Jump to ContentJump to Main Navigation
Agricultural Input SubsidiesThe Recent Malawi Experience$

Ephraim Chirwa and Andrew Dorward

Print publication date: 2013

Print ISBN-13: 9780199683529

Published to Oxford Scholarship Online: January 2014

DOI: 10.1093/acprof:oso/9780199683529.001.0001

Show Summary Details
Page of

PRINTED FROM OXFORD SCHOLARSHIP ONLINE (www.oxfordscholarship.com). (c) Copyright Oxford University Press, 2019. All Rights Reserved. An individual user may print out a PDF of a single chapter of a monograph in OSO for personal use. date: 21 November 2019

Agricultural input subsidies: changing theory and practice

Agricultural input subsidies: changing theory and practice

Chapter:
(p.15) 2 Agricultural input subsidies: changing theory and practice
Source:
Agricultural Input Subsidies
Author(s):

Ephraim Chirwa

Andrew Dorward

Publisher:
Oxford University Press
DOI:10.1093/acprof:oso/9780199683529.003.0002

Abstract and Keywords

Agricultural input subsidies were a major feature of agricultural development policies in rural economies from the 1960s to 1980s. The theoretical case for agricultural subsidies is based on their promotion of agricultural productivity by making investment in new technologies more attractive to smallholder farmers. If market failures mean that farmers’ private input costs are higher than true social or economic costs then a subsidy can generate a positive overall net economic return. However, there have been concerns related to inefficiency, leakages, and diversion of subsidized inputs. Despite these concerns there is resurgent interest in input subsidies in Africa, with new ‘smart’ input subsidies, particularly for staples, being viewed as one means of achieving food security and pro-poor growth as well as replenishing soil fertility. This chapter develops the theoretical underpinnings of ‘smart’ agricultural input subsidies, their pros and cons, and their roles in agricultural development in low income countries.

Keywords:   input subsidies, agricultural development, smart subsidies

2.1. Introduction

This chapter sets the scene and identifies critical issues addressed in the rest of the book by setting out evolving understandings on agricultural input subsidies in low income countries. We begin with a summary of conventional economic theories regarding agricultural input subsidies’ potential benefits and of the difficulties experienced in realizing these. This leads on to consideration of different theoretical and practical challenges to conventional criticisms of input subsidies. The chapter concludes with a conceptual framework that sets out key elements and processes linking input subsidies’ design, implementation, and impacts—a framework that underpins the structure and content of the rest of the book.

2.2. ‘Conventional’ input subsidies in agricultural development—theory and practice

Large-scale (so called universal) agricultural input subsidies were a common and major feature of agricultural development policies in poor rural economies from the 1960s to the 1980s. They were generally implemented as ‘across the board’ price subsidies accessible to all producers, or to all producers of a particular category. If they were sold through a state monopsony then there were common attempts at price discrimination, with, for example, only smallholder farmers supposed to purchase subsidized fertilizer and forbidden from selling it on. Fertilizer subsidies were particularly expensive and made heavy and growing demands on government budgets as they stimulated increased fertilizer consumption (and hence increased volumes of fertilizer (p.16) subsidy) while political pressures also led to pressures for the subsidy rate to increase, or at least not contract, in the face of rising fertilizer prices.

Conventional arguments for subsidies in agricultural development focused on promoting agricultural productivity by making adoption of new technologies more attractive to smallholder farmers (Ellis, 1992). The reduced costs of subsidized inputs increase their profitability and reduce the risks perceived by farmers with a limited knowledge of input benefits and of correct usage. With credit and extension services, input subsidies were supposed to help farmers implement, benefit from, and—with later subsidy withdrawal—buy and use inputs on their own: rapid learning about input use and benefits would mean that subsidies should be needed for only a short time and could be rapidly phased out. However, subsidies were often subsequently implemented more widely with pan territorial pricing to support agricultural development in more remote areas, and to counteract taxes on agriculture through export tariffs, managed exchange rates, and controls on domestic prices.

Standard economic analysis of price subsidies considers the costs and benefits of subsidies in shifting farmers’ supply curves for agricultural produce (see Figure 2.1). If there are no market failures then a subsidy of $Z per unit output increases effective producer price above the market price by $Z. If the subsidy is addressing a market failure then a subsidy of $Z per unit output will increase effective producer price above the market price by more than $Z (say $Z’). The increase in effective producer price causes a downward shift in the market price supply curve (S to S’ in Figure 2.1). This leads to an expansion in supply (from Q to Q’) and a fall in market or consumer price of the

Agricultural input subsidies: changing theory and practice

Figure 2.1. Input subsidy impacts on output supply, price, and stakeholder welfare

(p.17) product (from P to P’ in Figure 2.1, assuming that the good is a non-tradable with a downward sloping demand curve), with an increase in both producer surplus (shown in Figure 2.1 by the shaded area abcd) and consumer surplus (shown by the shaded area abef). The total cost of the subsidy is the total subsidy paid (new equilibrium quantity multiplied by the per unit subsidy, Q’.Z, shown by the shaded area dcef) plus administration costs (not shown in the graph). The total subsidy paid is greater than the sum of the increased consumer and producer welfare by a deadweight loss indicated in Figure 2.1 by the triangle bce (Siamwalla and Valdes, 1986). Under such circumstances, and even without allowing for administration costs, the subsidy leads to a net economic loss to the country and an income transfer from taxpayers to consumers and producers.

Three related points emerge from this analysis.

First, a subsidy only generates a positive overall net economic return if there is some market failure so that the downward shift in the supply curve is greater than the total cost of the subsidy (that is Z, the per unit cost of the subsidy to the government including administration costs, is less than Z’, the effective increase in output price—or reduction in per unit costs—received by producers). This may occur where farmers’ perceived private cost of inputs is higher than the true social or economic cost, and/or farmers’ perceptions of private benefits from increased input use are lower than the actual social or economic benefits.1 This may occur where

  • farmers’ lack of knowledge about input use means that their expectation of its benefits are less than the actual benefits;

  • there are learning costs, so that initial farmer returns to input use are low but will increase with experience (see, for example, Ellis, 1992; Crawford et al., 2006; Morris et al., 2007);

  • farmers’ private costs of working capital for input purchase are greater than the social cost of capital; and

  • farmers’ risk assessment and aversion in investing in input purchase and use are higher than society’s.

The first two divergences between farmers’ and society’s costs, benefits and perceptions of them, should decline with experience, knowledge, and efficiency in using inputs (and are effectively an infant industry argument), the latter two may decline with increasing farm productivity, wealth, and market integration.

Second, the size of the deadweight loss and the distribution of benefits between consumers and producers depend on elasticities of supply and (p.18)

Table 2.1. Effects of demand and supply inelasticities on consumer and producer gains and on deadweights

Perfectly elastic demand

Unitary demand

Perfectly inelastic demand

Perfectly elastic supply, shifts down

n/a

All gains to consumers, Large deadweight

All gains to consumers, No deadweight

Unitary supply, shifts down/to the right

All gains to suppliers, Large deadweight

Shared gains, Some deadweight

All gains to consumers, No deadweight

Perfectly inelastic supply (may shift to the right)

All gains to suppliers, No deadweight

Gains shared (depending on supply shift), No deadweight

n/a

demand, as shown in Table 2.1. This is important, as larger deadweight losses are associated with increasing inefficiencies, and the distribution of gains and costs between producers, consumers, and taxpayers has equity and poverty reduction impacts, depending on the relative wealth and incomes of the producers, consumers, and taxpayers concerned.

Elastic demand or supply tends to be associated with larger deadweight losses while producer and consumer shares of benefits are determined by relative supply and demand elasticities: inelastic demand is associated with larger shares of consumer surplus benefits, and inelastic supply (both price elasticity and in response to the subsidy) is associated with larger shares of producer surplus benefits. Supply and demand elasticities therefore affect both the efficiency of subsidy programmes and their equity and poverty reduction impacts (depending upon the relative wealth and incomes of affected producers and consumers). These observations are significant when linked with supply and demand characteristics of different crops in different contexts. Staple food markets in land-locked countries (with large import/export parity price differentials) tend to be associated with more inelastic demand (where prices lie between export and import parity prices). Demand tends to be more elastic for cash crops, particularly export cash crops, for traded staples and where subsidy implementation is not on a large enough scale to affect output prices (small-scale subsidies that do not significantly affect production and product prices are analytically equivalent to subsidies with highly elastic product demand: subsidy benefits are largely captured by suppliers/producers, and deadweight costs depend upon the elasticity of supply).

