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The economics of triangular food aid transactions
The economics of triangular food aid transactions
Bertin Martens
It has been shown that triangular food aid transactions (TFATs) could create, in certain circumstances, price increases on world food markets. Two typical cases have been identified: the price-inelastic Zimbabwe white maize market - where such price effects are likely - and the price-elastic Thai rice case - where they are unlikely. In the Zimbabwe case, and to a lesser extent in the Thai case, TFATs are an inefficient way of transferring resources to developing countries. However, TFATs can become efficient if the additional benefits in terms of cost-effectiveness and timeliness outweigh the resource transfer losses. If the transfer of resources to the supplier leads to a real increase in food supply, this could also offset the negative effects of the switch from bilateral to triangular transactions. Bertin Martens was a member of the Food Studies Group (FSG), Oxford University. He now works for the Commission of the European Community and can be contacted at BP 3345, Dakar, Senegal. The author would like to thank R. Hay, S. Hunt and G. Shuttleworth, colleagues at FSG, for their comments. This article is a soin-off of an evaluation studv of the EEC Triangular Food Aid programme, financed by the Commission of the European Communities and carried out bv FSG. All views and opinions expressed in this article, as well as all remaining errors, are the author’s,
‘Food aid statistics, however, usually classify the commodity used by the donor in the barter deal as ‘food aid’. This is not entirely correct.
0306-9192/90/010013-14$3.00
0
It is often claimed that triangular food aid transactions (TFATs) can be distinguished from bilateral ones by the fact that there are three parties involved in the former (a donor, a supplier and a recipient) and only two (a donor and a recipient) in the latter. This distinction is based on semantics rather than the economic reality which it refers to. If we look at the transactions at country level, then this distinction is correct. However, if we consider the transactions at a sub-country level, there are always three parties involved in a food aid operation. Both bilateral and triangular transactions involve a donor, a supplier and a recipient. The distinctive feature of a triangular transaction therefore is not the fact that there are three parties involved but that the supplier is located outside the donor country. This interpretation of the term ‘triangular transaction’ is more in line with the main objective of such operations (see further). Thus a TFAT could be defined as a food aid operation, financed by a donor country and delivered to a recipient country, whereby the source of supply is located outside the donor country. There are, however, different types of TFATs. In an ‘ordinary’ TFAT three different countries are involved - which has led to the adoption of the term ‘triangular’. But it is possible to conceive of a TFAT in which there are only two countries involved, a donor country and a suppliercum-recipient country. In that case the TFAT is called a local purchase. Another subject of TFATs consists of ‘swaps’. Swaps are TFATs with a special financial arrangement between the donor and the supplier. The supplier is not paid in cash for deliveries. Instead a barter deal is set up, whereby the donor exchanges his own food surplus commodity against the surplus commodity of the supplier. Although the donor does act, at first sight, as a commodity supplier in a swap, the swap itself is not a food aid operation but a commercial deal, at least if the ‘swap ratio’ the quantity of surplus commodity delivered by the donor divided by the quantity returned by the supplier - reflects the ratio of market values of the swapped commodities. If the donor agrees to a lower exchange ratio, then there is an element of concessionality in that aspect of the operation too. Only the second part of the operation, the delivery of the swapped commodity to the final recipient, can be classified as a pure food aid operation.’ Therefore swaps do fit in the above-presented definition of TFATs: the supply of the food aid commodity does not come from the donor country.
1990 Butterworth
& Co (Publishers)
Ltd
13
The economics
of triangular
food
aid lransactions
It is, of course, possible to combine a swap and a local purchase operation into one single food aid operation. That would be called a ‘local swap’. The analysis of TFATs is further complicated by the fact that different donors use a different terminology for these types of transactions. USAID carries out TFATs in the form of swaps, which it calls ‘trilateral’ transactions. It swaps US wheat surpluses for white maize in a number of African surplus-producing countries (Ghana, Kenya, Zimbabwe), which is then delivered to white maize deficit countries in the region.’ The World Food Programme (WFP) employs pledges in kind,s which are basically bilateral transactions with the WFP acting as a middleman. The supply comes from the donor country, not a third party, and the WFP’s role is limited to matching supply and demand. Its pledges in cash, however, can result in triangular transactions. These funds can be used to purchase foodstuffs in a third country.4 The WFP does carry out local purchases and local swaps, but so far it has not been involved in international swaps.
Objectives of triangular transactions
%ee A. Morton et al, ‘An Evaluation of the Trilateral Food Aid Programme of the United States Government’, report for USAID, Washington, DC, USA, 1988. 3Pledoes in kind are donor contributions in food commodities, supplied from the donor’s own surplus stocks. Cash pledges are financial contributions by donors. Cash pledges normally have no restrictions on the source from which supplies can be bought. ?See Relief and Development Institute, An
Critics of (bilateral) food aid operations have always denounced food aid as a means of dumping expensive agricultural surpluses from First World countries onto Third World markets, thereby creating disincentive effects to local food production in the recipient countries. Supporters of food aid have seized upon the possibilities of TFATs to silence that criticism. Triangular operations do not dump surpluses from First World markets on Third World markets. On the contrary, they support Third World producers by buying their surpluses, thus offering a production incentive, at least in the supplier country. Thus one major objective of TFATs is to stimulate domestic food This objective is to be realized production in developing countries. through a switch in donor expenditure from domestic food procurement to procurement in developing countries. However, the creation of effective demand for developing countries’ food supplies does not necessarily result in a real increase in food production. The conditions for a positive supply response are discussed later in this article. The switch-over from bilateral to triangular food aid has also changed the political economy of food aid. The donor’s domestic agricultural lobby, which favoured bilateral food aid operations for its own economic reasons, is an opponent of TFATs. An outlet to dispose of expensive agricultural surpluses has now been closed. To reduce the criticism of this previous ally but also out of genuine a number of additional justifications or operational considerations, objectives for TFATs have been developed:
l
l
Evaluation of the WFP Triangular Food Aid Programme, Occasional Papers Series
No 11, WFP, Rome, Italy, 1987.
14
0
Cost-effectiveness: A triangular operation could be cheaper, not only because of savings in transport costs, but also because the purchase price on a Third World market could be lower than on the world market. Timeliness: Buying food in neighbouring developing countries rather than on First World markets could reduce the transport distance and time. Triangular food aid could arrive faster than bilateral aid, which is especially important in emergency circumstances. Commodity appropriateness: Procurement of food aid in a country FOOD POLICY
February
1990
The economics of triangular food aid transactions
in the same region enables food aid donors to supply commodities which match existing taste preferences countries.
appropriate in deficit
The extent to which ‘supply side’ or operational objectives are emphasized varies from donor to donor. The WFP attaches more importance to operational considerations. Its rules and regulations are less concerned with supply side objectives. Above all, it wants to carry out efficient food aid operations. The EC rules and regulations governing TFATs do mention the ‘benefits to the supplier country’, which could be interpreted as a supply side objective. But operational objectives prevail for emergency operations and in cases where recipient countries ask for commodities where there are no surpluses available in the Community. The key question which we will try to answer in this article is: are triangular transactions an efficient way of transferring food resources to developing countries? The efficiency question can be broken down into three components: 0 0 0
How efficient is the switch of donor resources from bilateral to triangular procurement of food aid? How do the three operational considerations add to the efficiency of this switch of resources? Under which conditions can the supply response contribute to an efficient TFAT?
The following two sections attempt to answer the first question. Then we look at the contribution of cost-effectiveness and timeliness to TFAT efficiency.5 The final section analyses the supply side conditions for an efficient operation. Although the conclusions of the earlier sections may be rather negative from the point of view of efficiency of resource allocation, the later sections show the more positive aspects of TFATs.
Basic model
5The commodity appropriateness
argu-
ment will not be considered in this article. %ee, for instance, W. Schultz, ‘The value of US farm surpluses to underdeveloped countries’, Journal of Farm Economics, Vol42, 1960, pp 1019-1030; F. Fischer, ‘A theoretical analysis of the impact of food surplus disposal on agricultural production in recipient countries’, Journal of Farm Economics, Vol45, 1963, pp 863-875; F.McCarthy, ‘Welfare effects of tied food aid’, Journal of Development Economics, Vol 11, 1982, pp 63-79.
