Distortions to Agricultural Incentives in China Jikun Huang China Center for Agricultural Policy [email protected] Scott Rozelle Stanford University [email protected] Will Martin World Bank [email protected] Agricultural Distortions Research Project Working Paper xx, October 2006 This is a product of a research project on Distortions to Agricultural Incentives, under the leadership of Kym Anderson of the World Bank’s Development Research Group. The authors are grateful for helpful comments from workshop participants and for funding from World Bank Trust Funds provided by the governments of Ireland, Japan, the Netherlands (BNPP) and the United Kingdom (DfID). This Working Paper series is designed to promptly disseminate the findings of work in progress for comment before they are finalized. The views expressed are the authors’ alone and not necessarily those of the World Bank and its Executive Directors, nor the countries they represent, nor of the institutions providing funds for this research project. 0 Distortions to Agricultural Incentives in China The purpose of this paper is to present estimations of indicators of direct and indirect interventions of China’s government in agriculture. In order to put these indicators in context, the paper reviews China’s experience with policy reforms since the 1950s and the measures the effects of these reforms on the agriculture sector. Unfortunately, due to data constraints, we can only produce quantitative measures of distortions since the early 1980s, that is for the past 25 years. Due to the nature of China’s agricultural experience over the last six decades, this review emphasizes the sectoral and macroeconomic policies and elements of the institutional framework that have influenced the incentive framework facing the sector and factor markets. The trade- and price/marketing-policy-related changes in incentives for different products are reflected in estimated rates of government assistance (Nominal Rates of Assistance— NRAs, Direct Rates of Assistances—DRAs and consumer subsidies). The main finding of our paper is that the nature of policy intervention into China has changed dramatically over the past 25 years, propelling the agricultural sector from one characterized by high distortions to one that was relatively liberalized. In the 1980s and early 1990s (henceforth the early reform period) there were distortions in both external and domestic policies that isolated domestic producers and consumers from international markets. Importantly during the early reform period domestic marketing and pricing policies actually served to make the prices that domestic producers and consumers faced almost independent from the effects of trade policy. Because of this even in the case of an exportable commodity (e.g., rice), a commodity that appears to 0 have been subject to little distortion at the border (meaning that that the international price of rice and the free market price of rice were nearly identical), domestic pricing and marketing policies did not allow producers to reap the profits from international-level prices and instead forced farmers to sell much of their surplus to the state at an artificially low price. Hence, domestic policies levied a tax on farmers even though there was little distortion at the border. Similar dynamics characterized importable commodities (e.g., wheat and soybeans) where despite fairly high rates of protection from trade policies, consumers were still being implicitly taxed and producers were receiving much less protection than they would have had their been a free domestic market for the importable. In contrast, since the late 1980s and early 1990s (the late reform period), the liberalization of domestic markets has resulted in the reduction of distortions from domestic policies. During the late reform period the market gradually replaced the state procurement system as the primary mechanism for allocating resources and market- generated prices have become the basis of farmer production and marketing decisions. At the same time, especially in the case of importable commodities, trade policy has also become more liberalized, with distortions from border measures falling substantially. As a result, we find that by the end of the late reform period (that is, after 2000) China’s agriculture is much less distorted in two ways. First, the differences between international and domestic market prices have narrowed considerably for many commodities due to trade policy liberalization. Second, the elimination of domestic policy distortions mean that when trade liberalization allows for the increased import or export of agricultural commodities, prices in China’s domestic market change and farmers are directly affected by them. 1 In addition, we also examine the effect of input-oriented policies and exchange rate policies. We find that input-related policies have generated few distortions in the case of China since 1980. However, exchange rate policy, like changes to pricing and marketing and trade policies, has played a more important role. In the early reform era exchange rates were highly distorted and served to place an implicit tax (or reduce the amount of protection) on the agricultural economy. By the late reform era, however, exchange rate reforms gradually eliminated the distortions, reinforcing the gradual shift towards a more liberalized agricultural economy. Despite the finding that considerable liberalization has occurred due to policy reforms in both the domestic and external economy, in the mid-2000s 25 years after the beginning of reforms, there are still distortions to agriculture. In some cases, remaining distortions are mainly coming from the current tariff lines. While low in international comparisons, China’s tariffs are still providing a degree of protection for a number of importable commodities (e.g., wheat and soybeans). In