Assessing incentives and disincentives to economic agents in a value chain
framework
Discussion note on MAFAP methodology
Lorenzo Giovanni Bellù, Piera Tortora, FAO TCSP
15 February 2010.
Table of contents
1.
2.
3.
4.
Introduction ........................................................................................................................ 1
Investigating incentive and disincentives ........................................................................... 1
VCA/PAM versus OECD methodology ............................................................................ 3
Protection pass-through in the OECD and VCA/PAM methodologies ............................. 6
1. Introduction
Investigating incentives-disincentives provided by an economic system to a single agent or a
group of agents to carry out specific production or consumption activities implies analyzing
some fundamental features of economic systems and the way the policy and institutional setup influences it. This note, after highlighting some relevant aspects for investigating
incentives-disincentives with a focus on incentives to producers (section 2), compares the
basic features of the OECD methodology with the VCA/PAM methodology, in an attempt to
reconcile them (section 3). In addition, some considerations and open questions are provided
in section 4 on the way incentives or disincentives are distributed along a value chain, notably
between traded and non-traded commodities, and on methods to highlight this distribution.
The content of this note was presented at an informal meeting on MAFAP methodology held
at FAO on 11 Febreuary 2010.
2. Investigating incentive and disincentives
Some relevant aspects for investigating incentives-disincentives with a focus on incentives to
producers are listed here below.
a) Sources of incentives-disincentives. Economic agents receive incentives or dis-incentives
to produce from various interrelated sources:
1) “Autonomous” shifts in prices of outputs, inputs and factors (this refers to chances in
prices due to changes in prices of complements or substitutes, shifts in consumers’
income, changes of tastes etc
2) Features of input-output markets and related changes. This refers to factors affecting
the relative position of the agent with respect to surrounding economic partners
(customers, suppliers), such as entrance, exit, consolidation, transformation of partners
in the economic sector-segment in which the agent operates, including mono-
1
3)
4)
5)
6)
7)
8)
oligopolies, mono-oligopsonies and other market features allowing for rent-seeking
behaviours;
Changes in infrastructural services available to the agent (including changes in the
provision of public goods);
commodity-sector specific policies affecting output and input prices;
commodity-sector specific policies affecting technological choices, portfolios of
technological options, technical progress etc.
macro-economic policies affecting all the above;
External shocks (external to the economic system) affecting all the above
(international price shocks natural-climatic events, etc)
Other sources of incentives or disincentives (context-specific, such as geo-political
geo-strategic changes etc)
b) Benchmarking incentives and disincentives. In order to detect whether an economic
agent (or a set of agents) within a specific economic system receives an incentive or
disincentive to act, a benchmark need to be set. A quite common approach is to set as a
benchmark the contribution and/or the burden received by the economic system from the
activities carried out by the specific agent. If the agent contributes more to the economic
system than what he gets, the agent receives a disincentive; if he contributes less, he receives
an incentive. This implies that incentives raise the private profitability of an economic activity
above the social profitability; vice-versa for disincentives.
c) Policies versus missing policies. Policy measures in various forms can generate or alter
incentives-disincentives. Missing policies, i.e. unaddressed market failures generate or
perpetrate incentives-disincentives.
d) Commodity specific versus agent-specific, sector-specific area-specific incentives and
disincentives. Incentives-disincentives can be provided, either by policies or missing policies,
to specific commodities, i.e. to agents whenever they produce specific commodities, to
specific agents, irrespective to what they produce, to specific sectors, sub-sectors or value
chains or to specific geographic areas within an economic system.
e) Offsetting output and input side incentives-disincentives. Regarding producers,
incentives or disincentives can be generated both from the output side and the input side. As
usually the producer is not interested in the value of output per se, but in the margins he gets
from his/her economic activity, incentives from the output side may be partially, fully or more
than fully offset by disincentives from the input side and vice-versa.
f) Prices versus Margins. A price level of an output does not convey any message to the
producer if taken in isolation. In addition, a price shift conveys a message re incentives and
disincentives only assuming that other things remain equal. In order to monitor incentives and
disincentives, it looks therefore more appropriate monitoring margins.