FOOD POLICY
February 1990
Theoretical models for the analysis of the economic impact of ‘normal’ bilateral food aid operations are well-known among food aid economists.6 These models are based on neoclassical assumptions on domestic food market behaviour and have pointed out that food aid could depress domestic prices and, as such, have a disincentive effect on domestic food production. However, in certain cases disincentive effects will not occur or can be avoided through countermeasures. Bilateral food aid models usually deal with the impact on domestic markets in the recipient country only. Triangular transactions, however, consist of two operations: (a) purchase on a world market, and (b) disposal on a domestic market. The economic impact of the second part of the transaction can be analysed with bilateral aid disposal models,-but the analysis of the first part requires different analytical tools. For the analysis of triangular transactions, we start from the following pre-TFAT bilateral food aid situation (see Figure 1):
l a recipient
a
country, buying a certain quantity (Q) of its food import requirements commercially on the world market at the market clearing price (P) and receiving the remainder (Q*-Q) as bilateral food aid from a donor country; the donor country supplies food aid to the recipient from his own surplus stocks, valued at the opportunity cost of these stocks
15
The economics of triangular food aid transactions D+
D
s
Aid
\ P’
al
2
h
\ P
/ PO/
Q’
Figure 1. The impact of triangular transactions on the world market.
Q
Q*
4” Quantity
r+$O 0
a suiplier imported
< P, world
market
value
of the commodity
country which sells on the world commercially (Q) by the recipient.
market
minus
storage
the quantity
It is assumed that the donor’s food aid is additional to the recipient’s commercial food imports and does not replace the latter. Consequently, food aid does not depress the world market price for the food commodity. It is furthermore assumed that the donor does not attempt to replace the lost stocks by selling less on the world market; food aid donations do not change his commercial export behaviour. Note that the opportunity cost of food aid for the donor (PO) is a function of time: the longer he keeps the commodity in storage, the higher the storage cost and the lower PO. PO could actually become negative. However, Figure 1 does not capture the time dimension of food transactions or storage. Storage time is assumed fixed here, but not equal to zero (otherwise PO = P since storage costs are zero when storage time is zero). When the bilateral transaction is changed into a triangular one, a transfer of financial resources from the donor country to the supplier country is made, in return for food. Food aid funds which would normally be spent in the donor country under bilateral aid are then shifted to the supplier. As a result:
a a a 0
demand for exports from the supplier increases: he can now export Q plus the food aid quantity Q*-Q; as a result of this increased demand, the price on the world market increases to P’; the recipient’s commercial imports will decrease to Q’ as a result of the price increase; so that the supplier’s export volume and the recipient’s import volume falls from Q* to Q”.
Most donor countries control domestic agricultural product prices and have substantial surpluses of the products which they offer as food aid.
16
FOOD POLICY
February
1990
The economics of triangular food aid transactions
It is therefore assumed that the decrease in demand for donor country food surpluses has no impact on domestic prices in the donor country or world market prices. The surplus which would have been used as bilateral food aid will not be dumped on the world market but kept in stock by the donor. For the supplier, triangular food aid represents an effective increase in demand for a commodity which he sells on a competitive world market with no price controls. If supply is perfectly price-elastic, or if the additional demand is marginal, the resulting price increase will be negligible. But if supply is not perfectly elastic and/or additional demand is substantial, price increases can be important. Thus the supplier gains through both an increase in quantity and, possibly, a price increase. For the recipient country there is, at first sight, no change: it still receives the same amount of food aid but from a different source. But a relatively important indirect effect has to be taken into account. If the switch-over from a bilateral to a triangular operation causes a price increase on the world market, then commercial food imports by the recipient country will be reduced. The actual quantity reduction depends on the price elasticity of demand and supply. Consequently, total food imports and the domestic food supply will also drop. Graphic summary of the basic model
7Although Figure 1 assumes that the entire
bilateral food aid programme is turned into a triangular programme, the conclusions drawn from the model are also valid for a partial switch-over. *Note that it is assumed here that donor demand for food aid is not price elastic.
FOOD POLICY
February 1990
Figure 1 represents the world market (and not a domestic market) supply and demand situation for a particular food aid commodity. In this diagram the demand line D represents the sum of demand by all countries which import that commodity, while the supply line S is the sum of all supplies by all exporting countries. The starting point in the analysis is the bilateral food aid situation, represented by the intersection of the D(emand) and S(upply) lines where the recipient imports commercially quantity Q and pays the price P. On top of its commercial imports, it receives a quantity (Q*-Q) as bilateral food aid. Total food imports by the recipient thus amount to Q + (Q*-Q). Bilateral food aid does not shift the demand line to the right, at least not in the short run through direct effects, because it is released from the donor’s stocks and not bought on the world market. Effective world market demand remains at the D line and not at the D+Aid line. The model is furthermore based on the assumption that food aid is additional to commercial imports and does not replace them. When the donor decides to change the bilateral food aid programme into a triangular food aid operation, 7 then the effective world market demand curve D will shift to the right by the amount of triangular (formerly bilateral) food aid: D+Aid. The planned cost of this triangular operation is P x (Q-Q*). But the additional demand drives up the price to P’, at least in the short run when supply is not very price elastic. Hence the actual outcome of the operation is the intersection of S and D+Aid. The donor delivers the planned quantity but at a higher price, P’. The recipient is likely to reduce its own commercial imports because of the price rise to Q’. Consequently, total food imports by the recipient have been reduced by Q*-Q”. Clearly, the price elasticity of supply and demand play a crucial role.’ It should be pointed out here that the above model is theoretical. In particular, the price effect of a TFAT depends on the structure of the market and the relative importance of TFATs in that market. We will
17
The economics of triangular food aid transactions
use here the examples of the ‘Thai rice’ and ‘Zimbabwe white maize’ markets, referring to their most prominent real-life examples. Both examples could be generalized and considered as being representative of two fundamentally different types of markets with different implications for TFAT policy. TFATs are unlikely to cause price increases if their importance is marginal compared to the size of the supplier’s export market. Buying rice in Thailand or wheat in Argentina is unlikely to distort the world market price for these commodities. In the Thai rice case, the supply curve in Figure 1 should be drawn almost perfectly horizontal, reflecting an almost infinite price elasticity of supply, at least for the relevant quantity range of TFAT operations. However, in cases of very limited market size the risks of distortion are real. For instance, the fact that the WFP, the EEC and USAID purchased more than 40% of Zimbabwe’s white maize exports in the last few years may have been an important factor in the price increase of white maize in Southern Africa.’ For the Zimbabwe white maize case the sloped supply curve in Figure 1 reflects a reality: supply has a low price elasticity. Additional@
versus substitution
It is assumed in this model that the donor’s bilateral food aid is additional to the recipient’s commercial food imports. This is a very basic principle but not realistic for all food aid operations. Additionality or non-substitution is difficult to verify - which has helped to undermine this principle. The view that a substantial part of food aid is indeed substituting for commercial imports is more and more generally accepted. If food aid were additional to commercial imports, then it would not depress the world market price for the food aid commodity. P is assumed to be the market clearing price. On the other hand, if the amount of bilateral food aid received were substituted for commercial imports by the recipient, it would reduce demand on the world market and thus depress world market prices, at least in the Zimbabwe white maize case. The Thai rice case is indifferent to substitution or additionality: the price would not change.‘O In the Zimbabwe case and with substitution, P’ and not P would be the real world market clearing price in the absence of food aid. Replacing the bilateral by a triangular transaction would simply restore the ‘before food aid’ equilibrium at P’ and Q”. This would mean that, in the welfare analysis presented below, all signs of losses and gains would have to be changed: a loss due to a triangular transaction becomes a gain because it restores the orginal pre-food aid situation and eliminates the losses/gains caused by the bilateral operation. Thus substitution in the Zimbabwe case would be preferable to additionality! Dual markets ‘See Chapters 5 and 6 in Food Studies Group, ‘An Evaluation of European Community Triangular Food Aid’, report for the Commission of the European Communities, unpublished. “‘It would, of course, still make a difference to the recipient country’s external resources balance.
