in rural areas are being upgraded. Although part of the government agenda, rural electrification also posed problems. Nearly 6 million Vietnamese households (30 million people) in rural areas had no access to electricity (VLSS 1998). In 1995, only 14 percent of electricity sold by the state-owned power company went to rural areas. Thus, 20 percent of the total population (urban people) consumed 86 percent of electricity. Rural consumers use only one-fifth the electricity of urban consumers, but pay more than twice as much per unit (UNDP 1999). The government aims at connecting all rural villages to the power grid by 2010 (Viet Nam News, 2003) While nearly all urban people have access to clean water, only 32 percent of rural people have access to clean water, of which only 5 percent had tap water. These numbers were even lower for some mountainous and Mekong River Delta areas (VLSS98). Generally speaking, the condition of the rural infrastructure is much lower than urban infrastructure. As government is virtually the exclusive provider, the outcome clearly reflects the disproportionate government investment between rural and urban areas for infrastructure. This biased investment is quite inefficient when it is estimated that return from rural investment in infrastructure is as high as 20 to 35 percent (World Bank, 1998a). Moreover, such high rates of return strongly suggest that infrastructure acts as a crucial bottleneck in rural economic development. Therefore, some reallocation of infrastructure investment from urban to rural areas will certainly increase total output of the whole economy Government influence of price incentives Exchange rate The real exchange rate has a direct impact on import-export activities. If importers benefit from real exchange rate over-valuation, exporters will lose and vice versa in the 22 Analysing the income gap between rural and urban areas

34 case of under-valuation. If rural and urban areas do not have an equal share in import and export activities, the valuation of the real exchange rate will have different effects on rural and urban areas. Unfortunately, it is not possible to classify imports and exports in terms of rural or urban areas. However, Figure 2 provides some information about the share of rural and urban areas in import-export activities. Excluding the small share of fertiliser, imports of consumer goods, fuels & raw material, and machinery & equipment mainly serve urban consumption and urban industry. In the period 1993 to 1998, fertiliser imports accounted for less than 5 percent annually, while the remaining 95 percent mainly went to urban consumption and urban industry. Import Export 100% 100% 80% Fertilizer 80% Agriculture 60% 40% 20% Consumer goods Fuels & Raw material Machinery & Equipment 60% 40% 20% Light industry & Handicraft Heavy industry & Minerals 0% % Figure 2: Components of import & export activities A different pattern exists for export activities. Agriculture exports had the largest share (45 percent) from 1993 to 1998, while heavy industry & minerals had the smallest share (28 percent). Light industry & handicraft exports were quite difficult to classify into urban and rural. However, there is sufficient evidence to conclude that rural areas are dominated by export activities and urban areas by import activities. The unequal share of rural and urban areas in import-export activities allows the exchange rate to have an important impact on the rural-urban gap. It is necessary to calculate the benchmark or equilibrium rate, which is defined as the rate consistent with sustainable current account and appropriate level of trade barriers (see Montiel, 1999). The exchange rate in 1992 is usually used as the benchmark because at that time the initial economic reforms were almost complete, and a large devaluation consistent with the state of the current account had already occurred (Duc Le Viet and Hang Tran Thi Thu, 1995). As Vietnam has many trade partners, the Real Effective Exchange Rate (REER) is used instead of the real exchange rate to reflect the exchange rate s impact on import-export activities. Analysing the income gap between rural and urban areas 23

35 Nominal REER Figure 3: Nominal and REER from 1993 to Source: Author s calculation based on GSO various statistical yearbooks. Figure 3 shows that while the nominal exchange rate remained rather stable over the period, the real exchange rate (REER) declined rapidly; the declining REER shows that the Vietnamese currency was increasingly over-valued over the period, thus acting as an implicit tax on exports or implicit subsidy on imports. The value of this tax (or subsidy) rate (R) is: R = REER benchmark REER current REER current REER benchmark is assumed to be at the 1993 level, and thus can be set at 100. Table 22 presents the result of the tax (or subsidy) rate from 1993 to The figures are calculated using the equation for R above. In 1998, the tax rate was as high as 31.8 percent, meaning that for exports worth 100 million VND, the exporter would have received a further 31.8 million VND if the exchange rate was at the benchmark of 1993, while for imports of 100 million VND the importer would have to pay a further 31.8 million VND. An obvious resource transfer (31.8 million VND) occurred from exporters to importers when the exchange rate was overvalued Nominal (1) REER (2) Implicit tax (subsidy) (3) 10.8% 14.8% 19.2% 25.9% 31.8% Table 2: Nominal exchange rate, REER and implicit tax (subsidy). Source: (1) & (2) are the author s calculations based on GSO data, (3) is the result using the equation for R. 24 Analysing the income gap between rural and urban areas

36 Without intervention the exchange rate automatically tends to its equilibrium value (though there may be some fluctuation in the short-run), so the persistent over-valuation can only be caused by government intervention (Montiel, 1999). Aiming at rapid industrialisation, the Vietnamese government has tried to over-value the national currency to make imports of machinery and materials cheaper for urban industry. However, this has come at the expense of rural exports. Investment in urban industry (using imports as inputs) becomes more profitable and investment in rural agriculture (exporting products) becomes less profitable. Overall, the distorted environment impairs investment efficiency and has negative implications for future growth. Experiences from the Latin America debt crisis and the recent Asian financial crisis clearly show the high price of pursuing an over-valued exchange rate. Tariff protection for industry and agriculture A salient feature of Vietnam s tariff schedule is the highly complex structure with many different rates leading to high protection. However, different activities have different levels of protection. The Effective Rate of Protection (ERP) is the most widely used indicator to compare the tariff protection across economic activities. ERP calculation results are presented in Table 23. Unweighted ERP Import weighted ERP Product weighted ERP ERP with product weighted for output and import weighted for input Economy 47.6% 47.1% 48.1% 52.0% Agriculture 10.1% 9.0% 10.4% 11.6% Industry 1 (Intermediate products) 26.5% 26.2% 31.5% 36.5% Industry 2 (Consumer products) 96.4% 95.8% 92.1% 96.2% Table 23: Effective rate of protection for industry and agriculture, Source: IDRC, The average ERPs for the economy as a whole were quite similar in 1999, ranging between 47.1 percent and 52.0 percent. The high level of distortion in resource allocation is revealed in the observation that the economy is generally highly protected. However, agriculture and industry have quite different levels of protection. The ERPs for agriculture are much lower than the national average, around only 10 percent. Thus under the current trade regime, urban consumers of agricultural products gain while rural producers lose. ERPs for industries producing intermediate goods average around 30 percent, while very high ERPs are observed for industries producing consumer goods (averaging between 92.1 percent and 96.2 percent). It should be noted that an ERP of about 30 percent is often regarded as the benchmark for assessment of the level of protection (Cockburn, 1998). Analysing the income gap between rural and urban areas 25

37 Though tariff protection causes a dead-weight loss in the national economy, the level of protection for the whole economy is mainly explained by the ERPs for urban industry, and thus urban areas still gain somewhat, while rural areas suffer most of the loss. Specifically, (i) prices of industrial products are raised relatively higher than prices of agricultural products, leading to negative price scissors against rural farmers. (ii) Private investment such as FDI and domestic investment will tend to flow into protected industry instead of agriculture (around 65 percent of total FDI occurred in industrial products with an effective rate of protection above 60 percent) (CIE, 1998). Export quotas for agricultural products While industrial products for exports receive many government favours, most major agricultural exports like rice, coffee, and agro-forestry products must abide by export quotas. As a result of export quotas, rural producers of agricultural products suffer lower domestic prices and lower quantities of exports, while urban consumers benefit from the lower price, and urban state exporting companies get monopoly rents. Take the rural-urban resource transfer from export quotas on rice as an example. Rice is a good choice as it accounted for 50 percent of total agricultural income and is the leading agricultural export. Every year, the government announces an upper limit on the volume of rice that can be exported from Vietnam during the next year, adjusted to take into account the domestic availability of rice. The rationale of this policy is to ensure an adequate supply of food for the domestic market ( national food security ). By imposing export quotas, the government lowers the price for rice, implicitly taxing rural producers of rice and providing a subsidy to urban consumers. Moreover, the difference between export price and domestic price (after adjusting for marketing cost) is a source of profit to quota holders (mainly SOEs). These SOEs were reported to be making as much as 30 USD per ton of rice (VET, 1998). As these SOEs are mainly located in urban areas, there is clear resource transfer from rural to urban areas via the lower price for urban consumers and monopoly rent to SOEs. It should be noted, however, that recently regulations for import and export have been relaxed and a gradual change in policies in favour of rural areas can be observed. Still, many quotas and taxes affect national prices, imports and exports. Though often important for some purpose, such as national food security, these regulations seem to be in favour of urban areas and harm rural areas The urban registration system Despite that both bias of government investment and price distortions contribute to the gap between rural and urban areas, a large gap cannot persist if there is perfect labour movement. Search cost (Yap, 1976; Papola, 1981), risk aversion, family relations (Stark, 1984), and education (Dominique, 1998) are suggested as important obstacles to labour movement. However, for countries like Vietnam, China, and the former Soviet Union, the 26 Analysing the income gap between rural and urban areas

38 urban registration system plays also an important role. In the past (five or ten years ago) migrants without urban registration were not allowed to access many basic services such as education and health care. At present, these migrants can access the services but the procedures are much more complicated and costly than those with urban registration. Lack of urban registration also creates difficulties in searching for employment. Even if the submission of urban registration is not required, other documents (resume/social situation) are usually required and these documents are issued by the local Peoples Committee where the applicant lives, and hence indicates where registration is held. This restricts, though does not exclude, opportunities for employment in some sectors. In Ho Chi Minh City a policy dating from 1989 states that people with urban registration are to be given higher priority in employment than those without urban registration. The main effect of the registration system is to segment the labour market by directing migrants into those sectors where they have less benefits and work in difficult conditions. In addition, migrants without urban registration also suffer many other disadvantages in accessing credit and buying or renting houses. As 80 percent of the population and 70 percent of the labour force reside in rural areas, the loss due to urban registration requirements can be enormous if labour is kept working in rural areas. A movement of labour from low productivity jobs in rural areas to high productivity jobs in urban areas is absolutely necessary for future economic growth. However, this can create negative effects, such as uncontrolled urbanisation. These negative effects can create losses. A balance between positive and negative effects needs to be found for sustainable development. 1.5 Conclusion Main findings A significant gap between rural and urban areas exists, which is indicated by several measurements. Urban people are significantly better off than rural people across regions, economic activities, ethnic groups, professions and educational levels. Over the past few years, this gap has been widening and has been the key factor in explaining the rising inequality index (in both the Theil and FGT (Log Variance) indices). Also, given the income structure difference between the two areas, this gap is expected to increase in the future. In this chapter, the existing rural-urban gap was decomposed into (i) various household characteristics and (ii) aggregate factors (characteristics gap and discrimination). In terms of household characteristics, all categories with the exception of demographics made a positive contribution to the rural-urban gap. Education and occupation were the foremost determinants of the gap (10.29 percent and percent respectively). In terms of aggregate factors, over one-third of the rural-urban gap (37.03 percent) was explained by the characteristics gap and the remainder (62.97 percent) was explained by discrimination. Discrimination was also the main factor in explaining the increase in rural-urban gap from 1993 to 1998, accounting for 76 percent of the increase. Because government policies were Analysing the income gap between rural and urban areas 27

39 the main cause of the discrimination, these results clearly demonstrate the strong impact of government policies on the gap in Vietnam. By concentrating investment in urban areas and distorting rural-urban price incentives, policies of the government are contributing to the above discrimination. In terms of the government s investment strategy, obvious imbalances are observed in industry versus agriculture, heavy industry versus light industry, and urban infrastructure versus rural infrastructure. All these investment imbalances caused an increasing gap between rural and urban areas. Rural-urban price incentives are severely distorted in favour of urban areas, examples of which are an overvalued exchange rate, rice export quotas and high tariff protection for industrial products. In addition, the urban registration system is an important factor in sustaining the gap between rural and urban areas, severely hindering labour movement. Surprisingly, none of these government policies pass efficiency or equity criteria. As Lipton (1997) said, Resource allocations, within the city and the village as well as between them reflect urban priorities rather than equity or efficiency (Lipton, 1977:56) Main policy implications Urban people are significantly better off than rural people in terms of poverty incidence, depth, severity, and vulnerability; therefore, poverty is largely a rural phenomenon, according to the statistics. Any poverty alleviation effort must be concentrated in rural areas. Because dynamic inequality is mostly explained by the widening gap between rural and urban areas, efforts to prevent inequality from rising must be concentrated on narrowing down the rural-urban gap. Moreover, as welfare distribution in rural areas is more equal than that in urban areas, a given amount of extra income will probably be distributed more equally (and will thus generate more welfare) in rural rather than in urban areas. Therefore, economic growth targeting rural areas creates a more equal distribution and more social welfare than that targeting urban areas. Due to the positive impact of education on the gap, programs to expand education without rural-priority will probably increase the gap. In addition, urban concentration can be found for higher levels of education and rural concentration for lower levels of education, thus investment in the lower levels benefits rural people more than urban people. As the government budget is usually limited in providing education services, it should concentrate its limited efforts on lower levels of education and on rural areas to reduce the rural-urban gap. Because of the dominating share of rural labour in agriculture, government projects targeting agriculture will have strong positive effects on rural income, strongly reducing rural-urban gap. In addition, as other occupations are significantly better off than agriculture, widening occupation alternatives in rural areas is crucial to increasing rural income. A significant return gap in occupation between the two areas means that labour productivity is higher in urban areas than in rural areas. The concentration of physical capital (machinery) in urban areas explains the productivity gap between the two areas, thus 28 Analysing the income gap between rural and urban areas

40 policies are needed to move labour from low-productivity jobs in rural areas to highproductivity jobs in urban areas, making more efficient use of both labour and capital resources. Many government policies suffer from urban-bias, not only increasing the gap but also inhibiting economic growth. There is too much government investment in urban areas, leading to inefficiency and lower national output. The government should reallocate some investment from industry to agriculture, from heavy industry to light industry, and from urban infrastructure to rural infrastructure. There is a severe distortion in prices, leading to a social dead-weight loss and an unjust transfer from rural to urban areas. The government could help alleviate this distortion by abolishing agricultural export quotas, following an equilibrium exchange rate, and allowing fair tariff treatment between industry and agriculture. In general, by pursuing an efficient investment strategy and getting the price right, the Vietnamese government can achieve both a higher economic growth and a lower ruralurban gap. Analysing the income gap between rural and urban areas 29

41 Appendix 1: Econometric decomposition of the rural-urban gap The decomposition starts with a standard regression function, which is widely used to analyse determinants of household per capita expenditure (Glewwe, 1986; Deaton, 1997) ln Y = α + βx + u (1) ln Y is the natural log of household per capita expenditure, α is intercept, X is a vector of individual characteristics such as educational attainment, occupation, and household demographics, β is a vector of coefficients or return to characteristics, and u is a random disturbance term reflecting unobserved characteristics. Because discrimination may exist between urban and rural areas, dummy variables are necessary to reflect this discrimination. Equation 1 is thus modified as follows: ln Y = α + α 1 U + βx + β 1 UX + u (2) Here, U = 1 if urban and U = 0 if rural. If there is no discrimination between the two areas, then both α 1 and β 1 equal zero, so in that case Equation (2) is the same as Equation (1). A fundamental feature of the least squares estimator is that the fitted regression line will pass through the mean (average) value of both rural and urban areas. This implies that: Urban: Rural: ln u = α + α 1 + ( β + β 1 Y ) X r r u ln Y = α + β X (3) Then the difference for the two areas (urban minus rural) is: ln Y u ln Y r = α 1 + β 1 X u + β ( X u X r ) (4) rural-urban gap environment gap return gap characteristics gap discrimination Equation 4 is similar to the Oaxaca-Blinder s decomposition (1976), which was widely used in economics literature to analyse the gap between groups such as gender gap, racial gap, ethnic gap (Lazaer 1979, Freeman 1981, Corcoran and Duncan 1979, Filer 1983). Recently, Dominic (1999) has used this decomposition to explain the gap between ethnic groups in Vietnam (using 1998 VLSS data) i. 30 Analysing the income gap between rural and urban areas

42 Equation (4) states that the rural-urban gap ( lnyu lnyr ) can be decomposed into the three components on the right hand side. The first component is the environment gap, which means that the economic environment in urban areas is more favourable than rural areas, so that urban households can be better off than rural households (after controlling for household characteristics). The second component is the return gap, which means that urban households have higher return to the characteristics than rural households do (after controlling for household characteristics). The third component is the characteristics gap, which means that urban households have richer characteristics than their counterparts in rural areas. In particular, urban households have higher grades of education, are working in well-paid jobs, have less babies, and more adults. In Equation 4, discrimination is the gap between rural and urban areas after controlling for household characteristics. It means that discrimination is equal to the combination of the return gap and the environment gap. The Neoclassical view is reflected by the characteristics gap, and the Institutional view is reflected by discrimination. Equation 4 can also be used to explain a change in the rural-urban gap over time. The above concepts are replaced with one-letter symbols for ease of presentation: Gap: G = lnyu lnyr Environment gap: E = α 1 Characteristics gap: I = β ( X u X r ) Return gap: R = β 1 X u Equation 4 can then be rewritten as: G = E + R + C (5) So, dynamic change in the gap from time t to time t+1 is decomposed as follows: G t+1 G t = (E t+1 E t ) + (R t+1 R t ) + (C t+1 C t ) (6) Equation 6 states that the change in gap can be decomposed into three components on the right hand side: the first is the change in the environment gap, the second is the change in the return gap and the third is the change in the characteristics gap. From this decomposition, we can understand the role of each factor in explaining the widening gap in Vietnam over the past years. Results should be considered indicative or suggestive, rather than accurate (Litchfield, 1999). Analysing the income gap between rural and urban areas 31

43 Appendix 2: Methodology Variables Following other studies on the determinants of household per capita expenditure or welfare (Wodon, 1999; Glewwe, Gragnolati and Zaman, 1999), the next variables are included in the regression function (Equation 2 in Appendix 1). Education (of the household head): no education, primary-education, lowersecondary, upper-secondary, university (college) and higher. No education is treated as the benchmark; four dummy variables are used for the remaining educational grades. As people acquire higher educational attainments, they are likely to have a higher level of welfare. Occupation (of the household head): agriculture, non-working, sales and others, blue-collar workers, and white-collar workers. Agriculture is used as a benchmark, four dummy variables are used for the remaining occupations. It is normally expected that white-collar workers have the highest level of welfare, with the lowest welfare being observed in agriculture and non-working. Demographics: the age of the household head (younger than 30, 30-40, 40-50, 50-60, 60 and higher; sex of household head (dummy variable with female treated as the benchmark); number of young children (younger than 7 years old); number of children (between 7 and 18 years old); number of adults (over 18 years old); marriage status of household head (dummy variable with single being treated as the benchmark). Ethnicity (of the household head): Chinese, Vietnamese, and other minorities. Other minorities is used as the benchmark, two dummy variables are used for the remaining ethnic groups. Chinese is usually associated with the highest level of welfare, the Vietnamese and finally other minorities. Optimum regression function The underlying regression function for decomposition is Equation 2 from Appendix 1. The analysis is run in STATA with survey linear regression command (avoiding heteroscedasticity). Many coefficients are not statistically significant; this is especially true for the coefficients representing the discrimination between rural and urban areas (α 1 and β 1 ). A testing down procedure is used to drop out insignificant variables. The final outcome is an optimum regression function, where all unimportant variables (with insignificant coefficients) are dropped. Explanation of the results The results of return gap and characteristics gap (see Equation 4 in Appendix 1) are presented in column C of Appendix 3. Column C6 is return gap β 1 X, and column u 32 Analysing the income gap between rural and urban areas

44 C7 is characteristics gap β ( X u X r ). The intercept row provides the environment gap α 1. In column B, the percentage numbers in brackets show the change in Y (per capita expenditure) from one unit change in X (characteristics); computed as EXP(return) 1. Based on column C, we can derive the percentage share of each factor in the rural-urban gap ( ln Y ln Y ). u r Analysing the income gap between rural and urban areas 33

45 Appendix 3: Regression and decomposition results: 1998 Education A B C Average value Rural X r Urban X u Rural β Return (or coefficient) Gap β 1 Urban β+β 1 β 1 u Return gap Characteristics gap X β X X ) ( u r (1) (2) (3) (4) (5) (6) (7) Primary (12%) (12%) Lower-secondary (21%) (21%) Upper-secondary (37%) (49%) University or higher (73%) (73%) (No-education) Occupation sum up Σ=1.00 Σ=1.00 Σ= Σ= White-collar workers (35%) (58%) Blue-collar workers (12%) (38%) Saler and service (11%) (35%) Non-working (6%) (34%) (Agriculture) Demographics sum up Σ=1.00 Σ=1.00 Σ= Σ= Age of the head (3%) (-1%) Sex of the head (-6%) (-6%) (Male=1, Female=0) Number of baby (-9%) (-9%) Number of adult (6%) (10%) Marriage status (7%) (7%) (Couple=1, Single=0) Number of children (-6%) (-10%) Ethnicity sum up Σ= Σ= Vietnamese (33%) (33%) Chinese (71%) (71%) (Other minorities) sum up Σ=1.00 Σ=1.00 Σ= Σ= Intercept α=7.265 α 1 = α+α 1= Σ= Σ= Analysing the income gap between rural and urban areas

46 References Bates, R. (1981) Markets and States in Tropical Africa, University of California Press, Berkeley, California. CIE (1998), Vietnam s Trade Policies 1998, Centre for International Economics, Canberra and Sydney. Cockburn, A. (1998), Manufacturing Competitiveness and the Structure of incentives in Mali, EAGER/TRG project. Corcoran, M. and Duncan, G.J. (1979), Work History, Labor Force Attachment, and Earning Differences Between Races and Sexes, Journal of Human Resources, 14, no. 2, Winter 1979, pp Deaton, A. (1997), The Analysis of Household Surveys: a micreconometric approach to development policy, John Hopkins University Press. Dollar, D. and Litvack, J. (1998), Macroeconomic reform and Poverty Reduction in Vietnam s Transition, The World Bank, Washington D.C. Dominic, V. (1999), Causes of Ethnic Inequality in Vietnam, World Bank, Washington D.C. Dominique, M. G. (1998), Immigration Flows and Regional Labour Market Dynamics, International Monetary Fund Working Paper 98/47 (April 1998). Duc Le Viet and Hang Tran Thi Thu (1995), Ban ve pha gia va kha nag thuc hien pha gia o nuoc ta, Economic Studies, Hanoi. Filer, R.K. (1983), Sexual Difference in Earnings: The Role of Individual Personalities and Tastes, Journal of Human Resources, vol. 18. Foster, J., Greer, J. and Thorbecke, E. (1984), A Class of Decomposable Poverty Measures, Econometrica, vol. 52, pp Freeman, R.B. (1981), Troubled Workers in the Labor Market, NBER Working Papers 0816, National Bureau of Economic Research, Inc. Glewwe, P. (1986), The Distribution of Welfare in Cote d Ivoire in 1985, Living Standards Measurement Study Working Paper No. 29, The World Bank, Washington D.C. Glewwe, P., Gragnolati, M., Zaman, H. (1999), Who gained from Vietnam s boom in the 1990s? An analysis of poverty and inequality trends, Policy research working paper no. 2275/ World Bank, Development Research Group, Washington, D.C. GSO (1999), VLSS s Household Questionnaire: , General Statistical Office, National Steering Committee, Hanoi. (Last visited: ) IDRC (1999), The nominal and effective rates of protection by industry in Vietnam, International Development Research Centre, Hanoi. Lazear, E.P. (1979), Why Is There Mandatory Retirement?, Journal of Political Economy, vol. 87 (6), pp Analysing the income gap between rural and urban areas 35

47 Lewis, W.A. (1954), Economic Development with Unlimited Supplies of Labour, Manchester School of Economic and Social Studies. Lipton, M. (1977), Why poor people stay poor. A study on urban bias in world development, Temple Smith, London. Litchfield J.A. (1999), Inequality: Methods and Tools, Text for World Bank s Web Site on Inequality, Poverty, and Socio-economic Performance: McNabb, R. and Ryan, P. (1990), Segmented labour markets, in: Sapsford, D. and Tzannatos, Z. (eds.), Current Issues in Labour Economics, MacMillan, London. Montiel, H. (1999), Exchange rate misalignment: Concept and measurement for developing countries, Oxford University Press, New York. Papola, T. S. (1981), The Urban Informal Sector in a Developing Economy, Vikas Publishing House. Ravallion, M. (1994), Poverty Comparisons, Fundamentals of Pure and Applied Economics, vol. 56, Harwood Academic Publishers, Chur. Reder, M.W. (1971), Wage differentials Theory and Management, in: Burton, J.A., Benham, L.K., Vaughn, W.M. and Flanagan, R.J (eds.), Readings in Labour Market Analysis, Holt, Rinehart and Winston Inc.,New York. Stark, O. (1984), Rural to urban migration in LDCs: A Relative Deprivation Approach, Economic Development and Cultural Change, no. 32 pp UNDP (1999), Looking Ahead, United Nations Development Program, Hanoi. VET (1998), Vietnam Economic Times, March 1998, Hanoi, Vietnam. Viet Nam News (2003), All communes to have power by 2010, (National English Language Newspaper). Wodon, Q. (1999), Growth, Poverty and Inequality: A Regional Panel for Bangladesh, World Bank, Washington, D.C. World Bank (1998a), Promoting Vietnam s Rural Development: from Vista to Action, World Bank, Hanoi. World Bank (1998b), Vietnam Rising to the Challenge: An Economic Report, Poverty Reduction and Economic Management Sector Unit, East Asia and Pacific Region. World Bank (1999), Vietnam Attacking Poverty, Washington D.C. Yap, L (1976), Rural-urban migration and urban underemployment in Brazil, Journal of Development Economics, no. 3 pp Endnote i The author is indebted to Bob Baulch (World Bank, Hanoi) and Vu Quoc Huy (UNDP, Hanoi) for their suggestion of this decomposition. 36 Analysing the income gap between rural and urban areas

48 Chapter 2. Social Safety Nets; Identifying the Poor Le Duc Truong 2.1 Introduction The social safety net of a country involves arrangements developed to protect vulnerable groups within a population, and consists of all transfer programs designed to play both a redistributive and risk reduction role in poverty reduction (World Bank, 1999). Vietnam is transforming to a market economy while a large proportion of its population is still living in poverty: developing a reliable social safety net to protect the poor is an integral part of Vietnam s poverty reduction strategy. Some studies (Van de Walle, 1998; World Bank, 1999) suggest that Vietnam s social safety net is inequitable and has low coverage. In particular, social transfers are not properly targeted, and as a result the beneficiaries of the current system are not necessarily the poor. This chapter assesses the effectiveness of Vietnam s social safety net in protecting the poor by focusing on the issue of targeting. The outline of the chapter is as follows. In the next section, Vietnam s social safety net is described, including the current methods of targeting. In Section 2.3 a benefit incidence analysis of Vietnam s social safety net is conducted, using the Vietnam Living Standards Survey (VLSS93) and (VLSS98) to determine how pro-poor the current distribution is, and to what extent the social safety net of Vietnam has contributed to poverty reduction. Finally, in Section 2.4 a proxy means test to predict the welfare of potential recipients is assessed for its usefulness in targeting social transfers. 2.2 The social safety net of Vietnam Public expenditure on social protection in Vietnam is similar to that of the other lower income countries of Asia and Latin America (Fakin and De Crombrugghe, 1996). In 1997, public expenditure as a percentage of GDP was 23 percent, of which social security expenditure accounted for 14 percent (United Nations Vietnam and MOLISA, 1999). Expenditure on social safety protection and programs increased more than twofold in real terms in Vietnam between 1990 and 1997 (Thompson, 1999). The current social welfare system of Vietnam consists of five funds/programs: (i) the Social Guarantee Fund for Veterans and War Invalids, (ii) the Social Guarantee Fund for Regular Relief (the disabled, orphans, and the elderly), (iii) the Contingency Fund for Preharvest Starvation and Natural Disasters, (iv) the Hunger Eradication and Poverty Social Safety Nets 37

49 Reduction Program (HEPR) and (v) the Social Security System (for employees in stateowned enterprises (SOEs), civil servants and Vietnamese staff in non-state enterprises). Figure 1 shows the structure of spending in the welfare sector for Spending on pensions for state employees and payment to war veterans accounted for 75 percent, while the HEPR program attracts around 22 percent of spending annually. Welfare fund for the Poor 22% All other items 3% War Veterans 37% Pensions for State Employees 38% Figure 1: Breakdown of social welfare spending by type, Data source: ILO (1999) Targeting Each component of Vietnam s social safety net has different objectives, leading to different targeting outcomes. Although the government made a commitment to reducing poverty by launching the HEPR program in 1998, most of the other social welfare spending goes untargeted. The political will to raise the living standards of state employees and civil servants, and especially those who have contributed to the wars, is strong. Compensating those who have contributed to the wars in Vietnam is recognised by the government as one of the most important objectives of the social safety net. As a result, the Social Security System makes no effort to target the poor while the Social Guarantee Fund for Veterans and War Invalids exists purely on social and political grounds without any consideration of its economic efficiency. Freeing up resources by cutting and reallocating funds in these areas would be socially and politically difficult. However such payments should eventually depend more on individual circumstances. It is not impossible to target the poor within the politically privileged group, provided that the poor can be correctly identified. If the welfare levels of beneficiaries are known, it is possible to introduce an element of targeting whereby transfers would go primarily to the needy Current Methods of Targeting Vietnam s current social safety net is a highly decentralised, community-based system where beneficiaries of programs are identified at the local level, by the commune chairman and by mass organisations such as the women s union, the veterans group, and farmers associations, according to norms dictated by the Ministry of Labour, War Invalids 38 Social Safety Nets

50 and Social Affairs (MOLISA). The current method of targeting, which relies heavily on local selection of beneficiaries, may not be appropriate. Although there are clear advantages to local targeting, there are also possibilities for arbitrary selection, even when national criteria are established. MOLISA sets national standards for identifying the poor but the standards are interpreted and implemented inconsistently across the different regions in Vietnam. The local authorities are often very powerful, and political favouritism and other abuses of power almost certainly lead to biases. There is increasing seasonal and permanent migration to cities and other (non-urban) areas. Because many criteria exist for becoming a registered and legal resident, migrants stay unregistered and without any kind of social security. Many jobs require official registration, as do schools, health care facilities and other public services. Unless households are registered residents, the local authorities can simply ignore them. Thus, a highly decentralised, community-based safety net may well create spatial poverty traps, such as those found in Southern China (Van de Walle, 1998). Local targeting also leads to inequality between regions. Local authorities have incentives to make the list of qualifying individuals as long as possible in order to maximise transfers. Because the provinces are required to contribute funds, final decisions on total spending may be determined by the availability of local resources, which explains different coverage rates among provinces. The national HEPR program conducts surveys following central guidelines to establish a registry of poor households at the commune level. The national criteria define the starving as those with an income per capita equivalent to less than 13 kilograms of rice per month in rural areas and 15 kilograms in urban areas. The poor are those with less than 15 kilograms in rural mountainous areas, 20 kilograms in rural delta and midland areas, and 25 kilograms in urban areas. In theory these criteria are used to identify beneficiaries of transfer and safety net programs. In practice, they are altered to take specific province characteristics (including locally available resources) into account. For example, the Mekong delta, which has relatively high incomes, uses a locally more acceptable income equivalent of 30 kilograms. Since the standards of poverty are not uniform across the country, there will be uneven coverage and leakage (i.e. identifying non-poor as poor). Poor people living in poor areas will not benefit as much as poor people in well-off areas. Of course, higher poverty lines do not imply that more of the poor are covered or that all below the line are covered: a higher poverty line may simply allow more of those higher up on the income scale to be covered. 2.3 Benefit incidence analysis of Vietnam s social safety net Benefit incidence analysis has been a good starting point for many studies assessing social safety nets, providing a useful first approximation (Van de Walle, 1995). Benefitincidence studies typically proceed by ranking individuals or households by some indicator of welfare (most commonly per capita household income or expenditure). For making valid distributional comparisons, the welfare indicator is normalised for cost-of-living Social Safety Nets 39

51 differentials and household demographics. Next, the average benefits received by groups are tabulated against the welfare indicators. This exercise reveals how the government s outlay or benefit of the program varies across the relevant welfare indicator. In other words, it shows who (the rich or poor) receives what proportion of the benefit. The VLSS93 and VLSS98, involving 4,800 and 6,000 households respectively, were used following the approach of the World Bank to measure poverty (World Bank, 1999). In this approach, data on household consumption expenditure is used to measure household welfare. Total household expenditure is divided by the number of people in the household to get to household per capita expenditure, which is then compared with the poverty line. The general poverty lines for 1993 and 1998 were calculated at 1,160,363 VND and 1,789,871 VND per year respectively. These poverty lines do not take into account possible economies of scale and different needs in household consumption. Estimating such equivalent scales embodied in the poverty lines has proved to be theoretically and empirically difficult and no attempt has been made to do so for Vietnam i. The VLSS93 and VLSS98 data include receipts in cash or in kind during the past 12 months from: (1) the Social Insurance Fund of the government (pensions, severance payments and other social insurance payments to civil servants and state employees) and (2) social subsidies (payments to war veterans and the families of war martyrs and other types social transfers). VLSS98 data also includes receipts in cash or in kind from: (3) funds or programs related to the government poverty alleviation policy (direct income transfer from the HEPR Program of the government). Income from this source is very small as the program focuses on credits rather than direct transfers to poor households. This direct income transfer was therefore lumped with loans received from the same source in order to fully assess the incidence of this program. VLSS93 and VLSS98 data also includes any income received from persons who are not members of the household, providing information on the informal social safety net of Vietnam. Incomes from two miscellaneous sources are counted as private transfers: gifts, including gifts related to weddings, funerals, birthdays etc. and dowry or inheritance. Loans from relatives and other private creditors, which constitute the informal financial market in Vietnam, are also counted as private transfers Incidence of Social Transfers The incidence of the three components of Vietnam s social safety net identified by VLSS98 are shown in Table 1. Income from the Social Insurance Fund corresponds to the Social Security System, Poverty Transfers and Poverty Alleviation Credit correspond to the national HEPR program, and income under Social Subsidies correspond to the remaining three funds. Table 1 provides the sample estimates of total transfer payments for 1993 and The estimated total social transfers received in 1998 of VND 9,023 billion is close to the total welfare spending of 9,300 billion VND in 1997 reported by MOLISA. Total social transfers increased more than twofold over the period Total loans granted under 40 Social Safety Nets

52 the HEPR program is estimated at VND 602 billion in Total social transfers including poverty credit therefore amount to VND 9,625 billion. Pensions and other payments to SOE employees and civil servants (the Social Insurance Fund) claim the largest share of total transfer (82.8 percent in 1998). In contrast, poverty alleviation transfers account for only 1.1 percent. It is possible that these transfers are underestimated: survey respondents may underreport this type of social transfer because they do not know the sources of their social incomes. If poverty loans are added, the share of poverty alleviation assistance received increases to 7.3 percent. Spending in 1998 prices (Billion VND) Share of total spending (%) Social Insurance Fund Social Subsidies Poverty Transfers Total 3, , Table 1: Composition of Public Spending on the Social Safety Net, Sample Estimates. Data source: VLSS93 and VLSS98. Table 2 displays the coverage of the social safety net of Vietnam. It shows the percentage of the population receiving social transfers. In 1998, 23 percent of the population of Vietnam received one or more social transfers. This coverage is low compared to other countries, For instance, in Hungary the social safety net covers 91 percent of households (Grootaert, 1997). The coverage of the Social Insurance Fund is the largest with 11.2 percent of the total population receiving pensions or other payments. Although much lower in total spending, social subsidies are only 1.6 percentage points lower than the Social Insurance Fund in terms of coverage. Payments under poverty programs in Table 2 consist of both poverty transfer and loans, which cover nearly five percent of the population. If loans were not included, the coverage rate would drop to 2.2 percent (see World Bank 1999). To examine how the poor benefit from social transfers, we classify the population by their welfare ratio. An individual s welfare ratio is his/her per capita expenditure as a percentage of the general poverty line. The poor are those with welfare ratios less than 100. The first welfare group (the poor) represents 37 percent of the population. The shares of the total population of the middle welfare groups, with welfare ratios between and are 29 percent and 14 percent respectively. The richest group (those with welfare ratios greater than 200) represent 20 percent of the population. Note that the welfare ratio is affected by social transfers; there exists a direct relation between income and expenditure. Social Safety Nets 41

53 Social Insurance Fund Social Subsidies Poverty Programs All social transfers Vietnam Welfare ratio < > Rural/Urban Rural Urban Region Northern Uplands Red River North Central Central Coast Central Highlands South East Mekong River Ethnic group Kinh Chinese Others Age of the household head or above Education of the household head No schooling Primary Lower secondary Upper secondary Tech./vocational University Table 2: Number of beneficiaries as a percentage of population, Data source: VLSS98. Note: The welfare ratio is defined to be per capita expenditure as a percentage of the general poverty line. 42 Social Safety Nets

54 Considering the Social Insurance Fund, the poor have the lowest coverage rate. Only 5.5 percent of the poor received pensions or other social insurance payments while 17 percent of the richest were able to do so. As people become richer, they are more likely to receive these transfers. Those with welfare ratios between have the highest coverage by social subsidies. This suggests that beneficiaries of social subsidies are likely to be middle-income people. The only pro-poor component of Vietnam s social safety net is transfers and loans from the HEPR program. The rates of coverage range from 7.5 percent for the poor to 1.7 percent for the richest. Although the objective of this program is explicitly to help the poor, it covers certain portions of the richer population. Table 2 also classifies coverage rates by indicators that correlate with poverty (rural/urban, region, ethnicity, age of household head and education level of household head). Compared to those who live in rural areas, those who live in urban areas are less likely to benefit from the HEPR program but are twice as likely to receive benefits from the Social Insurance Fund. Most social transfers seem to concentrate on the northern part of the country. Around 30 percent of the population in the north or central north receives one or more social transfers, while less than 20 percent of the population in the central or southern part does so. The north has a higher concentration of civil servants and SOE employees, who receive transfers from the Social Insurance Fund. This lifts up the coverage of total transfer for the regions in the north. Ethnic minorities are less likely to receive pensions but more likely to receive poverty assistance than the majority Kinh. Coverage also varies by age and education of the household head. Although people with household heads aged 30 or under are poorer and too young to receive pensions, they are not more likely to be covered by any other type of transfer. Pensions are directed to those with higher levels of education while the HEPR program tries to help those with lower ones. Table 3 shows the average amount of social transfers received per recipient. The Social Insurance Fund has the largest average payment per recipient. Poor recipients on average receive 462,000 VND per year, while recipients in the richest group on average receive nearly three times as much. The figures for transfers and loans under the HEPR program are worse. Although the poor are more likely to be covered, they receive smaller average payments than do the rich. The reason may be that poverty programs wrongly identify the rich as poor, and when the rich have access to poverty assistance, especially cheap loans, they are able to get a larger amount. When we consider average payment per recipient, the regional difference in coverage disappears, especially with the Social Insurance Fund. The majority Kinh still receive higher average amounts than do ethnic minorities. Those with younger household heads receive smaller amounts of any social transfer. Education levels of the household head once again positively correlate with the average amount received. Social Safety Nets 43

55 Social Insurance Fund Social Subsidies Poverty Programs Total social transfers Vietnam Welfare ratio < > Rural/Urban Rural Urban Region Northern Uplands Red River North Central Central Coast Central Highlands South East Mekong River Ethnic group Kinh Chinese Others Age of the household head or above Education of the household head No schooling Primary Lower secondary Upper secondary Tech./vocational University Table 3: Average amount of social transfers per recipient ( 000 VND per person per year). Data source: VLSS98. Note: The welfare ratio is defined to be per capita expenditure as a percentage of the general poverty line. 44 Social Safety Nets

56 Another way to look at the magnitude of transfer (and to asses the effect of the benefit on the welfare ratio) is to look at the amount of transfer as a percentage of household expenditure. Table 4 shows the ratio of social transfers (aggregated to household level) to household expenditure. The figures are then averaged for recipient households by type of transfer and group of the population. Transfers from the Social Insurance Fund finance the largest portion of expenditure of recipient households. The HEPR program finances 10.5 percent of household expenditure for the poor but more than that for the richest. When averaged for all social transfers, those with welfare ratios between are still the ones that obtain the highest benefit. Welfare ratio Social Insurance Fund Social Subsidies Poverty Programs All social transfers < > Vietnam Table 4: Social transfer as a percentage of household expenditure, recipient households. Data source: VLSS98. Note: The welfare ratio is defined to be per capita expenditure as a percentage of the general poverty line To capture the differences in coverage as well as average amount of transfer per recipient, Table 5 shows the average amount of transfer per capita (recipient and nonrecipient). The average person receives a social income of 127,000 VND or about 7 percent of the general poverty line figure. The largest portion of this income is from the Social Insurance Fund. The Social Insurance Fund is the most pro-rich component. Social subsidies seem to benefit those with a middle per capita expenditure. Poverty alleviation transfers and loans are the most pro-poor component but its targeting is far from perfect, with the non-poor receiving nearly as much as the poor. Total transfers concentrate on the urban population, the northern part of the country, the Kinh group, older households, and those with household heads having high levels of education. Among the three components, transfers and loans under poverty programs are best targeted to the poor. However, substantial targeting errors show up in the figures. Richer urban citizens receive on average more poverty assistance than rural citizens. The Red River Delta and the Central Coast have the lowest poverty transfer amounts and loans per capita. The incidence of poverty assistance is quite uniform across other regions, despite the fact that some regions such as the Northern Uplands and the Central Highlands are very poor. Social Safety Nets 45