Third, transfers to producers can be analysed in terms of inefficiencies associated with economic rents. Rents arise in three ways. First, part of the cost of a general input subsidy goes to reducing the cost of production for produce that would be produced anyway (this is the producer surplus on produce that would be produced without the subsidy). This is an inefficient way of stimulating increased production and increased productivity, unless (p.19) there is some social or economic benefit from transferring income to producers already using the subsidised input. Second, producer transfers often end up affecting the demand for agricultural land and labour, and bid up the demand for inputs. Apparent transfers to producers may then be passed back to the suppliers of these factors of production as pure economic rents. This is not a problem if the providers of this land and labour are poor, indeed as will be argued later this can be an important way for subsidies to promote pro-poor growth. Third, where subsidized inputs are rationed (officially or unofficially), then this leads to opportunities for those controlling subsidized inputs (politicians, government officials, fertilizer suppliers, farmer organization office bearers, etc.), to divert subsidized inputs from their intended beneficiaries for a side payment or to demand payments from beneficiaries in return for provision of subsidized inputs. Economic rents mean that even if there are net economic and social gains from a subsidy (as discussed above), much of the subsidy cost may be a straight transfer from the state (or taxpayers) to producers and suppliers of land, labour, and inputs without any economic gain, with the relative shares of transfers depending on the elasticities of supply and demand.

Another concern with input subsides relates to the extent of leakages and diversion of subsidized inputs away from their intended use. This can be considered in three ways:

  1. a) Diversion between products: farmers are likely to apply inputs to the use with the greatest expected return. Fertilizers, for example, may be applied to a variety of crops. Even if subsidies are intended to expand production of the food staples consumed by poor people with inelastic demand (and benefit poor consumers with low deadweight losses), farmers may apply subsidized fertilizers to (cash) crops with more price elastic demand if these offer higher returns. Direct switching of inputs between crops or products may not be so easy for subsidized seeds, although some indirect switching may happen due to wider capital fungibility.

  2. b) Diversion from intended beneficiaries: input subsidies in developing countries have commonly been intended for smallholder rather than commercial farmers. With a general subsidy it is difficult to channel subsidized inputs to smallholders unless there are a limited number of tightly controlled supply chains, clear ways of identifying intended beneficiaries, and control of private fertilizer transactions. Use of subsidized inputs by larger scale commercial farms is likely to increase the diversion from staple food to cash crops and to less-poor producers less constrained by market failures. Similar issues arise in subsidy access between richer and poorer smallholders. (p.20)

  3. c) Cross-border leakages: these arise when subsidized inputs are sold outside the country at a discount. The value of the discount represents a straight loss from the transfer of resources outside the country, with the loss of any chance of consumer benefit or economic gain from increased input use.

The final point to note from analysis of input subsidies’ effects on product supply and demand is that the extent of supply shifts is critical in determining deadweight losses, the distribution of transfers between producers and consumers, and the extent of wider economic gains. The supply shift depends upon the technical efficiency of input use—determined by the quality and appropriateness of the inputs to the product they are used on, timing of their delivery to farmers, availability of complementary resources (for example, seed and fertilizer together, market access), and technical skills in input use.

This analysis of product supply and demand impacts of input subsidies helps to identify features of subsidies that are likely to yield more benefits and reduce the dangers of things going wrong, with additional insights into where subsidies are most likely to be useful, and into the ways that subsidies should be implemented. It suggests that inputs subsidies should be focused

  • on producers who are not using inputs because of market failures;

  • on inputs for products where they can induce a substantial supply shift (and this may also require complementary investments in, for example, other input supply, extension and output markets’ infrastructure and services); and

  • on inputs for products with inelastic demand and supply (particularly inelastic demand) among poor producers and consumers: staple grain production tends to have these characteristics in poor land-locked countries or large countries with suitable agro-ecological conditions.

Although input subsidies are directed at producers and at changing production methods and producer behaviour, this analysis emphasizes the importance of consumer benefits in addition to (or rather than) producer benefits for maximizing both economic and welfare gains from subsidies. Input subsidies should also be implemented in ways that (a) reduce deadweight losses and rents from straight transfers, (b) reduce leakages, and (c) have low administration costs. Subsidies may also be less efficient instruments if they are primarily aimed at delivering income transfers to producers and remote areas, because of high deadweight and administration costs, generation of rents, and the difficulties in developing/delivering complementary services needed for technically and economically efficient use of subsidized inputs. The distributional impacts and multipliers from expenditure on input subsidies also (p.21) need to be considered against alternative (tax and subsidy or transfer) instruments for changing income distribution and for stimulating growth.

The conclusions from the theoretical analysis above matches (and influenced) the conventional wisdom among most economists and northern policy analysts on the difficulties with input subsidy programmes. This also emphasized difficulties with

  • controlling costs, as there tend to be strong political pressures for the expansion of subsidies, and only weak pressures for their control;

  • ‘exits’, as there is strong political resistance to scaling down or termination of subsidies;

  • effectiveness of targeting of input subsidies to particular farmer types, with the problems of diversion and leakage noted above both expanding programme cost and reducing efficiency;

  • over use of inputs, or adoption of input intensive production methods, as a result of artificially low input prices;

  • regressive benefits favouring larger farmers who can afford subsidized inputs (the poorest farmers may not be able to afford inputs even where they are subsidized);

  • market distortions, and particularly parastatal involvement in subsidized input delivery, tending to crowd out and inhibit private sector investment in input supply systems and hence impede sustainable development.

These concerns led to the conventional wisdom among economists and international donors in the 1980s and 1990s that input subsidies had been ineffective and inefficient policy instruments in Africa and that they had contributed to government over-spending and fiscal and macro-economic problems. From the mid 1990s, however, this conventional wisdom was increasingly challenged, with a resurgence of interest in agricultural input subsidies in Africa, new thinking about the historical and potential roles in agricultural development, and the complementary emergence of innovative subsidy delivery systems and instruments.

2.3. Resurgent interest in input subsidies

The fundamental driver for new thinking on input (and particularly fertilizer) subsidies in Africa was concern among African politicians, NGOs, and some policy analysts about the apparent failures of liberalized policies in supporting broad-based agricultural development, particularly sustainable (p.22) intensification of staple food crop production. This was accompanied by continuing political demands for fertilizer subsidies in many countries; tensions among donors in resisting such demands (with increasing legitimacy of democratic governments in Africa and divergent donor views on subsidy merits); concerns about declining soil fertility, agricultural stagnation, and rural poverty in Africa; and identification of input subsidies as a potential instrument for social protection policies.

These concerns led to interest in the potential for input subsidies to deliver a wider range of (sometimes unstated) objectives than those formerly recognized in the conventional wisdom described earlier. These objectives included short-term private input market development, replenishment of soil fertility, social protection for poor subsidy recipients, and national and household food security (Morris et al., 2007).

There has also been considerable interest in the development of new instruments and approaches in designing and delivering input subsidies, as so called ‘smart subsidies’. Morris et al. (2007) describe 10 features of smart subsidies: ‘promoting fertiliser as part of a wider strategy’, ‘favouring market based solutions’ and ‘promoting competition’ in input supply, ‘paying attention to demand’, ‘insisting on economic efficiency’, ‘empowering farmers’, ‘involving an exit strategy’, ‘pursuing regional integration’, ‘ensuring sustainability’, and ‘promoting pro-poor economic growth’ (Morris et al., 2007: 103–4). They recognize that ‘in exceptional circumstances, poverty reduction or food security objectives may even be given precedence over efficiency and sustainability goals’ (Morris et al., 2007: 104–5). Instruments proposed for implementing smart subsidies include demonstration packs, vouchers, rationing, targeting, matching grants, and loan guarantees. For all of these the details of instrument design and implementation are critical to their success, and there is continuing concern over the problems of subsidies discussed earlier and the importance of addressing wider problems in input supply chains (Jayne et al., 2009; Minot and Benson, 2009; Bumb et al., 2011).

