calculating levels of protection: is it always appropriate to use world reference prices based on...

World Development, Vol. 21, No. 5, pp. 805415, 1993. 0305-750X/93 $6.00 + 0.00 Printed in Great Britain. Pergamon Press Ltd

Calculating Levels of Protection: Is It Always

Appropriate to Use World Reference Prices Based

on Current Trading Status?

DEREK BYERLEE

and

MICHAEL L. MORRIS* International Maize and Wheat Improvement Center (CIMMYT), Mexico

Summary. - Protection measures such as the nominal protection coefficient (NPC), the effective protection coefficient (EPC), the producer subsidy equivalent (PSE), and the consumer subsidy equivalent (CSE) are conventionally calculated using world reference prices based on current trading status. Under certain conditions, the conventional approach can lead to incorrect estimation of the degree and sometimes even the direction of protection. This paper spells out the conditions under which use of world reference prices based on current trading status is incorrect and presents data for wheat in Pakistan to illustrate how failure to consider these conditions can lead to misleading policy recommendations.

1. INTRODUCTION

During the past decade of structural adjust- ment and policy reform, it has become routine to calculate protection measures to indicate the degree of protection (positive or negative) afforded to producers or consumers by policy interventions in product and factor markets. Protection measures - such as the nominal protection coefficient (NPC), the effective protection coefficient (EPC), the producer subsidy equivalent (PSE), and the consumer subsidy equivalent (CSE) - are conventionally calculated using world reference prices based on current trading status, either border prices (CIF import and FOB export prices) or parity prices (border prices adjusted for domestic transport and marketing costs to the point of production or consumption) (see, for example, Scandizzo and Bruce, 1980; Gittinger, 1982).

While world reference prices based on current trading status often represent a reasonable approximation of the prices which would prevail in domestic markets in the absence of policy distortions, under certain conditions their use can lead to incorrect estimation of the degree and sometimes even the direction of protection (i.e., whether producers or consumers are taxed or

subsidized). These conditions are present in many developing countries where it has been suggested that the efficiency of domestic resource allocation can be increased by setting domestic prices equal to international prices.

This paper describes the conditions under which world reference prices based on current trading status do not represent a good approximation of the prices that would be expected to prevail in the absence of policy distortions and proposes an alternative approach to estimating levels of protection when these conditions are present. Data from Pakistan are presented to illustrate how failure to consider these conditions can result in misleading policy recommendations.

2. CONVENTIONAL CALCULATION AND INTERPRETATION OF PROTECTION

MEASURES

Although protection measures come in numer- ous forms, for simplicity only the nominal protection coefficient (NPC) will be considered here. (The argument is, however, identical for other

*Final revision accepted: July 1, 1992

805

806 WORLD DEVELOPMENT

more complete measures of protection, including subsidy equivalents.) The NPC for a tradeable commodity is conventionally calculated as NPC = PC,/Pw, where P,, is the domestic price of the commodity and P, is the world price. The choice of an import price or an export price to represent the world price is based on current trading status, i.e., whether the country is a net importer or a net exporter of the commodity.

Theoretically, the NPC is a marginal concept which expresses the ratio of the value in domestic production to the value in trade of an additional unit of output. In applied price policy analysis. the NPC is often viewed as a measure of the degree of government intervention in a commodity market, since differences between domestic prices and world reference prices are assumed to result from government policies affecting domestic prices (e.g., price controls, trade restrictions).’ For example, after calculating NPCs of less than unity for India, a recent USDA publication on methods for measuring price distortions concludes:

Indian wheat producers were taxed by government control of wheat trade and minimum support prices that were set below import parity prices (USDA 1987, p. 35).

NPCs have been used extensively as a means of estimating the extent to which domestic prices should be adjusted to bring them into line with “free market” prices. That is why many texts on price policy, while recognizing that there may be valid political reasons for governments to inter- vene in domestic markets in order to reduce short-run price fluctuations (especially prices of basic food staples), argue that efficiency will be increased if domestic prices are set based on moving averages or trend levels of world prices (for example. see Timmer 1986, 1989). This rationale is invoked with particular frequency by applied policy analysts writing in the “gray literature” of government policy reform propo- sals, development agency project appraisals, and unpublished consulting reports. For example, in Pakistan a recent Report of the Nationul Commi.v sion on Agriculture asserted that “prices for exportables and import substitutes should be supported at a level close to their import and export parity prices, respectively” (Government of Pakistan, 1988).