57 Social Insurance Fund Social Subsidies Poverty Programs Total social transfers Vietnam Welfare ratio < > Rural/Urban Rural Urban Region Northern Uplands Red River North Central Central Coast Central Highlands South East Mekong River Ethnic group Kinh Chinese Others Age of the household head or above Education of the household head No schooling Primary Lower secondary Upper secondary Tech./vocational University Table 5: Amount of social transfer per capita ( 000 VND per person per year). Data source: VLSS98. Note: The welfare ratio is defined to be per capita expenditure as a percentage of the general poverty line. 46 Social Safety Nets

58 2.3.2 Targeting simulations The natural benchmark for assessing how well social transfers are targeted is a uniform, untargeted allocation of the same budgetary outlay. We consider a simulation where the actual social safety net is replaced by an equal lump-sum transfer of the same gross budget to all persons in Vietnam (75.5 million VND in 1997). If poverty increases then the social safety net is said to be biased in favour of the poor; if poverty decreases then the social safety net is said to be biased in against the poor. We assume that households use 100 percent of their social income to finance consumption expenditure, so that household expenditure changes by the same amount as social transfers do. ii Table 6 equalises all social transfers. With a budget of about 9.6 trillion VND, each person would receive a lump-sum transfer of 127 thousand VND. The simulated welfare distribution is given in the last row of Table 6. Poverty incidence decreases from percent to percent as a result of the reallocation. This is not surprising because in the simulation, large payments from the Social Insurance Fund are taken away from the rich and redistributed to the poor. The equalisation promotes 5.06 percent of the population from poverty to the next immediate welfare group, while it relegates 3.33 ( ) percent of the population to poverty. Given that the objective of the Social Insurance Fund is not explicitly to target the poor, current methods of local targeting, as described above, were applied to benefits from the other two components. However, the simulation in Table 7 shows that the distribution of these benefits does not differ from a uniform transfer scheme. Equalising social subsidies and poverty assistance or only poverty assistance virtually has no effect on poverty. The conclusion of these simulations and analysis above is that the social safety net of Vietnam is not targeted to the poor. The objectives of the two largest components of the social safety net are not to support the poor, and spending on the most pro-poor component, transfers and credits under the HEPR program, is much smaller. Simulated distribution Actual distribution welfare ratio < Total (actual) < Total (simulated) Table 6: Shifts between welfare ratio groups as a result of equalising all social transfers. Data source: VLSS98. Note: The welfare ratio is defined to be per capita expenditure as a percentage of the general poverty line. Social Safety Nets 47

59 Simulated distribution Actual distribution welfare ratio < Total (actual) < Total (simulated) Table 7: Equalising social subsidies and poverty assistance. Data source: VLSS98. Note: The welfare ratio is defined to be per capita expenditure as a percentage of the general poverty line The Private Social Safety Net in Vietnam The strength of private safety nets has important implications for the design and targeting of public programs. If Vietnam has a strong informal social safety net that is doing the job of a public one, policy priority might be shifted away from building a strong formal social protection system Table 8 shows that 82 percent of the population receives private transfers (including private loans), and the average amount (per recipient or per capita) received is larger than that of public transfer. The poor and the rich are virtually equally likely to receive private transfers. The percentage of population who receives private transfers varies slightly depending on where the household lives and the ethnicity of the household head. Younger households are less likely to receive private transfers than older ones. On the other hand, richer households, those who live in the north or in the South East, the Kinh group, or households whose head has higher levels of education are more likely to give private assistance to others. As the poor are involved in smaller informal transactions, it can be concluded that the private safety net in Vietnam does not benefit the poor as much as it does to the non-poor. While this may be a justification for increased targeting of public assistance to the poor, the question of public transfers crowding out existing private ones is a difficult issue. Policymakers need to know the extent and patterns of crowding out among different types of public transfer as well as different groups of the population. 48 Social Safety Nets

60 % of population receiving % of population giving Amount received per recipient per capita Amount given per recipient Per capita All Vietnam Welfare ratio < > Rural/Urban Rural Urban Region Northern Uplands Red River North Central Central Coast Central Highlands South East Mekong River Ethnic group Kinh Chinese Others Age of the household head or above Education of the household head No schooling Primary Lower secondary Upper secondary Tech./vocational University Table 8: Private Transfers in Vietnam, Data source: VLSS98. Note: The welfare ratio is defined to be per capita expenditure as a percentage of the general poverty line. Social Safety Nets 49

61 2.4 Proxy means tests for targeting social transfers The current method of targeting has produced dismal results. Although political motivations for the current distribution is a hindering factor, the outcome is attributable to the incorrect method of identifying the poor at the local level. In this section an alternative method is proposed The need for a proxy means test The current method of local targeting is very similar to an application of means testing. The poverty line used is a food poverty line constructed by MOLISA. However, the interpretation of this poverty line is inconsistent across different regions of Vietnam. Problems arise mainly because there is no reliable method of determining the income or living standards of individuals. Income taxation applies to only a small part of the population and agricultural and land tax are generally fixed given geographic location and land quality. Since they do not vary with output, they are not very useful for the assessment of agricultural incomes. Also, production often takes place with family labour, which is not priced in a labour market and thus difficult to estimate. For these reasons, incomes used for assessing eligibility are often self-declared, subject to verification by local governments. By contrast, there is great prospect for applying self-targeting in Vietnam, where the design of the program itself appeals only to certain population groups. With high unemployment or underemployment and no unemployment benefits, public work programs may be particularly important in reducing poverty. The World Bank (1999) suggests that self-targeting should be used in Vietnam wherever possible. However, self-targeting can only be a partial answer to the question of how to target existing safety net programs. With the exception of self-targeting, all methods of targeting need to know the welfare levels of potential recipients. One way of doing that is to predict welfare based on verifiable household characteristics. This method is called proxy means testing. The use of OLS regressions to predict welfare has some important advantages over other algorithms. It is relatively simple and familiar to policy-makers and therefore has a greater chance of being implemented if the experiment with household data produces good results Selecting variables for the models Household characteristics that are closely correlated with welfare are chosen as explanatory variables and are used to predict household per capita expenditure, an indicator of living standard. Transforming per capita expenditure reported in the questionnaire into logarithmic form reduces the skewness in its distribution. Explanatory variables in our models therefore predict the logarithm of per capita expenditure iii. These predicted values are then transformed back to per capita expenditure for determining eligibility. The list of selected explanatory variables is provided in Table 9. Dummy variables are created in such a way that the variable identifies those characteristics that discriminate between the poor and the non-poor. Ownership of durable goods is the most difficult to verify. The benefit of including the asset variables must be weighed against the cost of obtaining and verifying them. 50 Social Safety Nets

62 Variable Description Location variables RURAL =1 if the household lives in rural areas, =0 otherwise REG1 =1 if the household lives in the Northern Uplands, =0 otherwise REG2 =1 if the household lives in the Red River Delta, =0 otherwise REG3 =1 if the household lives in the North Central, =0 otherwise REG4 =1 if the household lives in the Central Coast, =0 otherwise REG5 =1 if the household lives in the Central Highlands, =0 otherwise REG7 =1 if the household lives in the Mekong River Delta, =0 otherwise ETHNIC =1 if household head is a minority, =0 if Kinh or Chinese Housing variables PERM =1 if the household has a permanent house, =0 otherwise TAP =1 if the household has access to tap water, =0 otherwise WELL =1 if the household has access to well water, =0 otherwise ELECTRIC =1 if the household has electricity, =0 otherwise TOILET =1 if the household has flush toilet, =0 otherwise ROOF =1 if the house has concrete, tile, panel or iron roof, =0 otherwise WALL =1 if the household has concrete or fired-brick wall, =0 otherwise Family variables HHSIZE Number of people in the household PCTADULT Percentage of household member that are adults (>=18 years old) AGE Age of household head EDUCYR Years of education of household head HEADAGRI =1 if the household head works in agriculture, =0 otherwise Ownership of durables RADIO =1 if the household owns a radio, =0 otherwise TV =1 if the household owns a television, =0 otherwise STEREO =1 if the household owns stereo equipment, =0 otherwise VIDEO =1 if the household owns a video player, =0 otherwise MOTOBIKE =1 if the household owns a motorbike, =0 otherwise TELPHONE =1 if the household owns a telephone, =0 otherwise FRIDGE =1 if the household owns a fridge, =0 otherwise AIRCDN =1 if the household owns an air-conditioner, =0 otherwise ELECFAN =1 if the household owns an electric fan, =0 otherwise Table 9: Variables used in predicting household welfare. The four sets of variables in four different regression models have been combined. The first model uses only location variables. The second model uses location and housing variables. The third model adds family characteristics to the second model. The fourth Social Safety Nets 51

63 model is a full model that contains all four sets of variables. The regression results of Models I-IV are provided in Appendices 1.1 to Targeting accuracy Individuals are assigned to the eligible or ineligible group according to their predicted expenditures. We set the eligibility cut-off point at the general poverty line used in the previous section. Those who have predicted expenditure below the poverty line will be eligible and those who have expenditure above it will not. If both the predicted and actual expenditure of an individual are on the same side of the poverty line, it can be regarded as a targeting success. Targeting errors (when predicted and actual expenditures are not on the same side of the poverty line) are classified into under-coverage and leakage. Table 10 summarises the results of the simulations including targeting accuracy. Model I, which uses only location variables, identifies few people as poor. As a result, its under-coverage is very high with 71.6 percent of the poor being identified as ineligible. Other types of geographic targeting, for example Baker and Grosh (1994), produce better results because there are variables for many smaller regions as opposed to several large regions. VLSS98 classified the population into only seven large regions. Model I has the lowest leakage rate, in other words, it identifies few non-poor as poor. Targeting accuracy Transfer per Post-transfer Poverty iv Model (%) Undercoverage Leakage beneficiary (VND thousand) Headcount (α=0) (%) Poverty gap (α=1) Poverty severity (α=2) Model I (-22.85) (-33.75) (-41.30) Model II (-22.93) (-40.04) (-51.80) Model III (-21.73) (-44.34) (-58.88) Model IV (-23.09) (-47.22) (-62.73) Uniform transfer (-15.95) (-25.50) (-33.11) Perfect targeting (-41.56) (-58.59) (-69.46) Table 10: Targeting accuracy simulation results. Note: the fixed budget is VND 9,625,643,210,000. In the four models, those who receive a transfer should have predicted per capita expenditure below VND1,789,871. Numbers in parentheses are percentage change from the initial poverty 52 Social Safety Nets

64 indices before the transfer. Pre-transfer poverty indices were for α=0, 37.37%; α=1, 9.54%; and α=2, 3.55% (see also endnote iv). Model II adds housing variables to Model I and increases the predicting power according to the R-squared statistic from 39 percent to 49 percent. It also increases leakage and reduces coverage. Model III adds family variables to Model II and reduces undercoverage substantially although leakage remains almost the same. The reason may be that Model III starts introducing some continuous variables such as years of education and age of the household head. Variables on ownership of durables produce very good results. Including them in Model IV unambiguously increases targeting accuracy. Both undercoverage and leakage are reduced as the predicting power increases from 59 percent in Model III to 71 percent. This suggests that looking at ownership of durables is a very useful way to identify the poor in Vietnam, though it is also the most difficult way to collect data for Poverty reduction with a fixed transfer budget In our simulations, Model I has a lower leakage but higher under-coverage than the other models. How do we choose the best model considering the different levels and tradeoff between under-coverage and leakage? The best way is to look at the poverty impact of different models under a fixed transfer budget. The best model is one that reduces poverty the most. We assume a fixed budget of VND 9,625,643,210,000 to compare the models, which is the sample estimate of total state spending on Vietnam s social safety net in The only purpose of this assumption is to compare the models. Larger budgets would certainly have bigger impact on poverty than do smaller ones v. This budget is distributed evenly among those identified as eligible by the models. As the number of predicted poor people is different in each model, the amount of transfer received per person will differ by models. To see if the targeting method is acceptable, we compare the four models with a uniform transfer scheme where the fixed budget is divided equally among all individuals in the population, both poor and non-poor. This uniform transfer scheme would cover everyone so that the under-coverage is zero. Leakage is the proportion of the non-poor in the population, which is 62.6 percent. We also compare the models to the perfect-targeting transfer scheme where all of those who are actually poor are granted an equal amount to exhaust the fixed transfer budget. Both under-coverage and leakage under this scheme are therefore equal to zero. The poverty impacts of the four models, as well as that of the uniform and perfect targeting schemes, are also summarised in Table 10. Numbers in parentheses are percentage changes from the initial poverty indices before the transfer. All four models perform better than the uniform transfer targeting scheme. Poverty incidence was lowered from 37 percent to about 29 percent, which is a reduction of 23 percent. The uniform transfer scheme would reduce poverty incidence from 37 percent to 31 percent, which is a reduction of 16 percent. Social Safety Nets 53

65 In general, a lump-sum transfer reduces poverty more dramatically when we use higher values of α in the poverty indices (see endnote no. iv). With higher values of α, the superiority of Model IV begins to emerge. With α = 2, the poverty impact of Model IV is twice that of the uniform transfer targeting scheme and close to that of the perfect targeting scheme. Model IV just reduced poverty the most with all values of α and is thus our best model. To see if the models are sensitive to the poverty line, we use a lower poverty line estimated for Vietnam. In Table 11, the food poverty line is used to determine eligibility and to calculate poverty impact. We examine only Model IV as it is our best model. With a lower cut-off point, under-coverage is disappointingly high even for Model IV. This suggests that the OLS method is not very good at predicting the welfare of very poor people. The perfect targeting scheme would virtually eliminate food poverty while the uniform transfer would reduce about 30 percent of the initial headcount index. Model IV still performs better than the uniform transfer scheme and worse than the perfect targeting scheme. Targeting accuracy (%) Transfer per beneficiary Post-transfer Poverty (%) Model Undercoverage Leakage (VND thousand) Headcount Poverty gap Poverty severity (α=0) (α=1) (α=2) Model IV (-47.86) (-60.32) (-67.92) Uniform transfer (-29.11) (-40.02) (-48.08) Perfect targeting (-99.20) (-99.85) (-99.98) Table 11: Simulation results, using the food poverty line. Note: the fixed budget is VND9,625,643,210,000. In model IV, those who receive transfer should have predicted per capita expenditure below VND1,286,833. Numbers in parentheses are percentage change from the initial poverty indices before the transfer. Pre-transfer poverty indices were for α=0, 14.98%; α=1, 3.15%; and α=2, 1.02% Predicting Welfare for Rural and Urban Sub-Populations. Given that there are huge differences between the rural and urban populations in Vietnam, predicting expenditure using one model for the whole country might not be as accurate as using two separate models. The urban and rural populations differ in many of the characteristics that we use as explanatory variables. For example a relatively wealthy resident in a rural area may not have access to tap water. A separate model for the rural sub-population may also identify the poor more accurately because most of the poor in Vietnam live in rural areas. 54 Social Safety Nets

66 First the population is split into the rural and urban subsets and the full regression model (Model IV) is run for each subset. We just allow the variables and coefficients to be different between the two models. After the predicted per capita expenditures are obtained, the population is recombined to calculate the poverty impacts. Full regression results for the rural and urban sub-sets are provided in Appendices 1.5 and 1.6. Table 12 summarises the simulation results. The results, including targeting accuracy, are very similar to that presented in Table 10 for Model IV. This means that calibrating for rural and urban sub-populations does not improve the results. There is no additional benefit to compensate for the administrative cost of dividing the population into two groups and using two separate algorithms. Targeting accuracy (%) Transfer per beneficiary Post-transfer Poverty (%) Model Undercoverage Leakage (VND thousand) Headcount Poverty gap Poverty severity (α=0) (α=1) (α=2) Model IV (-23.20) (-47.10) (-62.40) Uniform Transfer (-15.95) (-25.50) (-33.11) Perfect Targeting (-41.56) (-58.59) (-69.46) Table 12: Simulation results, predicting expenditure separately for rural and urban areas. Note: the fixed budget is VND9,625,643,210 thousand. In model IV, those who receive transfer should have predicted per capita expenditure below VND1, Numbers in parentheses are percentage change from the initial poverty indices before the transfer. Pre-transfer poverty indices were for α=0, 37.37%; α=1, 9.54%; and α=2, 3.55% Predicting welfare for only the poorest half of the population The OLS method minimises the squared errors between the true and predicted levels of welfare. It may focus on predicting the welfare levels of those at the top or bottom of the distribution. This may also be more realistic than using the whole population. For most social welfare programs, the recipients must take some action to apply. They must incur some costs such as travel and application costs. Members of the middle and upper class may not bother to do so. This section uses the full model to predict the expenditures of only those at the bottom half of the distribution. The full regression was run again after deleting the observations for the richest 50 percent of the population to predict the expenditures of the poorest 50 percent of the population. The full regression results are given in Appendix 1.7. The simulation results are summarised in Table 13. Social Safety Nets 55

67 Targeting accuracy Transfer per Post-transfer Poverty Model (%) Undercoverage Leakage beneficiary (VND thousand) (%) Headcount Poverty gap Poverty severity (α=0) (α=1) (α=2) Model IV (-31.28) ) (-59.79) Uniform Transfer (-15.95) (-25.50) (-33.11) Perfect Targeting (-41.56) (-58.59) (-69.46) Table 13: Simulation results, predicting expenditure for only the poorest 50 percent of the population. Note: the fixed budget is VND9,625,643,210,000. In model IV, those who receive transfer should have predicted per capita expenditure below VND1,789,871. Numbers in parentheses are percentage change from the initial poverty indices before the transfer. Pre-transfer poverty indices were for α=0, 37.37%; α=1, 9.54%; and α=2, 3.55%. Using only the bottom half of the population improves targeting accuracy dramatically. Almost all the poor are identified with under-coverage less than 5 percent and leakage is slightly lower. Using the whole population reduces the headcount index by 23 percent while using only the poorest half achieves an impact of about 31 percent. With α = 1 and α = 2, the impacts are similar to that in Table 10, which uses the whole population Summary The proxy means test proves to be a reasonably good method for targeting social transfers in Vietnam. Credit is accorded with the ability of simple regression models to predict household per capita expenditure. All four sets of variables are good explanatory variables. The more variables added, the better the results. Variables on ownership of durable goods are particularly useful at predicting expenditures. However, they are also the most difficult to obtain. The benefit of including these variables should be weighed against the costs of verifying them. Possible options might be excluding all variables on ownership of durables or including only a few of them. Using four sets of variables to predict expenditure separately for rural and urban subpopulations does not improve the results. However, when targeting is conducted with only the poorest half of the population, almost all the poor are identified. Because targeting accuracy is increased, impacts on poverty, especially poverty incidence, improve substantially. 56 Social Safety Nets

68 2.5 Conclusions and recommendations A sound social safety net is particularly important to poor economies and transition economies. The primary objective of the social safety net in such countries is to protect the poor during normal and difficult times. With that in mind, the argument that public spending on social welfare should be targeted to the poor is well founded. However, targeting is known to be both difficult and expensive. The decision to target the poor has to be compromised with other objectives of the social safety net, such as smoothing the living standards of certain groups who are not necessarily poor. For Vietnam, some political motives may still be the most important factor that prevent social transfers from reaching the poor. Although it is very unlikely that this will be changed anytime soon, a consistent method for identifying the poor across regions of Vietnam is badly needed. The success of any social program requires that the poor are correctly identified. The Social Security System is the largest component of Vietnam s social safety net in terms of spending. Because this system is contributory and mostly covers those who work in the state sector, one possible proposal would be broadening the system to cover other groups of the population who are more likely to be poor, such as those who work in agriculture. The delivery of benefits or services of the other component programs is decentralised to the commune level. Beneficiaries are locally identified based on criteria that vary across geographic regions of Vietnam. Arbitrary selection and corruption at the local level cannot be ruled out. A conventional benefit incidence analysis of Vietnam s social safety nets shows the coverage of the formal system is relatively low with only 23 percent of the population receiving one or more types of assistance. By contrast, the informal social safety net, which primarily consists of private transfers and private loans, covers more than 80 percent of the population. However, both are not targeted to the poor. The poor are less likely to be covered than are the rich. Only 20.4 percent of those below the poverty line were covered while the middle-income and the richest groups have coverage rates between 23.6 percent and 26.4 percent. The absolute amount received per capita is also higher for richer groups. The Social Insurance Fund is the largest source of social incomes of the three components identified in VLSS98, and these incomes are for the relatively wealthy state sector employees. The second largest type of social incomes is paid from different social funds of the government and are reported as social subsidies in VLSS98. Because this component includes benefits to war veterans and families of war martyrs, who are not necessarily poor, it seems to target the rich and those at the middle of the welfare distribution. The smallest type of safety net assistance is poverty transfers and loans under the national HEPR program, which represents 7.3 percent of total safety net benefits received. Although this component is better targeted to the poor than the other two components, many of the non-poor still benefit from the program. One method of targeting that may outperform the current one is proposed. Data from VLSS98 are used to explore the usefulness of a proxy means test. The results are quite promising. Household characteristics, such as location of residence, housing and family Social Safety Nets 57

69 characteristics, and ownership of relatively expensive assets, can serve as good proxies for household welfare when combined in a simple regression model. Targeting accuracy improves as more variables are added to the model. The full model reduces undercoverage to around 30 percent and leakage to 24 percent. With the assumed fixed budget, it reduces poverty severity to a level very close to what could be attained by perfect targeting. Proxy means tests have great advantages over other methods: they obtain information about living standards of individuals and at the same time, prevent subjectivity and bias from both the individuals reporting incomes and the social worker evaluating these incomes. Following the convincing results of the targeting simulations, it can be concluded that proxy means tests constitute an effective targeting system for Vietnam. Reforms of Vietnam s social safety nets are critical to not only the country s poverty reduction strategy but also its more ambitious social and economic restructuring plans. Those reforms should be guided by the effective targeting system. Unlike self-targeting, proxy means tests are applicable to a variety of social programs. Therefore, one immediate policy implication may be the introduction of the targeting method to the national HEPR program, where political support is high. The same is true for the Social Guarantee Fund for Regular Relief and the Contingency Fund for Preharvest Starvation and Natural Disasters. With regard to the Social Guarantee Fund for Veterans and War Invalids, Vietnam currently should find itself struggling with the decision as to grant the poor or the heroes the legitimacy to receive the benefit. However, the targeting system still works even when the political will wins. If some element of proxy means testing is introduced, it will identify the poorer from the richer among intended beneficiaries, and officials should be tempted to discriminate recipients accordingly. Finally, the Social Security System might be an exception because it is contributory and relatively inaccessible to most of the poor, who are likely to work in agriculture and informal businesses. Introducing a minimum number of variables in the algorithm, or restricting benefit applicants to certain regions where the poor are concentrated, are some of the ways to minimise administration costs of implementing a method such as targeting. Discussing technical details in the design and implementation of such a targeting mechanism, as well as estimating the cost and benefit associated with it, is another issue. However, being aware that proxy means tests can work well encourages program designers to find cost-effective ways of implementing it. An appropriate targeting method, once found, ensures that public spending is used efficiently, and that one of the most difficult problems in designing a social safety net is solved. However, one should not forget that changing a social security system is politically, a very difficult issue. 58 Social Safety Nets

70 Appendix 1: Full Regression Results for Predicting Logarithm of Per Capita Expenditure A1.1 Model I: Location variables Number of observations = 5999 Number of strata = 10 Number of PSUs = 194 F (8, 177) = Prob > F = R 2 = 0.39 Variables Coefficient (β) T Prob. (β = 0) RURAL ETHNIC REG REG REG REG REG REG CONSTANT Note: Results are obtained from SVY regressions using STATA 6.0 Data source: VLSS98. Social Safety Nets 59

71 A1.2 Model II: Location and housing variables Number of observations = 5999 Number of strata = 10 Number of PSUs = 194 F (15, 170) = Prob > F = R 2 = 0.49 Variables Coefficient (β) T Prob. (β = 0) RURAL ETHNIC REG REG REG REG REG REG TAP ROOF WALL ELECTRIC WELL TOILET PERM CONSTANT Note: Results are obtained from SVY regressions using STATA 6.0 Data source: VLSS Social Safety Nets

72 A1.3 Location, housing, and family variables Number of observations = 5999 Number of strata = 10 Number of PSUs = 194 F (20, 165) = Prob > F = R 2 = 0.59 Variables Coefficient (β) T Prob. (β = 0) RURAL ETHNIC REG REG REG REG REG REG TAP ROOF WALL ELECTRIC WELL TOILET PERM HHSIZE EDUCYR AGE PCTADULT HEADAGRI CONSTANT Note: Results are obtained from SVY regressions using STATA 6.0 Data source: VLSS98. Social Safety Nets 61

73 A1.4 Location, housing, family, and assets variables Number of observations = 5999 Number of strata = 10 Number of PSUs = 194 F (26, 159) = Prob > F = R 2 = 0.71 Variables Coefficient (β) T Prob. (β = 0) RURAL ETHNIC REG REG REG REG REG TAP ROOF WELL TOILET PERM HHSIZE EDUCYR AGE PCTADULT HEADAGRI MOTOBIKE TV VIDEO TELPHONE STEREO ELECFAN AIRCDN FRIDGE RADIO CONS Note: Results are obtained from SVY regressions using STATA 6.0 Data source: VLSS Social Safety Nets

74 A1.5 Rural population Number of observations = 4269 Number of strata = 7 Number of PSUs = 136 F (26, 106) = Prob > F = R 2 = 0.58 Variables Coefficient (β) T Prob. (β = 0) ETHNIC REG REG REG REG REG REG ROOF TOILET PERM WELL HHSIZE EDUCYR PCTADULT AGE HEADAGRI MOTOBIKE TV FRIDGE VIDEO STEREO RADIO TELPHONE ELECFAN CONSTANT Note: Results are obtained from SVY regressions using STATA 6.0 Data source: VLSS98. Social Safety Nets 63

75 A1.6 Urban Population Number of observations = 1730 Number of strata = 3 Number of PSUs = 58 F (22, 34) = Prob > F = R 2 = 0.68 Variables Coefficient (β) T Prob. (β = 0) REG REG REG REG TOILET ROOF TAP WELL WALL EDUCYR HHSIZE PCTADULT AGE MOTOBIKE TELPHONE STEREO TV RADIO FRIDGE AIRCDN VIDEO ELECFAN CONSTANT Note: Results are obtained from SVY regressions using STATA 6.0 Data source: VLSS Social Safety Nets

76 A1.7 The Poorest 50 percent of the Population Number of observations = 2485 Number of strata = 10 Number of PSUs = 176 F (21, 146) = Prob > F = R 2 = 0.34 Variables Coefficient (β) T Prob. (β = 0) REG REG REG REG REG ROOF TOILET PERM WELL HHSIZE EDUCYR PCTADULT AGE TV MOTOBIKE ELECFAN FRIDGE VIDEO STEREO TELPHONE RADIO CONSTANT Note: Results are obtained from SVY regressions using STATA 6.0 Data source: VLSS98. Social Safety Nets 65

77 References Baker, J. L. and Grosh, M. E. (1994), Measuring the Effects of Geographic Targeting on Poverty Reduction. World Bank LSMS Working Paper, no. 99. Baker, J. L. and Grosh, M. E. (1995), Proxy Means Tests for Targeting Social Programs - Simulations and Speculation, World Bank LSMS Working Paper no Fakin, B. and De Crombrugghe, A. (1996), Patterns of Government Expenditure and Taxation in Transition vs. OECD Economies, Facultes Universitaires Notre-Dame de la Paix, no. 162, Namur. Grootaert, C. (1997), Poverty and social transfers in Hungary, World Bank Policy Research Working Paper 1770, World Bank, Washington D.C. ILO (1999), Social Safety Nets in Vietnam, International Labour Organisation, Hanoi. Minot, N. (2000), Generating Disaggregated Poverty Maps: An Application to Vietnam, World Development, vol. 28, no. 2, pp Thomson, K. (1999), Social Safety Net for Vulnerable Groups in Vietnam, VIE/98/032/09, International Labour Organisation, Hanoi. United Nations Vietnam and MOLISA (1999) Basic social services in Vietnam: An analysis of state and ODA expenditures, Hanoi. Van de Walle, D., Ravallion, M. and Gautam, M. (1994), How Well Does the Social Safety Net Work? The Incidence of Cash Benefits in Hungary, , World Bank LSMS Working Paper No. 102, Washington D.C. Van de Walle, D. (1995), Incidence and Targeting: An Overview of Implications for Research and Policy, in: Van de Walle, D. and Nead, K. (eds.), Public Spending and The Poor: Theory and Evidence, John Hopkins University Press, Baltimore and London. Van de Walle, D. (1998), Protecting the Poor in Vietnam s Emerging Market Economy, The World Bank Research Observer. World Bank (1999), Vietnam: Attacking Poverty, Vietnam Development Report 2000, Hanoi. Endnotes i Van de Walle, et al. (1994) use poverty lines for Hungary that are household specific, embodying such differences between households. ii Van de Walle et al. (1994) use panel data to derive the Propensity to Consume out of Social Income (PCSI) for Hungary. However, with PCSI less than unity, the results do not differ substantially. iii In contrast, Minot (2000) uses Probit models to predict the probability of an individual being poor. A Probit model has some advantage over OLS models in that it does not give much emphasis on predicting the welfare levels of those at the top of the welfare 66 Social Safety Nets

78 distribution. However, it does not produce consistent estimates in the presence of heteroskedasticity. iv The Foster-Greer-Thorbecke (FGT) class of poverty measures is often used to calculate the extent of poverty: p α 1 = n q i= 1 z y z i α where n is the number of individual in the population, q is the number of poor people, y i is the expenditure level of individual i, z is the poverty line and α is the poverty aversion parameter. If α = 0 we have the headcount index or the poverty incidence. If α = 1 we have the poverty gap. Values of α above 1 give more weight to larger poverty gaps. When a = 2, we have the poverty severity index. See also the chapter Analysing the Income Gap between Rural and Urban Areas in Vietnam in this book. v The assumption on the magnitude of the fixed budget is rather arbitrary. For example, the fixed budget for the sample in Baker and Grosh (1994) is equivalent to 10 percent of the poverty line times the number of individuals in the sample. Baker and Grosh (1995) take a fixed budget of 1 million domestic currency units (about 1 percent of the total welfare of the sample). Social Safety Nets 67

79 Chapter 3. The Impact of Income and Price on Nutritional Status in Vietnam Phan Hoai Duong 3.1 Introduction Income and food prices are regarded as important factors for decisions on food consumption and food expenditure of households, and hence for nutrient intake. It is obvious that in developing countries a higher income allows people to raise their nutritional status (World Bank, 1993). Evidence from some countries proves that there is a positive and significant effect of income on nutritional status and an adverse price effect on health of population (see for instance Lavy et al., 1995; Von Braun and Kennedy, 1994). In Indonesia, for example, rising incomes during brought about a reduction of malnutrition in nearly all fifty-two regions of the country. Conversely, higher food prices are generally translated into reduced nutritional status of poor people. For instance, during the 1980s in Côte d Ivoire increases in food prices reduced the weight of both children and adults (ibid.). It is expected that similar relationships also hold true for Vietnam. However, the effects of income and food prices on nutritional status by location (urban versus rural area), by gender, and by gender of household head are not clearly known. This chapter examines these issues, mainly using data from the Vietnam Living Standards Survey (VLSS98). The chapter discusses the following topics. Firstly, the next section gives an overview of existing studies that analyse the relation between income, prices and nutritional status. The section also contains a discussion of gender impacts and how to assess the nutritional status of a person. Section 3 analyses the nutritional status in Vietnam, while Section 4 specifically looks at the impact of income and prices on the nutritional status. Finally, Section 5 contains the conclusions and recommendations. 3.2 Theoretical overview Empirical studies of income and price impacts on nutritional status There are two broad types of studies on determinants of health: one type uses the reduced-form demand to estimate health outcomes, while the other uses the health production function of the household to estimate health outcomes. In the first type, income, prices and other factors are supposed to determine the health status of an individual; The impact of income and price on the nutritional status 69

80 whereas in the second type, the health of the individual is produced by a number of choices relating to consumption, time use, education, individual endowments, in addition to the education of relevant health decision-makers and implementers in the household, and household endowments. However, empirical research does not distinguish clearly between these two types of approaches, and there are fewer studies on health demand than studies on health production functions. Demand studies normally use cross-sectional data including household income, household characteristics and available health care, but often neglect market prices among explanatory variables. A large number of empirical studies has been carried out to analyse the relationships between income, prices and nutrition. Here we will discuss several studies that give a good representation of the current knowledge on this topic. Blau (1984) used predicted formal and informal sector wage rates, other incomes, the mother s age, education, and urban origin as independent variables to construct a demand function for age-standardised height of children under five years in Nicaragua. He concluded that the mother s (predicted) formal-sector wage rate significantly affects child health (positively), but that the informal-sector wage rate has no significant impact. To estimate joint reduced-form health and nutrient consumption status relations, Behrman and Deolalikar (1987) used an indicator of weight-for-height, and took into account various price and income responses by different household members (adult males, adult females, male children and female children). They found that three of six prices (rice, milk and male labour) had significant positive impacts on health status, even in the case of income control. Nevertheless, neither income nor differences in price and income responses had a significant effect across household members. They concluded that positive (income constant) price effects on health status may be due to strong cross-price substitution effects in the underlying food demand equations toward foods with high nutrient-to-food conversion factors. Estimating intra-familial deviation for health and nutrition demand relations in Nicaragua, Behrman and Wolfe (1984) and Wolfe and Behrman (1987) used many basic price and income variables in their demand equations. The results showed that income does not have a significant effect in any equation, whereas population size (a proxy for food prices) significantly negatively affected nutrition and breastfeeding. To determine anthropometric outcomes from public policy, Thomas et al. (1992) and Lavy et al. (1995) applied the same health outcome functions to Côte d Ivoire and Ghana using 1988 data. For children, z-scores of height-for-age and of weight-for-height were used as dependent variables. Household income was found to have a positive impact on child health, but was only significant for the height-for-age z-score among urban children. The result was similar in Ghana, where expenditure was not a significant determinant of child weight-for-height. However, the expenditure elasticity of the demand for height was both positive and significant in Ghana, and twice as high as the estimate for Côte d Ivoire. Both anthropometric measures were generally sensitive to price variations. In general, household per capita expenditure had a positive impact on adult BMI in Côte d Ivoire. However, it was different for men and women. The elasticity of BMI with 70 The impact of income and price on the nutritional status

81 respect to per capita expenditure (PCE) for men was much smaller than for women. An increase in household income is likely to be associated with substantial improvements in the women s health, while higher per capita expenditure is associated with a lower BMI in the lower third of the per capita expenditure distribution. Apparently, household income affects the health of men less than that of women. In Ghana, the household per capita expenditure also affects adult health significantly. There is a slight difference between the elasticity of BMI with respect to PCE by gender (higher for females than males) but elasticities were equal for rural and urban areas. Like the Côte d Ivoire case, the health of women in Ghana is very sensitive to changes in income level. Conversely, food prices are negatively associated with adult BMI in both countries. For example, adult BMI will decline by 10 to 20 percent if prices of beef and fish are doubled in Côte d Ivoire; and adult BMI will decline by 2.8 percent if all prices increase in Ghana. It is concluded that for both Côte d Ivoire and Ghana, nutritional status of children and adults are sensitive to changes in household income and food prices. However, these effects are distributed differently across the population Typically, in many health demand studies, prices have few significant impacts on the demand for health outcomes. There are two possible reasons: first, prices may be irrelevant in explaining inter-household variations in health status; second, empirical studies may use faulty methodologies or improper data. Many studies do not take care of probable simultaneity in right-hand-side choice variables. Most studies use poor proxies for health status, inappropriate prices and ignore the long lag with which prices may influence health. This reflects the difficulty of measuring and obtaining data to asses health and nutritional status. Health status, particularly of adults, is a cumulative outcome over a long time. That is why current prices and income, used as explanatory variables in most studies, explain health outcome poorly. In order to estimate health status well, it is necessary to have data over time (longitudinal data) on individuals and households, or studies on the demand for health outcomes should be restricted to infants and young children since there will be a small lag between current and cumulative factors. Both will be applied below Gender impacts An increase in household income does not always translate into improvements in nutrition. Many empirical studies (for example in India, Western Kenya, Malawi and Zambia) show evidence that serious malnutrition persists in households even if their per capita income has risen. It seems that equally high malnutrition persists in most households whether they are extremely poor, only moderately poor or even relatively well off in terms of income. One of the answers to this puzzle may lie in the gender of the person who manages the household income. A conventional household model is regarded as a pooling and sharing model of household income use, where all members pool their incomes together and use them jointly. In practice, however, households commonly are systems of male direction/female implementation of the household budget and separate male and female budget. In the The impact of income and price on the nutritional status 71

82 first system, men direct the allocation of income to different categories of use, whereas women implement budgeted expenditure to meet daily household needs. This system happens mostly in households where women themselves earn little or no income. In the second system, men and women separately direct and implement income use for household needs. This requires that women generate a substantial income of their own. It has been observed that women tend to distribute their income more to food than men do. For example, Guyer s study (1984) in Cameroon found that women both produce most of the staple food for family requirement and devote about 74 percent of their cash to the family food supply; while men produce no food and spend only 22 percent of their earnings on family food. Therefore, female income is inclined to have positive effects on child nutrition. Tripp s (1981) study of the relationship between the nutritional status of 196 children and the intra-household pattern of income control also illustrates that the mother s income from trade is associated significantly and positively with child nutritional status. Her earnings are used more directly for children s nutrition even if they are smaller than men s. Another study, carried out in Brazil (Haddad et al., 1997) using data from , also shows that an additional increase in maternal income, relative to paternal income, is associated not only with higher budget shares spent on nutrient intakes, but also with improved child nutrition outcomes. The nutritional status of women themselves is a problem. There are millions of malnourished women of childbearing age in developing countries (Ghasssemi, 1988). About 450 million women are stunted world wide because of protein-energy malnutrition, compared with 400 million men (World Bank, 1993). Women incur costs both in time and energy when they make more food available for their poor households. Consequently, female nutritional status does not improve or even declines. Kennedy (1989) shows that increases in income in both male and female-headed households in Rural Kenya raise female calorie intake but reduce the female Body Mass Index Assessing nutritional status Three indicators commonly used for assessing the nutritional status of children are height-for-age (for stunting), weight-for-height (for underweight) and weight-for-age (for wasting). All these three indicators can be calculated in terms of z-scores. A z-score of a child tells how many standard deviation units his measurements are away from the median of the reference distribution and takes the following form: z-score = Xo - Xm σ where: Xo is the observed value of a child (e.g., height), Xm is the median reference value of a child, σ is the standard deviation of reference population. 72 The impact of income and price on the nutritional status

83 According to World Health Organisation recommendations (FAO/WHO, 1993), a child who has a z-score value of minus two standard deviations or below is regarded as malnourished. The standards are taken from the U.S. National Centre for Health Statistics (NCHS) reference population and have been applied in Vietnam (Senemaud et al., 1998). For adults, the Body Mass Index (BMI) is a good choice for the anthropometric assessment of nutritional status. The BMI is a measure of chronic energy deficiency (CED) in adults (Shetty and James, 1994). CED is defined as a steady state where a person is in energy balance, as opposed to acute energy deficiency (AED). CED means that the energy intake equals the energy expenditure whether body weight and body energy stores are low or not; AED means that energy intake is less than the energy expenditure and will lead to death. Generally, a BMI value over 18.5 is considered normal (adequate nutrition), whereas a BMI value under or equal to 18.5 signifies CED. This index is best suitable for individuals between the ages of 20 and 65 years, excluding women who are pregnant or breast-feeding (Gibson, 1990). The formula for the BMI is: BMI = Body weight (Height) 2 where weight and height are measured in kilograms and meters respectively. 3.3 Nutritional status in Vietnam Presence of malnutrition About 37 percent of Vietnam s population were living in poverty in 1998 (data from VLSS98). More than 35 percent of children under five years of age wre stunted, over 30 percent were underweight, and nearly 40 percent of adults suffered chronic energy deficiency (CED). This reflects a serious public health problem (WHO, 1995). Malnutrition is different by gender with male children often having a higher prevalence of malnutrition than female children, but the opposite being true in adults. The prevalence of malnutrition in Vietnam for is presented in Table 1. Underweight a) Stunting a) Wasting a) CED b) % of children under 155 months % of adults from 18 years old Country Male Female Table 1: Prevalence of malnutrition in Vietnam by gender, Source: VLSS98. Note: criteria for a) anthropometric indicator is less than minus two standard deviations from the median of the NCHS sample (GSO, 2000); b) BMI equal or less than 18.5 (author s calculation). The impact of income and price on the nutritional status 73

84 Patterns of malnutrition in Vietnam vary according to age for both children and adults. For children, stunting and underweight rates increases rapidly from birth to the age of two (24 months), and after level off at a high rate of incidence, see Figure 1. There is a low weight-for-height peak in the second and third year of life, which declines then disappears at age months. Figure 1 indicates that the nutritional problems in children are most serious at age months. After two years of age, wasting children can obtain a normal body state because their height grows slowly allowing weight to catch up Percent Age (months) Height-for-age W eight-for-age W eight-for-height Figure 1: Incidence of Child Malnutrition in Vietnam, Source: GSO (2000) % of population Age group Adult's CED Male's CED Female's CED Figure 2: CED Distribution in Vietnam by age and sex, Source: Author s calculations based on VLSS98 74 The impact of income and price on the nutritional status