18
So far we have implicitly assumed that bilateral and triangular food aid transactions take place on the same market, in other words that the same commodity is used for both types of transactions. In reality this is not always the case. The EC, for example, decides on the type of transaction according to the type of commodity requested by the recipient country: food aid commodities can be mobilized on the world market (triangularly) only when they are not available in European
FOOD POLICY
February 1990
The economics of triangular food aid transactions
surplus stocks (bilaterally), except in emergency situations. Bilateral and triangular food aid commodities are thus not the same. But this ‘dual market’ phenomenon does not change the validity of the model presented above. Demand for the food commodity sold on the world market by the supplier and bought commercially by the recipient still increases. Only if the recipient country would not normally buy its commercially imported food on the same world market would the model have to be modified. This, however, would amount to providing the recipient with a non-preferred food commodity (a commodity which he would not buy commercially) through a triangular operation, contrary to one of the main aims of triangular operations, which is to provide more appropriate or preferred commodities. Additional to bilateral food aid Apart from additionality from the recipient’s point of view, discussed above, there is also the case of a TFAT being additional to other bilateral (and triangular) food aid operations. With the increasing importance of Japan as a (food) aid donor, this issue has surfaced: virtually all Japan’s food aid is triangular since it has no domestic food surpluses to be transferred to developing countries. This eliminates the cost of storage of domestic surpluses from the analysis. Several possibilities should be examined. Either Japan’s TFAT substitutes for bilateral or triangular food aid from other donors. In that case the above analysis remains valid, except for the elimination of storage costs. Or Japan’s aid is additional to other food aid, which leads to two sub-cases: 0
0
The supplier is a Thai-type market. This eliminates price effects too. The supplier and the recipient receive a net benefit equal to (Q*-Q) x P in Figure 1. The supplier is a Zimbabwe-type market. This creates a positive quantity effect but a negative price increase effect for the recipient. The final result depends on price elasticities of supply and demand.
Price-inelastic demand We have already pointed out that Figure 1 represents the Zimbabwe white maize case, the ‘normal’ neoclassical market where both supply and demand are reasonably price elastic. But market structures often deviate from this ‘normal’ case. One deviation on the supply side has already been considered and classified as the ‘Thai rice’ case, but there is also the possibility of a deviation on the demand side with extremely price-inelastic demand or an almost vertical demand curve in Figure 1. Let us consider the impact of a TFAT in the case of a combination of a Zimbabwe-type supplier with a sloping supply curve and a recipient with a steep price-inelastic demand curve - most of Zimbabwe’s neighbours. If total demand for food imports is price inelastic because it is mainly a function of population and domestic agricultural production and not of prices, then, in order to satisfy domestic demand for imported food when the price of imported food increases, the recipient would have to increase food aid imports, or spend more foreign exchange to stabilize commercial imports. In this case, either the recipient country’s dependence on food aid will increase or his external debt position will worsen as a result of the TFAT. It would be better not to go for a TFAT but to provide bilateral food aid in such situations,
FOOD POLICY
February
1990
19
The economics of triangular food aid transactions
except in emergency operations where factors such as timeliness are crucial. The actual price elasticity of commercial imports depends on the recipient’s import and foreign exchange policy. If the recipient has allocated a fixed foreign exchange budget to food imports, then the quantity imported will decrease proportionally to the world market price increase (price elasticity = -l), assuming that the foreign exchange budget is fully utilized. If the recipient considers food imports to be a priority, taking precedence over non-food imports, then the imported quantity remains constant (price elasticity = 0) but more foreign exchange will be spent on food imports. This can lead to a reduction in non-food imports (cross-price elasticity < 0) and/or an increase in foreign debts (cross-price and own-price elasticities = 0). Note that in emergency operations the short-run price elasticity of demand is virtually zero.
Welfare effects of triangular transactions Figure 1 enables us to calculate net gains and losses for the three parties involved in a triangular transaction. Note that an inter-country comparison of monetary gains and losses is not necessarily a reflection of welfare effects in the countries concerned. This would be true only if the welfare functions of the three countries were identical. Since this is unlikely to be the case for countries with widely different living standards, the following analysis should be interpreted with care. The supplier receives additional export revenue equal to: (Q”xP’)
- (QxP)
(I)
but, assuming that he sells his export commodities at the marginal cost of production, he also faces additional production costs equal to the area under the supply curve between Q and Q”, or: (P+P’)
x (Q”-Q)/2
so that his net benefit (Q+Q”)
- the increase
in producer
surplus
- comes
x (P-P)/2
The recipient imports: (Q+Q’)
(2) to: (3)
loses part
of his consumer
surplus
on commercial
x (PI-P)/2
food
(4)
To calculate the losses for the donor country, the cost of the triangular transaction has to be compared with the cost of a bilateral transaction, both of which the donor pays for. The cost of the bilateral transaction equals: (PO x (Q*-Q)
= PO x (Q”-Q’)
The cost of a triangular
operation
(5)
for the donor
equals:
P’ x (Q”-Q’) so that switching from bilateral cost of food aid by: (PI-PO)
20
(6) to triangular
transactions
increases
x (Q”-Q’)
the (7)
FOOD POLICY
February
1990
The economics of triangular food aid transactions
The total gain or loss in resources specified as: GAIN
= (Q+Q”)
x (PI-P)/2
for all three parties
-
(Q+Q’)
concerned
x (PI-P)/2
x = ((Q+Q”) - (Q+Q’)) = (Q”-Q’) = (Q”-Q’) where
Q”-Q’
x (PI-P)/2 - (PI-PO) x ((P’-P)/2 - (P’-PO)) x (-P/2-P’/2+PO)
> 0 = the quantity
of the TFAT.
-
can be
(P’-PO)
x (Q”-Q’) (8)
Since
PI2 + P’l2 > PO
(9)
the gain on a TFAT must be negative and, thus, a loss. The loss equals the volume of the transactions (Q”-Q’), multiplied by the difference between the opportunity cost to the donor (PO) and the average of preand post-transaction market prices (P and P’). Again, the above statement refers to the Zimbabwe white maize case. In the Thai rice case the final outcome would still be a net loss of resources, although the market price is not affected by the TFAT. In the Thai case P’ = P and Equation (8) can be simplified to: GAIN
= (Q-Q’)
x (PO-P)
(10)
Since PO < P, the gain is still negative. Only if PO = P would there be no gain or loss, but this can only happen if storage costs are zero or, in other words, when the donor’s surplus does not have to be stored and can be disposed of immediately at the world market price. This analysis should be slightly modified if the TFAT is financed by a Japan-type donor, that is a donor who does not switch bilateral for triangular transactions because he has no domestic surpluses available. As mentioned above this first of all eliminates the opportunity cost of storage, PO, from the calculations: there is no opportunity cost to the donor for carrying out a TFAT. The rest of the analysis depends on the type of market where the donor buys his supplies. If he buys in a Thai-type market there will be no price effects and the value of the TFAT is purely additional. That means the resource transfer equals the quantity times the market price and there are no further losses or gains for this TFAT. In other words, GAIN
= (Q”- Q’) x P
If he buys in a Zimbabwe-type effect, so that: GAIN
= (Q+Q”)
x (PI-P)/2
= ;eLQ’)
x
(P’-P))
(11) market,
-
there
(Q+Q’)
will be an upward
x (PI-P)/2
price
+ (Q”-Q’) (12)
which is still positive unless the price more than doubles or P’ > 2P. Thus for a Japan-type donor a TFAT always has a positive welfare effect, except in extreme price-increasing circumstances. The above cost-benefit analysis covers the direct effects of a switch of donor resources from bilateral to triangular food aid only. It does not include indirect effects, which might lead to more positive conclusions. Two sets of indirect effects will be considered in the next sections: (a) cost-effectiveness and timeliness, and (b) supply side effects.
FOOD POLICY
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1990
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The economics
of triangular
food aid transactions
Cost-effectiveness
and timeliness
In a hypothetical world where time and distance are eliminated and only one market clearing price exists for each commodity, there would be no cost advantage or disadvantage for the donor to switch over to triangular transactions: the price of the commodity would be exactly the same on the world market and on the donor’s domestic market. Savings in storage and transport costs and timeliness of delivery would not play a role in the decision. At least two of the justifications for TFATs presented earlier would thus become meaningless. But in reality time and distance and the resulting fragmentation and price differentiation in markets do play a role in decision making. Because of distances and transport costs, world market prices are not uniform. It may be cheaper to buy supplies at a point closer to the recipient because it saves transport costs and/or because the purchase price may be lower. The saving in transport time itself does in fact represent a cost reduction which increases with the opportunity cost of time (as measured by the recipient’s discount rate). In cases of emergency food aid deliveries the opportunity cost of time may become very high. Thus in the real world the cost of a triangular transaction may be lower/higher than the cost of a bilateral transaction (buying a similar commodity on the donor country market). The welfare gain/loss function defined in the last section can be modified to include these real-world factors. The gain from a lower purchase price and reduction in transport cost in the following formula: and time can be summarized = Q x ((Pd-Ps)
GAIN
+ (Td-Ts))
X (l+i)
^ (td-ts)
(13)
where:
Q=
Pd Ps Td Ts td ts i
“The recipient or consumer discount rate is, of course, hard to determine since it is a very subjective value. In ‘normal’ circumstances it would drop to a floor value set by the interest rate on savings accounts. In ‘emergency’ situations it could increase very fast, reaching infinity in cases of severe famine. See, for example, UNIDO, Guidelines for Project Evaluation, UN, New York, NY, USA, 1974, Ch 13. “/bid, Ch 18.
