Illustration of Elements of a Policy Memo

1. Policy Issues

a. Our government is considering whether to allocate a substantial amount of agricultural research resources to the development of high-yielding wheat varieties for the good-soil areas of the southern region.

b. This memo summarizes the results of research measuring the degree of efficiency and the effects of government policy on the existing technology for producing wheat in the target zone.

c. These research results need to be complemented by similar analyses of the existing efficiency of other agricultural systems and of the potentials for cost-reducing technological improvements in those systems so that the government can allocate its agricultural research resources most effectively.

2. Method of Analysis

a. The method of analysis used to measure the efficiency and effects of policy for the good-soil southern wheat system is the policy analysis matrix (PAM), which measures profitability in actual market (private) prices and in efficiency (social) prices.

b. The PAM method thus shows the actual revenues, costs, and profits that southern wheat farmers and millers are experiencing and those they would realize if they received sales revenues and paid the costs of production based on prices that would allocate resources most efficiently.

c. Variations of this method have been widely used in academic studies locally and abroad and in policy work in international aid agencies and agricultural research centers. However, this study is the first one based on the PAM in this ministry.

d. The principal strength of the PAM is that it gives measures of the economic efficiency of existing agricultural systems and of the effects of policy on those systems. Its main limitation is that its results are for a base year and thus need to be altered as principal parameters (such as world prices of outputs and inputs, wage rates, interest rates, and farming and processing technologies) change over time. The method, however, can readily accommodate such parameter changes.

e. The PAM efficiency measure, social profitability, is a requisite first step in the analysis. The next steps are to examine how much improved wheat technologies, developed with the research expenditure, might increase yields or save on inputs and thus reduce per unit costs and to contrast the results with those of similar studies for other systems that could benefit from more agricultural research.

3. Information Needs

a. The basic information required for PAM analysis is budget data (revenues and costs), broken down into prices and quantities for a representative wheat farm in the good-soil area of the southern region and for postfarm marketing and flour milling, world prices for products or inputs that are either imported or exported, and estimates of the efficiency values of wage and interest rates.

b. The basic PAM data need to be complemented by anticipated future changes in the budgets (related to the newly developed technologies), world prices, and factor (labor and capital) prices.

c. The budget data are complete and reliable, because they were compiled from agricultural census data, farm group information, and field surveys. The principal assumptions are that the social value of capital is 8 percent plus the rate of inflation and that the social value of skilled labor is ₂₃ percent less than the actual market wage rate, reflecting taxes for pension contributions paid by employers.

d. No complete historical budget data for this area are known to exist. The current representative technology has spread gradually through the region during the past two decades.

4. Interpretation of Results

a. In the base year (1983), the representative wheat system was very profitable; private revenues were 27.42 (esudos per hectare) and private costs were 16.92; thus private profits were 10.50. Profitability was maintained at social prices. Social revenues, 22.79, were 4.63 less than private revenues because of import quotas on wheat; social costs, 19.76, were 2.84 above private costs mainly because of subsidies on fertilizers and credit; and therefore social profits, 3.03, although positive, were 7.47 less than private profits.

b. Projections to 1995 were made, using various assumptions about future world prices and factor costs, and the wheat system remained socially profitable under all reasonable sets of assumptions. No changes in technology were projected, because that analysis awaits information from agricultural research. c. Two principal lessons emerge from these results. First, the current system operates efficiently, so all increases in social profit arising from new agricultural research will be net gains to the economy. Second, government policies-the import restrictions on wheat and the subsidies on fertilizer and credit-are resulting in excess private profits for good-soil wheat farmers.

d. The efficiency results appear robust because they are based on complete data and because they were realized under a wide variety of assumptions for key variables.

5. Implications of Results for National Interest Groups

a. The policy choice is whether the government should decide to allocate new research funds for southern region good-soil wheat.

b. The main beneficiaries of successful research results would be the wheat farmers and, to a lesser extent, the flour millers in the target region. The wheat farmers have farm wages and incomes that are currently among the highest in the country. They are already benefiting from agricultural price policies affecting wheat and inputs (see item 4). There are no obvious losers, other than taxpayers or those who would benefit if the research funds were spent elsewhere.

c. The size of the gains for wheat farmers is not yet estimable because no new budget data are now available on potential revenues and costs for the technologies to be developed with the research funds.

d. Successful research on wheat for the target area would likely advance two of the objectives of food policy but probably not the third. It would improve the efficiency of an already efficient system, and it would increase the productivity and reduce required imports for one of the country's staple foods, hence probably furthering food security. But the income distribution effects are not likely to be positive, because the technical innovations would aid mainly large, well-off farms that employ capital-intensive production technologies.

e. The policy tradeoff is thus a comparison of gains in efficiency and (probably) in food security with costs of income distribution. The decision will depend on the results of similar analyses for other commodities, technologies, and regions.

6. International Ramification of Results

a. Successful research is expected to reduce recent levels of imports of wheat by up to one-third, or a maximum of about 150,000 metric tons. This result is not

expected to cause problems with the country's foreign wheat suppliers or to have any noticeable impact on price levels or variability in international markets.

b. A marked expansion of domestic wheat production is not expected to have any important impact on foreign investment or on international flows of migrant laborers.

c. No negative ramifications for the country's foreign policy are anticipated. Investment in agricultural research to develop new technology creates no large conflicts, except for some unhappiness among wheat exporters abroad. The new research, if approved, would be done in collaboration with the International Maize and Wheat Improvement Center (CIMMYT).

7. Summary o f the Pros and Cons o f Policy Choices

a. Wheat in the good-soil areas of the southern region is currently produced efficiently. Farmers there could earn profits even if they did not receive the transfers from existing policies that substantially protect wheat prices and subsidize fertilizer and credit.

b. The government is deciding whether to allocate large new amounts of agricultural research resources to improve good-soil wheat production in the south. Because the current production system is efficient, all gains from newly discovered or newly adopted wheat technologies will lead to increases in national as well as wheat farmer incomes.

c. Allocation of public funds for successful wheat research would thus increase economic efficiency and probably improve the country's food security as well. But most of the benefits would accrue to farmers who are already among the best off in the country. Similar analyses of the extent and distribution of gains from research on alternative commodities need to be carried out to assure the best allocation of funds.