Working Party on Agricultural Policies and Markets

Transcription

1 Unclaified AGR/CA/APM(2001)24/FINAL AGR/CA/APM(2001)24/FINAL Unclaified Organiation de Coopération et de Développement Economique Organiation for Economic Co-operation and Development 22-Jul-2002 Englih - Or. Englih DIRECTORATE FOR FOOD, AGRICULTURE AND FISHERIES COMMITTEE FOR AGRICULTURE Working Party on Agricultural Policie and Market THE INCIDENCE AND INCOME TRANSFER EFFICIENCY OF FARM SUPPORT MEASURES Contact peron : Joe Dewbre, joe.dewbre@oecd.org. Englih - Or. Englih JT Document complet diponible ur OLIS dan on format d origine Complete document available on OLIS in it original format

2 Foreword Government in OECD countrie intervene in agriculture with a view to achieving a wide range of economic and ocial objective, in particular the improvement of farm houehold income. Thi tudy invetigate how efficient ome of the mot commonly ued policy intervention referred to a the tranfer efficiency of upport meaure with repect to income are in achieving thi objective. The author of thi tudy i Joe Dewbre. Thi tudy wa declaified by the Working Party on Agricultural Policie and Market (APM) in May

3 TABLE OF CONTENTS THE INCIDENCE AND INCOME TRANSFER EFFICIENCY OF FARM SUPPORT MEASURES... 4 Executive ummary... 4 Introduction... 5 Some general conideration in analying the benefit and cot of farm upport... 6 Benefit... 6 Cot... 7 Method, cope and limitation of analyi... 7 Tranfer efficiency of deficiency payment... 8 Income benefit of deficiency payment... 8 Effect on total revenue... 8 Effect on gro farm factor return... 9 Effect on net farm factor earning Leakage and length of run Taxpayer cot of deficiency payment Etimated reult Tranfer efficiency of market price upport Taxpayer cot of market price upport Conumer cot of market price upport Etimated reult Tranfer efficiency of factor ubidie Income benefit of an area payment Taxpayer cot of area payment Etimated reult Income benefit of ubidie to purchaed input Taxpayer cot of input ubidie Etimated reult Concluion and policy implication Reference Annex I Senitivity of tranfer efficiency etimate to elected aumption I. A two-region model of agricultural trade II. Reult Effect of ize and trading tatu of the home country Parameter enitivity III. Summary Annex II

4 THE INCIDENCE AND INCOME TRANSFER EFFICIENCY OF FARM SUPPORT MEASURES Executive ummary Government in OECD countrie intervene in agriculture with a view to achieving a wide range of economic and ocial objective. One of the mot cited reaon for intervention i to improve the income poition of farm houehold. Although largely a legacy of concern with the economic plight of farm familie in earlier time, the belief that government intervention i needed to enure adequate income level for farm familie i wide-pread. Thi paper invetigate how efficient ome of the mot commonly ued policy intervention are in increaing the income of farm houehold. Thi concept i referred to a the tranfer efficiency of upport meaure with repect to income. Broadly peaking, government help farmer earn more income than the market would otherwie provide them by either a) impoing tariff/granting export ubidie that drive up the price conumer pay producer in the dometic market or b) upplementing market receipt with payment drawn directly from budgetary fund. With perfect tranfer efficiency (which exit only in theory) every dollar of the extra money conumer pay through higher price and every dollar of the extra money taxpayer pay to fund direct payment would find it way directly into the income of the intended beneficiarie, i.e. farm houehold. In reality, however, the greater hare of that money end up in the pocket of other. Farmer can capture only that part of the upport that remunerate the factor of production they themelve own. Thi i typically a rather mall hare of the total coniting mainly of their land and family labour. Farmer buy mot farm input from outide the farm and, a a reult, input upplier capture ome, uually ignificant, hare of the benefit of upport. Similarly, if farmer rent rather than own the land, ome of the benefit of upport will accrue to the landowner. Moreover, a ignificant proportion of what conumer and taxpayer pay to upport farmer diappear in dead weight loe, the reource allocation ditortion caued by the upport. The etimate of tranfer efficiency reported here ugget that acro the OECD area tranfer efficiency i rather low. For the mot commonly ued meaure market price upport perhap only 25% tranlate directly into a net income gain for the farm houehold producing the upported commodity. Even for the bet performing of the agricultural upport meaure tudied here area payment le than half of the original payment tranlate into net farm income. Another phenomenon the capitaliation of upport into land value mean that income benefit accruing to thoe actually farming the land will be tranitory. Land valued at price inflated by farm upport i eventually either old or rented out. If it i old, it will be at a higher-than-otherwie elling price; if it i rented, the renter will pay a higher-than-otherwie rental rate. Thee higher-thanotherwie elling price or rental rate allow the eller and landlord to capture the full economic benefit of upport. However, thoe buying or renting that land to enter the ector or to expand will not reap any net 4