85 For adults, the pattern of BMI for men and women differs. For men, a normal BMI (i.e. a BMI > 18.5) mainly occurs between years, with BMI decreasing later. But for women, BMI is the highest between the ages of years. The prevalence of CED among adults in Vietnam is shown in Figure 2. The prevalence of malnutrition in Vietnam is among the highest in the world. In comparison with other countries of similar income levels (PPP GNP per capita between $1500 and $1700 annually), Vietnam has a lower proportion of underweight children than India does, but outnumbers Pakistan, Ghana and Côte d Ivoire. Some countries whose per capita incomes are lower than Vietnam have higher child malnutrition rates, such as Bangladesh, while others have lower rates of child malnutrition such as Mongolia, Gambia and Sudan (World Bank, 1999b), see Figure 3. Generally, Figure 3 shows that child malnutrition is negatively associated with income; but many deviation from the trend also suggests that child malnutrition is affected by other important factors. Children under five who are underweigh (%) India Vietnam Mongolia PPP GNP per capita (U.S. dollars) Figure 3: Income and Child Malnutrition in 15 Developing Countries, Data source: World Bank (1999) Causes of undernutrition In Vietnam, causes of undernutrition can be divided into three categories: immediate, underlying and basic causes (NIN, 1998). Being an immediate cause, inadequate dietary intake is the most common cause of undernutrition. In general, the Vietnamese diet is based on rice and some vegetables, and does not supply enough energy to meet the requirements of individuals. The average energy intake is 1,932 kcal/capita/day, which is only 84 percent of the recommended energy requirement of 2,300 kcal/capita/day according to FAO/WHO (1993). At the household The impact of income and price on the nutritional status 75

86 level, about 8.5 percent of households consume less than 1,500 kcal per consumer unit (CU) per day (regarded as chronic starvation) and 14 percent consume between 1,500 and 1,800 kcal/cu/day (inadequate energy intake). This means that 22.5 percent of Vietnamese households suffer from an insufficient dietary intake (UNICEF, 1991; FAO/WHO, 1993). According to a General Nutrition Survey ( ), rice was the staple food that dominated Vietnamese diets, accounting for 84.6 percent of energy intake and 59.7 grams of protein per capita per day (the recommended daily intake is 60g). Animal protein accounted for only 20 percent of total protein intake, whereas the recommended rate is 33 percent. Other dietary items comprised a very small proportion of total energy intake. Dietary intake was not the same across the country. The rural population consumes the lowest calories. Vietnamese patterns of dietary intake by region are illustrated in Table 2. Nutrients Urban Rural Mountainous No. = 1,655 No. = 9, 153 No. = 1,634 Total energy intake (kcal) 1,905 1,893 2,101 - Protein (%) Fat (%) Carbohydrate (%) Animal protein/total Protein (%) Vegetable oils/total fats (%) Table 2: Dietary intake in Vietnam in urban, rural and mountainous areas, per capita per day (1990). Source: NIN (1998). Household food insecurity is the underlying cause of undernutrition in Vietnam. According to VLSS98 (GSO, 2000), about 15 percent of the population are food poor, meaning they cannot buy enough food to meet 2,100 calories per day. This number is different between rural and urban areas, with only two percent of individuals lying under the food poverty line in urban areas, but 18 percent in rural areas. It is worth noting that food poverty fell remarkably from 25 percent in VLSS to 15 percent in VLSS98; that is two percent annually on average. This may explain the strong drop in child malnutrition between and , from 55 percent to 42 percent. Undernutrition in Vietnam is not a problem of insufficient food production, but availability, distribution and demand for food (UNICEF, 1994). The poor system of food procurement, transportation, storage and distribution, in addition to the existence of different major agricultural activities across regions, lead the population in some parts of the country to continuously suffer from chronic undernutrition. The final type of causes for malnutrition is basic causes. In general, undernutrition is associated with poverty. A region that has a higher level of poverty is one with a higher prevalence of undernutrition. Thirty seven percent of the population of Vietnam lives in poverty (VLSS98). The Northern Uplands is the poorest part of the country (59 percent of 76 The impact of income and price on the nutritional status

87 the population live in poverty), while Southeast is the richest (only 8 percent live in poverty). The correlation between poverty and undernutrition in different regions of Vietnam is illustrated in Figure Percent Country Urban Rural Northern Uplands Red River Delta North Central Coast Central Coast Central Highlands Southeast Mekong River Delta Poverty Underweight CED Figure 4: Undernutrition and poverty by region, Source: VLSS98. Notes: 1) The poverty rate is based on the total poverty line (GSO, 2000). 2) Underweight is the percentage of children aged months, who have weight-for-age z-scores less than two standard deviations below the median (GSO, 2000) CED is the percentage of adults (equal or over 18 years old) who have a BMI equal or less than 18.5 (author's calculation) Food consumption According to the VLSS98, income per capita per year in Vietnam is VND 3,073,000 (1998 prices; GSO, 2000) and varies among areas. Income per capita per year in urban areas is nearly four times that of rural areas. The Vietnamese use most (about 90 percent) of their income for expenditure and nearly half of total expenditure is for food. The food share of total expenditure varies between 38 percent and 64 percent. Expenditure on rice is the largest part of total food expenditure (24 percent), followed by meat (19 percent) and seafood (10 percent), whereas milk and milk products comprise less than 1 percent of food expenditure (ibid.). In general, the proportion of cereal consumption falls with increased total household expenditure, whereas consumption of meat, seafood, sugar and milk rises together with total expenditure. In Vietnam, households headed by women account for almost 22 percent and generally, female-headed households have a higher level of expenditure than male-headed The impact of income and price on the nutritional status 77

88 households (VND 3,345,000 and VND 2,712,000 per head per annum, respectively (1998 prices) (ibid.). In contrast, the proportion of food in total expenditure in male-headed households is higher than that in female-headed households (47.5 percent and 44.6 percent respectively). Moreover, consumption patterns differ by gender of household head, with male-headed households inclined to consume more rice, beer, coffee and tea but less meat and milk than female-headed households. It seems that the female head manages money more efficiently, particularly in taking care of household members nutrition Income and nutrition It is widely recognised that income and price influence people s nutritional status through purchasing power effects. The relationship between income, price and nutritional status may be explained through demand theory. Because of budget constraints, people must make a trade-off in allocating their resource to food and non-food items, and to allocate income to various kinds of food to maximise their satisfaction. Their choice of food, therefore, influences their nutritional status. An increase in purchasing power may enable people to enhance their health and nutrition. In recent years, Vietnam s economy has grown rapidly, accompanied with an increased per capita income. In parallel, the malnutrition rate has dropped significantly. During the stagnant economic period of , about 60 percent of Vietnamese children under five were stunted. After economic reform began ( ), the rate of stunting among pre-school children fell to 56 percent (Dollar et al., 1998). Between , economic growth saw GDP rise by 8.9 percent annually (Haughton, 1999) and the prevalence of stunting in 1999 fell to under 39 percent. The prevalence of CED in adults improved slightly, from 32 percent in to 28 percent in (World Bank, 1999a). The negative correlation between income and malnutrition can be seen in the two Vietnam Living Standards Surveys (Table 3). Expenditure per capita in was 1.4 times that of At the same time, child malnutrition in was only 0.8 times that of The relationship between income and nutritional status can be examined through different expenditure quintiles (Figure 5). The poorest households (Quintile 1) have the highest rate of malnutrition, and vice versa, the richest households (Quintile 5) have the lowest rate. Regional differences also shed light on the income-nutrition relationship. Rural areas (with a lower income) have a higher prevalence of malnutrition compared to urban areas, except in the case of wasting (Table 4). Among seven geographical regions in Vietnam, the Southeast region has the highest income per capita and also the lowest rate of undernutrition (both for children and adults). 78 The impact of income and price on the nutritional status

89 VLSS VLSS Rate of change (times) All Vietnam Expenditure/capita/year (VND 1000 at 1/1998 price) 1,936 2, Stunting (children aged months) 54.6* Urban areas Expenditure/capita/year (VND 1000 at 1/1998 price) 3,013 4, Stunting (children aged months) 37.3* Rural areas Expenditure/capita/year (VND 1000 at 1/1998 price) 1,669 2, Stunting (children aged months) 57.8* Table 3: Expenditure and Malnutrition, and Source: GSO (2000) and Haughton (1999) Percent Underweight Stunting CED Quintile Figure 5: Malnutrition rate in Vietnam by income quintile, Source: VLSS98. Note: Underweight and stunting figures: GSO (2000); CED figures: Author's calculation. Urban Rural Income/head/year (VND 1,000, 1998 prices) a) 7,105 2,409 Stunting b) Wasting b) Underweight b) CED c) Table 4: Malnutrition rate in Vietnam by urban/rural area, Source: VLSS98. Note: a) GSO, (2000); b) calculated for children under 155 months (GSO, 2000); c) calculated for adults aged 18 years old and older (author s calculation). The impact of income and price on the nutritional status 79

90 3.4 The impact of income and price on the nutritional status Introduction The positive relationship between income and nutritional status in Vietnam is further examined here through correlation and regression analysis. Under the assumption of the one-period, household-firm model with constrained maximisation of a joint utility function, Behrman and Deolalikar (1988) give a set of reduced-form demand functions, with endogenous variables for the household on the left-hand side and exogenous variables for the household on the right side: Z = f (V) where Z = (H i, N i, C i, C i H, P i L, Y h, T i H, T i L, T i W, T i/c E, L*, A, E i/c, B, M), and V = (P C, P F, P E, P* L, P A, P Y, P K, r, η i, Ω, θ, ξ, R, K h, Σ, d) H i N i C i health of household member i nutrient intake of the member i consumption of household member i C i H refers to other household goods such as pure public goods, health-care goods P i L wage of the member i Y h household firm/farm product T i H time of the i-th individual devoted to healthrelated procedures T i L leisure time of the i-th individual T i W labour-market work time of the i-th individual T i/c E school time of the i-th child L* effective hired labour used in firm/farm production A intermediate inputs used in firm/farm production education of household child i B births M mortality P [j] refers to price of different (consumption) goods and services j r rental rate on hired capital η i individual s endowment Ω household endowment θ refers to community characteristics ξ taste norms R transfers minus taxes (assumed to be lump-sum) K h capital stock (including land) used in the firm/farm production process owned by the household d depreciation rate on capital E i/c The reduced-form relations are usually used to specify the impact of changes in market prices, endowments, and policies on the health- and nutrition-related consumption of different types of individuals. Health and nutrition are fairly commonly estimated from such reduced-form demand relations. Below a similar approach is being used. Health and nutrition for Vietnamese are estimated using a range of explanatory variables, including prices and income. However, not for all variables mentioned in the model above data is available. Specifically, the magnitude of the impact of income and food price on the nutritional status of the population is examined, with a focus on location, individual gender and household head gender. Only adults between years of age (2,865 adults) and the prices of 35 food items were considered for analysis (Appendix 1 explains the choice of study sample). Table 5 summarises the nutritional status of all individuals in the sample, according to location (rural versus urban) and gender. 80 The impact of income and price on the nutritional status

91 All Urban Rural Male Female Number of observations Mean BMI Standard Deviation CED (% of observations) Table 5: BMI of adults (age years) in Vietnam, Source: Author s calculations from VLSS98 data Correlation analysis The methodology of the analyses presented below is explained in Appendix 2. Correlations between BMI and variables on income/expenditure and prices are obtained from the Pearson matrix using the Sidák method, which adjusts significance probability for the effect of multiple comparisons. Correlation coefficients statistically significant at the 5 percent level (and two at the 10 percent level) are presented in Table 6. Variable LnBMI P value Variable LnBMI P value Ln(per capita total expenditure) Ln price of: - Water morning glory Paddy Bean sprouts Instant noodles Sweet oranges Pork meat Fish sauce Rump roast MSG Scad (fish) Cooking oil Mullet (snakehead) White sugar Tofu Condensed milk Dry mung beans White rice wine Table 6: Correlation coefficients between BMI and expenditure and price variables. Source: Author's calculation based on VLSS98 data. Table 6 shows that income (using expenditure as a proxy) correlates highly and positively with the BMI. The value of the coefficient is and is highly significant. This means that increases in per capita income lead to increases in adult nutritional status. The double log-transformation of the variables results in elasticities. For instance, a 1 percent change in per capita total expenditure leads to an approximate 0.23 percent change in the BMI. Among the 35 food items for which prices were available, half (17 items) were found to have a significant association with adult nutrition. In particular, the prices of five foods The impact of income and price on the nutritional status 81

92 (pork, rump, mullet, tofu and morning glory) associate positively with BMI, and the prices of the remaining 12 items, associate negatively with BMI. Negative price effects indicate that if prices of those foods increase, nutritional status will reduce. On the other hand, positive price effects suggest that increases in prices of these foods improve nutritional status. This counter-intuitive effect may be explained by the fact that these items have close substitutes. For example, if there is an increase in the price of pork, people may change their consumption to buy more chicken or beef. Another explanation may be that when income increases considerably, people are willing to pay a higher price for nutrition (Houthakker s law) or they may prefer higher-quality foods Multivariate analysis A continuous model to estimate prices affecting the BMI To further estimate the impact of income and prices on adult s nutritional status, the following econometric relationship is used: lnbmi i = b 0 + b E lny E i + b F lnp F i + u i Where: BMI i is the Body Mass Index of adult i, Y E i is the total per capita expenditure of adult i, P F i is a vector of local market prices of food which adult i obtains, u i is an error term that measures unobserved characteristics of the adult and of his/her household or local community that may affect BMI. To estimate this model, principal components analysis is used (see Appendix 3). Principal components analysis is needed as the large number of price variables may lead to correlation of the independent variables, which should lead to spurious relationships. In this analysis, the food items that showed positive correlation with the BMI in the correlation analysis above need to be left out; thus the twelve food items that showed negative correlation are used as inputs of the model. It is suspected that regional and gender differences may exist in nutritional outcomes, and since the principle components analysis (or factor analysis) cannot be used on dichotomous variables (see Lewis-Beck, 1994), regression models are run separately for rural and urban areas and for male and female adults. Results of the estimated coefficients for the sample in total and for urban/rural areas and gender are given in Table 7. First we look at the expenditure impacts on adult nutritional status. In general, the nutritional status of adults is positively associated with per capita expenditure: the elasticity of BMI with respect to income/expenditure is The expenditure impact on BMI is different for rural and urban areas, and for men and women. The health of adults who live in rural areas seems to be much less affected by changes in expenditure than those living in urban areas (elasticities for rural and urban areas are and respectively). The health of male adults is less affected than that of female adults (elasticities for males and females are and respectively). The urban/rural area results are different than 82 The impact of income and price on the nutritional status

93 expected. A higher income (expenditure) elasticity of BMI in urban areas affirms that increases in income on average help to improve the nutritional status of wealthier people, who live mostly in urban areas, more rapidly. This is because nutritional status depends not only on food consumption (which rises with increased income), but also on other factors such as health services and sanitation, etc. which are better provided in urban areas. Another reason is that those in urban areas may use increased income more effectively for their health because of better nutritional knowledge. The result for males and females is as expected. The slight differences in the male and female reactions may infer that females are perhaps treated unfavourably in household resource allocation, so that males may get more nutrition from household food resources than females. Therefore, when households have more food (as income increases), female energy requirements will be met. Consumption behaviour between males and females may explain this, as more female-generated income is set aside for qualified food. All Rural Urban Female Male Constant Ln(per cap. tot. expenditure) Ln price of: - Paddy Instant noodles Scad (fish) Mung beans Bean sprouts Sweet oranges Fish sauce MSG Cooking oil White sugar Condensed milk White rice wine Sample size Table 7: Impacts of expenditure and prices on adult BMI in Vietnam, Source: Author's calculation based on data from VLSS98. Note: All independent variables are in the log form and the dependent variable is log of BMI of all adults between 20 and 65 years of age. Secondly we take a look at price impacts on adult nutritional status. Overall, market prices influence nutritional outcomes of the population. Lower food prices are correlated The impact of income and price on the nutritional status 83

94 with a higher BMI, but magnitudes of the impact rely on food type. If the price of sugar, for instance, decreases by one percent, the adult BMI on average will increase by nearly 0.02 percent, all else equal. Among the 12 food items, MSG, milk and sugar seem to affect nutritional status most (with an elasticity of 0.02); they may be luxuries for Vietnamese people. Conversely, the elasticity of BMI is the lowest with respect to the price of fish sauce, scad, or paddy; they may be necessities. The adverse price effects of these foods remain unchanged when the sample is stratified by gender. As expected, the coefficients of prices suggest that men s health is more protected than women s health when prices change. For instance, in the case of cooking oil, a price increase of one percent (everything else equal) leads, on average, to a decline in the male BMI of 0.01 percent, while the female s BMI declines by 0.02 percent. Different price impacts imply that gender bias may exist in intra-household food distribution. This means that females may be provided with less food than males; females will be the first to incur losses when household food purchases decrease. On the other hand, price effects are not uniform when rural and urban areas are estimated separately. Elasticities of BMI with respect to price (in absolute values) of some foods are higher in rural than in urban areas (e.g. oil or oranges), while others are lower (e.g. scad or wine). Still, all elasticities in rural areas are negative, while in urban areas five food items have a positive elasticity. This means that demand for food is not the same between rural and urban areas, or between the poorer and richer areas. In urban areas, higher prices of some foods (paddy, noodles, fish sauce, sugar, and milk) make adult nutrition better. For example, paddy rice, a main food source in the Vietnamese diet, does not affect nutritional status of urban population when its price rises. The phenomenon of positive price effects may be explained by the fact that in urban areas people have on average a higher income. Wealthier people are less responsive to price changes of those foods, as they have sufficient income to purchase those foods at varying price levels. In summary, the elasticity of BMI with respect to price varies across gender and location. Clearly these price effects reflect price sensitivity in food consumption of the population. Undernutrition, income and prices: a logistic model A logit model can be used to study the adult s undernutrition (yes or no CED) as a function of incomes and prices. Its form is: 1 P i = 1 + e -Zi or: L i = ln(p i /(1-P i )) = Z i where: Z i = β 0 + β E lny E i + β F lnp F i + u i Z i = 1 if adult i has CED, 84 The impact of income and price on the nutritional status

95 Z i = 0 if adult i does not have CED, P i is the probability of having CED, L i is the log of the odds ratio in favour of having CED (the logit) Other variables are defined as in the continuous model above. Applying the same procedure as in the continuous model, coefficients of the logit-model, computed for the whole sample, are presented in Table 8. The results indicate that the higher the log of per capita expenditure, the lower the log of the odds ratio of the adult having CED. On the other hand, the higher the log of food prices, the greater the odds in favour of having CED. For example, holding all else constant, if the log of per capita expenditure increases by one unit, the logit of odds decreases by around 0.06 units on average. Inversely, all else equal, if the log of the price of paddy increases by one unit, the logit decreases by around 0.11 units on average. Independent variables (Dependent variable: If adult has CED; Yes=1.) Coefficients Estimated probability of undernutrition when an independent variable changes by one unit, other variables are held constant, and initial probability is: 5 % 10 % 15 % Ln(per capita expenditure) Log of price of: - Paddy Noodles Scad Mung beans Sprouts Oranges Fish sauce MSG Cooking oil Sugar Milk Wine Constant Table 8: The logit model of Chronic Energy Deficiency (CED) in Vietnam, Source: Author's calculation based on 2865 observations from data of VLSS98. Note: All independent variables are in the log form, adults are from 20 to 65 years old. The impact of income and price on the nutritional status 85

96 Estimated probabilities of having CED when an independent variable varies by one unit and the initial probabilities are 5 percent, 10 percent, and 15 percent respectively are also shown in Table 8. Clearly, the probability that an adult will be undernourished reduces as his/her income (using expenditure as a proxy) increases, and the probability will increase if food prices increase. Take the case of a person whose estimated probability of having CED is 5 percent. If his/her income (log) increases by one unit, the estimated probability of having CED will decrease to about 4.72 percent. In contrast, if the log of the price of paddy increases by one unit, the probability of having CED will increase to about 5.54 percent. The results of the logit model are consistent with those of the continuous model. Individual nutritional status improves with increased income or reduced prices. Paddy or scad, among other foods, has a weaker effect on nutritional status while MSG or milk has a stronger effect. Adult nutritional status in households by gender of head Many attempts have recently been made to prove an association between female control of households and household members nutritional status in developing countries. Evidence often points to a better nutritional status of household members if women directly manage resources rather than men (Drèze at al., 1995). Table 9 summarises the BMI statistics of all adults in the sample, according to gender of household head. The mean BMI for male and female household heads is nearly the same, while the standard deviation of the BMI for households headed by females is slightly larger. The number of observations with CED is also nearly the same. All statistical tests show that there is no statistically significant difference in the mean of BMI, the variance of BMI, or the proportion of those having CED for male- or female-headed households (p-values are 0.65, 0.66, and 0.56 respectively). However, the members in each type of household may be affected differently by income and price factors. Gender of household head Male Female Number of observations Mean BMI Standard Deviation CED (% of observations) Table 9: Adult's BMI (20-65 years) by gender of household head in Vietnam, Source: Author's calculations from VLSS98 data. Estimates of health outcomes of adults according to gender of household head using the continuous model are recorded in Table 10. As in the previous cases, the most common feature is that expenditure has positive impacts, and prices have negative impacts, on the nutrition of members of each household type. The elasticity of BMI with respect to expenditure seems to be equal among members of those households ( for male- 86 The impact of income and price on the nutritional status

97 headed and for female-headed households). However, responsiveness to variations in price are not the same. The nutritional status of adults in female-headed households is likely to be more responsive than that in male-headed households, i.e. adult health in female-headed households is more likely to suffer from increases in food prices. For example, all else constant, if the price of paddy increases by one percent, the household member s BMI in female-headed households decreases by nearly percent (on average), whereas the households member s BMI in male-headed households only decreases percent. These findings suggest that when price levels increase, members of female-headed households are at a slightly higher risk of undernutrition than those of male-headed households. An explanation may be that resources in female-headed households are often less stable than those in their male counterparts. Again, the price of MSG or milk has the strongest effect on the nutritional status of people in both types of household, and the price of scad or paddy has the weakest effect. Male-headed household Female-headed household Sample size 2, Ln(per capita expenditure) Log of price of: - Paddy Noodles Scad Mung beans Sprouts Oranges Fish sauce MSG Cooking oil Sugar Milk Wine Constant Table 10: Effects of expenditure and prices on the nutritional status of adults by gender of household head in Vietnam, Source: Author's calculation based on data from VLSS98. Note: The dependent variable is lnbmi, all variables are in the log form, and adults are between 20 and 65 years of age, except pregnant and breast-feeding women. The impact of income and price on the nutritional status 87

98 3.4.4 Summary Overall, correlations between adult nutritional status and incomes are positive, and correlations between adult nutritional status and food prices are negative. The magnitude of the impact of income and prices on individual nutritional status varies according to location and gender. Generally, the nutritional status of rural adults seem to benefit less from income increases than that of urban adults, but the nutritional status of rural adults is more likely to be affected by price changes than that of urban adults. In terms of gender, women are more sensitive to changes in income and prices than men. In other words, men receive preferential treatment in household resource allocation. The gender of the household head does influence the nutritional status of its members, though the difference is small. Members of female-headed households have a slightly higher nutritional risk than those of male-headed households, i.e. male-headed households are more secure when income and food prices vary. These findings are similar to those in many developing countries, as reported in Section Conclusions and recommendations Malnutrition is a widespread problem in the developing world and is largely a reflection of poverty: people do not have income for food (World Bank, 1981). In Vietnam, malnutrition is indeed a serious issue and its prevalence is high. The theory of demand underpins the analysis of the impact of income and food prices on individual nutritional status. Given a budget constraint and market prices, a consumer or household will consume a bundle of goods and services that maximise preferences. In practice, food expenditure often takes a large part of the income of the poor. Empirical research in developing countries shows that income and price elasticities of demand for food (in absolute terms) are high among low-income groups and low among high-income groups. Moreover, when income increases, people tend to reduce the food share of total expenditure and buy more food of higher quality. Raising the incomes of the poor is viewed as the most efficient long-term policy to reducing the number of malnourished people in the coming decades (World Bank, 1981). Undernutrition or malnutrition in Vietnam is negatively related to income. The rate of undernutrition falls from the rich to the poor, from urban to rural areas, and from highincome to low-income regions. The highest prevalence of CED, a measure for malnutrition, is found in the poorest quintile (about 37 percent) and the lowest prevalence is found in the richest quintile (about 23 percent). About 45 percent of children are stunted in rural areas, nearly twice as high as that in urban areas (23 percent). Income and price factors affect nutritional status in Vietnam as follows. First of all, income has a positive correlation with the nutritional status of the population. In contrast, food prices have a negative correlation with nutritional status. If per capita income increases by one percent, adult BMI increases by nearly percent, on average. If the 88 The impact of income and price on the nutritional status

99 price of paddy increases by one percent, adult BMI decreases by nearly percent, on average. The following relationships have been found. The nutritional status of the population living in rural areas is more responsive to changes in income and prices than that of those living in urban areas. The nutritional status of females is more responsive to changes in income and prices than that of males. The nutritional status of members in female-headed households is more responsive to changes in income and prices than that of members in male-headed households. From these findings, some recommendations can be made to improve the nutritional status of the Vietnamese population. Firstly, increasing income or reducing poverty is an urgent task of the government. Programmes on generating incomes and resolving unemployment need to be promoted. Incentive measures should be provided to households to help them procure incomes on their own. The nutritional status of the population is affected by price changes, so a national policy to stabilise food prices could be proposed. Lower prices for essential food items, which most strongly affect undernutrition, should be pursued. Furthermore, from the perspective of solving undernutrition, the government could intervene by pricing some main foods to benefit or support a particular group when necessary. Macroeconomic policies should concentrate on strengthening the agricultural sector. Increased agricultural production will contribute to raise the incomes of farmers, lower food prices, and hence improve nutritional status. Furthermore, the majority of Vietnam s population live in rural areas, where households primarily depend on small-scale agriculture. Here the prevalence of malnutrition is much higher than in urban areas. This highlights the need to focus on improving the nutritional status of rural populations. Macroeconomic policies should target rural development. Also, policies that concentrate on females should be put into practice. It is suggested that women s status, their autonomy or control of resources, and their employment opportunities need to be recognised and enhanced. The impact of income and price on the nutritional status 89

100 Appendix 1: Choice of study sample Only adults were used to illustrate the impact of income and price factors on nutritional status in Vietnam, for the following reasons: 1. Adult health (or BMI) varies in the shorter run with changes in energy inputs (Strauss, 1986). 2. Adult BMI directly affects work capacity and thus work outputs. 3. Adults themselves have more free rights to decide consumption behaviour compared to children. 4. Computational and time constraints required the selection of a sub-sample. The sub-sample for the study was constructed as follows: - Only adults between 20 and 65 years of age were used, excluding pregnant or lactating women (which is a sub-sample of 12,982 adults). - In the VLSS98 survey, prices of 38 food items were collected, but not from all clusters. Information on prices of Hanoi beer, mango and 555 cigarettes were collected only in clusters 73, 105 and 143 respectively and hence they are excluded from the sub-sample to avoid a large loss of sub sample size. However, the number of observations meeting prices of 35 food types significantly reduced the sub-sample size to 2,865 adults. - The mean price was computed for each food item (as prices are often recorded more than one time), and then transformed to thousand VND per unit of food (the same unit as expenditure data). Appendix 2: Statistical methodology This study is interested in qualitative impacts of changes in income and prices on the nutritional status. Therefore variables on income and prices are taken into account. Correlation and regression analysis is used, which rests on the following assumptions and methods of choosing variables: 1. Income variable: because income is difficult to measure and expenditure is regarded as a better indicator of permanent income (Lavy et al., 1995), per capita total expenditure is used as a proxy for income (and hence household size is also controlled). Data on household per capita expenditure (total) were available in the VLSS data set (see Dollar et al. (1998) and GSO (2000) for calculations). 2. Food prices are deflated with a monthly food price index and regional food price index. All expenditures and prices referred to are January 1998 values ( 000 VND). 3. All variables (BMI, expenditure and prices) are converted into a natural (base e) logarithmic form to avoid highly skewed income and price curves. 4. The method of principal components is used in the regression analysis, because: (a) it solves the problem of multicollinearity (independent variables may be highly 90 The impact of income and price on the nutritional status

101 correlated); (b) it selects a subset of independent variables from a larger set (see, for example, Lewis-Beck, 1994). 5. Data was processed by STATA software. All models were run with survey commands (and hence, correcting heteroscedasticity problem by White-corrected standard errors). They were also tested for specification error. 6. Although incomes influence nutrition, nutrition is capable of creating incomes through work capacity (Ray, 1998), however this inverse relation was ignored in the regression model. Furthermore, a person s current nutritional status depends not only on his current consumption of nutrients, but also on the history of that consumption (Ray, 1998). Lagged variables however were not considered here. 7. Many households are self-sufficient or food producers. However, they are assumed to be net consumers of food in the analysis. Appendix 3: Principle components analysis The estimation method for the continuous model consists of four steps: 1. Prices of twelve food items that have reverse effects on adult health, accompanied with the per capita income variable (per capita expenditure as proxy) are used as inputs of the principal components analysis (the five food items with positive effects on adult health are omitted to avoid an errors-in-variables model; see Ravallion (1991) p. 31 for interpretation). 2. Only principal components with latent roots greater than one are calculated for the analysis (applying Kaiser s criterion). 3. Regress log of BMI on retained principal components by the svyreg command in STATA. 4. Obtain parameters in the original model from eigenvectors and regression coefficients. To calculate principle components (adopted from Lewis-Beck, 1994) Principle components are p linear transformations of the original p variables. They are: P p = Σa pi x i (i = 1,,p) or P = A x Where: P is a p element vector of principle components scores A is a p x p matrix of latent vectors (or eigenvectors) with ith row corresponding to the elements of the latent vector associated with ith latent root (or eigenvalue), X is a p element column vector of the original variables. To calculate parameters in the original model Assume that the original model is: The impact of income and price on the nutritional status 91

102 Y = b o + b 1 X 1 + b 2 X 2 + u And the principle components model is: Y = γ 1 P 1 + γ 2 P 2 + v Where P 1 = a 11 X 1 + a 12 X 2 P 2 = a 21 X 1 + a 22 X 2 The coefficients of the original model are b 0 = γ o b 1 = γ 1 a 11 + γ 2 a 12 b 2 = γ 1 a 12 + γ 2 a 22 References Behrman, J.R. and Deolalikar, A.B. (1987), Will Developing Country Nutrition Improve with Income? A Case Study for Rural South India, Journal of Political Economy, vol. 95, no. 3, pp Behrman, J.R. and Deolalikar A.B. (1988), Health and Nutrition, in:. Chenery H. and Srinivasan, T.N. (eds.), Handbook of Development Economics, vol. 1, Elsevier Science Publishers B.V., Amsterdam. Behrman, J.R. and Wolfe, B.L. (1984), More Evidence on Nutrition Demand: Income Seems Overrated and Women s Schooling Underemphasized, Journal of Development Economics, vol. 14, pp Blau, D.M. (1984), A model of child nutrition, fertility and women s time allocation: The case of Nicaragua, Research in population economics, vol. 5 JAI Press, Greenwich. Dollar, D., Glewwe, P. and Litvack, J. (1998), Household Welfare and Vietnam s Transition, World Bank, Washington, D.C. Drèze, J., Sen, A. and Hussain, A. (1995), The Political Economy of Hunger: Selected Essays, The United Nations University, Clarendon Press, Oxford. FAO/WHO (1993), Nutrition profiles of the developing countries in the Asia-Pacific Region, FAO regional office for Asia and the Pacific, Bangkok. Ghassemi, H. (1988), Women, Food and Nutrition, A report prepared for the Division of Family Health, The World Health Organization, Geneva. Gibson, R. (1990), Principles of Nutritional Assessment, Oxford University Press, New York. GSO (2000), Vietnam Living Standards Survey , General Statistics Office, VIE 95/043, Hanoi. Guyer, J.I. (1984), Family and Farm in Southern Cameroon, African Research Studies, no. 15, Boston. 92 The impact of income and price on the nutritional status

103 Haddad, L., Hoddinott, J. and Alderman, H. (1997), Intrahousehold Resource Allocation in Developing Countries: Models, Methods and Policy, The John Hopkins University Press, Baltimore and London. Haughton, J. (1999), Ten Puzzles and Surprises: Economic and Social Change in Vietnam, (Draft, December). Kennedy, E. (1989), The Effects of Sugarcane Production on Food Security, Health, and Nutrition in Kenya, Research Report 78, IFPRI, Washington. Lavy, V., Strauss, J., Thomas, D., and De Vreyer, P. (1995), The Impact of the Quality of Health Care on Children s Nutrition and Survival in Ghana, Living Standards Measurement Study Working Paper, no. 106, The World Bank, Washington D.C. Lewis-Beck, M.S. (1994), Factor Analysis and Related Techniques, International Handbook of Quantitative Applications in the Social Sciences, vol. 5, Sage Publications, United Kingdom. NIN (1998), Investment for Child Nutrition in Vietnam: Child Malnutrition Control Strategy, National Plan of Action for Nutrition, National Institute of Nutrition, Hanoi. Ravallion, M. (1991), Does Undernutrition Respond to Incomes and Prices?, The Living Standards Measurement Study Working Paper, no. 82, World Bank, Washington D.C. Ray, D. (1998), Development Economics, Princeton University Press, Princeton, New Jersey. Senemaud, B., Pham Van Hoan, and Nguyen Thi Lam (1998), Huong dan danh gia tinh hinh dinh duong va thuc pham o mot cong dong, [Instructions for assessment of nutritional status and food in a community], FAO project: GCP/VIE/018/FRA, Health Publishing House, Hanoi. Shetty, P.S. and James, W.P.T. (1994), Body mass index - A measure of chronic energy deficiency in adults, FAO food and nutrition paper 56, Food and Agriculture Organization of the United Nations, Rome. Strauss, J. (1986), Does better nutrition raise farm productivity?, Journal of Political Economy, no. 94, pp Thomas, D., Lavy, V., and Strauss, J. (1992), Public Policy and Anthropometric Outcomes in Cote d Ivoire, Living Standards Measurement Study Working Paper, no. 89, The World Bank, Washington. Tripp, R.B. (1981), Farmers and Traders: Some Economic Determinants of Nutritional Status in Côte d Ivoire, Cornell University Press, Ithaca and London. UNICEF (1991), Proceedings: International Symposium on Nutrition, Nutrition Section, New York. UNICEF (1994), Situation Analysis of Women and Children in Vietnam, Hanoi. Von Braun, J. and Kennedy, E. (1994), Agricultural Commercialisation, Economic Development and Nutrition, John Hopkins University Press, Baltimore and London. The impact of income and price on the nutritional status 93

104 WHO (1995), Physical status: The use and interpretation of anthropometry, Report of a WHO expert committee, World Health Organisation technical report series no. 854, Geneva. Wolfe, B.L. and Behrman J.R. (1987), Women s Schooling and Children s Health: Are the Effects Robust with Adult Sibling Control for the Women s Childhood Background? Journal of Health Economics, vol. 6, pp World Bank (1981), World Development Report 1981, Oxford University Press, New York. World Bank (1993), World Development Report 1993: Investing in Health, Oxford University Press, New York. World Bank (1999a), Attacking Poverty: Vietnam Development Report 2000, Hanoi. World Bank (1999b), World Development Indicators 1999, Washington D.C. 94 The impact of income and price on the nutritional status

105 Part B Rural Production

106

107 Chapter 4. Vietnam and the International Market for Rice Exports Nguyen Thi Thu Hang 4.1 Introduction The international market for rice is one of the most important markets for Asian countries. Rice is the major foodstuff for the population and it provides income for a large part of the farmers. Given the political importance of adequate and reliable domestic rice supplies, most Asian governments pursue policies to ensure self-sufficiency in rice production. Therefore, the rice market is strongly influenced by government policy. Trade theory shows that developing countries could, in principle, gain from trading agricultural products with other nations in the world. If linkages between the export sector and the rest of the economy are strong, these gains will contribute to overall economic growth of the country. At present, rice is one of the major sources of foreign exchange earnings for Vietnam, after textiles and marine products (ADB, 2002). Being a developing country much in need of foreign exchange to finance its development, the performance of rice in the world market has important implications. In 1989 Vietnam resumed exporting rice to the world market after a long period of being a net rice importer, and has since become the second largest rice exporter in the world (USDA, 2002). Yet the prices that Vietnam receives in the international rice market are lower than those of its competitors. Vietnamese rice sells at US$15 to US$25 per metric ton lower than the same grade of Thai rice. Furthermore, export price fluctuations create volatility in export earnings. Finally it is unclear if rice production in Vietnam should supply for the low, medium, or high quality market. This study focuses on the specific qualities of the rice industry of Vietnam in regard to its competitiveness in the international rice market. The study aims to identify the performance problems, opportunities and challenges for the rice exports of Vietnam, based on an analysis of the international rice market. We consider Vietnam s rice export performance since 1989, because that year marked the turn of Vietnam from a net rice importer to a rice exporter. However, the performance of the international rice market is considered over the past three to four decades, to identify the trends of this market. The chapter has the following outline. The next section discusses at the international rice market. Several topics are discussed, such as the market structure and price trends. Section 4.3 analyses the competitors of Vietnam in the rice market. This results in Section 4.4, in which the competitiveness of the rice exports of Vietnam is examined. Finally, Section 4.5 contains some conclusions and recommendations. Vietnam and the International Market for Rice Exports 95

108 4.2 The international rice market The rice market shares the main characteristics of the world food market: a long-term downward trend in prices, price instability, and protectionism. However, the rice market is also a special market. As rice is a basic and strategic foodstuff in some developed and many developing countries, almost all rice producing countries carry out protectionist measures to ensure rice self-sufficiency. The total amount of rice that is traded internationally is only a small fraction of the total global rice production. Hence, liberalisation of rice trade is predicted to have substantial effects on the characteristics, structure, and trends of the world market. This section examines the international rice market. First the market structure and market segmentation are analysed. Then an historic overview and the prospects of the international rice market are given. The issue of the rice price and trade liberalisation are the final two topics in this section Market structure and market segmentation Market structure An international commodity market is often a complex combination of different market structures. In some segments of the market there is a high level of competition; in other segments sellers can largely influence the price paid by consumers. Nevertheless, in many cases it is possible to identify a dominant market pattern. The rice market could be considered competitive with many buyers and sellers involved. Most of these buyers and sellers are trading agents (either parastatals, (government owned) or private traders) of exporting and importing countries. According to Maizels (1984), agricultural product markets are generally competitive with a large number of buyers and sellers, though often subject to corners or squeezes by large trading firms. The multinational nature and multiple sources of the major grain importers and exporters make international grain trade quite competitive, yet grain-trading has been dominated by a few transnational corporations (TNCs) for decades. These corporations have offices and affiliates all over the world, trade in large volumes, participate in grain auctions held by exporting countries, and their speculative activities can affect the world price of grain. Many other grain-trading firms involved in rice trade in Asia also act as intermediaries, buying in exporting countries and selling in importing countries. In short, the structure of the world rice market has a dual characteristic, being highly competitive with a large numbers of buyers and sellers, yet being dominated by a few large TNCs that have the potential to influence rice trade. Table 1 shows the volume of rice exported from different regions of the world for the period Asia is the most important source of rice exports in the world, exporting on average 70 percent of the total world rice exports. The second most important source is North and Central America, exporting about 15 percent of world rice exports. The total number of countries exporting rice in each region is relatively large, resulting in considerable competition. The main exporters of rice are Thailand, Vietnam, India, Pakistan, China and the United States (USDA, 2002). 96 Vietnam and the International Market for Rice Exports

109 Asia Africa Europe North & Cent.Amer South America Oceania World Table 1: Rice exports by region in million tons, Source: FAOSTAT (2002). On the demand side can be observed that rice importing countries are numerous and located in different regions of the world (see Table 2). Several features are worth noting about these importers. First, Asia is the largest rice-importing region of the world, followed by Africa. Thus, Asia has been not only the most important rice exporter but also the largest rice importer in the world over the past ten years, accounting for about 50 percent (on average) of total rice imports in the world. Asia has a large population which depends for a major part on rice as main staple. Individual countries mostly take only a small share of total imports, which is shown for the case of some Asian countries. Africa was the second largest rice-importing region in the world during the period studied. Africa has always been a net rice-importing region, accounting for slightly more than 20 percent of the world s total rice imports on average. Most African rice importers are low-income countries that depend on both rice aid and rice imports. In 1997, for instance, 10 percent of the total rice from external sources was from food aid (MARD, 1997). Latin American rice importers imported about 16 percent (on average) of the total rice traded in the world market over the past ten years. It is worth noting that many countries in Latin America, such as Mexico, Peru, Costa Rica, Guatemala, and Honduras, have banned Asian rice imports for phytosanitary (plant pest protection) reasons since 1995 (USDA, 1998) making it impossible for Vietnam to export rice to these countries. A second observation is that Asia, Africa and North and Central America showed upward trends in rice imports, while Europe and the Oceania were rather stable importers from 1989 to Thirdly, while America, Europe, and the Oceania were stable markets for rice exports, other regions of the world experienced considerable year-to-year fluctuations in rice import demands. In Asia, almost all rice importing countries showed fluctuations in their import volume. For example, Indonesia imported less than 0.6 million tons of rice per year during the early 1990s, 3.2 million tons in 1995, 0.3 in 1997, and 4.7 million tons in Similar consumption volatility occurred in Bangladesh and the Philippines. Vietnam and the International Market for Rice Exports 97