The interest in getting input subsidies to serve new functions and objectives, and the extent to which input subsidies are the most cost-effective way of achieving these objectives, continues to be controversial. The main text of the 2008 World Development Report on ‘Agriculture for Development’, for example, recognized all the features of smart subsides outlined above, but its summarized position was more restricted and conventional, focusing on subsidy roles as being to provide ‘sustainable solutions to market failures...through...‘market smart’ approaches to jumpstarting agricultural input markets....and underwriting risks of early adoption of new technologies to help achieve economies of scale...to reduce input prices...as part of a comprehensive strategy to improve productivity with credible exit options’ (World Bank, 2007b). (p.23)

It is, however, possible to question how important some of the objectives listed above were in successful Asian Green Revolutions (for example, replenishment of soil fertility and social protection for poor subsidy recipients) and to identify other, perhaps more important, outcomes from subsidy use in these green revolutions (see, for example, Hazell and Rosegrant, 2000) or in more recent input subsidy programmes. Such outcomes included

  • long-term ‘thickening’ of supply chains and rural markets;

  • lower staple food prices and higher wages;

  • increased real incomes for poor non-recipients as well as food-insecure recipients as a result of food price and wage changes; and

  • longer term structural changes in livelihoods and the rural and national economy with expanded domestic demand for higher value farm products and for non-farm goods and services, together with expanded supply capacity, due to release of land and labour as a result of increased staple crop productivity.

These debates, together with new insights into development processes, require an extension of the conventional wisdom on subsidies with a re-examination of:

  • the empirical record of their success and failure;

  • development opportunities and constraints facing African farmers;

  • thinking on input subsidies’ roles and objectives in development, on new design and implementation features, and on the conditions for inputs subsidies to be effective; and

  • a more holistic conceptual framework for examining the roles, instruments, and implementation of input subsidies.

We consider each of these issues in turn to provide a basis for a review of recent experience with input subsidies in Africa in the subsequent chapter.

2.4. Input subsidies’ successes, failures, and potential

The substantial success of the Green Revolution in Asian countries in driving growth and poverty and reduction is widely recognized but, implicitly or explicitly, this is often considered to have been achieved despite, rather than assisted by, input subsidies (see, for example, Economist Intelligence Unit, 2008). This position is taken despite longstanding work showing the importance of subsidies in Indonesia (see, for example, Timmer, 2004), in promoting agricultural growth in situations where subsidies should have the (p.24) greatest effect (food staples in large countries, with high physical returns from input use). Djurfeldt et al. (2005) argue that input subsidies were a critical element in Green Revolution policies across a range of Asian countries. Fan et al. (2007) estimate a significant contribution of input subsidies to growth and poverty reduction in India in the early stages of the Green Revolution but not later (although estimated returns to some other investments such as agricultural research were higher). Dorward et al. (2004a) argue that sustained (but not indefinite) input subsidies were a major part of successful Green Revolution packages, making a critical contribution to thickening and thus ‘kick starting’ markets, first within staple food supply chains and then in the wider rural economy.

Dorward et al. (2004a) also argue that later problems with input subsidies should not obscure their initial contribution to driving growth forward, and much of the pessimism about subsidies was founded on later inefficiency of Asian subsidies and African experience of such subsidies. The Berg report criticized input subsidies as a major element in inefficient and fiscally and economically unsustainable policies that distorted market incentives, blunted competitiveness and farmer incentives, and undermined growth in private sector services in Africa. Subsidized input systems may have looked good for farmers, but the theoretical problems discussed earlier were compounded by diversion and inefficiency such that actual benefits to farmers were often very limited (World Bank, 1981). However, there are African countries that implemented input subsidy systems that had initial success in raising productivity, but for varying political and economic reasons failed to sustain the fiscal investment and market systems needed to sustain benefits (for example, Zimbabwe and Malawi).

Taking these Asian and African experiences together, Dorward et al. (2009) note that while there are egregious examples of failure with state-led approaches, there are also examples of dramatic success in fostering widespread and sustained growth in smallholder food staples (as noted above). Private market-led approaches, on the other hand, have very few examples of such success, and many failures, but the failures of continued rural poverty may be more hidden from economists working with governments and businesses than macro-economic and fiscal crises. It can also be argued, however, that private market-led approaches have never been properly tried—liberalization of food markets has proved very difficult to implement consistently—and not just in Africa. This can also be seen, however, as another challenge to private market-led approaches. An exception to this was the mid-2000s growth of smallholder fertilizer use in Kenya (Ariga et al., 2008) which, while aided by special conditions which prevent its wholesale application to other countries, nevertheless carries important lessons. (p.25)

The record of input subsidies, as a major part of state-led development approaches, therefore appears to be more mixed than conventional criticisms suggest. This requires consideration of both context and programme design and implementation in appraising the potential for input subsidies as effective instruments for agricultural (and wider) development. Successful investments in input subsidies in the Asian Green Revolution cannot be simply transferred to African countries. It is important to identify situations where input subsidies could work to take opportunities and overcome constraints facing African farmers.

Poulton and Dorward (2008) and Dorward et al. (2008) consider constraints and opportunities for growth for different agricultural products in different situations in Africa and southern Africa. They suggest that while high response cereals (with roots and tubers) are the products with the greatest importance and potential for driving and/or spreading growth, they are also the crops that are most affected by interlinked challenges and failures in price instability, the price/productivity tightrope,2 and seasonal input finance provision. In terms of conventional economic theory on subsidy gains and losses (as discussed earlier in Section 2.2), these characteristics suggest that high response cereals fulfil many of the requirements for well-designed and implemented input subsidies to have a role to play in stimulating pro-poor growth:

  • the seasonal finance challenges are market failures that inhibit input use, so that the gains from subsidies addressing input affordability problems have the potential to exceed deadweight and implementation costs;

  • inelastic demand for food staples means that (a) deadweight losses should be relatively low and (b) many of the gains of producer subsidies should accrue to poor consumers—if subsidies increase production on a sufficiently large scale to lower prices—and in this way input subsidies can provide a means to address the food price/productivity tightrope;

  • they can, in the right agro-ecological conditions and with proper management, lead to substantial productivity and production increase.

This last point is important, in the context of arguments by Dorward et al. (2004a) that state interventionist approaches (including input subsidies) require (a) technologies, management, and agro-ecological conditions that generate sufficient productivity gains and (b) complementary infrastructure and institutions to support extension services and market activities. This ties (p.26) in with earlier arguments about large deadweight costs in producer-oriented subsidies in remote areas to suggest that input subsidies are more effective with favourable agro-ecological conditions for high response cereals, good market access, and higher population densities. This approach is articulated in AGRA’s thinking about prioritization of investments in ‘breadbasket areas’ in Africa (AGRA, 2008).

2.5. Input subsidies’ roles and objectives

2.5.1. Dynamic effects of subsidies on growth

The above discussion of subsidy impacts has been largely concerned with subsidies’ ‘static’ impacts on producer costs and decisions, hence on produce supply and prices and consumer welfare (the more dynamic impacts on producer knowledge of input benefits and efficient input use contributed to these static changes). There are, however, two important potential dynamic benefits of subsidies that have been given much less emphasis in conventional discussion of subsidies’ potential impacts.