5 economic benefit from the upport becaue the price they have to pay reflect the expected value of the upport. In fact, thi econd generation of farm houehold inherit higher capital (or operating) cot and reduced farm profitability. Thi paper confirm reult from earlier work that there i a trong invere correlation between the extent to which a meaure ditort production and trade, and it efficiency in tranferring income benefit to thoe who farm. It alo how that even the bet performing meaure are relatively ineffective in income tranfer efficiency term and allow a large hare of the upport to go to unintended recipient. The great bulk of upport to agriculture in the OECD area i till delivered through mechanim that ditort production and trade and are inefficient in generating increaed net income for farmer. It i in fact difficult to enviage any pecifically agricultural meaure that could achieve farm income upport and protection on a continuing bai without engendering ignificant wate and ditortion. Many meaure are alo inequitable a they are baed on output or land with the larget farm receiving the great bulk, a group that the data ugget doe not need income upport. In the light of thi concluion the bet potential to reolve income problem among people who farm may be offered by meaure that focu on the income need of the individual or the family rather than on occupation, i.e. upport meaure that are not pecifically agricultural at all. A firt tep would be to identify thoe farm and familie actually in need of income upport. Introduction The PSE indicate the gro value of monetary tranfer from conumer and taxpayer to farmer reulting from agricultural policie. The PSE can be interpreted a the additional money farmer receive in a particular year becaue government intervene in agriculture. How much of thi extra money hould be counted a net economic benefit for the intended beneficiarie? How much of it end up in the pocket of unintended beneficiarie and how much of it i wated? The anwer depend on who are deignated a the intended beneficiarie and on how the aociated agricultural policy work. Supporting and protecting the income of farm houehold remain a dominant goal of agricultural policy-maker in many OECD countrie, depite the lack of any trong evidence that farm houehold have ytematically lower income than other type of houehold (OECD, 2002). Conumer and taxpayer pay the cot. If farm houehold income went up by one dollar for each one-dollar increae in the combined conumer and taxpayer cot of upporting farmer, the tranfer efficiency would be 100%. However, the characteritic of a policy and the market condition neceary to achieve 100% tranfer efficiency of farm upport bear no reemblance to the real world. In the real world there are tranfer efficiency loe becaue a) all the different way government ue to upport farmer involve ditortion to relative price and the accompanying inefficiencie in reource ue and b) ome of the economic benefit of farm upport go to people who do not farm. Policy interet in tranfer efficiency arie not jut out of a deire to improve policy targeting and reduce wate but alo becaue of a cloe, invere relationhip between the trade effect and the tranfer efficiency of farm upport. Farm upport meaure with the highet degree of tranfer efficiency generate the mallet trade effect, while the mot trade ditorting farm upport meaure provide little income benefit for farm houehold per dollar of taxpayer and conumer cot. [Dewbre, Anton and Thompon; OECD (2001a); Schmitz and Vercammen] Tranfer efficiency ha featured frequently in pat Programme of Work of the OECD Committee for Agriculture (OECD, 1995 and OECD, 1996). Some of thi work focued on quantifying tranfer efficiency in order to etimate what percentage of conumer and taxpayer cot of farm upport could be 5

6 counted a income gain for farm houehold. It howed that output related upport i an inefficient way of improving the income poition of farm houehold. Thi paper extend the cope of quantitative analyi of tranfer efficiency in two way. Firt, in addition to output-related upport, the coverage of upport meaure i extended to include upport provided to individual factor of production. Second, there i a ditinction made between that part of extra farm houehold income due to farm upport in the form of higher return to land and that part due to higher return to farm houehold labour. Some general conideration in analying the benefit and cot of farm upport Benefit The broad aim of etimating and comparing the tranfer efficiency of different way government upport farmer i to identify policy alternative that could achieve the ame improvement in farm houehold income at the lowet cot to conumer and taxpayer, and that ditort trade a little a poible. The pecific indicator of tranfer efficiency employed here i the ratio of the abolute change in farm houehold income to the abolute change in the total of conumer and taxpayer cot caued by a mall increae in a upport meaure. Benefit are to be meaured by change in total income of farm houehold in the aggregate, making no ditinction amongt different kind of farm houehold within that population. 1 The total income of farm houehold comprie income they earn from both on-farm and off-farm activitie. In fact, in many OECD countrie the larget hare of the total income of houehold deignated a farm houehold come from off-farm ource [OECD (1995); Gunderon et al. (2001) USDA (2001) and OECD (2002)]. Government policie providing financial upport to farmer lead to higher-than-otherwie earning from farming activitie and, thu, to higher-than-otherwie total income from on-farm and off-farm activitie. A given increae in financial upport to farmer would caue an increae in the farm component of earning of farm houehold and thereby an increae in their total earning from all ource. However, ome lippage would likely occur at both level: 1) the increae in farm income due to increaed farm upport could be le than dollar-for-dollar and 2) the increae in total income of farm houehold due to increaed income from farming could alo be le than dollar-for-dollar. There are everal reaon to expect a le than one-to-one relationhip between extra money conumer and taxpayer pend to upport farmer and the reulting extra total income of farm houehold. Some of the money conumer and taxpayer pay for farm upport never reache farmer at all, going intead toward paying the cot of adminitering the programme. Then, ome of the money that farmer actually receive may be paed along immediately in the form of higher rent on land upplied by nonfarming landlord. Furthermore, farm upport i rarely pread evenly amongt farm commoditie competing for the ame reource. Farmer repond to policy-induced change in relative return by hifting reource away from relatively unupported crop and livetock toward thoe benefiting from upport. The income gain they experience from an increae in return to upported commoditie may thu be partially offet by reduction in income earned from the lower production of unupported commoditie. Moreover, to fully maximie their benefit from upport, farmer may expand production of upported commoditie by increaing the intenity of purchaed input ue, expending ome of the extra revenue they receive buying input upplied from off-farm upplier. Finally, even the additional income that farm houehold earn from their farming operation will not tranlate dollar-for-dollar into additional total income for the farm houehold if extra farm upport encourage farm houehold to divert ome of their work time, or other reource they own, from non-farm 6