g) Incentives-disincentives in value chains. A downstream agent in a value chain may
receive by policies or missing policies incentives or disincentives to produce. Upstream
agents could be affected by these incentives-disincentives, provided that some transmission
mechanisms exist to convey incentives disincentives. This issue is particularly relevant
h) External versus domestic benchmarking. A producer may be stimulated to produce (or
to produce more) by altering its relative position w.r.t .other competitors (within or outside its
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economic system). Comparing the output price of the competitors with the production costs of
the producer allows the analyst to understand whether the producer has an incentive to
produce or not. This is the case methods based on parity (reference) prices, i.e. prices faced by
other competitors somehow adjusted to make them comparable with the production costs of
the producer, which reflect opportunity costs for the economic system. However, in absence
of the possibility to calculate parity prices, Other ways of calculating opportunity costs of
inputs and outputs need to be calculated. This is particularly relevant for detect incentivesdisincentives to producers of non-traded/non-tradables goods and services
i) Monitoring Incentives-disincentives. Identifying and monitoring policy-relevant
indicators of incentives-disincentives to produce or consume specific goods or services
implies:
1) Identifying relevant sources of incentives-disincentives to be monitored
2) Identifying appropriate indicators, develop methods and tools to calculate them,
identify data sources etc
3) setting a benchmark for these indicators
4) Repeatedly calculating those indicators in different periods
3. VCA/PAM versus OECD methodology
In the VCA-PAM methodology, incentives-disincentives to producers are highlighted as
differences (gaps) between revenues and costs, calculated at market prices and revenues and
costs calculated at “social” prices, i.e. applying prices that reflect opportunity costs and
revenues for the socio-economic system as a whole (see figure 1). A battery of indicators
usually complements the PAM, in order to help interpreting the PAM calculations.
Calculations are carried out and reported in a PAM relate to specific commodities, agents or
any other relevant aggregate of agents, such as layers or segments of specific value chains or
whole value chains1.
1
For a detailed explanation of the VCA-PAM methodology see Monke and Person (1989) and all the material on
VCA hosted in EASYpol, including the FAO-VCA software, at www.fao.org/easypol.
3
Figure 1. Classical three-row PAM
COSTS
REVENUES Tradable Inputs
1) Revenues and
costs at MarketA
Prices
2) Revenues and
costs at SocialE
Prices
3) Gap
I
PROFITS
Domestic
Factors &
Not tradable inputs
B
C
D
F
G
H
J
K
L
In the OECD methodology, as a measure of incentives to producers, Producer Support
Estimates (PSE) are calculated.
PSE ( at an aggregate level) are the sum of Market Price Support (MPS)2 and Budgetary and
Other Transfers (BOT ) i.e. aggregate and other transfers to producers from policies.
PSE = MPS + BOT
(1)
PSE can be separated into components representing different degrees of commodity
specificity (transfers to single commodities, groups of commodities, all commodities, groups
of agents).
MPS is calculated as the quantity of commodity(ies) QC times the Market Price Differential
(MPD). The market price differential is in turn the difference between the Domestic market
Price (DP) and the Border Price (BP)
MPS= QD * MPD
(2)
MPD= DP-BP
(3)
which implies that:
MPS = QD*DP – QD*BP
(4)
The (4) and the (1) help to highlight the analogies with the VCA-PAM Approach.
The PAM reported in figure 1, in its classical format at three rows: 1) Revenues and costs at
“market” prices; 2) revenues and costs at “social” prices and 3) Differences between 2) and
MPS is “the value of transfers to producers from consumers and taxpayers to agricultural producers arising
from policy measures that create a gap between domestic market price and border prices of a specific
agricultural commodity measured at farm-gate level” P.100
2
4
1), can be adapted and extended to host revenues and costs calculated with different price
configurations and to report different balances relevant for monitoring incentivesdisincentives (see the “extended PAM in figure 2).
As a first adaptation, a balance which excludes the Budgetary and OTher transfers (BOT),
can be calculated by identifying and grouping revenue and cost components originate by such
transfers (see figure 2, rows 1, 2 and 3 ). Note that the consideration of BOT may not apply at
the more disaggregated level of the analysis (say, at commodity level), as transfers may apply
only at he level of agents, geographical zones or whole value chains/sectors.
Figure 2: Extended PAM
COSTS
Profits
Price sets used/items considered
Rev.
