MODULE 3. Price Incentives and Disincentives SESSION 2. Methodology for analysis

MODULE 3. Price Incentives and DisincentivesSESSION 2. Methodology for analysis

Presentation of the theoretical and empirical background of price incentive/disincentive analysis

Show the data needs for PID calculation

Demonstrate the rational using some examples

Receiving feedback from the participants.

Module objectives:

Farmers are affected by a myriad of agricultural and non-agricultural policies

The total effect can be quantified using one or several simple indicators which are comparable across time and between countries.

One of these indicators measures the support (or discouragement) that farmers face through the price they receive for their products

Due to the law of one price, the difference between domestic market prices and international benchmark price is assumed to be the result of trade and market support policy interventions

Theoretical basis of price analysis (I)

P

Q

World Price

Domestic Price

Transfer from consumers to

farmersOther transfer from consumers

S D

Market Price Differential(DP > WP)

Domestic Supply at world prices

Domestic Supply at domestic prices

Domestic Demand at domestic prices

Graphic representation of a market price differential (imported good)

World Price + Transaction costs

The previous analysis assumes that all markets in the country are free from interventions and takes observed data

Price differentials can be further examined as some of the observed data (i.e. costs, prices) can be considered “excessive” and thus shadow prices can be used.

These “excessive” costs can be the result of poor infrastructure, high processing costs, post-harvest losses or non-competitive market structures.

This allows to revisit the incentive structure and see how that would be without those interventions.

MAFAP considers both analysis and computes indicators, depending on data availability, using both sets of prices

Theoretical basis of price analysis (II)

P

Q

World Price

Domestic Price

S D

Domestic Supply at world prices

Domestic Supply at domestic prices

Domestic Demand at domestic prices

Graphic representation of a market price differential with additional analysis (imported good)

Transfer from consumers to

farmers

World Price + Transaction costs

World Price + TC + Excessive cost Transfer from consumers to Other agents

Other transfer from consumers Observed Price Differential

(DP > WP)

Price wedge(TC > Efficient TC)

The comparisons using observed prices show how market prices in the country compare to international benchmark prices

The differences will be the static wedge equivalent of policies on farmers (or any other point in the value chain) assuming efficient markets

The efficient market assumption might be too strong for an African context and observed incentives or disincentives could be significantly different if markets were efficient

Using data on shadow prices (i.e. efficient prices) allows us to see then impact of ALL policies on farmers and consider how they would be if they were modified

MAFAP focuses on policies affecting exchange rate and access costs

Theoretical basis of price analysis (&III)

DATAObserved Alterantive (shadow)

Prices A B

Access costs A B

CALCULATED PRICESObserved Reference Parity Reference

Wholesale (point of competition) Using A data Using B data

Farm gate (producer) Using A data Using B data

Theoretical basis in practice

Which indicators we will calculate (traded goods)

Price wedges

Differences between OBSERVED domestic and CALCUALTED reference prices

Can be calculated at different points along the value chain

Ratios

Wedge divided by reference price (in %)

OBSERVED PRICE WEDGE

PRICE WEDGE

PROPd Effect of trade and price support policy

PRPPd Effects of overall policy and markets

Imported products: the reference price

World MarketsQ

P(int$)

Pb(int$)

Tanzaniawh

ACwh

ROPwh

ACfg

Q

SBF

D

S

Q

P(int$)

Pb(int$)

Tariff

Tanzaniawh

ACwh

ROPwh

ACfg

Q

SBF

S

Tanzaniafg

Q Q

ROPfg

D

S

ACfgsh

RPPfg

World Markets

Imported products: the reference price

Imported product: the local market

ACfg

Q Q

SBF

Pdfg

D

Pdwh

S

Tanzaniawh Tanzaniafg

Imported product: the whole picture

Q

P(int$)

Pb(int$)

ACwh

ROPwh

ACfg

Q Q

SBF

ROPfg

D

S

S

Pdwh

Pdfg

ACfgsh

RPPfg

Tanzaniawh TanzaniafgWorld Markets

Q

P(int$)

Pb(int$)

