Post

E. Annette O. Balaoing-Pelkmans

With food security becoming an urgent concern in the middle of the pandemic, how will changes in the importation and local production of rice affect its price?

High aims for food security

It is not surprising that our government leaders would aim high as far as food security is concerned, especially in the context of the current pandemic. The Philippine government, for instance, set a target of three million metric tons (MMT) of rice exports for 2020, and around 13 MMT of local production. That these aims are high are due to two sets of facts. One, 2019 was the record year for rice imports (i.e., imports totalled to only 0.6 MMT and 0.9 MMT in 2016 and 2017, respectively and rising to 2 MMT in 2018). Two, the projected growth of around 2% in palay production is based on the average from 2010 to 2019, and therefore conceals the downward pattern from 2015 to 2019 (with the exception of 2017, where production rose to 9%).

The puzzle of 2019 farmgate prices and the COVID-19 pandemic

The aim of this post is to analyze the sharp drop of farmgate prices in 2019, the year when the Rice Tariffication Law (RTL) or Republic Act 11203 came into force. This led to the significant opening of the Philippine market, and fixes a minimum 35% tariff on imported rice. The quantitative restrictions (QRs) on rice imports are therefore abolished, and importation could be open to private traders. The main aim of the law is to address the rising inflation and make the staple crop more accessible to consumers.

As Table 1 shows, farmgate prices did drastically fall from Php 17.58 (per kilo) in 2016 to Php 15.68 in 2019. This cannot but have an impact on the incentives of farmers to plant, although PSA (Philippine Statistics Authority) data do not reveal any significant changes in quarterly patterns from 2016 to 2019. However, the question is exactly how much of the palay were milled, given the low price and the higher cost of fuel.

Going back to the puzzle of farmgate versus well-milled rice, the question is what factors drove such a huge disparity in price trends. The goal set by the RTL was to reduce prices to P38 a kilo, but while farmgate prices did fall by 22% (from 2018 to 2019), that of well-milled rice actually increased by 2% despite record import levels.

The increase of palay prices today is due to two sets of factors. One is short-term in nature and due to the obvious effects of the pandemic on global mobility of goods (affecting our rice imports as well), and the impact of the local lockdowns on labour supply and logistics.

But the second set of factors refers to more fundamental issues, which also help explain the puzzle of farmgate prices of 2019. The disparity in the impact of rice tariffication on well-milled and farmgate prices reveal the extent of the efficiency gaps between supply chains that trace their source from local sources, and those that come from abroad. The answer to the puzzle also explains why the Philippines has been a net rice importer despite the quota restrictions of the past.

The wicked problems of Philippine agriculture

The sharp fall in farmgate prices show that without the quantitative restrictions, consumers, especially, the big institutional buyers, will prefer to source their rice from imports. This is because the local supply chain is not cost efficient, and the one linked to the global supply chain is. To understand this let us look at the problem from the perspective of a lead firm in the rice value chain (typically an institutional buyer). The need to reach the level of cost efficiency that will ensure competitiveness causes lead firms to aim for the maximum volume possible in order to push down the production cost per unit of output. The cumulative process of bigger scale, greater efficiency, and productivity, which then leads to even more scale is one mechanism that drives the growth and competitiveness of a value chain. This process, in turn, is triggered by the dramatic expansion of markets (through liberalization of trade, reduction of transport costs, etc.) and technological change that permits greater specialization among producers.

There are at least two main strategies for lead firms to overcome the high transaction costs of sourcing and processing the necessary inputs in order to achieve scale economies. One is to link the local value chain to more efficient producers overseas through imports and outsourcing. The other is to link with big-scale local intermediaries who can internalize the high transaction costs further upstream in the value chain. This is indicative of the efforts of lead firms to “buy” efficiency and pay intermediaries a premium for allowing it to solve the problems caused by the institutional voids in the local market. In effect, intermediaries shield the lead firm from the consequences of market failures elsewhere in the chain, thereby capturing part of the value earned by the lead firm from the final consumers.

Focusing on local intermediaries, how are they, in turn, able to deliver that degree of efficiency needed by the lead firm? One option is to buy the inputs directly from the cheapest source, which is the smallholder. However, the high transaction costs of doing so would often lead the big intermediary to rely on local traders who charge higher prices than smallholders but shield it from the market failures further down the value chain. For example, in Dalaguete, Cebu, even local traders turn to what is known as “vegetable commissioners” who perform the tedious tasks of dealing directly with numerous smallholders, passing on the credit from the traders and buying their produce from the nearest market or consolidation point.

In the context of market and institutional failures, the value earned from the final consumers is distributed based on the power structures within the chain, which in turn, are derived from the ability to deliver efficiency and scale. For the same product and level of quality, value chains in poor countries will therefore be longer compared to those of more developed economies, because of the institutional void that attracts alternative (but relatively less efficient) transaction mechanisms and types of players.

Traders, of course, prefer to skip the big consolidators, just as smallholders would want to bypass the “commissioners,” but they cannot because of their inability to match the cost efficiency generated by the scale economies of the bigger players in the value chain. The relative cost of “selling” efficiency, or the relative transaction costs of intermediaries, increases as one goes upstream towards the smallholders. This is due to the higher risks of direct engagement with poor smallholders and operation in rural areas. Another reason is that as the scale of the transaction falls, the cost of transaction per unit of the product traded increases. In contrast, agricultural value chains in richer economies have relatively lesser layers of intermediation because of the farmers’ power to produce in greater scale, as well as their lower transaction costs thanks to the better functioning of markets and institutions.