The interpretation of NPCs and other common measures of protection in a marginal context can be defended both theoretically and empirically. Their use. however, to indicate the extent of government intervention and as a guide for setting domestic prices can be misleading, since they are not always calculated relative to the

situation that would prevail in the absence of policy distortions.

3. IMPORTANCE OF THE ASSUMPTION MADE ABOUT A COUNTRY’S TRADING

STATUS

The level of protection indicated by the NPC is sensitive to the assumption made about a country’s trading status, because import and export parity prices for the same commodity in the same country often differ by a wide margin. Differ- ences between the two arise from “external” transport costs (incurred in moving the commodity between the country’s borders and world markets), as well as from “internal” transport costs (incurred in moving the commodity between inland production or consumption points and the country’s borders).’

External transport costs arising when a commodity is moved between a country’s borders and world markets cause the CIF import price (Pm) to be higher than the FOB export price (P,) for the same commodity in the same country. Con- sider the simple example of three countries, where Country 1 exports grain to two other Countries 2 and 3. Country 1 exports at an FOB price of P,‘. while Countries 2 and 3 import at CIF prices of P,,,’ = P,’ + S” = P,,,’ = P,’ + s” (where 5” is the shipping cost from Country 1 to Country 2. assumed to equal s’j the shipping cost from Country 1 to Country 3). If Country 2 now increases production and becomes an exporter, then it can export to Country 3 at an FOB price of PC* = P,’ + s’* - Sag (in order to compete with Country 1 exports, Country 2 must absorb the shipping cost Sag). Since the FOB export price in Country 2 (P,‘) is less than the CIF import price (P,n2) by the shipping cost ?, it is apparent that the assumption made about a country’s trading status affects the level of the border price.

Differences between import and export prices become even larger when one moves from border prices to parity prices, which are border prices adjusted for internal transport and marketing costs. Assuming for simplicity that a commodity is produced and consumed in one inland region and is also imported for consumption in that region, then the import parity price is P,,,’ = P,, + td (where t,, represents the internal transport costs incurred in moving the imported commodity from the border to the inland production and consumption zone). Conversely, assuming that a commodity is produced and consumed in one inland region and is also exported from that region, then the export parity price is P,’ = P, - t(, (where tn represents the internal transport

LEVELS OF PROTECTION 807

costs incurred in moving the exported commodity from the inland production and consumption zone to the border). P,’ and P,’ can differ significantly if td is large and P, > P,.’ Where transportation infrastructure is poorly developed and distances between the border and inland production or consumption zones are large, the internal transport cost component is often larger than the external transport cost component.

To illustrate how external and internal transport costs can drive a large wedge between import and export parity prices for the same commodity in the same country, Table 1 summarizes estimated border and parity prices for major food staples in selected developing countries. In all of the examples, P,’ is at least double P,‘, and in many cases it is larger. Significantly, the examples presented in Table 1 do not even represent extreme cases. Koester (1986) presents a set of estimated import and export parity prices for cereals in selected locations of Southern Africa for 1977-78 and 1983-84. The P,‘lP,’ ratios reported by Koester frequently exceed three and occasionally surpass 10.”

As shall be seen in the following section, the wedge between import and export parity prices is important when it comes to calculating levels of

protection in countries where the trading status for a given commodity changes from year to year due to weather-induced supply variability, or where the trading status has been altered by policy interventions.

4. CALCULATING PROTECTION COEFFICIENTS UNDER DIFFERENT

ASSUMPTIONS ABOUT A COUNTRY’S TRADING STATUS

When the trading status of a commodity is unambiguous (i.e., the country can be only an importer or an exporter), calculating protection measures is relatively straightforward. In such cases, the NPC for an importing country is calculated as NPC,,,’ = PdP,,,‘, where P,’ is the import parity price in the inland consuming region. Similarly, the NPC for an exporting country is calculated as NPC,’ = PJPe’, where P,’ is the export parity price in the inland producing region.

