AAMP Training Materials
Module 2.3: Macro Effects on Smallholder
Commercialization
Shahidur Rashid, Nick Minot (IFPRI)
s.rashid@cgiar.org, n.minot@cgiar.org
Outline
•
•
•
•
•
Macro and trade policy distortions
Importance of understanding distortions
Economics of distortions
Foreign Direct Investment (FDI) in Africa
Foreign exchange markets (exercise)
Macro and Trade Policy Distortions to
Agricultural Incentives
Information
Supply
(production +
Import)
Technological
Capacity
Infrastructure
Institutional
capacity
Commodity
Price
Demand
Macro-economic
& Trade Policy
Distortions to incentives refers to the changes in
prices due to policies
Macro and Trade Policies
• Fiscal policy
– government spending, borrowing, taxes, subsidies
• Monetary policy
– money supply, interest rate, bank regulations
• Trade policy
– tariffs, quantitative controls
• Exchange rate
– import and export flows, FDI, pricing and quantitative controls
Importance of understanding distortions
• More than two-thirds of the world’s poor live in
developing countries; and a large share of them directly
or indirectly depend on agriculture for their livelihood
• Government policies can depress farm incomes
through:
– Anti-agricultural policies in developing countries
– Pro-agricultural policies in developed countries, which lower
international food prices and thereby some farm-gate prices in
developing countries
Importance of understanding distortions
• Poverty is alleviated by economic growth
• Economic growth is enhanced when distortionary
government interventions in markets are reduced
• Gradual, phased trade reform in particular can contribute
at little cost
• Agricultural trade reform is likely to be pro-poor in
aggregate, although some poor may lose
Importance of understanding distortions
Applied tariff rates in Agriculture
• Tariffs on agriculture
have been historically
high in developing
country agriculture
• Though declining
recently, developing
countries continue to
have higher applied
tariff rates than the
MIC and HIC
Economics of Distortions
P
Pd
Consumer
Gains
So
Producer
gains
Pg
D
Q
Measuring distortions due to tax and subsidies
• Consider the following notations:
–
–
–
–
–
–
–
–
Pf = Producer price
Pc = Consumers’ price
E = Exchange rate
P = the border price
tm = Import tax
te = Export subsidy
Tm = Transactions costs for imports
Tx = Transactions costs for exports
Measuring distortions due to tax and subsidies
• If a tariff on imports is applied:
NRA = (E.P(1+tm) – E.P))/E.P = tm
and CTE = Consumers’ Tax Equivalent is tm
(where tm<0 if it is an import subsidy)
• The effects of an export subsidy, sx, are the same
except sx replaces tm above (where sx<0 if it is an export
tax)
Measuring distortions due to tax and subsidies
S
Price
Pa
P 1  Tm  1  tm 
P 1  Tm 
P
Import Tax
Example
Import tax
revenue
Trading
costs
D
Quantity
Measuring distortions due to tax and subsidies
• If a production subsidy is applied:
NRA = (E.P(1+sf) – E.P)/E.P = sf
and CTE = 0
where sf < 0 if it is a production tax
Measuring distortions due to tax and subsidies
Price
D
S
P
P 1  Tx 
P 1  s x  1  Tx 
Pa
Trading costs
Tax revenue
Export Tax
Example
Quantity
Distortions from exchange rate misalignment
• Inappropriate exchange rates are another distortion in
the market
• An overvalued currency makes export expensive, which
makes firms less competitive
• An undervalued currency makes export cheaper, which
in turn promotes export (but at the expense of some
other countries)
Distortions from exchange rate misalignment
Ethiopia Coffee
0.00
-0.10
-0.20
-0.40
-0.50
-0.60
-0.70
-0.80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
TRA
-0.30
Year
TRA for exportables
TRA for non-tradable
TRA (total)
Distortions from exchange rate misalignment
1
0.9
0.8
NRA with parastatals’ overhead
0.7
0.6
0.5
0.4
Derge Regieme
Post Liberalization
0.3
0.2
0.1
0
-0.1
-0.2
-0.3
-0.4
-0.5
-0.6
-0.7
-0.8
1981
1983
1985
1987
1989
NRA_at_Eqlm_ER
1991
1993
1995
NRA at official_ER
1997
1999
2001
2003
NRA_officail_ER+Overhead
2005
Foreign Direct Investment (FDI)
• Offers one source of foreign exchange inflows
• In any resource constrained country, FDI can contribute
towards:
–
–
–
–
Promoting technology and institutional innovation
Building human capital
Creating jobs and increasing household incomes
Promoting overall development
• Many emerging countries have benefited from increased
flow of FDI (India, China, Brazil, South Africa)
– Latin American countries had particularly benefited from FDI in
promoting agricultural commercialization
• Developing countries are receiving an increasing share
of FDI
Trends in FDI to sub-Saharan Africa
Decades
FDI to SSA
SSA Share in Word FDI
1970s
US$907 Million
5 Percent
1980s
US$ 1.3 Billion
2 Percent
1990s
US$ 4.3 Billion
3 Percent
Early 2000
US$10 Billion
4 percent
FDI Trend in AAMP Countries
1400.0
1200.0
1000.0
800.0
600.0
400.0
200.0
0.0
-200.0
2000
2001
2002
Burundi
Kenya
Uganda
2003
2004
2005
Ethiopia
Malawi
Zambia
2006
2007
2008
Ethiopia
Rwanda
2009
Trends in FDI to sub-Saharan Africa
• FDI to Africa has increased in absolute terms, but has
declined relative to growth in overall flow of FDI to
developing countries.