110 Asia Bangladesh China Indonesia Iran Japan Malaysia Philippines Saudi Arabia Africa Europe North & Cent.Amer South America Oceania World Table 2: Rice Imports by region and principal countries in million tonnes, Source: FAOSTAT (2002). The above three features of rice importers give us a relatively clear picture of the demand side of the international rice market. Asia has been the largest rice exporting and importing region of the world. At the same time, Asia has also been the major source of fluctuations in world rice trade over the past ten years. The large number of importers and the instability of import demands indicate that not any country dominates the world market. In addition, increasing rice imports means that countries are increasingly dependent on the international rice market. In summary, the supply and demand in the world rice market is relatively competitive. Both exporting and importing countries are numerous and no participators could substantially influence general rice prices. However, the rice market can be divided into sub-markets, and certain countries can dominate these sub-markets. Particularly on the export side some large rice-producing countries, such as Thailand, may influence rice prices, as we will see later in this chapter. Market segmentation Market segmentation can arise as a result of the physical characteristics of products traded. Even for relatively homogenous products like rice, slight differentiation can occur due to physical characteristics, transport costs, or sales services. Distinct varieties may be quite independent on the demand side (i.e. they are neither substitutes nor complements) 98 Vietnam and the International Market for Rice Exports

111 and the result is that the market breaks down into a number of independent sub-markets or segments. As market size increases, the industry structure will become fragmented as well (Sutton, 1992). With this kind of product differentiation, price competition is tough and may gradually lead to changes in market structure. Rice has more than 6,000 varieties that can be classified into two main types: Indica and Japonica (Minot, 1998). These two types command a different segment of the international rice market. Further division of the rice market is based on grades of quality and varieties. The international market for rice exports can be divided into three segments based on the quality levels: high, medium, and low. Long-grain, very high quality rice accounts for more than 25 percent of the total world rice imports (Nguyen Trung Van, 1998). Importers are mainly high income, industrialised countries that require a high level of processing and food safety. The demand for rice in this segment is stable, and exporters are mainly the USA and Thailand. Rice sold in this segment often receives very high prices. Long-grain, medium to high quality rice accounts for 45 percent of total imports (ibid.). Consumers are mainly Asian, African and Latin American countries. These consumers are often price-sensitive and will change to lower quality rice when prices rise in the international market (USDA, 1998). This market segment is often less stable than the consumers of long grain, high quality rice. Thailand has the largest market share of this category of rice, followed by Vietnam, India, Pakistan, and China. Low quality rice accounts for the remaining 30 percent and is imported by low-to-middle income countries in Asia and Africa. Prices are low and demand is unstable, depending on the availability of foreign exchange to import rice. Exporters are the same as that of long grain, medium to high quality rice. The international rice market can also be divided into three other categories, based on rice varieties: Indica, Japonica, and special varieties, such as Basmati and Jasmine. The largest segment is Indica rice, with the major exporters being Thailand, Vietnam, the USA, and India. The second segment is Japonica rice, exported from the USA, Australia, and China. This segment accounts for about 10 percent of total world rice imports (Nguyen Trung Van, 1998). Finally, a small part of the world rice market is devoted to special varieties such as Basmati and Jasmine rice, demanded by high-income countries. These special varieties may receive prices as high as US$900 per ton, which is two to three times higher than high quality plain rice and four to five times higher than low quality plain rice (USDA, 1998). The main exporters are Thailand, Pakistan, and India. Market segmentation also indicates the areas of competition in the international rice market. For example, in the market for medium-to-low quality rice, the competitors of Vietnam are: Thailand, India, Pakistan, China, and Burma. On the other hand, Vietnam supplies little very high quality or Japonica rice; the main exporters of these types are not in direct competition with Vietnam Market developments There is significant debate on the trends and prospects of rice supply and demand. Some analysts predict a downward trend in demand due to low (or even negative) income Vietnam and the International Market for Rice Exports 99

112 elasticities of demand, and substitution of rice by high-quality diversified food (Mitchell et al., 1997). Others predict an upward trend from population growth and income growth in the poorer parts of the world (Pingali et al., 1997; Nguyen Trung Van, 1998; Mitchell et al., 1997). There are also controversies over the trends in rice supply. In order to verify these contrasting supply and demand projections for rice, we review the past and current situations of the world rice market and prospects for the world rice market in the next 20 years. The world rice market In discussing the world rice market we can distinguish several periods. During the period 1960 till 1990, rice production increased much faster than population growth; world rice production increased at an average rate of 2.7 percent per year (see Figure 1 below), while the average growth rate of the world population was only 2 percent per year for the period and 1.75 percent per year for the period (Mitchell et al., 1997). An abundant rice output contributed to the decline of rice prices over 30 years. The high growth rate in rice production was mainly due to the increase in area harvested and rice yields. The food crisis of the 1970s resulted in a pessimistic view of the ability of the world to feed its growing population. The food crisis was caused by a sharp increase in prices as a result of oil price increases, high population growth, unfavourable weather conditions, and a cut in production by the major grain exporting countries. However, the situation for rice was not as bad as for the grain group as a whole. Rice production fell in 1973 by more than 3 percent while consumption of the same year fell less than 2 percent. World rice production recovered quickly the following year, leading to an increase in stock of 5 million tons, equivalent to nearly 20 percent of the world rice stock in the early 1970s (MOT, 1999). During the remaining years of the 1970s, world rice production exceeded world consumption, doubling the 1970 rice stock (26.4 million tons) by 1980 (53.7 million tons), see Figure 1. The 1980s witnessed a slowdown in rice production and a consumption growth rate nearly equal to that of production. The world rice stock remained at a higher level during the 1980s than in the previous decade, thus the world managed to produce enough rice to meet its growing consumption demand in the 1980s. In the period from 1990 onwards, the world rice production growth rate slowed down to 1.4 percent per annum as a result of slow yield growth and almost no expansion of cultivated area (USDA, 1998). During the same period, world rice consumption also slowed down, but to a lesser extent than production, leading to small shortfalls of rice during the decade, which could be met by the rice stock. The year 2000 saw the highest world rice production, followed by three years of decreasing production, mostly due to unfavourable weather in these years (USDA, 2002). The forecasted 2003 production was at 1996 levels. The world rice trade, on the other hand, increased faster with more severe fluctuations than in the previous decades. Rice trade in 1998 rose to a record high of Vietnam and the International Market for Rice Exports

113 million tons compared to an average of 16 million tons per annum for the period. For 2003 the trade was projected at 26.6 million tons (USDA, 2002). Million tonnes Production Consumption Stock Trade Figure 1: World rice production, consumption, trade and stock. Data source: MOT (1999). In summary, during the past few decades, the world s rice production has increased quite fast and at a rate to feed the world s growing population. The growth of production is decreasing, while trade is strongly increasing. Prospects for the world rice market Looking at the prospects for the world rice market we consider the supply side and the demand side separately. The four main determinants of rice supply are: (i) the area of land used for rice production, (ii) the profitability of rice farming in exporting countries, (iii) irrigation and technology in rice production, and (iv) the growth rate of rice yields. Firstly, agricultural land and paddy fields are increasingly converted to industrial and urban land. It was predicted that about 84 million hectares of fertile agricultural land will have to be converted to urban uses in Asia (excluding Japan) between 1990 and 2025 (Pingali et al, 1997). The area dedicated to rice has already been declining in many countries. For instance, five million hectares of rice land has been converted to non-rice uses between 1978 and 1993 in China alone (ibid.). Moreover, that area mostly consisted of fertile irrigated lowland with access to fresh water, power, transport, and communication infrastructure. Increase of rice production needs to take place on more marginal lands, with lower yields and for higher costs. Vietnam and the International Market for Rice Exports 101

114 Regarding the second determinant, there has been a declining profitability in rice farming compared to other agricultural and non-agricultural alternatives. Economic growth and urbanisation have attracted labour to the industrial sector out of the agricultural sector, leading to increases in wage rates. The commercialisation of agriculture has also encouraged rural households to switch to higher-value products. Diversification away from rice has grown in popularity in Asian developing countries. Thirdly, gains from the Green Revolution technologies and irrigation are claimed to be close to exhaustion. By 1990, 74 percent of the rice area in Asia used modern varieties, accounting for almost all irrigated land in Asia. Further expansions of modern variety use are severely constrained in non-irrigated lands (Pingali et al, 1997). In addition, competing uses for water resources between rice production and other purposes is becoming an important issue that can constraint the growth of rice output. Fourthly, related to the previous constraints, the potential for further yield increases from modern varieties and irrigated land is limited given the current decline in irrigation investment conditions and land availability. The above supply side conditions suggest a substantial slowdown in rice supply over the next years, a view shared by many (Nguyen Trung Van, 1998; FAO, 1999; Pingali et al., 1997). Analysts suggest that further technological improvements to increase yield, and a substantial increase in rice prices, are essential to solve the problem of maintaining self-sufficiency in rice production in many developing countries. On the demand side, the three major determinants for growth of rice consumption include (i) population growth, (ii) income growth and (iii) rice substitution. The world population growth is predicted to slow down (US Bureau of the Census, 2002). Between 1995 and 2000, the growth rate was about 1.4 percent per annum, but is predicted to be 1.1 to 0.8 percent from 2000 to 2030 (ibid.). However Asia, which consumes 90 percent of the world s rice, accounts for 60 percent of the total world population, and the population growth rate of this region is expected to be higher than other regions of the world (except Africa). The population of Asia is expected to increase by 1.2 to 1.1 percent during and 1.0 to 0.6 percent during (ibid.), a rate higher than the current growth rate of world rice production. This means there will be continuous upward pressure on rice demand from Asia for the next years. If the high population growth rate of Africa is also accounted for, then these consumption pressures become even more serious. Many economists argue that rice demand is declining in many Asian countries. A study on rice demand in Asia by Ito et al. (1989) indicates that rice is becoming an inferior good, with negative income elasticities of demand for rice in Japan, Malaysia, Nepal, Singapore, Thailand, and Taiwan. However, these countries consume less than 10 percent of total world rice consumption (MARD, 1998). The level of income at which per capita rice consumption declines has not yet been reached in many other countries in Asia (such as Vietnam, Indonesia, Philippines, Bangladesh, India and China) and these countries account for more than 70 percent of world rice consumption. As long as incomes to not 102 Vietnam and the International Market for Rice Exports

115 reach this higher level where substitution by other foodstuffs takes place, demand for rice will increase. Rice has been substituted in many developing countries for wheat, especially in urban areas where incomes are in general higher. However, as discussed above, the income level at which rice is substituted has not been reached in most major rice consuming countries, so a shift away from rice will not be significant in the near future. In addition, there is also a trend of replacing cassava and other root crops with rice in many poor parts of Africa and South Asia. In summary, if the past trends and predictions of demand and supply will continue in the near future, the world will face difficulties in meeting the rising demand for rice. Though, given the volatile nature of both supply and demand in the world market, it is difficult to accurately project changes in the world rice market The price of rice For the convenience of analysis, the past three decades are divided into two subperiods, and Unfortunately, for this study no consistent data is available for the period from 1984 till The most noticeable feature of rice price patterns during was the presence of large short-term fluctuations due to weather conditions, and the Green Revolution s impact on irrigation and development of diseaseand insect-resistant rice varieties (see Figure 2) $US/Ton Figure 2: The export price of rice (Thai, 5 percent broken, FOB, Bangkok, ). Source: Barker et al. (1985). Note that these are nominal prices, not taking into account inflation. Vietnam and the International Market for Rice Exports 103

116 In more recent years ( ), the relatively stable increase in rice production and consumption has resulted in fewer fluctuations in rice export prices (see Figure 3). Prices showed an downward trend over this period, though prices substantially decreased after 1998, while only stabilising in 2001 and beyond. Real prices, however, have decreased even more. Also, short-term fluctuations still persist and contribute to the continuous changes in world rice stock levels. US$/Ton Year Figure 3: The export price of rice (White Rice, Thai 100% B second grade, FOB Bangkok Friday closing price). Source: FAOSTAT (2003). Note that these are nominal prices, not taking into account inflation. The figure for 2003 is estimated. Several factors can be attributed to the greater fluctuation in prices of rice compared to the prices of other agricultural products. Firstly, because 90 percent of rice production takes place in monsoon Asia, weather-related shocks affect supply and cause short-term price shocks. Secondly, only a small proportion of the total rice production in the world is traded. On average 3 to 4 percent of the total rice production is traded compared to, for instance, 30 to 40 percent of the total wheat production (Nguyen Trung Van, 1997). As a result, a small change in production in a large rice exporting country can lead to large change in trade volume. This thinness of rice trade can lead to price instability. Thirdly, as rice has a strategic interest for countries with high labour to land ratios, Asian governments have traditionally tended to shield domestic producers and consumers from price fluctuations. These interventions may unintentionally exacerbate international price fluctuations as the demand and supply reactions are disconnected from price movements in the world market. In sum, instability is the most striking feature of rice price patterns over the past three decades, and the most important factors behind this instability are weather conditions, the thinness of the rice market, and government policy regarding rice. 104 Vietnam and the International Market for Rice Exports

117 If world rice consumption growth is expected to exceed growth rates of production in the next decade, see the discussion above, the stocks of rice will further decline and world rice prices are expected to continue their upward trend. Given the dependence of rice supply and demand projections on many factors and the volatile nature of rice prices, the predictability of world rice prices, especially in the longer-run, is less certain. Population growth, income growth, and government policies regarding agricultural investment, rice pricing and others will all affect rice price trends Rice trade liberalisation As rice is an important, strategic crop in Asian countries, the rice industry and market are strongly protected by governments in order to ensure self-sufficiency. As mentioned above, this policy has contributed to the wide fluctuations of rice prices in the world market. We will now consider the possible effects of the liberalisation of the rice industry and market on countries participating in the world rice market. The liberalisation of the world rice market has been closely related to the General Agreement on Tariffs and Trade (GATT), currently the World Trade Organisation (WTO). In 1995 the Uruguay Round started agricultural trade liberalisation and thus also affected rice trade. The most important measures to promote rice liberalisation are: market access with reductions in import tariffs, reductions in non-tariff barriers, reductions in export subsidies, reductions in domestic price subsidies, and reductions in sanitary/phytosanitary measures. A special treatment for rice (the rice clause ) is applicable to developing countries where rice is the predominant food, and to developed countries that import less than 3 percent of their rice consumption. These countries, including Japan, South Korea, the Philippines and Indonesia, are exempted from tariff reductions in exchange for minimum access quotas. Japan, for example, imported 4 percent of its total rice consumption in the period , and was to increase this level by 0.8 percent every year from 1995 onwards until it reaches 8 percent (Gulati and Narayana, 2002), though in 1999 it allowed over-quota imports with a decreased growth of 0.4 percent per year. The European Union uses preferential quotas that can undermine market access for other countries (ibid.). The short- and medium-term impacts of GATT on rice trade are expected to be modest (Pingali et al., 1997). According to the agreement, Japan and Korea (with traditionally closed rice markets) will only be gradually lower their trade barriers. Due to the gradual nature of the opening process, and the high over-quota import tariffs by Japan (Gulati and Narayana, 2002), the short-term impacts will not be clearly felt. Many countries keep protecting inefficient domestic rice production. The direct beneficiaries of the market liberalisation are Japonica rice exporters, which are the United States, Australia, and China, who currently supply these two countries. However, a higher price for Japonica rice in the longer run might increase the supply for long-grain Indica rice from production substitution leading to gains for Thailand and Vietnam. Both the European Union and the United States agreed to reduce their tariffs on rice with 36 percent by the year Again, Japonica and high quality rice exporters have Vietnam and the International Market for Rice Exports 105

118 been the first to gain. The world rice market is not affected remarkably by reductions in export subsidies because subsidised exports account for a very small part of total rice exports. Recently, regional initiatives for rice trade liberalisation have taken place, such as the ASEAN agreement to lift all quantitative trade restrictions by 2010 (Gulati and Narayana, 2002). Many analysts expect that rice trade liberalisation will increase prices and reduce price volatility in the international rice market. The opening of traditionally closed markets and reductions in rice import tariffs will likely increase the demand for imported rice, leading to higher world prices if the supply does not increase with the same amount. Moreover, trade barriers contribute a great deal to the instability of international commodity prices. Therefore, rice trade liberalisation is expected to reduce price volatility in the world market. It was estimated that liberalisation policies in OECD countries will increase the price level of rice by 18 percent and the coefficient of variation of prices will be reduced to 28 percent from the pre-liberalisation level of 38 percent (Anderson and Tyers, 1990). Also, a 50 percent reduction in rice protection by industrialised countries during would cause a 4 percent annual increase in rice prices; a remarkable change that will help increase the earnings of rice exporting countries and reduce the fluctuations of world rice prices. However, negative effects, mainly in the short run, could cause problems for the food supply of the poorest people who will face higher rice prices (Gulati and Narayana, 2002). In short, the liberalisation of the rice market, especially in developed countries, will increase world rice prices. The direct, short-term effects of this liberalisation will fall on the exporters of Japonica rice, which are mostly developed countries. Longer-term effects are expected to expand into benefits for the Indica rice exporters, including Vietnam. The overall effects will depend on a number of factors, such as the emergence of new suppliers, economic incentives for sustaining production in current exporting countries, changes in food preference, and further liberalisation of the rice market. 4.3 The competitors of Vietnam in the international rice market Overview Only a few countries together account for the major part of the total world rice exports: Thailand, Vietnam, the USA, India, China and Pakistan. Although they maintain high ranks in rice exports, most of these major rice-exporting countries have experienced volatility regarding the volumes of rice export. In addition to the traditional exporters, there have been cases of emerging and disappearing nations as a large rice exporters. Although some countries take a large share of the market, they usually do not dominate the market, though they can dominate submarkets. As rice plays an important role in both exporting and importing countries, most trade transactions, whether carried out by private traders or by government agents, are closely monitored and/or supported by the governments. Moreover, a large proportion of rice trade is carried out through government-to-government 106 Vietnam and the International Market for Rice Exports

119 agreements. Therefore, when discussing competitors in the world rice market, we characterise exporters as their host country. A framework for analysing the competitiveness of Vietnam as a rice exporter can be developed by studying how major rice exporters have recently performed in the world rice market, how these countries differ from each other in their export performance and export strategies, and how these characteristics affect the role of these countries in the world rice market. One of the interesting features of the major rice exporters over the past few decades is the changing rank of the largest rice exporters. In the 1960s, Thailand, Burma, China, the USA, and Australia were major rice exporters. During the early 1990s, Burma, China, and Australia disappeared as major exporters, while Vietnam and India emerged as the leading rice exporters in the world. This was a reversal from their status as net rice importers in previous decades. Figure 4 shows the details of the changing situation of the leading rice exporters since At present, the largest rice exporters are Thailand, Vietnam, the United States, India, Pakistan, and China. These six countries account for more than 80 percent of the trade volume in the world. Thailand has been the leading rice exporter for many years and in more recently Vietnam is challenging the USA and India as the second largest exporter Export (1000 tonnes) China India Pakistan Thailand USA Vietnam Figure 4: Export of the six largest rice exporters. Source: FAOSTAT (2003). Of the current major exporting countries, India and China have experienced the highest average export growth over the period (rates of 47 percent and 46 percent respectively), see Table 3. The USA has had the lowest average growth rate. The Vietnam and the International Market for Rice Exports 107

120 major observation that can be made from Figure 4 is that the export growth of most countries strongly fluctuates over the years. Weather conditions play an important part in this, though also political decisions and production technology, such as the availability of irrigation affect the export growth. More developed countries, such as the USA and Thailand, experience a more stable export growth than less developed countries. China India Pakistan Thailand USA Vietnam Average growth 47% 46% 13% 3% 0% 12% Table 3: Growth of rice exports Analysis of the competitors Thailand, the leading rice exporter in world market, is an important case study as it competes with Vietnam most directly and has advantages over Vietnam and other competitors in several ways. An analysis of the USA is also relevant as it has long played an important part in the international rice market, especially for food aid purposes. The production technology in the USA is very different from Vietnam, using more capital (machines) and less labour. If Vietnam is to penetrate the high-quality rice market segment, the USA will be an immediate competitor. The other competitors, India, Pakistan and China, are also discussed below. Thailand In Thailand, rice is planted on 60 percent of total farmland (USDA, 1998). It is estimated that Thailand produces about 4 percent of the total world rice production. About one third of the area for rice cultivation is irrigated (DOFT, 2001). Infrastructure is relatively well-developed in Thailand, which facilitates transportation of rice. Thailand exports to a very large number of countries and has a steady market share of about 30 percent (DOFT, 2001). However, as can be calculated from the export statistics in Figure 4, the past few years Thailand s share in the world rice market has declined to about percent due to competition from Vietnam, India, and China. Nonetheless, this significant market share still allows Thailand to affect the international prices for rice, and for this reason the prices of Thai rice (of different grades) are considered representatives of their world prices. Thai rice competes in all segments of the rice market, ranging from the high-quality markets of the United States to the lower quality markets of Vietnam and India. In the highquality market, Thai rice is offered at a discount for the same grade of rice exported by the United States. In lower quality markets, Thai rice enjoys a price premium over the rice of other competitors, such as Vietnam, India, and Pakistan. The reasons for this premium are that Thai rice of the same grade is claimed to be of better quality than other countries and the supply from Thailand is far more stable and reliable than that of other countries in Asia. Discounts and premiums depend mainly on the demand for rice exported from different countries and on the exchange rates among the currencies involved. The fall in Thai prices 108 Vietnam and the International Market for Rice Exports

121 due to a devaluation (in late 1997 and early 1998) forced the competitors of Thailand to lower prices to remain competitive, which contributed to a decrease of the world s rice prices. Million tons Thailand World Figure 5: Rice Export: Thailand and the world total rice exports ( ). Source: FAOSTAT (2003). Thailand has several comparative advantages over other competitors, which allows the country to sustain its rank in the world rice market. Firstly, Thailand has established a reputation as a stable and reliable source of rice exports. Secondly, Thailand has a diversified network of export markets, which allows the country to switch easily from market to market when facing a stagnation or decline in one market. Thirdly, Thailand s export policies and strategies create positive conditions for rice export. The policies include the absence of export quotas, favourable taxes, and favourable credit possibilities for rice growers and exporters. Moreover, the exporting channels of Thailand are well organised and integrated. They are dominated by the private sector resulting in reduced costs from an efficient and highly competitive environment (Nguyen Van Nam et al., 1997). Thailand is expected to remain the leader in rice exports for some more time (Lien, 1998, USDA, 2002). However, Thailand also has some disadvantages compared with other competitors, including Vietnam. These disadvantages are mainly in rice production. At present, still two thirds of Thai rice production depends on rain, which makes it vulnerable for water scarcity. Land resources in Thailand have become scarce, so production increase through increase of cultivated land becomes difficult. In addition, as a result of development more labour opportunities arise, which decreases the labour force available for rice cultivation and labour shortages arise. In addition, costs of inputs, especially labour, have increased rapidly in recent years, leading to higher production costs. Moreover, various subsidies for rice producers are becoming increasingly a burden on the Thai government (Nguyen Van Nam et al., 1997). Assistance measures, such as favourable credit access, are being scrutinised and may not be tolerated within the World Trade Organisation. The competitiveness of Thailand will likely be affected by these issues. Vietnam and the International Market for Rice Exports 109

122 United States of America The USA produces only 1 to 1.5 percent of total world rice production, but has always been an important exporter. The country has a reputation for exporting high-quality long and medium grain rice. Latin America, the Middle East, and Europe are the main rice markets for the USA. From 1989 to 1994, its exports accounted for 19 percent of world trade, but then it lost its share to Vietnam, India, and China in the following years. The past few years, the market share of the USA has been around 10 percent. Rice exports of the USA have certain comparative advantages over other exporters. Firstly, the USA has a high quality standard and strict grading procedures reduce consumer risk. Secondly, the rice industry in the USA has the ability to meet the most sophisticated and varying specifications of an importer. It can export both long-grain and medium-grain rice at any stage of processing (rough, brown, milled, or parboiled) at any level of quality (percentage broken) and in any form of packaging or shipping. While no Asian country allows the export of paddy (rough rice), the United State enjoys a lower tariff on paddy in nearly all Latin American markets. Paddy exports accounted for more than 30 percent of total US rice export recent years (USDA, 2002). Thirdly, for the major part the United Stated only faces competition of Thailand, because it exports very little low quality rice and generally does not attempt to compete in low quality market segments. Fourthly, since 1995, Mexico and five Central American rice importing countries effectively ban imports of Asian rice for phytosanitary reasons, thus allowing the USA to capture virtually all of these expanding markets. Fifthly, rice farmers receive, like in many other countries, various types of support from the USA government. For instance, a marketing loan program was introduced in 1986 to improve the competitiveness of USA rice in international markets. Under this program, the USA sells rice through credit terms at a concession and donates rice to countries in need. Commercial sales under the program help private and government importers meet foreign currency constraints. These supports have considerably boosted the competitiveness of the rice exports of the USA. Presently, USA rice competes mainly with Thai rice and does not compete directly with Vietnamese rice in the world market; the USA is competitive primarily in the high quality rice market. If Vietnam is to export more high quality rice, as many experts suggest as a way to improve foreign earnings, Vietnam will face strong competition from the USA. China China is the largest rice producer in the world, producing about 35 percent of the total world rice output in 1998 (MARD, 1999). However, most of this output is consumed domestically. Traditionally, China imported a small quantity of high quality rice (mostly from Thailand), while exporting its surplus of medium-to-low quality rice to Africa and the Middle East. However, in recent years China has exported Japonica rice to higher-income markets, such as Japan and Korea, and imported medium-to-low quality rice for domestic use (USDA, 2002). The main reason is that Japonica rice receives a good price in the world market, and increase in high-quality rice exports could bring larger export revenues. 110 Vietnam and the International Market for Rice Exports

123 However, a major shift to producing high-quality rice could endanger food security and necessitate rice importation for domestic consumption. As China is the largest rice producer and consumer, implications of Chinese rice trade are important for the conditions of the global rice market. When China was a net rice importer (in 1995 and 1996) many experts thought that the country might become a regular rice importer, resulting in food shortages for the world because of its huge population. However, the Chinese government does not want to depend on the world market for any substantial portion of its rice needs and is acting to increase rice area and yield. In predicting China s future ability to export rice, Huang et al. (1997) concluded that in the baseline scenario (maintaining current growth rates of population, income, and agricultural investment) China would have net imports of 3 million tons of rice, but would cease importing by 2010 and turn to have net exports of 9 million tons in India Although India is a large rice producing country, it imported significant amounts of rice in the 1960s and 1970s to feed its large population. During the 1980s, India started to export only a small quantity of high-value aromatic rice, mostly Basmati, and continued to import low-quality rice for domestic consumption (Nguyen Trung Van, 1998). From the early 1990s onwards, India managed to reduce imports to less than 200,000 tons per year and export a greater quantity of rice to the world market. Since 1995, India has twice ranked second among the world s leading rice exporters (in 1995 and 1998). Because India is a major parboiled rice exporter, its main rice export market is the Middle East. In other low-to-medium quality rice markets, Indian rice is not as price competitive as Vietnam and Pakistan, because of high transportation costs and lower quality rice (IFPRI, 1996). Despite these difficulties, India is expected to sustain its position as a major rice exporter and will remain an important competitor for Vietnam. Pakistan Pakistan has been a traditional rice exporter, exporting even prior to World War II. Despite a low level of production, the amount of rice available for export is large due to low domestic consumption. In the 1980s when Vietnam and India were still rice importers, Pakistan was able to export an average of 1 million tons per annum. During the 1990s, the rice exports of Pakistan steadily increased by an average of 13 percent. Unlike other countries in South and Southeast Asia, rice is a cash crop that is grown for export. This is an advantage for Pakistan in the world rice market because the problem of rice-sufficiency is not an issue. The government of Pakistan is actively trying to increase rice production through price incentives, timely supply of inputs, and technical assistance. Pakistan exports both long-grain high-value Basmati rice at a substantial premium to high-income markets and medium-to-low quality rice to developing countries, where it competes with Thailand, Vietnam, and India. Pakistan has an advantage in exporting Basmati rice because of the low level of competition in this special variety rice market. Vietnam and the International Market for Rice Exports 111

124 Pakistan also has some disadvantages in the international rice market. The low level of rice production in Pakistan does not allow the country to capture a large market share nor influence the rice market. Pakistani non-basmati rice is a lower quality compared to Vietnam and Thailand, making it less competitive in the world market. Yet, Pakistan is likely to continue its steady increase in rice exports over the next decade. An analysis of the major rice exporters that are Vietnam s important competitors shows that there are considerable fluctuations in the export volumes. India and China are the most unstable exporters. They can undermine Vietnam s market share and affect world export prices whenever they enter the market with a significant quantity. The USA does not presently compete with Vietnam as it grows higher-quality rice. Pakistan s rice export is stable and predictable. However, Pakistan exports both high-quality Basmati, which belongs to a different market segment from that of Vietnam, and medium-to-low quality rice that is less price-competitive than Vietnam. At present, Thailand is the most important competitor of Vietnam in all market segments in which Vietnam participates. 4.4 The competitiveness of Vietnamese rice exports Rice accounts for a large part of the cultivated area of Vietnam and is produced by 84 percent of rural households. Rice contributes about three quarters of the calories of a typical Vietnamese family s diet; one of the highest levels in the world (Goletti et al., 1997). Moreover, rice has become a major source of foreign exchange earnings for Vietnam during the past decade (ADB, 2002). From the position of continuous food shortages, due to stagnant agricultural growth and weather related problems in the 1980s, Vietnam turned to exporting nearly 1.4 million tons of rice in 1989 and more than 3.5 million tonnes each year from 1997 onwards (see Figure 6), making Vietnam the second largest rice exporter of the world. These achievements are the result of reforms in the agricultural sector and the liberalisation of the rice market in the late 1980s. The major issue of Vietnam s current role as a rice exporter is whether this level of production and global market share will be sustainable. Two factors can easily undermine this phenomenon: an increase in domestic demand or a decrease in foreign demand of Vietnamese rice. Moreover, the competitiveness of Vietnamese rice exports has been debated. This section covers four topics: (i) Vietnam s performance in the international market for rice, (ii) the rice market conditions in Vietnam, (iii) rice export sustainability, and (iv) current export constraints. Most of the data analysis focuses on the first decade after Vietnam started exporting rice Rice export performance Export growth Over the period, rice exports of Vietnam grew at an average of 12 percent, which is a relatively high growth rate compared with the larger, more stable exporters, such 112 Vietnam and the International Market for Rice Exports

125 as Thailand and the United States. The high rate of export growth has contributed to the increase of Vietnam s share in the world rice market, from around 10 percent in 1989, to 17 percent in record year 1999 and about 14 percent in the years thereafter (see Figure 6). million tons World Vietnam Figure 6: Proportion of Vietnam's rice exports in total world rice exports. Source: FAOSTAT (2003). During the same period, rice export revenue increased steadily by nearly 18 percent, bringing Vietnam more than one billion US dollars in 1998 and 1999 (MOT, 1999). The higher growth rate of export revenue indicates a higher average price over the period. Figure 6 shows year-to-year fluctuations in the exported amount of rice. The major reasons for these fluctuations are government policies, either to limit exports in bad harvest years or to raise export quotas in response to bumper crops, and fluctuations in the demand for rice in the world market. Export prices Earnings from rice exports are a key determinant of foreign exchange earnings in Vietnam. Table 4 shows the changes in the average prices of rice exported from Vietnam over the period Year Av. Av. price % Change n.a Table 4: Average Export price of rice in Vietnam (USD per ton). data source: MOT (1999). Average export prices received by Vietnam for all rice grades increased by 2.4 percent annually, or 21.6 percent from 1989 to 1998, while Thai prices increased by only roughly 1 percent annually or 8 percent over the same period (MOT, 1999). The gap between Vietnamese and Thai prices has been closing as a result of improvements in quality. While the improvement in the average and relative prices of rice exported from Vietnam over the past ten years has helped to increased export revenue, several factors Vietnam and the International Market for Rice Exports 113

126 have hindered the price competitiveness of Vietnam in the world market and reduced the income earned by rice growers. One of the most important factors is the real exchange rate between the Vietnamese Dong and the US Dollar. Table 5 shows changes in the nominal and real exchange rates since Vietnam began exporting rice. Over the period , the nominal exchange rate depreciated by more than 300 percent from only 4,000 VND for 1 USD to 13,200 VND for 1 USD. However, the purchasing power parity based exchange rate (a proxy of the real exchange rate) reveals an appreciation of the Vietnamese Dong against the US Dollar of 30 percent from In other words, the Vietnamese Dong was overvalued in every year of this period. Compared to 1989, the exchange rate maintained by the government of Vietnam has reduced the price competitiveness of rice exports. Also the exchange rates of competitors affect the relative prices of rice in the world market. For instance, in the latter half of 1997, Thailand devalued its currency by more than 50 percent, making its rice export prices very competitive in the world market during the next few months (USDA, 1998). Year NER (VND per USD) NER index 1989=100 RER index 1989=100 4,070 5,160 9,260 11,277 10,708 10,984 11,014 11,033 11,617 13, Table 5: Nominal and Real Exchange Rate Indices ( ). Source: State Bank of Vietnam, Annual Report. The improvements in the average and relative export price of Vietnam s rice imply that the quality of rice exported and the confidence of foreign buyers has improved; leading to an increase in the rice export revenue of Vietnam. However, the current exchange rate and trade regimes have overvalued the domestic currency and reduced the price competitiveness of Vietnamese exported rice. Export Quality Quality improvements are a key determinant of price improvements. In the early 1990s, Vietnam was known as an exporter of inexpensive and low quality rice. Yet, the share of high quality rice (10 percent broken or less) has increased remarkably from less than 2 percent in 1989 to over 50 percent in 1998 (see Table 6). The change in production is a response to the higher quality standards of foreign demand. 114 Vietnam and the International Market for Rice Exports

127 Quality G.rate Mean <= 10% % > 20% Table 6: Share of rice in different qualities. Source: MOT, Growth rates and means calculated by author. It is worth noting that although lower quality rice receives a lower price, this does not suggest a complete shift towards higher quality rice exports. Many importers demand for a substantial amount of medium-to-low quality rice, guaranteeing considerable earnings from exports of this type of rice. Moreover, the production and processing of high quality varieties often requires larger investments and can result in lower yields. Hence, Vietnam should continue to export low quality rice as long as the demand for such rice remains high. While export demand will decide the share of different grades of rice exported from Vietnam, the quality improvement indicates the ability of Vietnam to diversify its export markets to meet the requirements of foreign buyers. Destination of Export The most important export markets for Vietnamese rice are Asia and Africa, followed by the Americas, the Middle East, and others (Table 7). Asia is the largest importing region, not only of the world but of Vietnam as well. Although Asia did not take the largest share of rice exported from Vietnam in every year of the period , on average it imported more than one third of the Vietnamese rice exports. Africa is the second largest market for rice exported from Vietnam, buying on average roughly 27 percent of Vietnam total rice exports every year over these years. However, most of the rice exports to Africa entered through intermediaries (i.e. TNCs of France, Switzerland, and the United States). Region Mean Asia Middle East Africa America Europe and others Table 7: Destinations of Vietnam s exported rice by regions (percentage share). Source: MOT, In the early 1990s, the Americas took a relatively large share (about percent) of total rice exported from Vietnam. However, this share has significantly declined to percent due to the ban on Asian rice for phytosanitary reasons by many Latin American Vietnam and the International Market for Rice Exports 115

128 countries. The United States imported a significant amount of rice from Vietnam, despite being a major rice exporting country and consuming only high quality rice. The rice bought from Vietnam was mainly used for food aid and sale-on-credit programs (for instance the Intermediate Export Credit Guarantee Program) to food-deficit countries in Asia and Africa. The import of Vietnamese rice by the Middle-East and Europe shows a significant growth; the total volumes are, however, still far below the Asian exports. The import volumes of the above regions fluctuated remarkably during the decade. Asia, for example, could take a share as high as 70 percent in 1998 or as low as 23 percent in Similar fluctuations occurred in all other rice export destinations of Vietnam, with individual importing countries also exhibiting a similar pattern. The volatile nature of rice supply, demand, and the world rice market is the explanation for these fluctuations. The fluctuations in individual destination markets will persist as a problem for Vietnamese exporters until Vietnam establishes an extensive export network, similar to Thailand, to shift from markets of declining demand to markets of increasing demand. International intermediaries can help buffer these fluctuations, as they are familiar with the markets and can easily shift from one to another. Export through intermediaries Vietnam started to export rice to the world market in 1989 while still under US embargo. Therefore, during the early years of export, Vietnam had to export most of its rice through intermediaries, instead of selling directly to consuming countries. By the mid- 1990s, Vietnamese rice reached 80 countries and direct exports accounted for only percent of total rice exports (Nguyen Trung Van, 1998). However, the amount of rice exported through intermediaries has declined during the years that followed. In 1997, direct exports accounted for 30 percent of total rice exports, and for 40 percent in 1998 (MOT, 1999). This indicates that Vietnam s trade relationship with importing countries has improved. Yet, the proportion of rice exported through intermediaries is still high. At present there are about 85 foreign companies buying rice from Vietnam to sell to a third country. These intermediaries are often large TNCs that have an extensive network of agents throughout the world. They have large amounts of capital and timely information about export and import markets. They have extensive experience in the international rice market and have established good reputations. As a result, they have much better access to markets than Vietnamese export agents. Export through intermediaries has helped Vietnam to reach remote markets like Africa. Besides, Vietnam has not been able to gain purchase contracts with rice importers by bidding as a result of a poor reputation (MOT, 1999). In addition, intermediaries help Vietnam to buffer export fluctuations. Exporting through intermediaries means a loss of profits, though improvements of Vietnam s reputation; final consumers get to know Vietnamese rice, which is provided through reliable intermediaries. It is necessary for Vietnamese export agents to utilise intermediaries to supply rice to consumers in certain, difficult-to-reach markets. Export through intermediaries is inevitable at the present. It has allowed Vietnam to expand its 116 Vietnam and the International Market for Rice Exports

129 export market to many countries. In the future, improvements in the relationships between Vietnamese suppliers and importing countries are likely to increase the amount of rice directly exported Sustainability of Export Despite previous food shortage problems necessitating rice imports, the performance of Vietnamese rice production over the past few decades has led many people to believe that Vietnam could sustain rice exports in the future. Others suggest that due to fast growing domestic demand, saturated yield, and constraints of land and water, the level of rice export is not sustainable in Vietnam (World Bank, 1994; Pingali et al., 1997). However, recent evidence is more optimistic of sustaining rice exports. Over the past decade, rice export growth was achieved without compromising food security. The net availability of rice per person (production minus export) has increased by 8 percent since The coefficient of variation of rice calories per capita for the period of (0.05) was less than half of that of paddy production (0.12) and about one sixth that of rice export (0.32) (Goletti et al., 1997). These figures indicate that increases in rice calories per capita are more stable than increases in paddy production and rice exports. Sustainability depends on demand- and supply-side factors. On the demand side, the most important determinants are population growth, income growth associated with income elasticity of demand, and urbanisation. Goletti, et al., (1997) believe that the population growth rate of Vietnam will fall considerably in the near future as a result of economic growth and government family planning policies. According to Minot (1998), in Vietnam the income elasticity of rice demand is approximately 0.35, and across income groups per capita rice consumption tends to rise initially and then decline. Urbanisation tends to reduce per capita rice consumption, as urban people tend to consume higher quality food and diversify their diets. Assuming the different growth rates of population, income, and urbanisation, Goletti et al. (1997) suggest that rice demand will grow at an average rate of 0.6 percent per annum until the year 2020 in a low demand scenario and 1.5 percent in a high demand scenario. On the supply side, it is more difficult to predict potential rice production growth. According to most standard methods of forecasting, rice production in Vietnam is expected to peak at the level reached at the end of the 1990s (Minot, 1998). In the Red River Delta, the potential for area expansion is very limited, given the rate of urbanisation and agricultural diversification in the area. In general, additional sown areas would be devoted to vegetables and other crops as farmers diversify production to meet the demand from urban consumers. In the Mekong River Delta, the chance for expansion is larger but investment is needed to improve the irrigation system. The chance for increasing yield is not great either. Pingali, et al. (1997) argue that further increases in yields might be difficult to achieve and suggests that yield growth may decline towards the level of other developing countries in Asia. This means a prediction of a 1.2 percent rice supply annual growth rate till the year 2020 in a low supply scenario, 1.6 percent in a medium supply scenario, and 1.9 percent in a high supply scenario. In short, Vietnam and the International Market for Rice Exports 117

130 rice production is expected to grow at less than 2 percent over the next 30 years, compared with 4-5 percent over the last ten years. Therefore, in the most pessimistic scenario (with demand for rice growing at 1.5 percent per annum and supply growing at only 1.2 percent per annum) Vietnam will still be able to export about million tons of rice over the forecast period. At the other extreme (demand growing at 0.6 percent per annum and supply at 1.9 percent per annum) Vietnam could export more than 9 million tons in Even under these pessimistic conditions, Vietnam still legitimately challenges Thailand to become the largest rice exporter in the world. The validity of these projections depends heavily on the trends in world demand and the behaviour of major competitors. Yet it is clear that Vietnam has the potential to sustain its position in the world rice market Export constraints Although there has been progress in the performance of rice exports, Vietnam still faces many constraints. If these constraints are removed, the competitiveness of Vietnamese rice in the world market will be significantly improved. Export Quotas Rice exports are subject to export quotas and food security is the main reason to justify the application of export quotas. Firstly, quotas have been allocated almost exclusively to state-owned enterprises (SOEs). In 1999, 32 of the 42 enterprises allowed to directly export rice were SOEs (MOT, 1999) and took more than 80 percent of total rice exports in the first five months. This lack of competition from the private sector has led a number of inexperienced SOEs to either enter unfavourable contracts, cancel contracts, or lose money through unprofitable pricing (Minot, 1998). Secondly, setting quotas at levels lower than the surplus available for export (i.e. binding quota) reduces the demand for rice. This further lowers the prices received by farmers. As a large proportion of the population relies on selling rice as a major source of income, this policy lowers the income of the rural poor, while benefiting urban residents, who can consume rice for lower prices. IFPRI (1996) concluded that in 1995 the implicit tax rate associated with the rice export quota on farmers was about 25 percent of the wholesale price. Moreover, the gap between low domestic prices and higher international prices has created a strong incentive for smuggling and illegal exports. Recognising the negative effects of export quotas and given the fact that the food security has not been affected by rice exports since 1989, the quotas have been removed in May According to Nielsen (2003) the export quotas have been a strong tool in achieving national self-sufficiency and stable rice prices, but have also kept Vietnamese production and exports well below potential, as domestic prices were kept low. Removing the quotas has created a stronger incentive to increase rice production, and thus has been an appropriate move of the government. 118 Vietnam and the International Market for Rice Exports