First, subsidies that are effective in raising land and labour productivity (with overall increases in on-farm labour demand) and in driving down food staple prices will raise the real incomes of large numbers of poor consumers and producers, and this should expand demand for locally produced non-staple foods (horticultural and animal products) and non-farm goods and services, driving up local labour demand and wages and improving people’s nutrition.3 At the same time increasing staple crop productivity can release resources for production of the same non-staple foods (horticultural and animal products) and non-farm goods and services. These growth multipliers were critical in driving growth in Asia (Hazell and Rosegrant, 2000). Subsidies’ potential contributions to the three core development processes of ‘hanging in, stepping up and stepping out’ (Dorward, 2009a) require particular emphasis on subsidy impacts on wages and food prices for poor consumers and producers who are net food buyers (around 50% of African farmers—Barrett, 2008) as well as subsidy implementation over a longer period, to achieve structural change rather than short-term productivity gains. The focus on staple crops—and both on labour productivity in their cultivation and on (p.27) prices faced by net food buyers suggest that there can be particular benefits for women, with common gendered responsibilities in staple crop production and acquisition.

A second set of important potential dynamic benefits from input subsidies arises from their stimulation of increased input and output trade and wider economic activity (as described above) having positive spillover effects with ‘market thickening’. This happens if the greater volume of economic activity stimulated by the subsidy reduces coordination and transaction costs and risks and promotes institutional and communications and transport service and infrastructure development (see Dorward et al., 2004a, 2009; Dorward and Kydd, 2004). Dynamic effects of input subsidies on the development of input supply systems (considered below) are a specific feature of this.

These potential dynamic benefits of subsidies require longer term and stable implementation of subsidies to induce behavioural and structural change, integration of subsidy policy and implementation with other policies promoting these changes, and evaluations of subsidy programmes that take account of and ideally assess these wider indirect and dynamic impacts.

2.5.2. Soil fertility replenishment

One of the reasons put forward for implementing fertilizer subsidies is the need to combat the alarming decline in soil nutrients in many parts of Africa and the need for (and benefits of) their replenishment. Crawford et al. (2006) summarize soil fertility problems in terms of declining fallows, rapid deforestation, land degradation, and declining nitrogen, phosphate, and potassium levels in arable soils. Subsidies to promote fertilizer application may then be justified in terms of positive externalities where increased fertilizer use, higher soil fertility, and higher farm yields provide a number of benefits to society rather than to individual farmers: reductions in soil erosion and downstream flooding and siltation, in deforestation and CO2 emissions, and in soil and wider ecosystem and biodiversity loss as a result of reduced pressures to cultivate marginal and fragile land; and reductions in poverty and in rural–urban migration and hence in the wider social costs of addressing rural and urban poverty as a result of increased farm and rural incomes (Sánchez et al., 1997). It may also be argued that poverty and food insecurity cause many African farmers to place a higher value on short-term income and food production and a lower value on longer term investments in soil fertility and other types of natural capital (as compared with their value to wider society), again leading to under investment in soil fertility and a justification for subsidies to promote investments in better soil management. Negative externalities from nitrate leaching are not generally a problem with the very low rates of fertilizer application on poor farms in Africa. (p.28)

2.5.3. Effects of subsidies on input supply systems

Effective large-scale input subsidies should lead to substantial increases in volumes of inputs purchased by farmers, and this can have a number of different impacts on input supply systems and markets. We consider a number of different processes and impacts.

First, the short-run effects of an input subsidy on the input market depend upon the nature of the subsidy and on the structure of the input supply system. If the subsidy is provided to farmers this has the effect of shifting input demand upwards. Alternatively input subsidies may be provided to input suppliers (India, for example, has used fertilizer subsidies to domestic producers to develop and protect its fertilizer industry, Fan et al., 2007). The effects of this on the input market depend upon input supply elasticity, and this in turn will depend upon the structure, conduct, and performance in domestic production and imports. This varies between countries and between different kinds of inputs. Few African countries produce fertilizer, with local fertilizer suppliers either importing blends or blending particular formulations from domestic and imported raw materials. Price elasticities for imported fertilizers should be very high, unless there are either significant importation costs and limited importation capacity (as may be the case for land-locked countries, with increased input demand bidding up importation costs and revenues (rents) in transport costs) or limited competition between importers (bidding up revenues (rents) of importers). The situation is often very different with seed supply, where imports are impeded by national seed certification controls and there is limited domestic capacity in seed production, with long multiplication lead times. Short and long run supply elasticities also differ (with greater long-run elasticity with stable policies). More elastic input supply leads to more of a subsidy accruing to producers, with gains for producers and/or consumers depending on the product elasticity of supply and demand (see Dorward, 2009b, for a graphical presentation of this). More elastic input supply leads to reduced subsidy capture by input suppliers, increased benefits to producers and/or consumers, and greater development benefits.

Input subsidies can impact beneficially on input supply systems by reducing supplier margins through economies of scale across the industry and within particular suppliers (as a result of increased volumes) and/or through increased competition if increased volumes attract new entrants into input supply. These benefits should accrue to both subsidized and unsubsidized supplies of the same inputs, and expand supply and its elasticity. The extent of improvements in economies of scale and competition depend upon the nature of the inputs and their supply systems, and upon ways in which subsidized inputs are acquired and disbursed (for example, through general price support, voucher systems or direct issue with distribution involving (p.29) government institutions, input supplier cartels, or competitive input markets). Government supply is not incompatible with realization of economies of scale in subsidized input disbursement, but spillovers to unsubsidized sales are likely to be limited (unless the government also markets these) and lack of competition faced by government organizations (and by cartels) tends to undermine the achievement of such economies.

Another process by which input subsidies can impact beneficially on input supply systems is through their promotion of new relationships and forms of relationships among input sellers and buyers in poor rural areas with, for example, interlocking arrangements for linking input sellers, seasonal finance providers, and produce buyers. Again this process depends on the nature of the inputs and their supply systems, and on the ways in which subsidized inputs are disbursed. As noted earlier, this can also contribute to wider economic and market activity due to input market activities’ potential spillovers into other markets (for example, expansion of a network to sell subsidized inputs may also promote buying and selling of other commodities).

The impacts of input subsidies on input supply systems are not, however, always beneficial. Damaging effects can arise in two main ways.

First, input subsidies may create considerable uncertainty and risks for input suppliers and directly undermine incentives for private investment in input supply systems. This occurs most obviously when governments intervene directly in input markets through direct supply of subsidized inputs and/or through regulation of input markets. Direct supply of subsidized inputs by government may take away business from private suppliers if there is significant displacement of unsubsidized sales by subsidized sales, leading to unsold stocks and lower sales volumes to carry fixed costs.4 Regulation of input markets may restrict prices or volumes, or require sales of unprofitable lines or in unprofitable locations—again restricting revenues and increasing costs and risks. Inconsistent and changeable policies and interventions are particularly damaging.

Subsidies may also damage the development of input supply systems by distorting incentives so that input suppliers direct resources into competition for government contracts to supply subsidized inputs, instead of competition to expand retail sales.

The implications of this discussion are that subsidy programmes can promote input supply system development, but this needs careful consideration of input supply markets’ structure, conduct and performance, careful programme design, and long-term stable but efficiency-focused (p.30) relationships of trust between governments and private suppliers. Quick exits and unstable, changeable subsidy programmes are unlikely to induce the private sector investments necessary for supply system development. These issues are the major concerns of many subsidy analysts (for example, Crawford et al., 2006; Morris et al., 2007; Jayne et al., 2009; Minot and Benson, 2009; Bumb et al., 2011).

2.5.4. Social protection

A number of authors (for example, Morris et al., 2007) suggest that subsidies may provide an effective way of delivering social protection. Dorward et al. (2006) locate this within an evolving relationship between agricultural development and social protection policies which they characterize as (a) social protection from agriculture, (b) social protection independent of agriculture, (c) social protection for agriculture, (d) social protection through agriculture, and (e) social protection with agriculture. Input subsidies fit into (a), (d), or (e) depending upon the relative emphasis on social protection and agriculture in subsidy policy design and implementation. There seems to be little empirical review of the effectiveness of subsidies as social protection instruments: we discuss issues and evidence in Malawi later (in Chapters 6 and 7) but note here that as compared with cash transfer programmes, social protection benefits from direct input subsidy transfers are reduced in a number of ways: by targeting that is only partially effective in reaching the vulnerable and marginalized; by difficulties and costs in redeeming coupons; by the difficulties that labour- and land-scarce households have in using fertilizers; and by rents or ‘cuts’ taken by middlemen in secondary markets for coupons and inputs. Poor, labour-scarce households may also receive limited benefits from indirect subsidy impacts on wage rates. However, poor and vulnerable households should receive more benefits from indirect impacts on staple food prices and from wider growth impacts which increase the resources available for informal social protection mechanisms.