22
= = = = = = =
quantity of triangular food aid (= Q” - Q’ in Figure donor market price (triangular) supplier market price donor to recipient transport cost supplier to recipient transport cost donor to recipient transport time supplier to recipient transport cost consumer (recipient) discount rate”
1)
The operationality of the above equation is enhanced by the fact that all variables are straightforward to calculate, except for the discount rate. This should not be a problem, however, if the executing agency wants to use the equation to decide on various alternative sources and routes of supply for one single recipient. In that case the discount rate could be taken as an exogenously fixed variable, or the ‘switching value’i2 for the discount rate between different routes and sources could be calculated. If this switching value is outside a reasonable range, the decision is easily taken. If the switching value is within a ‘normal’ range, then the agency should be indifferent between alternatives and more qualitative factors such as risks and reliability of the supplier could be taken into account. This gain function for TFATs can be integrated in the gain function
FOOD POLICY
February
1990
The economics of triangular food aid transactions
defined in the previous section. The net gain/loss on a TFAT equals the sum of both functions. In the Thai rice case we assumed that the price-increasing and commercial-imports-reducing effects are virtually zero, so that in the gain function in the last section P = P’ and the sum of both gain functions becomes: GAINSUM
= Q x ((PO-Pd) - ((Pd-Ps)+(Td-Ts)) x (1+i) ,. (td-ts))
(14)
This equation shows a more positive picture of TFATs. The result of a TFAT is no longer necessarily a loss of resources. The first term of the equation (PO- Pd) could be negative because of price increases induced by the TFAT, but the other terms could offset this loss. In the Zimbabwe white maize case, however, we would have to add the resource losses due to price increases. The final result in GAINSUM would depend on the magnitude of losses due to price changes and storage costs and gains due to timeliness and cost effectiveness.
Supply side effects So far we have discussed the resource transfer and cost efficiency of TFATs. One major objective of TFATs - providing a food production incentive to producers in developing countries - has not yet been discussed. The supply side argument for TFATs goes as follows. If TFATs can improve the export market prospects for a supplier country by increasing the price it receives for exports and/or by expanding demand for these exports, then the supplier is likely to produce more of the exportable commodity. In the Zimbabwe case there is both a price and a quantity effect for the supplier. In the Thai case there is only a quantity effect. From a neoclassical economics point of view this is entirely feasible. A price increase or a shift to the right of the demand curve causes a positive supply effect, if not in the short run than at least in the long run. However, in practice markets do not always obey neoclassical rules. Market distortions and rigidities may block the supply response mechanism. Price-induced supply effects The Zimbabwe white maize case does generate a positive price effect for the supplier country. But does this price increase actually reach the primary supplier, the Zimbabwe farmer, or does the difference flow into government coffers? A very common rigidity is that all food commodity exports are handled by a government marketing agency and domestic farm gate prices are fixed. Price increases on export markets are not passed on to farmers. They are simply considered as windfall profits for the marketing agency. Consequently farmers will not react to export incentives. One could argue that governments should not adjust domestic prices because of changes in export market prices because:
l l FOOD POLICY
February
1990
these changes are often short-run fluctuations while it is the government’s objective to stabilize long-run domestic farm incomes; exports represent only a small part of total domestic production and
23
The economics of triangular food aid transactions
purchases by the marketing agency; to introduce a general domestic price increase because of a price increase in a small part of the market is not justifiable. On the other hand, if good prospects (for both quantities and prices) in food commodity export markets turn out to be long-lasting, than the government or marketing agency could slightly increase farm gate prices to give an additional production incentive to farmers. If consumer prices are not increased simultaneously, consumption could be subsidized with the profits made on exports. The advantage of such a policy would be that additional foreign exchange is generated without additional costs to the consumer. If the cost of the subsidy plus the additional production cost (in local currency) is lower than the gain in foreign exchange (in local currency at the shadow exchange rate), then such a policy is rational. So far there is very little, if any, evidence that developing countries set domestic prices for staple food commodities as a function of export prices, mainly because (a) they have not been confronted with reliable long-term export prospects, and (b) they already have problems supplying enough for the domestic market, let alone exports. Only for traditional export products are export prices taken into account. Non-price supply effects Supply side effects are not only provoked by food price changes. In fact, both donors and recipients of triangular food aid have an interest in stabilizing the price of triangular commodities in order to avoid a negative impact on the donor’s budget and the recipient’s food import volume. A stabilization in the demand for the supplier’s exports, for instance through forward buying contracts with donors, could result in increased production. The supplier could use the additional foreign exchange earned to buy more (productive) agricultural inputs or lower the domestic price of these inputs, and thereby increase production without farm gate price increases. Here is an opportunity for donors to create the necessary conditions for long-term reliable export prospects for potential exporters of food commodities. Triangular transactions may contribute to creating nonprice export incentives, if organized properly. Conducting triangular transactions in an ad hoc and unplanned way, following the whims of the market, is unlikely to provide a sustained export incentive to potential exporters; it is more likely to enhance windfall profit-taking behaviour by marketing agencies. Inefficient resource allocations Before a decision is taken to stimulate production of a certain food crop, policy makers should evaluate whether the supplier country does have a comparative advantage in that crop. If not, it will lead to an inefficient allocation of resources. Two factors should be taken into account: 0 0
whether resource allocation to the production capacity for this crop is profitable and desirable; whether resource allocation to this crop will result in undesirable cross-effects on other crops.
These factors can only be evaluated agricultural and food policy strategy.
24
in the framework
FOOD POLICY
of a national
February
1990
The economics of triangular food aid transactions
Compensation for lost resources Above we came to the conclusion that, from a pure resource transfer efficiency point of view, a TFAT can produce a loss of resources if it induces price increases on the food commodity market - in the Zimbabwe white maize case. We then saw that this loss could be compensated (or aggravated) by an improvement (deterioration) in the cost-effectiveness of the TFAT compared to a bilateral transaction. However, one objective of TFATs is not just to transfer more resources to developing (supplier) countries but to ensure that these additional resources create a positive supply response in food production in the supplier country. This supply response has to be introduced into the cost-benefit analysis to arrive at a proper picture of the efficiency of a TFAT. The resource loss of a TFAT, excluding the cost-effectiveness and timeliness aspects, was earlier found in Equation (8) to be: LOSS
= (Q”-Q’)
x (-P/2-P’/2+PO)
(15)
If we exclude the price effect of TFATs on world markets P, then the above equation can be reduced to: LOSS
= (Q-Q’)
A positive
supply
(Q”-Q’)
x (PO-P) effect can compensate
x (PO-P)
=<
where Qp = the additional is true only if: Qp >=
(Q”-Q’)
and set P’ =
(16) for this loss if:
Qp X P production
x ((PO-P)IP)
(17) in the supplier
country(ies).
This
(18)
The larger the difference between the opportunity cost and the market price of the TFAT commodity, the larger the supply effect has to be to compensate for the loss. Again, this condition can be combined with the cost-effectiveness equation presented in the last section. A complete cost-benefit evaluation of a TFAT programme would then include three components: 0 0 0
the losses due to the switch from bilateral to triangular transactions; the losses/gains due to a deterioration/improvement in costeffectiveness and timeliness; the gains due to an increased supply of the food commodity.
Conclusions It has been shown that TFATs could in certain circumstances create price effects on world food markets which cause transfers of resources between the three parties involved in the operation. Two typical cases have been identified: the Zimbabwe white maize market, where such price effects are likely, and the Thai rice case, where they are unlikely. It was found that, in the Zimbabwe and to a lesser extent in the Thai case, TFATs are an inefficient way of transferring resources to develop-
FOOD POLICY
February
1990
25
The economics of triangular food aid transactions
ing countries because the cost of the operation is higher than the benefit and, thus, results in a net loss of resources. However, TFATs can be cost-effective if the additional benefits in terms of cost-effectiveness and timeliness outweigh the resource transfer losses. Moreover, if the transfer of resources to the supplier leads to a real increase in food supply, this could also offset the negative effects of the resource transfer described. In conclusion, it can be said that the economic efficiency of triangular transactions cannot be evaluated a priori. One has to take into account the above three aspects of the transaction. The final impact of an individual TFAT will depend on the magnitude of each of these three components.