But trading status is not always unambiguous. For example, some countries which are close to self-sufficiency fluctuate between importing and exporting the same commodity due to weather-

Table 1. Estimated relationships between border prices and parity prices for major food staples in selected developing countries, 1980s

Country

Crop and year

Import Border Border Export parity import export parity Ratio price price price price of

(Pm’) (P”,) (PJ (P.‘) P,‘lP,’

($us/t) Burkina Faso* Millet 283 na na 43 6.6

1986 Ethiopia? Maize 230 165 145 85 2.9

1988/89 Kenya* Maize 200 187 180 73 2.7

1984/85 Zimbabwe9 Maize 245 na na 110 2.3

1981 India1 Wheat 130 141 116 65 2.0

1987 Pakistan11 Wheat 225 180 160 115 2.0

1989

*Delgado (1991). tEstimated from data provided in Seyoum, Franzel and Kumsa (1988). SWestlake (1987). OBlackie (1990). fiGulati (1988). Ludhiana, Punjab is the reference production point and Bombay the consumption point, so P,’ < P,. IlEstimated by the authors for Lahore as production and consumption point. Based on data provided by the Ministry of Agriculture.

808 WORLD DEVELOPMENI

induced supply variability. The problem of choosing an appropriate world reference price for countries which fluctuate between import and export status has occasionally been addressed in the literature (Ahmed, 1988; Gulati, 1988; West- lake, 1987; Buccola and Sukume, 1991). No satisfactory method, however, has been pro- posed to calculate measures of protection when trading status changes from year to year. Ahmed (lY88) advocates calculating NPCs based on some average of import and export parity prices. but this approach has no theoretical basis.’

Even more problematic. a country’s trading status may appear unambiguous when in fact it has been altered by policy interventions. Where policy distortions are recognized to exist (e.g., domestic price controls and/or trade restrictions), most analysts assume the situation depicted in Figure 1, where the controlled domestic price (P,,) lies between the import parity price (P,,,‘) and the export parity price (P,‘) and imports of Q,-Q, are subsidized to consumers. Since imports are currently taking place, the NPC is logically calculated using the import parity price as the world price, so that NPC,,,' = PJP,,,'. In this example, such an approach is correct, since the policy distortion is not altering the trading status of the commodity; in the absence of the policy distortions. the country would still be an importer.

But this approach may be incorrect. because domestic policy distortions may have altered the country’s trading status.’ Given that a country can have three different trading statuses (importer. exporter. or self-sufficient), six possible scenarios can be distinguished in which the trading status is altered (Table 2).’ In all of these scenarios, it is assumed that P,, (for simplicity set equal for producers and consumers) is fixed by

Price

Q, Q2 Quantity

Figure 1. Commonly assumed drmund arId supply situation showing domestic and world prices.

government policy and that the government regulates trade in the commodity, a common situation for basic food staples in many developing countries. Thus, depending on government policy. the controlled domestic price (PC{) may lie above, between, or below the import and export parity prices ( P,,z' and P,~'). Likewise, depending on domestic supply and demand factors and external and internal transport costs, the level of the expected market-clearing equilibrium price P*) which would prevail in the absence of the controlled domestic price and in the absence of trade may vary relative to P,,, P,,,' and P,,'.

It can easily be shown that, assuming stocks are at optimal levels, total economic surplus is maximized by setting domestic prices as follows:

If P,,,' < P* set P</ = P,,,’ 3

if P,,,' > P* > P,,' set P,, = P*, and

if P* < PC' set P,, = P,'.

Buccola and Sukume (1YYl) provide a comprehensive framework for optimizing price policy in the short run in the presence of stocks and stochastic supply and demand. For purposes of this paper, where we seek a simple approach for measuring protection levels over the longer term. the above conditions provide an adequate set of policy rules for optimizing price policy and calculating unbiased protection measures.

Conventionally calculated protection measures are biased when trading status has been altered in one of the six possible ways listed in Table 2. To illustrate the exact nature of the bias in each case, the six scenarios are depicted graphically in Figure 2.