7 to farming activitie. Such a reallocation would limit the gain in total income with a reduction in non-farm income partially offetting the induced gain in income from farming. Cot The mix of conumer veru taxpayer contribution to the total cot of upporting farmer will differ depending on the form in which upport i provided. The implication for farm houehold income, the tranfer efficiency, will alo vary depending upon the policy mechanim ued. Thu, it i important to recognie the variou avenue through which upport i delivered from taxpayer and/or conumer. One avenue i a policy of market intervention in order to force the market price to a government target price level. Dometic buyer of commoditie under a regime of market price upport pay a part, perhap the larget part, of the cot in the form of higher dometic price. Taxpayer mut alo pay if the upported commodity i exported: they pay the cot of ubidie to buyer in other countrie plu the aociated cot of government purchae and public tockholding. If the upported commodity i imported, however, taxpayer may benefit if the government collect and keep tariff on import. Variou policie that deliver payment directly to farmer baed on ome criteria, uch a the quantity of production or the ue of a certain input (typically land), repreent an alternative mechanim of upport. Taxpayer pay the entire bill for agricultural policie that channel financial upport to farmer in the form of direct budgetary payment. To the extent that thee payment caue extra production and lower-than-otherwie market price, conumer could become net beneficiarie of farm upport. Taxpayer cot include not jut the amount of money the government pay out in the form of payment to producer or a export ubidie, there are alo adminitrative cot and o-called dead-weight cot of taxation that arie when citizen are taxed to collect revenue to fund the program. Thee latter tranaction cot are ignored here (an extended dicuion of them i found in OECD, 1995). Method, cope and limitation of analyi In the following ection there i dicuion and analyi of the benefit, cot and tranfer efficiency of four categorie of farm upport meaured and claified eparately for the PSE: 1) deficiency payment, 2) market price upport, 3) area payment, and 4) payment baed on input. Thi analyi lead, for each category of upport, to a pie chart howing numerical etimate of the income incidence of farm upport on farm houehold, farm input upplier and landlord. The general procedure followed involved developing equation for the benefit and then the cot of marginal change in upport. Thi led to the development of equation expreing tranfer efficiency, the ratio of benefit to cot, a function of ome familiar economic parameter: the elaticitie of upply of land, labour and capital and their cot hare; the elaticitie of commodity demand; the initial rate of upport and trade ratio. Thee equation are then olved to obtain numerical etimate of tranfer efficiency by introducing reaonable value for all thee parameter. Thi method wa choen to keep the expoition a imple and elf-contained a poible. However, to the extent thoe goal were achieved, it wa at the cot of implifying aumption that circumcribe the generality of the reult. Numerical reult mut be viewed a approximation becaue the tranfer efficiency formula are derived uing the calculu applying to differential change in the variou price and quantity variable. In addition, the pecific numerical etimate of tranfer efficiency obtained depend on the pecific value aumed for the variou upply and demand parameter in the formula. In making the illutrative calculation of tranfer efficiency for thi paper, a et of value thought to be 7

8 generally repreentative of total agriculture in OECD countrie wa choen. The enitivity of reult to ome of the key aumption i analyed in Annex I. Tranfer efficiency of deficiency payment It i convenient to begin tudying the tranfer efficiency of farm upport by comparing the cot and benefit of a imple deficiency payment. Under uch a program, the government announce a target price for ome farm commodity and then make payment to producer to cover the difference between that price and the price the producer receive from the market. Thi kind of upport i claified a payment baed on output under the new ytem for claifying PSE upport meaure. Although thee payment do not account for a large hare of total upport provided to farmer in mot OECD countrie, it i intereting to analye their tranfer efficiency a they provide a imple tarting point for introducing key parameter and formula, a well a explaining mot of the baic idea. Income benefit of deficiency payment Deficiency payment increae farm houehold income becaue they increae earning from the upply of owned factor to the production of the upported commoditie. In the medium to longer term, the two mot important categorie of farm factor owned and upplied by farm houehold are land and farm houehold labour. To implify the analyi, thee two input are aumed to be the only farm-owned factor in the mix. In etimating the income benefit of deficiency payment a three-tep procedure, a uggeted by Helmberger (1991), i followed. In the firt tep, the extent to which total producer revenue increae with an increae in the deficiency payment i etimated. Secondly, how much of that induced increae in total revenue i paid to each of the two farm-owned factor, i.e. how much do gro factor receipt increae, i then analyed. In the final tep, an etimate i made of how much of thoe extra gro factor earning can be counted a a net gain in farm houehold income. Effect on total revenue Total revenue earned by farmer from ale of a commodity upported through a deficiency payment comprie a market component and a government component, (1) TR = [P m * Q ] + [(P p -P m ) * Q ]. TR i total revenue from ale of the upported commodity, P m i market price, P p i the government target price and Q i quantity produced. The firt bracketed term in Equation 1 meaure what farmer earn from market ale and the econd bracketed term meaure what they earn a deficiency payment. If the government hould increae the target price by a mall amount, labelled P p 2, thi would increae the ize of the per unit deficiency payment by P p and thereby the government component of total revenue. It can be expected that producer would repond to the higher effective price by increaing production, the magnitude of which 8