26
FOOD POLICY
February
1990
Bertin Martens
It has been shown that triangular food aid transactions (TFATs) could create, in certain circumstances, price increases on world food markets. Two typical cases have been identified: the price-inelastic Zimbabwe white maize market - where such price effects are likely - and the price-elastic Thai rice case - where they are unlikely. In the Zimbabwe case, and to a lesser extent in the Thai case, TFATs are an inefficient way of transferring resources to developing countries. However, TFATs can become efficient if the additional benefits in terms of cost-effectiveness and timeliness outweigh the resource transfer losses. If the transfer of resources to the supplier leads to a real increase in food supply, this could also offset the negative effects of the switch from bilateral to triangular transactions. Bertin Martens was a member of the Food Studies Group (FSG), Oxford University. He now works for the Commission of the European Community and can be contacted at BP 3345, Dakar, Senegal. The author would like to thank R. Hay, S. Hunt and G. Shuttleworth, colleagues at FSG, for their comments. This article is a soin-off of an evaluation studv of the EEC Triangular Food Aid programme, financed by the Commission of the European Communities and carried out bv FSG. All views and opinions expressed in this article, as well as all remaining errors, are the author’s,
‘Food aid statistics, however, usually classify the commodity used by the donor in the barter deal as ‘food aid’. This is not entirely correct.
0306-9192/90/010013-14$3.00
0
It is often claimed that triangular food aid transactions (TFATs) can be distinguished from bilateral ones by the fact that there are three parties involved in the former (a donor, a supplier and a recipient) and only two (a donor and a recipient) in the latter. This distinction is based on semantics rather than the economic reality which it refers to. If we look at the transactions at country level, then this distinction is correct. However, if we consider the transactions at a sub-country level, there are always three parties involved in a food aid operation. Both bilateral and triangular transactions involve a donor, a supplier and a recipient. The distinctive feature of a triangular transaction therefore is not the fact that there are three parties involved but that the supplier is located outside the donor country. This interpretation of the term ‘triangular transaction’ is more in line with the main objective of such operations (see further). Thus a TFAT could be defined as a food aid operation, financed by a donor country and delivered to a recipient country, whereby the source of supply is located outside the donor country. There are, however, different types of TFATs. In an ‘ordinary’ TFAT three different countries are involved - which has led to the adoption of the term ‘triangular’. But it is possible to conceive of a TFAT in which there are only two countries involved, a donor country and a suppliercum-recipient country. In that case the TFAT is called a local purchase. Another subject of TFATs consists of ‘swaps’. Swaps are TFATs with a special financial arrangement between the donor and the supplier. The supplier is not paid in cash for deliveries. Instead a barter deal is set up, whereby the donor exchanges his own food surplus commodity against the surplus commodity of the supplier. Although the donor does act, at first sight, as a commodity supplier in a swap, the swap itself is not a food aid operation but a commercial deal, at least if the ‘swap ratio’ the quantity of surplus commodity delivered by the donor divided by the quantity returned by the supplier - reflects the ratio of market values of the swapped commodities. If the donor agrees to a lower exchange ratio, then there is an element of concessionality in that aspect of the operation too. Only the second part of the operation, the delivery of the swapped commodity to the final recipient, can be classified as a pure food aid operation.’ Therefore swaps do fit in the above-presented definition of TFATs: the supply of the food aid commodity does not come from the donor country.
1990 Butterworth
& Co (Publishers)
Ltd
13
The economics
of triangular
food
aid lransactions
It is, of course, possible to combine a swap and a local purchase operation into one single food aid operation. That would be called a ‘local swap’. The analysis of TFATs is further complicated by the fact that different donors use a different terminology for these types of transactions. USAID carries out TFATs in the form of swaps, which it calls ‘trilateral’ transactions. It swaps US wheat surpluses for white maize in a number of African surplus-producing countries (Ghana, Kenya, Zimbabwe), which is then delivered to white maize deficit countries in the region.’ The World Food Programme (WFP) employs pledges in kind,s which are basically bilateral transactions with the WFP acting as a middleman. The supply comes from the donor country, not a third party, and the WFP’s role is limited to matching supply and demand. Its pledges in cash, however, can result in triangular transactions. These funds can be used to purchase foodstuffs in a third country.4 The WFP does carry out local purchases and local swaps, but so far it has not been involved in international swaps.
Objectives of triangular transactions
%ee A. Morton et al, ‘An Evaluation of the Trilateral Food Aid Programme of the United States Government’, report for USAID, Washington, DC, USA, 1988. 3Pledoes in kind are donor contributions in food commodities, supplied from the donor’s own surplus stocks. Cash pledges are financial contributions by donors. Cash pledges normally have no restrictions on the source from which supplies can be bought. ?See Relief and Development Institute, An
Critics of (bilateral) food aid operations have always denounced food aid as a means of dumping expensive agricultural surpluses from First World countries onto Third World markets, thereby creating disincentive effects to local food production in the recipient countries. Supporters of food aid have seized upon the possibilities of TFATs to silence that criticism. Triangular operations do not dump surpluses from First World markets on Third World markets. On the contrary, they support Third World producers by buying their surpluses, thus offering a production incentive, at least in the supplier country. Thus one major objective of TFATs is to stimulate domestic food This objective is to be realized production in developing countries. through a switch in donor expenditure from domestic food procurement to procurement in developing countries. However, the creation of effective demand for developing countries’ food supplies does not necessarily result in a real increase in food production. The conditions for a positive supply response are discussed later in this article. The switch-over from bilateral to triangular food aid has also changed the political economy of food aid. The donor’s domestic agricultural lobby, which favoured bilateral food aid operations for its own economic reasons, is an opponent of TFATs. An outlet to dispose of expensive agricultural surpluses has now been closed. To reduce the criticism of this previous ally but also out of genuine a number of additional justifications or operational considerations, objectives for TFATs have been developed:
l
l
Evaluation of the WFP Triangular Food Aid Programme, Occasional Papers Series
No 11, WFP, Rome, Italy, 1987.
14
0
Cost-effectiveness: A triangular operation could be cheaper, not only because of savings in transport costs, but also because the purchase price on a Third World market could be lower than on the world market. Timeliness: Buying food in neighbouring developing countries rather than on First World markets could reduce the transport distance and time. Triangular food aid could arrive faster than bilateral aid, which is especially important in emergency circumstances. Commodity appropriateness: Procurement of food aid in a country FOOD POLICY
February
1990
The economics of triangular food aid transactions
in the same region enables food aid donors to supply commodities which match existing taste preferences countries.
appropriate in deficit
The extent to which ‘supply side’ or operational objectives are emphasized varies from donor to donor. The WFP attaches more importance to operational considerations. Its rules and regulations are less concerned with supply side objectives. Above all, it wants to carry out efficient food aid operations. The EC rules and regulations governing TFATs do mention the ‘benefits to the supplier country’, which could be interpreted as a supply side objective. But operational objectives prevail for emergency operations and in cases where recipient countries ask for commodities where there are no surpluses available in the Community. The key question which we will try to answer in this article is: are triangular transactions an efficient way of transferring food resources to developing countries? The efficiency question can be broken down into three components: 0 0 0
How efficient is the switch of donor resources from bilateral to triangular procurement of food aid? How do the three operational considerations add to the efficiency of this switch of resources? Under which conditions can the supply response contribute to an efficient TFAT?
The following two sections attempt to answer the first question. Then we look at the contribution of cost-effectiveness and timeliness to TFAT efficiency.5 The final section analyses the supply side conditions for an efficient operation. Although the conclusions of the earlier sections may be rather negative from the point of view of efficiency of resource allocation, the later sections show the more positive aspects of TFATs.
Basic model
5The commodity appropriateness
argu-
ment will not be considered in this article. %ee, for instance, W. Schultz, ‘The value of US farm surpluses to underdeveloped countries’, Journal of Farm Economics, Vol42, 1960, pp 1019-1030; F. Fischer, ‘A theoretical analysis of the impact of food surplus disposal on agricultural production in recipient countries’, Journal of Farm Economics, Vol45, 1963, pp 863-875; F.McCarthy, ‘Welfare effects of tied food aid’, Journal of Development Economics, Vol 11, 1982, pp 63-79.
