Budget proposals for agriculture: Five important points

A home cultivation of cassava. It is very wrong to assume all farmers in Sri Lanka want to become commercial farmers. The identification process needs to be aligned with identification of potential commercial crops as well 

– Pic by Shehan Gunasekara

The section on agriculture in the Budget proposals 2017 speaks the right words, for the most parts. Paragraphs from 41 to 52 carry most of the necessary vocabulary. This is very 

appealing to me since I have written most of these words. 

For example, paragraph 44 highlights the importance of the “out-grower model” in 

export-oriented value chains and cooperatives and farmer organisations are appearing in several places. This is 

something that I have been writing and speaking at forums about. Therefore, willingness to promote forward-looking 

polices like these by the Government is an incentive for independent economists like 

us to continue. 

But it is important that we look at the larger picture. Will 

mentioning the correct words be enough? We have seen right words being mentioned in 

previous budget proposals as well, however most of them became “words in a document” since there wasn’t any implementation plan behind. Hence 

I feel responsible as a researcher to comment on several of these proposals. 

The objective is not to take sides and criticise these 

proposals since as mentioned earlier they are associated with the right words. But I hope what I discuss below would 

help implementation.

1. Transition from subsistence agriculture to commercial agriculture

Our farmers work on fragmented land, with little mechanisation and innovative farming technologies. Most of the time they operate individually in terms of cultivation and selling the harvest, therefore they lack the bargaining power over price. 

They do not have sufficient storage facilities, therefore the probability of selling the harvest as soon as possible is ideal for them and the transaction cost of price negotiation and selling at a later date is high for them. They don’t achieve economies of scale, thus it limits them from going for any investments for productivity gains. 

Therefore, in order to bring farmers out of subsistence farming to commercial farming, is going to take some serious efforts. It’s going to need interventions from many fronts. 

In my view, the term “commercial” is also loosely interpreted. Are we talking about pushing a farmer to sell some of the stuff he produces for his own consumption? If this is the case then our policies are misaligned. Rather than pushing a small farmer to sell some of his produce, we could encourage households to produce what they need and reduce spending. That will be more attractive and would address the food security issues as well. 

Therefore in terms of commercial agriculture we should think of “export-oriented value chains”. Becoming commercial is an investment. In terms of economics, a farmer would not invest in becoming a commercial farmer unless he sees a financial gain, or in other words, he would continue to be a commercial farmer as long as he receives a price that at least cover the average variable costs. 

Therefore, in promoting commercial agriculture, it is important to identify and answer several important questions: 

(1)     What crop/value chain should be focused on?

(2)     What would be the investment and rate of return (rate of return can be simply expressed in terms of the price)?

(3) Are necessary inputs in place in terms of planting materials, fertiliser, and investments?

(4) What would be the marketing strategy or is there a potential market 

(5) What are the opportunity and transaction costs in terms of certifications and innovations?

Let me explain this a bit further by taking an example from my own experiences. The Department of Agriculture rolled out a program to promote agricultural crops to the European region. They started with cucurbits. The Council for Agriculture Business (CAB) officers managed the program. 

They were involved with the farmer from the beginning and provided Good Agricultural Practices (GAP) certification. This certification is needed for the produce to be exported to the EU region. The program was supposed to roll out in more than 10 districts. 

Now, this is not the platform to evaluate the program, however I want to make couple of points. The program later realised the export demand for cucurbit is being outrun by other crops such as leafy vegetables and fruits such as mango. 

All the major exporters were centred in Katunayake, therefore farmers from distant districts such as Matale and Anuradhapura did not have direct access and had to work with collectors. Therefore there was a greater price difference between farmers who were close to the exporters and the ones who were away. 

The current value chain requires investments in land preparation, water management and purchasing seeds and fertilisers. For some farmers, the costs associated with these investments outweighs the price they receive. 

Furthermore, the CAB officer was an essential component in price negotiation between the farmer and the exporter; almost all the time the CAB officer decided where the produce would go. This is not an ideal situation and can lead to many issues. Price negotiation should happen between the producer and the buyer. The Budget proposal for 2017 stresses the importance of eliminating the middleman as much as possible. 

However, the export-oriented cucurbit value chain for the EU has potentially converted the CAB officer also into a middleman. Therefore, becoming commercial farmers is not easy and it can easily can go seriously wrong and farmers might give up the value chain altogether. 

Now, we have to also acknowledge that fact that some farmers would like to remain subsistence. Take organic farming for example and I am writing on my personal experience. 

There are farmers in many areas such as Kandy, Matale and Galle who do not want to become commercial organic farmers; despite the interesting financial proposals put forth by several leading supermarket chains, they remain subsistence. Therefore the starting point is to identify the potential farmers who would want to be in a commercial value chain. It is very wrong to assume all farmers in Sri Lanka want to become commercial farmers. The identification process needs to be aligned with identification of potential commercial crops as well. 

