MARKET IMPERFECTIONS AND THE CHOICE OF AGROFORESTRY SYSTEMS

MARKET IMPERFECTIONS AND THE CHOICE OF AGROFORESTRY SYSTEMS By Tran Chi Thien, Ph.D. Thai Nguyen University ABTRACT Market in upland regions is usually imperfect. Unfortunately, the market perfection is a major determinant of the agroforestry systems. The more perfect markets, the better -chosen agroforestry systems. Under imperfect market condition, the agroforestry choices are not based on comparative advantages of the regions and the farms. That makes agroforestry choices economically unefficient, and environmentally unsustainable. Solutions to a good agroforestry choice are therefore solutions to more perfect market conditions. 1. What is the role of market perfections in agroforestry system selection? Agroforestry is the use of trees in farming systems where agricultural crops are either interplanted spatially with forest trees or rotationally planted with them. Agroforestry systems that include the right trees for the right environments can improve soil fertility, allow for better watershed management and increase tree diversity in the landscape. Developing such agroforestry systems, while the needs of people are more effectively met natural resources. In perfections in markets are the most important determinants of the agroforestry systems. The more perfect markets are, the better, more efficient and more sustainable the agroforestry systems are. Solutions to develop economically efficient and environmentally sustainable agroforestry systems, thus target the improvement of market in perfections - enhancing the equity of access to commodity, land, and labor markets, and access to technology and extension. 2. How are agroforestry systems selected under perfect competitive market conditions? 2.1. What are major properties of perfect competitive market? A perfectly competitive market is an ideal market, equitable to everyone. First of all, in this market, the price mechanism is neutral, playing the role of the judge for all economic decisions. All buyers and sellers are price takers. No one can change the prices by their own actions. Second, there is perfect knowledge concerning prices and quantities of material inputs and outputs exchanged in the markets. Third, everyone can freely enter and exit from all markets when they want because resources including land, credit, technology, and material inputs, and market information are perfectly mobile and equitable to everyone. 2.2. In perpect competitive market, comparative advantages is the base to choose agroforestry systems. Economic theory says under perfect competitive market conditions, land use patterns based on comparative advantages and trading among regions and among households will generate maximum benefit to the whole country. Deltas have advantages in producing rice, and annual crops will specialise to produce these crops to exchange them with other products 1

on the market. In constrast, mountainous and hilly regions (hereafter referred to as uplands) have comparative advantages in planting forest trees, fruit trees, industrial trees and other upland crops that will be exchanged with rice and other lowland products in the market. Since these productions are based on comparative advantage, total social cost is at a minimum, and thus total social benefit is maximised. For each producer, thanks to comparative advantage, his private production cost will be less than the social cost, and thus receive higher than ordinary average benefit s. Hence, under perfect market conditions, upland farmers will make full use of their comparative advantages in planting perennial trees and other upland crops. Agroforestry systems that include all comparatively advantaged trees and crops will be developed. Agroforestry systems that include all comparatively advantage trees and crops will be chosen and developed. However, in reality, there is no perfectly competitive market, and farmers in upland regions still produce food crops on slope land as their major crops for their subsistence. 3. How are agroforestry systems selected under imperfect competitive markets? 1.1. What are major properties of imperfect competitive market? There are imperfections of the markets in one or more, or even all of the following aspects: Imperfect access to commodity markets Commodity markets in uplands, especially in remote regions are imperfect due to underdeveloped infrastructures, low educational attainment and a tradition of self-sufficiency. Transportation and marketing infrastructures in uplands are usua lly underdeveloped. In many communes such as Na Ot, Phieng Pan, Ta Hoc in Mai Son district, Son La province, there is no electricity or no telephones. In Na Ot, there is even no communal market. In many hamlets such as Huoi Khet in Na Ot commune, Mai Son district, Ban Khet in Cho Don district, Bac Kan province, there is no road to connect the hamlets to commune roads. People there have to go by foot on pathways through mountains and forests. In many cases, villagers have to spend the whole day to reach the nearest rural market. Thus, it is very difficult for them to buy material inputs and sell their farm products. In less remote regions, private traders can go directly to the hamlets. They bring material inputs and industrial products to sell; and buy farm products. However, due to lack of information on the prices, quality and use of the inputs, the farmers usually have to sell their products at cheaper prices and buy material inputs at higher prices compared to true social prices. Dang et al. (2003) argued that education attainment of upland people, especially in remote regions, is low. That limits their understanding ability, awareness of marketing and adoption of new agroforestry technological advances. Elis (1993) notes that the imperfections of the markets are due to the tradition of self - sufficiency and the self-provision of land and labor. The peasants rely on markets only to meet their demand for chemical fertilisers, pesticides, and to sell a portion of their products. In contrast, large farms have to rent and/or buy almost all labor, material inputs, and sell almost all their products, hence they are much more integrated into the markets. 2

