Why agricultural value chains fail – Part (3): The curse of the subsidy

During the last stages of the fertiliser subsidy, farmers were on average using around 200 Kg of fertiliser per acre, which is way beyond the recommended levels

Agricultural subsidies are common and popular interventions by governments. They are sometimes considered as essential economic tools. However, there are plenty of examples showing how they have miserably failed causing economic, social and environmental negative externalities. 

This led to question whether the real intentions behind the subsidy are adequately justified. There is also evidence to suggest that the policy makers might have got it wrong. One might therefore argue that subsides, as an economic instrument might not be an economic instrument to begin with. May be it is a political instrument, disguised as an economic one. 

Subsidies are attractive. Anything given free is preferred, sometimes even things that are not essential. However that is the human nature. Therefore farmers always prefer subsides. Farmers face a production function that they would try to maximise as a profit function under cost constraints. Anything that either increases their revenue or reduces their costs is attractive. Therefore agricultural subsides are either input oriented or output oriented. Therefore subsides are an attractive intervention for a profit maximising farmer. 

Just like any other individual a farmer also thinks about himself and he is rational. He is a consumer, even before he became a producer. Just like we learnt in economics, more is preferred to less and he tries to maximise his utility each and every time possible. 

Therefore giving a subsidy to a farmer and expecting him to be responsible and think of economic, social and environmental consequences is a joke. Rather the policy makers must think from a farmer’s perspective in the beginning and map out how the subsidy would be adopted, utilised and realised by farmers. This is where the importance of “evidence based polices” comes in. 

However, this is very limited in many developing countries. In developed countries to certain extent the policy research is somewhat mainstreamed to university research process. Generally MSc or PhD research work is directly tied to a specific policy intervention and would be funded by the government, private or the combination of it. However many policy interventions especially the ones that focused on agricultural subsidies are hardly researched. Therefore such policies have a higher probability to fail, resulting many consequences. 

The objective of the article is not to brand every agricultural subsidy as a bad decision. However there are plenty that have clearly gone wrong. Yet they give us opportunities to learn new lesson. These lessons might help the policy makers in the future and they might also help to drive the ones that have derailed. I will only take few examples.

Fertiliser subsidy and the sustainable agriculture 

I believe this is the single most discussed and researched subsidy scheme of Sri Lanka. Yet we are not sure whether we got it right. I agree fully that this was an important subsidy scheme. The world population was on the rise, and as many developing nations Sri Lanka was also experimenting things to increase the production. 

The main focus was on increasing the production or the productivity of paddy. Once the research work proved that new-improved varieties of rice work very efficiently with the chemical fertilisers, the Government decided to give a fertiliser subsidy. The subsidy was very significant accounting for almost 90% of the value. 

The subsidy initially helped to increase the paddy production and there is plenty of research work to prove that. However in the middle of the way, especially since late 80’s research work started flowing in highlighting the negative environmental, health and socio-economic impacts of the fertiliser subsidy. 

The research work highlighted the fact that: 

(1) farmers are overusing the fertiliser subsidy 

(2) farmers are misusing the fertiliser subsidy by putting it to other crops than paddy 

(3) the soil conditions are degrading and paddy lands are becoming less productive 

(4) downstream water pollution is causing health hazards 

(5) fertiliser subsidy administration and management process is highly corrupt 

(6) rice produce is becoming toxic 

(7) farmer’s use of agro-chemical have gone up and causing health hazards 

(8) fertiliser subsidy itself is not contributing to any significant production gains anymore and 

(9) the subsidy was a heavy burden on the Government expenditure. 

Despite all these results the consecutive governments that came in to power insisted on giving the fertiliser subsidy. International fertiliser companies enjoyed the spillover benefits in importing fertiliser on behalf of the Government. When a particular government wanted to reduce or abolish the fertiliser subsidy for paddy it became a political advantage for the opposing party. Sometimes the fertiliser subsidy was at the top of the political mandate during the election times. This was there even during 2015 elections. Ultimately the fertiliser subsidy became a political innervation rather than an economic intervention. 

However, despite all challenges in terms of politics, the present Government decided to abolish the subsidy program overnight. The replacement was a coupon system. Decision to move away from the fertiliser subsidy is a good decision and some of my research work supports this. However, the transition from the subsidy program directly to a market oriented program or a coupon-based program is not well planned. 