The highest transaction costs are experienced by smallholders at the end of the value chain, where the extent of market failures is typically most severe. This is the so-called “poverty penalty,” which refers to the relatively higher costs shouldered by the poor in their participation in the value chain, compared to the other players.2 The poor’s reliance on informal credit sources means that the interest rates they face are significantly higher. In addition, the opportunity costs of spending their time in search-related activities (i.e. for better markets, more advantageous credit conditions) are higher because a great part of their effort is spent on satisfying their more basic needs.3
In the absence of markets for the goods and services needed by the poor (e.g. roads, credit, know-how, insurance from risks), the costs of participation in value chains can be prohibitive. This leads to the situation wherein smallholders are lodged in the margins of value chains, where market mechanisms do not function and transactions are largely relational: contracts are informal and smallholder incomes are dictated not by market prices, but by the nature of their relationships vis-à-vis the buyers/traders.

Middlemen are often demonized and seen as pure exploiters of the smallholders’ state of poverty. In reality, they fill in a gap in that institutional void, precisely where the support of government and all the rest of the actors in the value chain are lacking. The greater the extent of the institutional void, hence, the distance between smallholders and markets, the more important the role of middlemen becomes. Since the transaction costs closest to smallholders are highest, relatively speaking, intermediaries are left with little option but to also demand higher returns (i.e., by pushing down the price given to smallholders) and charge high interest rates, or not be active at all when the markets are too thin. The extent of non-inclusion is worsened when the determination and distribution of value is tainted by opportunistic behavior. The absence of the usual mechanisms that curb opportunism is one of the key properties characterizing institutional voids. Institutional voids characterized by the absence and weakness of market institutions therefore reinforce existing social inequalities as market access and opportunity are governed by local institutional arrangements.4

But what perpetuate, and, in fact, reinforce this non-inclusive status quo? The answer lies in the degree of efficiency generated in the value chain, creating powerful incentives to preserve the current state of affairs. As long as the value chain is perceived to be competitive, there will hardly be any private motive to rock the efficient boat of profits. When competitive pressures emerge, however, the multiple prisoner’s dilemma so characteristic of collective action problems becomes even more apparent. It is in the interest of every player in the value chain to collaborate in order to increase overall productivity, but in the absence of credible coordination mechanisms, all players choose to maximize their individual gains with the result that everybody loses.

To summarize, farmgate prices fell with respect to the prices of well-milled rice because, presented with the more efficient option of sourcing rice, consumers and buyers flocked to the more efficient (and hence, cheaper) global supply chain for rice. The extent of this gap could be proxied by the minimum tariff of 35% of rice under the RTL. Even with a 35% handicap, imported rice has managed to beat their local counterparts. Explaining the increase in the prices of well-milled rice in 2019 is complex but with the risk of over-simplification, we could attribute this to demand still overtaking supply. But because of the further loss of scale economies in the local supply chain (especially in consolidation and logistics), imports have crowded-out local suppliers. This means that the local producers no longer possess the market power (that comes with volume and scale economies) to contest the prices of imports.

The government was therefore faced with the painful trade-off between consumer and producer (farmer) interest. The high inflation of 2018 was partly the reason why imports were liberalized even at the cost of local farmers. The tariff revenues earmarked for agricultural development and other safeguard measures were meant to address the impact on local farmers, but the short-run transition costs were nonetheless inevitable.

Today, in the context of the COVID-19 pandemic, the price of the palay is rising because buyers now turn back to the local supply chain for their rice. Imports were already falling in January and February, even before the impact of the pandemic was felt. This is most probably due in part to the safeguard measures that the Government was putting in place following the mounting protests from local farmers. But the global market for rice is highly volatile, especially now that the biggest exporter, India, has also been hit by the pandemic. Even if we assume that their rice production would still be stable, the global logistical disruptions will undoubtedly exert a negative effect on supply flows.

The expected low levels of imports, the impact of ECQ on local production, coupled with the fundamental systemic problems of the rice sector will ensure that prices will continue with their upward trend. This provides local farmers with a huge incentive to step up production. But aiming for both high imports and high local production seems unrealistic because the factors driving one contradicts the other.

References

Balaoing-Pelkmans, Annette O. 2019. “Levelling the Playing Field for the Rural Poor through Inclusive Value Chains.” UP CIDS Discussion Paper 2019-01. Quezon City: UP Center for Integrative and Development Studies.

Crow, Ben. 2001. Markets, Class and Social Change: Trading Networks and Poverty in Rural South Asia. New York, NY: Palgrave.

Mendoza, Ronald U. 2011. “Why Do the Poor Pay More? Exploring the Poverty Penalty Concept,” Journal of International Development 23, no. 1 (January): 2, https://doi.org/10.1002/jid.1504.

Rodrik, Dani, ed. 2003. In Search of Prosperity: Analytic Narratives on Economic Growth. Princeton, NJ: Princeton University Press.