FOOD POLICY
February 1990
Theoretical models for the analysis of the economic impact of ‘normal’ bilateral food aid operations are well-known among food aid economists.6 These models are based on neoclassical assumptions on domestic food market behaviour and have pointed out that food aid could depress domestic prices and, as such, have a disincentive effect on domestic food production. However, in certain cases disincentive effects will not occur or can be avoided through countermeasures. Bilateral food aid models usually deal with the impact on domestic markets in the recipient country only. Triangular transactions, however, consist of two operations: (a) purchase on a world market, and (b) disposal on a domestic market. The economic impact of the second part of the transaction can be analysed with bilateral aid disposal models,-but the analysis of the first part requires different analytical tools. For the analysis of triangular transactions, we start from the following pre-TFAT bilateral food aid situation (see Figure 1):
l a recipient
a
country, buying a certain quantity (Q) of its food import requirements commercially on the world market at the market clearing price (P) and receiving the remainder (Q*-Q) as bilateral food aid from a donor country; the donor country supplies food aid to the recipient from his own surplus stocks, valued at the opportunity cost of these stocks
15
The economics of triangular food aid transactions D+
D
s
Aid
\ P’
al
2
h
\ P
/ PO/
Q’
Figure 1. The impact of triangular transactions on the world market.
Q
Q*
4” Quantity
r+$O 0
a suiplier imported
< P, world
market
value
of the commodity
country which sells on the world commercially (Q) by the recipient.
market
minus
storage
the quantity
It is assumed that the donor’s food aid is additional to the recipient’s commercial food imports and does not replace the latter. Consequently, food aid does not depress the world market price for the food commodity. It is furthermore assumed that the donor does not attempt to replace the lost stocks by selling less on the world market; food aid donations do not change his commercial export behaviour. Note that the opportunity cost of food aid for the donor (PO) is a function of time: the longer he keeps the commodity in storage, the higher the storage cost and the lower PO. PO could actually become negative. However, Figure 1 does not capture the time dimension of food transactions or storage. Storage time is assumed fixed here, but not equal to zero (otherwise PO = P since storage costs are zero when storage time is zero). When the bilateral transaction is changed into a triangular one, a transfer of financial resources from the donor country to the supplier country is made, in return for food. Food aid funds which would normally be spent in the donor country under bilateral aid are then shifted to the supplier. As a result:
a a a 0
demand for exports from the supplier increases: he can now export Q plus the food aid quantity Q*-Q; as a result of this increased demand, the price on the world market increases to P’; the recipient’s commercial imports will decrease to Q’ as a result of the price increase; so that the supplier’s export volume and the recipient’s import volume falls from Q* to Q”.
Most donor countries control domestic agricultural product prices and have substantial surpluses of the products which they offer as food aid.
16
FOOD POLICY
February
1990
The economics of triangular food aid transactions
It is therefore assumed that the decrease in demand for donor country food surpluses has no impact on domestic prices in the donor country or world market prices. The surplus which would have been used as bilateral food aid will not be dumped on the world market but kept in stock by the donor. For the supplier, triangular food aid represents an effective increase in demand for a commodity which he sells on a competitive world market with no price controls. If supply is perfectly price-elastic, or if the additional demand is marginal, the resulting price increase will be negligible. But if supply is not perfectly elastic and/or additional demand is substantial, price increases can be important. Thus the supplier gains through both an increase in quantity and, possibly, a price increase. For the recipient country there is, at first sight, no change: it still receives the same amount of food aid but from a different source. But a relatively important indirect effect has to be taken into account. If the switch-over from a bilateral to a triangular operation causes a price increase on the world market, then commercial food imports by the recipient country will be reduced. The actual quantity reduction depends on the price elasticity of demand and supply. Consequently, total food imports and the domestic food supply will also drop. Graphic summary of the basic model
7Although Figure 1 assumes that the entire
bilateral food aid programme is turned into a triangular programme, the conclusions drawn from the model are also valid for a partial switch-over. *Note that it is assumed here that donor demand for food aid is not price elastic.
FOOD POLICY
February 1990
Figure 1 represents the world market (and not a domestic market) supply and demand situation for a particular food aid commodity. In this diagram the demand line D represents the sum of demand by all countries which import that commodity, while the supply line S is the sum of all supplies by all exporting countries. The starting point in the analysis is the bilateral food aid situation, represented by the intersection of the D(emand) and S(upply) lines where the recipient imports commercially quantity Q and pays the price P. On top of its commercial imports, it receives a quantity (Q*-Q) as bilateral food aid. Total food imports by the recipient thus amount to Q + (Q*-Q). Bilateral food aid does not shift the demand line to the right, at least not in the short run through direct effects, because it is released from the donor’s stocks and not bought on the world market. Effective world market demand remains at the D line and not at the D+Aid line. The model is furthermore based on the assumption that food aid is additional to commercial imports and does not replace them. When the donor decides to change the bilateral food aid programme into a triangular food aid operation, 7 then the effective world market demand curve D will shift to the right by the amount of triangular (formerly bilateral) food aid: D+Aid. The planned cost of this triangular operation is P x (Q-Q*). But the additional demand drives up the price to P’, at least in the short run when supply is not very price elastic. Hence the actual outcome of the operation is the intersection of S and D+Aid. The donor delivers the planned quantity but at a higher price, P’. The recipient is likely to reduce its own commercial imports because of the price rise to Q’. Consequently, total food imports by the recipient have been reduced by Q*-Q”. Clearly, the price elasticity of supply and demand play a crucial role.’ It should be pointed out here that the above model is theoretical. In particular, the price effect of a TFAT depends on the structure of the market and the relative importance of TFATs in that market. We will
17
The economics of triangular food aid transactions
use here the examples of the ‘Thai rice’ and ‘Zimbabwe white maize’ markets, referring to their most prominent real-life examples. Both examples could be generalized and considered as being representative of two fundamentally different types of markets with different implications for TFAT policy. TFATs are unlikely to cause price increases if their importance is marginal compared to the size of the supplier’s export market. Buying rice in Thailand or wheat in Argentina is unlikely to distort the world market price for these commodities. In the Thai rice case, the supply curve in Figure 1 should be drawn almost perfectly horizontal, reflecting an almost infinite price elasticity of supply, at least for the relevant quantity range of TFAT operations. However, in cases of very limited market size the risks of distortion are real. For instance, the fact that the WFP, the EEC and USAID purchased more than 40% of Zimbabwe’s white maize exports in the last few years may have been an important factor in the price increase of white maize in Southern Africa.’ For the Zimbabwe white maize case the sloped supply curve in Figure 1 reflects a reality: supply has a low price elasticity. Additional@
versus substitution
It is assumed in this model that the donor’s bilateral food aid is additional to the recipient’s commercial food imports. This is a very basic principle but not realistic for all food aid operations. Additionality or non-substitution is difficult to verify - which has helped to undermine this principle. The view that a substantial part of food aid is indeed substituting for commercial imports is more and more generally accepted. If food aid were additional to commercial imports, then it would not depress the world market price for the food aid commodity. P is assumed to be the market clearing price. On the other hand, if the amount of bilateral food aid received were substituted for commercial imports by the recipient, it would reduce demand on the world market and thus depress world market prices, at least in the Zimbabwe white maize case. The Thai rice case is indifferent to substitution or additionality: the price would not change.‘O In the Zimbabwe case and with substitution, P’ and not P would be the real world market clearing price in the absence of food aid. Replacing the bilateral by a triangular transaction would simply restore the ‘before food aid’ equilibrium at P’ and Q”. This would mean that, in the welfare analysis presented below, all signs of losses and gains would have to be changed: a loss due to a triangular transaction becomes a gain because it restores the orginal pre-food aid situation and eliminates the losses/gains caused by the bilateral operation. Thus substitution in the Zimbabwe case would be preferable to additionality! Dual markets ‘See Chapters 5 and 6 in Food Studies Group, ‘An Evaluation of European Community Triangular Food Aid’, report for the Commission of the European Communities, unpublished. “‘It would, of course, still make a difference to the recipient country’s external resources balance.