ACwh

ROPwh

ACfg

Q Q

SBF

ROPfgD

S

S

Pdwh

Pdfg

ACfgsh

RPPfg

Observed price wedge

Price wedge

Imported product: the whole picture

Tanzaniawh TanzaniafgWorld Markets

SUMMARY & RECALL (import substitute)Benchmark price Exchang

e rateBorder Price

Border Price Access cost to wholesale

Reference parity price at wholesale

Reference price at wholesale

Access cost to farm gate

Reference parity price at farm gate Domestic price at farm gate

Domestic price at wholesale

A

B

Price wedge at farm level

Price wedge at wholesale level

+A

DATA CALCULATED

Quality and/or quantity adjustment factor


vs

vs

Observed

Shadow

DATA NEEDS

INDICATORS ANALYSIS

Data needs and issues for PID calculation

WORLD PRICE

DOMESTIC PRICE

TRANSACTION COSTS

Observed prices

Shadow prices Alternative transaction costs

Externalities

Alternative exchange rates

Alternative benchmark price

DATA NEEDS: Observed prices (I)World Price: benchmark price Serves as a benchmark as what farmers would get as a reward

for their use of production factors.

Should reflect the equilibrium price in international markets for the commodity under study.

If the product is exported by the country under consideration it should be the FOB price received by exporters

If the product is imported by the country under consideration it should be the CIF price paid by importers

Exchange rate to transform benchmark price into a border price

Border price is the benchmark price in local currency

Border price = benchmark price times exchange rate

Observed prices

CIF Price(USD/Ton)

Exchange rate (TZSH/USD)

Border Price (TZSH/Ton)

Assuming entrance via Dar es Salaam

Is it realistic to assume imports coming via Dar for all Products?

NEED: Identify data sources for CIF prices

NEED: Identify data sources for FOB prices

DATA ISSUES: Observed prices (I)

1. Non-traded: alternative approaches Is a product really not traded? Calculating wedges and indicators:

Consider a substitute product as a reference price (i.e. cassava and maize) accounting for potential quantity and quality differences

Assuming a zero wedge Calculate cost to price ratio for product and

compare to potential substitute Undertake a value chain analysis

Observed prices

World Price: benchmark price

DATA ISSUES: Observed prices (I)

1. Non-tradables: alternative approaches

2. Different entry points for imports Spatial differentiation [weighted averages / multiple

estimates]

3. Different prices during the year [seasonal variability] Temporal differentiation [weighted averages / multiple

estimates]

Observed prices

World Price: benchmark price

DATA NEEDS: Observed prices (II)Domestic Price

Reflects the price received by farmers in the country

Ideally should be a farm gate price

Obtained from national statistics, agricultural census or national panel surveys

Observed prices

Producer Price (TZSH/Ton)

Maize Production in Tanzania

Observed prices

CIF Price(USD/Ton)



DATA ISSUES: Observed prices (II)Domestic price

1. Lack of Farm Gate Price:

a. Use wholesale price as close to production area as possible corrected for access costs to the wholesale market

Farm Gate Price (FCFA/Ton)

Wholesale Price (FCFA/Ton)

Access costs farm gate – wholesale (FCFA/Ton)Minus

Calculated Farm Gate Price (FCFA/Ton)

Observed prices


1. Lack of Farm Gate Price:

a. Use wholesale price as close to production area as possible corrected for access costs to the wholesale market

b. If no access cost data is available undertake calculation at wholesale level

Observed prices


1. Lack of Farm Gate Price

2. Multiple producing areas:

a. Specific calculation for different areas

b. For aggregation use a weighted average according to production shares

Observed prices


1. Lack of Farm Gate Price

2. Multiple producing areas

3. Seasonal variability of prices:

weighted average of prices by marketed volume

time specific calculation of indicators

Selection of the most relevant marketing period

Observed prices

DATA NEEDS: Observed prices (&III)Transaction costs: access costs

Border price and farm gate price are not directly comparable as the commodity is in a different position along the value chain.

Transaction costs are named as “access costs” in MAFAP terminology and cover all costs that are involved with taking the product from one point in the value chain to another.