Research work clearly suggests that removal of the subsidy total from all the areas of paddy production can threaten the paddy production in the short run and might increase the rice prices. Therefore a gradual removal program was suggested which would span around three to five years. However none of these suggestions were taken into consideration. 

During the last stages of the fertiliser subsidy farmers were on average using around 200 Kg of fertiliser per acre. This is way beyond the recommended levels of the Department of Agriculture. The coupon system would give Rs. 25,000 per year per hectare. The coupon system is basically to encourage farmers to adopt the recommended fertiliser levels for paddy and substitutes the additional requirements (based on the land fertility states) by organic fertiliser. 

There is no any concrete research work done to show whether farmers have gone back to the recommended fertiliser levels and adopted the usage of organic fertiliser for the additional requirements and whether the farmers are actually using the coupon to buy fertiliser. However, my personal engagements with many farmers suggest that 

(1) the coupon is not enough to buy the required fertiliser (which is true since they were used to applying more) 

(2) the organic fertiliser is hard to find/hard to manufacture therefore the cost of cultivation has gone up 

(3) fertiliser prices in the market is too high for farmers who do small scale cultivations (they don’t have economies of scale) 

(4) short term supply of paddy had gone down with decreased area of cultivation 

(5) rive prices have gone up with decreased supply of paddy in the short run and 

(6) farmers are using the coupon to buy other things and sometimes this involves alcohol consumption as well. 

Therefore it is to a certain extent is clear that things are not going well as they expected. However I believe that this is something economists expected. If any policy maker is interested in reading there is plenty of research work available from the African region on how to transition from input subsidy programs especially from fertiliser subsidy programs. My intention was not to highlight those studies but to point out what should have been done. 

One of the main objectives of moving away from fertiliser subsidies is to allow the private fertiliser markets to develop and encourage farmers to adopt organic fertilisers. The coupon system is a temporary intervention to help the transition. However, all the other countries did the research work to evaluate the anticipated challenges I explained before. It helped them to understand the ability of the private fertiliser market to develop, farmer’s affordability of unsubsidised fertiliser, the land responses to decrease fertiliser use, farmers short term responses to subsidy removals such as less cultivation and prices increases, other uses of coupon money instead of buying fertiliser and the ability of the organic fertiliser supply chain to cater the increased demand. 

Now the question is “what did we do?” I still think we are not too late. Still this is at the early stage, research can be planned to assess all these changes. It will possibly give us the right directions to go. Some policymakers need to make that call independent economists like us can’t do this alone unless the research work is funded. 

Agricultural crop insurance program

Crop insurance is something that is very important but hardly given any priority. Sri Lanka started its crop insurance program with paddy. In an ideal situation a crop insurance is something that should be demanded by the farmer, not pushed by the government. However, the argument is that our farmers are with little capacity to pay for insurance even if they really need it and even a little damage to crops can either increase the prices heavily or threaten the food security status. Therefore rather than allowing the farmers to decide on the crop insurance based on the perceived risks the government made it mandatory. This is not something new, many developing countries do this initially, until the private sector involves in the insurance market. 

However, the previous Government made a decision to tie the crop insurance program into the already existing fertiliser subsidy. The insurance premium was taken from the framers when they collect the fertiliser subsidy. This is however, was not an ideal proposition since farmers with different levels of risks were paying the same premium. Therefore, farmers who did not see any future danger in their cultivation were not motivated to pay the insurance premium. 

However money collected was enough to make the crop insurance program self-sufficient as claimed by the previous Government. I have argued about this in two separate articles. The point I was trying to make was the forced insurance is not a good thing in the long run and tying the crop insurance program in to a subsidy scheme is not good at all. There are still many pending cases of insurance claims and many claims are influenced (either politically or bureaucratically).

Things all went south when the Government decided to transform the fertiliser subsidy into a coupon system. The Government was not able to make any arrangements for the crop insurance program to continue. There isn’t a way to collect the insurance premium. The private sector involvement at this point is also very low therefore the Government was forced to continue the crop insurance program by using the “crop levy” collected from the financial institutions. If the private sector involvement was significant in the crop insurance sector, the money from the crop levy could have been used to back up the risks of the insurance cover. However that might not be possible anymore.