Imperfect access to credit: Frank Elis (1993) argued that the lack of collateral and small land endowments prevent peasants from access ing soft loans. Instead, they have to depend on informal credit system such as businessmen, or local landlords as sources borrowed capital under interest rates based on the specific characteristics of the business rather than on market conditions. In Vietnam, the Bank for the Poor is a special bank system serving the poor at the lowest interest rate. However, it is not easy for all the poor to get a loan and a loan ceiling is small. In contrast, large farmers can easily contact financial organisations and have more advantages in obtaining soft loans. They have large collateral, and their investment projects are usually much bigger, more promising and more convinc ing. Imperfect access to technology: Information on agroforestry technological advances is also necessary for upland farm production. However, many farms do not have access to them since in many areas, these advances are not available even in the form of demonstration models. Many farmers even do not have newspapers, journals, televisions or radios to get information on the technologies. Nguyet, N.B (2003) comments that technology transfer via the extension service system in Vietnam currently has many limitations including the shortage of extension workers and other resources. In 2000, only 70% of the total districts nation-wide have Extension Centers, and only 30% of the total communes have Extension Teams. There are only 2800 extension workers serving 10 million farm households. The budget for agricultural research accounts for only 0.2% of the annual GDP of the sector. In contrast, farmers who are beneficiaries of different rural development projects, and who live near main roads, or near district and provincial capitals, often have good access to technology and extension services. Imperfect access to land: The land market is also imperfect. In different regions, due to differential population pressure, farmers can have different land endowments. Even in the same region, each farm has a different land area from inheritance. Large farms tend to have more inherited and bought land. Better access to larger amounts of soft loans also allows large farms to buy more land, while small farms have to sell land at cheap prices due to their he avy debt loan. Land tends to gravitate gradually to large farms. Therefore, in rural areas, many farmers (usually rich and better -off) have much newly accumulated land while many others have little or even no land to cultivate (Chung, 2000) 2.2. How does the market imperfections determine the choice of agroforestry systems in upland regions? 3.2.1. The choice of agroforestry systems in each region depends on the population pressure and the access to market. Market access is one of the major determinants of the nature of farm production systems (Boseyup, 1981). First, to the extent that cash crops are more profitable per unit area than food crops, an increase in cash crop production would increase the marginal value product of soil and encourage the adoption of agroforestry practices. Income from cash crops will also 3

help relax the liquidity constraint that may restrict such investment. Second, market access will also increase the opportunity cost of labor by generating off-farm job opportunities. This will make labor-intensive agroforestry practices more expensive, thus encouraging a preference for labour-saving methods, especially if the population density is also low (Pandey, 2001). Under good market access condition, thanks to good transportation and marketing infrastructures, consumption expenditure to sell commercial products will reduce, thus allow agroforestry systems with more cash crops, less food crops. Farmers may find investments in agroforestry more economically attractive when cash crops are being grown (Clarke, 1992). In the Philippines, distance from the farm to the market was a significant explanation variable to explain why farmer adopt contour hedgrows (Pandey and Lapar, 1998). In addition to the direct effects, the cost of accessing technical knowledge and information will be lowers in area with better access than in remote areas, thus reinforcing cash cropping (Pandey, 2001). Similarly, improved access to markets in Thailand as result of road, helped to diversify upland systems (Shinawatra, 1985). Crop diversification may allow for the crops with comparative advantages to develop helping not only to reduce the liquidity constraint faced by upland farmers, but also improve food security as land use patterns based on comparative advantages evolve (Pandey, 2001). Low population density leads to less labor - intensive or less intensified agroforestry systems. In these systems, labor is the most limiting factor. Hence, labor-saving agroforestry technologies will be chosen to maximize labor productivity. These systems are ecologicaly sustainable. In contrast, high population density leads to labor - intensive agroforestry systems. In these systems, labor is abundant but land becomes the limiting factor. Hence, land-saving technology will be chosen to maximize land productivity. Labor - intensive agroforestry systems that make full use the land will be adopted. These systems may may not be ecologicaly sustainable if population density is high, and the chosen agroforestry technologies are not good. Poor market access forces farmers to produce subsistent products. Crops and trees for domestic consumption will be planted in the system. They will adopt few agroforestry systems in which commercial crops are mainly grown because they cannot sell commercial crops. Food crops will be grown primarily. Agroforestry systems that are grown will be ecologically sustainable if the population density is low. In constrast, if the population density is high agroforestry systems will be ecologically unsustainable due to depleted land. 3.2.2. The choice of agroforestry systems of farm households depends on the imperfections of the factor markets Elis (1993) observes that factor markets in developing countries are imperfect and their imperfections lead to differences in relative prices among the factors. In turn, the relative price differ make the agroforestry system choices of small farmers different fron those of large farmers. Land prices are continuously going up since the total land area is constant while the demands for land are constantly increasing. Large farms have large areas of land inherited or previously bought at prices much cheaper than the current prices. Even if they have to buy 4