9 would depend on the ize of the price increae the government decided to give farmer and on the price reponivene of upply. Can the extra production be old without cauing the market price P m to go down? More importantly for preent purpoe, can uch price dependence be afely ignored? Reult of enitivity analyi preented in Annex I ugget that perhap it can. When world market effect are taken into account, tranfer efficiency i lowered in exporting countrie or region and i increaed for importer. However, thee difference are mall unle the country or region in quetion i a large one. 3 Accordingly, contant world market price are aumed for thi analyi. Thi implification mean that the change in total revenue due to an increae in a deficiency payment can be expreed a: 4 (2) TR = [Q * P p ] + [ε * Q * P p ] = Q * (1 + ε ) * P p. TR i the induced change in total revenue due to the change in the deficiency payment and ε i the elaticity of upply (the per cent change in output aociated with a one-percent change in the producer price). The firt bracketed term in Equation 2 how how much total revenue would increae if the quantity produced did not go up with the increae in upport. The econd one how the increment to revenue earned on the induced increae in production. Effect on gro farm factor return How much of the increae in total revenue hown in Equation 2 will be paid to land and to farm houehold labour? Thi quetion i much eaier to anwer by auming contant factor hare. Model embodying a contant factor hare aumption feature frequently in analye of agricultural production repone and policy. Contant factor hare are a defining characteritic of the famou Cobb-Dougla production function, a common choice for analying the benefit and cot of agricultural policie (Helmberger 1991, and Helmberger and Chava, 1999). It i aumed that contant factor hare give a good approximation of change in factor payment caued by change in farm upport meaure, even if the underlying aggregate production function i not exactly of the Cobb-Dougla form. 5 The two equation for meauring the gro increae in farm factor earning caued by an increae in deficiency payment are thu, (3) GFE n = n * n r * TR (4) GFE l = l * l r * TR GFE n and GFE l are, repectively, the change in gro factor earning of farm houehold land and labour caued by a change in farm upport. The ymbol n tand for the hare of total cot of production attributable to land the total of that upplied by farm houehold and that upplied by landlord who do not farm. The ymbol l correpond to the hare of total cot of production attributable to labour, the total of that labour upplied by farm houehold and that upplied by hired labourer. Finally, n r i the proportion of the total land farmed that i owned by farm houehold and l r i the proportion of total labour ued in farming upplied by farm houehold. It i hown below that the four parameter n, n r l and l r are key determinant of the tranfer efficiency of the variou upport meaure tudied. Thi i further illuminated in the enitivity analyi reported in Annex I. 9

10 Effect on net farm factor earning How much of the increae in gro factor earning caued by the increae in deficiency payment can be counted a gain in net factor earning, and thu a a net gain in farm houehold income? One way of clarifying thi quetion i to conider under what circumtance all of the increae in farm-owned factor payment could be counted a an increae in farm houehold income. Thi would occur only in the pecial circumtance where the two farm-owned factor were completely fixed in the production of the farm commodity or commoditie benefiting from the extra upport. To aume that the farm houehold labour and land ued in the production of a farm commodity receiving deficiency payment are completely fixed in that ue may be realitic in the very hort term. It i quetionable when applied to the medium or long term. Conceptually, there are two way farm houehold can adjut the number of hectare and the amount of work time they devote to production of farm commoditie. Thee are 1) by changing the total quantitie of thoe factor employed on-farm veru offfarm and 2) by reallocating amongt on-farm ue. The poibilitie for adjuting the total amount of land ued on-farm veru off-farm are undoubtedly limited in mot OECD countrie in the hort to medium run, but hifting land among competing on-farm ue can and doe occur frequently in repone to hort to medium run change in relative return. Both channel of adjutment are open for farm houehold labour, and epecially o if the adjutment horizon i medium to longer term. Typically, farm houehold earn a ignificant hare of total farm houehold income working off the farm. Improvement over time in the education and job kill of farmer and their familie have led to increaed flexibility in hifting work time between on-farm and offfarm employment in repone to change in relative earning potential. The earning farm houehold forego when they divert their land and labour from other ue to the production of farm commoditie benefiting from upport are the opportunity cot of thoe factor. Thee cot have to be ubtracted from the increaed earning farm houehold get from producing upported commoditie in calculating the net gain in farm houehold income. Conider, a a concrete example, the effect of introducing a deficiency payment for wheat. Let u uppoe that farm houehold reponded by increaing the quantity of wheat they produce. Thi might mean that ome portion of a farm houehold available work time formerly pent working off the farm might now be pent eeding, weeding and reaping wheat. It might alo mean that ome patureland get ploughed and planted to wheat. The conequent reduction in off-farm income and in livetock enterprie return would have to be ubtracted from the extra wheat earning to arrive at the net gain in farm houehold income. The eae with which farm houehold can adjut the quantitie of land and labour they upply to farming activitie will be reflected in the elaticity of factor upply for thoe two factor. The higher the elaticity of factor upply, the greater i the adjutment in factor ue in repone to a policy-induced change in factor return, and the le the net gain in farm houehold income for a given change in upport. Helmberger propoe a imple formula for uing the elaticity of factor upply in calculating the net gain in factor return due to a policy-induced increae in factor payment. The general verion of the formula i (5) NFE = 1/(1+e) * GFE. NFE i the net gain in factor earning due to a policy-induced increae in gro factor earning and e i the elaticity of upply of a factor. A zero elaticity of upply for a factor correpond to that ituation where the factor i completely fixed in production. In Equation 5 i the only ituation in which all the gain in factor payment induced by an increae in upport can be counted a net gain in factor earning. In all other circumtance, the 10