18
So far we have implicitly assumed that bilateral and triangular food aid transactions take place on the same market, in other words that the same commodity is used for both types of transactions. In reality this is not always the case. The EC, for example, decides on the type of transaction according to the type of commodity requested by the recipient country: food aid commodities can be mobilized on the world market (triangularly) only when they are not available in European
FOOD POLICY
February 1990
The economics of triangular food aid transactions
surplus stocks (bilaterally), except in emergency situations. Bilateral and triangular food aid commodities are thus not the same. But this ‘dual market’ phenomenon does not change the validity of the model presented above. Demand for the food commodity sold on the world market by the supplier and bought commercially by the recipient still increases. Only if the recipient country would not normally buy its commercially imported food on the same world market would the model have to be modified. This, however, would amount to providing the recipient with a non-preferred food commodity (a commodity which he would not buy commercially) through a triangular operation, contrary to one of the main aims of triangular operations, which is to provide more appropriate or preferred commodities. Additional to bilateral food aid Apart from additionality from the recipient’s point of view, discussed above, there is also the case of a TFAT being additional to other bilateral (and triangular) food aid operations. With the increasing importance of Japan as a (food) aid donor, this issue has surfaced: virtually all Japan’s food aid is triangular since it has no domestic food surpluses to be transferred to developing countries. This eliminates the cost of storage of domestic surpluses from the analysis. Several possibilities should be examined. Either Japan’s TFAT substitutes for bilateral or triangular food aid from other donors. In that case the above analysis remains valid, except for the elimination of storage costs. Or Japan’s aid is additional to other food aid, which leads to two sub-cases: 0
0
The supplier is a Thai-type market. This eliminates price effects too. The supplier and the recipient receive a net benefit equal to (Q*-Q) x P in Figure 1. The supplier is a Zimbabwe-type market. This creates a positive quantity effect but a negative price increase effect for the recipient. The final result depends on price elasticities of supply and demand.
Price-inelastic demand We have already pointed out that Figure 1 represents the Zimbabwe white maize case, the ‘normal’ neoclassical market where both supply and demand are reasonably price elastic. But market structures often deviate from this ‘normal’ case. One deviation on the supply side has already been considered and classified as the ‘Thai rice’ case, but there is also the possibility of a deviation on the demand side with extremely price-inelastic demand or an almost vertical demand curve in Figure 1. Let us consider the impact of a TFAT in the case of a combination of a Zimbabwe-type supplier with a sloping supply curve and a recipient with a steep price-inelastic demand curve - most of Zimbabwe’s neighbours. If total demand for food imports is price inelastic because it is mainly a function of population and domestic agricultural production and not of prices, then, in order to satisfy domestic demand for imported food when the price of imported food increases, the recipient would have to increase food aid imports, or spend more foreign exchange to stabilize commercial imports. In this case, either the recipient country’s dependence on food aid will increase or his external debt position will worsen as a result of the TFAT. It would be better not to go for a TFAT but to provide bilateral food aid in such situations,
FOOD POLICY
February
1990
19
The economics of triangular food aid transactions
except in emergency operations where factors such as timeliness are crucial. The actual price elasticity of commercial imports depends on the recipient’s import and foreign exchange policy. If the recipient has allocated a fixed foreign exchange budget to food imports, then the quantity imported will decrease proportionally to the world market price increase (price elasticity = -l), assuming that the foreign exchange budget is fully utilized. If the recipient considers food imports to be a priority, taking precedence over non-food imports, then the imported quantity remains constant (price elasticity = 0) but more foreign exchange will be spent on food imports. This can lead to a reduction in non-food imports (cross-price elasticity < 0) and/or an increase in foreign debts (cross-price and own-price elasticities = 0). Note that in emergency operations the short-run price elasticity of demand is virtually zero.
Welfare effects of triangular transactions Figure 1 enables us to calculate net gains and losses for the three parties involved in a triangular transaction. Note that an inter-country comparison of monetary gains and losses is not necessarily a reflection of welfare effects in the countries concerned. This would be true only if the welfare functions of the three countries were identical. Since this is unlikely to be the case for countries with widely different living standards, the following analysis should be interpreted with care. The supplier receives additional export revenue equal to: (Q”xP’)
- (QxP)
(I)
but, assuming that he sells his export commodities at the marginal cost of production, he also faces additional production costs equal to the area under the supply curve between Q and Q”, or: (P+P’)
x (Q”-Q)/2
so that his net benefit (Q+Q”)
- the increase
in producer
surplus
- comes
x (P-P)/2
The recipient imports: (Q+Q’)
(2) to: (3)
loses part
of his consumer
surplus
on commercial
x (PI-P)/2
food
(4)
To calculate the losses for the donor country, the cost of the triangular transaction has to be compared with the cost of a bilateral transaction, both of which the donor pays for. The cost of the bilateral transaction equals: (PO x (Q*-Q)
= PO x (Q”-Q’)
The cost of a triangular
operation
(5)
for the donor
equals:
P’ x (Q”-Q’) so that switching from bilateral cost of food aid by: (PI-PO)
20
(6) to triangular
transactions
increases
x (Q”-Q’)
the (7)
FOOD POLICY
February
1990
The economics of triangular food aid transactions
The total gain or loss in resources specified as: GAIN
= (Q+Q”)
x (PI-P)/2
for all three parties
-
(Q+Q’)
concerned
x (PI-P)/2
x
Q”-Q’
x (PI-P)/2 - (PI-PO) x ((P’-P)/2 - (P’-PO)) x (-P/2-P’/2+PO)
> 0 = the quantity
of the TFAT.
-
can be
(P’-PO)
x (Q”-Q’) (8)
Since
PI2 + P’l2 > PO
(9)
the gain on a TFAT must be negative and, thus, a loss. The loss equals the volume of the transactions (Q”-Q’), multiplied by the difference between the opportunity cost to the donor (PO) and the average of preand post-transaction market prices (P and P’). Again, the above statement refers to the Zimbabwe white maize case. In the Thai rice case the final outcome would still be a net loss of resources, although the market price is not affected by the TFAT. In the Thai case P’ = P and Equation (8) can be simplified to: GAIN
= (Q-Q’)
x (PO-P)
(10)
Since PO < P, the gain is still negative. Only if PO = P would there be no gain or loss, but this can only happen if storage costs are zero or, in other words, when the donor’s surplus does not have to be stored and can be disposed of immediately at the world market price. This analysis should be slightly modified if the TFAT is financed by a Japan-type donor, that is a donor who does not switch bilateral for triangular transactions because he has no domestic surpluses available. As mentioned above this first of all eliminates the opportunity cost of storage, PO, from the calculations: there is no opportunity cost to the donor for carrying out a TFAT. The rest of the analysis depends on the type of market where the donor buys his supplies. If he buys in a Thai-type market there will be no price effects and the value of the TFAT is purely additional. That means the resource transfer equals the quantity times the market price and there are no further losses or gains for this TFAT. In other words, GAIN
= (Q”- Q’) x P
If he buys in a Zimbabwe-type effect, so that: GAIN
= (Q+Q”)
x (PI-P)/2
= ;eLQ’)
x
(P’-P))
(11) market,
-
there
(Q+Q’)
will be an upward
x (PI-P)/2
price
+ (Q”-Q’) (12)
which is still positive unless the price more than doubles or P’ > 2P. Thus for a Japan-type donor a TFAT always has a positive welfare effect, except in extreme price-increasing circumstances. The above cost-benefit analysis covers the direct effects of a switch of donor resources from bilateral to triangular food aid only. It does not include indirect effects, which might lead to more positive conclusions. Two sets of indirect effects will be considered in the next sections: (a) cost-effectiveness and timeliness, and (b) supply side effects.
FOOD POLICY
February
1990
21
The economics
of triangular
food aid transactions
Cost-effectiveness
and timeliness
In a hypothetical world where time and distance are eliminated and only one market clearing price exists for each commodity, there would be no cost advantage or disadvantage for the donor to switch over to triangular transactions: the price of the commodity would be exactly the same on the world market and on the donor’s domestic market. Savings in storage and transport costs and timeliness of delivery would not play a role in the decision. At least two of the justifications for TFATs presented earlier would thus become meaningless. But in reality time and distance and the resulting fragmentation and price differentiation in markets do play a role in decision making. Because of distances and transport costs, world market prices are not uniform. It may be cheaper to buy supplies at a point closer to the recipient because it saves transport costs and/or because the purchase price may be lower. The saving in transport time itself does in fact represent a cost reduction which increases with the opportunity cost of time (as measured by the recipient’s discount rate). In cases of emergency food aid deliveries the opportunity cost of time may become very high. Thus in the real world the cost of a triangular transaction may be lower/higher than the cost of a bilateral transaction (buying a similar commodity on the donor country market). The welfare gain/loss function defined in the last section can be modified to include these real-world factors. The gain from a lower purchase price and reduction in transport cost in the following formula: and time can be summarized = Q x ((Pd-Ps)
GAIN
+ (Td-Ts))
X (l+i)
^ (td-ts)
(13)
where:
Q=
Pd Ps Td Ts td ts i
“The recipient or consumer discount rate is, of course, hard to determine since it is a very subjective value. In ‘normal’ circumstances it would drop to a floor value set by the interest rate on savings accounts. In ‘emergency’ situations it could increase very fast, reaching infinity in cases of severe famine. See, for example, UNIDO, Guidelines for Project Evaluation, UN, New York, NY, USA, 1974, Ch 13. “/bid, Ch 18.
