Outline. L8- Agricultural Research Policy. Why is research important? Competitive firms adopt cost saving technologies 1/29/09

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1 Outline L8- Agricultural Research Policy AGRC 113 Jan 2008 Richard Gray Why is research important What kind of good is it The overall rates of return to research Incentives for research Factors affecting the distribution of returns Policy choices and consequences Why is research important? Why do firms adopt new technologies? Lower costs for the same output - eg. zero tillage, fuel efficient tractors Greater output and/or higher quality for the same cost higher yielding varieties Canola bred from rapeseed All of the above Technology improvement - Shifts isoquants in toward the origin less inputs for same output Fert 100 t wheat (1990) 100 t wheat (2007) Land Competitive firms adopt cost saving technologies ($/u) MC MC Technology -Supply curves shifting out over time $ P S P Increase in PS P S Quantity Q Q Quantity 1

2 Rates of return Alston, Pardey et al. s (2000) meta-analysis of 1144 studies reported an average rate of return to public agricultural research of 99.6 % per annum Overall a very wide range of results Median results 40 to 60%/yr range Historical Canadian results Average real rate of social return for crops grown in Saskatchewan Year First Crop Type Min Max 1978 Nagy Rapeseed Research Zentner Wheat Research Zentner Wheat Ext. &Res Zentner Wheat Research * Farrell C. Barley Research * Farrell C. Wheat Research Ulrich Barley Research Ulrich Wheat Research Ulrich Barley Research Furtan Canola Research More Recent Canadian results Canola Wheat Pulses $ million Canola Research Investment Private Applied R&D Public Applied R&D Public Basic R&D years Canola Rates of Return (Gray and Malla) % depr. 0 % depr year of variety adoption Figure 5: Estimated IRR for Canola Yield Increasing Research ( ) Canadian wheat research expenditures (1998 $) Years 2

3 Estimated net present value of yield increasing wheat variety research Canada: Wheat Returns (Gray Malla, and Ferguson, 2001) 40% /yr very sporadic WGRF (Gray, Scott, Guzel) 22 to 36%/yr Summary of Benefit/Cost Ratios for SPG Expenditures to 2004 Genetics Research Time Period ( ) Ben/Cost Ratio: Producer Ben/Cost(1) Producer IRR 20.4% Industry Ben/Cost(2) Incentives for research Prior to plant breeders rights and biotechnology - no private incentives - governments funded research as part of an economic growth strategy With IPRs and biotech - private breeders could capture value for their processes and products MII and other processes accelerated private growth in some crops ie. Canola Governments have reduced applied research and use the private sector for commercialization Policy is still evolving What kind of good is knowledge? Why are governments involved? Where is the market failure? 3

4 Public & Private Goods Goods with certain characteristics, not goods provided by public or private entities, Important because they explain market failure, Implications for policy. Attributes of Goods and Markets For markets to efficiently allocate resources, social marginal costs and benefits must equal private marginal costs and benefits or: MBs = MBp = Price = MCp = MCs For markets to work the good must be Excludable and Subtractable Excludability a good is excludable if non-owners can be excluded from the use or enjoyment of that good, Excludability allows the owner of the good to charge a price for the good in return for its use. Without excludability there is no incentive to pay for a good and the private demand will be less than the social demand for the good or MBp MBs Subtractability A good is subtractable if the use by one individual means it reduces (subtracts from) the use by another individual by the same amount, If a good is not subtractable the marginal cost of a another unit of consumption will always be less than the average cost of providing the good, For example- the use of a bridge, the use of knowledge, viewing the moon The Economic Classification of Goods Private goods Excludable Non- Excludable Subtractable Private goods Common pool goods Non-subtractable Toll goods Public goods Excludable MBs = MBp Subtractable MCs = MCp These goods will tend to be produced by a competitive market at the point where MBs = MBp = Price = MCp = MCs In other words the invisible hand driven by self interest is at work to efficiently allocate resources 4