11 elaticity of factor upply (which i alway poitive) erve to regulate what fraction of the gro gain in factor earning get counted a net gain. 6 The net gain in farm houehold income due to a change in upport i equal to the um of the induced net gain in factor earning on the land and labour they upply. Accordingly, the relationhip hown in Equation 5 can be ued to derive the following equation for calculating the net gain in farm houehold income due to an increae in deficiency payment (6) FHI = GFE n / (1+ e n ) + GFE l / (1+e l ). FHI i the change in farm houehold income due to the change in deficiency payment. The ymbol e n refer to the elaticity of upply of land (whether owned by farm houehold or by other) and e l i the elaticity of the upply of farm houehold labour. Combining Equation 5 and 6 and implifying the reult give the following formula for etimating the gain in farm houehold income aociated with a given increae in total farm revenue. (7) FHI = [ n * n r / (1+e n ) + l * l r / (1+e l )] * TR Note from Equation 7 that, all other thing being equal, the increae in farm houehold income due to an increae in total revenue will be maller: a) the maller the cot hare of farm houehold land and labour and b) the larger i the elaticity of upply of thoe factor. Leakage and length of run Reult preented below how that one reaon the income tranfer efficiency of farm upport turn out to be o low i that a ignificant proportion of the economic benefit go to upplier of input purchaed by farmer. Thi can be demontrated by following the ame analytical approach a ued above to meaure income impact for farm houehold. Auming contant factor cot hare for the land and labour ued in agricultural production implie a factor cot hare for all other factor combined that i contant a well. In thi analyi we label thi aggregated factor purchaed input. Multiplying thi hare by the induced increae in total return analogouly to the calculation of gro farm factor earning uing equation (3) and (4) above give the extra amount that will be pent on input purchae. In turn, net factor earning (called input upplier profit later on) can be calculated uing an equation imilar to (5). That equation expree the net increae in factor earning a the ratio of the gro increae in factor earning GFE to (1+e), where e i the elaticity of upply of the factor in quetion. It wa noted that if that elaticity i zero, the aociated factor i completely inelatic in upply and the entirety of the gro increae in factor payment can be counted a a net increae. However, what if e i very large indicating that the quantity of the aociated factor i completely elatic in upply, i.e. that the quantity upplied can eaily be increaed in repone to increae in it price? If that elaticity i large enough then none of the increaed expenditure on the factor can be counted a net gain in factor return. Auming the upply of a factor i completely inelatic mean the price, but not the quantity, of that factor varie with change in demand. Auming the upply of a factor i infinitely elatic mean the quantity, but not the price, varie with change in quantity demanded. In meauring income ditributional effect of agricultural policy analyt frequently combine thee two aumption applying the firt to land, the econd to all non-land input (including farm houehold labour) ued in agricultural production. (See, 11

12 for example, Abler and Salhofer in OECD, 2001a; Chapter 3 in Helmberger, 1991; and Chapter 4 in Gardner, 1987). A Gardner note, thee aumption lie behind the widely accepted belief that the benefit of farm price upport accrue predominantly to landowner. The elaticity of upply of non-land input might reaonably be regarded a infinite if the run i long enough. For the medium run context in which farm policy analyi i politically relevant, it eem doubtful. Filling total farm ector demand for the raw material: natural ga, crude oil, teel and o on ued to manufacture farm input probably put little train on the world price of them, even in the hort run. However, to manufacture farm input and then make them available to and uable by farmer require more than raw material. Input upplier mut add proceing, tranportation, ditribution and marketing ervice. Providing thee ervice require invetment in capital, both phyical and human, that i pecific to thoe ervice and which may not be a eaily adjutable in the hort to medium term a that of the underlying raw material. Example are farm machinery and equipment merchant; garage, workhop and mechanic that pecialie in repairing and maintaining farm machinery and equipment; fertilier mixing plant and the pecialied equipment ued to tranport and ditribute fertilier; livetock feed proceing plant, animal health facilitie and veterinarian ervice. Accordingly, in the analyi that follow it i aumed that no factor ued in farm production i completely fixed in upply, though the upply of land i aumed le elatic than that of non-land factor. Likewie, no factor i aumed to be in completely elatic upply, though the upplie of purchaed input and farm houehold labour are each aumed more elatic than that of land. Naturally, the longer the length of run aumed, the le the net gain overall and the greater i the hare of that diminihed total going to landowner. In other word, the longer the period of adjutment to an increae in upport the lower the income tranfer efficiency, a reult which will hold regardle of the particular upport meaure ued in delivering that upport. Taxpayer cot of deficiency payment The taxpayer cot for a deficiency payment i, (8) TC = (P p P m ) * Q, A mall change in the government target price and the aociated deficiency payment rate would caue total taxpayer cot to rie by, (9) TC = [Q * P p ] + [Q * ε * op * P p ] = Q * (1 + ε * op) * P p TC i the change in taxpayer cot aociated with a mall change in deficiency payment and op i the initial payment ratio, (op = (Pp- Pm)/ Pp), the ratio of the initial rate of deficiency payment to the producer price. (It i given the ymbol op to accord with the label payment baed on output applied to thi category of upport meaure in the PSE.) The initial upport ratio, op ha a familiar interpretation in the pecial circumtance where the deficiency payment i the only ource of farm upport provided. In thi pecial cae, the upport ratio (converted to a percentage) would be the per cent PSE. The higher thi initial ratio, the higher the cot of further increaing upport. To undertand why thi i o, and therefore why the initial upport ratio end up in the equation, it i helpful to think of the increae in taxpayer cot a compriing two part. 12