They are added or subtracted to the border price depending on the type of trade status of the product and where the competition between domestic and international products take place

Observed prices

CIF Price(USD/Ton)




Transaction costs Import substitute

Point of competi

tion

Access costs (TZSH/Ton)


Reference observed Price

(TZSH/Ton)

Observed prices

Assuming point of competition in Dar

FOB Price(USD/Ton)




Transaction costs Exported Good

Point of competi

tion



Reference observed Price

(TZSH/Ton)

Observed prices

Assuming point of export in Dar

DATA ISSUES: Observed prices (&III)Transaction Costs

1. Data sources:

a. Bottom-up: existing value chain analysis

Add transport costs, storage costs, handling costs and margins

b. Top-down: using domestic prices along the value chain

CIF Price – Wholesale price = access cost import port to point of competition

Wholesale price – farm gate price = access cost point of competition to farm gate

Observed prices

Transaction costs: access costs

SUMMARY DATA NEEDS: Observed prices

Observed prices

Once data is inserted the excel spreadsheet calculates three year averages for the different options

Year 2005 2006 2007 2008 2009 2010 Notes

DATA Unit Symbol trade status x x x x x x insert x for exports / m for imports

1 Benchmark price USD/TON Pb(int$) FOB Price

2 Observed Exchange Rate TZSH/USD ER0

3 Observed acess cost to point of competition TZSH/TON ACwh

4 Wholesale Price 0 Pdwh

5 Observed access cost to farm gate 0 ACfg

6 Farm gate price 0 Pdfg

DATA UNIT SYMBOL 2005 2006 2007 2008 2009 2010 Notes 2005-2007 2006-2008 2007-2009 2008-20101 Benchmark price USD/TON Pb(int$) 10.00 12.00 12.00 15.00 11.00 10.00 CIF/FOB 11.33 13.00 12.67 12.00

2 Observed Exchange Rate TZSH/USD ER0 2.00 2.50 2.50 1.50 3.00 2.50 2.33 2.17 2.33 2.33

3 Observed acess cost to point of competition TZSH/TON ACwh 4.00 3.50 3.00 3.50 3.00 2.50 3.50 3.33 3.17 3.00

4 Wholesale Price 0 Pdwh 25.00 40.00 38.00 34.00 40.00 35.00 34.33 37.33 37.33 36.33 5 Observed access cost to farm gate 0 ACfg 2.00 1.50 2.00 2.50 1.00 1.50 1.83 2.00 1.83 1.67 6 Farm gate price 0 Pdfg 20.00 38.00 35.00 30.00 35.00 32.00 31.00 34.33 33.33 32.33

Data needs and issues for PID calculation

WORLD PRICE

DOMESTIC PRICE

TRANSACTION COSTS

Observed prices

Shadow prices Alternative transaction costs

Externalities

Alternative exchange rates

Alternative benchmark price

But are markets efficient? The former analysis builds on OECD experience assuming markets are

functioning more or less efficiently. This might not be the case in many African countries.

Results based on observed data is not consistent with theoretical measures of opportunity cost nor does it show the impacts of all policies.

For this, the analyst has to have evidence that some of the data used might not be reflecting a functioning market either due to explicit policies or uneven market power distribution along the value chain and then:

Identify the alternative data source for the concept where an issue exists

Collect the data from these sources for the selected concepts for the same years that the observed data has been obtained

Shadow prices

DATA NEEDS: Shadow prices (I)Alternative benchmark price

WHEN? Benchmark price is not valid as an indicator of the price farmers would get in competitive international markets

WHY? Market power by importers of exporters of the commodity for the country leads to higher (lower) prices for imports (exports)

HOW? Imports: obtain FOB price for main source of imports and add

standard insurance and freight costs

Exports: compare to FOB prices for other countries and check for differences

Other ideas?

Shadow prices

DATA NEEDS: Shadow prices (II)Alternative exchange rate

WHEN? there is an explicit exchange rate policy in the country that means that the exchange rate is not the result of a currency free market. There is a higher (lower) price for foreign currency in secondary markets

WHY? Some countries want to have an over or under-valued currency for political reasons (i.e. control monetary flows, promote exports, etc.)