In pushing towards an out-grower model, it is important to look at the incorporation of a traceability system as well. In export-oriented value chains, the consumer is very interested in knowing where the produce comes from. This is not only knowing geography of the produce but many additional details as well, such as whether they have used ethical labour, whether the produce is environmentally friendly and even on the water footprint. 

Studies have shown that the consumer willingness to pay for such information is high. Therefore, while pushing the industry to produce more value-added products, it is also important to look at traceability as well. The industry should be willing to invest in such a system since it has the potential to attract higher prices. Some companies are already doing this. 

The Department of Agriculture is hoping to establish a traceability system for its crops under the GAP program. There are different ways that the Government can go about this. Some possible ways could be asking the industry to make traceability a mandatory for high-value export agriculture products (asking private sector to invest), establishing demonstrations with Government investment and later allowing the private sector to take over and even forming Public-Private Partnerships to establish traceability for five main high value agriculture export products.

2. Subsidising the most important input, the land

The Budget proposal repeatedly talks about the fact that farmers have fragmented and small land parcels. Therefore, one suggestion made is to allow the farmers to use the State-owned land that stands idle and is uneconomical. The proposal refers to this with respect to the promotion of “Out-Grower Model”. 

I have written about the out-grower model several times, but let me emphasise again, there are several important points. Paragraph 44 talks about realising the idle and uneconomically used land for out-grower model. Paragraph 50 talks about releasing 20,000 acres of land for five major food crops on a long-term lease basis, minimum plot of 1,000 acres for a commercial farmer. The below synopsis is based on these points. 

In property rights theory, economists argue that private ownership of land has the highest potential of realising the maximum benefits of land use. The common property is not efficient since it has the ability to create the popular economic phenomenon called “tragedy of commons”. 

On the other end of the spectrum, the overlapping ownership with simultaneous exclusion rights will leads to “tragedy of anticommons”. Therefore a discussion needs to happen how the land should be handed out to farmers/or for the companies to engage in out-grower agriculture. 

Let’s assume that the land rights would be given to farmers/companies so it would hold the characteristics of private property (the proposal simply mentions the release the idle and uneconomically used land: paragraph 44). The land ownership would potentially decide the investment structure in an out-grower model. Economic theory (asset ownership model) argues that the owners of the productive assets would be the suitable investors. 

There is the option for the Government to give lands to the commercial farmers or to the larger companies. The socially appealing option would be to give the land to the farmer, but it might be economical to give the lands to the company. This situation might change depending on the value chain hence a careful study is needed. Therefore, if a value chain to function with the potential of future investments, it is essential to be clear who would own the productive assets. 

Referring to paragraph 44 and the promotion of the out-grower model, one might also interpret it as the Government giving authority to use the land for out-grower farming (basically issuing a permit) rather than transferring any ownership. If this is the case, the ownership structure of the Government land will create many challenges in using it.

For example, though these are idle lands, they might fall within the administration of several Government organisations. Research has shown that the State-owned land of Sri Lanka is most of the time being managed by several Government organisations with overlapping jurisdictions. Therefore, this creates a perfect recipe for “tragedy of anticommons”. 

The proposal is clear on releasing land on long-term lease basis for five major food crops: paragraph 50. This is a good suggestion, especially if this land can be used by larger farmer organisations. This will be a better option for them to achieve economies of scale and also to improve on mechanisation. 

One other important concept discussed in the proposal is to release the uneconomically used land to promote commercial agriculture. Please note that I am not picking on the word “uneconomically”, rather I want to discuss some aspects that might be linked to this word. 

There could be many reasons for a land to be uneconomical and some of them might be: 

(1) The geography of the land might limit its economical use 

(2)     The property rights might limit the economical use of the land 

(3)     The land might not be suitable for range of crops and might be suitable for one crop (such as paddy land) 

(4) The productivity of the land might have decreased therefore don’t yield gains any more (e.g. high fertiliser application for a prolong periods) 

(5) The physical infrastructure around the land is not supportive for agriculture production (no roads to transport inputs and harvest). 

In addition use of Government land might call for amendments to land ordinances. For example, the paddy land is prevented from using for any other crops. However, there is enough paddy land that is not used for agriculture simple because the productivity of the land is very low and the land is highly eroded. Use of such land might require special provisions and measures in terms of land use management as well as land rehabilitation. 

Therefore let me ask this, if the land is seriously eroded and unproductive, who will look after the costs in rehabilitating the land? Giving away the idle and uneconomical land might look like a genius option for a person who has not seen or worked on an agricultural land. However we need to look at the decision making process of the farmer. We need to start asking questions such as, “How will the out-grower model internalise the externalities associated with the idle and uneconomically used land?”

3. Increasing productivity through mechanisation

We constantly talk about decreasing productivity, increasing labour prices and labour outmigration. Research has proven many times that mechanisation could potentially eliminate most of these issues. I do not think that the technology is not out there. The Government policymakers (through their countless number of visits to technology-savvy countries have seen these innovations), and private sector companies know where to get these efficient machinery. 

Even farmers are aware of existing new technologies and machineries. Therefore, I disagree with “lack of awareness”. Rather I think it is about the cost of technology and its suitability to our farming lands and practices.