13 Firt, there i the extra cot due to having to pay the marginal increae in deficiency payment P p on the pre-exiting level of production Q. Thi i hown in the firt et of bracket in Equation 9. Second, there are the extra cot due to having to pay both the marginal increae in the deficiency payment and the pre-exiting rate on all new production. Thi i meaured by the econd bracketed term in Equation 9. Etimated reult The equation needed to etimate the tranfer efficiency of a deficiency payment for farm houehold income i 7 (10) TE (fhi) = FHI / TC =[ n * n r / (1+e n ) + l * l r / (1+e l )] * [(1 + ε ) / (1 + ε * op)] Thi equation contain eight parameter. Table 1 how the relationhip between tranfer efficiency and each of thee eight parameter a well a ome indicative numerical value for them. Parameter value are to be viewed a indicative ince they will be different for different circumtance: countrie, commoditie and term (medium or long). The elaticitie of factor upply in Table 1 are meant to reflect factor adjutment occurring over a medium run adjutment horizon of, for example, three to five year. The etimate of factor cot hare choen for Table 1 were inferred from data preented in two OECD report [OECD (2001a) and OECD (1999)]. The firt of thee report, Market Effect of Crop Support Meaure, yntheie reult of analyi uing the PEM crop model. It contain etimate of factor cot hare for crop in Canada, Japan, Mexico, the European Union (treated a one country), Switzerland and the United State. The econd, Economic Account for Agriculture, report etimate of cot of production for the entire ector. In general, total land (that upplied by farm houehold plu that upplied by non-farming landlord) uually account for approximately 20% of total cot of crop production in the countrie tudied for the PEM crop analyi. Annex II contain etimate of the hare of owned farmland for a election of OECD countrie. Thee etimate average around 50%, the ame figure ued for the calculation on tranfer efficiency. A recent tudy of the effect of government payment on land value in the United State (Barnard et al. 2001) found that of the land receiving the mot benefit from government payment a ignificantly higher proportion wa rented than wa the cae for all land. Auming that one half the cropland i rented give a cot hare for owned land upplied by farm houehold of 10%. The cot hare for hired labour ued in crop production in the countrie tudied for the Market Effect report wa around 5%, leaving a cot hare of 15% for that labour upplied by farm houehold. Let u uppoe for preent purpoe that thi i repreentative for the ector a a whole. Combining the hare for farm houehold land and farm houehold labour would thu yield a total of 25% for all farm houehold factor ued in crop production. The ector-wide aggregate reported in the Economic Account for Agriculture ugget a total factor hare for farm houehold upplied factor in thi ame neighbourhood. Although the Economic Account data do not allow calculation of factor cot hare eparately for farm houehold upplied labour and land, etimate of net farm income reported can be ued to etimate a cot hare for their total. Net farm income a a percentage of total value of output i typically le than 30% in individual OECD countrie, frequently below 20%. 8 The elaticitie of factor upply for land, labour and purchaed input in Table 1 were choen baed on data preented in review of pat tudie of agricultural upply repone in North America (Abler, 2001) and in Europe (Salhofer, 2001) that were undertaken in developing the PEM crop model (OECD, 13

14 2001a). The author were aked to make recommendation of plauible range of parameter value to ue in policy imulation analyi. A total land-upply elaticity of 0.10 for modelling ector-wide upply repone fit comfortably within their recommended range. In the following analyi, that elaticity i applied equally to land owned by farm houehold and by other. The upply of farm houehold labour in the medium to long term i generally aumed to be more reponive than the upply of land to change in relative return; a difference which widen the longer the run being conidered. Thi elaticity will reflect the eae with which farm houehold member can hift between on-farm and off-farm work a well a houehold preference for work veru non-work (including leiure) activitie. Mathematically, the elaticity of output upply ε i itelf a function of value aigned the factor cot hare and the elaticitie of factor upply. However, to calculate thi elaticity (a wa done to obtain the value 1.0 for the table) the lit of factor mut be extended to include all productive factor, not jut land and farm labour. The factor hare and the elaticity of upply characteriing thoe input purchaed by farmer mut alo be conidered. A combined cot hare of 0.40 for total land and total labour implie a cot hare of 0.60 for all purchaed input combined. An elaticity of purchaed input of 1.5 i alo well within the range of plauible value recommended by the PEM conultant. A dicued above, one would be looking at ubtantially higher number for the elaticitie of purchaed factor if the adjutment horizon were long run. If it were only thi upply elaticity, i.e. that for purchaed factor, that would be higher in the long run, one might conclude from reult hown in the table that tranfer efficiency would alo be higher in the long run. However, the elaticity of the upply of farm factor, epecially that of farm houehold labour, i alo likely to be greater in the longer run. In calculating tranfer efficiency, the poitive effect of higher purchaed factor elaticitie will be offet by the negative effect of higher farm factor elaticitie. The etimate of tranfer efficiency for deficiency payment of 0.25 in Table 1 wa obtained by introducing the lited parameter value into the tranfer efficiency formula, Equation 10. Thi reult would imply that for each extra dollar of upport provided to farmer in the form of deficiency payment, only twenty-five cent tranlate into a gain in net earning for the land and labour upplied by farm houehold. In other word, for each one-dollar gain in factor earning, taxpayer mut pay around four dollar in deficiency payment. Figure 1. The incidence of deficiency payment $0.21 $0.40 $0.11 $0.14 $0.14 Farm houehold labour Farm houehold land Landlord Input upplier profit Reource cot 14