HOW? Check for exchange rate in the secondary market

Use this alternative exchange rate for calculations

Shadow prices

DATA NEEDS: Shadow prices (III)Alternative access costs

WHEN? Observed access costs are considered too high as compared to other countries in the region, transport time increases post-harvest losses, transport market is not efficient, non-transport costs are substantial. It can happen at any stage in the value chain (port to wholesale, wholesale to farmgate) and for any concept of access cost (transport, handling, storage, processing)

WHY? Lack of infrastructure, lack of competition, lack of rule of law.

HOW? Check literature for analysis of transport costs in the country

Obtain data from ad-hoc studies or compare with costs in neighboring countries.

Shadow prices

CIF Price(USD/Ton)




Transaction costs Import substitute

Point of competi

tion



Reference Parity Price (TZSH/Ton)

Observed prices

Assuming point of competition in Dar

FOB Price(USD/Ton)




Transaction costs Exported Good

Point of competi

tion



Reference ParityPrice (TZSH/Ton)

Observed prices

Assuming point of export in Dar

DATA NEEDS: Shadow prices(&IV)Externalities

WHEN? The production technology of the commodity is directly related to a negative or positive effect outside the farm (i.e. increased water pollution, enhanced biodiversity).

WHY? Equivalent to a quality difference between the domestic and the reference product.

HOW? Identify if there are any major externalities associated with the

production of the commodity in the country which are not present in the areas which set the benchmark price.

Obtain from the literature a monetary estimate of the externality.

Shadow prices

Year 2005 2006 2007 2008 2009 2010

DATA Unit Symbol trade status x x x x x x

1 Benchmark price XXX/TON Pb(int$)

2 Observed Exchange Rate YYY/XXX ER0

3 Observed acess cost to point of competition YYY/TON ACwh

4 Wholesale Price YYY/TON Pdwh

5 Observed access cost to farm gate YYY/TON ACfg

6 Farm gate price YYY/TON Pdfg

1b Adjusted benchmark price XXX/TON Pbalt

2b Shadow exchange rate YYY/XXX ERsh

3b Shadow access cost to point of competition YYY/TON ACwhsh

5b Shadow access cost to farm gate YYY/TON ACfgsh

7 Externalities associated w ith production YYY/TON E

SUMMARY DATA NEEDS: Shadow prices

Shadow prices

As for observed data, once data is inserted the excel spreadsheet calculates three year averages

OTHER ISSUESAssuring that same is compared to same Quality: if domestic commodity is not directly comparable to

internationally traded good there needs to be a quality adjustment for the calculation of the reference price (i.e. if local quality is lower the reference price needs to be reduced).

When: there is a different price in the market for local and imported commodity.

Quantity & Processing: if good purchased to the farmer and good traded internationally is not exactly the same (i.e. sugar cane – sugar) there needs to be a quantity adjustment for the calculation of the reference price (i.e. two units of sugar cane per unit of sugar) plus access costs need to consider processing margins:

When: farm gate price and reference price do not refer to the same product

OTHER ISSUESIntroducing commodity specific public expenditure MAFAP also will study the public expenditure in agriculture

Some of the public expenditure will be commodity specific

This expenditure can be added to the monetary measure of incentives or disincentives provided by prices

Avoiding the impact of inflation Different inflation rates in world and domestic markets influence calculations

For ratios this is not an issue as this effect is cancelled out

However for wedges and overall price support the difference between nominal and real terms does affect results

Annual results are reported as three year averages in nominal terms, comparisons across time are done in real terms or using relative indicators

SUMMARY DATA NEEDS

Shadow prices

The Excel sheet is now ready for computing the indicators

If observed prices are considered efficient or there is no alternative data source data does not need to be inputted

Year 2005 2006 2007 2008 2009 2010 Notes

DATA Unit Symbol trade status x x x x x x insert x for exports / m for imports

1 Benchmark price XXX/TON Pb(int$) 197.00 1,480.05 248.00 1,565.11 358.00 FOB Price

2 Observed Exchange Rate YYY/XXX ER0 1,251.90 178.37 1,196.31 158.23 1,409.27 3 Observed acess cost to point of competition YYY/TON ACwh