Trad
Non-trad
1
Market Prices +BOT
A
B
C
D
2
Budget and Ot. (BOT)
3=1-2
Market P. net of BOT
4
Financ. parity price
5=3-4
Non border-policy Wedge (MPSnot pol.)
6
Reference prices OECD (OER+marg)
7=4-6
Border-Policy wedge (MPS policy)
8=2+7
Total commodity/agent/VC pol.wedge
9=2+5+7
Producer Support Estimate (PSE)
10
Social Prices (incl.extern. SER)
E
F
G
H
11=1-10
Total incentives-disincentives
I
J
K
L
Furthermore, considering the multiplicity of sources of incentives-disincentives, it looks that
domestic market prices are the resultant of various elements. Some of them are explicit price
policies, due to border taxation or other commodity-specific price policies. Other, refer to the
institutional context or the specific set-up of input and output markets. The possibility to
identify and keep track of the different sources of incentives-disincentives and their relative
weight is important in the context of a monitoring exercise. The extension of the classical
PAM framework proposed in figure 2 highlights the different sources of incentivesdisincentives by calculating two different “price wedges”: the first due to border-price
policies (and other possible policies directly altering the prices of selected commodities, see
rows 6 and 7) and the second due to all the other factors affecting domestic prices (rows 5 and
6).
The “direct-price policy” wedge is assessed using revenues, costs and margins calculated
using ,the OECD “reference” prices, i.e. a specific configuration of the Border Prices (BP)
calculated adding transport, handling, and processing margins to the CIF-FOB border price in
local currency (row 6). The “other” wedge is calculated using parity prices plus which
incorporate also the effects of “direct price” policies.
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The sum of “direct-price policy” wedge, plus the “other” wedge plus BOT provides a
configuration of the Produces Support Estimate (PSE)
Last by not least, the extended PAM hosts calculations of revenues and costs based on “Social
prices” which, at least in principle, should reflect opportunity costs and revenues for the
society as a whole (rows 10 and 11). They embody environmental and other externalities.
Missed incorporation of externalities provides an altered picture of actual incentivesdisincentives provided by the economic system to producers (and/or consumers), as costs and
revenues would not reflect actual opportunity costs to the whole socio-economic system.
Overall, the extended VCA-PAM framework and the OECD PSE approach look fully
compatible. In addition, the extended VCA-PAM approach could host the essential features of
OECD PSE approach, provided that the same criteria to calculate OECD “reference” prices
are adopted.
4. Protection pass-through in the OECD and VCA/PAM methodologies
Does a protection measure, such as a tariff, affect all agents of a given value chain equally?
And does a protection measure over one agent of a value chain, such as a subsidy, spread
proportionally over all other agents operating in the same value chain?
In this paragraph, we briefly describe how this kind of questions are addressed in the OECD
methodology and in the VCA/PAM methodology and highlight some open questions
regarding this issue.
OECD Methodology
The OECD methodology, as expounded in the PSE Manual, suggests that the price gap
between the domestic market price and the reference price be computed for a given level of
the value chain (i.e., farm gate). Then the price gap for another level can be derived either by:
(i) assuming that the price gap measured at another level of the value chain (i.e. wholesale) is
the same in absolute values, or by (ii) computing a “rate of protection” and assuming that it is
the same at all levels of the value chain. The basic idea of latter method is that rather than
inducing the same “absolute” price differential, policies affect all agents operating in the
chain in the same “degree” or “proportion”. This assumption can be made when the
assumption of competitive markets is made, but proves inaccurate when the competitive
markets assumption is removed.
VCA/PAM Methodology
In the VCA/PAM methodology, the price gap between the domestic market price and the
reference price is computed at farm gate and wholesale level by using data collected at both
levels, and no assumption is made on the transmission mechanisms of protection from an
upstream to a downstream agent. The reference price of traded commodities is computed on
the basis border prices, while for non- traded commodities the computation is done on the
basis of input opportunity costs. The non-traded commodity enters as an input in the
calculation of the PAM of the traded commodity, following a quite common assumption in
VCA/PAM methodology, i.e. that the cost of the non-traded commodity is split into its
tradable and non-tradable components, as it results from the PAM of the non-traded
commodity. However, while this assumption is consistent with the other assumptions adopted
to build PAMs, it may hide some shifts un protection between the downstream (traded) and
the upstream (non-traded) commodity. In other words, when an agent passes on some
protection to another agent in the value chain, this transfer is captured only to some extent by
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standard VCA/PAM indicators such as the Effective Protection Coefficient (EPC). Let’s show
this through an example.
