USAID Policy Paper

Pricing, Subsidies, and Related Policies

in Food and Agriculture

**Bureau for Program and Policy Coordination**

**U.S. Agency for International Development**

**Washington, D.C. 20523**

**November 1982**

**Table of Contents**

Executive Summary i

I. Introduction 1

A. Purposes and Scope 1

B. The Subject 2

II\. Economy-Wide Considerations 4

III\. Pricing and Subsidy Policies in Three

Sub-Sectors 5

A. Food 5

1\. The Objectives of Food Pricing and

Distribution Policies 5

2\. Targeting Net Benefits from Consumer Food

Subsidies 6

3\. Price Control on Consumption 7

4\. Producer Price Policies 8

B. Agricultural Inputs 10

1\. Income Compensation 11

2\. Popularizing New Inputs 12

a\. Pricing Inputs within Agricultural

Projects 12

b\. Economy-Wide Price Control 13

3\. Excess Demand and Allocation Problems 14

C. Finance 15

1\. The Role of Financial Services 15

2\. Financial Policy 16

IV\. Implementation 18

References 18

**Executive Summary**

**A. Scope.**

This paper describes and analyzes the conse­quences of certain policies
regarding pricing and distribution in markets directly connected with
food and agriculture: markets for agricultural in­puts, agricultural
credit, and food itself. These policies involve interventions found both
in LDCs and in developed economies, such as price con­trol,
subsidization, public-sector production and distribution, and rationing.
These interventions have tended to result in substantial reductions in
efficiency and productivity, with little or no benefit to the
disadvantaged groups they are often supposed to help. In many cases, the
benefits of these policies do not redound to low-income groups, but go
to relatively well-off groups instead.

Consistent with U.S. foreign policy, USAID will, through the process of
policy dialogue with host-­country governments, and through its programs
of technical, financial, and commodity assistance, encourage countries
to modify such policies so as to minimize governmental intervention in
price-­formation and distribution systems (except for certain limited
circumstances identified in the paper).

The paper recognizes that the achievement of an efficient allocation of
resources and of the overall goal of sustained, broadly-based economic
growth also often requires complementary reforms, such as the promotion
of competition in the private sec­tor, and complementary public
investment in basic physical infrastructure, development of human
resources, and research, which encourage and facilitate growth in the
private sector. Policy dialogue and assistance programs can also help
achieve these complementary objectives. The paper also recognizes that
the political en­vironment will often constrain the *degree* of policy
change possible over the short term, and that in­terim steps toward
longer-term goals for policy reform may be the best feasible course. A.
I. D. should, however, persist in seeking policy changes favoring
competitive and free markets.

USAID will provide technical assistance and train­ing to strengthen the
capacity of host-country governments and USAID Missions to analyze the
effects of existing and alternative policies regard­ing pricing and
distribution related to food and agriculture.

**B. Food**

Food subsidies do not reduce the cost of food, but merely shift this
cost\'s financial burden through the fiscal system back onto the public
(or onto donors, thus depriving the public of the benefits of
alternative uses of aid). Therefore, the *net* benefits received by
consumers from broad food subsidies are smaller and distributed
differently than are the gross benefits of price reductions. Meeting
special nutritional needs through such broad programs is costly and
inefficient.

Therefore, it is the objective of USAID policy to support food
distribution programs that:

are targeted to particular groups with special and substantial unmet
nutritional needs,

· do not rely on suppression of producers\' prices,

· do not regulate food prices or the bulk of the private food market,
but instead use market mechanisms so far as possible, and

· procure supplies at minimum economic cost. The secular level and the
stability of farmgate prices of foodstuffs are adversely affected by
general economic policies in many LDCs and by natural causes, such as
seasonal crop cycles and climatic fluctuations. Efficient
price-formation by a competitive private-sector trading system can,
however, mitigate these adverse effects. There­fore, USAID is prepared to
assist the creation and development of such systems, where appropriate,
through assistance to governmental provision of infrastructure and
technical assistance in the area of marketing.

A government may nonetheless decide to ac­cumulate a certain amount of
food to guard against the coincidence of a poor harvest and a scarcity
of foreign supplies (commercial and con­cessional). The often high costs
of storing and managing such reserves must be weighed carefully against
alternative approaches to enhancing short-­term food security, such as
accumulating foreign exchange reserves or participating in the IMF\'s
cereal import facility.

**C. Agricultural Inputs**

Governments sometimes attempt to control (or to \"subsidize\") the
prices of agricultural inputs to compensate the farm sector for its
losses under food-price regulations. However, the farm sector\'s
compensation is generally not complete, and benefits received are
concentrated on better-off farmers who buy more controlled inputs.
Further­more, the input supply system must also be sub­sidized to
compensate for reduced input prices. The supply system\'s dependence on
fiscal sub­sidies (and thus frequently on foreign aid) can reduce its
effectiveness and thus hamper agricultural productivity.

Therefore, it is USAID policy to encourage the freeing of output prices
where they are controlled, thereby eliminating the need to compensate
farmers, rather than to compound the inefficiency of the intervention in
output markets by adding other interventions in input markets.

Temporary subsidization of the experimental use of inputs may be
justified within projects that in­troduce new techniques to farmers.
However, prices should not be set below the farmers\' (limited)
willingness to pay for new inputs and should be increased to market
levels by the end of the project. If it appears likely that a project\'s
in­put subsidy will lead to lasting economy-wide price control on inputs,
then another method of inducing farmers to participate in the project
(e.g., insurance) should be considered.

**D. Finance**

The primary purpose of a country\'s financial in­stitutions should be to
mobilize and to allocate private indigenous financial resources.
Interest-­rate controls prevent financial institutions from doing this
efficiently. Savers respond to higher real interest rates by increasing
deposits in finan­cial institutions. Further, farmers are willing to pay
interest rates charged in unregulated markets when profitable
investments are available and credit and repayment are scheduled
conveniently. However, controls that artificially hold interest rates
down discourage saving and lead to credit rationing which often excludes
small borrowers that some programs were intended to help. Fur­thermore,
regulated rates are sometimes below the rate of inflation. Negative real
interest rates con­tribute to the decapitalization of financial
institu­tions.

Therefore, interest rates should be set according to the market demand
for funds, so that as much resources will be mobilized as the economy\'s
bor­rowers are willing to pay for. One condition for support from USAID
to or through financial in­stitutions is that interest rates be set
according to these principles or that substantial measures be taken to
reduce interest-rate controls where they have adverse affects on
mobilization and alloca­tion of funds. USAID is prepared to assist the
development of innovative institutional ap­proaches to meeting the credit
needs of small farmers and other small enterprises in ways that do not
distort the price of credit.

**I. Introduction**

**A. Purposes and Scope**

The purposes of this policy paper are to state on a general level some
propositions about the conse­quences of certain economic policies
affecting food and agriculture in less developed countries (LDCs), and
to establish, subject to the Am­bassadors\' authority, certain goals for
USAID Mis­sions to pursue in the process of policy dialogue with host
governments. Through policy dialogue as well as technical, financial,
and commodity assistance, USAID will encourage host-country governments
to modify policies that impede economic efficiency and sustained,
broadly-based economic growth. In cases where it is judged that success
in achieving a project\'s purposes would re­quire a policy environment
that does not exist and cannot be created, however, USAID will not
pro­vide (or will withdraw) support.

