Agricultural Supply and Structural Change with Focus on Caucasian countries

1. Agricultural Supply and Structural Change with Focus on Caucasian countries Ulrich Koester University of Kiel, Germany Ukoester@ae.uni-kiel.de Agricultural Supply and Structural Change Tbilisi

2. Justification of the Topic Agricultural Supply is far below potential production as compared to other regions Changes in agricultural supply are important for reducing poverty in rural areas WTO accession of Russia can have a positive effect on agricultural supply The Government can pay a significant role for increasing agricultural supply in the region Agricultural Supply and Structural Change Tbilisi

3. I. Georgia’s current conditions in agriculture in a comparative perspective 1. An agricultural growth substantially below potential Agriculture growth in Georgia is lagging that in other regions of the world in spite of high potential Agricultural Supply and Structural Change Tbilisi

4. I. Georgia’s current conditions in agriculture in a comparative perspective 2. A lagging structural transformation: Excess labor in agriculture Differential sector growth and stagnant population shares imply a rapidly rising income disparity between agriculture and the other economic sectors Agricultural Supply and Structural Change Tbilisi

5. I. Georgia’s current conditions in agriculture in a comparative perspective 4. A relatively low land and labor productivity in agriculture Compare to Guatemala (smallholders), Chile (labor in agroindustry), Hungary (EU 2004): Countries with diverse temperate crops and strong links to international markets Agricultural Supply and Structural Change Tbilisi

6. Agricultural Supply and Structural Change Tbilisi

7. OUTLINE The individual supply function The aggregate supply function Determinants of the shifts of the aggregate supply function The role of the government to increase agricultural supply Agricultural Supply and Structural Change Tbilisi

8. The individual supply functions • Some specifics • Joint production • Alternative production • Subsistence and market production • The slope of the supply curve Agricultural Supply and Structural Change Tbilisi

9. The slope of the individual supply curve > 0; The normal case • < 0 Inverse reaction a possibility in agriculture = 0 Agricultural Supply and Structural Change Tbilisi

10. The aggregate supply curve Wit constant marginal costs With positive marginal costs The concept of the marginal producer Agricultural Supply and Structural Change Tbilisi

11. Hypothese ofthe inverse supplycurve Real income Indifference curve p0 y0 p1 y1 Income possibility curve L0 16 h L1 Leisure time Production q1 q0 w0 w1 working time Agricultural Supply and Structural Change Tbilisi

12. Linear total costfunction: Inelasticsupply C C = C(q) variable costs fixed costs q price marginal costs q qmax Agricultural Supply and Structural Change Tbilisi

13. Aggregation of individual supplycurves: Leads to a positive slope Farm B Market supply Farm A mc vc mc vc q q q Farm A Farm B Market supply mc mc qmax q q q Agricultural Supply and Structural Change Tbilisi

14. The concept of the marginal supplier Not all farmers will likely react to policy changes or to changes in the economic environment The marginal supplier will react The marginal supplier is not the producer which is technically not efficient Small farmers may not be the marginal supplier because opportunity costs of labor might be near to zero Agricultural Supply and Structural Change Tbilisi

15. Supplyelasticities p short term medium term long term p1 p0 q0 q Agricultural Supply and Structural Change Tbilisi

16. Shifts of the supply curve P q Agricultural Supply and Structural Change Tbilisi

17. Determinants of the shift of the market supply curve • The amount of land used • Transaction costs: Market price remains constant, but farm gate price increases • Know how of farmers • Structure of farms • Price and availability of inputs • Technical progress • Capital • Behavior of farmers • Risk Agricultural Supply and Structural Change Tbilisi

18. Determinants of the shift of the market supply curve • The amount of land used • There seems to be no accurate data available, however, estimates go up to 40 or even 50 percent • Some hypotheses for non-use • Unclear property rights: it is possible to overcome the problem partly • Small plots: There must be small or larger plots nearby which are under cultivation • Lack of profitability due to low prices : Lower transaction costs by setting up market organizations and a market and price information system Agricultural Supply and Structural Change Tbilisi

19. Structure of Land Ownership at the End of 2002 (Thousand ha) Source: Source: World Bank estimation based on reconciliation of various sources, e.g. ‘Land Balance, April 2002, State Department of Land Management. World Bank 2009 Agricultural Supply and Structural Change Tbilisi

20. Determinants of the shift of the market supply curve Transaction costs Market price Farm gate price • The amount of land used • Transaction costs: Market price remains constant, but farm gate price increases • Farm gate price is lower than market price due to transaction costs Agricultural Supply and Structural Change Tbilisi

21. Transaction costs (exchange property rights • Costs incurred for transactions • Search cost • Monitoring costs • Enforcement costs • A main element of transaction costs is uncertainty with respect to • the other party’s behavior (trust, reliability etc) • to the quality of the product • to the prospects of its own ability to fulfill the contract in an uncertain world Agricultural Supply and Structural Change Tbilisi

22. Determinants of the shift of the market supply curve Supply curve of a subsistence farmer p Demand curve of a subsistence farmer q Farm production costs High transaction costs as cause for subsistence production Transaction costs can be reduced by a better enforcement system and marketing system Agricultural Supply and Structural Change Tbilisi

23. Determinants of the shift of the market supply curve • The amount of land used • Transaction costs • Know how of farmers • Low yields of crop and livestock indicate that more yield increasing input would be profitable • Farmers have to be trained : The German dual education system is considered as a world-wide model • Extension service is needed • Extension has to include farm management and agricultural economics Agricultural Supply and Structural Change Tbilisi

24. Determinants of the shift of the market supply curve Know-how of farmers Modern agriculture is knowledge based Human capital is of high importance Agricultural Supply and Structural Change Tbilisi

25. Determinants of the shift of the market supply curve Average Costs Transformation costs Internal transaction costs External transaction costs q • Structure of farms • Is there an optimal farm size? • Small farms can be more profitable than large farms • The technology is of importance but also internal and external transaction costs Agricultural Supply and Structural Change Tbilisi

26. Determinants of the shift of the market supply curve The amount of land used Transaction costs Know how of farmers Structure of farms Price and availability of inputs Capital Technical progress Behavior of farmers Risk Agricultural Supply and Structural Change Tbilisi

27. What can the Government do? A selection Provision of public goods Agricultural Supply and Structural Change Tbilisi

28. II. Lessons from the WDR 2008 and new opportunities in agriculture Many countries have insufficient public expenditures in agriculture Volume and - even more important -the pattern of expenditure is inadequate in many countries Successful countries typically have public expenditures in agriculture equal to 10-11% of agricultural GDP Agricultural Supply and Structural Change Tbilisi

29. What can the Government do? A selection Provision of public goods Budget has to be increased and restructured Public expenditure review and functional review is needed Agricultural Supply and Structural Change Tbilisi

30. What can the Government do? A selection • Provision of public goods • Provide incentives to use land • Reduce transaction costs • by improving market organization • by improving in formation through a market and price information scheme • Improve know-how of farmers • by provision of an extension service • By introducing a dual education system • Set up a sound agricultural research and higher education system in agricultural economics Agricultural Supply and Structural Change Tbilisi