5 Private goods Toll goods price P MCp=MCs MBp=MBs Excludable Non- subtractable With non rival inputs - Natural monopolies (MC < AC) If P = MC then firms go broke Oligopoly structure - eg. Malting industry Often provided by government- roads Q s quantity Common Pool Goods (resources) Subtractable but not excludable Eg. Fish in the ocean, Clean air Here MBp MBs These resources tend to get over-used and under-supplied Use tends to be regulated Public goods This are non-excludable and nonsubtractable These goods be under supplied in the market place If they are made excludable then they become natural monopolies Examples, knowledge, security Public goods Public goods price P MBp MBs AC MC Pure public goods are perfectly nonexcludable and non-subtractable Quasi-public goods are somewhat non excludable and/or somewhat non subtractable Governments often provide public goods but not all good provided by government are public goods Q 5

6 The Past Century of researchin Canada Experimental Farm Act A recognition of the non-rival non-excludable public good aspects of research Modeled from the US experience To create viable farms and make settlement of the West possible Teaching went to Universities Extension went to provinces Mixed system evolved private sector important in livestock genetics, machinery, pesticides, some crop genetics Research Output New genetics Improved quality- eg. Marquis wheat Higher yields -1-2% growth per year Pest resistance - rust/sawfly/fungal New agronomics Summerfallow 1890 s Crop rotations Pest management, weeds, insects Zero tillage 1980 s Was the research policy successful? Real Saskatchewan Wheat Prices (1981$/bu.) AAFC Research Expenditures Crop Research Resource Conservation Animal Research Food Research Millions 2006 $ Year The Establishment of Property rights Genomics can identify property IRPs ie. Ability to patent Potential to capture value Large investment by private firms $ million Research Spending in Canola Private Applied R&D Public Applied R&D Public Basic R&D years

7 Check-off funded research Many research check-off funds have been created to invest in research Has the advantage of bringing key industry players together to identify and systematically address issues Producers see it as a way of guaranteeing access to new varieties Factors affecting the distribution If adopted new technology generally benefits farm operators increased farm productivity also benefits processors and consumers through greater supply and lower prices input suppliers, including land owners can benefit the technology provider can also benefit Many factors affect this distribution Research benefactors genetic improvement consumers processors farm adoption Other input suppliers Factors affecting benefit distribution Small markets Limited area will increase the per acre cost of research For markets where world demand will be limited to a million acres or less - most of benefits of any cost reduction will go to consumers If research is tax funded then this could mainly help foreign consumers If research is levy funded then the cost will be born in a similar proportion to the benefits ie. the cost will be born by consumers seed growers Factors affecting benefit distribution IPRs and Concentrated Ownership IPRs give the innovators a monopoly over their product If there are no (or very few) alternatives the innovator is able to capture most of the value from their innovation Farm operator benefits from research are limited eg. Canola Factors affecting benefit distribution Research in value added better value added processes can help develop these industries The impact on producers will always be limited unless they own these activities or the demand is so large that it changes the export /import flow of the raw commodities 7

8 Factors affecting benefit distribution Health Benefits are external to the market Potential health and environmental benefits cannot be captured in the market - they spillover to non consumers and non producers Even with perfect market incentives the private sector will under invest in healthy products Policy choices and consequences The total returns research are high The size of market, concentration of ownership, and external benefits affects the distribution of returns Policy choices and consequences Consumer health: is becoming a one hundred billion dollar issue $100,000,000,000 for Canadians nutrition and functional foods can be part of the solution Because the benefits are external public goods we can t expect market driven solutions One percent of the health budget is 1 billion dollars/yr We need a huge public investment in nutritional and functional food development -for the sake of our health and our wallets Policy choices and consequences Value added research: The development of small value added markets are of limited value to producers unless they own the process The development of technologies to replace fossil fuels can create very large markets with a better long run potential Burning grains and other biomass to replace natural gas makes the most economic sense Policy choices and consequences Farm income: Productivity improvement allows grain producers to be competitive It is unclear how private research or niche market value added research can help if benefits accrue to the innovators 8