2.5.5. Input profitability

Input subsidies are just one of four ways of improving the profitability of input use, the others being (a) raising physical productivity of inputs (through adaptation of technologies and farmers’ learning how to manage them, and when—and when not—to use them); (b) reducing the costs of input purchases by increasing efficiencies (for example, in fertilizer or seed production and/or delivery systems); and (c) increasing output prices (with either high consumer prices or with subsidies funded by tax payers). As noted earlier, there are often considerable opportunities for both raising productivity and (p.31) reducing costs (Crawford et al., 2006; Morris et al., 2007; Jayne et al., 2009; Bumb et al., 2011).

As we have seen, conventional thinking on input subsidies emphasizes their role in improving the profitability of input use. While profitability constraints on input use on food crops continue to be important, the nature of these constraints has changed, and (as will be discussed later) at the same time affordability constraints have become more important.

We discuss these two changes in turn, noting that different analysis may be needed for different inputs (for example, fertilizers and seeds).

Regarding constraints to farmer purchases as a result of lack of knowledge of fertilizer benefits and their correct usage, it is generally no longer the case that most farmers are unaware of fertilizers’ benefits, indeed lack of access to fertilizer is commonly cited by farmers as a major constraint on their agricultural production. Although the extent of farmers’ direct experience of fertilizer use varies, in most areas there are farmers with direct experience of fertilizer use, and observation and reports of fertilizer use are widespread. Farmers’ ability to use fertilizers effectively and efficiently (through proper selection of fertilizer types, appropriate timing and method of application, and use of complementary investments in, for example, soil and water management and crop varieties) is more variable. Poorer farmers who do not have access to fertilizers for cash crop production may face particular problems. Input subsidy programmes continue to have a potential role in helping farmers to learn from experience here, but this requires timely provision of appropriate fertilizers supported by complementary investments in extension services and in promotion of improved soil and water management and crop varieties. Seed subsidies may have an important and more conventional ‘profitability’ role in promoting both achievement and knowledge of higher returns from fertilizer use and of higher returns from their own use in conjunction with fertilizer.

The high costs of fertilizers (as a proportion of crop production costs) mean that the (perceived and actual) profitability of their use is strongly influenced not only by physical responses to fertilizer use (discussed above) but also by relative fertilizer and crop prices. Relative global prices of crops and fertilizers have fluctuated over the last 40 years with a trend of falling relative cereal prices (Dorward, 2013). Relative domestic prices, however, will have changed in different ways in different countries. Although we cannot generalize as regards declining or increasing profitability of unsubsidized fertilizer use over the last 30 years, variability in food prices is a major issue in many countries. Risks of low food prices leading to the low profitability of fertilizer use may depress fertilizer use in less poor farmers’ production of surplus food for the market. Fears of high food prices may make fertilizer use more profitable, but use of fertilizer by poorer food deficit farmers is more likely to (p.32) be constrained by affordability arising from problems in accessing seasonal finance, to which we now turn.

2.5.6. Input affordability

As noted earlier, access to seasonal finance is widely considered to be a major constraint on input use on staple food crops, especially among poorer farmers (see, for example, Newberry and Stiglitz, 1981; Feder et al., 1985; Binswanger and Rosenzweig, 1986; Binswanger and McIntire, 1987; Dorward, 1996, 2006; Dorward et al., 2005b, 2009). We describe this in terms of difficulties with the affordability of inputs. In theory farmers can finance input purchases from farm savings, from non-farm income sources, or from borrowing. However, (particularly poorer) small farm households are rarely able to save enough to fund significant intensification, and few have access to sufficient non-farm income sources for this purpose. Credit has therefore long been recognized as a priority to support input purchases and agricultural intensification (see, for example, Feder et al., 1985) and state provision of subsidized seasonal credit services were a significant part of the bundle of subsidized services, with input provision, in successful Green Revolutions (Dorward et al., 2004a; Djurfeldt et al., 2005). Severe (and justifiable) criticism of agricultural credit programmes (for example, Adams and Vogel, 1986; Yaron, 1992) as fiscally unsustainable (with a large subsidy component and major repayment problems), and regressive (with the majority of loans going to well-connected, wealthy borrowers and limited benefits to poor households) led to their demise. The abolition of these programmes has not, however, led to their replacement by private sector and micro-finance services for staple food crop production.5

The absence of financial services allowing farmers to access credit to finance the significant costs of purchasing fertilizer means that only if subsidies lead to sufficiently large reductions in fertilizer prices for poorer farmers will they lead to increased access to fertilizers by such farmers. If subsidies lead to smaller reductions in fertilizer prices which do not make them affordable by poorer farmers then they are likely to mainly benefit less poor farmers whose use of unsubsidized fertilizer is less constrained by inability to finance their purchase. Such considerations are likely to be particularly pertinent for poorer women farmers, with particular shortages of working capital and difficulties in accessing credit and/or input subsidies. (p.33)

Dorward (2009b) examines the issue of affordability using analysis of input use, comparing marginal value products and marginal factor costs in input use in the presence of seasonal capital constraints and financial market failures. Poor households face high interest and transaction costs when borrowing short-term capital, with limited capital of their own and high opportunity costs. These capital costs lead to much higher total marginal factor costs, and lower (often zero) input use as compared with households without affordability constraints. Dorward (2012a) presents a wider review of these issues in farm household models. Both analyses show how an input subsidy which substantially reduces the capital requirements and costs of input purchase for capital-constrained households can make input purchases possible for such households. They also show, however, how there may be substantial inefficiencies if heavily subsidized inputs are made available to farmers whose unsubsidized input use is not significantly limited by capital constraints. This suggests that input subsidies’ efficiency and effectiveness in stimulating increased input use can be improved by smart subsidies that reduce the quantities of input subsidies received by less capital-constrained farmers. This can be achieved in two ways: by targeting and by rationing, topics that we consider later in this chapter and which, as we shall see in later chapters, have been major issues in the Malawi Farm Input Subsidy Programme.

An alternative and complementary perspective on the role of subsidies in overcoming affordability constraints on fertilizer use is provided in a study by Duflo et al. (2011) in Kenya. They report that a small targeted subsidy for fertilizer purchases provided shortly after harvest time is as effective in promoting fertilizer purchases among poorer households as a larger subsidy later in the season. This is because this helps farmers commit available funds to fertilizer purchase, which, once purchased, is much less fungible. This phenomenon has parallels with the popularity in Malawi of a ‘fertilizer for work’ programme as compared with food for work (Gregory, 2006; Devereux, 2006) and offers a potential alternative to, or graduation pathway away from, large-scale subsidies. Further investigation is needed, however, into the applicability of these findings in other contexts.

2.5.7. Political economy issues

Large-scale input subsidy programmes are extremely costly, represent very significant transfers to subsidy recipients, and offer opportunities for very substantial captures of rents by a variety of stakeholders (politicians, programme administrators, input suppliers, traders, and less poor farmers). Political economy difficulties with large-scale input subsidies are consequently found in almost all countries where subsidies are implemented. Thus, in OECD countries agricultural subsidies (not specifically input subsidies) are widely (p.34) recognized to be inefficient but have continued because they serve particular political interests. Input subsidies (fertilizer and electricity, for example) persist for similar reasons in many Asian countries after they have served their role of ‘kick starting’ rural growth, despite being extremely costly (Gale et al., 2005; Gulati and Pursell, 2008; JiKun et al., 2011).