the case of other importable commodities (e.g., maize), the use of export subsidies (which in fact are mostly disguised as domestic marketing, transport and storage subsidies allowed to developing countries under WTO rules) continue to keep a wedge between the domestic price in China and the international market. To more fully show these results and provide the reader with a fuller discussion of recent changes to the structure of China’s economy, the policy environment within which the changes have been occurring and the analytical approach and findings of the distortion analysis, the rest of the paper is organized as follows. In the next section (section II) we present two sets of discussion, one that examines the changes in the 2 performance of the economy and the other that reviews the policy environment and reform agenda that is occurring during the periods of change. We examine the changes for two separate time periods: the Socialist era (1950 to 1979) and the Reform era (1980 to the present). The period is split like this, not only because of the differences in performance and policy changes between the two eras, but also because in the subsequent distortion analysis, we are only able to quantify the effect of China’s liberalizing domestic and external changes after 1980. In the following section III, we discuss our quantitative approach and sources of data. The results of the distortion analysis are presented and discussed in section IV. And the final section concludes. Growth and structural change of agriculture over the past 50 years The Socialist Era: 1950-1978 Socialist policies dominated the 1950s, 1960s and 1970s in China and had a profound and complicated effect on agriculture. In this section, we briefly review the performance of the agricultural sector, laying out the successes and failures of the sector. Second, we recount the major policies—inside and outside of agriculture—that we believe are responsible for producing the outcomes that were realized during the Socialist period. Performance during the socialist period The record on the performance of agriculture in producing food and other raw materials for industry during the Socialist period is mixed and in part depends on the standard against which the sector’s performance is being judged. On the one hand aggregate trends show that agriculture played an important role in increasing food availability, especially that of staple grains (Huang et al., 2006). Between 1952 and 1978 3 total sown area only changed marginally, increasing by 6.3 percent; likewise, grain sown area was about steady, declining by 2.7 percent. Grain yields, in contrast, increased by 91 percent from 1952 to 1978, an annual growth of 2.8 percent. In the aggregate, China’s grain production rose by 86 percent, a rise of 2.5 percent per year. Indeed, the growth rate of grain production outpaced that of the population (1.9 percent), meaning that China’s agricultural sector increased per capita calorie availability during the Socialist period. While credit has to be given to leaders to increasing the absolute and per capita levels of food and agricultural raw material availability during a time that many other nations in the world were suffering from falling food production, it is hard to argue that agriculture’s performance was stellar enough as to be considered a transformative force of the Socialist-era economy. Throughout the 1950s, 1960s and 1970s, China’s consumers remained on strictly rationed diets. Coarse grains—maize, sweet potato, millet and sorghum—made up much of an average citizen’s staple food intake. Cooking oil, sugar, meat and vegetables were not available on a daily basis for the typical consumer during many years. Most telling, despite the growth, the average level of consumption in urban areas in the 1970s was still low, only 2328 calories per capita; per capita calories was less for the average rural resident—barely at the UN’s average minimum requirement of 2100). Moreover, food production systems at time also were so fragile that at time it was subject to catastrophic failure as was experienced during the famine of 1959 to 1961, a famine that killed more than 30 million people (Ashton et al., 1984). In fact, food availability became such an issue that during the late 1960s and 1970s China began to turn to international markets to supplement domestic production. Between 1973 and 1980, China imported on average more than 6 million tons of grain, 4 mostly wheat. During the peak import years, grain accounted for a large percentage (in value terms) of China’s imports. Obviously, at a time when China’s planners were trying to jump-start China’s industrialization with imported machinery and other technologies, the inability of the agricultural sector to produce enough food (not to mention for foreign exchange earnings from exports) put a drag on the nation’s development. Structural Stagnation Beyond the performance of the food production sector of the rural economy (which is at best mixed), almost everything else about the record of structural change during the first three decades of agricultural development during the People’s Republican period is negative (Huang et al., 2006). For example, the production structure of cropping showed almost no change at all. In 1952 grain accounted for 88 percent of sown area; grain was still being sown on 83 percent of the nation’s sown area in 1970. Likewise, there was little change in the structure of the agricultural sector, according to a broader definition. The value of the cropping sector as a share of total agricultural output value was 83 percent in 1952 and was still 75 percent in 1970. Perhaps of greatest importance, income per capita of rural farmers and other metrics of wealth also showed the stagnation of the agricultural sector. Despite the rise in grain output, earnings per capita in the 1970s were almost the same as they were in the mid-1950s (Lardy, 1983). Annual per capita levels of rural consumption even by 1978—nearly 30 years after the start of the Socialist era—of almost every food in an absolute sense were low—only 1.1 kilograms of edible oil and 6.4 kilogram of meat (Huang and Bouis, 2001). The poverty rate was between 30 and 40 percent. 