As is true of efforts to lift technical and resource constraints on
economic development, the effort to lift constraints posed by
counterproductive economic policies cannot be expected to produce major
results overnight. There are real and substantial reasons for the
resistance to policy reform: the potential for political opposition from
major groups that benefit (or perceive a benefit) from existing
policies, for example. Overcoming such obstacles is the object of the
day-to-day exer­cise of ingenuity in politics and in the design of policy
dialogue and of foreign assistance. For the implementation of policy
dialogue and reform to be successful, it must identify constructive
interim solutions to policy problems and recognize the relatively long
time-frame of the process of im­proving upon each interim solution in
pursuit of desirable goals. It is hoped that this policy paper will
assist efforts at policy reform by more clearly stating certain
reforms\' underlying rationale and by increasing the emphasis on their
practical im­portance.[^1] These efforts must take place within the
framework of the overall dialogue between the U.S. Government and
USAID\'s host governments, and therefore must be consistent with overall
U.S. foreign policy and with U.S. policy toward the host countries.

The scope of this paper is narrowly limited to cer­tain governmental
pricing and subsidization policies in food and agriculture. Some closely
related subjects are therefore not treated fully in this particular
paper. For example, this paper does not comprehensively review the
problems of private markets in LDCs, nor does it attempt to give
complete guidance on promotion of more competitive market structures, on
promotion of private-sector involvement, or on the role of parastatals
and other public-sector agencies. There are many improvements in such
areas that would complement the reforms discussed in the present paper.
Such policies and programs, in­cluding public investment in agricultural
research and physical infrastructure, have been found to be essential to
the promotion of growth of the private sector, as well as to achieving
broadly-based growth overall. Some of these other topics are discussed
in USAID\'s Policy Papers on Food and Agricultural Development and
Private Enterprise Development, or will be discussed in the forth­coming
policy paper on Public Enterprise.

Furthermore, the present paper does not analyze the *ideal* governmental
role in the area of pricing and subsidization. Rather, the paper\'s
subject is the set of pressing problems caused by some *existing*
governmental policies. Therefore, the reforms discussed in this paper
are not proposed as a complete policy framework for governments in LDCs
or for donors. These reforms are steps that may be complementary with
other desirable initiatives, and that may indeed be the prerequi­sites of
these other initiatives in some cases.

**B. The Subject**

Although there is a wide range of productive governmental interventions
in the development process that may affect and improve markets, the
particular area of price formation is one in which many interventions
have proved to be counter­productive. Subsidies and related price and
distribution controls[^2] adopted by many LDC governments, in such areas
as food marketing and distribution, marketing of agricultural inputs,
and agricultural credit, have tended to result in sub­stantial reductions
in efficiency and productivity, with little or no benefit to the
disadvantaged groups they are often supposed to help. In many cases, the
benefits of these policies do not redound to low-income groups, but go
to relatively well-off groups instead. The gross benefits of these
policies tend to be offset by the costs of taxation and other fiscal
measures used to pay for any subsidies that may be involved. As a
result, *net* benefits are much smaller and may be distributed quite
dif­ferently than gross benefits. Government-fixed prices frequently
discourage production of valuable outputs and promote instead activities
that have excessively high true costs, to the detri­ment of the economy
as a whole and, in the long term if not in the short term, the poor
majority in particular. Furthermore, in order to enforce price controls,
it is often necessary for the government to intervene directly in the
physical distribution system for both inputs and outputs. Distribution
controls instituted under price controls (such as rationing) frequently
are costly and result in ineffi­cient allocation of resources.

Similar pricing and distribution policies occur in many other markets,
such as the markets for the factors of production (land, labor, and
capital), markets for manufactured goods (especially those that enter
international trade), markets for ser­vices (such as electrical power and
transport), and the market for foreign currencies. However, pric­ing and
subsidy policies that affect food and agriculture directly are of
particular interest to USAID because of this sector\'s important role in
the Agency\'s policies and programs.

This paper first provides an overview of the economy-wide aspects of
pricing and subsidy policies. It then discusses desirable policy reforms
in three areas directly related to food and agri­culture (food products,
agricultural inputs and agricultural credit).

A policy of minimizing governmental intervention in pricing and
distribution, using market forces to establish practical prices and
allocations, and avoiding public-sector displacement (or pre­emption) of
private firms in distribution of goods will not only reduce the fiscal
costs of subsidies but will also allocate resources more efficiently
than under the various controls that have been in­stituted in many LDCs.
However, there are some areas where the involvement of the government,
including subsidization or direct allocation of goods, may be useful.
These are usually cases where, in order to obtain efficient results,
in­dividuals find it advantageous to coordinate their activities through
collective action and organiza­tions such as governmental agencies and
private cooperatives. For example:

· Although some types of adaptive research and development of new
products are effectively undertaken by the private sector, in general it
is difficult for individual investors in agricultural research to retain
adequate returns from the knowledge of new agricultural techniques which
the research generates. Therefore, it would not be efficient to rely
entirely on individuals\' funding of agricultural research. The
appropriate amount of agricultural research can be funded only by using
private farmers\' organizations (where possible) and the government to
collect resources;

· Given that in the short term special food pro­grams are necessary to
reduce severe under­nourishment and to assure healthy development of
young children, this goal may be more effec­tively pursued by funding
targeted food programs through contributions from private voluntary
organizations and/or from the government, rather than solely through
uncoordinated individuals\' contributions;

· The fixed costs of large surface-water irrigation systems are
frequently financed through contribu­tions from private water-users\'
associations and/or from land taxes, rather than through individuals\'
irrigation fees only. Although this may appear to be a subsidy to water
users, it can be an efficient method of finance. Charging individuals
water rates sufficient to cover both fixed and operating costs would
generally not result in either sufficient investment in irrigation
capacity or effi­cient utilization of existing capacity.[^3]

USAID does not oppose such forms of governmen­tal subsidization where
they are appropriately designed and implemented. However, even though
the government may provide additional incentives in the form of
subsidies, such goods and services should be delivered through private
organizations (including non-governmental cooperatives) if they have the
potential to be more efficient alternatives to public-sector delivery
mechanisms.

When the government does intervener, in the economy, the more efficient
form of intervention should be chosen and the intervention should not
extend beyond what is needed to achieve the government\'s specific
goals. Therefore, direct, ex­plicit (or \"transparent\"), and limited
subsidization that is tied to producers\' performance, or to target
groups\' special, unmet needs, is generally to be preferred to indirect
methods. Methods that at­tempt to provide benefits indirectly may not
pro­vide adequate incentives for production or may not provide the
desired benefit to the target groups. Indirect methods may also have
unin­tended effects that are counterproductive or that benefit groups who
are not in need of assistance. They are also more difficult to monitor
and to evaluate, and therefore are more likely to be con­tinued beyond
their intended and useful life than if they were explicit and
transparent.

For example, to develop road transportation the government should first
consider directly financ­ing the maintenance and construction of roads
and reducing regulatory burdens on trucking. Indirect measures, such as
artificial reductions in the price of petrol, or restrictions on
competing railways, might encourage shippers to switch from rail to
petrol-powered trucks. However, these effects would be indirect,
uncertain, and difficult to evaluate. The most direct effects of price
controls and other restrictions would be instead in the sup­plies of
petrol and of railway transportation. These direct effects would likely
be counter­productive from the point of view of developing the overall
transportation system, including road transport.

**II. Economy-Wide Considerations**

It is a basic A. I. D. policy to assist host countries in the creation
and development of free, competitive markets to allocate resources
efficiently, rather than to support policies that attempt to regulate
prices in order to affect the distribution of income among the
economy\'s broad sectors. If income redistribution is viewed as a
desirable goal, it is best accomplished by other means. However,
governments in both developing and developed countries are tempted to
seek to provide im­mediate increases in the standard of living in several
sectors simultaneously, or production in­centives for several sectors
simultaneously, by shifting spending power from sector to sector through
subsidies or price controls.