Political economy difficulties can, however, be particularly problematic in poorer rural economies where (a) there are very substantial economic opportunity costs from the diversion of scarce fiscal resources to input subsidies and away from other productive investments, and (b) potential personal and political gains from subsidy rents are very large relative to other income, patronage, and rent seeking opportunities in the economy. A paradox arises because substantial political commitment is needed for large-scale input subsidies to be implemented, but the political objectives behind such commitment may often focus around or be shifted towards short-term patronage opportunities.6 Unfortunately, however, pursuit of these opportunities may undermine the economic efficiency and wider pro-poor growth benefits of input subsidies—by directing subsidies to less poor recipients with more political voice, directing subsidies towards cash crops, undermining competition and efficiency in input delivery systems, and increasing leakages and non-transparent secondary markets. These difficulties are particularly prevalent in political systems with significant neo-patrimonial elements, as is common in many poorer rural economies, particularly in Africa (Van de Walle, 1999) and may be enhanced rather than reduced by the electoral cycles of democratic government (Poulton, 2012).

Another political economy paradox arises with regard to stable, continuing, and longer term subsidies if they are to lead to supply system development and wider dynamic changes in rural economies (as discussed earlier). While this carries important benefits, it also carries important risks, as if subsidies are not set up with clear time limits and if they continue for long periods then the risks of their being politically entrenched and ‘hijacked’ are increased. Similarly, the longer subsidies are in place with stable subsidy systems, the greater the opportunities for fraud and subsidy diversion. There are therefore substantial challenges in promoting stability and trust for farmers and input suppliers while at the same time specifying clear exit mechanisms and rules (to reduce risks of political capture) and varying systems (to reduce fraud).

A key part of addressing these political economy issues is understanding the diverse legitimate and illegitimate interests and powers of different (p.35) stakeholders (for example, farmers with different livelihoods; produce buyers, sellers, and consumers; tax payers; local and national politicians; technicians; donors; input supply businesses and employees; civil society; government and private organizations and their managers; traditional leaders), as they relate to personal, local, organizational, and wider political, financial, economic, and symbolic7 constraints and objectives and promoting transparency and accountability.

2.6. Design and implementation features

2.6.1. Targeting and rationing of input subsidies

A subsidy is likely to be more economically efficient and effective if subsidized inputs are directed or targeted at farmers who otherwise would not use inputs (for example, due to affordability or risk aversion constraints) but who will make productive use of any subsidized inputs they can obtain. Dorward (2009b) extends the analysis of Figure 2.1 above to show that if poorer, capital-constrained farmers are targeted, then this increases the economic efficiency of the subsidy (as compared with a universal subsidy) and leads to a transfer from less-poor producers and tax payers to poorer producers and consumers (assuming that the subsidy is increasing production of a staple food crop and reducing its price relative to wages). The extent to which less poor producers (without the subsidy) actually lose from a fall in producer prices depends on the price fall (which depends upon incremental production among targeted famers and elasticity of demand) and upon alternative activities open to them (affecting their elasticity of supply).

The targeting of subsidized inputs to different groups or types of people is, however, a critical and sensitive issue, with significant costs and difficulties. In this it is helpful to distinguish between geographical targeting (between regions, districts, and different geographically defined communities) and intra-community targeting (between different categories of people or households within communities). Geographical differences between areas and communities are often correlated with socio-economic and cultural differences between these areas and communities. Costs of geographical targeting will generally be lower than intra-community targeting, with the relative effectiveness of these targeting approaches (in terms of inclusion and exclusion (p.36) errors) and the political tensions they cause depending on inter- and intra-community differences and social, political, and cultural factors. Targeting also commonly leads to secondary markets for inputs where recipients sell subsidized inputs to non-recipients (we discuss this issue below under leakages and diversion).

The political, economic, welfare, and equity issues associated with targeting mean that targeting criteria and methods are constrained by political concerns and practicalities (at national, regional, and community levels), by programme objectives (for example, production, growth, or social protection objectives), and by the feasibility and costs of targeting. There may be arguments for comprehensive or area targeting that delivers smaller quantities of inputs (or of entitlements to inputs) to all households or farmers in a country or area (to allow greater accountability, avoid political and financial costs of attempts at targeting, and possibly even reduce targeting errors if targeting mechanisms are very ineffective).

A final comment is needed on the relative efficiencies of input use by poor and less poor producers. It has been argued above that targeting poor producers can improve subsidies’ effectiveness in addressing market failures (reducing displacement, and increasing welfare and distributional benefits). These arguments, however, are undermined if poor producers make less efficient use of inputs than less poor producers. There is substantial empirical evidence supported by continually evolving theory that smaller, poorer farms tend to be more efficient users of land in the cultivation of labour intensive staple crops in poor rural economies, but larger farms tend to be more efficient users of land in the cultivation of capital and market-intensive higher value cash crops (Poulton et al., 2010). There is less evidence on relative efficiencies in use of inputs. Although poorer farmers are generally more efficient users of capital, this may not apply if there are increasing returns to capital with the use of purchased inputs (this may occur if input productivity is enhanced by complementary investments).

Targeting limits total subsidy volumes and costs by limiting access to subsidized inputs to a limited number of beneficiaries. Rationing also limits total subsidy volumes, by limiting quantities of subsidized input per beneficiary. Like targeting, it can be an effective way of reducing the total costs of a subsidy programme while at the same time allowing a higher per unit subsidy. Dorward (2009b) uses marginal analysis and supply and demand analysis (extending Figure 2.1) to show that rationing can also raise the efficiency of input use, with or without targeting, as there are commonly diminishing marginal benefits to increased input use. However, as with targeting, rationing is only effective where there are no (or limited) secondary markets in which recipients sell subsidized inputs to non-recipients. (p.37)

2.6.2. Entitlement and distribution systems

Any targeting or rationing system restricts access to subsidized inputs. This requires specification of entitled beneficiaries and their subsidized input entitlement, with a mechanism allowing access to that entitlement. This may involve physical distribution of inputs against lists of entitled beneficiaries, with secure identification, or separate distribution of evidence of entitlement which is then ‘redeemed’ at authorized retail outlets. Evidence of entitlement is most commonly a paper voucher, but scratch cards and electronic systems involving bank cards, electronic ‘smart’ cards, and mobile phones may also be used. Since entitlements have considerable financial value, these must be very secure to prevent counterfeit fraud and theft (with secure printing processes and print features and/or real time, secure, and centralized monitoring of allocated and redeemed entitlements). Different systems offer different potential benefits but pose different political, technical, administrative, and social challenges (biometric information, for example, raises questions about intra-household control over input subsidy entitlements; electronic systems must be able to operate in areas with no electricity, and may require reliable mobile phone network access and expensive and/or sensitive equipment).

Entitlements may be input specific (entitling the beneficiary to a particular quantity of a particular input) or flexible (allowing choice between a limited range of specified inputs). They may also be fixed value (with beneficiaries paying a top up which varies for different locations, outlets or inputs) or associated with a fixed top up (where the top up paid by the beneficiary is constant but the redemption value to the retail outlet varies). There are important interactions between types of vouchers, secondary markets, recipient choice (of inputs and suppliers), control of fraud and of programme costs, and gendered access to and control of subsidized inputs within households.

2.6.3. Programme exits and graduation

As discussed earlier, a major criticism of input subsidies has been that for a variety of reasons they tend to continue as expensive and ineffective programmes long after their initial economic and developmental justification has become irrelevant. Consequently an important feature of ‘smart’ subsidies has been an ‘exit strategy’ (Morris et al., 2007) or ‘exit options’ (World Bank, 2007b). This should involve a clear understanding of the market failures that the subsidy is intended to overcome and hence of the structural changes it is intended to promote—with regard, for example, to farmers’ knowledge of input use and its benefits, wider thickening of markets, soil fertility, input supply system development, input profitability, and/or input affordability. Such understanding should lead to the design of criteria and (p.38) processes for ‘exits’ or, to use a more nuanced term, ‘graduation’ from the use of subsidies in promoting farmers’ access to inputs to reliance on other, generally market-based, systems and processes. Graduation processes and criteria will need to consider interactions between the objectives of a programme, the particular constraints it is attempting to address, available resources, and the needs and situations of different targeting groups. We discuss this in more detail in Chapter 11.