131 Export Tax Rice exports from Vietnam are taxed at an irregular level that creates purchasing difficulties for export agents. Export taxes are much better than a quota because it at least creates revenue for the government. However, the constant changing of tax rates introduces additional uncertainty to rice export activities. Exporters often become less confident in signing large contracts, fearing losses due to changes in tax rates. The imposition of export taxes contributes to a reduction of price received by farmers, similar to export quotas, and limits rice exports. Other Constraints The government also has intervened in rice exports by restricting certain exports in certain cases and by export price floors. Sometimes, due to fear of domestic shortfalls or changes in the world rice market, the government decides to restrict or stop rice exports or advises exporters not to export below a specific price. These bans have reduced foreign buyers confidence in Vietnam s ability to be a reliable rice supplier and lowered the credibility of Vietnamese export agents in completing contracts with foreign buyers. The minimum export price, a form of non-tariff barriers to trade, creates inflexibility for exporters signing contracts, especially when competition is tough and international prices are low. In summary, export constraints have created many problems for rice exports in Vietnam, reducing benefits from exports and limiting the ability of Vietnam to increase market share and competitiveness. Vietnam should carefully address these constrains in the same manner as the competing nations, such as Thailand and India. 4.5 Conclusions and policy recommendations Based on the analysis above it is possible to draw some conclusions and formulate policy recommendations to improve the performance of Vietnam in the international rice market. Firstly, taking a global perspective we can conclude that due to low yield growth, limited land expansion, and the declining profitability of rice farming, total world rice production will likely exhibit a low growth rate in the next years, continuing the trend of the previous decades. On the other hand, a relatively high population growth rate, especially in Asia and Africa, means the demand for rice will continue to increase at a high rate in the next years. Especially if you add to this a rather slow rate of income growth and low level of income, which means a slow rate of rice substitution. Thus, if supply grows slower than demand, it is expected that stocks will reduce and prices will increase. The longer-run prospect is expected to be brighter if necessary investments are channelled into agriculture. Rice trade will become more important as countries find it more difficult to remain self-sufficient. Vietnam and the International Market for Rice Exports 119

132 The trend of world rice prices over the past three to four decades is not clear. Nominal prices appear to have increased, but conclusions regarding real prices are debatable. It is clear that international rice prices fluctuate widely year to year, and the future gap between a slow production growth rate and a high consumption growth rate indicates an increase in rice prices over the next one to two decades. However, in recent years a lower supply has been accompanied with low prices, which may be the result of increased trade. The effect of liberalisation of rice trade is, however, unclear. It may lead to a higher demand with higher prices, though increased supply in the context of international trade may lead to lower prices. The rice market remains unpredictable. The structure of the world rice market is characterised by a high level of competition among many buyers and sellers in terms of countries involved. A few large transnational companies dominate rice trade, though many small agents exists and countries trade directly with each other. In addition, the world rice market is segmented into various submarkets. This dual characteristic greatly influences competition among rice exporting countries. Among major rice exporting countries, Thailand is the most important competitor of Vietnam in all market segments. Thailand has advantages over Vietnam in most areas of rice export, except in costs of production. India and China, although unstable exporters, can considerably undermine the market share of Vietnam whenever they enter the market with significant quantities. The USA does not directly compete with Vietnam at present as it produces mostly high-quality rice. However, if Vietnam is to extend its share in the market segment of high-quality rice, it can face competition from the USA. Vietnam has made much progress in rice exports in terms of quality and confidence of customers, though still improvements can be made. It has considerable potential for expanding rice exports, but this potential is limited by various constraints, especially government policies. In the international rice market, Vietnam has established itself as a major player. To increase the competitiveness of Vietnam in the international rice market, this study suggests the following policy recommendations: - The analysis of the rice export quota system suggests that this system should be progressively dismantled. - Regulations on rice export taxes and direct export permits should not be frequently changed. Exporters can make better long-term plans and foreign buyers can become more confident in Vietnamese rice exports without these uncertainties. - It is necessary to encourage the private sector to participate in rice export. This will likely improve the efficiency of rice export. - It is necessary to promote rice exports through improvements in quality, reduction of transportation costs, improvements in export marketing infrastructure, and timely monitoring and analysis of international market conditions. These measures will help Vietnam to penetrate new markets and to maintain a strong position in present markets. Extending the network for rice exports of Vietnam can be improved in this way. 120 Vietnam and the International Market for Rice Exports

133 Government assistance is essential to stimulate Vietnamese exporters to become more flexible in adapting to the changing conditions of the world market. - Vietnam s ability to maintain a rice surplus for export depends heavily on continuous investment in the agricultural sector. Investments in (agricultural) infrastructure, production technology, and post-harvest processing play a key role in sustaining food security and rice exports for Vietnam. References ADB (2002), Asian Development Bank, Key Indicators 2002: Population and Human Resource Trends and Challenges, ADB, Manila. Anderson, K. and R. Tyers (1990), How developing countries could gain from food trade liberalisation in the Uruguay Round, in: Goldin, I. And Knudsen O. (eds.), Agricultural Trade Liberalisation: Implications for developing countries, OECD Development Centre, Paris. Barker, R., Herdt, R. W. and Rose, B. (eds.) (1985), The Rice Economy of Asia, Resources for the future Inc., Washington D.C. DOFT (2001), Department of Foreign Trade, Grain Division, Royal Thai Government, (Last visited: ) FAO (1992) World Rice Situation and Outlook , Committee on Commodity Problems - Intergovernmental Group on Rice - Thirty-fifth session. FAO (1999), Rice Market Monitoring, No. 1-4, Rome. FAOSTAT (2002), FAO Statistical Databases, (last visited: ). Goletti, F., Minot, N., and Berry, P. (1997), Marketing Constraints on Rice Export from Vietnam, IFPRI, Washington D.C. Gulati, A. and Narayanan S. (2002), Rice Trade Liberalisation and poverty, MSSD Discussion Paper No. 51, International Food Policy Research Institute, Washington. Huang, J., Rozelle, S. and Rosegrant, M.W. (1997), China s Food Economy to the Twenty- First Century: Supply, Demand, and Trade, Food, Agriculture and the Environment Discussion Paper 19, IFPRI, Washington. IFPRI (1996), International Food Policy Research Institute, Rice Market Monitoring and Policy Options Study, TA No VIE, Washington, D.C. Ito, S., Wesley, E., Peterson, F. and Grant, W.R., (1989), Rice in Asia: Is it becoming an inferior good?, American Journal of Agriculture Economics, February, 71 (1), pp Vietnam and the International Market for Rice Exports 121

134 Lien, H. (1998), Thai Lan Van La Nuoc Xuat Khau Goa Lon Nhat The Gioi, [Thailand to Remain the World s Leading Rice Exporter], Thoi Boa Kinh Te [Vietnam Economic Times] issue No. 52. Maizels, A. (1984), A Conceptual Framework for Analysis of Primary Commodity Markets, in: World Development, vol. 12, no.1, Pergamon Press Ltd. MARD (1997), Ministry of Agriculture and Rural Development, Ban tin gia ca - thi truong lua gao [Paddy and Rice - Market and Price News], No [issues from Jan to Dec]. MARD (1999), Ministry of Agriculture and Rural Development, Ban tin gia ca - thi truong lua gao [Paddy and Rice - Market and Price News], No [issues from Jan to Dec]. Minot, N. (1998), Competitiveness of Food Processing in Vietnam: A Study of Rice, Coffee, Seafood and Fruits and Vegetable Subsectors, IFPRI, Washington, D.C. Mitchell, D.O., Ingco, M.D., and Ducan, R.C. (1997), The World Food Outlook, Cambridge University Press, Cambridge. MOT (1999), Ministry of Trade, Tong Hop Cung, Cau va Du Tru Gao Toan Cau [World Rice Supply, Demand and Stock Situation, ], Hanoi. Nielsen, C.P. (2003), Vietnam s rice policy: recent reforms and future opportunities, Asian Economic Journal, vol. 17, no 1. Nguyen Trung Van (1998), Luong Thuc Viet Nam Thoi Doi Moi Huong Xuat Khau [Vietnam s Food - Export-oriented Reform Era], Nha Xuat Ban Chinh Tri Quoc Gia [The National Political Publishing House], Hanoi. Nguyen Van Nam, Nguyen Thai Nguyen, Nguyen Dinh Phuoc, Cao Duc Phat and Tran Van Dinh (1997), Luu Thong Gao o Thai Land, [Rice Circulation in Thailand], Nghien Cuu Kinh Te [Economic Research] Magazine, No. 230, pp Pingali, P.M., Hossain, M., and Gerpacis, R.V. (1997), Asian Rice Bowls: The Returning Crisis?, CAB and IRRI, Washington. Sutton. J. (1992), Sunk Costs and Market Structure: Price Competition, Advertising and the Evolution of Concentration, the MIT Press, England. US Bureau of the Census (2002), International Database, International Programs Centre, Washington DC, (Last visited ) USDA (1998), Rice Yearbook, Economic Research Service, U.S. Department of Agriculture, Washington, DC. USDA (1999), World Rice Trade, Economic Research Service, U.S. Department of Agriculture, Washington, DC. USDA (2002), Rice Situation and Outlook Yearbook, Market and Trade Economics Division, Economic Research Service, U.S. Department of Agriculture, November 2002, RCS World Bank (1994), Vietnam: Agricultural Marketing Study, Report No VN, Agricultural and Natural Resources Operations Division - Country Department I - East Asia and Pacific Regional Office, Washington, U.S.A. 122 Vietnam and the International Market for Rice Exports

135 Chapter 5. Impact of Price Fluctuations on Coffee Producers: a Case Study of Dak Lak Province Nguyen Thu Duyen 5.1 Introduction The Vietnamese economy is dominated by the agricultural sector. Over the past few decades, Vietnam has obtained significant achievements in agricultural production, shifting from a situation of food shortages to a situation of being a large exporter of several products such as rice, coffee, pepper, cashew nuts and rubber. Among the agricultural products, coffee ranks second after rice in terms of export value (Duong Ngoc, 2002). Vietnam is now the second largest coffee exporter in the world, with a share of about 15 percent of global coffee trade. Vietnam is very competitive as a coffee producer due to a favourable climate and natural conditions, and low labour costs. Over 90 percent of the coffee output is exported to about 60 countries. However, similar to the case of rice discussed in the previous chapter, Vietnamese coffee fetches lower prices than the world average. This can be explained by lower quality due to poor processing, drying facilities and post-harvest technologies, manifested in a high moisture content. Moreover, in the context of trade liberalisation, the Vietnamese economy is vulnerable to external shocks. The strong decrease of the coffee prices in the world market in the past few years has lowered export earnings, in spite of continuous expansion of coffee export volumes. Most of the price risk is borne by the farmers, as the shock stabilising system is weak and operates inefficiently. The situation of the coffee industry is worsened due to the practice of non-zoned production, causing an imbalance between demand and supply. The large expansion of the coffee-growing area in Vietnam since 1994 partially explains the excess supply and the strong decrease of the world coffee prices. This situation is not unique to coffee, but also to some other products, such as cashew nuts and pepper. The low coffee price in the world market seriously hampers coffee farming profitability in Vietnam. In particular, Dak Lak province is hit strongly as it produces 53 percent of Vietnam s coffee volume. However, information regarding the impact on living standards in the affected regions is very scarce. In this study, impact of fluctuations in coffee prices on farmers is assessed by analysing the case of coffee farmers in Dak Lak province. Impact of Price Fluctuations on Coffee Producers 123

136 The central question to which this study tries to find an answer is how price fluctuations affect coffee farmers. An analysis of the global coffee market, the coffee production structure in Vietnam, and the effect of coffee price fluctuations on farmers earnings, debt and investment behaviour is carried out to answer this question. The study uses data from a survey carried out among 178 coffee growing households in Dak Lak province in 2002 (ICARD, 2002). This chapter contains five sections in addition to the introduction. Section 2 reviews theoretical issues of price fluctuations of agricultural commodities in general and coffee in particular. Section 3 highlights movements of the world and domestic coffee markets, focusing on coffee price volatility and the relationship between world and domestic prices. Section 4 presents the structure of the coffee industry in Vietnam, which affects the distribution of export income as well as price risk. Section 5 considers impacts of price fluctuations on coffee farmers in Dak Lak province. Finally, Section 6 gives a conclusion and makes recommendations. 5.2 Commodity price fluctuations Introduction Agricultural products are of considerable importance to many developing countries as sources of export earnings, government revenue and growth. Millions of people depend on agriculture as source of income and employment. Therefore, fluctuations in prices of agricultural products have a direct impact on their living standards. Fluctuating prices can be explained by both inelastic and unstable demand and supply (Salvatore, 1995). Demand for many primary exports such as coffee, tea and cocoa of developing countries is price inelastic because individual households in developed nations, who are main consumers of these products, spend only a small proportion of their income on these commodities. A fluctuation in the prices of these commodities does not significantly change their purchases of the commodities. The demand curve for agricultural commodity is thus very steep. Meanwhile the demand for the primary exports of developing countries is unstable because of business cycle fluctuations in developed countries. On the supply side, inelasticity results from the rigidities and inflexibility in resource uses in most primary commodity production; coffee trees, for instance, only produce beans a few years after planting. Instability of supply is caused by the dependence on weather conditions; draughts or cold weather can lead to considerable lower coffee harvests. In addition, plant diseases or insect plagues can harm harvest. With inelastic demand and supply curves, any shift of demand or supply can lead to wide fluctuations in the world prices. The volatility in the world prices, in turn, transmits to export revenues of producing countries and further to producer prices and their income. 124 Impact of Price Fluctuations on Coffee Producers

137 5.2.2 The agricultural marketing system in developing countries Agriculture marketing includes all activities that are involved in transforming, storing, transporting, and promoting agricultural products to the domestic consumers or foreign buyers (Elz, 1987). The structure of an agricultural marketing system affects the pattern of income distribution to actors in the system and thus influences risk sharing of price fluctuations of exported commodities. Actors that typically can be identified are: producers, assemblers, processors, and exporters. Producers deliver to assemblers, which in their turn deliver to processors. Processors can either supply directly to the domestic market or supply to exporters. The actors involved in a domestic marketing system all aim at maximising their income, which can result in conflicts. In the context of wide fluctuations of agricultural commodities, income of producers seems to be most volatile; other actors are better able to maintain their income when prices fluctuate. Most governments intervene in primary commodity markets and, as a result, affect the market structure and the outcome of the distribution of export revenues. Governments intervene by defining who does and who does not participate in the markets, by setting rules of inclusion, by assisting participants to achieve standards and by monitoring their performance (Kaplinsky and Morris, 2000). The stated objectives of intervention largely reflected the justifications offered by development economists: stabilising prices, maintaining food security, protecting farmers from local traders (who were perceived to have certain bargaining advantages), controlling exports in order to influence world prices, and protecting sources of foreign exchange and tax revenue. While the instruments of intervention varied across countries and crops, a dominant architecture emerged in the second half of the 20 th century. Most commonly, governments controlled domestic markets by restricting trade, by introducing licensing regulations, or by granting monopolistic marketing powers to parastatals. In West African cotton and sugar markets, for instance, and in some of the plantation systems in Asia, all aspects of production and sale were subject to government control and command. More often, government control extended to key processing and transport facilities. For coffee, cocoa, and grain markets, where processing required relatively small investments, government controlled domestic markets by licensing processors and setting processing margins. For products where larger investments were needed, governments often obtained a monopoly position as processor (World Bank, 2001). The intervention had only limited successes. Many parastatals found themselves financially strained. The lack of transparency in management of government-controlled systems also caused problems. Steady productivity gains in agriculture, transportation, and communication began eroding the efficiency of intervention instruments, and economists and policy makers increasingly turned to a market-based approach in the 1990s. Agricultural commodity market reforms are carried out to reduce governments involvement, open domestic and export markets to competition, and put in place public and private institutions that support free market activities (World Bank, 2001). In order to achieve these goals, governments generally take some measures such as eliminating Impact of Price Fluctuations on Coffee Producers 125

138 government marketing agencies and statutory monopolies in output and input markets, reducing explicit and implicit taxes and privatising marketing and processing assets. In most coffee and cocoa producing countries, the increased competition and lower taxes (both implicit and explicit) resulting from the reform raise the ratio of farm prices to export prices substantially. In Uganda, for example, coffee producers saw prices for their products increase to over 60 percent from 30 percent of FOB since the reform began in 1991 (World Bank, 2001). In contrast to these benefits of reform, agricultural producers are likely to face increased price volatility due to stronger links between domestic and world prices, that are established after the reforms Coping with commodity price fluctuations Farmers all over the world face fluctuations in the price of the crops that they produce. Changes in price of a single commodity directly leads to changes in revenue of this crop and total crop income. The impact of the price risk may vary across farms, depending on the level of specialisation in that commodity. Farmers that highly specialise in a commodity are most affected by fluctuations in the price of that commodity. In contrary, highly diversified farmers may not experience much revenue loss because their farm revenue should be relatively insulated against single price changes. Commercial farmers are typically more specialised than smallholders, so they are more affected by fluctuations of a single commodity price (UNDP, 1989). However, small farmers are more susceptible to price changes; the welfare consequences for even a small drop in income can be very high. A large commercial farmer may be able to absorb a huge drop in annual revenue, while a small subsistence farmer may starve as a result of a little drop in revenue. Moreover, agricultural price fluctuations may affect not only farm revenues but also the price that farmers pay for the products they consume. In addition, if farmers do not produce enough food for their own consumption, they do not enjoy the benefits from any increase in the world price of the commodity they produce (Fafchamps, 1992). It is also important to note that price declines are more severely felt if the price were high in the previous year, because this phenomenon tends to boost up expectation and increase proportion of land allocated to this crop. Not only producers are affected by commodity price fluctuations; commodity price variability also causes problems for both governments and traders. For governments, unforeseen variations in export prices can complicate budgetary planning and can jeopardise the attainment of debt targets. This is in particular a problem for countries that are highly dependent on commodity exports, such as Vietnam. For exporters, price variability increases cash flow variability and reduces the collateral value of inventories. Several ways exist to cope with commodity price fluctuations. Some methods rely on self-insurance and income diversification by farmers, while others rely on government intervention or on market institutions. Firstly, farmers have developed a variety of ways to mitigate the effect of commodity price risk on their well-being. Alderman and Paxson (1992) classify farmers strategies into two categories, risk management and risk coping. The first category refers to ex-ante 126 Impact of Price Fluctuations on Coffee Producers

139 adjustments to production and resources used before the occurrence of crop revenue shock. It can occur before or during the production season. The second set of strategies consists of ex-post responses or actions taken after a shock has already occurred, aiming at minimising impact of production shortfall on revenue and consumption. Risk management includes strategies like crop and field diversification, and non-farm employment. Risk coping strategies are divided into intertemporal smoothing of consumption through precautionary saving behaviour, and consumption smoothing across households through sharing risk. The former takes place through borrowing, lending, and storing goods for future consumption. The latter includes transfer arrangements such as forward sale to traders, by which the trader pays the farmers some money in exchange for a promise of future delivery at time of harvest at specific price. A second way to deal with commodity price fluctuations is through government intervention and by using the agricultural market. Self-insurance methods applied by farmers are seldom sufficient to eliminate risk. Government intervention in commodity markets plays an important role to moderate volatility of commodity price. There are several methods used by governments to reduce price volatility. Governments can establish buffer stock schemes to moderate price and supply fluctuations. A buffer stock scheme is an organisation which buys when the price is low and sells when the price is high (Begg et al, 1991). Another method is that governments establish stabilisation funds, which are sometimes accompanied by marketing boards and/or state trading enterprises. A domestic stabilisation fund compensates producers when prices fall below a predetermined floor or price band, and accumulates reserves when prices increase above the fixed price or band. Both buffer stocks and stabilisation funds need to be very large, and need considerable financial funds, especially when trading volumes are large. If these schemes are administered in conjunction with a marketing board or state trading enterprises, these institutions risk bankruptcy if funds are insufficient. Under these domestic schemes, the risks of international price fluctuations are transferred from the producers to the government, which often finds it too costly to finance the schemes. Internationally, price stabilisation has been attempted via international commodity agreements by imposing export quotas on participating countries or establishing international cartels. In order to keep the world prices within a price range agreed by members, the cartel controls supply for export in the world market by distributing export quotas to member exporting countries. However, commodity price cycles tend to be asymmetric (Gilbert, 1999). This means that schemes, which are designed to stabilise prices about a supposedly known trend, face intractable problems when the long-term relative prices change. Moreover, once prices rise in the short term, some producers are encouraged to break away and sell above their quotas of exports, so discipline of the cartel may be violated. Furthermore, competition from non-members can hamper the cartel to obtain the goal of price stabilisation. As a result of the repeated failures of domestic and international attempts to stabilise commodity prices, efforts are now being made towards setting up schemes that aim at dealing with commodity price volatility in developing countries based on a market Impact of Price Fluctuations on Coffee Producers 127

140 approach. The available market based tools, such as futures and options, which are widely used in developed countries, are often inaccessible for small agricultural producers in developing countries. This has three reasons: (i) sizes of contracts traded on organised exchanges far exceeds the annual value of production of individual small producers; (ii) small producers as well as many market intermediaries in developing countries have lack of knowledge of such insurance instruments; and (iii) the sellers of such instruments, which are usually international trading firms, are often unwilling to engage with new and unfamiliar customers with a small value contracts. These obstacles should be overcome to make risk management instruments more widely available to producers in developing countries. Initiatives in Mexico and Costa Rica show that market based tools can be effective to reduce price volatility for small producers (World Bank, 1999; Fontenay and Leung, 2001). 5.3 An overview of the coffee market Introduction Coffee is cultivated in over 70 countries in the world, mainly in South America, Africa and Asia, where tropical and sub-tropical weather is suitable for coffee growing. Coffee is the second largest globally traded commodity after oil. In 1999/2000 the total value of traded coffee was 9 billion US$ per year. Coffee production employs more than 25 million people on more than 5 million farms and is regularly consumed by more than 40 percent of the world s population (Rotzoll and Henniges, 1997). Revenue from coffee exports is an important source of export earnings for many developing countries. There are between 25 to 100 different species of coffee, but most commercial coffee is either arabica or robusta. Arabica is grown at altitudes over 1000 metres above sea level. It produces superior quality beans which possess the greatest flavour and accounts for over 70 percent of the total global coffee production (ICC, 2000). Robusta plants can grow at lower altitudes, have higher yields and are more resistant to disease, but produce beans of inferior taste to arabica. Robusta beans are offered at a lower price in the markets. Recently, new technologies for steam cleaning robusta have improved its quality and allowed some substitution with arabica in markets such as Germany. This section firstly discusses coffee as a global commodity, then highlights movements of the international and the Vietnamese coffee markets, focusing on volatility of the world coffee prices and the relationship between world and domestic prices The world coffee market Coffee is mostly grown in developing countries. The largest coffee exporters in the world in the period from 1990 to 2001 were Brazil, Colombia, Mexico Guatemala, Côte d Ivoire, Costa Rica, Uganda, Vietnam, Indonesia, and India. Brazil ranks first in the list of largest exporters with the market share of around 25 percent, see Table 1. Colombia used to rank second in this list for a long time; though, since 2000, this position has been occupied 128 Impact of Price Fluctuations on Coffee Producers

141 by Vietnam, a new entrant in the world coffee market. The world coffee production was growing at 3.7 percent per annum in the period from 1991to Brazil Colombia Vietnam Indonesia Mexico Guatemala Cote d'ivoire Uganda India Costa Rica Table 1: Export of ten largest exporting countries (as a percentage of the world export). Source: ICO Database ( While coffee is planted in developing countries, most of world consumption of coffee takes place in industrial countries. Large markets for coffee consumption are Europe, the United States and Japan. The European market, with an annual consumption of around 2 million tonnes, accounts for over 40 percent of total global demand. The United States accounted for 24 percent of total consumption and Japan for over 10 percent. In contrast to the large coffee consumption in industrial countries, coffee consumption in exporting countries only explains for about 20 percent of world demand and half of this 20 percent is consumed in Brazil, where domestic consumption accounts for 40 percent of the production. Demand is slowly growing at 1.5 percent per annum, which is lower than the growth in supply. While coffee consumption grew rapidly outside Europe and the United States, at annual rates of 9 percent in 1990s (Fitter and Kaplinsky, 2001), consumption in the traditional importing countries is showing a decrease. The slow growth of coffee consumption and the relatively strong expansion in coffee production has caused very low coffee prices in the past few years. An important characteristic of world coffee market is the prevalence of a high degree of price instability. An indicator of price volatility is the coefficient of variation, which is measured as standard deviation divided by the mean. This indicator shows a variability of 48.6 percent of the composite indicator price of the International Coffee Organisation (ICO) from year to year in the period from 1965 to Variability on short term is also high. The intra-year variability is shown in Figure 1. Over this period, the intra-year variability was 10.6 percent on average. Impact of Price Fluctuations on Coffee Producers 129

142 0.50 Coefficient of variation Figure 1: Coefficient of variation of world coffee price Source: Author s calculations based on ICO database ( The high volatility in coffee price is primarily caused by supply shocks rather than demand factors. Historical evidence shows that large changes in coffee price can often be related to frosts and droughts in Brazil, the largest coffee exporter in the world. Most significant was the frost in Brazil in 1975, driving the prices in the two following years to very high levels. Similarly, Brazilian severe drought in 1985 and frost in 1994 also caused strong price increases. In contrast to these external supply and price shocks that cause price increases, increases in production cause falling prices in the world market. This is shown in Figure 2. The transfer of supply shocks to price shocks is immediately, though supply response to price takes place with a delay. High price expectations can only lead to slightly higher production from existing trees through better care taking, while new trees need a gestation period of three to five years. Therefore, it takes several years for supply to response to high prices. This can also be inferred by positive correlation indices of the world production and lagged international coffee prices. These indices are 0.53, 0.57, 0.61, 0.63 and 0.63 for prices lagged by one to five years respectively. Similar to many other agricultural products, the prices of coffee in the world market also show a long-term downward trend. In the coffee market, oversupply is the result of a 3.7 percent average growth in supply and a 1.5 percent average growth in demand. Although the average combined prices of four main categories of traded coffee increased from about 40 US cents/lb in the mid 1960s to around 45 US cents/lb in 2001, real coffee prices fell sharply to a level of around half of that of the mid 1960s, and around 20 percent of peak market values in 1977 (Fitter and Kaplinsky, 2001). For many farmers, the coffee price of 2001 did not cover total costs of producers. The ICARD s survey in Dak Lak (Vietnam) at the beginning of 2002 shows that farmers were receiving only half of their production costs. As coffee production resulted in losses, growers in diverse regions of 130 Impact of Price Fluctuations on Coffee Producers

143 Production (million ton) World Production World Price 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1, Price($/ton) Figure 2: World production and price Source: FAOSTAT (2002) Vietnam, Ethiopia, Guatemala, Mexico and Kenya are either not harvesting, or cutting their coffee trees down. Despite the downward trend of green coffee prices, roasted coffee prices in the consumer market showed different trends. Morisset (1997) found that the price of green coffee fell by 18 percent in the world market, while the price for roasted coffee for consumers in the United States increase by 240 percent in the period This is caused by the domination of some large trading companies in the United States coffee market. To take advantage of roasting coffee beans in large quantities, large plants have been established. Large plants have high sunk costs and form a natural barrier to prevent new entrants in the coffee market for consumers. The oligopoly power allows these companies to set high prices at profit maximising level. When the world price declines, they keep the domestic price high and when the world price increases, they mostly transfer the high world price to a higher domestic price Vietnam s coffee market Coffee trees were introduced in Vietnam by the French missionaries in Till 1975, areas for coffee farming in Vietnam reached 14,000 hectares. Production of coffee significantly increased after the re-unification in 1975, expanding to 150,000 hectares in 1994 (Hau, 1996). In the late 1990s, coffee plantation areas rapidly expanded due to the strong price increase in the world coffee market, caused by a severe frost in Brazil in Areas for coffee farming reached to 516,700 hectares in the year Dak Lak, the biggest coffee-specialised region in the country, accounted for 260,000 hectares. The increasing area devoted to coffee production and increasing yields per hectare resulted in an annual increase in coffee production of 32 percent over the 1990s, reaching a record of 802,000 ton in 2000 from 92,000 ton in As a result of the rapid increase in production capacity, coffee has become one of Vietnam s key agricultural export Impact of Price Fluctuations on Coffee Producers 131

144 commodities, ranking second after rice in terms of export revenue (Duong Ngoc, 2002). Vietnam now exports coffee to 59 countries. Switzerland (20.1%), the United States (14.1%), Germany (10.5%), Singapore (8.3%), England (7.8%), the Netherlands (7.0%), Italy (4.8%), Belgium (4.6%), Japan (4.2%) and Spain (3.5%) are the ten largest importers of Vietnamese coffee. Vietnam is the largest exporter of robusta coffee with a share of about 40 percent in the world market. Along with the rapid growth in export quantity, there was an upward trend of export value in the period, with annual growth of 36 percent. However, export revenue has fallen due to low prices since In 1999, the export value reduced only slightly, despite a growth in export volume of 26 percent. In 2000, however, export revenue fell by 14 percent, while export volume grew 52 percent. The downward trend in export revenue continued in 2001 (FAOSTAT, 2002). The low prices in the world market can partially be explained by strong growth of coffee production in Vietnam. Since about 1995, Vietnam s exports started to affected the world coffee price and thus Vietnam s export price. A small regression analysis confirms this relationship. An estimation of export demand for Vietnamese coffee, which is based on quarterly coffee export data from 1994 to 2002 released by Vicofa (the Vietnamese Coffee and Cocoa Association), and adjusted by seasonal factors, indicates a significant negative relationship between Vietnam s coffee export volumes (Q) and prices (P). Q Coefficient Std. Err t-value P-value P Constant 208, , Adjusted R Number of obs. 32 Table 2: Relation between Vietnam s export and received prices. From this estimated demand function, it is possible to compute the elasticity of export demand for Vietnam s coffee with respect to its prices, and calculate the theoretical optimal exported quantity, for which revenue is maximised. The calculation shows that the optimal point occurs at the export volume of 104,198 tons quarterly or 416,789 tons annually, at a price of US$ 1,473 per ton, totalling a revenue of US$ 614 million (everything else equal). Comparing this figure with the export volume of 713,735 ton in 2002 shows that the current volume is about 300,000 tons or 42 percent higher than the optimal point. If Vietnam were monopolist, it could reduce is production to increase revenue. However, Vietnam is not the only player in the world market. With over 90 percent of the coffee output exported, the Vietnamese coffee sector is closely linked with the international coffee trade. Price changes in the world market are transmitted and translated to domestic prices. Particularly at export and wholesale levels, international and domestic prices are closely related. At these levels, the pricing and 132 Impact of Price Fluctuations on Coffee Producers

145 marketing system is efficient due to accessibility to market information. A high correlation coefficient of 0.98 exists between the world coffee prices and Vietnam s export coffee prices for the period of The price dissemination and transmission may be, however, less accurate as it reaches coffee producers. The producers may, for instance, not getting a fair price in the event of adverse price movements. An additional issue in the relation between the world market and Vietnamese exports is the fact that Vietnamese coffee fetches a lower price in the international market. The gap between Vietnam s export price and the world price is shown in Figure 3. The price gap seems to have narrowed in recent years, though this does not mean a better performance for Vietnam s coffee price in the world market. The export price of Vietnamese robusta coffee price as a percentage of those of Brazil and Indonesia were 0.72 and 0.96 in 1997, and 0.64 and 0.88 in 2000 respectively. The smaller absolute gap is a result of low coffee prices in the last few years. 3,000 2,500 Vietnam's Export Prices World Robusta Prices 2,000 1,500 1, Figure 3: Vietnam s export prices versus world prices (in USD per ton). Source: Vicofa. The low price of Vietnamese coffee can be explained by following reasons: The relatively low quality of coffee exported. This is caused by the practice of strip harvesting, which mixes ripe and unripe cherries, and inadequate primary processing at both farm and post-farm levels, which mainly use dry processing methods. Incompatibility with international standards of grading coffee has harmed the reputation of Vietnam s coffee industry in the world market. As a result, Vietnamese coffee is exported using individual contracts in which import requirements are specified in each contract, rather than using international requirements and according prices that are quoted for specific grades. This results in lower coffee prices offered for Vietnam s coffee beans. This problem has, however, been solved when Vietnam adopted new coffee quality standards at the end of Impact of Price Fluctuations on Coffee Producers 133

146 The monopoly of state exporters prior to 1999 was responsible for lowering Vietnam s reputation in the international market, as the state-owned enterprises in charge of coffee export not always fulfilled their side of the contracts. Poor marketing also affected Vietnam s bargaining power in the international market, especially in the event of adverse price movement. 5.4 The structure of the coffee industry in Vietnam Before 1999 Before the Doi Moi in 1986, most coffee was grown in state-owned farms. The statefarm workers harvested cherries, dried them and delivered them to the state processing plants. After processing, the coffee beans were delivered to the ports for export under government contracts. Following the Doi Moi, many of the state farms began allocating plots to workers, retaining the ownership of the land and the trees, and providing a variety of inputs and services to the farmers. In exchange, the farmers associated with the state farms to sell their coffee to the state processing plants. Currently, only 10 to 15 percent of planted area is owned by state farms and coffee is grown under a wide range of production systems, including small farms of less than one hectare and state farms of more than 1,000 hectare. Until 1999, small farmers mostly sold their coffee to private assemblers. These assemblers were licensed by state owned processors or exporters. The assemblers were able to keep the farm-gate prices relatively low as they had a monopsonist position and had better information on prices than the farmers. The risks of export price fluctuations was also passed on to the small farmers. The assemblers delivered the coffee beans to processors. Both private processors and state-owned processors were in the market, though the relative size of the private processors was quite small. The production from the stateowned farms bypassed the assemblers and was delivered directly to the state processors. Before 1999, liberalisation in the coffee industry only took place in fields of production and processing; coffee-exporting was restricted to state-owned enterprises The structure of Vietnam s coffee industry since 1999 Since 1999, private firms are permitted to engage in coffee exports. Assemblers can take part in the coffee market without a license of state-owned enterprises. This participation of the private sector in coffee exports has negatively impacted, to some extent, on the state-owned and state-licensed cartel that existed prior to the liberalisation of export marketing channels. There are currently over 80 organisations (both government and private) involved in the coffee collection and export (Fontenay and Leung, 2002). The current structure of the coffee system is displayed in Figure 4. It should be noted that with the liberalisation of export marketing, the structure of the market is currently rather fluid 134 Impact of Price Fluctuations on Coffee Producers

147 Small Farmers State Farms On Farm Processing (Hulling) Private Assemblers (licensed or unlicensed by SOEs) Private Processing Factories (cleaning, sorting and grading) State Processing Factories (cleaning, sorting and grading) Private and State Exporters Domestic Market Foreign Market Figure 4: Coffee marketing system in Vietnam since Impact of a structural change on distribution of income and price risk With the liberalisation of the market, the farm-gate price of coffee can increase, as was discussed in Section 2 for the case of some African countries. However, a time series of farm-gate prices as a percentage of export prices in the period 1996 to 2001 does not seem not support this argument in the case of Vietnam. Shares of farm-gate prices in export prices have even declined since 1999, as is shown in Figure 5. Farmers seem to bear most of the downward price trend. As the price decrease has been rather strong, it distorts the impact of the recent liberalisation. Hence, the impact of the liberalisation of the coffee market is unclear. An analysis of the cost structure of the coffee channel will make clear how farmers bear the price risk. Table 3 presents the cost structure of Dak Lak s coffee channel in The farm-gate price for coffee beans, as seen from this table, was about VND 4,000 per kilogram in This was less than half of the production costs, that amounted to VND 8,821 per kilogram in the district of Cumga, 8,649 per kilogram in the district of Buon Don and 6,983 per kilogram in the districts of Lak. Farmers thus suffered serious losses from coffee plantations. However, the assemblers, processors and exporters still gained from doing coffee business. Impact of Price Fluctuations on Coffee Producers 135

148 100 % Figure 5: Farm-gate price as a percentage of export price. Source: Farm-gate prices from General Statistical Office and export prices from Vicofa. The assemblers bought at price of VND 4,002 per kilogram from farmers, while they sold to processors or exporters at the price of VND 4,192 per kilogram. The difference of VND 190 per kilogram was revenue for the assemblers, of which costs for assembling, maintenance cost, and transportation costs to processors or exporters was subtracted. As these costs amounted to VND 56 per kilogram, the assemblers could still make a profit of VND 134 per kilogram or 2.4 percent of the export price. For exporters, the situation was even brighter. They could still earn a net profit of about VND 1,000 per kilogram of exported coffee, which is 18.7 percent of the export price. This in spite of the low export price of VND 5,784 per kilogram in the year A survey by MARD (1998) in Dak Lak province reported farm-gate, assembler and export prices in 1996 of VND 10,322 per kilogram, VND 14,562 per kilogram and VND 20,983 per kilogram respectively. With these prices, farmers earned a profit of around VND 2,000 per kilogram (or 10 percent of the export price), while the profit for assemblers was about VND 4,000 per kilogram (or 20 percent of the export price) and about VND 700 per kilogram (or 4.4 percent of export price) for exporters. However, the very modest profit of VND 700 per kilogram that was reported by the exporters, could be distorted. If using cost structure in the survey of 2002, exporters profit in 1996 should be roughly VND 5,000 per kilogram (or approximately 24 percent of export price), including 5 percent revenue tax. In this case, farmers still receive the smallest part of the profits of coffee production. 136 Impact of Price Fluctuations on Coffee Producers

149 Cost (VND/kg) Value added Value added as a % of Profit as a % export price of export price Farm-gate price 4, , % Total production cost 8, Profit of farmers -4, loss Assembler price 4, % Total assembling cost Assembling cost Maintenance cost 1.00 Transportation cost to processors or exporters Profit of assemblers % Export price 5, , % Total reprocessing and exporting cost Custom fee 6.00 Maintenance cost Reprocessing cost Transportation cost to Saigon port Award for export *) Profit of processors and exporters 1, % Table 3: Cost structure of Dak Lak s coffee channel in Source: Estimates from data of Survey in Dak Lak, * ) Government has encouraged enterprises to expand coffee export markets by using export bonus policy, which awarded approximately VND 220 per USD 1 of exports. This means that each kilogram of coffee exported with the price of VND 5,784 or USD 0.37 (at an exchange rate of VND 15,000 for USD 1) was awarded VND By looking at available data of two years 1996 (a year of high price) and 2001 (a year of low price), it is clear that farmers were bearing most of price risk. While farmers could earn a profit of VND 2,000 per kilogram in the year of high price, they were bearing the losses in the year of low price. The situation for other actors in the marketing channel is rather different. Assemblers, processors and exporters still make profits even in a low-price year. In order to maintain high profit margins, they tend to transfer most of price risk to farmers. In this situation, it is understandable why the shares of farm-gate prices have not become better after the liberalisation. However, it is important to note that coffee traders also face highly volatile prices and bear price risk. Coffee prices change daily and some time passes between the moment coffee traders buy for farmers and the moment they sell the coffee again. If prices decrease Impact of Price Fluctuations on Coffee Producers 137

150 substantially in this period, the profits of coffee traders also decrease. This explains why many coffee traders are in a difficult financial situation. Also in the other direction in the marketing channel coffee traders face price risks, as many of them sign long-term contracts. They suffer losses when prices have increased after they agreed to deliver coffee at a low price. According to Ha (2002), insufficient market information and incapacity of information analysis and price forecast are traditional problems of Vietnamese businesses. In response to the sharp drop in the world coffee price, partially explained by the expansion of Vietnam s coffee growing area, the Vietnamese government decided to buy 150,000 tonnes of robusta coffee beans for reserve (60,000 tonnes at November 2000 and 90,000 tonnes in February 2001). The stockpiling of 150,000 tonnes had increased domestic price for ground coffee from VND 5,700 per kilogram to VND 6,000 per kilogram and 6,500 per kilogram (VNA, 2001). However, the effectiveness of this policy to all groups in the marketing channel is difficult to perceive. Unavailability of information of the prices at which assemblers are purchasing coffee for the stockpile does not allow to estimate the impact of the scheme on farmers. Moreover, if aiming at supporting small farmers, it is more effective to directly pay the growers rather than to spend public funds on a stockpile. In addition, Vietnam is not the only beneficiary from such scheme; while Vietnam bears all the cost, other robusta coffee exporting countries share the benefits of the higher prices under such policy. The Ministry of Trade reported that losses incurred by state-owned exporters as a result of the stockpile were USD million (Fontenay and Leung, 2001). The cost of stockpiling coffee beans, in addition to the fact that coffee beans cannot be stored for a long time, meant that the stockpiling policy was abandoned in July This undid the earlier increase in coffee price as a result of the stockpiling. 5.5 The impact of coffee price fluctuations on producers in Dak Lak province Overview of coffee production in surveyed farms of Dak Lak Dak Lak is a mountainous province in the Central Highlands with a total area of 1,953,546 hectare, of which 790,000 hectare is bazan soil. Bazan soil is very fertile and suitable for coffee cultivation, but it is unevenly distributed over the province and therefore the suitability for coffee cultivation is different between regions in the province. The communes surveyed, namely Ea Pok (Cumga district), Ea Nuol (Buon Don district) and Dak Phoi (Lak district), represent three different geography regions: Region 1 - highly favourable for coffee cultivation, Region 2 - moderately favourable for coffee cultivation and Region 3 - least favourable for coffee cultivation. The coffee industry makes a key contribution of around 95 percent to provincial export revenue (CRP and Action Aid, 2000) and is considered as a major crop of rural households. The survey that was carried out comprised a sample of 178 households in nine villages, including Buon Pok, Boun Ea Sut, Buon Lang (Ea Pok commune), Buon Nieng 1, Buon Nieng 2, Hoa Nam 1 (Ea Nuol commune), Buon Paiar, Buon Dung and Buon Yo Yok (Dak Phoi commune) (ICARD, 2002). Among the households interviewed, over 90 percent were ethnic minority people. 138 Impact of Price Fluctuations on Coffee Producers