For example, consider how the following set of hypothetical policies
might be advocated (each policy perhaps by a different sponsor), even
though the whole set would not necessarily, be adopted.

· Because the government seeks to placate the ur­ban population, the
consumer\'s price of food is held down;

· Increasing demand for food necessitates promo­tion of food production
by raising the farm-gate price of foodgrains and by lowering the prices
of agricultural inputs;

· Non-agricultural industries are promoted by sharply raising prices of
their outputs (perhaps by raising tariffs or non-tariff barriers on
competing imports) and by lowering prices of their inputs, especially
imported capital goods;

· Because of expanded subsidies, revenues from taxation of domestic
sales cannot meet the govern­ment\'s needs, and therefore exports are
taxed; and \* Because there is a shortage of export earnings for
necessary imports, such as capital goods and agricultural inputs,
exports are promoted through subsidization or exemption from taxation.
Aside from the problems these policies have in­dividually, the set taken
as a whole is self-­contradictory. For example:

· Fiscal transfers that benefit net buyers of food as a group
necessarily make production of food by net sellers less remunerative.

· Fiscal transfers to the farm sector necessarily reduce the resources
and incentives available to manufacturers.

· Protection of the manufacturing sector from im­ported competition
necessarily increases the cost of manufactures to firms and households,
especially in agriculture.

Since resources are limited, it is impossible to raise the standard of
living in *every* sector at once or to provide production incentives for
every sector simultaneously, merely by shifting incomes or resources
from sector to sector. The limits to the amounts of resources available
imply that every action has an \"opportunity cost\", the value of the
best alternative foregone for lack of additional resources. The
price-system is best used to measure these opportunity costs, in order
to iden­tify the best of the alternative courses of action and thus to
maximize the resources\' productivity. In an ideal *(i.e.,*
hypothetical, if not perfect) economy where each good\'s price is
determined by relatively free and competitive markets, the money-cost of
a good could be used as a relatively accurate measure of the
market-value of the good\'s cost in terms of alternative goods,
*whatever* those alternative goods would have been. Without such a means
of measurement, it is very difficult to see how one could take account
of costs. This is a basic rationale for assisting in the creation of
free, competitive markets.

The scarcity of available resources is sometimes disputed by those who
argue that the whole set of policies described above could be financed
through expansion of credit and implemented through use of unemployed
resources or by ex­panded foreign aid. On the contrary, however, the
dominant strands of research on economic policy in developing countries
demonstrate that pervasive attempts at price control and subsidiza­tion
induce misuse, rather than greater use, of available resources.[^4]

**III. Pricing and Subsidy Policies in Three Sub-Sectors**

This section examines pricing and subsidy policies toward food,
agricultural inputs, and credit.

**A. Food**

1\. *The Objectives of Food Pricing and Distribution Policies*

USAID\'s basic objective is to promote sustained, broadly-based economic
growth in the countries it assists. Therefore, USAID supports food
pricing and distribution policies with the following
[objectives:]{.underline}

· to give domestic producers the incentive to pro­duce as much output as
is justified by costs, the demand for food, and considerations of food
security;

· to distribute food at minimum cost in conformi­ty, by and large, with
demand; and

· to alleviate undernourishment, especially of vulnerable groups (such
as children and pregnant and lactating women).[^5]

Many price and distribution controls found in LDCs do not effectively
pursue these objectives, or they have consequences counter to those
in­tended. In some cases this may be because the ef­fects of those
policies are misunderstood. In other cases, the objectives themselves
may be called into question. For example, price control sometimes has
the objective of lowering the cost of food to middle- and upper-income
consumers. However, it may be doubted that controls actually do increase
those groups\' standard of living compared to what it might be under
other policies. In any case, the objective of subsidizing the
consumption of these particular groups at the expense of the rest of the
population may legitimately be questioned by a donor when foreign
assistance is used. Another example is a policy of prohibiting
cross­border trade in food in order to achieve food self-­sufficiency.
Such \"self-sufficiency\" may turn out to imply *greater* scarcity and
insecurity in the supply of food than if the economy used trade
cautiously but more efficiently. Therefore, the ob­jective itself could
be defined more carefully, and policies adjusted accordingly.

The following sections will expand on the prob­lems of existing food
policies in developing coun­tries and on the policy reforms that USAID
supports.

2\. *Targeting Net Benefits from Consumer Food* *Subsidies*

Urban food consumers in LDCs often constitute a relatively large,
concentrated and politically vocal and influential group. A natural goal
of most LDC governments is to support urban food-consumers\' desires for
a higher standard of living. However, attempts to use price controls and
subsidies to lower the cost of food to such large portions of the market
for food as the main urban groups can be largely self-defeating. The
cost of food can be shifted away from the urban consumer only to a
limited extent before the burden imposed on domestic agriculture or on
the foreign exchange budget (including foreign aid) seriously impairs
the supply of food (and other goods) to the urban population. Past this
point, the cost of a large sub­sidy to the broad urban population will
largely be borne by the urban population itself in various ways:
increased direct taxes, higher prices of non-food items as a result of
higher taxation, higher prices as a result of inflationary finance, the
op­portunity costs of the diversion of governmental resources (including
foreign aid) from programs that would have benefited the urban areas,
and the inconvenience and possible deprivation resulting from food
shortages and rationing (due to both over-expanded demand and production
disincentives posed by reducing the returns to pro­ducers). Thus, the
urban population\'s net benefit from broad subsidization of food
consumption may well be substantially less than the reduction in their
nominal expenditure on the controlled food items. Over the long term,
when inefficien­cies introduced into the structure of production as a
result of price controls and subsidies have had their adverse effects on
overall economic growth, this net benefit and its political dividends
may well

become negative.

Even in a broad program, there may still be sub-groups within the urban
population for whom the net benefits are a substantial increase in
income. However, the small group that escapes the costs of a broad food
distribution program could as easily be a relatively well-off group as
it could be a group with special nutritional needs. Furthermore, any
such result would come about largely by chance. In order for a program
to provide beneficiaries with an assurance of positive net benefits, the
program would best be targeted to a relatively small group. In such a
targeted pro­gram, benefits would be concentrated on a small and needy
group while total costs would be relatively small and spread relatively
widely.

Therefore, the objective of USAID policy is to employ food and other
assistance resources to support food-distribution programs that are
effec­tively targeted to small portions of the population with special
and substantial unmet nutritional needs.[^6] USAID Missions should
attempt to orient assistance in this direction as far as possible. Any
support from USAID to broad and untargeted food subsidization programs
should be justified by a careful analysis of benefits and costs actually
ac­cruing to a specific group with unmet nutritional needs, since the
effects on nutritional status can­not otherwise be assured.

3\. *Price Control on Consumption*

In the long term, a basic goal of USAID\'s assistance is to enable the
poor majority in developing countries to afford a more adequate diet.
Generally, the most effective method of doing this is to in­crease the
productivity and employment of the poor in agriculture (and other
industries). This increases both the supply of food and the effective
demand by the poor for food, with no need for price control. Efficient
pricing is a useful instru­ment in increasing productivity and
employment.