Example of protection pass-through in the VCA/PAM methodology
Let’s take the value chain of sugar and consider two types of agents in the value chain:
sugarcane producer and sugar producer. We compute a PAM for each of the two agents,
adopting a quite common assumption VCA/PAM methodology, i.e. that the cost of sugarcane
enters the PAM of the sugar producer (sugarcane being one of the inputs of sugar production)
split into its tradable and non-tradable components, as it results from the PAM of the
sugarcane producer. The two PAMs are the following:
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Figure 3: Policy Analysis Matrix -baseline situation
A. Sugarcane producer
REVENUES
COSTS
Tradable
Domestic
Inputs
Factors &
Not traded
inputs
B. Sugar producer
COSTS
PROFITS
REVENUES
Tradable
Inputs
Domestic
PROFITS
Factors &
Not traded inputs
Market
Prices
120
30
80
10
Market
Prices
1000
200+30=
230
500+80+10=
590
180
Social
Prices
110
40
70
0
Social
Prices
800
200+40=
240
500+70=
570
-10
Gap
10
-10
10
10
Gap
200
-10
20
190
The numbers in blue colour derive from the PAM of the sugarcane producer.
Panel A and B of Figure 3 show that sugarcane producer and sugar producer enjoy both
higher revenues and higher profits than what they would enjoy in a perfect competition and
no policy situation. This is due to the fact that domestic market prices are higher then the
social values of both sugarcane and sugar.
Now, suppose that, all other thing staying equal, sugarcane producer is able to sell sugarcane
to the sugar producer at a higher price (i.e., 130), thus reducing the profits that the sugar
producer is making because of the policies in place/ existing market distortions (=supernormal
profits). We call this situation: “alternative scenario”. We build a PAM for the two agents
under this new scenario (Figure 4) and compute the Effective Protection Coefficient (EPC)3
(Figure 5). The EPC of the sugarcane producer in the alternative scenario is higher than that
in the baseline situation, because part of the protection of the sugar producer has been
transferred to the sugarcane producer. Surprisingly enough, this same transfer is not captured
by the EPC of the sugar producer, which in turn stays unchanged, even though the
supernormal profits of the sugar producer have decreased.
Similarly, another widely used indicator of the VCA/PAM tradition, such as the Domestic
Resource Ratio (DRC), would fail to capture this change at sugar producer level, because the
change simulated does not imply any change in the social prices.
Figure 4: Policy Analysis Matrix –alternative scenario
A. Sugarcane producer
REVENUES
3
COSTS
Tradable
Domestic
Inputs
Factors &
Not traded
inputs
B. Sugar producer
COSTS
PROFITS
REVENUES
Tradable
Inputs
Domestic
PROFITS
Factors &
Not traded inputs
Market
Prices
130
30
80
20
Market
Prices
1000
200+30=
230
500+80+20=
590
170
Social
Prices
110
40
70
0
Social
Prices
800
200+40=
240
500+70=
570
-10
Gap
20
-10
10
20
Gap
200
-10
30
180
Please note that the EPC is computed as (A-B)/(E-F).
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Figure 5: Effective Protection Coefficients: Summary table
SUGARCANE
PRODUCER
SUGAR
PRODUCER
CONSOLIDATED
VALUE CHAIN
BASELINE SCENARIO
1.29
1.37
1.37
ALTERNATIVESCENARIO-1
1.43
1.37
1.37
In conclusion, even when we release assumptions such as the “single rate of protection” or
“single absolute price gap”, we fail to capture protection transfers among agents if we apply
standard VCA/PAM indicators, such as the EPC.
The observed uneven distribution -along the value chains- of benefits stemming from policies
in place/existing market failures, suggests that the “single rate of protection” or “single
absolute price gap” be dismissed and the pass- though issue be investigated. A set of suitable
indicators (sensitive to protection transfers) should therefore be developed. As a possibly
alternative solution to be explored, the assumption of inserting the non-traded commodity in
the PAM of the traded commodity split in its non-traded and traded components could be
somehow adjusted.
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