15 Table 1. Parameter value ued and etimated reult from tranfer efficiency calculation Parameter Decription Relationhip to TE Repreentative value Factor cot hare n Land Poitive 0.20 l Labour Poitive 0.20 o Purchaed input Negative 0.60 Farm houehold upplied hare n r Land Poitive 0.50 l r Labour Poitive 0.75 Factor upply elaticitie e n Land Negative 0.10 e l Farm houehold labour Negative 1.00 e o Purchaed factor Poitive 1.50 ε Output upply elaticity Poitive 1.00 Initial upport ratio op Output payment Negative 0.30 mp Market price upport Negative 0.30 ap Area payment Negative 0.30 i Purchaed input ubidy Negative 0.30 Etimated tranfer efficiency: Deficiency payment 0.25 Market price upport 0.24 Area payment 0.48 Input ubidy 0.17 If farm houehold receive jut twenty-five cent of each extra dollar taxpayer pay in deficiency payment, what happen to the other eventy-five cent? Figure 1 how how the entire one-dollar of extra taxpayer cot for deficiency payment i divided up. The larget portion, forty cent, goe a extra profit to upplier of farm input. Another fourteen cent goe out a extra rent for non-farming landlord. Reource cot, that i the money needed to offet the combined opportunity cot of diverting reource from other productive ue to the production of the upported commodity, account for the remaining twenty-one cent. Thee cot comprie the economic efficiency loe for the dometic economy a a whole the economy-wide cot of the production ditortion caued by the deficiency payment. The entire ditribution of leakage and efficiency loe revealed in Figure 1 will be different for different aumption concerning value of the parameter hown in the Table 1. Reult preented in Annex I how the enitivity of tranfer efficiency etimate to alternative model and parameter aumption, and reveal that the mot important aumption concern the factor hare applying to the farmland and farm houehold labour upplied by farm houehold. The higher thoe hare, the higher are etimated tranfer efficiencie. 15

16 Note from Figure 1 that the twenty-five cent of net gain in farm houehold income i itelf plit: fourteen cent to farm houehold upplied land and eleven cent to farm houehold upplied labour. However, thoe fourteen cent going to farm houehold upplied land hould be een a tranitory, applying only in the medium-run context of the preent analyi. Economic theory implie that thoe extra land rent, appropriately dicounted to reflect the time value of money and uncertainty about the permanence of government upport, will be capitalied into the price of the land (Barnard et al., 1997). Eventually, that land will be old at thoe higher price when farmer leave the ector or retire. The new owner may continue to receive the government payment, but their value to him/her will be jut offet by the extra cot of owning that higher-priced land (either a interet expene on the loan taken out to buy the land or a foregone earning on owner equity). Tranfer efficiency of market price upport Let u uppoe now that the government rather than uing a deficiency payment to increae the effective producer price, doe o by a program of market price upport. Market price upport continue to account for the larget hare of the total etimated monetary tranfer to farmer attributable to agricultural policy in OECD countrie (OECD, 2001b). A tylied verion of a program of market price upport under which the government et a price to apply equally to all dometic eller and buyer of a farm commodity will be analyed here. The government will enforce that price by impoing a tariff high enough to enure that no import can be old at a lower price and, if neceary, by ubidiing export of urplu product. Taxpayer cot of market price upport For the ame effective producer price, the income benefit of market price upport will be the ame a for a deficiency payment. It i only the difference in their repective cot that need concern u here. The taxpayer cot of a program of market price upport depend critically on whether a country i an exporter or an importer of the upported commodity. If dometic production exceed dometic conumption, the country in quetion i an exporter and the government mut pay ubidie to buyer in world market to make up the difference between the upported price and the prevailing world price. If dometic conumption exceed dometic production, the country in quetion i an importer and may receive tariff revenue on import. However, not all program of market price upport generate tariff revenue for government of importing countrie. Voluntary export retraint and tariff rate quota are example in which the rent from retricting import may not accrue to the importing country government. The formula for meauring the taxpayer cot of export ubidie or, if negative, the tariff revenue earned, for a program of market price upport i (11) TC x = (P d -P w ) * (Q - Q d ) TC x i the taxpayer cot (benefit) of export ubidie (import tariff), P d i the dometic price in the preence of market price upport, P w i the world price and Q d i dometic conumption. A mall change in the guaranteed price and thu in the aociated market price upport rate would caue total taxpayer cot to change by (12) TC x = [(1+ mp * ε ) cr * (1 + mp * ε d )] * P d * Q The ymbol cr tand for the ratio of dometic conumption to dometic production (if le than one, the country in quetion i an exporter, if greater than one, an importer). The proportional rate of 16