151 Coffee production in the households is examined in a simple regression analysis. The regression equation is based on a Cobb-Douglas function i with some modifications, using data of 107 households (the others were excluded due to lack of information). Determinants of coffee output, including capital (land, investment cost), labour and the quality of these factors are comprised in this regression. Definitions of variables in the regression are presented in Table 4. Regression results are reported in Table 5. Econometric tests of heteroscedasticity, normality, variable omission and functional form have been conducted and passed. Variables Mean Std. Dev. Definition Output Total coffee output (ton) Harvested area Harvested coffee area (hectare) Dist Dummy variable, 1 if household locates in Cumga Dist Dummy variable, 1 if household locates in Buon Don Cost 2, ,649 Investment cost per hectare (1,000 VND) Labour Number of agricultural labourers in household Education Years of schooling of household head Ethnic Dummy variable, 1 if Kinh household head Age Age of household head Sex Dummy variable, 1 if male household head Table 4: Definitions of variables Variables Coefficients t-values P-value Ln(Harvested area) Dist Dist Ln(Cost) Ln(Labour) Education Ethnic Age Sex Constant Adjusted R Number of observations 107 Table 5: Determinants of coffee output in surveyed households. Source: Estimates from data of survey in Dak Lak (ICARD, 2002). Note: Dependent variable: Ln (Output). Impact of Price Fluctuations on Coffee Producers 139

152 Estimated coefficients of the econometric model suggests that impact of capital on coffee production is significant while impact of labour factor is not at the 5 percent level of significance. Land is main factor for growing coffee. Harvested coffee areas, obviously has positive relationship to coffee output. Elasticity of this factor to coffee output is 0.59, meaning that 1 percent increases of this factor will lead to an increase of 0.59 percent in coffee output. Contribution of land to output is not only explained by coffee area but also by land quality. Geographical location, used here as a proxy for quality of coffee land, and captured by dummy variables Dist1 and Dist2, reports higher yields in Cumga and Buon Don, where soils are better than in Lak. Estimated coefficients of variables Dist1 and Dist2 suggest that yield per hectare of households in Cumga and Buon Don are 1.77 and 1.46 times higher than in Lak. This is confirmed by statistics of yield per hectare of households surveyed in Table 2 quotes that yield per hectare in Cumga and Buon Don are 1.84 and 1.49 respectively, while in Lak this is only This results in much higher profit per coffee hectare in Cumga and Buon Don. Investment costs per hectare, here including costs for fertiliser, pesticide, hired labour, irrigation and loans, are also an important factor for output. The regression results report an elasticity for output to investment cost of 0.44, meaning that a 1 percent increase in these costs will result an increase of 0.44 percent in coffee output. The number of agricultural labourers in the household, and proxies for quality of the labours, namely sex, education, ethnicity, and age of the household head, are not significant in this regression. This can be explained by the fact that labour in coffee cultivation can be replaced or supplemented by hired labourers, especially for harvesting. Hired labour is 17 working days per coffee hectare. Thus family labourers are not the sole labour source for coffee production. The quality variables are also statistically insignificant. It was reported by CPR and Action Aid (2000) that experience in coffee cultivation (measured by number of years that households grow coffee) may be used as a proxy for quality of the labour rather than factors used in this regression. However, information of experience in coffee farming is not available in the survey Empirical analysis of impacts of price fluctuations on farmers As mentioned in Section 3, coffee prices fluctuated and decreased strongly in the past few years. In 2001, prices offered to farmers only covered about 50 percent of the production costs. Obviously, this has a serious impact on the household income of coffee growers. The impact of the coffee price fluctuations on income depends, however, on the share of coffee in the income; so it is likely to vary across regions and across farms. Coffee production contributes for a major part to the income of coffee growing households in Dak Lak province. An examination of earning structure of surveyed households showed that most income comes from crop earnings (about 85 percent), of which coffee has on average a share of 77 percent. In the three districts, however, the level of specialisation in coffee farming is different. The district of Cumga has the highest level of specialisation (90 percent of total earnings), Buon Don ranks second (71 percent of total 140 Impact of Price Fluctuations on Coffee Producers

153 earnings) and Lak ranks third (37 percent of total earnings). So, most likely Cumga is most affected by changing prices. To analyse the different impacts of changing prices across farms, the households in the survey have been grouped by revenue: Group 1: revenue per person of over VND 5 million Group 2: revenue per person between VND 1 and 5 million Group 3: revenue less than 1 million Group 1 Group 2 Group 3 ha % of farming land ha % of farming land ha % of farming land Farming land Foods and vegetables of which paddy Coffee Other crops Table 4: Distribution of land to crops. Source: Estimates from data of Survey in DakLak (MARD, 2002) Table 4 shows land use as reported in the household surveys. This table reports that for households of Group 1, on average 74 percent of farming land is attributed to coffee cultivation. For the two other groups, the figures are 68 percent and 38 percent respectively. It can be concluded that more wealthy households are more dependent on coffee production. Combining the region and the household earnings one can find that households in Cumga, which is the most suitable region for coffee cultivation, specialise most in coffee production. Shares of coffee-production income in total income are high for all three income groups in Cumga (93 percent, 87 percent and 74 percent respectively). The proportions are lower for surveyed households in Buon Don and are significantly lower for the case of Lak. Now, some simulation exercises are carried out to illustrate the impact of changes in coffee price on household earnings. Simulation 1, using cost data of 2001 (assuming the same costs), reports that net income per coffee hectare is very sensitive to changes in coffee prices. While a hectare used for coffee production could generate net income of over VND 20 million in 1997 and 1998 in Cumga, it made a loss of nearly VND 6 milion in The same performance was also found in the districts of Buon Don and Lak. Simulation 2, using the 2001 revenue structure data (assuming the same revenue structure), shows that the farmers experience quite significant fluctuations in their earnings Impact of Price Fluctuations on Coffee Producers 141

154 as a result of large variation in the coffee prices. The level of dependence varies according to the differences in coffee shares among household groups. Simulation 1 Net income per coffee hectare under various simulation scenarios of coffee prices (VND 1 million) Farm-gate coffee prices (VND /kg) 18,100 18,853 11,531 6,153 4,002 Cumga Buon Don Lak Simulation 2. Household earnings under various simulation scenarios of coffee prices (VND 1 mil.) Simulation 2.1. Impact across geographic regions Farm-gate coffee prices (VND/kg) 18,100 18,853 11,531 6,153 4,002 Cumga Buon Don Lak Simulation 2.2. Impact across farms categorised by earnings Farm-gate coffee prices (VND/kg) 18,100 18,853 11,531 6,153 4,002 Group Group Group In general, the simulations show that that the declines in coffee prices in three consecutive years caused serious impacts on coffee growers earnings. Households specialising in coffee production have been mostly affected by fluctuations in coffee prices. Households living in suitable geographic areas for coffee cultivation, such as Cumga, tend to highly specialise in coffee. Many of them become coffee-monoculture households. Coffee is grown as single crop in 53 out of 63 surveyed households in Cumga, and 25 out of these 53 households depend for 100 percent on coffee production as source of earnings. These figures were for Buon Don 18 out of 25 and 13 out of 18, and for Lak 20 out of 57 and 14 out of 20. In time of high coffee prices, all land was converted for coffee 142 Impact of Price Fluctuations on Coffee Producers

155 production. Many households heavily invested to expand coffee-farming areas from accumulated funds and mobilised debts. Many households borrowed over VND 10 million. When the coffee price suddenly dropped, there was no money left for maintenance investments for coffee trees, such as buying fertiliser or maintaining irrigation. Facing high debts, many coffee farmers had to find other jobs. Some farmers, who had bought coffee trees in 1994/1995, when coffee prices were high, faced very low coffee prices by the time their trees were able to carry cherries. This put them in a difficult situation. Most coffee growers have high debts. The high coffee price encouraged many households to borrow money to invest in maintenance of existing trees and in planting new trees. About 63 percent of the surveyed households borrowed from banks, private credit institutions or individuals. Average values of debts of the three household groups in at time of the survey were VND million, 8.13 million and 1.93 million respectively. With the very low price of coffee in 2001, many households were unable to repay their loans. This also brings the banks in a difficult situation, as the total debt of commercial banks located in Dak Lak province reached VND 3,700 billion, of which 90 percent was provided for coffee production and trading. Backed by the state bank, commercial banks have waived interest obligations for poor households. As a result of the low coffee prices there have been changes in investment behaviour in Dak Lak province. Expenses for maintenance of coffee trees have been cut considerably. Better-off households pay less attention to their coffee trees, while poor households forego even basic maintenance investment for their coffee trees. In addition, agricultural production becomes again more diversified. In the context of very low and fluctuating profitability of coffee production in the last years, other livelihoods options rather than coffee are becoming more important. In all surveyed communes, some households have cut down coffee trees for other crops such as maize, soy and cotton. 5.6 Conclusions and policy recommendations Summary and conclusions A disturbing characteristic of the world coffee market is the prevalence of a high degree of price instability, which can primarily be explained by supply side shocks. The instability in the international price is transmitted to the domestic price, directly affecting domestic coffee producers prices and income. The transmission of international price volatility to the producers price is affected by the structure of the industry. Experiences of reforms towards liberalisation in commodity markets in some countries show that producers are likely to face increased price volatility due to a stronger link between domestic and world prices after the reforms. Nevertheless, the benefit of the reforms is that the producers price, as a percentage of export price, increases after the reforms. In Vietnam coffee industry liberalisation takes place since However, here the shares of farm-gate prices in export declined in the period of 1999 to This can be explained by the downward trend of export prices since 1999, of which farmers bear most, and which distorts impacts of the reforms on coffee farmers. Impact of Price Fluctuations on Coffee Producers 143

156 The study of coffee farmers in Dak Lak province indicates that the very low coffee prices since 1999 have had varying impacts on coffee farmers across geographic regions and farm sizes. Coffee farmers who own and operate larger farms and whose income depends wholly or largely on coffee production, have seen their income mostly reduced. Impact on poor farmers who own and operate very small coffee farms has been also severe because a small drop in smallholders income can push them into severe poverty. As a result of the low coffee prices, the farmers now seek diversification of agricultural activities to offset their reduced incomes. Most of the farmers, however, do not wholly abandon their coffee farms. They still expect prices to increase in the future. Often these farmers take less care of their coffee trees, which can influence future production potentials. Impacts of price volatility at the farm level can be seen clearly in this study. Moreover, at macro level, price volatility may affect the government s fiscal revenues and trade balance, and as a result things as the ability to implement policies and programs to assist the poor. The inability to manage this volatility remains a major development challenge. Some policies and programmes have been carried out, such as stockpiling and providing preferred credit to poor farmers, lessening the negative impacts of low prices and price instability on the producers, but the effectiveness of these policies is limited. If the downward price trend is long lasting, these policies will lead to financial burdens on the economy. Another problem of Vietnam s coffee industry is that Vietnamese coffee fetches lower prices than the international prices. This is caused by low quality of coffee, incompatibility to international standards of grading coffee and poor marketing services. In view of the foregoing issues and developments, some suggestions are made in the following section Policy recommendations Firstly, it is recommend that farmers located in unfavourable areas for coffee farming shift towards other crops and diversify crops, particularly in coffee monoculture areas. For crop restructuring, extension and consulting services should be given to farmers in making decisions about crops they should plant and techniques they should apply. Secondly, coffee quality should be improved at both farm and post-farm levels. At the farm level, 50 to 70 percent of the cherries harvested are found to be unripe cherries in 80 percent of the coffee growing households. This practice lowers not only coffee quality but also quantity per crop; estimates of lost output are 210,000 tonnes annually (Enterprise Forum, 2001). In addition, poor facilities at farm level result in a high percentage of mouldy coffee beans which can damage coffee favour. It is clear that farmers play a very important role in improving coffee quality. Therefore, enhancing awareness of farmers of this issue and providing them technical assistance is required. However, it should be accompanied by a appropriate assembling policy, such as applying different collecting prices for products of different qualities or standardising requirements for quality of coffee beans. At post-farm level, further investments for processing are necessary, such as 144 Impact of Price Fluctuations on Coffee Producers

157 investments in wet processing lines and application of the International Coffee Organisation s new quality standard system Thirdly, in order to facilitate the co-operation among producers, processors and exporters, which is required for a wet processing line become efficient, coffee farming under contract associated with the processing and export companies should be encouraged. This will also help to share price risk between the farmers and companies. In this regard, a comprehensive survey and analysis of existing forms of co-operation between coffee farmers and companies should be carried out to find effective ways to enhance the reciprocal and mutual-beneficial relationship between coffee growers and processing and export companies. Fourthly, Vietnam should aim at extending the coffee market. The Russian, Eastern European and Chinese markets should have special focus. China is considered as a large potential consumer of Vietnamese coffee. The level of current consumption of the Chinese market is very low at 0.02 kg per capita. Thus developing Vietnam s coffee exports to this market should get more attention. Setting up representative offices in foreign markets for direct exports, which may result in an increase in exported quantities and profit, is recommended. In addition, the domestic coffee market should be developed. Domestic consumption now accounts for only 6 percent of the coffee production, with a low level of coffee consumption of 0.37 kg per capita. With high economic growth of the Vietnamese economy, the demand for coffee is expected to increase. Therefore, promotion services for coffee products in the domestic market should be enhanced. Fifthly, risk-management tools based on a market approach should be developed. As mentioned in Section 2, small scale producers do not have direct access to risk management instruments. Therefore organisations similar to ASERCA in Mexico or FEDECOOP in Costa Rica could be set up to aggregate individual producers into a contract of a commercially viable size. The organisation can guarantee farmers a minimum price at a fixed fee and then hedge the price risk in derivative markets. The organisation would (i) discuss with farmers whether they wish to purchase insurance or not, (ii) accept their orders and collect their premium payments, (iii) aggregate the individual demand of all farmers into a size of order for insurance that would be commercially viable, and place the order on the international market, then in case of pay-out, (iv) collect the funds from the pay-out and pass it back to farmers. The scheme, if successfully carried out, would enable farmers that produce even a relatively small quantity of coffee to indirectly access to market-based risk management tools, which give them the opportunity to insure themselves against short-term price movement. Given the lack of private brokers, government-sponsored institutions operated by MARD or MT might be more appropriate for Vietnam s current stage. Impact of Price Fluctuations on Coffee Producers 145

158 References Alderman, H. and Paxson, C. H. (1992), Do the Poor Insure? A Synthesis of the Literature on Risk and Consumption in Developing Countries, World Bank Policy Research Working Paper 1008, Washington D.C. Begg, D., Fischer, S. and Dornbusch, R. (1991), Economics, Third Edition, McGraw Hill Book Company. CRP and Action Aid Vietnam (2000), Globlization and Its Impact on Poverty: Case Studies, Volume 3, Hanoi. Duong Ngoc (2002), Mat Hang va Thi Truong Xuat Khau Lon Nhat [The Largest Export Commodities and Markets], Vietnam Economic Times, no. 114, September 23, Elz, D. (1987), Agricultural Marketing Strategy and Pricing Policy, A World Bank Symposium, Washington D.C. Enterprise forum (2001), Chat Luong Ca Phe: Noi Dau Cua Rieng Ai? [Coffee Quality: Whose is problem?] Enterprise Forum, March 12, Fafchamps M. (1992), Cash Crop Production, Food Price Volatility and Rural Market Integration in the Third World, Department of Economics, University of Oxford. FAOSTAT (2002), FAO Statistical Databases, (last visited: ). Fitter, R. and Kaplinsky, R. (2001), Who Gains From Product Rents as The Coffee Market Becomes More Differentiated? A Value Chain Analysis, Institute of Development Studies, University of Sussex. Fontenay, P. and Leung, S. (2001), Managing Commodity Price Fluctuations in Vietnam s Coffee Industry, National Centre for Development Studies, Australian National University. Gilbert, C.L., (1999), Commodity Risk Management for Developing Countries, Vrije Universiteit, Amsterdam. Ha, T. N. (2002), Coffee Export to Fail of Goal, Vietnam Economics News, No. 35/ Hau, V.C. (1996), Industrial Crops in Vietnam, The Gioi Publisher, Hanoi. ICARD (2002), Anh Huong Qua Trinh Tu Do Hoa Thuong Mai Den Nguoi Trong Ca phe Tinh DakLak: De Xuat Chinh Sach [Impacts of Free Trade on Coffee Farmers in DakLak Province: Policy Implications], Hanoi, Vietnam. ICC (2000), Overview of Coffee Market, Document No. ICC 82-83, International Coffee Organisation. Kaplinsky, R. and Morris, M. (2000), How do South African firms respond to trade policy reform?, in: Jalilian H., Tribe M. and Weiss J. (eds.), Industrial Development and Policy in Africa: Issues of De Industrialisation and Policy, Elgar, London. MARD (1998), Bao Cao Khoa Hoc Ket Qua Dieu Tra Danh Gia Hieu Qua Kinh Te Cua Mot So Hang Nong San Hang Hoa Xuat Khau cua Vietnam: Lua gao, Ca phe, Che, Cao su, Lac va Thit lon [Scientific Report on the Surveys and Estimation of 146 Impact of Price Fluctuations on Coffee Producers

159 Economic Efficiency of Some Agricultural Export commodities in Vietnam: Rice, Coffee, Tea, Rubber, Ground-nut and Pork], Ministry of Agricultural and Rural Development, Hanoi. Morisset, J. (1997), Unfair Trade? Empirical Evidence in World Commodity Markets Over The Past 25 Years, World Bank, Washington D.C. Rotzoll, F. and Henniges, H. G. M. (1997), Cam nang ca phe [Bags of Coffee] (Vietnamese Version), The German Coffee Association. Salvatore (1995), International Economics, Firth Edition, Prentice Hall International Editions. UNDP (1989), Agricultural Price Instability: Impacts of Programmes and Policy Options- Asian Experience, Economic and Social Commission for Asian Pacific. VNA (2001), Government to Buy Another 90,000 Tonnes of Coffee, Mar. 20, 2001, (Last accessed on May 20, 2002). World Bank (1999), Dealing with Commodity Price Volatility in Developing Countries: A Proposal for a Market-Based Approach, International Task Force on Commodity Risk Management in Developing Countries, World Bank, Washington, D.C. World Bank (2001), Commodity Market Reforms: Lessons for Two Decades, World Bank Regional and Sectoral Studies, Washington, D.C. Endnote i In farm production, output can be expressed in a Cobb-Douglas form as follows: Q = A e αidi + αjxj F i βi (1) Where: A is a parameter of total factor productivity; D i is a set of dummy variables representing characteristics of farm head; X j is a set of dummy variables representing characteristics of farm; and F i is vector of farm assets. When taking the natural logarithm, we can obtain: LnQ = LnA + α i D i + αjx j + β i LnF i (2) The equation (2) is in form of log-linear, which allows us to estimate coefficients for total factor productivity of all variables in logarithm forms. Impact of Price Fluctuations on Coffee Producers 147

160 Chapter 6. Structural Change in the Sugar Cane Industry: the Case of Lam Son Luong Thi Ngoc Oanh 6.1 Introduction To ensure economic stability during the industrialisation process, Vietnam requires a sound agricultural base. Agricultural development will advance with the development of agricultural commodity production. This is feasible by promoting the adoption of crops with a higher value per unit through diversification and specialisation (Nguyen Do Anh Tuan et al., 1998). The evolution of commodity production is the catalyst for progressive agricultural development. A number of questions pertaining to the problem of commodity production in Vietnam s agricultural sector have arisen. Firstly, given the Vietnamese farmers nonmarket oriented background, what creates responses to commodity production? Secondly, what are the gains and losses from shifting towards commodity production? Are farmers really better of when they shift to commodity production. A third question is related to what extent it is possible to develop commodity production. Are there sufficient conditions in Vietnam for commodity production to become fully commercial as in industrialised countries? The sugar cane industry in Lam Son provides a way to understand some of these questions. A study of this particular region and industry directly addresses the broader issues of agricultural development as the Lam Son sugar cane industry provides a strong example of agricultural transitions. Before 1990, Lam Son was an extremely impoverished area. The rapid growth of Lam Son s sugar cane industry should show clear signs of whether commodity production directly affects farmers living conditions. For the year 2000 the Vietnamese government set a target of one million tons of domestically produced sugar. This objective was amply met as nearly 1.2 million tons was produced (Agroviet, 2003). In Lam Son, the regional farmers have responded to this demand increase by supplying the local sugar factory with a stable source of inputs, ensuring operation at full capacity. The factory s success, after some initial problems, demonstrates farmers behaviour with market incentives. A study of Lam Son will assist in making policy decisions for the development of the sugar cane industry and other agricultural commodity industries. This chapter addresses problems in transforming to cash crop production, the impact of such a process, prospects for further development of commodity production, and recommendations relating to commodity production in Vietnam. This chapter is based on Vietnam and the International Market for Rice Exports 149

161 fieldtrips and a study project carried out in Therefore, it focuses on the transitions that have taken place in this region during and before this year. The chapter has the following outline. In the next section a theoretical framework is presented to analyse the sugar cane industry in Lam Son. Section 3 introduces the case study with the discussion of sugar cane as a cash crop in Lam Son. Section 4 assesses the impacts of the shift towards sugar cane production and section 5 analyses the comparative advantage of Lam Son in producing sugar cane. Finally, section 6 contains the conclusions and recommendations. 6.2 Behaviour of farmers and agricultural production Farmers behaviour towards new crops is a major topic in the field of agricultural economics. Todaro (1989) asserted that farmers exhibit risk averse behaviour. Farmers are reluctant to adopt new crops and new technology because of the additional risk of unfamiliar agricultural techniques and the outcome of the change. In this respect, Ellis (1992) noted that the difference between a good harvest and a bad harvest is the difference between survival and starvation for many poor farmers. In addition, market fluctuations and social uncertainties mean that farmers are very cautious in making production decisions. As a result, they are unwilling or slow to adopt innovation in crop patterns and technology. Saith and Tankha (1972) described these production decisions as irrational, sometimes making apparently negative profits. Most authors agree however, that such behaviour is rooted in the limits of their economic life. It is not necessarily that these farmers are irrational, but the economic environment of limited information causes a rational decisionmaking process to result in seemingly irrational behaviour. In more recent studies risk and uncertainty are included as elements of the analyses and as a result are better able to describe the production decision-making behaviour of farmers. According to Todaro (1989) three stages in the evolution of agricultural can be distinguished: Stage 1: Subsistence farming, characterised by risk aversion, uncertainty, and survival At this stage, most output is produced for the farmer s own consumption, although a small share may be sold or traded in local markets. Output and productivity are low. Subsistence agriculture is normally risky and uncertain. In bad years, the peasant and his family risk starvation. In this situation, a peasants economic motivation is to maximise the family s chances of survival, rather than maximise assets. Priorities are to avoid a bad year and a total crop failure, rather than to maximise output in the better years. Throughout much of the developing world, agriculture is still in this subsistence stage. Stage 2: The transition to mixed and diversified farming At stage 2, production is for both self-consumption and commercial sale. Diversified or mixed farming is a logical intermediate step in the transition to specialised production. For small farmers, complete reliance on cash crops is riskier than pure subsistence agriculture, since risk now includes market fluctuations. If farmers have a reasonable safe 150 Structural change in the sugar cane industry

162 economic position, they will respond to price incentives and new opportunities to improve their families standard of living. Stage 3: From divergence to specialisation: modern commercial farming At stage 3, agricultural production develops into a fully commercialised activity. The goal of farming activities is to maximise profits. In this sense, specialised farming is not different from large industrial enterprises in terms of concept and operation. Through these three stages of agricultural development, there is a gradual process of transforming from subsistence farming to cash crop production. As far as Vietnam is concerned, in 1997 subsistence farming accounted for 60 percent of the total households in the Red River Delta and 40 percent of the total households in the Mekong River Delta (Dao The Tuan, 1997). It is therefore reasonable to associate Vietnam s current agricultural development with the first stage agricultural production with a trend towards the second stage. Features typifying agricultural production and farmers lives are the factors influencing the decision making process of poor peasant households. Timmer (1988) pointed out that several unique features of agricultural production contribute to the decision-intensity of farming. The most important of these features are: seasonality (growing conditions change over the year), geographical dispersion (characteristics of land vary over space), and risk and uncertainty (related to weather and prices). Another set of features are the markets for inputs and outputs. The distance to a daily vegetable market may, for instance, affect a farmer s decision to start growing lettuce instead of rice. A specific feature typifying agricultural production is that a farm household is often both producer and consumer in stages 1 and 2 of agricultural development. It is not possible to separate those two in the analysis of decision-making. Only under restrictive and unrealistic assumptions about completeness and fully accessible markets can agricultural production and farmers consumption be considered separately (Singh et al., 1986). Thus it is impartial, if not impractical, to study Vietnamese farmers decision-making processes without combining the analysis of consumption and production decisions. It is widely acknowledged that a high level of uncertainty typifies the lives of peasants in developing countries. Agricultural risks are particularly burdensome to smallscale farmers in developing countries (Ellis, 1992; Hazell et al., 1986; Hoogeveen, 2001). Lipton (1968) argued that poor small farmers are necessarily risk-averse and that disaster avoidance is their survival algorithm. Risk-averse peasants avoid profit dispersion. If the risk-averse farmer expects a greater dispersion of profit, in order to maintain the same level of utility, expected returns must also increase. The peasant s nature of risk-aversion can result in sub-optimal resource allocation (Bliss and Stern, 1982). As peasants behave very risks-averse, they always acts as if the worst possible outcome, i.e. a bad harvest, will happen. More formally, he chooses to operate at the point where the marginal value product in the bad year equals the marginal cost. However, economic rationality demands that the farmer should operate at the point where the expected marginal value product equals the marginal cost, assuming good years Vietnam and the International Market for Rice Exports 151

163 and bad years over a run of seasons. As the expected marginal value product is always greater than marginal value product in a bad year (the worst possible marginal value product), the expected marginal value product, is well above marginal cost. This means that the optimal level of resource use is not being followed and profit is not being maximised. To deal with production risk, farmers in agriculturally risky environments have developed several loss management and risk mechanisms in response to lower-thanexpected crop income caused by natural hazards (Hoogeveen, 2001). Loss management is practised when crop income falls short of expectations; farmers then try to find alternative sources of income. Common measures are the sale of producer durables (livestock and machinery), non-farm income, geographic mobility, family remittances, or sometimes community remittances. Risk management includes spatial and sequential diversification, tenancy, and intercropping. Spatial diversification offers scope for improving income stability from imperfect correlation of risks over geography and time. Walker and Jodha (1986) found a reliance on spatial diversification and crop diversification by farmers in India, Tanzania, and El Salvador. No feature of small farm risk management is as striking as the high incidence of intercropping or mixed cropping. Intercropping allows greater yield stability for three reasons: (1) higher yield in stress conditions, (2) lower incidence of disease and pests, and (3) compensatory yields. Tenancy also shares risk and manages losses. As final topic in this theoretical section we discuss the Domestic Resource Cost Analysis (DRC). DRC analysis provides an estimate of domestic resources values in a production process by valuing all intermediate inputs at world prices and all factor inputs at their true social opportunity costs. The estimated DRC ratio for a given activity is: DRC j = DC j / IVA j (Equation 1) In Equation 1 DC j is the domestic cost of producing j (with factors valued at their social opportunity costs) and IVA j is the value added to activity j (at border prices). DRC analysis is an accurate way of examining whether a country has a comparative advantage in producing a given product in the long-term without market distortions, such as trade barriers. It will be used and discussed more extensively in section Transforming to cash crop production: sugar cane in Lam Son In this section the issues regarding the shift to sugar cane production in the Lam Son region will be discussed. Lam Son is a region located in south west of Thanh Hoa province, south of Hanoi (see Figure 1 below). Lam Son became an area producing sugar cane when the government established Lam Son Sugar Factory in As a result of this, there has been a structural change in agricultural production of the region with a shift from rice production to sugar cane growing. The primary information for this and the following sections was obtained during two fieldtrips to Lam Son in March and May, The field trips included interviews with 152 Structural change in the sugar cane industry

164 household representatives, commune leaders and officers of Lam Son Sugar Factory and some other local officials. A sample of 110 households at seven communes was selected randomly from different income classes. The sample covered both members and nonmembers of sugar cane co-operatives, households having low shares as well as high shares of sugar cane production. Secondary data was derived from documents of Lam Son Sugar Factory, Lam Son Sugar Cane Association (LSA), the Ministry of Agriculture and Rural Development (MARD), and General Statistical Office (GSO). The collection of information was carried out in co-operation with a study project held by the Centre for Consultation on Agriculture and Rural Development (CECARDE), in which the author was the key member. The aim of this study project was to define the comparative advantage of Lam Son, and it was designed by CECARDE to study the overall economic growth and the development prospect of the region. Figure 1: Location of Lam Son Background Before the launch of sugar cane in Lam Son, four state firms tried to introduce various crops, but that resulted in low levels of productivity. This led to a very low income per capita and output levels of kilograms of paddy/head/year, which required government subsidies to farmers. Sugar cane was the most profitable (LASUCO, 1997) of the crops that were tried. Farmers started intercropping trees but most of the harvest was retained for home consumption, as agricultural production in the region was primarily subsistence farming. The production of sugar cane was insignificant until in 1988 the Vietnam and the International Market for Rice Exports 153

165 inauguration of the Lam Son Sugar Company (LASUCO) created the opportunity for the development of this cash crop. It took, however, several years before sugar cane production became significant in Lam Son. In the first years after establishment, LASUCO met many difficulties. From 1988 to 1991, total sugar cane output was 26,000 tons/year with the factory working at only 10 percent of the designed capacity. Cultivation remained in rice and other traditional crops with a very slow increase in sugar cane output over the period. However, a recent surge in sugar cane production caused the LASUCO factory to increase capacity twice. The significance of this experience is important, considering that other sugar factories in the country are operating at less than 50 percent of their designed capacity. The expansion at LASUCO reflects a recent change in farmers behaviour. In analysing the process of changing crop structure in agriculture over the period, two issues are worth considering: firstly, the farmer s response to the cultivation of sugar cane as a cash crop, and secondly, the causes for this response to cash crop cultivation Incentives for sugar cane production To begin the cultivation of sugar cane, several requirements need to be met before potential producers can start their activity: an initial capital requirement of approximately 11,000,000 VND/ha (1997 data), machine-prepared land, fertilisers, powder-lime, water access, a farm size of at least 0.05 hectares, and a transportation system that enables large trucks to reach individual plots. Because of these reasons and the reasons mentioned in the theoretical section, farmers need incentives to shift their activities to sugar cane production. We can distinguish direct and indirect incentives. Firstly, indirect incentives include a high import duty. The entire sugar industry of Vietnam is highly protected by a high import duty (30-40 percent in the past years), variable quota s and temporary bans. Thus, sugar cane production is subsidised indirectly being the raw material for sugar production. Direct incentives given to sugar cane growers include: - Advances in kind. LASUCO provides advances to any household committed to selling sugar cane to the factory. These advances are normally in the form of inputs (sprout, fertiliser, and pesticide), food, or money for land taxes. Advances are up to 100 percent of required inputs with a portion of these advances interest-free. - Announcement of sugar cane prices applied to harvests. To promote sugar cane cultivation, LASUCO announced prices applicable for the harvests (VND 260,000/ ton, VND 280,000/ton, and VND 300,000/ton respectively, for 10 percent sugar content sugar cane). - Financial assistance to households exploiting new land. Farmers who clear land in hills and mountains to expand the sugar cane growing area receive 1 million VND for each hectare of newly exploited land. - Encouragement by the Lam Son Sugar cane Association. The Lam Son Sugar cane Association began in 1995 as a two-dimensional co-operation system. Horizontal co- 154 Structural change in the sugar cane industry

166 operation is among sugar cane growing teams and sugar cane co-operatives. The vertical direction is the co-operation between growing teams on the one hand and LASUCO and the Vietnam Bank for Agriculture (VBA) on the other hand. This creates close ties between state-owned enterprises and the farm household economy. As members of the Association, farmers benefit from contract farming. With institutional co-operation in farming (the so-called core-satellite model), LASUCO is the core promoting a network of co-operation. In connection with the VBA, LASUCO provides member farm households with inputs and capital advances. LASUCO buys sugar cane based on mutual benefit. Prices are negotiated at the annual member conference of the Association; this grants in principle bargaining power to sugar cane growers. To help farmers obtain high efficiency, the factory continuously transfers technology and knowledge pertinent to sugar cane cultivation. Furthermore, the Association has a losscompensating fund fed by member households to reimburse for damages caused by natural disasters. - Installation of a new plant. The recent establishment of a new plant with an additional capacity of 4000 tons/day has created a promising prospect for sugar cane production. This assures the ability to meet high future demands for sugar cane for the producers. - Establishment of five pilot co-operatives. The Co-operative Law facilitated the development of five sugar cane co-operatives. The purpose of these co-operatives was to assist farmers in cultivating sugar cane. The co-operatives contract sales with the factory and help to pass inputs given in advance to farmers Structural change towards sugar cane cultivation The population of Lam Son has been increasing in both the number of households and the number of family members. To see how farmers have responded to sugar cane cultivation, the change in area of sugar cane and the change in the number of households engaged in producing sugar cane are considered here. Figure 2 shows the change in area for sugar cane cultivation in Lam Son over the period. Less than 2,000 hectares were used for sugar cane in 1990, this area increased to 16,000 hectares in In particular, there was a sharp increase in the sugar cane area after the price announcement in Vietnam and the International Market for Rice Exports 155

167 Ha Year Figure 2: Sugar cane area in Lam Son over Source: Lam Son Sugar Cane Association. CECARDE (1999) shows that the number of households engaged in sugar cane cultivation increased from 1,034 in 1990 to 15,880 in The number of communes involved in sugar cane production increased from 22 to 73 during this period. These values are consistent with increases in total sugar cane area. The structural change for seven communes (Tho Xuong, Tho Lap, Tho Minh, Xuan Phu, Xuan Thien, Xuan Lam, and Xuan Chau) shows that communes have different responses to sugar cane cultivation and transform at different rates. Farm households are either resistant to sugar cane cultivation and change with caution or are very responsive to the potential economic benefits of sugar cane and already have a large share of sugar cane in their total harvest. Key observations with respect to sugar cane cultivation are as follows: 1. Communes react differently to sugar cane cultivation 2. Households in the seven communes are cautious in shifting toward sugar cane cultivation. 3. Areas dedicated to the production of sugar cane increased sharply after the price announcement of A small number of households show a resistance to sugar cane cultivation. 156 Structural change in the sugar cane industry

168 6.3.4 Factors responsible for the observed patterns of structural change The following list of factors can be mentioned as contributing or discouraging farmers to shift to sugar cane production. Land structure and plot size The Lam Son region has a low land/man ratio and a small average plot size. This suggests that farmers should grow crops that use less land (the scarce factor) and more labour (the relatively abundant factor). Farmers have rationally accessed this situation and have shifted production to labour-intensive crops. However, sugar cane is the least labourintensive among crops currently available in Lam Son (source: Xuan Chau Co-operative Report 1999). For households with no opportunity for exploiting new land, a shift to sugar cane cultivation means a loss of employment for family labourers. This does not necessarily mean a loss of income, as a workday of cultivating sugar cane earns a higher salary than other regional crops (Source: interviews with farm household representatives). However, with much underemployment in households, this results in a barrier to shift to sugar cane production. The land of the seven communes where the interviews have been carried out is not homogenous. Among the seven communes, Xuan Phu has the largest proportion of unused, mountainous land. From the perspective of the farmers, mountainous fields, if left in a natural state, offer little or no income. So there is a low opportunity cost for clearing mountains and hills for sugar cane production. In contrast, farm households in Tho Minh, Tho Lap, and Xuan Thien, where land is more intensively used, have a higher opportunity cost as the output of other crops decreases with larger sugar cane areas. The opportunity cost of a potential higher income versus increased uncertainty of food supply results in cautious decision making. These differences in opportunity costs among the seven communes result in different reactions related to this type of risk aversion and thus in different percentages of households planting sugar cane. The plots in Tho Minh and Tho Lap are small and fragmented, resulting a higher percentage of plots below the minimum requirements for machine operation needed for sugar cane. Where small plot size is a constraint, there is less response to opportunities with sugar cane. In general, it is not the attitude of the commune, but other circumstances, such as land endowments, that generate the differences in the behaviour of communes towards the new crop. Risk aversion - the nature of poor farm households The poor peasants in Lam Son demonstrate typical risk averse behaviour. Almost all of the respondents said that if they planted rice, they felt more secure from their experience with the production process. This behaviour corresponds with expectations of the first stage of agricultural production. The living standard of many households remains at foodsufficiency level and modest savings cannot rescue households from natural disaster. Thus, the main motivation of the peasant household is to maximise the chances of survival by cultivating rice. Vietnam and the International Market for Rice Exports 157

169 Risk-aversion results from the farmers economic environment and typifies their decision-making process. This condition impedes the adoption of sugar cane or other cash crops. Differences in savings and economic background of farm households As in other regions, households in Lam Son have varied income levels and economic backgrounds. When sugar cane was introduced, a number of households had higher, more stable incomes and greater cash savings. These households were, as expected, less riskaverse and more willing to adopt new crops or techniques. Advantages of rice cultivation Rice cultivation still possesses many beneficial qualities to farmers in the region. Firstly, the peasants have experience in growing rice and extended experience in production management. Secondly, since rice has been the main food of the peasants, growing rice is an important way to ensure food security. Thirdly, different from rice and other traditional crops, sugar cane is a cash crop and the economic gain from this crop is subject to market conditions. Fourthly, paddy rice cultivation enables three harvests a year while sugar cane has only one. Farmers recognise the distribution of harvests over the year as a means to avoid risk (source: interviews with household heads). Finally, sugar cane is a more complex product to sell; farmer s lose labour hours from engaging with the factory, resulting in a fixed cost. The land areas suitable for sugar cane cultivation of some households are so small that this fixed cost does not allow sugar cane production to generate a higher profit than other crops. The development of the market for sugar cane According to Association rules, at the beginning of the harvest the factory signs contracts with sugar cane growers committing to buy all output. From the perspective of the sugar cane growers, this helps rule out fluctuations in the demand for sugar cane. In principle, the Association of sugar cane growers contributes to determining the price at the beginning of the harvest. However, at Association conferences, the factory puts forward a price and the growers, in almost all cases, have to accept the price. Most of the households acknowledge that the factory has monopsony power in deciding on the price. The problems of monopsony constrain sugar cane cultivation. The real price of sugar cane compared to rice increased over the period. Up to 1997, the price of sugar cane was unknown to farmers at the beginning of harvest. The period experienced mixed results in changes in crop production. Since the 1998 announcement of prices for the next three years, price uncertainty was eliminated for those three harvests, increasing the sugar cane areas of the seven communes. This shows that a decreasing uncertainty (and risk) increases the propensity to shift to sugar cane production. The profitability of sugar cane depends mainly on the real price and productivity per hectare. The following two indices have been calculated in which sugar cane prices and rice prices are compared by calculating the real sugar cane price over the period using the rice 158 Structural change in the sugar cane industry

170 price as deflator: (i) sugar cane productivity per hectare index and (ii) the relative price index. The results are presented in Table 1. Year Sugar Productivity Index Relative price index Table 1: Profitability of sugar cane over time. Source: Calculated from LSA figures, The period shows an upward trend in both indices, meaning an increase in sugar cane profitability versus rice. This reinforces that farmers are rational in their responses to economic incentives and profits. Constraints to land consolidation As plot size in the region is too small for efficient cultivation of sugar cane, land needs to be consolidated to make profitable sugar cane fields. However, leaders of the seven communes revealed that consolidating and exchanging land is a slow process. Most farmers break off negotiations, as land consolidation can lead to unequal land distribution. Production uncertainty Unfavourable climatic conditions is a risk faced by all rural agricultural units, though sugar cane growers face an additional issue as harvest timing affects sugar content. As regional factories dictate the harvesting schedule without farmers input, sugar yields seldom have the highest sugar content. This is an additional uncertainty to sugar cane output in qualitative terms. Although price flexibility partially limits economic loss (different prices are applied at the beginning and at the end of the harvest) production uncertainty still confronts sugar cane growers. The practice of crop diversification For years, peasants in Lam Son have distributed crop types across different land plots. Crop diversification distributes weather uncertainty as different crops have different susceptibility to weather. Distribution of crop types over different plots has further the benefit of being more efficient in land utilisation as certain plots are more suitable for certain crops. Besides spatial crop diversification, sequential diversification also improves land quality, which increases crop yields the following year. Moreover, this practice allows for a diversified diet for subsistence farmers. In short, many factors affect the decision to shift to sugar cane production. Most factors are related to the risk of changing to a new crop and not being able to feed the household members in case of a failure. External factors, such as plot size and prices, increase this risk. Reduction of this risk, and thus a greater propensity to shift, can be achieved by improving these external circumstances. Vietnam and the International Market for Rice Exports 159