An objective of USAID food and agricultural development policy,
therefore, is to encourage host governments to minimize direct
manipulation of the market food prices paid by consumers. Because food
markets when unregulated can generally be relatively competitive, market
prices can be used to guide consumers to the lowest-cost sources of
food.[^7] In contrast, an arbitrary reduc­tion of the price of a specific
food commodity win stimulate demand for that particular type of food. To
meet that demand, resources must be shifted into production or import of
that food and away from lower-cost substitutes. Given the limited supply
of resources (as well as the limited availability of foreign aid), the
results are reduced availability and higher costs of food in the
ag­gregate.

Furthermore, programs of subsidized food distribution supported by USAID
should minimize interference in pricing. Where it is administrative­ly
possible and economical to subsidize under­nourished groups through cash
grants or distribu­tion of parallel monies such as food stamps, allow­ing
the beneficiaries to purchase their own addi­tional food from existing
private-sector markets at unregulated prices, this mechanism should be
preferred. If this is not possible and some degree of price control on
sales to the target group must be used instead, the degree of control
should be minimized:

· by controlling the price of only a limited por­tion of the food bought
by each member of the target group (if administratively feasible), so
that the beneficiaries will have more purchasing power but at the same
time will be guided by market prices to choose truly economical
combinations of different foods for their diets; and

· by leaving the remainder of the food market free of price control.[^8]

4\. *Producer Price Policies*

A variety of considerations may prompt the government to intervene in
the private process of setting farmgate prices for foodstuffs by fixing
prices at artificially high or low levels. Among them are:

· the need to finance some of the cost of consumer subsidies at the
farmers\' expense by procuring sup­plies at reduced farmgate prices;

· the desire to raise the incomes of the farm sector or of certain farm
groups (especially where farmers have organized and become politically
ac­tive);

· the desire to increase national output of foodstuffs either to raise
national income or to achieve food security through greater
self-­sufficiency; and

· the desire to reduce the risk faced by farmers by reducing the
fluctuations of prices around their long-term trends.

A.I. D.\'s basic goal, broadly-based economic growth, is not consistent
with the use of inefficient price controls to pursue either of the first
two goals for changing the distribution of income. Economic growth can
best be encouraged by using the price system to allocate productive
resources efficiently, instead. Where changes in income distribution are
desired, they should be pursued in ways other than price control. When
an inefficient policy is the source of low income in one sector, the
preferred course is to reform that policy, rather than to attempt to
offset its effects with another inefficient intervention that would only
tend to depress overall national income further. USAID Missions should,
therefore, work to avoid a multiplication of inefficient controls, in
which each control is adopted to offset the effects that the others have
on income distribution.

Both the latter two goals of producer price-policy, briefly stated as
stability and security, are ultimately related to increased food
production and farm income. There is a perception shared by farmers and
governments, both in LDCs and elsewhere, that the process of private
trade and price-formation does not serve these goals ade­quately.
However, the range of governmental in­terventions that has resulted
includes some rather extreme measures, such as uniform administered
pricing (\"pan-territorial pricing\") and nationaliza­tion of the grain
trade. More moderate alternative policies sometimes chosen include
limited govern­mental purchases at support prices and restrictions on
inter-regional or international trade in food.

Two underlying conditions affecting agriculture support the perception
that private trade and price-formation are faulty. First, fluctuations
in available agricultural output induced by natural causes (such as
weather, seasonality of produc­tion, and wastage)\'interact with
relatively stable demand to cause greater year-to-year and intra-­year
fluctuations in agricultural prices than there are in the prices of
things that farmers buy. Se­cond, agricultural production is more
diffused (over large numbers of farms) than is production in other
industries and, more to the point, than is the food trading sector.
Individual farmers, therefore, face an economically exceptional set of
marketing problems and at the same time are relatively disadvantaged in
dealing with these problems organizationally.

When private trade is competitive, however, there are strong tendencies
for the process of price­formation to address the farmers\' problems.
First, under competition a firm\'s survival and profits de­pend on
keeping costs as low as or lower than those of other firms. As a result,
the secular level of farmgate prices will be held as high as is
permit­ted by the underlying consumer demand for food. Second, price
differentials across space and (though difficult to predict) across time
are power­ful inducements to \"buy low and sell high\", and thus to
reduce any price differential, such as a seasonal differential, that is
not already smaller than \"carrying costs\" (transportation, storage,
in­terest, and so forth.)[^9]

In theory, because small-scale traders can be cost-­competitive, the
food-trading sector has the struc­tural capacity to be highly
competitive. In fact, competition in this industry is common and the
results of competition between even a relatively small number of traders
compare quite closely with the theoretically expected results given
large numbers of traders. Where competition is lacking, the underlying
ability of small- to medium-scale traders to operate cost-competitively
should allow the government to promote it. (Too often govern­mental
controls only confer privileges that, inten­tionally in some cases,
reduce rather than enhance competition.)

The government should promote competition in the food-trading sector in
various ways: by reduc­ing regulation in some instances, by
standardiza­tion of measures and quality designations, and by providing
infrastructural inputs like transporta­tion and communication systems
where they are not adequately provided privately, for example. USAID can
support this effort especially through training and technical assistance
to the trading sec­tor.

For the government to go further than these (already formidable)
measures would expose it and the economy to the risk of excessive costs
and inefficiencies that may be directly counterproduc­tive to the goals
of increased stability, security, and output. Pan-territorial pricing,
for example, is likely to raise the aggregate cost of food produc­tion by
eliminating the competitive disadvantage of distant regions that would
otherwise be subject to price-discounts to offset transportation cost
dif­ferentials (and equally by eliminating the price-­premium incentive to
the more favorably situated farms).

More commonly advocated on the basis of ex­perience in the U.S. is a
system of limited govern­mental purchases at pre-announced support
prices. Such a system can be organized in a variety of ways, and may be
designed to confine price variations within a narrower range or to raise
the average price. The difficulty with governmental attempts to narrow
price variations is that, unless the government is a better predictor of
future prices than are farmers and private traders, the government\'s
effort will be unprofitable and thus expensive and, more importantly,
will exacerbate rather than reduce fluctuations in prices over the
course of procurement and disposal of stocks.

One problem with raising average farmgate prices of food is that
increased food output may come at the expense of output of exportable
cash crops. Another difficulty with raising the secular price level is
that it ignores the effective level of demand and leaves the government
holding stocks of food, which can be extremely costly. The U.S.
Govern­ment\'s solution to this problem has been to bear this cost out of
its huge income and to become a major food donor both domestically and
overseas. This is not, however, a practical option for governments in
LDCs, which are often recipients of food aid rather than donors.

Nonetheless, a government might decide to ac­cumulate a certain amount of
food, both in order to support farm prices and incomes at certain times
and to guard against the simultaneous in­cidence of a poor harvest and
scarcity of both imports and food aid. Complex issues arise, however,
regarding the cost of such reserves com­pared to those of alternatives
such as financial reserves and international programs such as the cereal
import facility operated by the IMF. Governmental food reserves are not
necessarily the best alterative.[^10]

**B. Agricultural Inputs**

As part of overall food and agriculture policy, many LDC governments
have promulgated economy-wide price controls on agricultural in­puts such
as fertilizers. The intended purposes of these controls are:

· To compensate farmers for income lost due to price controls or
taxation in markets for agricultural outputs;

· To popularize the use of new inputs in order to increase productivity;
and

· To lower the cost of production of food in order to lower the cost of
food to consumers.

In addition, the input distribution system is fre­quently regulated or
operated by the public sector. Part of the purpose of governmental
distribution control is to ensure that benefits from price con­trols
(calculated before taking the controls\' fiscal burden into account) are
distributed to the intend­ed beneficiaries (eg., small farmers), and that
in­puts are not diverted from intended users through the black market.
Producers and distributors of agricultural inputs are subsidized to
permit sale to farmers at prices set below costs. Although some farmers
may benefit from controlled prices, the subsidies are usually not paid
directly to the farmers themselves.

