Making Agricultural Markets Work For The Poor
Making Agricultural Markets Work For The Poor
Making Agricultural Markets Work For The Poor
Working Paper for the Renewable Natural Resources and Agriculture Team, DFID Policy Division
This paper was produced in collaboration with Andrew Dorward of Imperial College and John Farrington and Priya Deshingkar of the Overseas Development Institute, London. The authors are grateful to the UK Food Group for their additional contributions and comments. This working paper is intended to stimulate public discussion. It is not necessarily DFID or UK Government policy. September 2004
Contents
Executive summary ...................................................................................................... 3 1. What is the issue and why is it important?.................................................................. 4 2. Agriculture, growth and poverty reduction the importance of effective markets in making connections that matter for the poor.................................................................. 5 2.1 Agricultural productivity the key to poverty reduction .......................................... 5 2.2 How does increasing productivity reduce poverty? ................................................. 6 3. The role of markets in the productivity/poverty relationship ......................................... 7 3.1 Initial concepts market efficiency, coordination and failure................................... 7 3.2 The importance of effective economic coordination ................................................ 8 3.3 From states to markets: a short narrative on agricultural policy............................... 9 3.4 How can markets be made to work better? ......................................................... 12 4. Enabling transmission mechanisms and social exclusion ............................................ 15 4.1 Types of social exclusion.................................................................................... 16 4.2 How is exclusion manifested?............................................................................. 16 4.3 How does exclusion affect transmission mechanisms? .......................................... 18 4.4 Policy options for reducing the negative affects of exclusion ................................. 19 5. Closing the evidence gap ........................................................................................ 19 5.1 States and markets ........................................................................................... 19 5.2 What questions versus how questions .............................................................. 20 References ................................................................................................................ 21
Executive summary
Agricultural growth, particularly through improved productivity, is one of the principal routes to reducing poverty in developing countries. Four transmission mechanisms have been recognised, all of which depend on effective market coordination to ensure that the benefits of agricultural growth reach the poor. Making agricultural markets work for the benefit of the poor depends on: finding ways to stimulate and nurture the development of an exchange economy that promotes agricultural growth; and improving the extent and terms of access to and beneficial participation in markets for the poor. In the past, state- and market-led approaches to coordination have not been wholly successful. Responding to the two challenges above therefore means taking a new approach to market coordination. However, there is little consensus on how this might be achieved. There are two main views: 1. The market failure view suggests that liberalisation can dispense with policies that are costly and lead to corruption, and that stifle markets rather than helping them develop. According to this view, liberalisation has been either poorly or partially implemented and states continue to meddle in markets with detrimental effects. If markets are to function effectively, state intervention must be restricted to cases of market failure, mostly related to public goods. Policy prescriptions include a set of public good measures to address problems in financial markets. These include increasing investment in infrastructure, legal and market institutions and agricultural support organisations. 2. The embedded market view suggests more far-reaching policy prescriptions. This view questions the underlying logic of liberalisation and makes a case for a more significant coordination role, either for the state or for other institutions, in market coordination. Abandoning essential state functions without replacing them with private sector activity is regarded as the main reason for low and stagnating agricultural productivity. States should not only provide roads, health care, education, property rights, information and anti-monopoly regulation, etc., but should address issues of risk insurance, social capital building, intermediation and coordination between market parties. These economic analyses of the problems of market coordination make useful suggestions for what should be done the efficiency of markets. However, even where markets work well in a technical sense, exclusion (economic, political and social) can prevent the benefits of agricultural growth reaching the poor. Exclusion results in two main processes segmented markets and interlocking markets. Segmented markets occur where there is any form of non-economic discrimination including that based on gender, religion, ethnicity and caste. Interlocking occurs when immediate domestic needs lead poor households into necessary but unhealthy patronclient relationships in which they borrow from, work for and hire land from the same person. This kind of relationship tends to disadvantage poor clients, who have to accept their patrons terms and become less and less able to break out of the ensuing dependence trap.