The crop insurance program, which was piggybacking on the fertiliser subsidy, was an indemnity based insurance program. This way it was easy to manage. However this indemnity based insurance program is not efficient and what is ideal is an index-based program, something like the weather index based crop insurance program. However the involvement of the subsidy in to crop insurance mix prevented the implementation of an efficient index based crop insurance program. 

Illusion of guaranteed pricing and Government purchase

Guaranteed price schemes are a common type of out-put subsidy. This is most of the time to ensure that farmers get a fair price at the farm gate level. This type of a subsidy is based on the Government’s ability to buy the particular commodity at the guaranteed price and then hopefully storing them and releasing to the market appropriately (without allowing the market prices to fluctuate frequently). The most popular guaranteed price program in Sri Lanka is for paddy. This has been there for a while, going through ups and downs under several government regimes. 

Two main components of such a program require careful analysis in order to look at the success of it. First the buying capacity of the Government has to be backed up by proper storage facilities. Much research work suggests that the amount of paddy being bought at the guaranteed price only accounts for a very little amount of the total production. In terms of the distribution per district the amount that the guaranteed price scheme buys is insignificant. Sometimes the ability to buy runs out very quickly within couple of days and most farmers are unable to sell their produce at that price. There are farmers who would stay in a line for several days and see they are not accepted due to capacity constraints. They then simple sell it to a collector or a miller close by for pennies. 

The Government holds its own storage facilities for the most part. The Paddy Marketing Board sometimes hires private warehouses when they run out of storage facilities. However there is enough public information to confirm the poor quality storage facilities in most of these warehouses. 

The management of the guaranteed price program is utmost important. How and when to release the stored paddy are the important questions. Ideally this paddy should be released to competitive mills under competitive prices. However to what extent the competitive process exists is a matter that deserves through investigation. It is important that this should be looked at from the whole value chain perspective. 

The Government is giving a significant subsidy for farmers by offering them a guaranteed price. However if the same paddy ends up in larger conglomerates then that will affect the ultimate prices faced by the consumers and the Government loses as well. In an ideal situation the paddy bought at a guaranteed price should have been released for several small and medium scale mills at a competitive price so that small business benefit from the subsidy as well. 

The administration of the buying process of the guaranteed price program for paddy is managed by couple of individual officers, who have the discretion power. Discretion power on the other hand is the source of corruption and bribery. 

Subsidies on mechanisation in agricultural value chains

Mechanisation could be the answer to many issues in agricultural value chains. Mechanisation could increase the production efficiency, facilitate value addition and answer the labour scarcity issues. However, inventing in machinery is not affordable for all farmers. Hence in promoting mechanisation in agricultural vales chains governments often give subsidies. When the subsidy for mechanisation is given it is important to carefully look at the value chain and see whether the incentives for using machinery is there. The classical example is the pepper export value chain.

The majority of pepper from Sri Lanka goes to India. Pepper can be processed either using the feet or by using a machine. Using feet takes time and sometimes results in contamination. Therefore the Government administered a subsidy scheme for machinery. However, the subsidy program never became popular. This is because the incentives for quality improvements are not in place. The exporter does not provide any price premium for processing the pepper using the machines. Therefore there is little incentive for a farmer to invest in machinery and pay interest even at a subsidised rate. 

Therefore what should be done is to promote machinery where the incentives for value addition are visible. The 2017 Budget for agriculture carries a proposal to provide subsidies for entrepreneurs to introduce machinery. However the condition is that the business must bring in value addition using the subsidy for machinery. This is a very practical budget intervention. It has recognised the importance of promoting the use of machinery where the incentives for quality improvements (or any type of value addition) are in place. 

Conclusions

Subsidies are necessary. They are very crucial to get things started. However, subsidies can’t continue forever. Farmer needs to make decisions, they need to take responsibility in investing and the private sector needs to develop so subsides do not become a necessity. 

Any subsidy program must have a transition program. It is not easy to give a subsidy and take it back, especially in a developing country context. Subsides can easily transform from being an economic instrument to a political instrument. Subsidies should be stand-alone programs, otherwise it will bring burden to other program as well. Capacity to implement and the management process is essential in a successful subsidy program implementation. 

Finally, the subsidy must take the whole value chain into consideration. If these things are not assessed, then the subsidy can easily become a curse. 

(Dr. Chatura Rodrigo is an agriculture and environment economist. He can be reached at [email protected] and 94 77 332 6834)