It is USAID policy to encourage the freeing of both agricultural output
and input prices, so that out­put prices compensate farmers adequately
without artificial reduction of input prices, and so that in­put prices
are sufficient to support development of an effective input supply
system.

With regard to inputs supplied to farmers by USAID-supported
agricultural projects, it is fre­quently proposed that the project
subsidize the in­puts that farmers would not initially be willing to buy
at full cost. It is USAID policy that such. sub­sidies under
USAID-supported projects be offered only under certain conditions, which
are specified below.

These policies are elaborated in the following sec­tions.

1\. *Income Compensation*

Economy-wide price and distribution controls achieve at best only partly
the objective of income compensation for farmers, and even then only for
some farmers. Farmers will receive benefits proportional to the amount
of inputs they buy at controlled prices. This gross benefit is therefore
larger for larger farmers and for farmers who use ad­vanced techniques
requiring relatively large amounts of cash inputs. Farmers who use
relative­ly few cash inputs because they have little land, because they
are not technically advanced, or because they are not favored by the
controlled distribution system will receive little benefit if any.

Against this gross benefit must be set the costs that farmers bear as a
result of price and distribution controls on inputs. Since only part of
the cost of production and distribution of inputs is usually covered by
controlled prices, the remainder must be financed by the government\'s
subsidies. The source of funds for these subsidies depends on the
methods of governmental finance.[^11] Greater taxa­tion could directly
lower some farmers\' after-tax income, and inflationary finance through
expand­ing the availability of credit in the aggregate could reduce
farmers\' real income by raising the cost of things they buy.
Governments are also tempted to lower official procurement prices of
farm products when under fiscal stress, so that some of farmers\' losses
of income from depressed *output* prices can be attributed directly to
the fiscal costs of sub­sidies to suppliers of agricultural *inputs.* An
input. program\'s net impact also depends on which alter­native programs
(such as tax reduction or in­frastructural investment) the government
would undertake if it reduced expenditures related to agricultural input
controls.

In addition, to the extent that price and distribu­tion controls on
agricultural inputs do not fully compensate input producers and
distributors, the amount of inputs available will tend to decline,
reducing the profits of those farmers thus excluded from access to
inputs. Furthermore, blackmarketing may deprive farmers of the benefit
from reduced input prices.[^12]

As a result of these costs, the *net* benefit from price and
distribution controls will clearly be negative or zero for most farmers
who use little or no controlled inputs. Farmers who use controlled
inputs intensively and who are privileged to buy them directly at
controlled prices are the group most likely to receive a positive net
benefit from controls on *inputs.* This benefit will tend to offset
losses from controls on *output* prices, but even for these farmers the
offset is unlikely to be complete.

In fact, reductions in input prices must be propor­tionally much larger
than reductions in output prices before a net benefit is realized by the
farmer from the overall set of controls.[^13]

Finally, to the extent that the farm sector as a whole is compensated
(even though some farmers gain and some farmers lose), the net benefit
of the non-farm sectors (who are by definition net con­sumers of food) is
reduced from what it would be otherwise, because they are the ultimate
source of any compensation for farmers. Complete compen­sation of the
farm sector means that consumers as a group would receive *no* net
benefits from the package of price controls, thus obviating the original
rationale of the whole program. In fact, the process of shuffling and
re-shuffling costs and benefits introduces administrative costs and
ineffi­cient distortions which create an overall net loss for the
economy.

Therefore, it is USAID policy to support the de­control of output prices,
thereby eliminating the need for compensation of farmers, rather than to
compound the inefficiency of the intervention in output markets by
adding other interventions in the input markets.

*2. Popularizing New Inputs*

The second and third purposes of input controls, raising food output and
lowering food prices by lowering costs of food production, may be taken
together because they both depend on expanding the use of inputs and
thus on expanding the supply of inputs. The relation between pricing
policy and input supply can be examined in two different contexts: (a)
distribution of inputs within agricultural projects, and W economy-wide
price control. The difference between these two con­texts is that input
supply may be assured in a pro­ject, but is generally not assured by
economy-wide price control.

a\. *Pricing Inputs within Agricultural Projects*

In order to provide farmers knowledge and ex­perience with new
techniques, many projects must induce farmers to use new inputs.
Initially, farmers may not be willing to buy these new in­puts at market
prices that cover the inputs\' full costs. One approach to developing
farmers\' de­mand for new inputs is to distribute pre-arranged supplies
of the inputs directly to farmers at whatever prices the farmers are
initially willing to pay, or even for free. If this approach is
followed, the project will either have to buy the inputs itself or it
will have to subsidize the input distribution system.

This approach can be consistent with USAID policy, even though it may
involve an element of subsidization, providing it meets the following
tests.

· Prices to farmers should be no lower than is required to induce their
participation. The purpose

of these projects is to increase farmers\' productivity and income in
the long term by increasing the

farmers\' knowledge and skills, not to increase farmers\' consumption in
the short term by under­pricing inputs that they would willingly have
bought at higher prices.

· Prices to farmers should rise in steps during the project as the
farmers\' willingness to pay is in­creased by learning about the inputs.
(This is especially important where the life of the project is several
years or longer, and where there is a significant gap between the
initial price and the suppliers\' costs.) Before completion of the
project, prices should be at the levels that would be charged by
efficient, competitive, private input suppliers.

· After completion of the project, the input sup­ply system should be
able to supply farmers\' demands dependably. This implies that the
system not be dependent upon fiscal subsidies, but instead that it be
self-sustaining on the basis of full-cost pricing.

· The use of inputs should be economically justified. A cost-benefit
analysis should be done to

show that the benefits from increased use of inputs exceed the full
costs of inputs (not just that portion

of costs paid by farmers).

· Subsidization should be cost-effective compared to other methods of
assuring farmers that they will suffer no loss from participation. If,
for example, an insurance scheme that guarantees a certain minimum
income for the (temporary) duration of the project can generate the same
participation and learning at a lower cost to the project than
subsidizing input distribution, then such a scheme is more
cost-effective than input subsidization. put subsidization.

A key problem likely to be encountered in using input subsidies within
agricultural projects is that it may be difficult to prevent a
temporary, project­-related subsidy from becoming a permanent,
economy-wide policy of price control. As elaborated below, economy-wide
price controls, even if compensated by subsidies, tend to reduce the
effectiveness of the input supply system (thus violating the third
requirement above). In some cases, it may be necessary to find a method
other than subsidizing inputs (such as insurance schemes, as in the
fifth requirement above) to carry on projects without risking damage to
the input supply system. If the input supply system is already unable to
function adequately because of controls, it may in some cases be prudent
to delay implementing agricultural projects whose long-­term benefits
depend on input supplies, until policy is changed to permit the supply
system to function adequately.

b\. *Economy-Wide Price Control*

Superficially, lower input prices mean lower costs of production and
thus lower prices to consumers. However, without the increased
productivity that stems from increased use of inputs, these connec­tions
do nut hold. The true costs of production are the alternative goods that
resources could have produced had they not been used for agricultural
inputs. Price control and subsidization by themselves do not lower these
costs; they merely shift the costs\' financial burden onto the fiscal
system, and ultimately back onto the public. The public as a whole,
therefore, ends up no wealthier and no better able to afford food as a
result of price control.[^14]

Economy-wide price control and subsidization can, however, severely
handicap the input pro­duction and distribution systems, because
sub­sidization is a poor substitute for the sales revenues lost due to
price control. The fiscal pro­cess is affected by a variety of influences
that may conflict with the financial needs of the input sup­ply system,
and it generally has a poor record of delivering subsidies at the times
needed to serve the very time-bound agricultural sector. In some cases,
the government may allocate funds only after a financial crisis has
arisen in the input sup­ply sector. Furthermore, subsidies may not give
suppliers appropriate incentives, especially if they are allocated
according to suppliers\' financial losses. Indeed, such subsidies may
create perverse incentives to relax efforts to minimize costs. In
contrast, dependence upon sales revenues gives suppliers the incentive
to improve their per­formance, without encouraging excessive costs.