17 market price upport i denoted by mp and ε d i the elaticity of dometic demand for the upported commodity. Conumer cot of market price upport One way of meauring the conumer cot of market price upport i to imply multiply the quantity they conume Q d by the price gap (P d P w ), the difference between the dometic and the world price. However, that cover only part of the additional cot impoed on conumer when dometic price are increaed by market price upport meaure. Thi i becaue the amount conumed at upported dometic price i probably le than would be oberved at the lower world market price. When conumer reduce their conumption in repone to policy-induced price increae there are additional cot to be accounted for. Thee cot are ometime called the real income loe aociated with the higher conumer price. Thee can be meaured by calculating, for a given policy-induced change in conumer price, not the change in the conumer expenditure but the change in conumer urplu [ee OECD (1995) for a fuller dicuion and graphical expoition]. An equation to approximate the change in conumer urplu when the dometic price i increaed by the mall increment P d i (13) CS = (- P d * Q d * P d * Q d ) = ( * ε d * P d /P d )*Q d * P d CS i the reduction in conumer urplu (the negative of the change in conumer cot) due to market price upport. 9 A cot-verion of thi equation that i more convenient for the following total cot calculation can be obtained by multiplying and dividing the lat expreion in Equation 13 by -Q. Thi accomplihe two thing. Firt, it change the ign of the meaured change in conumer urplu from negative to poitive allowing u to add it to the induced change in taxpayer cot, which we have o far meaured with a poitive ign. Second, it eliminate Q d from the equation. (14) - CS = cr * (1-0.5 * ε d * P d /P d ) * Q * P d An equation for the change in the total of taxpayer and conumer cot induced by the mall change in market price upport can now be obtained by combining reult from Equation 12 and 14, giving (15) TC = [(1+ mp * ε ) cr * (1 + mp * ε d )] + [cr * (1-0.5 * ε d * P d /P d )] * Q * P d, Etimated reult Equation 15 give the needed meaure of cot for the cot ide of the tranfer efficiency ratio for market price upport. The benefit ide of that ratio i obtained in the analyi of the tranfer efficiency of deficiency payment in Equation 7. Combining thee, and making the required ubtitution and implification, lead to the following equation for meauring the tranfer efficiency of market price upport. (16) TE (fhi) = FHI / TC = [ n * n r / (1+e n ) + l * l r / (1+e l )] * (1 + ε ) / [cr * (1-0.5 * ε d * P d /P d ) + (1 + mp * ε ) cr * (1 + mp * ε d )] 17

18 Equation 16 contain all of the ame parameter found in Equation 10, the equation derived above for etimating the tranfer efficiency of a deficiency payment, plu two new one: ε d the price elaticity of dometic demand and cr the ratio of dometic conumption to dometic production. A value of for the price elaticity of demand for aggregated agricultural output and a ratio of dometic conumption to production of 0.90 i aumed. The latter correpond roughly to the average relative value of total agricultural conumption and production in OECD countrie. Annex I contain ome reult howing the enitivity of tranfer efficiency etimate to the trading tatu of a country. Introducing thee value, and thoe for all other parameter from Table 1, into Equation 16 yield an etimate of the tranfer efficiency of market price upport of 0.24, a figure lightly le than the reult of 0.25 obtained for the tranfer efficiency of a deficiency payment. In other word, farm houehold would experience a gain of only twenty-four cent for each one-dollar of additional taxpayer plu conumer cot for market price upport. Put the other way round, taxpayer and conumer together pay more than four dollar for each one-dollar gain in farm houehold income due to market price upport. Figure 2 how thi breakdown. Figure 2. The incidence of market price upport $0.27 $0.36 $0.11 $0.13 $0.13 Farm houehold labour Farm houehold land Landlord Input upplier profit Reource cot The bigget difference between the tranfer efficiency reult obtained when analying a deficiency payment, hown in Figure 1, and the reult for market price upport, hown in Figure 2, i the extra reource cot of market price upport. Reource cot are higher for market price upport becaue dometic economic loe reulting from induced reduction in conumption mut be included. Tranfer efficiency of factor ubidie The objective of the two tylied upport meaure analyed above, whether implemented uing a deficiency payment or a tariff, i to increae the effective price farmer receive for their output. Another way of upporting farm income i to provide payment per unit of factor ue. In term of the etimated amount of money OECD government pend each year, the mot important category of factor ubidie i area payment. The tranfer efficiency of area payment i alo intereting to tudy becaue it i virtually the only kind of upport targeted directly to a factor of farm production owned and upplied by farm houehold. In principle, government could devie policy meaure aimed directly at increaing return to farm houehold labour, via the income tax ytem for example. Surpriingly, thee form of targeted upport do not account for very much of the money government pend (or, equivalently, the tax revenue they forego) ubidiing agriculture. 18