• Understanding this puzzling trend is subject of large
body of research
• The Challenge: How to attract more FDI to SSA?
What will Attract FDI to Africa?
• The simplest answer to the question is “ possibility of
profitability”
• What determines the FDI profitability? Consider the
following:
–
–
–
–
–
–
Economic openness
Size of the economy
Political stability
Infrastructural development
Institutional capacity
Regulatory environment
Trends in FDI to sub-Saharan Africa
• One way to analyze why FDI vary by country is to
compare a common indictor. World Bank produces such
an indicator, called “the ease of doing business”. It ranks
countries based on the following indicators:
• Starting a Business
• Dealing with
Construction Permits
• Registering a property
• Getting credit
•
•
•
•
•
Protecting Investors
Paying taxes
Trading across borders
Enforcing contracts
Closing business
Trends in FDI to sub-Saharan Africa
The ease of doing business (2011)
150
•
None of the AAMP
countries ranks worse
than BRIC countries
•
Rwanda and Zambia
rank better than any of
the four BRIC countries
•
Are these results
puzzling?
125
100
75
50
25
BRIC
AAMP
Zambia
Uganda
Tanzania
Rwanda
Malawi
Kenya
Ethiopia
China
India
Russia
Brazil
0
FDI Exercise
• Open Excel workbook and click the [Ex. 1 – FDI
Exercise] sheet
• Examine the example: Zambia v. Brazil
– What do you notice?
• Copy and paste rows of data from [FDI Inflows] sheet for
further comparison
– Compare SSA countries with BRIC countries
Model of foreign exchange (Explanation)
• Characteristics of Excel model [Ex 1 – Forex Market]
–
–
–
–
One “product”: foreign currency
Supply and demand of foreign exchange
“Price” of foreign exchange is exchange rate
In model, you can shift fixed exchange rate, supply for foreign
exchange, demand for foreign exchange, and income
– Output shows effect with fixed exchange rate and market (floating)
exchange rate
• How to use the Excel model
–
–
–
–
–
BLUE represents cells you can change to calibrate model
YELLOW represents cells you can change to simulate a shock
GREEN shows the output cells, which should not be changed
Table shows “before” and “after” simulated shock
Solid lines represent “before”, dashed lines “after”
Model of foreign exchange (Discussion)
• What factors determine supply of foreign exchange?
–
–
–
–
Exports of products
Exports of services (e.g. tourism)
Foreign direct investment
Inflow of international remittances
• What factors determine demand for foreign exchange?
– Imports of products
– Imports of services
– Speculative demand
Model of foreign exchange (Exercises)
Open Macro Effects on Smallholder Commercialization.xls
and open [Ex 1 – Forex Market] worksheet
1. Suppose there is a burst of economic growth and
income rises 20%
–
–
–
–
–
If exchange rate floats, what happens to exchange rate?
Who benefits from this change in exchange rate?
Who loses from this change?
If exchange rate is fixed, what happens to exchange rate?
What happens to excess demand?
Model of foreign exchange (Exercises)
2. Suppose the cost of imported goods rises dramatically,
causing a 50% increase in demand for foreign
exchange
– If exchange rate floats, what happens to exchange rate?
– If exchange rate is fixed, what happens to excess demand?
Model of foreign exchange (Exercises)
3. Suppose the price of the main export rises, causing a
40% increase in inflow of foreign exchange
–
–
–
–
If exchange rate floats, what happens to exchange rate?
What does this do to other exports?
Concept of Dutch disease
If exchange rate is fixed, what happens to excess demand?
4. Suppose oil is discovered in a country, causing a surge
in foreign direct investment
– If exchange rate floats, what happens to exchange rate?
– If exchange rate is fixed, what happens to excess demand?
Resources
http://www.doingbusiness.org/
http://unctadstat.unctad.org/TableViewer/tableView.aspx
http://economics.adelaide.edu.au/newsletter/agdis.html
Beginners guide to the economics of foreign exchange markets (
http://economics.about.com/cs/money/l/aa022703a.htm)
Wikipedia article on foreign exchange markets
(http://en.wikipedia.org/wiki/Foreign_exchange_market)
Gaucan, 2010. “Introduction to the foreign exchange market”
http://www.scientificpapers.org/wpcontent/files/1120_Introduction_to_the_foreign_exchange_
market.pdf