22
= = = = = = =
quantity of triangular food aid (= Q” - Q’ in Figure donor market price (triangular) supplier market price donor to recipient transport cost supplier to recipient transport cost donor to recipient transport time supplier to recipient transport cost consumer (recipient) discount rate”
1)
The operationality of the above equation is enhanced by the fact that all variables are straightforward to calculate, except for the discount rate. This should not be a problem, however, if the executing agency wants to use the equation to decide on various alternative sources and routes of supply for one single recipient. In that case the discount rate could be taken as an exogenously fixed variable, or the ‘switching value’i2 for the discount rate between different routes and sources could be calculated. If this switching value is outside a reasonable range, the decision is easily taken. If the switching value is within a ‘normal’ range, then the agency should be indifferent between alternatives and more qualitative factors such as risks and reliability of the supplier could be taken into account. This gain function for TFATs can be integrated in the gain function
FOOD POLICY
February
1990
The economics of triangular food aid transactions
defined in the previous section. The net gain/loss on a TFAT equals the sum of both functions. In the Thai rice case we assumed that the price-increasing and commercial-imports-reducing effects are virtually zero, so that in the gain function in the last section P = P’ and the sum of both gain functions becomes: GAINSUM
= Q x ((PO-Pd) - ((Pd-Ps)+(Td-Ts)) x (1+i) ,. (td-ts))
(14)
This equation shows a more positive picture of TFATs. The result of a TFAT is no longer necessarily a loss of resources. The first term of the equation (PO- Pd) could be negative because of price increases induced by the TFAT, but the other terms could offset this loss. In the Zimbabwe white maize case, however, we would have to add the resource losses due to price increases. The final result in GAINSUM would depend on the magnitude of losses due to price changes and storage costs and gains due to timeliness and cost effectiveness.
Supply side effects So far we have discussed the resource transfer and cost efficiency of TFATs. One major objective of TFATs - providing a food production incentive to producers in developing countries - has not yet been discussed. The supply side argument for TFATs goes as follows. If TFATs can improve the export market prospects for a supplier country by increasing the price it receives for exports and/or by expanding demand for these exports, then the supplier is likely to produce more of the exportable commodity. In the Zimbabwe case there is both a price and a quantity effect for the supplier. In the Thai case there is only a quantity effect. From a neoclassical economics point of view this is entirely feasible. A price increase or a shift to the right of the demand curve causes a positive supply effect, if not in the short run than at least in the long run. However, in practice markets do not always obey neoclassical rules. Market distortions and rigidities may block the supply response mechanism. Price-induced supply effects The Zimbabwe white maize case does generate a positive price effect for the supplier country. But does this price increase actually reach the primary supplier, the Zimbabwe farmer, or does the difference flow into government coffers? A very common rigidity is that all food commodity exports are handled by a government marketing agency and domestic farm gate prices are fixed. Price increases on export markets are not passed on to farmers. They are simply considered as windfall profits for the marketing agency. Consequently farmers will not react to export incentives. One could argue that governments should not adjust domestic prices because of changes in export market prices because:
l l FOOD POLICY
February
1990
these changes are often short-run fluctuations while it is the government’s objective to stabilize long-run domestic farm incomes; exports represent only a small part of total domestic production and
23
The economics of triangular food aid transactions
purchases by the marketing agency; to introduce a general domestic price increase because of a price increase in a small part of the market is not justifiable. On the other hand, if good prospects (for both quantities and prices) in food commodity export markets turn out to be long-lasting, than the government or marketing agency could slightly increase farm gate prices to give an additional production incentive to farmers. If consumer prices are not increased simultaneously, consumption could be subsidized with the profits made on exports. The advantage of such a policy would be that additional foreign exchange is generated without additional costs to the consumer. If the cost of the subsidy plus the additional production cost (in local currency) is lower than the gain in foreign exchange (in local currency at the shadow exchange rate), then such a policy is rational. So far there is very little, if any, evidence that developing countries set domestic prices for staple food commodities as a function of export prices, mainly because (a) they have not been confronted with reliable long-term export prospects, and (b) they already have problems supplying enough for the domestic market, let alone exports. Only for traditional export products are export prices taken into account. Non-price supply effects Supply side effects are not only provoked by food price changes. In fact, both donors and recipients of triangular food aid have an interest in stabilizing the price of triangular commodities in order to avoid a negative impact on the donor’s budget and the recipient’s food import volume. A stabilization in the demand for the supplier’s exports, for instance through forward buying contracts with donors, could result in increased production. The supplier could use the additional foreign exchange earned to buy more (productive) agricultural inputs or lower the domestic price of these inputs, and thereby increase production without farm gate price increases. Here is an opportunity for donors to create the necessary conditions for long-term reliable export prospects for potential exporters of food commodities. Triangular transactions may contribute to creating nonprice export incentives, if organized properly. Conducting triangular transactions in an ad hoc and unplanned way, following the whims of the market, is unlikely to provide a sustained export incentive to potential exporters; it is more likely to enhance windfall profit-taking behaviour by marketing agencies. Inefficient resource allocations Before a decision is taken to stimulate production of a certain food crop, policy makers should evaluate whether the supplier country does have a comparative advantage in that crop. If not, it will lead to an inefficient allocation of resources. Two factors should be taken into account: 0 0
whether resource allocation to the production capacity for this crop is profitable and desirable; whether resource allocation to this crop will result in undesirable cross-effects on other crops.
These factors can only be evaluated agricultural and food policy strategy.
24
in the framework
FOOD POLICY
of a national
February
1990
The economics of triangular food aid transactions
Compensation for lost resources Above we came to the conclusion that, from a pure resource transfer efficiency point of view, a TFAT can produce a loss of resources if it induces price increases on the food commodity market - in the Zimbabwe white maize case. We then saw that this loss could be compensated (or aggravated) by an improvement (deterioration) in the cost-effectiveness of the TFAT compared to a bilateral transaction. However, one objective of TFATs is not just to transfer more resources to developing (supplier) countries but to ensure that these additional resources create a positive supply response in food production in the supplier country. This supply response has to be introduced into the cost-benefit analysis to arrive at a proper picture of the efficiency of a TFAT. The resource loss of a TFAT, excluding the cost-effectiveness and timeliness aspects, was earlier found in Equation (8) to be: LOSS
= (Q”-Q’)
x (-P/2-P’/2+PO)
(15)
If we exclude the price effect of TFATs on world markets P, then the above equation can be reduced to: LOSS
= (Q-Q’)
A positive
supply
(Q”-Q’)
x (PO-P) effect can compensate
x (PO-P)
=<
where Qp = the additional is true only if: Qp >=
(Q”-Q’)
and set P’ =
(16) for this loss if:
Qp X P production
x ((PO-P)IP)
(17) in the supplier
country(ies).
This
(18)
The larger the difference between the opportunity cost and the market price of the TFAT commodity, the larger the supply effect has to be to compensate for the loss. Again, this condition can be combined with the cost-effectiveness equation presented in the last section. A complete cost-benefit evaluation of a TFAT programme would then include three components: 0 0 0
the losses due to the switch from bilateral to triangular transactions; the losses/gains due to a deterioration/improvement in costeffectiveness and timeliness; the gains due to an increased supply of the food commodity.
Conclusions It has been shown that TFATs could in certain circumstances create price effects on world food markets which cause transfers of resources between the three parties involved in the operation. Two typical cases have been identified: the Zimbabwe white maize market, where such price effects are likely, and the Thai rice case, where they are unlikely. It was found that, in the Zimbabwe and to a lesser extent in the Thai case, TFATs are an inefficient way of transferring resources to develop-
FOOD POLICY
February
1990
25
The economics of triangular food aid transactions
ing countries because the cost of the operation is higher than the benefit and, thus, results in a net loss of resources. However, TFATs can be cost-effective if the additional benefits in terms of cost-effectiveness and timeliness outweigh the resource transfer losses. Moreover, if the transfer of resources to the supplier leads to a real increase in food supply, this could also offset the negative effects of the resource transfer described. In conclusion, it can be said that the economic efficiency of triangular transactions cannot be evaluated a priori. One has to take into account the above three aspects of the transaction. The final impact of an individual TFAT will depend on the magnitude of each of these three components.
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FOOD POLICY
February
1990