Effectiveness o f Price Policies

The next step is to examine how the objectives-constraints-policies framework can be made operational. The analytical approach views policy-makers as enacting policies (price, macro, or investment) to further objectives (efficiency, distribution, or food security) in the face of economic constraints (supply, demand, and world prices). The main services policy analysis can provide to policy-makers are to distinguish whether a policy is likely to improve the efficient operation of the economy and thus raise the level of national income, to measure the expected magnitude of the efficiency gains or losses, and to quantify, when possible, the direction and extent of the policy's likely effects on the distributional and food security objectives. Even when the nonefficiency effects are difficult to measure, economic analysis can provide a reasonable estimate of the efficiency costs associated with the promotion of nonefficiency objectives.

The ways in which agricultural price policy can lead to efficient gains are limited to offsetting market failures, assisting agricultural infant industries, and stabilizing domestic prices. In developing economies, the most prevalent market failures usually are found in the factor markets, particularly for capital and occasionally for labor. These market failures are caused by insufficient development of institutions (such as financial intermediaries) and communication networks (so that information on jobs is not widespread). A second type of market failure is the existence of monopolies or monopsonies, where only one or a few (cooperating) sellers or buyers have the ability to manipulate market prices to their own advantage. Externalities (costs for which the person responsible cannot be charged or benefits that cannot be appropriated by the enterprise creating them) are a third source of market failures. Public goods are the principal source of externalities in developing countries. A public good is inadequately provided because not all of those benefiting from it can be charged for their use of it; governments thus invest in public infrastructure (roads, ports, large irrigation works), which would otherwise be inadequately supplied by private individuals.

The two other rationales for efficient intervention may also be viewed as responses to special kinds of market failures. One is to assist agricultural infant industries by correcting for dynamic market failures. The essence of the infant industry argument is that, over time, the existence of market failures (usually in the capital market or because of information bottlenecks) will cause insufficient investment and technical change and thus not permit the economy to benefit from dynamic learning effects. The presence of efficient operations in the future is not enough to justify policy that offsets the market failures; the efficiency cost to society of the inefficient use of resources in the early years must be compensated by larger efficiency gains in the later years.

The third rationale is to stabilize domestic agricultural prices (relative to unstable world prices) when insurance markets are absent. Governments perceive benefits from reducing price risks for producers, fending off consumer pressures, averting hunger if food crop prices rise, and avoiding adjustment costs for producers and consumers. Price stabilization requires public intervention in international trade and domestic marketing (transport and storage). If a public agency manages a buffer stock, the benefits from price stability may justify producer prices that are lower than average world prices and consumer prices that are higher than world prices. This margin should cover the costs of buffer stock management.

The circumstances for efficient intervention-offsetting of domestic market failures, assistance to infant industries, and stabilization of domestic prices-are potentially widespread. Analysts of efficient policy intervention look for the sources of market failure and assess the present and future benefits and costs of such policies. Even efficient intervention typically has costs as well as gains.

The analyst of nonefficiency objectives begins by measuring constraints and then considers the effects of policy on objectives. If full information is available on a single commodity, the analyst can summarize the supply constraints into a supply schedule and the demand constraints into a demand schedule and can draw a standard price-quantity diagram that will portray the situation before the policy is enacted.

If a policy to raise the price of a commodity-for example, a tariff on competing imports-is put into place, the analyst examines the hypothetical effects of the restrictive trade policy on government objectives. The tariff (tax on imports) raises the domestic price to producers and consumers and influences the quantities produced, consumed, and traded internationally. Facing a higher price, producers will increase output (because they can cover higher costs of production), consumers will cut back consumption (and shift to cheaper substitutes), and the country's demand for imports of the commodity will decline on both accounts. The impact on efficiency will be negative-producers will overproduce and consumers will underconsume relative to the world price-unless the higher domestic price serves to offset a market failure. The trade policy will redistribute income, causing transfers from consumers (who will consume less at the higher price) to producers (who will grow more at the higher price) and to the government treasury (which will receive the tariff revenue on remaining imports); the effect on distribution will depend on how well off the producers and consumers are without and with the policy. The influence of the policy on food security depends on the relative stability of the additional domestic output versus the imports it replaces.

This simplified example shows how a price policy can be analyzed in order to identify its effects on government objectives. In actual price policy analysis, the process is more complicated. The first step in choosing among policies is to investigate the feasibility of the policy instrument. The imposition of a tariff on imports of a commodity can be done readily if rampant smuggling can be prevented, whereas the distribution of subsidy payments to millions of small-scale farmers might not be feasible. The next step is to measure the administrative costs of implementing the feasible instruments-for example, the costs of hiring additional customs agents. Such costs should be added to any efficiency losses of the policy or subtracted from any gains. In this way, the analyst can incorporate policy feasibility and administrative costs.