land at present, they can also borrow credit at low interest rates to buy. Hence, they usually evaluate their land at lower prices compared to small farmers do. At the same time, large farms usually buy material inputs and machines at cheaper prices owing to larger-scale purchase and softer loans used, and then they evaluate these materials and machine cheaper than what the small farms do. Land and material inputs for the large farm thus become relatively cheaper than labour. Small farmers also have inherited land but not enough to operate the farm optimally. They cannot afford to buy more land. They have limited access to credit. Many small farms have to rent the land from large farms at high cost. Land for the small farms thus become relatively more expensive than labor. Similarly, some small farm cannot buy material inputs in large quantities, they have to accept higher prices. They normally cannot buy machines since they are too expensive. Sometimes, machines are too big for small farms. When the machines are needed, the small farmer usually rents them from the large farmers at high costs. Therefore, material inputs for the small farm become relatively more expensive than labor. That is why large farms often choose more capital - intensive and less labor-intensive agroforestry technologies to obtain the highest labor productivity while small farms usually choose less -capital and more labor -intensive agroforestry technologies to obtain the highest land and capital productivity. 3.2.3. The choice of agroforestry systems at each household also depends on its capital endowment and the access to credit: an emphasis on financial supprots. One of the properties of these market imperfections is the difference in capital endowment among households, and in the access to credit as well. The poorer farmers are always vulnerable in the market. Any unpredictable change in the market price can seriously damage the household economy while it has little impact on rich farmers. Hence, the poor people tend to adhere to the existing farming systems. They are risk adverse and not brave enough to adopt a new technology. However, rich farmers are more risk neutral, or may even be risk lovers. Furthermore, the poor usually have poorer access to credit since many credit organisations require them to post collateral. That in turn can prevent them from establishing a new agroforestry system on their farm. Figure 1 shows that to set up a desirable agroforestry system with perrenial trees and /or conservation measures such as making terraces, plating contour hedgerows, etc., a large fund provided is necessary in the begining years when the the perennial crops have not been havested. To enable the poor to do so, soft loans or subsidies may be needed for the initial adoption of the technology, with amounts declining overtime. These investments are worthy of support from the government since an environmentally sound agroforestry systems can bring benefits to the economy as a whole through its on-farm and off-farm effects. 5

UD$ Innitial phase in need of financial supports Net return 0 Year Figure 1. Net return of an agroforestry system with perennial treesand/or conservation measures 4. What are major measures to develop agroforestry systems in Vietnam? To develop good agroforestry systems, conditions favorable to perfectly competitive markets should be created. In upland regions of Vietnam, the following measures should be conducted: a) Transportation and marketing infrastructure should be developed and marketing information should be provided to farm households via radio, newpapers, newsletters, television, and so on, b) Agroforestry technologies should be made available and extension service should be provided to ensure that the agroforestry systems are technically feasible, c) Credit systems should be developed and mobilised to ensure that the agroforestry systems are financially feasible, d) Small irrigation projects and wetland rice technologies locally suitable to each upland region should be developed to relax the food pressure on upland farming. 6

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