Because they cannot engage in labour markets on an equal basis, the poor are often unable to benefit equally from increases in rural incomes resulting from agricultural productivity gains and growth. They may also be excluded from opportunities in the wider non-farm economy, particularly where there is discrimination against caste and gender. There is little evidence and experience to guide policy options for overcoming social exclusion. At the same time, encouraging anti-discrimination practices is difficult in countries where capacity is limited, and the powerful have a vested interest in maintaining the status quo. It is also important to avoid confusing the issue. Tackling discrimination and exclusion as a rights and justice issue is completely different to tackling exclusion because it causes market imperfections, thereby limiting the effects of agricultural growth on poverty reduction.
overarching issue to explore is how to 'make markets work for the poor'. This implies two key questions: 1. How can we stimulate and nurture the development of an exchange economy that promotes agricultural growth? 2. How can we improve access to and beneficial participation in markets for the poor?
relationship clearly. Thirtle et al. (2003) use data collected between 1985 and 1993 in 48 developing countries to show that for every 1% increase in recorded agricultural productivity there was a corresponding fall of between 0.6 and 1.2% in the number of people living below US$ 1 a day. No other sector of the economy shows such a strong correlation between productivity gains and poverty reduction and Thirtles conclusions are supported by a sizeable volume of literature (e.g. Lipton and Longhurst, 1989).
Lowering the cost of food for the urban and rural poor
From the mid-1960s onwards, increases in production of staple foods have comfortably outstripped population growth in most developing countries. Only in sub-Saharan Africa have food supplies not kept pace with population growth. The significant increase in per capita supply, and the relatively low elasticity of demand for basic foods, has resulted in real world market prices of the major traded grains falling more or less continuously since the early 1950s. At individual country level, increased production of food grains has often had a dramatic effect on prices. Reduced market prices have two main effects on consumers. Firstly, they enable poor households to buy food that they could not otherwise afford, thereby improving nutrition. Secondly, because poor households typically spend a high proportion of their domestic income buying food, lower prices free up household income for other needs e.g. health care and school fees. Many such households are in urban areas but there are also a significant number of rural farming households that are net consumers of cereals (i.e. they buy more than they produce), and they benefit in the same way.
have been most rapid, agriculture still provides jobs for 60% of the working population and generates 27% of GNI. Given agricultures relative dominance in the economy, it remains the most likely source of significant growth in most developing countries. More immediately, when agriculture performs well (or poorly), the impact is felt quickly, not just in the agricultural sector but also in the wider non-farm economy through the strong links (multipliers) which exist between agriculture and the rest of the economy.
deteriorate or demand may have decreased. Transactions must be reliable if investments in market participation are to take place. If farmers can sell their output this season but perhaps not (or at very different conditions) in the next, they may not find it worthwhile to invest in market transactions at all. Likewise, output buyers may not invest if delivery of produce is ensured this season but not the next. Transactions must also be sustainable: they must be attractive to encourage both transaction partners to continue. For instance, if producers are systematically exploited through low or variable price setting (due to the larger market power of buyers) producers may not be able to continue to participate in the market. From the theoretical perspective, when markets are efficient and fully coordinated, economies will be at their most efficient and will grow. Productive resources such as land, labour and capital will be allocated effectively between alternative and competing uses, specialisation will occur according to the principle of comparative advantage and the benefits of growth in one area of the economy will be effectively translated to other parts. In addition, economies will generate the maximum benefit to individuals including the poor as markets provide the vehicle through which people can engage in a growing economy. The downside is that markets rarely, if ever, work in the perfect stylised manner described above. In many situations, markets are said to fail, and the degree of market failure will determine how well the economy can grow and generate economic opportunity. When markets can approach the theoretical ideals of efficiency and coordination, they are more likely to contribute to economic growth and the generation of opportunity, including for the poor. Conversely, when markets are characterised by inefficiency and poor coordination, growth will be slow with fewer economic opportunities generated. However, experience in Africa and Asia demonstrates that coordination is unlikely to result from an invisible hand. Indeed, the Green Revolution in Asia would not have achieved such dramatic results if it had received only a light touch from the state; in fact, most countries were heavily involved in the coordination of input and output markets.
markets are poorly coordinated, farmers will be less certain of input supplies, credit, access to markets, final price and so on, and will consequently be generally less willing to invest and innovate. This is particularly true for poor farmers for whom the cost of failure is high. In such a situation, market failure impedes the pace of productivity improvement to the detriment of growth and poverty reduction. The degree of coordination in any economy is generally a function of the level of economic development. As economies become more sophisticated, the level of coordination tends to increase automatically. Developed economies are characterised by high levels of economic integration, brought about partly by infrastructure, and partly by the presence of more sophisticated economic institutions which provide a range of functions such as credit, banking and insurance. These help to link buyers with sellers through ever larger markets, creating a conducive environment for investment. Conversely, where economies are small and poorly integrated, coordination is inherently less. The concepts of market coordination and market failure have been recognised for many years (Nelson, 1956) and market failure has been identified as an impediment to realising the potential of agricultural growth to poverty reduction (Ponte, 2001). There are numerous and diverging explanations as to why markets fail and how to get them to function better, but opinions tend to diverge on the question of the role of the state. The remainder of this chapter synthesises evidence on this issue and identifies areas of debate concerning how market coordination in the agricultural sector can be achieved. Two key questions lie at the heart of such a synthesis: 1. How can we stimulate and nurture the development of an exchange economy that promotes agricultural growth? 2. How can we improve the extent and terms of access to and beneficial participation in markets for the poor?