5 The stagnation of income, given (even modest) rising output, suggests that productivity growth was low. Although data sources do not facilitate rigorous analysis of total factor productivity, there appears to have been a complete absence of productivity gain or allocative efficiency increase. In fact, the work of Stone and Rozelle (1995) and Wen (1993) support just such a conclusion. Using aggregate data, both papers end up concluding that total factor productivity growth between 1950 and 1978 was zero or close to zero. Finally, there also was almost no sign of shift in the employment structure in the economy. While other rapidly developing countries in East Asia were diversifying the sources of income of the rural population and expanding employment in the off farm sector, little was happening in China’s rural sector (Lardy, 1983). In 1957 about 84 percent of the population was in the agricultural sector; by 1970, the share of the population in the agricultural sector actually had risen to 85 percent (CNBS, 2000). In 1980 it was still 83 percent. In 1980, of the more than 400 million people in China’s rural labor force, only 4 percent had a full time off farm job (deBrauw et al., 2002). In fact, according to data on percent of population in agriculture and GDP (World Bank, 1985), for its level of income, there were more people living and working in the agricultural sector than in any other country. Socialist policies and institutions Blame for the poor performance of the agricultural sector almost certainly can be placed squarely on the shoulders of poor policy. Even while local leaders were experimenting with privatized land through an ambitious set of land-to-the-tiller policies in the early 1950s, other factions of the Socialist leadership were already developing 6 policies that were threatening the incentives embodied in private land ownership (Lardy, 1983, p17). The levels of investment believed to be required to promote industrialization were, in part, obtained through transfers from the agricultural sector. During the planning era, the prices of agricultural products were depressed to allow food to be sold at low, rationed prices to non-agricultural sector consumers. Yao (1994, p138) reports Guo Shutian’s estimates of the ‘scissors difference’—the extent to which the agricultural sector was taxed by the prices of agricultural goods being set below their market values and the prices of industrial goods being set above their market prices. These involved an estimated taxation rate of 26 percent in 1957 and 27 percent in 1978, primarily from direct taxation of the prices of agricultural goods. After the early 1950s farmers were organized into collectives and then communes, eliminating the household farm in China. The main negative effect of the communization movement was one of absence of incentives. The basic problem was that individual families were not the residual claimant of production and decision making was left to collective leadership that was not doing all of the work (Putterman, 1993). Instead, farm workers were assigned points based on tasks which were difficult to monitor. While there is a debate over the extent to which the collectives were able to motivate farmers to exert effort and attempt to increase the efficiency of production on their farms (Dong and Dow, 1993; Lin and Yang, 2000; Chang and Wen, 1995), most scholars believe that free riding and the inability to monitor agricultural labor undermined the incentives in agriculture. Socialist era pricing and marketing policies also did little to either encourage the efficient production or allocation goods and services. Prices were fixed by the state (Sicular, 1988b). Between 1962 and 1978, the price of grain remained almost unchanged, 7 being adjusted only three times, rising by a total of less than 20 percent. Input prices played mainly an accounting function as shortages kept most producers from having access to the quantities that they demanded. Marketing institutions—monopolized by government parastatals—also did not encourage the development of agriculture; there was little competition and marketing officials did not have an incentive to search out low cost or quality producers. Through plans directed by the marketing system, production was carried out based on (mostly) planned acreage, target volume, quality and variety of production. Even the ratio between home consumption and marketed surplus was stipulated. The system also served to help—at least in the short run—the state’s effort at forced industrialization by keeping down the price of staples in order to allow the state to keep wages low. Except for the amount used for the farm-households' home consumption for food, feed and seeds, all production of grains and edible oils and fiber crops was procured only by the state at quota prices for a specified (compulsory) amount (Sicular, 1988b). After the early 1960s, the state also procured any surplus production beyond the quota and home consumption at a somewhat higher above-quota price to provide an incentive to increase production. The incentives, however, were targeted at collective leaders and not the farmers on whose effort labor depended. To suppress the demand for agricultural products that were in short supply (and priced low), marketing policy also exercised tight control over food marketing in urban areas. Almost all major commodities were sold by government agencies to urban consumers and rural households in grain deficit regions at ration prices upon presentation of coupons. 8