171 6.4 The impact of a change towards sugar cane production In this section the focus is on the impact of the shift to sugar cane cultivation. Cash crop transformation affects the households in the region in several ways. It is possible to make a distinction between economic impacts and non-economic (other) impacts, which are discussed below Impacts on the regional economy Income level The immediate effect of a rise in the percentage of total land dedicated to sugar cane production may be a rise in income. Table 2 shows the per capita changes in GDP in the Lam Son region from 1990 to The income in the Lam Son has grown considerably. Though this does not directly prove the effect of sugar cane cultivation, it can give an indication of positive economic impacts Nominal price ,325 1,865 1,927 Real price Income growth / 2 yrs. +1.6% +10.7% +9.1% +4.5% Table 2: Increase in average GDP per capita in Lam Son Unit: VND 1,000. Source: CECARDE, To study the issue further, a more detailed breakdown of the survey results is given in Table 3. The income level of households presently cultivating sugar cane is higher than those not engaged in sugar cane and slightly higher than the average of the whole Lam Son region. Group of households Average GDP per capita Whole Lam Son region 1,927 Households not engaged in sugar cane 1,629 Households cultivating sugar cane 1,989 Mixed households 2,092 Non-farm households 2,123 Table 3: Average GDP per capita of different groups of households in Unit: VND 1,000. Source: CECARDE, Overall poverty (measured as households with less than 13 kg rice per head/month) among the seven communes decreased from 48 percent in 1994 to 12 percent in 1998 (source: interviews with commune leaders). 160 Structural change in the sugar cane industry

172 With income levels increasing, savings have increased in both absolute and relative terms, see Table 4. Group of households Savings/Value Added ration Whole Lam Son region 9.2 Households not engaged in sugar cane 6.5 Households cultivating sugar cane 8.3 Mixed households 13.7 Non-farm households 15.3 Table 4: Savings ration in Lam Son in Unit: VND 1,000. Source: CECARDE, These figures show us that farm households cultivating sugar cane are better of than farm households not engaged in sugar cane. This change in incomes may not be a complete result of sugar cane cultivation, but there is evidence to associate the correlation between the increase in income and sugar cane production. Firstly, among crops available in Lam Son, sugar cane has the highest profit. The increased percentage of land dedicated to sugar cane immediately results in higher income per unit of land. Second, LASUCO factory s demand for sugar cane generates scope for expanding arable land; increasing conversion of mountains and hills into sugar cane fields. These two phenomena complement each other in the generation of a higher total income. Income distribution and gap Traditionally crop production resulted in a rather equal level of productivity among households. Land distribution was dependent on family size, causing limited sources of differences in income per person (although differences in household incomes could exist as a result of sources of income other than agriculture). Starting from this position of relatively equal returns among households, sugar cane production introduces a source choice and income inequality. Household incomes for sugar cane producers are higher than homes dedicated to traditional crops. Since the introduction of sugar cane production, there has been an increase in income disparity among households in the seven communes. Households with favourable initial conditions, such as cash reserves or savings to invest, are the first to adopt this new crop. Poorer households are late movers because their incomes do not allow them to risk trying the new cash crop nor can they afford the initial investment. The higher profit of sugar cane increases the incomes of the richer families. Poor families also missed opportunities as early movers to expand arable land. These two factors contribute to a wider income gap. Table 5 is an example of the income gap for the seven communes in (Unfortunately no data for other years is available.) Vietnam and the International Market for Rice Exports 161

173 Commune Highest GDP Lowest GDP Highest/Lowest Xuan Phu 65,000 3, Xuan Chau 60,000 1, Tho Xuong 75,000 2, Xuan Lam 28,000 3, Xuan Thien 50,000 3, Tho Minh 30,000 2, Tho Lap 40,000 4, Table 5: Income differences in the seven communes in Unit: VND 1,000. Source: Field-trip survey, Creation of jobs and non-farm activities Employment increases both directly and indirectly from increases in sugar cane cultivation. Arable land expansion projects require a significant number of labourers to be employed in the region for some time. Indirectly, sugar cane cultivation creates employment through input-supply requirements. The sugar cane industry requires the production of new products like powder lime and the supply of services, like transportation and other non-farm activities. Moreover, an increase in the demand for agricultural inputs, such as fertiliser and pesticide, develops employment in those sectors. These factors are a great contribution to solving the problem of unemployment and under-employment in the region. Development of the labour market. Sugar cane production requires a substantial amount of labour during the peak seasons of weeding and harvesting. Traditionally, the method for meeting peak season labour demand was to exchange labour between households in a neighbourhood. However, when introducing sugar cane production in a region, the demand for labour during peak season is higher than the supply. When neighbours cannot meet the demand for labourers, migrant workers from the surrounding areas are hired. This situation has resulted in the development of a wage-based labour market. Especially if sugar cane farms become larger, they depend more on seasonal workers for meeting the peak demand. During these periods, wages increase significantly. So, the production of sugar cane as a commodity has contributed to the development and consolidation of a labour market in the Lam Son area. Evolution of modern banking services A result of the prospects of sugar cane production is an increase the demand for capital. Using sugar cane contracts between the factory and households as collateral, the Lam Son VBA has extended various loans on rather flexible terms. Banking facilities are also required to acquire the capital needed to obtain lorries and to initiate leases and lease exchanges. Sugar cane production is a catalyst for the development of banking facilities in the region. 162 Structural change in the sugar cane industry

174 6.4.2 Other impacts Larger plot size Sugar cane requires a larger, consolidated land area. The profitability of sugar cane stimulates producers to acquire more land by exchanging plots. Table 6 shows the distribution of plot size before and after the adoption of sugar cane. Clearly, plot sizes have increased. Plot size < 0.05 ha ha ha ha. Before adopting sugar cane After adopting sugar cane 10 % 33% 57% 0% 5% 11% 63% 21% Table 6: Distribution of plot size before and after the adoption of sugar cane. Source: field trip survey. Better infrastructure To maintain consistent and stable production the sugar cane industry requires adequate infrastructure. Roads and other facilities must be in good condition to accommodate the transportation of sugar cane. To increase sugar cane returns, it is essential to invest in infrastructure development. Transportation infrastructure has improved in line with the expansion of sugar cane production. Table 7 shows the increase in infrastructure projects from 1990 to Improvements in infrastructure benefit the entire region. This is obviously one of the positive externalities of the sugar cane industry s development. Sugar cane harvest Investment to commune budget Investment in Infrastructure , , , , , , ,500 1,179, , , ,800 3,643, ,000 4,375, ,000 5,256, ,556 6,752,000 Table 7: Investment by Lam Son Sugar cane Factory in the region. Unit VND 1,000. Source: LASUCO, Report on Lam Son Sugar cane Association model, Vietnam and the International Market for Rice Exports 163

175 Higher seasonality of labour All commune leaders who have been interviewed revealed that sugar cane cultivation has created a higher degree of seasonality of manual work. This is simply because sugar cane has only one harvest a year while most of traditional crops have two or three. Furthermore, the timing element of producing higher returns from sugar cane concentrates the demand for labour. This can be considered mainly as a negative impact of sugar cane production. Miscellaneous effects The transformation from subsistence crops to the production of profit-oriented commodities stimulates farmers economic awareness. Working in a market environment requires a different way of decision-making than working in an environment aiming at subsistence farming. Some farmers may be better in exploring market opportunities than others. Interviews with farm leaders revealed that the introduction of sugar cane production might also lead to some shifts between the tasks carried out in households. While subsistence farming was for a large part carried out by women, sugar cane production has shown an increasing involvement of men. To what extent this has affected other tasks and sources of income requires further study. The economic and non-economic impacts of transformation towards commodity production have shown both positive and negative results. However, the net affects appear to be positive. Sugar cane cultivation has not created economic equality within the region, but has increased developed the region as a total. Market forces have not yet eliminated poverty, but only the relative levels of poverty. A problem with a complete assessment of the sugar cane industry is to what degree government interference negates efficiency gains. The State s protection of the sugar industry makes us question whether the peasants in Lam Son have become more efficient and will be able to survive in a more competitive global market if trade restrictions are reduced or abandoned. 6.5 Assessing the comparative advantage of Lam Son in producing sugar cane In this section we will analyse the Domestic Resource Cost Ration (DRC, see also Section 2). By calculating the DRC for sugar produced in the Lam Son area, we can show the benefits of the shift towards sugar cane in the region from a social viewpoint and identify weaknesses. Up till now, the main focus was individual households. Now the discussion is brought to the regional (macro) level when analysing allocative efficiency. Moreover, the analysis also helps to identify previous policies that have contributed to past development and future prospects. 164 Structural change in the sugar cane industry

176 6.5.1 The Domestic Resource Costs calculated for sugar produced in Lam Son The DRC can be used to detect levels of competitiveness. It measures the cost of domestic resources used by the commodity system to the value created by the commodity system. The formula of calculating the DRC is: DRC n Aij j= k + 1 i = k b Pi j= 1 P A * j ij P b j (Equation 2) where: DRC i domestic resource cost of product i; A ij quantity or technical coefficient of the j-th input, i.e. units of non-traded inputs used to produce a unit of i; P j * P i b P j b shadow price of primary factors (e.g. land, labour), or non-traded goods; the international price of product i at the border; the international value of traded inputs; j=k+1, n primary factors or non-tradable goods; j=1, k tradable goods. As a result, the lower the DRC, the higher the competitiveness. Sugar produced in Lam Son is socially profitable if it gives a high added value to the domestic inputs. The shadow prices for traded and non-traded inputs were calculated as follows: - The base rate to be used in this calculation is VND 14,000/USD 1 (exchange rate in 1999; ADB, 2002). Also, it is necessary to analyse the sensitivity of the exchange rate at a price level of VND 15,000/USD 1. - Assumptions and arguments concerning the determination of shadow costs of primary factors used in producing sugar cane in Lam Son: Labour: Daily earnings for labour hired during the peak periods are sometimes as high as VND 18,000 per day. Considering slack periods, the shadow cost of family labour in Lam Son is widely considered by commune leaders to be VND 10,000 per day. Land: The shadow price of land used in our estimation is VND 1,200,000 per hectare/year, which is equal to the income from cultivating a single paddy of rice crop (ADB, 1997). Capital: The total amount of initial capital invested in each hectare of sugar cane is 7,000,000 (not including labour cost and the cost of some other items already in possession of the household). Farmers can borrow from either LASUCO or VBA at the subsidised interest rate of 12 percent (in 1998). The shadow price of capital is then estimated according to the following formula: Vietnam and the International Market for Rice Exports 165

177 rate of interest = r = R f + ß i (R m -R f ) (Equation 3) where R f is the risk-free rate or the interest rate of the most recently issued five-year Treasury bonds. Nominally, the accrued interest for five years is 50 percent, which is 8.45 percent per annum (VFT, 1999). ß i is the beta coefficient of stock i, R m is the market rate of return. As the statistics of the last two variables are not available in Vietnam, international data are used. Damodaran (1996) provides the historical statistics of market premiums for emerging markets, including Asia. This market premium is 7.5 percent and can be seen as R m -R f in Equation 3. The beta coefficient for the sugar industry is determined at Thus, r = * 0.74 = 14 percent. Costs of other non-tradable inputs include the prices of sprout (plant material), manure, lime powder, land making, and other fees. As no distortions for these products are evident, we assume that market prices adequately reflect their shadow costs. The figures are drawn from the profitability comparison table of Xuan Chau Sugar cane Co-operative Report Yield of sugar cane per hectare is a sensitive factor. Thus, we will analyse the sensitivity of this factor at 50 ton/ha and 70 ton/ha. - Calculation of costs of tradable inputs used in producing sugar cane at border price: Fertiliser: The fertiliser market is rather liberalised and largely privatised. Prices for fertiliser appear are reasonably aligned in markets throughout the country. The retail price of fertiliser in Lam Son is VND 1,500 per kilogram. The border price is VND 1,050 per kilogram. Pesticide: The amount of pesticide applied is small. The margin between the market price and border price is very small considering the total cost. Thus, the market price is assumed at the adjusted border price of pesticide. The cost is VND 200,000 per hectare. - Calculation of costs of non-tradable and tradable inputs of sugar production: All the costs of transforming sugar cane to sugar were adjusted to reflect the true opportunity costs - Calculation of reference price of sugar: The insurance fee and freight are added to the original price of sugar in London market to have the border sugar price to be applied. The applied price will be USD 253.8/ton, which is obtained by adding USD 50/ton to the average world sugar price of 11 months in However, the world price of sugar can fluctuate strongly. Thus, we carry out a sensitivity analysis covering the world prices of USD 300/ton and USD 220/ton. If the DRC is calculated based on the arguments above it results in a figure of 0.76, see Table Structural change in the sugar cane industry

178 Changes in yield (ton/ha) Changes in international reference prices Exchange rate = VND14.000/USD CIFprice = CIFprice = CIFprice = USD220/ton USD253.8/ton USD300/ton Exchange rate = VND15.000/USD CIFprice = CIFprice = CIFprice = USD220/ton USD253.8/ton USD300/ton Table 8: Sensitivity analysis of the DRC for sugar. Note: CIF price is the border price of sugar (World price + USD 50/ton: insurance premium and freight) Interpreting the results The lower the DRC, the higher the competitiveness. A DRC below 1 means that a region has a comparative advantage for a product and can compete in the world market. Based on the average figures of the costs, the DRC calculated for sugar produced by LASUCO shows that Lam Son obviously has a comparative advantage in producing sugar and sugar cane. However, the sensitivity analysis shows that in some cases the DRC is above 1. Low sugar prices, low yields and unfavourable exchange rates can change the comparative advantage in a comparative disadvantage. Regarding the world sugar prices, the long-term average price is about 250 USD per ton (CIE, 2001). As with many other commodities, it is expected that the prices decrease in the long term. Increases in efficiency are thus needed to remain competitive. Concluding, the calculation of DRC and the sensitive analysis of DRC for sugar produced in Lam Son shows that this region has a comparative advantage in the production of sugar cane and sugar. i Farmers responses to price signals given by LASUCO also reinforce the assertion that farmers have been rational when shifting towards sugar cane production. However, in the scenario of globalisation and decreased government protection, restoring land to previous crops or new crops will be an economical rational activity. While the sugar cane industry has generated significant gains, it is apparent that there are weaknesses. 6.6 Conclusions and Recommendations In this chapter we have seen that the farmers in Lam Son have rationally responded to incentives resulting the establishment of a sugar industry. Particularly the announcement of the buying prices for sugar cane by the factory have proved a strong incentive for farmers to shift to sugar cane cultivation. Initially the shift to sugar cane was low due to several factors, which forced the sugar factory to produce below production capacity. An important factor is that many farmers have to give up subsistence farming of rice and vegetables, which can be risky in case the returns of sugar cane cultivation turn out to be lower than expected. Other impediments in the shift to sugar cane production are land fragmentation, land suitability and use, initial Vietnam and the International Market for Rice Exports 167

179 income differences, and market uncertainties. As a result farmers exhibit risk-averse behaviour. In order to promote sugar cane cultivation, LASUCO has successfully removed an important source of risk: the expected income of sugar cane cultivation. Other stimulating measures to promote sugar cane cultivation are mainly focussing on removing initial barriers by supporting the financing of initial investments. LASUCO should, however, be careful not to give any wrong price signals to the farmers. The buying price should reflect the true market price. Otherwise, sugar cane cultivation cannot be sustainable in Lam Son and will harm the local farmers. An analysis of the impacts of sugar cane cultivation in Lam Son indicates that the region as a whole has benefited from sugar cane cultivation. It is, however, difficult to obtain figures for a clear statement on the results for individual households. Comparison of household income of different types of household shows a higher income for sugar cane cultivating households. An analysis of the sustainability of sugar cane cultivation in Lam Son shows that the region has, under the current conditions, a strong comparative advantage in sugar production. However, this advantage strongly depends on the current world sugar price, the exchange rate, and the yield. It is, however, expected that sugar cane cultivation in Lam Son can remain competitive. Hence, to come back to the questions posed in the introduction, it is possible to develop commodity production, which improves the situation of farmers. In general, the following recommendations can be given, based on the experience of sugar cane cultivation. - The risk and uncertainty for farmers should be reduced to make a shift to a new crop possible. This can be done by fixing prices or setting up some kind of insurance system in case of bad crops or low prices. However, this should not result in an unsustainable situation, whereby price incentives from, for instance, world prices, are not transferred to the producers. Hence, it is important to evaluate the true opportunity cost of sugar production, so that the cost is competitive in the world market in the future. - If considerable initial investments are required, soft loans can be provided to stimulate lower-income households with no or few saving to undertake the shift. Also assistance in providing production knowledge can help. - Finally, side requirements, such as a good transportation system and appropriate plot size, should also be fulfilled to assure a successful transition. References Agroviet (2003), Vietnam s Economy in 2001, (last visited: ). ADB (1997), The Rural-Urban Transition in Vietnam: Some Selected Issues, Asian Development Bank, Manila. 168 Structural change in the sugar cane industry

180 ADB (2002), Key Indicators 2002: Population and Human Resource Trends and Challenges, Asian Development Bank, Manila. Bliss, C. and Stern N. (1982), Palanpur: The Economy of an Indian Village, Oxford University Press, New York. CECARDE (1999), Survey Report, Centre for Consultation on Agriculture and Rural Development, Hanoi. CIE (2001), Vietnam Sugar Program, Where Next?, Centre for International Economics, Canberra and Sydney. Damodaran, A. (1996), Investment Valuation: tools and techniques for determining the value of any asset, John Wiley & Sons, New York. Dao The Tuan (1997), Kinh Te Ho Nong Dan [Economics of Peasant Households], National Political Publishing House, Hanoi. Ellis, F. (1992), Agricultural Policies in Developing Countries, Cambridge University Press, Cambridge. Hazell, P., Bassoco, L.M., and Arcia, G. (1986), A Model for Evaluating Farmers Demand for Insurance: Application in Mexico and Panama, in: Hazell, P., Pomareda, C. and Valdez, A. (eds.), Crop Insurance for Agricultural Development, John Hopkins, Baltimore. Hoogeveen, H. (2001), Risk and Insurance in Rural Zimbabwe, Ph.D. thesis, Vrije Universiteit, Amsterdam. LASUCO (1997), Company Report, Lam Son Sugar Company. Lipton, M. (1968), The Theory of the Optimising Peasant, Journal of Development Studies, pp Nguyen Do Anh Tuan, Pham Thi Ngoc Linh, and Nguyen Trung Kien (1998), Vietnam s agriculture in Economic Transformation: Achievements and Challenges, Vietnam- Netherlands Research Programme (VNRP) Report, Hanoi. Saith, A. and Tankha, A. (1972), Economic Decision Making of the Poor Peasant Household, Economic and Political Weekly, Vol. VII, No. S7, Annual Number (February). Singh, I., Squire, L., and Strauss, J. (eds.) (1986), Agricultural Household Models, The Johns Hopkins University Press, Baltimore. Timmer, C.P. (1988), The Agricultural Transformation, in: Chenery, H. and Srinivasan, T.N. (eds.), Handbook of Development Economics, vol. 1, Elsevier Science Publishers, Amsterdam. Todaro, M.P. (1989), Economic Development in the Third World, Longman, London. VFT (1999), Announcement of the State Treasury of Vietnam, Vietnam Financial Times, May 21, Vietnam and the International Market for Rice Exports 169

181 Walker, T.S. and Jodha, N.S. (1986), How Small Farm Households Adapt to Risk, in: Hazell, P., Pomareda, C. and Valdez, A. (eds.), Crop Insurance for Agricultural Development, John Hopkins, Baltimore. Endnote i Note, however, that CIE (2001) concludes that the situation in other regions of Vietnam may be different: the Lam Son mill area receives yields well above the average in Vietnam and yields of competitive products, such as rice, are relatively low in this area. 170 Structural change in the sugar cane industry

182 Chapter 7. The Agro-forestry Household System in Yen Bai Province Nguyen Quoc Toan 7.1 Introduction Agro-forestry is an agricultural system that combines trees with agricultural crops, pastures or animals, either spatially or sequentially (MacDonald, 1981). Growing multipurpose trees on farmlands provides a wide range of economic and environmental benefits (Current et al., 1995). Agro-forestry creates a balance between commercial plants (such as tea, coffee, and cinnamon) and forest areas. The trees provide shade, plant material, and protection against erosion and can directly supplement farmers income as forestry products. Agro-forestry appears to be an ecologically sound method of sustainable rural development. Agro-forestry in Vietnam has thus far been of two flavours: state or privately managed. Vietnam s privately managed agro-forestry farms (PAFs) only recently began to appear in significant numbers. As PAFs become more prevalent in rural Vietnam, it is appropriate to address their impacts and sustainability. This chapter approaches the following issues regarding PAFs: a. the main opportunities and constraints affecting the adoption and development of agroforestry systems; b. the returns for the operators; c. the effectiveness of investment in PAFs; d. the interaction between PAFs and the market; e. the environmental and social implications of developing agro-forestry systems. These issues will be discussed using the case study of Yen Bai province. Yen Bai is a mountainous province of about 688 thousand hectares located in the north-west of Vietnam, see Figure 1 below. In 1998 a survey was undertaken of 40 agro-forestry farms in this province (YBBARD, 1998a-d). The data and information in the present chapter are for an important part derived from this survey. Additional information was derived during field interviews by the author, undertaken in The study focuses on the 10-year period after the 1988 Land Law. This chapter is organised as follows. Section 2 first gives some information on Yen Bai. Subsequently, it discusses the situation of the key factors of production in the province, which are land, labour and capital. Section 3 looks at the market for log products that are generated by the agro-forestry farms. Section 4 briefly analyses the environmental The agro-forestry household system 171

183 and social aspects of agro-forestry when sustainable land use is discussed. Finally, Section 5 contains the conclusions and policy recommendations. Figure 1: Location of Yen Bai province 7.2 Key factors of production in Yen Bai province Yen Bai province Before starting the analysis of key factors of production, first some information of Yen Bai province is presented in this section. As already mentioned above, Yen Bai is a mountainous province in the north-east of Vietnam. Forestland covers 77 percent of the total area while agricultural land covers 14 percent. The 1996 estimate of utilised natural area was 50 percent, with only 25 percent believe to be used effectively (YBBARD, 1998c). Yen Bai has excellent natural conditions for the development of PAFs. Yen Bai s land resources are suitable for the development of forestry and perennial trees, such as tea, coffee, and cinnamon. While Yen Bai has one of the most favourable transportation systems compared to other Northern provinces, there is a marked distinction between communication systems among sub-regions within the province. Some regions have welldeveloped communication systems while in others considerable upgrading is needed. The extensive network of rivers and ranges of mountains are the determinants for the location of agro-forestry in Yen Bai (Donovan et al., 1997). Yen Bai has a history of forestry development with seven state forestry farms covering an area of 70,000 hectare of natural land. Poor management of the forest area has resulted in a 60 percent drop in the natural forest area over a 14-year period ( ). Silvicultural and agricultural outputs accounted for over 50 percent of Yen Bai s GDP in 1997 (YBBARD, 1998a). In 1998, there were 7,252 PAFs in Yen Bai. The majority of PAFs are less than 5 hectares in size (see Table 1) with a yearly income of less than 20 million VND (see Table 2). 172 The agro-forestry household system

184 Size < 2 ha 2 5 ha 5 10 ha 10 ha Total: ,611 2, Percentage 50% 35% 12% 3% Table 1: Classification of farms according to size. Note: For farms with sizes smaller than 2 ha, the minimum total income must be VND 5 million per year to be considered as PAFs in this survey. Source: Summarised from YBBARD (1998b) mil mil mil. > 30 mil. Total: ,502 2, Percentage 48% 41% 8% 3% Table 2: Classification of farms based on income (in VND). Source: Summarised from YBBARD (1998b) Key factors of production: land Policy governing the development of PAFs in Yen Bai The government attempted to manage forest areas in Yen Bai with the goal of providing a stable supply of forestry products in an environmentally sound manner. Having failed in both issues, the state officially recognised the emerging privately managed firms in 1989 and transferred ownership of state farms to private individuals (Gia Hoang Thang et al., 1997). Governmental policy has encouraged the development of PAFs by giving more rights to agricultural producers, improving land tenure arrangements, and providing cheap credit. Privately managed farms boomed after a resolution to comprehensively reform agricultural management (YBBARD, 1998b). This resolution focused on giving more rights to agricultural producers, allocated land to individuals, and encouraged household economies. The 1991 Forest Act secured land for up to 50 years to private individuals. With ownership, farmers had the incentive to plant commercial trees in lowlands and to manage natural forests in the highlands (CIE, 1998). The Revised Land Law of 1988 officially recognised privately managed farms and legalised their terms of land use. Further resolutions in 1998 encouraged the development of privately managed farms for their role in sustainable development with a goal of establishing five million hectares of new forest (TTCP, 1998). Land types There are five sources of land for PAFs in Yen Bai (Duc Tran, 1997; Phuoc Nguyen Dinh, 1997; YBBARD, 1998b): (i) state-allocated land, (ii) contracted land from state farms, (iii) transferred land, (iv) reclaimed land, and (v) rented land. State-owned land and The agro-forestry household system 173

185 contracted land constitute the overwhelming majority of sources of land for PAFs and total about 98 percent. Transferred land is close to 2 percent, reclaimed land is about 1 percent and rented land constitutes a tiny fraction (about 0.08 percent) (summarised from Phuoc Nguyen Dinh, 1997). State-allocated land is land that district authorities directly distribute to farmers. The state undertook this procedure with the hope of boosting agricultural production. Farmers are the main beneficiaries by gaining greater control over land. According to the Revised Land Law of 1998, state-allocated land owners have the right to exchange, assign, rent, inherit, mortgage and contribute to joint-ventures. However, state land-allocation schemes have possible biases by not considering the current economic situation of the farmers; leading to an exclusion of poorer farmers (Phuoc Nguyen Dinh, 1997). State farms under unfavourable production conditions will often distribute lands to employees under contract, which becomes contracted land. Before the reform periods, all agro-forestry state farms in Yen Bai suffered from losses and inefficient management (Gia Hoang Thang et al., 1997). After 1989, most of these farms tried to improve their situation by contracting land to workers. The duration of these contracts varies over the lifecycle of the trees on the land. Contract owners are fully responsible for their land s production and management. The state guarantees that state agro-forestry farms will buy all the products of the farms. In addition, farmers can borrow money from financial institutions and buy extension services from such organisations. Contracted land rights encourage efficient and responsible land usage. For example, contracted land rights generate incentives for farmers to switch from mono-crop farming to agro-forestry (Gia Hoang Thang et al., 1997). However, since this only grants de facto rights, it does not create incentives for large and long-term investment. Contract owners also do not have the transfer rights included under state allocated land. These two negative aspects significantly reduce the security of land users and investment decisions. Transferred land, legally reclaimed land, and rented land contribute only a very small proportion of total land. All land types share several term requirements stipulated by the Land Law from The maximum tenure is 20 years for agricultural land and 50 years for forest land. Upon expiration of the tenure, operators can re-register if the state has no plans for the land. According to farmers, the current tenure duration does not constrain investment decisions. Land tenure comes with expectations of reforestation. If land is left uncultivated, the land use rights are withdrawn and reallocated to others. This stipulation prevents absentee landholders and disinvestment. However, field research reveals that many PAFs leave their lands to natural growth; a less costly and less risky option. Furthermore, agricultural land cannot exceed three hectares, while forestry land has no maximum size. Farm size, income and productivity Table 2 in the introduction showed the classification of farms based on income. From this table it becomes clear that about half of the PAFs have an income between VND 5 million and VND 10 million per year. The average income for PAFs in Ben Yai estimated 174 The agro-forestry household system

186 in YBBARD (1998b) and Duc Tran (1998) ranged between VND 14 million per year to VND 24 million per year in There exists a relationship between the size and the income of the farm. To show this relationship the farms were grouped based on size and plotted against average income and average income per hectare. Group 1 comprises farms smaller than 5 hectares (accounting for over 85 percent of all PAFs in Yen Bai); Group 2 comprises farms ranging from 5 hectares to 10 hectares (accounting for 12 percent); and the third group includes farms equal to or greater than 10 hectares (accounting for 3 percent). Obviously, farm size correlates clearly with incomes; larger farms have higher incomes than smaller farms, see Figure 2. More interesting is to look at the average income per hectare. Average income per hectare and the net income per hectare are plotted in Figure 2 in order to compare productivity between the three farm sizes. Despite having a higher average income, larger farms in Yen Bai have lower productivity than smaller farms. The figure indicates that Group 1 is 5-10 times more productive than Group 3. This may prove a higher intensity of land utilisation in small farms. Note that the figure also shows that large farms have larger costs, such as taxes, as the difference between the total income and net income increases with size. These costs are also not proportional per hectare, as they become smaller per hectare if the size increases Average total income Average net income Average income per ha. Average net income per ha. million VND <5 ha ha. >10 ha Size category Figure 2: Average income of PAFs in Yen Bai in Source YBBARD, 1998a. The agro-forestry household system 175

187 Security of land use rights It is generally agreed that ownership or secure holding of land is a prerequisite for farmers to undertake long-term investment in agriculture. For agro-forestry systems this is particularly important because of the extended period, sometimes several years, needed for crops to mature (Cook and Grut, 1989). Under conditions of land ownership uncertainty, the period required before farmers can expect a return hinders investment. Nair (1990) argues that if land tenure systems can guarantee ownership, long-term agricultural strategies will become more probable. In Yen Bai, there are currently two main forms of registering land-use rights. The most secure one is the Red Book. Land registered under the Red Book gives the owner all rights stated under the Land Law. Registered land waiting for upgrading into Red Book status is registered in the Blue Book. Field interviews in Yen Bai indicated that the distinction between these two classifications is not clear in terms of land security. This has several reasons. Firstly, the state is able to revoke Blue Book status land. Secondly, the prevalent use of unregistered land contributes to the perception that it is legal. Thirdly, the procedure of converting from Blue Book to Red Book status is lengthy and complicated (Van Hung, 1999). Since 1989, only 30 percent of Yen Bai s 7,252 farms have obtained Red Book status (YBBARD, 1998c). Previous studies indicate that land security is among the most important determinants for a PAF s success. CIE (1998) reports that improvements in land-tenure arrangements led to an increase in tree planting. Suu Vu (1997) notes that all the PAF success stories in Yen Bai occurred after farmers received land and forest plots on a more secure basis. A simple quantitative analysis confirms that land ownership security directly affects the investment decision of farmers. When land use rights have Red Book status, the investment decision is significantly different. To test this, the number of cinnamon trees (CinnTrees) were regressed against: Red Book status (RedBook), the total current cash investment (CashInv) and the size of forest land available (SizeLand). The number of cinnamon trees is considered as a proxy for the invested capital. The results of the regression are provided in Table 3. Ordinary Least Squares Estimation Dependent variable is CinTrees Variable Coefficient Standard Error T-Ratio (Prob) Constant (0.11) CashInv (0.00) SizeLand (0.20) RedBook (0.05) adjusted R-squared 0.75 No. of observations: 20 F-statistic Table 3: Regression results for impact of land use rights. 176 The agro-forestry household system

188 The adjusted R-squared of 0.75 indicates a rather high level of correlation. The model passed all diagnostic tests, and the F-statistic is significant at the 1 percent level. The constant and the size of forest land available are not significant. The coefficient of the constant could indicate a base-size of 30 cinnamon trees for a agro-forestry farm. However, being not significant, it could be interpreted that without complementary assets (land, capital) no cinnamon trees will be planted. The size of forestland does not have a significant effect on cinnamon planting decisions, perhaps because not every location in the plot can be used to plant cinnamon. However, the insignificance could be due to the small size of the sample. The t-statistics for CashInv and RedBook are statistically significant at the 5 percent level. This regression validates the claim that capital availability and land security impact planting decisions (i.e. the investment decision) of the farms. A Red Book status accounts for the investment of 50 cinnamon trees on average. The causality, however, has not been proved by this simple regression model. It is also possible that in regions suitable for cinnamon trees, more land has a Red Book status. Further analysis is required to study this, though this falls outside the scope of the current chapter. Land concentration and land allocation There are concerns over whether the development of PAFs will create extensive land concentration and consolidation. Analysis suggests that land concentration is unlikely in Yen Bai for several reasons: - Crop production occurs in small-sized farm units. In Yen Bai, 50 percent of the farms are smaller than 2 hectares, with 85 percent being less than 5 hectares. - The family unit is the major source of labour in Yen Bai s PAFS. Investments in capital goods are insignificant; the main production factor is family labour. - The practice of PAFs in Yen Bai is principally for subsistence purposes. In our sample, total income in most PAFs did not significantly exceed the average income of Yen Bai province. In addition, the household net income, excluding returns to family labour, is low. - Land in Yen Bai is primarily acquired through the allocation program. The larger size of some PAFs in Yen Bai is the result of permitted reclamation of uncultivated land. Less than 1 percent of PAFs rent land for production (Phuoc Nguyen Dinh, 1997). - The incomes of farm households are generally not significantly different, making expansive land consolidations unlikely. Land consolidation requires accumulated savings to a degree that is not available in Yen Bai. At present, land for further agro-forestry development is still available. Yen Bai has roughly 344,457 hectares of unused, cultivatable land. However, the history of agroforestry development in Yen Bai shows that there is no trend of transforming family farms to enterprises. In fact, there has only been one case where an agro-forestry farm registered The agro-forestry household system 177

189 as an agribusiness (YBBARD, 1998b). Furthermore, the difficulties of acquiring Red Book status for land are a disincentive for investment. Several factors are believed to influence forestland allocation. The age of the farm manager, Communist Party membership, ethnicity, level of savings, and the size of families can all affect the allocation of land by the state. It is, however, difficult to make founded statements on this issue, as factors are often interdependent and data is not available. A regression analysis that has been carried out did not confirm any of the relationships, except that larger families tend to have larger forestland areas Key factors of production: labour PAFs in Yen Bai have two main sources of labour: family employment / labour exchange and hired labour. Family self-employment and exchanged labour, where farm members help each other out when necessary in exchange for help later, have no direct wages. Studies indicate that most PAFs in Yen Bai rely on family and exchanged labour as the primary sources of labour (Duc Tran, 1998; YBBARD, 1998b and 1998c). In our sample, 92 percent of PAFs relied on family and exchanged labour, with the remainder using hired (casual) workers only at busy times. Casual employment lasts usually around 1 to 3 months. Return to labour and employment stability Analysis indicates that the return to labour in PAFs is higher than the average GDP per capita of Yen Bai. Table 4 presents the 1998 average income per family member and per worker compared with average GDP per capita in Yen Bai in The sample s average income is close to the average workers income of VND 6.5 million (Duc Tran, 1998). The income per family member and income per worker are both significantly higher than the average GDP per capita of Yen Bai average GDP per capita of Yen Bai 1998 average income per family member 1998 average income per worker Percentage having income higher than average GDP per capita N/A 62 % 84 % Table 4: Return for family workers in PAFs. Unit: VND million, current prices. Sources: CIE, 1998 and YBBARD, 1998a. For family employment, employment stability is very high because most of the surveyed farms rely on the operator s family as the main source of labour. The small size of the farm is not beyond the scope of typical family sizes. On average, one worker can take 178 The agro-forestry household system

190 care of 1.4 hectares of agro-forestry land (YBBARD, 1998c). This means that a fivehectare farm will require 3 to 4 workers. As 50 percent of all PAFs in Yen Bai are smaller than 2 hectares, and 85 percent are smaller than 5 hectares (see Table 1 above), it is likely that family labour will suffice. In addition, integration of agro-forestry, food crops, industrial crops and fruit trees on PAFs means there is no real off-season. Agro-forestry farms require stable employment throughout the year. However, saying that family work is stable in PAFs does not mean that the labour is fully utilised. The fact that 29 percent of the households in our sample have members with off-farm jobs suggests that farm employment is not at full capacity. Hired workers in PAFs have limited employment security. The sizes of the PAFs in Yen Bai and the nature of the work generally does not allow for full-time employment. Very few farms hire labour and then only in busy times. Employment in these conditions is very casual. Although there is limited employment stability in PAFs, this is rather insignificant considering the low level of hired labour. The potential of PAFs to absorb surplus labour is small. While PAFs do provide employment for family members, their ability to employ outside labour is extremely weak. Among the whole population of 7,252 farms in Yen Bai, only 0.4 percent hire labour, the majority of which is on a daily basis. In addition, in fieldtrip interviews farmers revealed that the main source of outside labour does not come from the local unemployed but from in-service soldiers residing in the area. Under current conditions, there appears to be limited scope for PAFs to alleviate unemployment Key factors of production: investment and credit issues Financing is a major issue in the development of PAFs. Previous studies have paid much attention to this topic, see for instance Duc Tran, 1998; Suu Vu, 1997; Phuoc Nguyen Dinh, 1997; and Viet Nguyen Quoc and Le Phan (1998). This section addresses the major issues of investment finance for PAFs in Yen Bai. Main Sources of Investment Table 5 summarises the sources of investment funds for the PAFs in the research sample. Finance for investment in PAFs in Yen Bai comes from self-finance, formal credit institutions (such as local Banks for Agriculture and Rural Development), special programs (such as Program 327 and Program 120), the Rural Mountainous Region Development Program (RMRD), and other credit organisations. The main source of investment funding is self-finance. YBBARD (1998b) suggests a high proportion of farms using self-finance over total investment. Analysis of a sample in Duc Tran (1998) found that this proportion was about 54 percent; our sample shows a figure of 57 percent. The agro-forestry household system 179

191 Self MRRDP Other Bank finance Program Program Program Program Loan Source of investment fund (% of households) 57% 16% 3% 8% 24% 5% 38% Sum of total cash invested in all surveyed PAFs a) (VND million/%) 2, % % % % % % % Sum of total cash invested in all surveyed PAFs b) (VND million/%) % % 0 0 % 17 4% % % % Table 5: Sources of investment finance. Note: Amounts calculated from cash invested in PAFs since the establishment of farms to date, and includes both initial investment and investment for developing and expanding farms. The largest borrowing amount is VND 270 million, while the second largest amount is VND 53 million. Similarly, the largest self-finance amount is VND 2,325 million while the second largest self-finance amount is VND 110 million. a) Total sum and percentage including the outliers. b) Total sum and percentage excluding the outliers. Source: research sample results, taken from YBBARD (1998a). The second most important source of finance is interest-bearing loans from both banks and informal creditors. 43 percent of the sample reported having such loans. However, these interest-bearing loans contribute a very small share to total cash invested: 10 percent in the total cash investment if the largest loan is included, or 34 percent if the largest loan is excluded. Interest-free loans from special programs (Programs 327, 264, 120, and MRRDP) occupy a small share of the total amount of cash invested. Although over 50 percent of our sample had interest-free loans, the total amount of these loans is small percentage of the total amount of cash invested (9.5 percent if the largest investor is excluded, or 10.2 percent if the largest investor is included). However, the purpose for granting cash under these programs is not for developing PAFs, but for poverty alleviation (264), reforestation (327), or rural development (120 and MRRDP). Self-finance is comparable to interest-free loans as it does not involve any financial obligation. Together, self-finance and interest-free loans amount to 90 percent (excluding the largest investor) or 64 percent (including the largest investors) of total cash invested. The high proportion of self-finance and interest-free capital compared to bank loans as a share of total cash invested in PAFs points out two issues. Firstly, the primary means of financing investment in PAFs is interest-free finance, which could indicate that PAFs are not as profitable as expected. Secondly, there could be constraints that prevent agro-forestry farm operators from borrowing. 180 The agro-forestry household system

192 The next section examines the current state of bank loans in PAFs in Yen Bai, the effectiveness of investment, and the major constraints preventing the borrowing of money to finance PAF development. Debt and capital requirements Some confusion exists regarding the figures on total debt accumulated by PAFs. The Bank for Agricultural and Rural Development reported in 1998 an average debt of VND 1.2 million per farm. However, YBBARD (1998) reports a figure of VND million per farm. Also regarding total investment similar differences between different organisations and authors exist. The large differences in these figures result from differences in methodology for calculating debt and investments. The Bank for Agricultural and Rural Development only takes into account farms borrowing under the bank loan scheme, not including interest-free loans allocated under special programs. As very few farms are able to borrow under the bank loan scheme, the average investment level is underreported. Other studies adjust for farms that have significantly higher levels of total investment and debts. Our sample suggests that the average total debt per farm is extremely small for the majority of farms. Table 6 presents average debt and cash investment per PAF for the sample of 40 households. Values for average debt and cash invested depend heavily on the four largest farms. Excluding these four farms reduces the average debt to VND 3.7 million. Debt Average total cash invested Sum of total amount in all the surveyed PAFs (excluding the 4 largest farms) Average (excluding the 4 largest farms) Sum of total amount in all the surveyed PAFs (including the 4 largest farms) Average (including the 4 largest farms) Table 6: Average debt and cash invested per PAFs in VND million. Note: the four largest amounts are: 33, 50, 53 and 270 VND million, compared to the fifth and sixth largest amounts of 14 and 10 in VND million. Source: research sample results from YBBARD (1998). There is some contention over whether PAFs have a high demand for investment capital. The estimated minimum investment to finance an agro-forestry farm of 2 to 5 hectare is about 30 to 40 million VND (YBBARD, 1998c). Thus, for 7,500 farms at least VND 225 to 300 billion is required. Based on our sample, the PAFs demand for financing investment is not homogeneous; demands differ significantly with the size of the farm. Farms larger than 10 hectares have a higher investment per hectare than farms less than 10 hectares in size. Table The agro-forestry household system 181