smallholder agriculture sector. Models of intervention varied significantly between regions and crops and over time, but generally, they involved some combination of the following: provision of key inputs, including irrigation, fertiliser, seed and credit, often at subsidised rates; guaranteed markets and prices; and creation of a network of organisations including parastatals, state-sponsored cooperatives and agricultural finance organisations to administer the system of state intervention. The development and poverty outcomes of this model of state-led agricultural growth were very mixed. In some countries (mainly in Africa), large government expenditure and official development assistance focused on agriculture led to very little growth and the systems established to support agriculture became a huge drain on government budgets. In other countries (mainly in Asia), however, such state-led systems supported and produced the most dramatic and widespread processes of agricultural growth and poverty reduction seen in history. So why did the same basic policy result in such widely different results? A review of policies in successful and partially successful Green Revolution areas found that the vast majority of transformations to higher growth and productivity involved, in the early stages, government interventions to stabilise output prices and maintain them somewhere between import and export parity prices, and to subsidise input supply and credit (Dorward et al., 2004). There are, therefore, certain necessary conditions for intensive cereal-based transformations and, in addition to high yielding technologies, there must be effective input, output and financial exchange systems offering producers stable and reasonable returns to investment in improved technologies, together with reasonably secure and equitable access to land. In the successful Green Revolution, government intervention played a critical role in kick starting markets by establishing coordinated exchange systems at a critical time. However, even in these areas, parastatals tended to become inefficient and ineffective (Dorward et al., 2004).
resource cost than would have applied if these outputs had been procured from the world market. Maintaining anti-competitive and oligopolistic structures held back market entry and stifled initiative and investment. It simultaneously drained public resources, inhibited macroeconomic stabilisation and diverted public expenditure.
Liberalisation
Many of the criticisms levelled at parastatals were justified and, in Africa at least, the policy situation of the 1980s became indefensible and largely unsustainable. Consequently, donors and international agencies increasingly promoted (by more or less coercive measures) the liberalisation of economies. International donors, with government and non-government organisation (NGO) support (and opposition), encouraged privatisation or dismantling of agricultural marketing parastatals to deregulate markets and to eliminate credit, input and output subsidies. These agricultural sector reforms matched the economy-wide need for a stable and favourable macro-economic environment with reduced public expenditure. They also tied in with the removal of tariffs and controls that had led to over-valuation of exchange rates. With time, increasing emphasis was given to social action funds, which assisted the poor who were likely to suffer in the short term from the stabilisation and liberalisation processes. More recently, institutions to support markets have been developed (see for example recent World Development Reports, World Bank, 2000a). So, what was the outcome of these transformations? Unfortunately, agricultural adjustment and market liberalisation have not been widely successful in getting agriculture moving in the poor rural economies where agricultural transformation has not already occurred. The agricultural sector in least developed countries (LDCs) shows low rates of growth during the 1980s and 1990s. Indeed, negative growth rates are recorded for value added per capita over most of the period (World Bank, 2000b; FAO, 2000; Dorward and Morrison, 2000). LDC performance (which comprises mainly sub-Saharan African countries) contrasts markedly with that of Asian countries, where agricultural growth advanced ahead of population growth and labour productivity in agriculture continued to increase (World Bank, 2000b; FAO, 2000; Dorward et al., 2001). Although there is considerable heterogeneity within each region, there is a striking correspondence between patterns of agricultural growth and poverty reduction (or persistence) in recent years, with poverty incidence and severity generally falling in Asia (although only slowly in South Asia) while remaining static or even increasing in sub-Saharan Africa (Dorward et al., 2004). While few would argue that the pre-liberalisation situation could or should have been sustained, liberalisation has not delivered the substantial agricultural growth needed to drive rural poverty reduction and improve food security. Despite the benefits (such as reduced food prices for processed staples for poor consumers in southern Africa, and positive impacts in supply chains for cash crops in some countries see Poulton et al., 2004; Jayne and Jones, 1997), there has been a notable lack of success in developing input, output and financial markets that offer the attractively priced, timely and reliable services needed to intensify crop, particularly cereal, production.