4 Wholesale Price YYY/TON Pdwh 251,137.50 201,386.00 345,386.67 407,404.17 340,965.00 5 Observed access cost to farm gate YYY/TON ACfg 49,046.67 36,530.17 69,815.83 114,328.33 43,280.83 6 Farm gate price YYY/TON Pdfg 202,090.83 164,855.83 275,570.83 293,075.83 297,684.17

1b Adjusted benchmark price XXX/TON Pbalt

2b Shadow exchange rate YYY/XXX ERsh

3b Shadow access cost to point of competition YYY/TON ACwhsh

5b Shadow access cost to farm gate YYY/TON ACfgsh 38,247.77 28,487.10 54,444.07 89,155.99 33,751.44 7 Externalities associated w ith production YYY/TON E8 Budget and other product related transfers YYY/TON BOT 20.00 From PE Analysis

Quantity conversion factor (border - w holesale) Fraction QTwh

Quality conversion factor (border - w holesale) Fraction QLwh

Quantity conversion factor (w holesale - farm gate) Fraction QTfg

Quality conversion factor (w holesale - farm gate) Fraction QLfg

INDICATORS

ANALYSIS

Reference observed and parity prices With the inputted data we can calculate 3 main prices:

Border price: Benchmark price in local currency [Pb(int$) * ER]

Reference price at point of competition: border price plus or minus access costs to point of competition

IMPORT: Pb(loc$) + Acwh

EXPORT: Pb(loc$) - Acwh

Reference price at farm gate: reference price at point of competition plus or minus access costs to farm gate

IMPORT & EXPORT: RPwh – Acfg

Depending whether observed or shadow data is used these prices are labeled OBSERVED or PARITY.

If no data is available for shadow concepts Excel sheet uses observed data

Indicators (I) Wedges are the difference between the observed prices and the reference

(observed or parity) prices

If observed data is used the are called observed wedges while if shadow data is used the are just called wedge

At wholesale level (point of competition): Pdwh - RPwh

At farm gate: Pdfg – RPfg

The ratios between the wedge and the reference price are:

If using observed data: OBSERVED RATE OF PROTECTION

If using shadow data: NOMINAL RATE OF PROTECTION

Nominal Rate of Assistance: price wedge plus budget and other transfers.

fg

fgdfg

ROPROPP

fg

fgdfg

RPPRPPP

Indicators (II) The difference between the “observed wedges” and the “wedges” can be split into

the different components for which shadow data is inputted:

These decomposition considers the difference between observed and shadow access costs, benchmark price and exchange rate

A. Access cost wedge to point of competition (impacts of market structure between wholesale markets and point of export or import)

Imported good: observed access costs minus shadow access costs

Exported good: - (observed access costs minus shadow access costs)

B. Access cost wedge to farm gate (impacts of market structure between wholesale markets and farm gate)

- (Observed access costs minus shadow access costs )

Indicators (III) Exchange rate and benchmark price have a combined effect thus the direct

difference does not allow an additive decomposition of the difference in wedges.

International markets wedge: covers the impact of distorted benchmark price isolated from the potential impacts of exchange rate policy

Exchange policy wedge: covers the impact of exchange rate policy isolated from the potential impacts of distorted benchmark price

Externality wedge: the value inputted for externalities with changed sign

whwhsh

bbalt QLQTERERPP

2

0$)(int

whwhbbalt

sh QLQTPP

ERER

2$)(int

0

Indicators (IV)

fgfgwhwhfgwhfgfg QLQTROPRPPEWACWACWERPWIRWOPWPW 1

If all data is only available as observed or the different markets are assumed to be efficient then:

fgfg OPWPW

Name of product Type of good importInternational currency USD Local currency TZSH

DATA Unit Symbol 2005 2006 2007 2008 2009 2010 Notes1 Benchmark price USD/TON Pb(int$) CIF Price

2 Observed Exchange Rate TZSH/USD ER0

3 Observed acess cost to point of competition TZSH/TON ACwh

4 Wholesale Price TZSH/TON Pdwh

5 Access cost to farm gate TZSH/TON ACfg

6 Farm gate price TZSH/TON Pdfg

1b Adjusted benchmark price USD/TON Pbalt

2b Shadow exchange rate TZSH/USD ERsh

3b Shadow access cost to point of competition TZSH/TON ACwhsh

5b Shadow access cost to farm gate TZSH/TON ACfgsh

7 Externalities associated w ith production TZSH/TON E8 Budget and other product related transfers TZSH/TON BOT From PE Analysis

