Explaining Food and Agricultural Policy: New Data and Hypothesis Tests

1. Explaining Food and Agricultural Policy: New Data and Hypothesis Tests Will Masters wmasters@purdue.edu www.agecon.purdue.edu/staff/masters Friedman School Seminar 24 September 2008

2. Motivation: the development paradox

3. Motivation: the development paradox Why? Why? Meanwhile…

4. New Data • A 3-year project funded through the World Bank involving 100+ researchers and case studies for 68 countries, 77 commodities over 40+ years • Project results to be published in six books • Four volumes of country narratives • Africa (Anderson & Masters); Asia (Anderson & Martin); LAC (Anderson & Valdes); European Transition (Anderson & Swinnen) • Two global volumes • One with regional syntheses and reform simulations • One with political economy explanations for policy choices • Results today are mostly from W.A. Masters and A. Garcia (2009), “Agricultural Price Distortion and Stabilization: Stylized Facts and Hypothesis Tests,” in K. Anderson, ed., Political Economy of Distortions to Agricultural Incentives. Washington, DC: World Bank. • All available at www.worldbank.org/agdistortions

5. Country coverage

6. Commodity coverage (top 30 products only)

7. The method: price distortions from “stroke of the pen” policies • Tariff-equivalent Nominal Rate of Assistance in domestic prices relative to free trade: • Sometimes estimated directly from observed policy: • More often imputed by price comparison: • We also introduce a new “stabilization index”, for the standard deviations around trend prices:

8. Explaining the data Our approach is to test for: • stylized facts • persistent correlations with broadly-defined variables, that could result from many different policymaking mechanisms • specific political-economy mechanisms • other correlations with narrowly-defined variables, as implied by particular theories of policymaking • these could explain residuals and add explanatory power to the stylized facts, or explain the stylized facts themselves • most tests are weak; only in one case do we have a strong identification strategy

9. The three stylized facts The three broad influences we capture are: • A development paradox from taxation to subsidies as incomes rise, as measured by real GDP per capita at PPP prices (PWT 6.2) • An anti-trade bias from taxation of both imports and exports, as measured by whether commodity is importable or exportable in each year • A resource curse effect from taxation of natural resources, as measured by arable land area per capita (FAOSTAT)

10. Seven specific hypotheses We test for each standard theory of policy failure: • Rational ignorance when per-person effects are small • Free ridership when groups of people are large (versus more political support from larger groups) • Rent-seeking by unconstrained incumbents (versus checks-and-balances from institutions and markets) • Revenue motives for cash-strapped governments • Time consistency of policy when taxation is reversible but investment is not (as opposed to simultaneous choices) • Status-quo bias from loss aversion or conservative social welfare functions in politics • Rent dissipation from the entry of new farmers (as opposed to free riding among existing farmers)

11. Results:A new view of the development paradox National average NRAs by real income per capita, with 95% confidence bands Our tests aim to account for nonlinearity in these lines, and also dispersion around them, as well as the NRA-income relationship itself Net taxation of consumers NRA>0 ≈$5,000/yr Export taxes with import restrictions = anti-trade bias NRA<0 Net taxation of farmers (≈$400/yr) (≈$3,000/yr) (≈$22,000/yr) Notes: Each line shows data from 66 countries in each year from 1961 to 2005 (n=2520), smoothed with confidence intervals using Stata’s lpolyci at bandwidth 1 and degree 4. Income per capita is expressed in US$ at 2000 PPP prices.

12. Results:A new view of policy change over time Average NRAs for all products by year, with 95% confidence bands Increased taxes on consumers in 1990s Heavy taxes on farmers in 1970s then reform Heavy taxes on consumers in the 1980s, then reform

13. Results:A new view of policy change over time Average NRAs for importables and exportables by year, with 95% confidence bands Trend away from taxes on exports, with rising import restrictions Heavy taxes on exports in 1970s then reform with varied import restrictions

14. Results: The stylized facts in OLS regressions Table 1. Stylized facts of observed NRAs in agriculture The development paradox The resource curse Some regional differences Anti-trade bias

15. Results:Specific hypotheses at the country level Table 2. Hypothesis tests at the country level Revenue Motives Rent dissipation Rational ignorance Number of people Governance

16. Results:Specific hypotheses at the product level Table 3. Hypothesis tests at the product level Time consistency Status-quo bias

17. Results:How much stabilization is achieved? Stabilization index over the 1961-2005 period, by income level When stabilizing, SI>0 SI<0 if gov’t is destabilizing Not much! Many governments actually destabilize prices

18. Results: Richer countries stabilize more Table 4. Determinants of the stabilization index Another development paradox Exportable crops and land-abundant countries have less stabilization Asia has more imports and less land, which explains high stabilization

19. More results: Since 1995, policies have moved closer to free-trade prices National average NRAs by income level, before and after the Uruguay Round agreement Flatter curves, closer to zero

20. Low-income Africa taxes farmers less, Higher-income Asia taxes consumers less National average NRAs by income level, before and after the Uruguay Round agreement Pro-farm reforms in lower-income Africa Pro-consumer reform in higher-income Asia

21. There has been less improvement in E. Europe-Central Asia or Latin America National average NRAs by income level, before and after the Uruguay Round agreement Less reform – lines are more similar

22. The biggest change has been in high-income countries National average NRAs by income level, before and after the Uruguay Round agreement US, EU and Japan: reforms and WTO commitments But current events could change the pattern: …will return of high food prices cause policy reversals? …how will the 2008 credit crisis affect policy choices?

23. Some conclusions • Three stylized facts help explain policy choices: • A development paradox from taxing farmers to taxing consumers as incomes rise • An anti-trade bias from taxation of both imports and exports • A resource abundance effect against natural resources • Three mechanisms help explain the income effect: • Rational ignorance when per-person costs are small • Improved governance from more checks and balances • Revenue motives for import taxes when financial systems are deeper

24. More conclusions • Four other mechanisms help add to the income effect: • More people in the sector leads to more favorable policies • An end to entry of new farmers leads to more farm support • Crops with more sunk costs (perennials) are taxed more • Policy changes try to reverse the last year’s price changes • Two widely-held views are not supported: • Policy changes do not try to reverse changes in area planted • Policy provides little price stabilization in poor countries • Status quo bias and price stabilization are not consistent characteristics of real-life policies; other explanations work better.

25. Finally… • Policy relationships have changed over time • Relative to income levels, prices are now much closer to free trade than in the past, especially in Africa, Asia and the high income countries. • The recent move to freer trade could be reversed • In particular, a return of 1970s-style food prices could easily cause a return to 1980s-style food policies. • Policy outcomes are far from predetermined! • Our models explain less than half of the variation we see.