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Concluding remarks
The story of agricultural market policy implementation and agricultural growth over the past 50 years or so is generally agreed, and there is consensus that growth requires: a minimum degree of good governance; a minimum level of infrastructure; labour-demanding productive opportunities arising from access to new exchange opportunities and/or new technologies for existing activities; and (more) equitable access to education, land, health services and productive resources such as water. It is not surprising that disappointment with state-led agricultural policy and recent disillusionment with liberalisation has resulted in little agreement about the face of future agricultural policy and strategy. The next section further explores the debate about what agricultural policy can and should do to improve the ways in which markets can benefit the poor.
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Similarly, the weak institutions view explains slow market development in terms of weak institutional support to market and private sector development (for example World Bank, 2002; World Bank, 2003), with cultural, political and legal factors undermining clear property rights and hence private investment incentives. Here the liberalisation agenda that attempted to avoid the problem of state failure in market interventions has run up against different problems of state failure. These concern the delivery of public goods i.e. the institutions and infrastructure needed for privatised competitive markets to operate in the challenging conditions where poverty is most intractable. The resulting policy agenda emphasises completion of the market liberalisation process, accompanied by additional (public good) measures to address problems affecting financial markets and remote producers. These additional measures include: increasing investment in infrastructure, legal and market institutions, and agricultural support organisations (research and extension); promoting smallholder production of export crops; removal of developed countries protectionism and poor countries own restrictions on external and internal trade; tackling concentrations of local power which force the poor to access markets (such as credit) on highly adverse terms; providing short-term targeted support for vulnerable groups in remote areas (e.g. safety net transfers); implementing credible and sustainable macro-economic policies; implementing institutional innovations for input credit, such as contract farming and group approaches (World Bank, 2000a); and replacing non-tradable rights to resources based on community membership with tradable property rights to land, water and buildings. The sense of working markets to which the above measures apply assumes that the problems preventing the markets from functioning adequately are relatively limited. It also assumes that the broader conditions required for markets to work are already met. These include an economic environment of labour specialisation and a monetary system, political and macro-economic stability, sufficient levels of education and social capital and so on. This may be an appropriate assumption for developed economies but, as some argue, it is not necessarily the case in developing economies.
Barriers to entry include the fixed costs associated with building trust and reputation, and those of information and knowledge acquisition. Market entry is also impeded by increasing returns to scale. Agricultural inputs are indivisible and are often characterised by economies of scale. Farmers typically need to invest beyond some threshold level in order to reap the gains of higher productivity. If most farms have very limited investment capacity, this excludes the bulk of farmers from access to technology. A cycle is triggered whereby small-scale farmers use very little fertiliser, remain focused on subsistence agriculture, which offers low returns, and cannot benefit fully from markets. Simultaneously, low demand for fertiliser prevents market entry by fertiliser suppliers. Increasing returns to scale and minimum investment thresholds also exist in marketing, particularly to foreign markets. Such scale economies may deter entry by agribusiness firms to input and output markets. When there are too few farms, or too small an output volume in any one market, returns to investment are too low to be attractive. Larger-scale farmers often deliberately attempt to sustain market imperfections by maintaining economies of scale and by building information exchange networks based around social capital, which can exclude newcomers. Non-insurable risks are another major pervasive problem. While risk levels in African agriculture are high, at least those related to natural causes (e.g. pests and diseases) and business risks (e.g. transport problems and theft) are, in principle, insurable. However, insurance markets work imperfectly and, in certain cases, have exceptionally high premiums. Several additional risks (e.g. political interference) are uninsurable.
It is typically beyond the capacity of individual market agents to ensure that all transactionenabling factors are present and there is a need for coordination by a third party. The policy implication is that markets need to be embedded in a sensible policy framework if they are to work. Policy suggestions include, but supersede, those implied by the 'market failure' view. States should not only provide roads, health care, education, property rights, information and anti-monopoly regulation. In this view, they should also address issues of risk insurance, social capital building, intermediation and coordination between market parties, and make initial investments to establish a minimum market size that will attract private players.
transnational corporations (TNCs) or associated with TNCs (United Nations 1999; cited by Yusuf, 2001). Alternative forms of transactions take place away from conventional markets and are described as hierarchies. A view is emerging in some quarters that hierarchies, rather than markets, may present the best opportunity for efficient transactions. Thus, Fafchamps (2004) argues that large organisations, or hierarchies, should become the main context for development of exchange systems, and should replace markets. Africa generally lacks such organisations; many transactions occur in open markets, not in hierarchies. The question then becomes not how to make markets work for the poor, but how to make hierarchies work for the poor.