Price control\'s effects on both the supply system\'s financial strength
and its incentives may well result in reduction in the overall supply of
agricultural inputs.

On the other hand, *if* the government makes in­puts available to the
full extent of demand generated by very low prices (which are ­sometimes
only twenty percent of cost), the result will be over-use of inputs,
which implies higher real costs of supplying food.[^15]

Therefore, USAID Missions should encourage governments not to disguise
the true costs of agricultural inputs through economy-wide price
control. Instead, governments should permit the national input-supply
system to be efficiently financed through the system\'s own sales
revenues rather than forcing it to depend on unreliable fiscal
subsidies.

3\. *Excess Demand and Allocation Problems*

Price control creates excess demand, which in turn creates serious
problems in allocating agricultural inputs. Any buyer who pays the
controlled price for an input can profit, whether he or she is a farmer
or not, by re-selling the input (given a little ingenuity and assuming
that the transaction cost of re-marketing does not exceed the difference
be­tween the market-clearing price and the controlled price). Indeed,
price-control creates an artificial scarcity in which buyers are often
able to re-sell inputs at prices higher than the market-clearing price.
As a rule, the benefit of lower-priced agricultural inputs accrues to
their *buyers* and not necessarily to their users, who may be different
groups of people.

Given that resale cannot effectively be eliminated, the government is
usually forced to control the distribution of inputs in order to pro­vide
the benefits of price control to the target groups. However, even a well
motivated rationing authority faces a delicate problem of to whom among
the excessive number of legitimate demanders in the target groups to
allocate the available inputs. No choice open to the rationing authority
delivers inputs to productive users and benefits to target groups better
than would be done by a combination of direct income subsidiza­tion of
target groups, a free market in inputs, and provision of information and
technical assistance to the inputs\' prospective buyers.

Moreover, the whole process of rationing diverts personnel from other
tasks that are necessary to assuring timely delivery and other services
that real users of the inputs need. Indeed, excess de­mand for inputs
sometimes has the result that the inputs are delivered without needed
services or even in an adulterated form. When the distribu­tion system is
licensed and regulated, as is fre­quently the case under price controls,
there is no scope for competition to force suppliers to provide retail
services or to maintain product quality. In the extreme, the controlled
supply system may ad­just quality in such a way that what many farmers
get is worth no more than the controlled price they pay. Alternatively,
supplies may be allocated through bribery, which also deprives intended
beneficiaries of some of their benefits (besides hav­ing deleterious
effects on administration and politics).

Therefore, it is USAID policy to encourage host governments to dismantle
price and distribution controls on agricultural inputs. USAID Missions
should support alternative policies that help to develop and to support
a competitive private in­put distribution system that relies on market
mechanisms to allocate inputs efficiently and to maintain inputs\'
quality while providing timely delivery and needed services to farmers.

C. **Finance**[^16]

*1. The Role of Financial Services*

The basic role of financial institutions is to lower the transaction
costs of matching savings with in­vestments. Aside from the direct
cost-savings, this increased efficiency induces an increased flow of
funds from savers to borrowers. The value of the financial transactions
thus brought about is the in­creased productivity with which real
resources are used when they are bought by borrowers of funds instead of
by depositors of funds. Some of this benefit accrues to borrowers, whose
rate of return on the real resources they buy with borrowed funds is
higher than the rate of interest they pay on those funds. Some of the
benefit accrues to depositors, whose rate of return on the real
resources they would have bought would have been less than the rate of
interest they receive on their deposits. The remainder of the benefit
ac­crues to financiers themselves, from the difference between the rates
of interest on loans and deposits (the \"spread\"), less operating
costs.

Some credit projects underemphasize this role of financial institutions.
Just as in some cir­cumstances a simple, massive transfer of food into a
country can reduce farmers\' incentive and finan­cial ability to produce
food, simple massive transfers of credit by a project can reduce the
in­centive and ability of financial institutions to \"produce\" financial
resources by mobilizing and aggregating the savings of individuals. This
is il­lustrated by the example of a project that used na­tional and local
financial institutions to provide agricultural inputs and capital goods
to farmers. The project\'s evaluation calculated that additional crop
production net of additional input use yield­ed a relatively high rate of
return on the agricultural investments financed under the project. On
this basis the evaluation concluded that the credit project was
successful. Yet, the evaluation provided no evidence that the project
had improved capabilities of the financial institutions to mobilize or
to allocate indigenous financial

resources. On the contrary, the evaluation documented the fact that
external concessional resources were in part merely substituted for
in­digenous funds that the institutions had previous­ly used. Therefore,
the project did little to develop the ability of the financial system to
sustain agricultural investment independently of outside assistance.
Indeed, from the point of view of *financial* development the project
may have been counterproductive.

2\. *Financial Policy*

USAID\'s primary purpose in the area of credit and finance should be to
create and to support a system of financial institutions that
effectively mobilizes and allocates private indigenous finan­cial
resources. The financial system should be en­couraged to mobilize as much
savings as the economy\'s borrowers are willing and able to pay for.
Financial institutions should, therefore, be free to set interest rates
for loans and deposits high enough to clear the market between borrowers
and savers. De-control of interest rates would also allow a spread
between deposit and lending in­terest rates sufficient to make financial
institutions self-sustaining and to eliminate the need for sub­sidies.

Furthermore, de-control of interest rates would eliminate a variety of
other ill effects, such as the following.

· Reduced interest rates on loans benefit larger and better-off
borrowers in proportion to the amount they borrow. Larger borrowers also
stand to gain more by defaulting. (The ultimate effect on the
distribution of wealth depends not only upon who receives the loans and
who defaults, but also upon who bears the costs of defaults and reduced
rates of interest: *eg*., savers and taxpayers.)

· Since interest is generally a small portion of cash costs in
agriculture, reduced interest rates on loans seldom reduce production
costs enough to have a substantial impact on a farmer\'s decision to
adopt a novel or risky technique.[^17] On the con­trary, evidence shows
that even small farmers are willing to borrow at substantial rates of
interest to make investments in proven and profitable new techniques,
provided that credit and repayment are conveniently scheduled. Since
interest-rate controls tend to suppress financial intermediation and the
supply of credit, such controls actually tend to reduce adoption of
those new techniques that require additional credit.

· Interest-rate controls hide the fluctuations of market-clearing
interest rates and thus obscure the true scarcity of credit in the
economy.

· Interest-rate controls are sometimes adopted in connection with
targeted credit allocation pro­grams. Aside from the point noted above
that reduced interest rates are seldom necessary to in­duce target groups
to borrow, the control over credit allocation itself has adverse
effects, such as the following.