We need to realise the fact that farmers are profit makers. The farmer would not be doing commercial farming if he is not making profits. Therefore, when someone recommends the use of machinery, the farmer will put that in to his calculations and see the trade-off. 

A farmer is capable of addressing very critical questions when it comes to machinery and new technologies: 

(1) Should I buy the machinery or rent?

(2) How should I finance it if I want to buy?

(3) Am I making enough profits to cover up the cost of new technologies?

(4) What would the scalability?

(5) What are the other competitive products out there?

Therefore any budgetary intervention needs to address these questions that a farmer would have.

Research also suggests that farmer organisations would be in a better position to increase productivity through mechanisation. The proposal agrees with this. Therefore the proposal proposes tax reduction in importing new machinery. 

While this is a new business opportunity for machinery importers, it is an ideal situation for farmers/farmer organisations as well since the product price would go down with the tax cut. At the same time, the Government backs up the 75% of the interest taken to invest in such machinery. Hence these are very timely and essential Budget proposals, hats off. 

4. Agriculture 

modernisation and matching grant process

It is a pleasure to see that the Government has realised the importance of value chain development. The Budget proposes a 50% interest subsidy for a farmer/farmer organisation that invests on infusion of new technologies into product development. This subsidy is being extended to the paddy sector as well, promoting silo storages among medium-scale millers. 

While these are very attractive propositions, it must be dealt with careful attention. It is important to identify the areas for value chain development and how the incentives are structured for quality improvements after modernisation.

Let’s take an example. Assume a pepper value chain that is export oriented. The majority of our pepper goes to India. In thrashing many farmers use their feet as oppose to using machinery. Machinery increases the productivity and quality as well. However, the buyer does not incentivise the farmer based on the quality. Therefore the only outcome of investing in modernisation in that segment of the pepper value chain will be productivity (output per unit of effort) and also a farmer would gain from lower labour cost. 

However supporting a pepper-thrashing machine through a 50% interest subsidy might not be very attractive for a farmer, unless the buyer starts paying for the quality. Yet, enough research has been done on value added products such as pepper sauce and pepper paste. Such an industry has a larger potential to be benefitted from an interest subsidy since these value added products can be locally manufactured and easily exported. There will also be a local demand for such products. 

The technology is available for such an initiative; the Department of Export Agriculture under the Ministry of Primary Industries has done enough research on this. Therefore in terms of modernisation, especially with interest subsidies, it is important to identify where the potential investments are, and that calls for a detailed study of the value chains. 

The proposal also mentions a ‘Food Technology Research Unit’ at the Wayamba University. This is also an essential component. However, new establishments need to work closely with the already-established research institutions. Plenty of food-related research, especially looking at product development and innovation, takes place at University of Peradeniya, Faculty of Agriculture (this is my alma-mater and has one of the best food science programs in the region), Department of Export Agriculture, independent research funded by the National Science Foundation (NSF) and Industrial Technology institute (ITI). All this work has to be collaborated. 

5. Agricultural insurance

The proposal has put lot of emphasis on out-grower model and the cooperative model. I have written many times on the importance of moving to these models from the traditional subsidy-based system. However, one of my arguments for possible failures of these models are the unaccounted “transaction costs”. Some major transaction costs come with the uncertainties associated with agricultural value chains. Therefore, crop insurance is an important aspect for these innovative models to work.

The existing crop insurance programs have their own advantages and disadvantages. The current systems have little private sector involvement, lack of coverage in terms of crops (currently it is mainly for paddy), lack of coverage in terms of insured amounts and lack of operational methods (the current indemnity-based system as oppose to a more efficient index-based system). 

The current Budget proposal has not emphasised on crop insurance. It might be the case that the Government does not see any issues with the current crop insurance systems. However, if we were to move towards out-grower models, crop insurance becomes a vital component. Let me again take an example from my own experience. 

Cucurbits that are in the export value chain (going for EU, Middle East and Maldives) needs to be of a certain size. If you talk to a farmer, they will mention that cucurbits that are in the export value chain are long; for example the snake-gourd has to be around four to five feet long and less in diameter. These farmers operate without any crop insurance, but are in the export value chain under the out-grower model.

There are farmers who have experienced defects/irregularities in the seeds they have bought. All these seeds were bought from recommended places either by the exporter or the CAB officer (sometimes the exporter in gives seeds on a cost recovery basis). In some cases, four out of 10 of snake-gourds come out as short varieties, two to three feet long and high in diameter. These are rejected by the exporters and end up in the local market. 

The exporter does not give the farmer compensation and the farmer does not have an insurance to cover the cost, thus leaving the farmer in a bad situation. Such a failure can remove the farmer from the value chain. Therefore it is essential such farmers are insured. Whether such a system should be supported by a subsidy in the initial stage or not is up to debate. However, such a system is important, which is not reflected in the Budget proposals. 

(The writer, PhD, is an agriculture and environment economist and can be reached via [email protected] or 94 77 986 7007.)