193 7 summarises several indicators of cost and investment. Note that most of the average labour cost per farm is family employment. Farm size (ha.) Av. total Av. total labour cost/ha. Av. debt Av. selffinance Av. total Av. capital invested/ha. labour cost investment/ha Table 7: Average annual labour cost and debt per PAF in VND million. Note: Average total labour cost is the estimated hypothetical wage that family labourers should receive for the last working year. Average total investment per hectare equals average labour cost per hectare plus average capital invested per hectare. Average value is the average value of that category of all observations in the sample. Source: research sample results taken from YBBARD (1998a). As indicated in Table 7, the average capital invested per hectare for larger farms is significantly higher than that of smaller of farms. However, the average investment per hectare, which includes labour cost and money invested, is highest in the smaller farms. This relationship and the high average labour cost per hectare of smaller farms suggests that smaller farms have substituted labour for capital, while investment in larger farms is more capital intensive. Returns to investment Our research sample shows that the return on investment for Yen Bai s PAFs is lower than expected. Research of Duc Tran (1998), YBBARD (1998b), and TUYB (1998) report an average income per year of VND 14 to 20 million, which is an extremely high figure for rural Vietnam. These figures are inflated because they do not account for household labour. The inflated level of rural income leads to an inflated rate of return, see Table 8 Rate of return Percentage of PAFs < 20 % 32 % 20 % - 50 % 14 % 50 % % 27 % > 100 % 27 % Table 8: Proportion of net income (not adjusted for family labour) over total investment (rate of return). Source: survey results. 182 The agro-forestry household system

194 As mentioned earlier, over 90 percent of PAFs use family members as full-time workers. On average three family members are employed in the household farm. Previous surveys have not deducted their labour contribution to total income. Using these rates of return leads to false conclusions because real income is actually very low. When the opportunity cost of family workers is deducted in our sample of 40 agro-forestry farms, the net income is significantly lower. Table 9 shows that nearly 50 percent of all observations had a net income lower or equal to VND 5 million in 1998 and nearly 84 percent had a net income lower or equal to VND 20 million. Only about 16 percent had a net income over VND 20 million per year. Range of Income Percentage Cumulative % 48.6 % % 64.8 % % 83.7 % > % 100 % Table 9: Analysis of net incomes in 1998 in VND million. Source: survey results. The return per hectare is also low. Table 10 shows that only 5 percent of farms had a total return greater than VND 10 million in If net income is included, only 8 percent of the surveyed farms had returns in the range of VND 5 to 10 million and no farms had net returns over VND 10 million. More than half of the surveyed farms had net returns ranging from VND 0-2 million. These return values are not encouraging. Amount Percentage of farms (VND million) Total return per ha Net return per ha % 65 % % 27 % % 8 % 10 5 % 0 % Table 10: Returns per hectare. Source: survey results The most relevant values for understanding the productivity of PAFs is average income per hectare or unit of investment (cash or total investment). Although smaller farms have lower gross and net income, their average net income and income per hectare is larger than larger farms. This relationship suggests that smaller farms have higher rates of return per hectare than large farms. This was already shown in Figure 2 of Section 2.2. The decreasing line for average (net) income per hectare indicates the lower productivity of larger farms. In addition, gross and net income per unit of capital or cash invested is The agro-forestry household system 183

195 significantly higher for smaller farms, indicating that smaller farms are more efficient, see Figure 3. million VND <5 ha ha. >10 ha Size category Average income/investment ratio Average net income/investment ratio Average income/total cash ratio Average net income/total cash ratio Figure 3: Analysis of income (in VND million). Our conclusions indicate that investment effectiveness is higher in small-sized farms. This result is in agreement with the experiences of other developing countries and the conclusions of other agricultural economists, such as Ellis (1988). Further analysis of the figures in a regression analysis has proved the negative correlation between investment and income. This relationship suggests that PAFs are in general unsuccessful at making profits, and serve primarily as employment for family members at a subsistence level. However, as the sample size is small, and may contain agro-forestry farms of which trees have not matured yet, future gains can be expected. Further study is needed for a more founded confirmation of claims about the profitability of agro-forestry farms. Credit Constraints Current regulations have imposed heavy constraints on borrowing to develop PAFs. Despite the Party s Central Committee recognition of PAFs (11/1998), there has been no official lending policy focused on PAFs. As of March 1999, the Group of Banks for Agriculture and Rural Development (GBFARD) General Director revealed that there was no credit policy to support PAFs (Nguyen Van Loc, 1999). In March 1999 the government issued credit policies to support the development of farms under private management 184 The agro-forestry household system

196 (TTCP, 1999). However, without concrete policy guidelines these funds will not be available to PAFs. Administrative procedures to apply for credit also constrain PAF development. In an interview by Dao Duy Vuong, Pham Dinh Phuc and Nguyen Cong Bang (1997), 80 percent called for reform in credit procedures and mechanisms. Currently, procedures for obtaining credit are usually lengthy, bureaucratic, and unrealistic. The owner of a privately-managed farm must be able to satisfy five conditions to borrow from banks (Nguyen Van Loc, 1999). The unrealistic nature of these conditions and the time-consuming procedures discourage borrowing. The five major conditions that a farm operator must meet in order to borrow include: 1. The farm must be recognised by the state as an agricultural business entity: a. The farm must operate as a private enterprise solely responsible for investment decisions. b. The government will not give favourable loans; c. The farm must have the legal right to borrow from banks and credit institutions. 2. In order to be eligible for a loan, the land must have Red Book status. 3. The farm operator must provide detailed statistics on land use, type of trees, and capital structure. 4. The bank requires a current assets evaluation so that loans that will not exceed the total current value of assets. 5. The borrower must provide the bank with a detailed feasibility study for investment expenditures. For most of the agro-forestry farms, these requirements are difficult to fulfil. In particular the second requirement is difficult to meet: 70 percent of the farms in Yen Bai lack Red Book status and are automatically ineligible for loans (YBBARD, 1998b). As of 1996, less than 6 percent of all farms in Yen Bai obtained credit from banks. The fourth requirement, an evaluation ensuring debt will not exceed assets, makes PAFs investment requirements unobtainable. Planting log-providing trees or industrial crops (cinnamon or coffee) requires at least 10 million VND per hectare. With 85 percent of farms smaller than 5 hectares, asset requirements are seldom met. The requirement of collateral effectively prevents farmers from accessing credit. The other conditions are also highly impractical. The majority of farm operators have low levels of education. Very few can correctly survey their farms land use or the current assets. With limited market knowledge, over 70 percent of our survey could not estimate the current values of their trees. A feasibility study is even more unrealistic; most farmers are unable to predict future input and output markets. In addition, the markets for agricultural products have a high level of instability. Farmers must occasionally change tree types according to market conditions. The fieldtrip interviews revealed that recently many owners of PAFs in Yen Bai have cut down The agro-forestry household system 185

197 cinnamon trees because of uncertainty in market demand. A feasibility study is impractical under these conditions. A key to the promotion of lending programs is to reduce interest rates for PAFs. While special lending programs give interest-free loans, the interest rates of banks are beyond market demands to encourage borrowing. Interest rates range from 1 to 2 percent per month, equivalent to 12 to 24 percent per annum. In 1998, CIE reported that, at current log prices and growth rates, non-subsidised interest rates are too high to make plantation investment viable. To test how other factors constrain credit for small farmers, we set total loan, including interest-rate loan and interest-free loan, as an dependent variable to be regressed against the following variables: - total amount of forest land: ForestLand - total amount of agricultural land: AgrLand - total amount of other land (including living area, fish pond, garden): OtherLand - age of farm head: Age - Communist Party membership (dummy variable): CPmember - Red Book registration (dummy variable): RedBook - number of full-time family workers: FFworkers - savings of the household for self-finance: Savings - total income of the household: TotInc Table 11 summarises the results. The adjusted R-squared indicates a very high correlation. The F-statistic is significant at 1 percent level. Among the three kinds of lands (ForestLand, AgrLand and OtherLand), the coefficients for forest land and other land are positive and significant at 1 percent level of confidence (two-tailed test). This implies that farms with larger forest areas and other land areas have a higher loan, and presumably better access to credit. However, the coefficient of forest land is small compared to the coefficient of other land, signifying limited impact on loan access. Considering the illiquidity of forest land, this result is logical. Other land contributes to loan accessibility because it provides more collateral from being relatively more secure and the inclusion of living areas. Homes are more tangible and assessable than future commodity indexes, and are a better gauge for lending institutions. It is interesting to note that the t-statistic for agriculture land (AgrLand) is insignificant at even the 10 percent level (two-tailed test). In addition, the coefficient is negative. This implies that statistically, the size of the agriculture land in PAFs does not affect accessibility of credit. This result might be particular for the region; most land in Yen Bai are unsuitable for producing crops. In addition, it is currently not possible to mortgage agriculture land. 186 The agro-forestry household system

198 Ordinary Least Squares Estimation Dependent variable is Loan Variable Coefficient Standard Error T-Ratio (Prob) Constant (0.32) ForestLand (0.01) AgrLand (0.61) Otherland (0.01) Age (0.32) CPmember (0.17) RedBook (0.69) FFworkers (0.07) Savings (0.06) TotInc (0.12) adjusted R-squared 0.97 No. of observations: 37 F-statistic Table 11: Regression results for impact of land use rights. The t-statistic for Age is insignificant at the 10 percent level, indicating that statistically, there is no age discrimination. The t-statistic for CPV is insignificant at a 10 percent level (two-tailed test) showing that, being a member of the Communist Party does also not affect credit accessibility. Interestingly, according to this model, security of land use right does not seem to have impact of the amount of cash borrowed. The t-statistic for RedBook is insignificant at 10 percent level (two-tailed test). In the previous model, presented in Table 3 above, the Red Book status was significant and had a considerable impact on the investment in cinnamon trees. This can mean that Red Book status does have a relation with loans, but this relation is very weak compared to the other factors. The t-statistic for FFWorkers, the full-time family workers, is significant at the 10 percent level (two-tailed test), but insignificant at 5 percent level (two-tailed test). It shows that there may exist a negative relationship between the number of full-time family workers and the amount of loan obtained. The negative coefficient indicates that labour in PAFs in Yen Bai is substitutable for cash; the more family labour, the less cash needed. The t-statistic for self-finance (Savings) is also significant at a 10 percent level, but not 5 percent level (two-tailed test). At 10 percent confidence level we can say that the amount of loan is positively affected by the borrowers savings. However, as the coefficient for savings is very small, the impact of self-finance on credit accessibility may not be high. The agro-forestry household system 187

199 Finally, total income (TotInc) is insignificant at a 10 percent level (two-tailed test); indicating that statistically, total income of the farm household does not affect loan amounts Summary In conclusion, an analysis of the three main factors of production indicates that smaller farms (less than 10 hectares) have a higher average income and productivity per hectare than larger farms. There are marked differences in productivity among farms of different sizes. Smaller farms use labour more intensively, while larger farms use more capital-intensive production methods. The effectiveness of investments is, however, higher in smaller farms. Still, small farms are restricted in access to credit facilities. The requirements for borrowing are too difficult to meet for many small farmers. Thus, current investment in PAFs is not very effective and improvements in land security and credit procedures are necessary to ensure sustained future development of PAFs. Furthermore, there is no evidence of discrimination in forest land allocation. The reforms in the Land Laws have contributed to a better situation, though still improvements can be made. It is, for instance, unlikely that conditions for land concentration exist. The income of family labour in PAFs is generally comparatively high and secure. The household income, however, is mediocre and most farms produce at subsistence level. 7.3 Market structure of log products Marketability of agro-forestry farm products is a prerequisite for the further development of PAFs. International experience has shown that without assessing the marketability of products, it is very likely that agro-forestry projects, though technologically beneficial, can fail (Current et. al., 1995; Lutz et. al., 1994; Gregersen and Lundgren, 1990; Cook and Grut, 1989). In Vietnam, concerns have been raised over the market structure for log products. There are many allegations that the current market structure for PAFs does not create incentives for further production and development of PAFs. Calls have been made for improvements in the market for log-products (Viet Nguyen Quoc and Le Phan, 1998; Van Hung, 1999; Hoai Le Anh 1998; and YBBARD, 1998 a, b, and c). This chapter assesses the hypothesis that the current market structure for log products of PAFs in Yen Bai has not been effective in creating incentives for further development. Specifically, the marketability of log products, the nature of the market structure for log products and its impacts on the development of PAFs, and other marketing constraints on the development of PAFs will be addressed. Although the products from PAFs comprise of food crops, fruits, industrial crops, livestock and forest products such as fuel wood and logs, only forest products are considered here as log. PAFs are the focus of this study, and forest trees are the difference between PAFs and other farms. For other products one can refer to some of the other chapters in this book. 188 The agro-forestry household system

200 7.3.1 Analysis of market structure The market for log and fuel wood is strong, although the only consumer of log products is Bai Bang paper mill (BAPACO). Yen Bai is one of the main raw material areas of the mill (CIE, 1998). CIE reports a strong potential for demand for logs from Bai Bang mill. A strong market is also evident from the Vietnamese government s plan: five million hectares of plantations are planned to be established by 2010 nation wide, in which one million hectares are expected to provide material for pulp production and form part of the government s master plan for log supplies (VPCP 02/13/99). It is estimated that up to thirty percent of logs are currently being purchased from private growers. Ten percent of the mill s log requirements are now coming from PAFs (CIE 1998). The money injected into the log supply region of Yen Bai was VND 6.69 billion in The log industry has generated a strong perception of growth. Government plans and expectations of growth imply a high future demand. However, this development will not occur as long as farmers are not allowed to maximise their welfare. If farmers do not gain from the projected incentives, PAF development and the logging industry will fail to materialise. The next sections will analyse important factors that are believed to have a strong impact on the development of PAFs. They are market structure and other marketing constraints. Prices and market structure Although the market for logs is much freer than that which existed in the 1980s (CIE 1998), the current market structure of log procurement from PAFs to processor still imposes significant constraints on the development of PAFs, reducing farmers incentives to invest in this type of agro-forestry system. BAPACO is the only buyer of logs produced by PAFs for paper production. However, to reach the buyer, logs must pass through a cumbersome and expensive supply channel. Before 1990, the log procurement procedures were highly bureaucratic and governed by state plans. From 1990 till 1996, the mill bought logs from many supply sources. This system led to poor forest management and uncontrolled destruction of forests. Since 1996, the raw material supply company (VPMC) is BAPACO s sole provider of logs. The supply company buys logs from independent forest enterprises and private growers. This system assures the mill a supply of logs at a set price, thus reducing risk and uncertainty on the supply side. In addition, with VPMC being the sole supplier, it is possible for authorities to identify the source of the logs and hence to control the rate, area, and location of harvest. This can assist management of the forest estate and is helpful in preventing illegal logging. However, under this arrangement, the VPMC has monopolistic power over the mill and monopsonistic power over producers. The price farmers receive for logs are much lower than they expected or is reasonable. In addition, they are restricted in selling to alternative buyers. BAPACO, on the The agro-forestry household system 189

201 other hand, cannot make decisions on choosing suppliers and prices. Furthermore, VPMC cannot make decisions on purchases or prices as well. Instead, the Vietnam Paper Corporation (VPC) controls major purchases and prices. In addition, VPMC is subject to pressure from provincial authorities to buy logs from local farmers, even when its supply exceeds the mill s demand. Field interviews with tree-growers revealed that, with the exception of a few very large farms, VPMC never comes to tree-growers to buy logs directly. Purchases are usually made with private log dealers. Interviewees reported that they sold their logs to private log dealers, who sell to VPMC, who sells to BAPACO. Log transactions filter through two intermediaries before logs are reaching the mill. This marketing channel is highly inefficient. The intermediaries do no deliver value added to the process, and merely squeeze profit margins from the lower tier (Nguyen Ngoc Luu, 1998). In this channel of procurement, the price of one cubic metre of log can increase by 200 percent of the farm gate price. Transportation and collection costs generate most of the price increases. The average transportation cost of one cubic metre of log to the mill is approximately VND 100,000 (in 1999 prices). Figure 5 illustrates Yen Bai s supply channel. The system allows private dealers to set low purchasing prices to the benefit of themselves and the VPMC. When there are numerous producers, private dealers extract larger amounts of farmers surpluses (Nguyen Ngoc Luu, 1998). This is disadvantageous to producers, end-consumers, and impedes commercialisation of agricultural production. It is clear that farmers and consumers have lost surpluses to private dealers, VPMC, and BAPACO. Logs from farms Private dealers VPMC BAPACO VND 160,000 / m 3 VND 330,000 / m 3 Figure 4: The log supply channel. Price per cubic metre of Styrax. Source: field interview with farmers (farm gate price) and People s Committee Yen Bai (mill door price). We now turn to the supply-side characteristics. The number of log providers is quite large. Among the 7,252 farms surveyed by YBBARD (1998c) over 90 percent provided logs. Each farm provides a very small amount of logs to the mill; even the largest log providing farm can provide only 600 tones of Styrax. This is only a small proportion of total log demand, which is about 40,000 tones per year. Given the average size of agroforestry farms in Yen Bai, it is estimated that one hectare of log providing trees can provide about 80 to 100 cubic metres of log (which equals approximately 60 to 80 tons of logs; 190 The agro-forestry household system

202 CIE, 1998). With such supplying capacity, it is unlikely that one provider alone can affect prices. There is a potential for suppliers to have influence on the prices, if they were to use collective bargaining techniques. However, this has not occurred between log suppliers in Yen Bai. Log suppliers in Yen Bai have never co-operated with each other to form an organisation in order to increase their bargaining position. All interviewees in our sample said that they had no arrangement with each other in selling logs. Prices are always determined through independent negotiations between farms and private dealers. This provides private dealers with an advantage in negotiations through experience and dealer information collaboration. Without proper information, farmers have very little reference for the regional log market, thus prices are variable and volatile. Reported prices by farms confirm this situation. Similar quality logs sell at different prices at different farms; ranges have reported from VND 80,000 per cubic metre to VND 120,000 per cubic metre. The VPC works to unite all paper producers and raw material companies. However, the corporation excludes tree-growers and its decision-making process has no reference for farmer s interests. The supply of logs is highly inelastic. The maturity period of trees means that planting decisions are only effective 5 to 8 years later. As a result, the supply of logs is stable regardless of changes in price. Once the investment is made, there is little capital left for investment in other crops. The financial system also requires farmers to follow their contracted business plan to keep the loan and have legal status over their lands. Finally, in many cases in Yen Bai province forest land is unsuitable for planting trees for cash or food crops. As a result, planting log is the only possibility for farmers. From a study of smallholder reforestation projects in other provinces, it was concluded that the prices of logs at the farm gate were too low to make such plantings financially attractive (CIE, 1998). The paper mills have to pay the price set by the raw material supply companies and the VPC. Table 12 compares the mill door and farm gate log prices. Type of tree Mill door price (VND/ton) Farm-gate price (VND/ton) Eucalyptus 420, ,000 Acacia 340, ,000 Styrax 330, ,000 Manglieta 330, ,000 Bamboo 360, ,000 Table 12: Mill door and farm-gate log prices in Source: CIE (1998). CIE (1998) reports that growers considered the prices paid for logs as low; about half that of mill door prices. CIE (1998) also confirms that the difference accrues to The agro-forestry household system 191

203 intermediate costs such as transportation. The common situation in the log market in Yen Bai as observed by Viet Nguyen Quoc and Le Phan (1998) is that the majority of farmers have to sell log to private dealers at VND 160,000 per cubic metre while the average mill door price is about VND 360,000 per cubic metre. It is reported that many log growers have suffered from heavy losses in recent years. The People Committee of Yen Bai explicitly recognises that current log prices are discouraging log growers as they have to bear losses. They estimate that the average mill price at BAPACO is VND 388,085 while the average price in the official market is only VND 271,000. In addition, it is estimated that even if the growers sell log directly to the mill at mill door price, the growers still lose on average VND 48,698 per cubic metres of log sold. The transportation and handling costs and the costs of growing trees cannot be covered by the current prices offered by the intermediaries, even if the mill gate price is set above the market prices. Table 13 presents the current mill door prices and the new mill door prices proposed by the People Committee of Yen Bai (in 1999 prices). These prices should result in an average profit of only VND 15,336 per cubic metre of log to the farmer. The differences between the previous and proposed prices are relatively large, inferring the possible loss to farmers. Per m 3 Proposed minimum mill door prices Previous mill door price Difference Styrax 400, ,000 70,000 Eucalyptus 460, ,000 40,000 Other 410, ,000 70,000 Table 13: Proposed and previous mill door prices (in VND). Source: Summarised from People Committee Yen Bai. Table 14 summarises the results of our survey and the result of previous studies. It is clear that growers sell at a price approximately one third to one fourth that of the mill door prices. Transportation costs are nearly one third of total cost. In addition, the growers must pay a tax on logs sold to contribute to a Forest Fund. The transportation costs and reforestation tax create a high burden on the growers and discourage further planting. The difference between the average private dealer prices and the average close-toroad farm gate prices shows the severity of transportation costs. The average close-to-roadfarm gate prices are usually two times greater than the average private-dealer prices. This difference is roughly the transportation cost and the cost of intermediaries. Further evidence of VMPC s monopsonistic position is the difference between the average official market prices and the fixed mill door prices. The difference is high and implies that the VMPC has extracted surpluses from being the sole buyer of log products. 192 The agro-forestry household system

204 Type of wood (1) Av. private dealer pr./m 3 (2) Av. close-toroad farm gate pr./m 3 (3) Av. official market pr./m 3 (4) Fixed mill door prices/m 3 (5) (6) Tax/m 3 Transport cost/m 3 Styrax 160, , , ,000 20, ,000 Eucalyptus 120, , , ,000 20, ,000 Other 100, , , ,000 20, ,000 Table 14: Log-prices and transaction costs at various points in the supply chain in VND. Notes: (1) Average private dealer-prices: Prices for logs bought by private log dealers. (2) Close-toroad farm gate prices: Log prices sold directly by farmers whose farms are near main roads. (3) Average official market prices: Log prices sold at official log market governed by the local authorities. (4) Fixed mill door prices: Log prices set by the VPC that BAPACO must buy at the mill. (5) Forest Fund Contribution: for every m 3 of log, the growers must contribute VND 20,000 to the socalled Forest Fund. (5) Transport cost: transportation cost of 1 m 3 to the mill. Sources: (1) Fieldtrip interview, Viet Nguyen Quoc and Le Phan (1998) (2) Fieldtrip interview. (3) Average official market price: Peoples Committee Yen Bai. (4) Fieldtrip interview (5) Fieldtrip interview. (6) Peoples Committee Yen Bai Other marketing constraints Other marketing constraints that discourage growers from developing their farms include market accessibility, infrastructure and knowledge of the market. Poor market accessibility is the result of market interventions and poor infrastructure. Physical market accessibility is an important determinant of the development of PAFs, as wood is a bulky and thus an expensive product to transport. Research by CIE (1998) shows that the distance from the supplier to the mill determines the return for log growers. There is a need to upgrade transportation infrastructure accessing existing forests. As road transportation is in most cases the only transportation mode, roads need to be constructed that can allow heavy trucks to enter the production sites. Communication facilities are also not up-to-date in many areas of Yen Bai, limiting communication between suppliers and purchasers. Observation of the distribution of PAFs confirms that the infrastructure is a critical condition affecting the development of PAFs: districts closer to main transportation systems, or having main transportation systems have a much higher number of farms. Another market constraint is marketing knowledge. There is a need to improve marketing knowledge in farms. A proxy to estimate the owners market knowledge is their abilities to estimate the current value of their farms. In our sample nearly 50 percent were unable to estimate the current value of their farms. The fact that farmers are willing to declare their assets but unable to estimate their value is evidence of a lack of market knowledge. In addition, over 30 percent of farmers in the sample asked for extension assistance in marketing information, and technical training. This means that intermediaries can easily dominate the negotiation processes and set a price. The agro-forestry household system 193

205 7.3.3 Concluding remarks In the previous sections we have seen that the household incomes from PAFs are reasonably good compared to the average GDP per capita in Yen Bai. This section, however, showed that log production is an unprofitable activity under the current circumstances. Hence, PAFs must obtain their income mostly from the other agricultural activities. Agro-farming covers a wide range of activities. Trees planted can, for instance, also bear fruits. With the current data and scope of study we are unable to make any further assessments on this topic. Further study is needed to assess the profitability of agroforestry. Here the conclusion is that other alternatives to log production in agro-forestry farms should be sought to stimulate agro-farming. 7.4 Sustainable land use A major benefit of PAFs is their ability to provide sustainable, ecologically sound land development. It is therefore useful to discuss how successful PAFs have been at meeting this key objective. We will now analyse PAFs in terms of common natural resource theory and environmental protection. In general, forest land can be owned by the state, in which case it is often considered as a common resource, which is accessible to everyone, or it can be privately owned. As pointed out by Berkes, McCay, and Acheson (1989), when natural resources are under state management, it is often the case that the government may not be able to control, manage, or prevent degradation to those resources. The reality of Yen Bai s forests is that forest land under state management has seriously degraded. Full privatisation of forest land provides an alternative to state management of land. However, this is also found to be ineffective in many cases; natural resources are being overexploited as external effects and social benefits are not taken into account by the private owner. In addition, the state ideology of the Vietnamese government does not allow for full privatisation of land. Recognising the problems existing with both solely private or solely state management of common resources, there is now a tendency for joint management of resources on state land. Here, control and ownership is retained by the government but local people take on the responsibilities of management. It is acknowledged that this option is better than either state or private management as it can utilise the advantages of both options and significantly reduce any negative effects (Sheperd and Laar, 1990). The development of PAFs in Yen Bai is in fact similar to this kind of combination. On one hand, the operators have five main rights over the land, yet the state takes the control in monitoring whether the operator uses the forest land for planting forest or not. In addition, the actual ownership is in the hands of the government. After 50 years, the state has the right to decide whether the operator is qualified to have land for another period. Thus it is clear that while the local people take on the responsibilities of management and have use rights, the state still retains control and ownership. Looking at the impacts of PAFs on sustainable land use, we first note that the Vietnamese government intends to plant 5 million hectares of new forest land by the year 194 The agro-forestry household system

206 2010, and to effectively protect the current 9.3 million hectares of existing forest. Policies for developing sustainable forestland aim to: - protect natural resources; - create a stable supply source of silvicultural products; and - improve the living conditions of people living in the mountainous regions. In the past, the centralised state management system for forests led to overproduction of natural forests and planted forests in Yen Bai. To assess the current development of PAFs, in relation to the state objectives above, it is necessary to check if they have promoted long-term sustainable land use, while contributing to the welfare of the farmers in Yen Bai. Regarding the economic contributions of agro-forestry, in Section 2 we have found that the majority of household incomes of PAFs exceed the average GDP per capita of Yen Bai province. Employment stability for family labourers for Yen Bai s PAFs is high as a result of the integrated nature of agro-forestry systems. Overall, PAFs have been successful in improving human welfare by raising incomes and providing stable employment for households. Results from log production have, however, been very disappointing. The recognition of PAFs has significant increased reforestation efforts in Yen Bai. From 1990 till 1996, PAFs in Yen Bai have increased replanted forest areas from 6,299 hectares to 11,261 hectares (YBBARD, 1998a). Table 15 presents statistics on forest land managed by state and private sectors. It is clear that private sector managed forest area has increased substantially, as well as forest managed by the state. Unit Total State Private Total State Private Total State Private Concentrated reforested forest Sporadically planted forest Cared forest land ha 3,223 1,406 1,817 8,605 5,396 3,209 9,476 6,025 3,451 ha 4, ,000 1, ,075 1, ,785 ha 4,529 4, ,780 5,500 3,280 12,864 8,364 4,500 Total 11,752 5,935 5,817 18,459 10,896 7,564 24,125 14,389 9,736 Table 15: Forest land managed by the state and private sectors. Source: YBBARD, 1998d. The statistics show the contribution of the private sector in the reforestation effort: the private sector has total control of sporadically planted forest, while the private sector also saw a strong growth in cared forest land and to a smaller extent in concentrated reforested forest. Sporadically planted forest takes place on a small scale, which is not carried out by the state. Obviously, the total area of cared forest land managed by the private sector has The agro-forestry household system 195

207 increased substantially in just five years since the popularisation of PAFs. However, cared forest by the private sector is carried out under control of the state. Agro-forestry systems reduce pressures on natural forests. In Yen Bai, it is evident that replanted forests have reduced the magnitude of natural forest exploitation. Figure 5 illustrates this contribution. As indicated in this figure, there has been a declining trend in exploited natural forest in Yen Bai. The quantity of wood exploited in natural forest has reduced considerably, from 15,600 cubic metres in 1989 to approximately 2,000 cubic metres in This trend goes with an increase in exploited planted forest. In addition, according to Nguyen Quy (1999), Yen Bai province has logging access to the natural forests in 143 of a total 152 counties. In the future, Yen Bai expects to shift all logging activities from natural forests to planted forests. Summarising, PAFs are believed to have the potential to create sustainable human welfare development without destroying natural resources. From the perspective of sustainable human welfare, PAFs in Yen Bai have already improved household income and created a secure source of employment. From the perspective of a sustainable resource base, they have contributed positively to reforestation efforts, reducing pressure on natural forest, and possibly improving soil quality. 60,000 50,000 Quantity of exploited wood in m3 40,000 30,000 20,000 Natural Forest Planted Forest Total 10, Year Figure 6: Quantity of exploited wood over the period of 10 years in Yen Bai. Source: based on statistics of Nguyen Quy (1999). 7.5 Conclusions and recommendations Yen Bai s PAFs are clearly a stimulus for sustainable rural development. Privately owned and operated agro-forestry systems effectively manage resources with sound 196 The agro-forestry household system

208 ecological practices. The household income in PAFs is on average higher than the per capita GDP and agro-forestry provides stable employment throughout the year. Differences exist, however, between different types of farms. Large farms have a higher income, but their productivity per hectare is lower. Smaller firms are thus more efficient than larger farms. If the government wishes to support this production method, the primary policy recommendation would be to facilitate a smoother, easier method of Red Book registration. Land security generates incentives to develop farmland with intentions of long-term use. To further facilitate this development, credit must be more accessible to these projects. The current system makes loans beyond the scope of most rural households. These changes will increase investment incentives, but without restructuring the log market, they will be constrained. Two forces have created a system of excessive extraction of farmer surpluses: high transportation costs and limited information. Improved infrastructure will lower transportation costs, but without more market information, this lower cost will not improve the farmer s bargaining position. Although these recommendations are not simple to carry out, the experiences of Yen Bai have shown that PAFs will contribute to sustainable land development. In short, the following policy recommendations can be formulated: - The process of Red Book registration needs to be improved in Yen Bai in order to encourage sound investment. - There is a need to have a clear credit policy focusing on PAFs. - In addition, credit mechanisms should be reformed. - It is necessary to remove constraints on log-marketing channels and create arrangements allowing growers to sell logs directly to the manufacturer. - There is a need to improve the transportation system, and extension services such as marketing information and technical training are also needed. - The government should recognise the importance of PAFs in contributing to sustainable land use. References Berkes, F., McCay, B., and Acheson, J. (1989), The benefit of the commons, Nature, no. 340, July. CIE (1998), Impact of the Bai Bang project in Vietnam: an evaluation, vol. 1, Centre for International Economics, Canberra & Sydney. Cook, C. and Grut M. (1989), Agroforestry in Sub-Sahara Africa: A Farmer s Perspective, World Bank Technical Paper, No. 122, World Bank, Washington, D.C. Current, D., Lutz, E. and Scherr, S. (1995), The costs and benefits of agro-forestry to farmers, The World Bank Research Observer, vol. 10, no. 2, p Dao Duy Vuong, Pham Dinh Phuc and Nguyen Cong Bang (1997), Von va su dung von trong cac trang trai hien nay o Huyen Yen Binh, tinh Yen Bai [Capital and Capital Use The agro-forestry household system 197

209 in farms at Yen Binh county, Yen Bai Province], unpublished paper, Vietnam- Netherlands Research Program, Hanoi. Donovan D., Rambo A.T., Fox J., Le Trong Cuc, and Tran Duc Vien (eds.) (1997), Development Trend in Vietnam s Northern Mountain Region, vol. 1, East-West Center and Centre for Natural Resources and Environmental Studies, Vietnam National University (VNU), National Political Publishing House. Duc Tran 1998, Kinh te trang trai vung doi nui, [Farm business in mountainous areas] Vietnam- Netherland Research Program, SPH, Hanoi. Ellis, F. (1988), Peasant Economics and Agrarian Development, Cambridge University Press, Cambridge. Gia Hoang Thang, Nguyen Chi and Tam Dao Thi (1997), Doi moi nong lam nghiep o cong ty che bien va xuat khau che Van Hung tinh Yen Bai [Agro-forestry reforms at Van Hung Export and Processing Tea Corp (Yen Bai Province)], unpublished paper, Vietnam Netherlands Research Program, Hanoi. (Field interview) Gregersen, H. and Lundgren, A.L. (1990), Forestry for sustainable development: Concepts and a framework for action, Forestry for sustainable Development Program Working Paper no.1, University of Minnesota, St. Paul, Minnesota. Hoai Le Anh (1998), Dieu chua noi trong cac ban bao cao, [Unmentioned points in the reports], Nong Thon Ngay Nay [The Rural Region Today Newspapers], no /16/1998. Lutz, E., Pagiola, S. and Carlos, R. (eds.) (1994), Economic and Institutional Analyses of Onfarm Soil Conservation Projects in Central America and the Caribbean, World Bank Environment Paper, no.8, World Bank, Washington D.C. MacDonald, L. H. (ed.) (1981), Agro-forestry in the African Humid Tropics, Proceedings of a Workshop Held in Ibadan, Nigeria, 27 April - 1 May 1981, NRTS-17/UNUP-364, United Nations University Press, Tokyo. Nair, P.K.R. (1990), The Prospects of Agroforestry in the Tropics, World Bank Technical Paper, no. 131, World Bank, Washington, D.C. Nguyen Ngoc Luu (1998), Lecture Notes on Institutional Economics Approaches to Agranian Problems, Vietnam-Netherlands Master s Program in Development Economics, National Economics University, Hanoi. Nguyen Quy (1999), Yen Bai giam khai thac go tien toi dong cua rung tu nhien, [Yen Bai reduces wood exploitation in natural forest to stop exploiting natural forest in the future], Lao Dong newspaper, no. 97/99, Friday 06/18/1999. Nguyen Van Loc (1999), Dieu kien kinh te trang trai duoc vay von, [Conditions for borrowing money that privately-managed farms must meet], Dau Tu [Investment Review], 1 March Phuoc Nguyen Dinh (1997), Quan he dat dai trong kinh te trang rai o Huyen Yen Binh (Yen Bai), [Land relationship in farm business at Yen binh county (Yen Bai)], unpublished paper, Vietnam-Netherlands Research Program, Hanoi. 198 The agro-forestry household system

210 Shepherd, A. and Laar, D.A.V (1990), A framework for the analysis of common pool natural resources, Institute of Social Studies Working Paper Series No. 77, Institute of Social Studies, The Hague. Suu Vu (1997), Mot so mo hinh lam kinh te trang trai co hieu qua o tinh Yen Bai [Some successful farming model at Yen Bai province], unpublished paper, Vietnam- Netherlands Research Program, Hanoi. TTCP (1998) Thu Tuong Chinh Phu [Office of the prime minister of Vietnam], Quyet dinh ve muc tieu, nhiem vu chinh sach va to chuc thuc hien du an trong moi 5 trieu hec ta rung, [Decree on the objectives, tasks, policies and implementation of the 5-million-haforest-land-planting Project], Decree 661/1998/QD-TTg, 07/29/1998. TTCP (1999), Thu Tuong Chinh Phu [Office of the Prime Minister of Vietnam], Quyet dinh ve mot so chinh sach tin dung ngan hang phuc vu phat trien nong nghiep va nong thon [Decree on some banking and credit policies to serve rural and agricultural development] Decree 67 /1999/ QD-TTg, TUYB, Tinh uy Yen Bai [Poliburo of Yen Bai] (1998), Bao cao: Tinh hinh kinh te trang trai trong nhung nam doi moi, mot so dinh huong phat trien kinh te trang trai trong nhung nam toi, [Farm household economy in the renovating time, some orientations for developing farm household economy in the coming years: Seminar paper], First draft, Dec 1998, Yen Bai. Van Hung (1999), Dat rung co chu se mau xanh, [Forest land will have more trees if it has real owner], Thoi Bao Kinh Te Viet Nam [Vietnam Economics Times], No. 43, 05/29/1999, p.7. Viet Nguyen Quoc and Le Phan (1998), Doi dieu ve kinh te trang trai o Yen Bai [Some notes on household-managed farms in Yen Bai], paper on Conference on Household Farms in Yen Bai, December 1998, Yen Bai. YBBARD (1998a), Yen Bai Bureau for Agricultural and Rural Development, Khai quat noi dung bao cao cho vay ho san xuat theo mo hinh kinh te trang trai o Yen Bai, [Overview on current lending to household production in the form of privately-managed farms], paper presented on Conference on Household Farms In Yen Bai, December YBBARD (1998b), Yen Bai Bureau of Agriculture and Rural Development, Bao cao tham luan: ve nhung van de to chuc va quan ly kinh te trang trai o Yen Bai trong nen kinh te hien nay [Seminar paper: Organisational and Managerial Issues in house-hold managed farms in Yen Bai in the current economic situation], paper presented on Conference on Household Farms in Yen Bai, December 1998, Yen Bai. YBBARD (1998c), Yen Bai Bureau of Agriculture and Rural Development, Ket qua buoc dau khao sat thuc trang kinh te trang trai o Yen Bai, [ Report of preliminary findings on household-managed farms in Yen Bai], paper presented on Conference on Household Farms in Yen Bai, December 1998, Yen Bai. YBBARD (1998d), Yen Bai Bureau of Agriculture and Rural Development, Bao cao tinh hinh kinh te trang trai gia dinh o Yen Bai, [Report on household farm economy in Yen The agro-forestry household system 199

211 Bai], paper presented on Conference on Household-managed farms in Yen Bai, December The agro-forestry household system

212 Chapter 8. Specialised Non-Farm Villages in the Red River Delta Doan Hong Da 8.1 Introduction In most developing countries, non-farm activities have become increasingly important to the development of the rural economy. Non-farm activities is an effective means of helping to shift the rural economy away from reliance on agricultural production. Employment opportunities in rural areas are often not keeping pace with the growth of the labour force in developing countries. And as land available for agriculture becomes increasingly scarce, non-farm employment must expand if deepening rural poverty is to be avoided. The term non-farm economy is usually applied to a wide range of rural activities, including manufacturing/processing, trading, transportation, and activities involving the provision of social and personal services. Trade and services are rapidly growing activities in rural Vietnam, however, the number of villages specialising in trade and services are few. Although services and trade play an important part in the economy, they are largely dependent on good infrastructure and specialisation in these does hardly occur in rural areas. Manufacturing and processing industries generate the largest array of non-farm activities, and can catalyse the overall development of rural areas by providing productive employment and by creating backward and forward linkages to boost the growth of other sectors. There exists a large number of villages where people have a long experience in producing non-agricultural handicraft goods. Several do very well and the share of nonfarm income is considerable in their total income, providing a good base for rural industrialisation. But there have also been many cases of failure, as a large number of traditional handicrafts have declined, and farmers had to turn back to agriculture. If nonfarm economic activities are to be developed in a sustainable way, it needs a long-term strategy, a commitment to investing time and effort, as well as funds, and the ability to have the right people with appropriate skills in the right place. Thus, a study of villages with specialised non-farm products is useful to understand and support rural development in Vietnam. So far, several studies have been carried out on the situation of traditional craft production in Vietnam, mainly focussing on how to preserve and promote the country s cultural heritage, irrespective of the financial aspects. The UNIDO International Workshop on Preservation and Development of Vietnam s Traditional Handicraft Village, Hanoi, 1996 identified the development of specialised manufacturing villages (SMVs) as Specialised non-farm villages 201

213 centres for the preservation of national cultural traditions in need of government support. However, SMVs in this workshop were viewed not as economic agents, but rather as centres for the preservation of national cultural traditions requiring government support. In 1996 the Ministry of Labour, War Invalids and Social Affairs conducted a survey on creating jobs through the preservation and development of traditional handicraft villages, which examined the economic value of SMVs. However, as in the UNIDO International Workshop, the discussion centred on how to preserve non-farm economic activities and provide better access to capital, technology, infrastructure, and marketing services. Topics such as marketability and dynamic trends of development were only addressed in general. The economic realities of preserving SMVs have also not sufficiently been addressed. One important point that has been ignored is whether these professions are worth preserving at all. The question of are we producing the right thing? has not been adequately examined. There are external factors that have strong and decisive influences on the sustainability of such production, especially in the market economy, and these factors may undermine efforts to promote production. A more general empirical analysis, with a more specific classification of potential rural non-farm activities, is needed to determine the relative role and future prospects of villages with specialised non-farm products in Vietnam. This chapter focuses on the Red River Delta (RRD), a region that lies in the northern coastal area of Vietnam, see Figure 1. The area is framed by branches of the Red River and includes eleven provinces with a total area of 27,898 square kilometres. The population of the region is about 17 million people and with over 1,000 persons per square kilometre it has one of the highest population densities in the country. Figure 1: Location of the study area. 202 Specialised non-farm villages