Quantity conversion factor (border - w holesale) Fraction QTwh

Quality conversion factor (border - w holesale) Fraction QLwh

Quantity conversion factor (w holesale - farm gate) Fraction QTfg

Quality conversion factor (w holesale - farm gate) Fraction QLfg

CALCULATED PRICES Unit Symbol 2005 2006 2007 2008 2009 2010 Formula

Border Price9 Observed TZSH/TON Pb(loc$) - - - - - - [1]*[2]

10 Parity TZSH/TON Pb(loc$)sh - - - - - - [1]*[2]Reference Price at w holesale

11 Observed TZSH/TON ROPwh - - - - - - [9]+[3]12 Parity TZSH/TON RPPwh - - - - - - [10]+[3]

Reference Price at Farm Gate 13 Observed TZSH/TON ROPfg - - - - - - [11]-[5]14 Parity TZSH/TON RPPfg - - - - - - [12]-[5]

INDICATORS Unit Symbol 2005 2006 2007 2008 2009 2010 Formula

15 Observed price w edge at w holesale TZSH/TON OPWwh - - - - - - [4]-[11]16 Price w edge at w holesale TZSH/TON PWwh - - - - - - [4]-[12]17 Observed price w edge at farm gate TZSH/TON OPWFG - - - - - - [6]-[13]18 Price w edge at farm gate TZSH/TON PWfg - - - - - - [6]-[14]19 Observed rate of protection at w holesale % ORPwh #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! [15]/[11]20 Nominal rate of protection at wholesale % NRPwh #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! [16]/[12]21 Observed rate of protection at farm gate % ORPfg #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! [17]/[13]22 Nominal rate of protection at farm gate % NRPfg #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! [18]/[14]23 Nominal Rate of assistance % NRA #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! [18]+[8]

Distribution of price wedge Unit Symbol 2005 2006 2007 2008 2009 2010 Formula24 International markets w edge TZSH/TON IRW - - - - - - - 25 Exchange policy w edge TZSH/TON ERPW - - - - - - - 25 Access costs w edge to point of competition TZSH/TON ACWwh - - - - - - - 27 Access costs w edge to farm gate TZSH/TON ACWfg - - 28 Externality w edge TZSH/TON EW - - - - - - -

Total values Unit Symbol 2005 2006 2007 2008 2009 2010 Formula

29 Production volume tons 100030 Market price support YYY - [17]*[29]31 Alternative price support YYY - [18]*[27]

SUMMARY & RECALL (import substitute)Benchmark price Exchang

e rateBorder Price







A

B



+A

DATA CALCULATED



SUMMARY & RECALL (export good)Benchmark price Exchang

e rateBorder Price







Domestic price at port of export

A

B



+A

Price wedge at border

+B

DATA CALCULATED



ANALYSIS

What do the indicators mean If price wedge is positive

Farmers are receiving a price that is higher than the one that they would receive in international markets

The overall policy context incentivizes production If the price wedge is negative

Farmers are receiving a price that is lower than the one they would receive in international markets

The overall policy context dis-incentivizes production BUT we have two sets of indicators......

Potential situationsPrice Wedge

>0 <0

Observed Price Wedge

>0 I II

<0 III IV

Session 4 will deal with how to interpret these cases

TAKE AWAY MESSAGE Incentives and disincentives are calculated using international

prices as benchmarks Data is needed for two main concepts: prices and access costs Observed data assumes markets are efficient, shadow data tries to

reflect the effect of potential inefficiencies All data has to be documented [source, assumptions, etc] The analysis is done after you know the value chain through a

Value Chain Analysis. This provides the necessary information to understand how to

correctly implement the methodology

AN EXAMPLE: A) IMPORT SUBSTITUTE

EXAMPLES

AN EXAMPLE: B) EXPORTED GOOD

EXAMPLES

AN EXAMPLE: C) NON-TRADED

EXAMPLES

Thank you!

Documents

MODULE 3. Price Incentives and Disincentives SESSION 2. Methodology for analysis