2.7. Conditions affecting effectiveness

An effective input subsidy needs design and implementation that ensure (a) that input subsidies reach and are used by beneficiaries that would not otherwise use these inputs, and (b) that they are used efficiently and effectively to increase crop production. The design features of targeting, rationing, and entitlement and distribution systems discussed above are intended to promote (a) and, less directly, (b). We now consider three other issues affecting the reach, use, and productivity of input subsidies.

2.7.1. Leakages and secondary markets

Leakages were discussed earlier in terms of cross-crop, cross-farmer, and cross-border leakages. These are associated with the development of secondary markets where subsidy recipients sell their inputs (or input entitlements) to others, at prices normally discounted against unsubsidized inputs. Such markets may arise with targeted and rationed subsidies as a result of differences between subsidy recipients and non-recipients in access to and needs for working capital (with poorer, capital-constrained farmers selling inputs to less poor farmers) and/or differences in perceived marginal benefits to input use (with farmers with more land, for example, requiring larger quantities of inputs).

It is often argued that secondary markets should not be impeded because (a) farmers generally know what is best for them and (b) attempts to limit secondary markets generally lead to (poorer) sellers of inputs into these markets getting lower prices to the benefit of (less-poor) buyers and middlemen who capture a large share of subsidy benefits. Such arguments lead to a common related question: would it be better to give poor producers cash rather than an input subsidy and let them choose what to do with the money? This is important in the context of social protection and welfare policies’ increasing use of cash transfers to avoid the inefficiencies and leakages common in subsidy administration and secondary markets.

There are, however, significant arguments that both the provision of cash transfers and widespread secondary markets fundamentally undermine (p.39) input subsidy programmes’ wider benefits. At the heart of arguments for input subsidies are information and market failures and externalities, all of which cause individual optimizing farmers to make decisions that are sub-optimal or inefficient in meeting the goals of wider society. A well designed and effectively implemented input subsidy programme can address four interacting sets of information and market failure and externality problems together:

  • Farmers’ under-valuation of the benefits of input use to themselves as individuals and to society, as a result of inadequate information on the effects of inputs when properly used and on efficient ways to use them—an information failure.

  • Poorer farmers’ inability to obtain seasonal working and consumption capital, or ability to obtain it only at much higher cost than the social opportunity cost of such capital—a credit market failure.

  • Farmers not benefiting directly from economies of scale when increased input volumes reduce input supply costs and margins—a ‘non-pecuniary’ externality that arises from increasing returns to scale.

  • Farmers not benefiting directly from lower output prices and consequent dynamic pro-poor growth effects of subsidies which raise staple food production and productivity—a ‘pecuniary externality’.

If cash transfers replace input subsidies, or secondary markets are encouraged, then welfare transfers can be delivered more efficiently to subsidy beneficiaries (subsidy recipients and/or staple food consumers) but cash transfers are unlikely to be able to address as efficiently at least three of the four information and market failure and externality problems described above.8 Policy choices between cash transfers and input subsidies with or without constraints on secondary market operation therefore need to take account of specific policy objectives; of the nature of the informational, market, externality, and distributional problems that need to be addressed; and of alternative instruments and combinations of complementary instruments that may be used (Filipski and Taylor, 2011).

This discussion of the role of subsidies in addressing information and market failures and externalities has important implications not only for thinking and policies on secondary markets but also on farmer choice within subsidy programmes. It is sometimes argued that voucher systems (p.40) can and should be used to extend farmer choice, with fixed value vouchers being redeemable for different inputs which farmers may choose between. This empowers farmers, and allows them to use the subsidy to invest in inputs that they consider will make the largest contribution to their livelihoods. The effectiveness with which subsidies address information and market failures and externalities may, however, require some restrictions on farmer choice, to ensure that their choices align with wider social efficiency objectives.9

2.7.2. Subsistence production and net deficit producers

Our discussion of input subsidy impacts on output supply and stakeholder welfare has considered separately the subsidy impacts on output producers and consumers, linking them through market prices. This analysis is, of course, highly stylized. While there is evidence that many staple food markets in southern and eastern Africa are reasonably well integrated (Abdulai, 2007), they also tend to be characterized by high margins that inhibit exchange and incentives for surplus production (Barrett, 2008). This, together with variable staple food prices and limited off-farm income opportunities, leads to substantial subsistence production and very large numbers of African farmers who are poor deficit staple food producers and net staple food buyers (Barrett, 2008). Such farmers are both producers who can utilize an input subsidy and consumers who benefit from lower food prices.

Dorward (2009b) examines subsidy impacts on supply and demand within households and their impact on maize sales and purchases. He shows that the impacts of a subsidy on farmers will differ with the initial situation of the household as autarchic or a net buyer or seller, household composition (consumers and workers), and access to land and capital. Subsidy impacts in production and consumption by many households will not be fully reflected by changes in quantities bought and sold in food markets, and this may dampen market effects of subsidies when measured in absolute terms. However, the significant quantities of produce that are consumed within farm households without ever reaching markets also means that produce markets may be very thin, so that small percentage changes in production can lead to very large percentage changes in market supply and demand, making markets very unstable. This can be important for understanding the food market impacts (p.41) of input subsidies (and indeed of any policy or natural events that affect smallholder production).

2.7.3. Complementary integration, investments and policies

Positive impacts from input subsidies are determined by the on-farm physical productivity of inputs; by input supply system efficiency, transport and communication systems and costs; and by output market efficiency—as well as by the effectiveness and efficiency of implementation of the subsidy programme itself. Programme impacts can therefore often be enhanced by complementary investments in agricultural research and extension that can raise input productivity; by subsidies for complementary inputs (for example, seeds and fertilizers); and by investments in road, communications, and market infrastructure and service development. Changes in power relations—for example, in men’s and women’s responsibilities and control of resources—may also have critical impacts on input access and use and on direct and indirect impacts. Programme effectiveness and efficiency can also be improved by designing and implementing subsidy and other policy instruments in ways that are complementary (for example, cash transfer or cash for work programmes may be linked to subsidy entitlement systems to facilitate participation by and benefit for very poor producers; more gender aware entitlement and access systems may increase input uptake and efficiency; or subsidy entitlements may be linked to and incentivize investments in soil and water conservation). Complementary development of staple food markets is an area of complementary policy that is particularly important given the way that major subsidy benefits involve consumers’ accessing food at lower prices.

2.8. Rethinking input subsidies: a conceptual framework

We now build on the integration of conventional and newer thinking in this chapter to identify key issues that need to be considered in designing, implementing, and evaluating agricultural input subsidy programmes.

The ‘success’ of an input subsidy programme has to be judged against the objectives of that programme. As we have seen, input subsidy programmes can and do have a wide range of different possible objectives. Most of these objectives are mutually complementary but there may be incompatibilities between some objectives (for example, there are some trade-offs between consumer and producer objectives, and between efficiency objectives and some rents—even allowing for some rents being necessary for political economy purposes to allow a subsidy to be implemented). It is also important to note that stated formal programme objectives may differ from the objectives of (p.42) individual stakeholders. The balance of programme objectives should then determine the key design and implementation elements of input subsidy programmes—their focus and scale, the inputs to be subsidized, targeting and rationing systems, procurement and delivery systems, private and public sector roles, entitlement systems, graduation systems, and complementary policies and investments.

These elements have all been discussed explicitly or implicitly in earlier sections. They have suggested that input subsidies will generally (but not always) yield the greatest social and economic returns where they

  • focus on consumer benefits and on indirect gains to pro-poor economic growth from increased food staple productivity;

  • operate at a large enough scale (in terms of the number of beneficiaries, the subsidy per beneficiary and the total subsidized volumes) to lower staple produce prices and/or raise the productivity of substantial amounts of land and labour;

  • have rationing and targeting criteria and methods with entitlement and distribution systems which direct subsidized inputs to producers whose productive input use is constrained by market failures which can be overcome or substantially reduced through the subsidy; and

  • include graduation processes and criteria which encourage the achievement of structural changes which then allow the scaling down and phasing out of subsidies.

Rationing and targeting will normally be best achieved by various forms of voucher systems which enable cost-effective and timely input distribution, which support sustainable unsubsidized (commercial) input supply system development, and which limit secondary market development and leakages. Effective implementation of these various elements will normally require coordinated complementary investments and policies supporting infrastructural development, agricultural research and development, and efficient output markets offering lower and more stable staple prices to consumers.