· Governmentally mandated loans often burden financial institutions with
both increased ad­ministrative costs and reduced loan recoveries.
Administrative costs of mandated loans may be higher than those of
normal commercial loans when, as is often the case, a set of borrowers
(*e.g.*, small farmers) is specified with which the institution is (at
least initially) ill equipped to deal. Loan recoveries may decrease for
two reasons: (a) credit is pushed into riskier areas where borrowers are
more often unable to repay; and (b) targeted bor­rowers may be less
inclined to repay their loans. They may feel that the loan is
essentially a govern­mental grant or that the financial institution will
be unable to enforce any penalty, such as withholding credit in the
future.

· To reduce costs in the face of these problems, financial institutions
frequently have to cut back their levels of service, especially to
smaller bor­rowers who are more expensive to deal with per dollar lent.
As a result, small borrowers find that transaction costs such as travel,
time spent waiting, and fees, rise to offset much or all of the expected
savings from low interest rates.

· As the combined result of low deposits, excess demand for cheap loans
with the potential for default, and increased administrative costs,
finan­cial institutions frequently become inclined to ration credit
according to personal political in­fluence and administrative
convenience, rather than according to the borrower\'s productivity or
need. Small farmers and other small businesses are likely to be
discriminated against in the competi­tion for loans under these
circumstances, even though lending to them is mandated.

USAID Missions therefore should support elimina­tion of controls on
interest rates, so that rates will be set at market-clearing levels
through financial intermediation, rather than at arbitrary levels by
governmental controls. Both loans to final bor­rowers and the funds
provided by host govern­ments to financial institutions for on-lending
under USAID-supported projects should bear rates of interest that are
comparable to market-clearing rates of interest for non-concessional
sources of funds. Some of the interest yield to the govern­ment under
such programs could be set aside for technical assistance to the
financial institutions or to the sub-borrowers for facilitating the
credit transactions. (The same result could be achieved by requiring the
financial institutions themselves to set aside from the market interest
payment, all of which would otherwise go to the government, a portion
reserved for specified purposes of institu­tional development or services
to sub-borrowers. However, the interest payment to the government should
not be reduced simply as an unbudgeted subsidy to the financial
institution.) Otherwise, technical improvements to financial
institutions can be funded by grants or loans that are budgeted
separately from the funds made available for on ­lending. This latter
method may be preferred if it is desired that the institution-building
activities should proceed before the on-lending activities can generate
revenues.

Missions should also endeavor to assist financial institutions by
finding innovative, cost-effective methods by which they can eventually
serve target groups on a self-sustaining basis. Alternative pilot
approaches may be supported through training, technical assistance, and
modest financial assistance. Such efforts should examine a range of
policies and characteristics of credit programs and practices that input
upon target groups such as small farmers (e.g., traditional collateral
re­quirements).

Where it is not possible to persuade a government to eliminate interest
rate controls or credit ration­ing in one step, Missions may provide
support to or through financial institutions on the basis of significant
measures being undertaken by the government to reduce controls where
they adversely affect the mobilization or allocation of credit.

However, the importance of interest rates should not be overlooked even
in the short to medium term. A credit fund that prices its loans only
five percentage points below the rate of inflation and that sustains
only a nine percent default rate on principal will still shrink to
one-half its initial pur­chasing power by the end of a five-year project
(if the whole fund is continuously loaned out).

*IV. Implementation*

USAID\'s policy regarding pricing and distribution policies related to
food and agriculture has im­plications for two aspects of USAID\'s
programs:

· analysis and formulation of recommended economy-wide policies for
consideration by host governments; and

· pricing and distribution components of USAID­supported projects.

Two projects coordinated by the Science and Technology Bureau (S&T) will
facilitate Missions\' access to technical assistance in analysis and
design of policy-related programs. An \"Agricultural Policy Analysis\"
project is being designed both to assist Missions in policy analysis and
to assist the development of better policy­making institutions in host
governments.[^18]

The Rural Savings for Capital Mobilization Proj­ect, designed by S&T\'s
Rural Institutions Divi­sions (S&T/MD/Rl), will assist Missions in
establishing, testing, and implementing improved approaches to rural
savings and credit, as well as in performing, and in strengthening the
capacity to perform, analysis of interest-rate and credit ­allocation
policies, both in USAID Missions and in host governments.

In addition to support through these projects, a forthcoming USAID
Policy Paper on \"Approaches to the Policy Dialogue\" will provide
general ad­vice and guidance to Missions on the conduct of discussions
with host governments regarding economic policies.

In the area of pricing and distributional aspects of USAID-supported
projects, the present paper con­tains general guidance as to the goals
that Mis­sions should pursue. Implementation may require some Missions to
increase their access to expertise in analysis of economic policies.
Missions may wish to consider increasing the number of their personnel
positions in such designations as \"Program Economist\" and
\"Agricultural Economist\". USAID has recently emphasized recruitment of
economists and agricultural economists for its Foreign Service, as well
as under joint Career Corps appointments, which should allow more
Missions to fill such positions with the appropriate skills.

Project design in the areas of concern of the pres­ent paper will also be
assisted by the forthcoming evaluations of project\'s in the
Agricultural Services Sector, to be conducted by USAID\'s Evaluations
Office (PPC/E). This series of evaluations will in­vestigate the
effectiveness and sustainability of agricultural development programs in
the provi­sion of inputs, equipment, and credit, and in im­proving
marketing channels for crops.

*References\**

1\. Abt Associates, \"Evaluation of Agricultural Sector Planning
Activities in Latin America and the Caribbean,\" (Report submitted to
LAC/DR/ARD), July 1982.

2\. USAID, Spring Review of Small Farmer Credit, June 1973.

3\. USAID Policy Discussion Paper, \"Food Aid and Development,\" July
1981.

4\. USAID Policy Paper, \"Economic Policies of Developing Countries and
the Effectiveness of U.S. Economic Assistance: Approaches to the Policy
Dialogue,\" forthcoming.

5\. USAID Policy Paper, \"Financial and Capital Market Development,\"
forthcoming.

6\. USAID Policy Paper, \"Food and Agricultural Development,\" May 1982.

7\. USAID Policy Paper, \"Nutrition,\" May 1982.

8\. Bhagwati, Jagdish and Anne Krueger (general editors), Foreign Trade
Regimes and Economic Development (11 vols.) (Cam­bridge, MA: Ballinger
Publishing, 1978).

9\. Krueger Anne O., \"The Political Economy of the Rent-Seeking
Society,\" The American Economic Review 63:3 (June 1974), 291-303.

10\. Little, Ian, Tibor Scitovsky, and Maurice Scott\' Industry and
Trade in Some Develop­ing Countries (New York: Oxford University Press,
1970).

11\. McKinnon, Ronald I., Money and Capital in Economic Development
(Washington, D.C.: The Brookings Institution, 1973).

12\. Shaw, Edward S., Financial Deepening in Economic Development (New
York: Oxford University Press, 1973).

\*This list simply provides more complete references to documents cited
in the paper. It is not intended to be an exhaustive list of the
im­portant literature dealing with pricing and related policy issues in
food and agricultural development.

[^1]:     ^?^The concluding action of this paper on \"Implementation\"
    briefly describes resources that Missions may draw on to assist in
    policy analysis and related program design.

[^2]:     ^?^It is useful to distinguish subsidies from price controls.
    Price control is a *regulation* that controls (or restricts) the
    price that may legally be paid or received for some good or service.
    A subsidy is a type of *fiscal outlay* to a firm or household.

[^3]:     ^?^Similar arguments apply to roads, bridges, and so forth. In
    cases like these, it may be useful to keep in mind the distinc­tion
    between a subsidy and a governmental investment. A subsidy is
    gratuitous payment to a firm or a household. (It is gratuitous in
    the sense that no goods or services am rendered to the government
    that provides the subsidy, although as a result of the subsidy,
    goods or on-vices may be rendered to others, even if not in
    consideration of, or equal in value to, the subsidy). Governmental
    investment is the purchase or production of a durable good by the
    government.