Section 1. Where markets are poorly coordinated, transmission mechanisms also operate poorly but this is not the only factor. Social exclusion is an equally important problem that limits the extent to which transmission mechanisms enable the poor to benefit from agricultural growth.
information on opportunities and terms of employment. Poor and landless families take any work they can find locally. They are less likely to hear of more remunerative opportunities further afield and they cannot usually afford to travel for agricultural work. Women often receive between 20 and 50% less pay than men for identical work, except for low status work such as paddy weeding. In Andhra Pradesh, land markets are similarly segmented. Leasing gives households access to land with assured irrigation but many landowners prefer to lease only to their own caste. When poor and lower caste households do successfully lease land from higher castes, the terms are less favourable than those offered to higher caste households. Source: Ashley et al. (2003) Interlocking occurs when households find themselves borrowing from, working for, hiring land from and selling harvests to a single landlord/employer/moneylender. Immediate household needs may lead poor households into necessary, but unhealthy, patronclient relationships, and the resulting balance of power means that the creditors are able to impose unfair conditions on their debtors, who have no choice but to comply. Interlocking can impede entrepreneurial capacity and trap the poor in low-return activities (Figure 1). Ashley et al. (2003) comment: Interlocking markets are particularly open to abuse because the terms of all transactions are inter-related and the low returns offered are much easier to conceal from the moral and competitive scrutiny of others in society.
Figure 1: How the poor get trapped in interlocking markets Source: Ashley et al. (2003)
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Other perspectives on interlocking cast a more positive light. Deb et al. (2002) suggest that interlocking provides a risk aversion mechanism for poor households. Policies that stimulate competition between landlords and traders and that reduce the cost of information or make wage rates and interest rates more transparent can improve terms of engagement for the poor. It is more difficult for lenders and landlords to set and conceal low wage or high interest rates when they are subject to greater competition and information sharing. Governments can also help landlords and traders to increase their market share without setting poor terms for debtors in interlocked markets by encouraging investment in crop processing (Dorward et al., 1998). It is important to note that it is not just economic relationships between individuals and households that can become interlocked. Marketing parastatals in Africa during the stateled phase of agricultural policy offered credit, supplied inputs and guaranteed purchase prices to individual farmers. However, the vested interests within parastatals constitute a significant hazard for the terms of engagement of farming households (Jayne and Jones, 1997).
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to a single occupation or activity the scope for entrepreneurial activity and innovation outside agriculture is severely hampered.
development and the subsequent liberalisation processes are in danger of throwing the baby out with the bath water. In other words, it is not disputed that state-led agricultural development and state coordination of markets in the post-independence era resulted, in many cases, in market failure. However, the response perhaps should have looked more at combating poor coordination and less at getting rid of coordination completely. Emerging perspectives on the role of the state in market coordination suggest two things: 1. Given the role of agriculture in pro-poor growth, there are strong arguments for state coordination of agricultural markets, especially commodity and labour markets, to be viewed as a public good. 2. It is not only the state that can provide a coordinating role in markets. Farmers or labour organisations can contribute to overcoming price information asymmetries and the private sector, for example through TNC supply chains, may offer an alternative system of exchange. How far the states role in providing public goods should go is, however, a moot point. For some it extends to establishing an enabling macro-environment (especially political and macro-economic stability, and sufficient levels of education and social capital). For others it extends further to addressing inequalities in capital assets (including social capital), and addressing risk and vulnerability. Regarding the role of farmers and labour organisations, there has been only limited systematic review of the prospects for alternative systems of exchange to contribute to poverty reduction and further work needs to be done.
Responding to exclusion
Better coordination of markets will ensure that the poor benefit from agricultural growth because technical fixes to market coordination will not overcome exclusion by caste, class, gender, religion, etc. Thus, markets can only be made to work for the poor if there is social change to overcome exclusion. The problem is that we know little about how to achieve this and which instruments are appropriate. We do not understand the links between rights-based approaches that combat discrimination, and attempts to encourage inclusion within agriculture specifically. Finally, the manifestation of social exclusion (for example in interlocked markets) can overlap with strategies for reducing risk. The poor may trade off exploitation against risk leaving responses to exclusion and exploitation susceptible to counter-intuitive effects. Again, we understand little about how this works.
appear to revolve around how precisely to achieve or avoid given outcomes; how to, say, sustainably improve smallholder farmers access to specialized inputs and credit. Herein lies the problem, for these questions have yet to receive sustained attention from scholars and remain largely unanswered. Thus, after exploring the causes of market failure in Africa, and identifying a series of institutional constraints, Omamo makes a strong argument for focusing attention, not on what needs to be done about markets, but on the precise mechanisms and processes that need to be employed. This - the how question - he argues, should guide policy research as it will help identify appropriate responses to the problem of market coordination.
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