However, as should also be clear from these sections, these elements are also highly inter-related, with many synergies and trade-offs. These interactions are most easily identified around the themes of scale and scope: large-scale subsidy programmes offer wider supply-side benefits (in input supply system development, in consumer and dynamic pro-poor growth impacts) but make effective, timely, and efficient programme management more difficult and can crowd out complementary investments needed for higher productivity of input use. Different entitlement, targeting, and rationing systems are effectively attempts to control the scale of subsidy programmes by directing limited resources to their most productive uses—but these are themselves often (p.43)

Agricultural input subsidies: changing theory and practice

Figure 2.2. A conceptual framework for investigating agricultural input subsidies’ impacts (adapted from School of Oriental and African Studies et al., 2008)

difficult and costly to implement. Indeed there is something of a paradox here, that it is in the application of targeted subsidies to input use on staple foods in poor rural areas that such subsidies both offer the greatest potential benefits and pose the greatest implementation, resourcing and coordination challenges (Dorward et al., 2009).

Figure 2.2 provides a conceptual framework that draws on the analysis and issues addressed in this chapter to identify the key variables and relationships affecting input subsidy programme impacts. It details how implementation (and its various elements) impact directly on rural households, input supply systems, and the macro-economy. Impacts on rural households can be separated into direct impacts on subsidy recipients or beneficiaries and indirect impacts on other households through the effects on the rural economy of changes in beneficiary behaviour and market activities. Direct and indirect rural economy effects, input supply system effects, and macro-economic effects all interact with and affect each other, and are also affected by and may affect other policies and processes. The figure may most easily be interpreted as an examination of short-term (say annual) effects, but longer term impacts will also arise, and may be conceptualized with a similar framework. (p.44)

Table 2.2. Critical aspects of input subsidy programmes

A

Design & implementation

A.1

Basic subsidy system (objectives, focus on consumer or producer benefits, direct recipients)

A.2

Product focus—staple foods, cash crops, etc.

A.3

Input specification

A.4

Scale—beneficiary coverage

A.5

Subsidy per beneficiary

A.6

Total volumes subsidized

A.7

Procurement systems

A.8

Voucher or other entitlement systems, distribution & input access systems & timing

A.9

Rationing—objectives, methods

A.10

Targeting—objectives, criteria & methods

A.11

Input supply systems (involvement of parastatal & /or private importers & wholesale & retail suppliers) & timing

A.12

Secondary market & leakage policies (& enforcement mechanisms)

A.13

Complementary integration & investments & policies

A.14

Timing of all activities

A.15

Private & public sector incentives, resources, roles & responsibilities

A.16

Resource allocation & mobilization (finance, personnel, transport, etc.)

A.17

Auditing systems

A.18

Consistency, adaptation across areas, years

A.19

Graduation objectives, criteria, processes, etc.

B

Outputs

B.1

Subsidized input deliveries & receipts– quantities, locations, timing, target groups

B.2

Subsidy imports & disbursement by private sector suppliers, by type & location

C

Outcomes

C.1

Incremental input use

C.2

Input leakage, displacement, diversion

C.3

Incremental production

C.4

Increased productivity

D

Impacts (short & long term)

D.1

Output price changes (producer & consumer prices)

D.2

Input price changes

D.3

Labour market changes (hired labour demand, wages)

D.4

National/household food self sufficiency/security

D.5

Input supply system

D.6

Other market changes

D.7

Rents (supplier, producer, administrative, political)

D.8

Programme benefit–cost analysis (fiscal, economic)

D.9

Opportunity costs of programme

D.10

Macro-economic effects

D.11

Welfare & growth impacts

D.12

Wider (pro-poor) economic growth

D.13

Consumer benefits—lower output prices, access (emphasis on poorer consumers?)

D.14

Producer welfare (emphasis on poorer producers?)

D.15

Input supply system development & efficiency

D.16

Soil fertility replenishment

D.17

Sustained input adoption

D.18

Sustained input use efficiency

D.19

Soil fertility management

(p.45)

This framework, along with the previous discussion, helps to identify critical aspects of subsidy programmes. These are summarized in Table 2.2. The distinctions between design and implementation, outputs, outcomes, and short- and long-term impacts should not be taken as at all precise. Design and implementation must of course take into account short- and long-term objectives and the intended logical framework linking implementation to desired outputs, outcomes, and impacts. Similarly, separations between outputs and outcomes, between outcomes and impacts, and between short- and long-term impacts are by no means clear. Nevertheless, this provides a helpful guide to the gradation between on the one hand long-term impact objectives which are influenced but not controlled by programme design and implementation, and on the other hand short-term output and (to a lesser extent) outcome objectives which are directly controlled by and the responsibility of programme designers and implementers—as a direct result of their design and implementation decisions and actions.

Figure 2.2 and Table 2.2 together set out the key issues that are examined in the remainder of this book, as we consider the recent record of agricultural input subsidies in other countries in Africa (in Chapter 3) and in Malawi in Chapters 4 to 12. They also underpin the analytical framework set out in Part II for examining the Malawi subsidy programme’s implementation and impacts.

Notes:

(1) Dorward (2009b) shows this using marginal value product and marginal factor cost analysis.

(2) The price/productivity tightrope is the dilemma in poor agrarian countries where on the one hand high food prices are needed to stimulate investment in inputs but on the other hand high prices damage poor consumers who spend a large part of their income on staple foods.

(3) Effective subsidies for staple crop production offer double benefits when staple markets are relatively isolated from international markets—with both broad-based increases in land and labour productivity and increases in real incomes for net food buyers who benefit from falling staple prices. However, the dynamic benefits of broad-based productivity increases in staple production may by themselves be very significant, even if staple markets are more open to imports and exports, with a narrower band between import and export prices reducing the scope for falling prices of staple foods.

(4) An extreme case arises if farmers do not purchase unsubsidized inputs because they expect to obtain subsidized inputs, but subsequently cannot—in such circumstances a subsidy can not only displace unsubsidized inputs but actually depress total input use.

(5) Financing of inputs for staple crop production cannot use ‘interlocking’ or contract farming mechanisms for loan recovery, mechanisms which have been and continue to be successful models for delivery of seasonal finance to non-staple producers where higher value crops give limited numbers of produce buyers incentives to invest in smallholder production (for example, Dorward et al., 1998; Jayne et al., 2009). Staple crops pose further difficulties for farmers’ consumption, rather than sale, of the product.

(6) This is not intended to suggest that there are not other less self-interested and extremely important reasons for political interest in agricultural input subsidies—these are a major focus of this book. As will be discussed, subsidies may be particularly attractive to policy makers because they can lead to quick increases in food production and in some circumstances it may also be more cost-effective to subsidize fertilizer than to pay for food imports.

(7) ‘Symbolic’ constraints and opportunities are those that while not apparently technocratically rational have significant symbolic importance. Examples include national food self-sufficiency—this may or may not be an economically efficient way of ensuring national food security, but in some countries it has significant symbolic political importance. Avoiding of weakness or devaluation of national currency is another example of a symbolic objective in some countries.

(8) One would expect cash transfers to address seasonal credit market failures, but Gregory (2006) and Dorward (2006) suggest that this may not be the case as transfers as input subsidies rather than cash may help with ‘enforced savings’ as money savings are too fungible. Observations by Duflo et al. (2011) regarding poor Kenyan farmers’ changing willingness or ability to invest in fertilizer purchase suggests further behavioural reasons for in-kind rather than cash transfers.

(9) This discussion is also relevant to suggestions that it is ‘theoretically optimal’ to address market failures directly, not through input subsidies, for example by providing credit services to poor farmers’ production of staple foods, as argued, for example, by Wiggins and Brooks (2012). Such arguments ignore both the arguments made here about input subsidies’ ability to address multiple market failures and the very great difficulties with, and lack of examples of, successful experience in providing credit services to poor farmers’ production of staple foods (Dorward et al., 2008).