[^4]:     ^?^The misuse of resources caused by external trade policies
    has been studied more thoroughly than that in any other sector.
    Perhaps the best summary of findings is that of the multi-­country
    study supported by the OECD\'s Development Assistance Committee:
    *Industry and Trade in Some Develop­ing Countries,* by Ian Little,
    Tibor Scitovsky, and Maurice Scott. See also the various volumes of
    *Foreign Trade Regimes* *and Economic Development,* a more recent
    multi-country study under the general editorial leadership of
    Jagdish Bhagwati and Anne Krueger, financed by USAID, which studies
    the inter-relations of exchange control, foreign trade regulations,
    and economic development. \'Me frequently negative contributions of
    policies relating to money and finance have received increased
    attention in recent years. See Ronald McKinnon, *Money and Capital
    in Economic* *Development,* and Edward S. Shaw, *Financial Deepening
    in* *Economic Development.* The economic implications of the
    political culture created by inefficient pricing and distribution
    policies is the subject of Anne Krueger\'s article, \"The Political
    Economy of the Rent-Seeking Society.\" (See the end of this paper
    for full references.)

[^5]:     ^?^Given the limits on available resources, many countries
    will be able to reach the third objective only partly in the short
    term, even with external food aid.

[^6]:     ^?^Methods of targeting food programs to undernourished groups
    are discussed in USAID\'s \"Nutrition\" Policy Paper, May 1982. They
    are also discussed in the USAID Policy Discussion Paper, \"Food Aid
    and Development,\" July 1981. Administrative problems of targeted
    food programs will be dealt with further in a proposed review of
    Tide II programs.

[^7]:     ^?^Promoting efficiency in food markets is briefly discussed
    below.

[^8]:     ^?^To give a hypothetical, numerical example of this approach,
    suppose that the average household in the target group buys twelve
    kilos of some grain a week at a price of three rupees each in an
    uncontrolled market (at a total expenditure of thirty-six rupees),
    and that the program goal is to raise pur­chasing power over this
    grain by eight rupees. This could be accomplished by instituting
    price control and setting the con­trolled price at two-and-half
    rupees, on the assumption that the typical response would be to
    expand consumption (given the lower price) by four kilos to sixteen
    a week, as a half-­rupee saving on each of sixteen kilos amounts to
    eight rupees. This plausible consumer behavior would result in a new
    total expenditure of forty rupees on this grain, implying that four
    rupees of expenditure on other goods (including other foods) has
    been diverted to purchases of this particular grain because of its
    relative (but artificial) cheapness.

    This bias in demand, with its attendant excess cost of supply (if
    indeed such an adjustment in supply is possible), can be avoided and
    the same eight rupees\' benefit extended if the policy were instead
    to reduce the price of *just the first eight kilos* bought by each
    household weekly to two rupees each, leaving the ninth and further
    units to be bought at uncon­trolled prices. Since the price of extra
    kilos of this grain (beyond the twelve kilos bought without the
    price reduction) is not artificially depressed by this alternative
    policy, no bin in demand would be created. A plausible consumer
    response would be to increase consumption of this particular grain
    by only two kilos to fourteen a week, at a total expenditure now of
    only thirty-four rupees (eight times two plus six times three,
    assuming the change in the uncontrolled price to be negligible).
    Thus, the benefit of eight rupees would be (effi­ciently) distributed
    over not just this particular grain but also, to the extent of two
    rupees out of the initial thirty-six, to other goods as well
    (including other foods), depending upon the true costs of the
    various goods.

[^9]:     ^?^ It is possible for private traders to exacerbate price
    instability by driving prices up untenably high through purchasing
    for inventory, and then driving prices down when the inventory is
    marketed. However, although this is possible, it is not pro­fitable.
    Private firms that tend to buy high and sell low (and there have
    been many of them) are short-lived and not representative of the
    bulk of the food trade, which is pro­fitable and survives.

[^10]:     ^?^Food security itself is a complex matter which will be
    dealt

    with in a future USAID policy paper.

[^11]:     ^?^Use of counterpart funds generated by foreign aid to
    finance the local costs of such a subsidy generally only divots
    those funds from uses such as other agricultural program, and thus
    ultimately has opportunity costs for farmers as large as or larger
    than other means of finance.

[^12]:     ^?^All these offsetting costs to farmers as a result of input
    controls are analogous to offsetting costs consumers bear as a
    result of food price controls, some of which were discussed

    in the previous section.

[^13]:     ^?^For example, assume that (1) the free-market cost of cash
    in­puts is one-third of the free-market value of the entire crop, (2)
    one-half of the entire crop is marketed, and (3) one-half of the
    fiscal burden of the subsidies paid to producers and distributors of
    the inputs is ultimately borne by the farmer. Then a *sixty* percent
    reduction in the total cost of controlled inputs is required to
    offset entirely a *twenty* percent reduc­tion in the price of farmers
    outputs, assuming no change in marketing or input use.

    Numerically, if the crop is worth \$600, so that the marketed half
    is worth \$300, then a twenty percent reduction in output price will
    reduce cash income by \$60. If the controlled inputs\' free-market
    cost is one-third of \$600, that is, \$200, then a six­ty percent
    reduction in price would save the farmer \$120. Consistent with
    assumption #3, however, half of that \$120 is\' lost to higher
    taxation and higher prices of other goods the farmer buys due to
    such factors as, for example, excise taxes and inflation required to
    finance the input subsidy. Them Iowa leave a net gain from *input*
    control of \$60, which merely offsets the low from *output* control.

[^14]:     ^?^As suggested above, although increased productivity and
    food supplies will lower consumer prices over time without price
    control, artificial price reductions may stimulate pur­chases of a
    specific good beyond the level that is most effi­cient, given
    national income.

[^15]:     ^?^For example, fertilizer that is imported for \$100 and
    sold to a farmer for \$20 would willingly be used if it produced
    \$40 worth of additional crops, assuming that a two-to-one ratio
    (*ie*., \$40/\$20) adequately compensates the farmer for addi­tional
    costs and risk and thus raises net profits (and the farmer\'s
    welfare). But, even if cif import prices of food are twice domestic
    prices, it would still cost only \$60 to import the same amount of
    food. On this assumption, the real cost of this food would be 25%
    higher than if imported directly (\$100 compared to \$80).
    Furthermore, food produced with imported fertilizer is no more
    secure from the risks of foreign trade than is food directly
    imported.

[^16]:     ^?^This section draws on extensive research on finance and
    credit policies in developing countries, including papers prepared
    for the USAID Spring Review of Small Farmer Credit and subsequent
    work at Ohio State University and elsewhere. USAID\'s policy in this
    area will be stated more fully in the forthcoming USAID Policy
    Paper, \"Financial and Capital Market Development.\"

[^17]:     ^?^If an expensive, long-lasting capital good is a major part
    of the technical package, interest will be a larger portion of
    pro­duction costs, and reductions of interest rates will have
    pro­portionally more importance. Such investments are, however, rare
    for small farmers in LDCs.

[^18]:     ^?^Of related interest is the \"Evaluation of Agricultural
    Sector Planning Activities in Latin America and the Caribbean,,,
    July 1982, commissioned by the Latin America Bureau\'s Rural
    Development Division (LAC/DR/ARD) to review the results of
    USAID-supported projects in that region.