(a) SLmurios I und 2: Commodities that are currently imported

Figure 2(a) reflects the reality of markets for food staples in many developing countries (Sce- nario 1). A low and controlled domestic price (P,,) discourages production, and imports make up the deficit. In this case, however, if the domestic price were set at the import parity price (Pm'), the country would have a surplus, since supply would increase well beyond demand (that is, P,' < P* < P,,'). The appropriate undis- torted price to maximize economic surplus is market-clearing equilibrium price P* at which expected domestic supply and demand are in balance.x Hence the correct measure of protection is given by NPC* = P,jP*, which is obviously a larger number than NPC,,,' = Pcf/P,,l' (the larger number indicating a lower level of taxation of producers). Where the difference


Price

p:

P’

5

6

Table 2. Ways in which the trading status of a commodity can be allered

Scenario Current trading status Free-market trading status

(with policy distortions) (without policy distortions)

1. imported not traded 2. imported exported

3. exported not traded 4. exported imported

5. not traded imported

6. not traded exported

S - ---- ---- >(- -- -t_- - L-+--:-

D

Q, d* d,

(Cl Scenario 3

p; - ------ s c - :---- : p’ __+- :

e cpi$ - :--i--i 0

0, o* 0,

Price

p,’

4

pa

(b) Scenario 2 S ------ --- - >( : . - --;--;- : : : : : :

:: : D

0, Q, 04 02

(d) Scenario 4

(e) s cenario 5

S f=k

P,

---- % ‘i( ’ -- -+-

- +---_i-

0

: :

S __----

-- ---

--+-

><..

: .

: . D

. : .

0, o* 0, 0, 0’ 0,

Ouant1ty Quantity

Figure 2. Six scenarios under which the trading status of a commodity can be altered by policy distorkjns

S p, ---, ---: P, L - --.

e I->( : :

- : A+-_i;-

: .: :

D

: . i .

810 WORLD DEVELOPMEN?

between P,H’ and PC,’ is large, the difference P,’ and P,,,‘. In the second, more extreme case between P,,’ and P* is also potentially large, (Scenario 4) removal of the policy distortion leading to a large bias in the conventionally estimated NPC. It should also be noted that for a

would result in trade reversal, changing the trading status of the commodity from being

country that fluctuates between exporting and exported to being imported (Figure 2d). Because importing a commodity, even in the absence of the country is currently exporting the commod- policy distortions, the appropriate measure of the ity, the conventional measure of the NPC is NPC is also NPC* = PJP* as long as Pt.’ < NPC,’ = PJPr’, which will be higher than the P* < P,,,’ (where P* is the expected market correct measure NPC,,,’ = PJP,,,’ to the extent clearing price for domestic supply and demand). that P,,,‘lPr’ > 1.

In the second, more extreme case involving a country which is currently importing, removal of the policy distortion would result in trade reversal, changing the trading status of the commodity from being imported to being exported (Scenario 2). This case is illustrated in Figure 2(b), in which the location of the export parity price (P,‘) above the domestic market-clearing price (P*) would encourage exports if price and trade controls were removed. In this case, the correct measure of protection is given by NPC,’ = PJP?‘, which may be double the conventionally estimated NPC,,,’ = P,‘, given that often P,,‘IP,,’ > 2 (as shown in Table 1).

(c) Scenarios 5 and 6: Commodities that currently are not being traded

The two additional scenarios in which policy distortions alter the trading status of a commodity are depicted in Figures 2(e) and 2(f). In these cases, imposition of a complete trading ban leads to a situation of self-sufficiency (with the domestic market allowed to clear at P,, = P*), when in the absence of the ban the commodity would be either imported (Scenario 5) or exported (Sce- nario 6). Under these two scenarios, however. it is likely that NPCs will be calculated correctly; only if the direction of trade in the absence of the trading ban is incorrectly anticipated will the resulting measures of protection be inaccurate. Since this is not likely, Scenarios 5 and 6 are less important.

(b) Scenarios 3 and 4: Commodities that are currently exported

Incorrect estimates of the NPC can also arise in the case of countries which support domestic prices above P* and P,’ and then subsidize exports to dispose of surplus production which would not otherwise occur. While this situation is not common in developing countries, it occasionally arises in industrialized countries and is therefore worth mentioning. Figure 2(c) depicts one such situation, in which the country would be

self-sufficient in the absence of domestic policy distortions (Scenario 3). since P* lies between

Table 3. Biased and unbiased estimators of NPC under si.r

Table 3 summarizes the six scenarios under which the trading status of a commodity can be altered by domestic policy distortions and presents the conventional (biased) estimators of NPC. as well as the correct (unbiased) estimators. Of the six scenarios. Scenario I is the most common, arising frequently in developing countries where (a) food imports are taking place, (b) food prices are set below import parity prices, and (c) the gap between P,,,’ and P,’ is large.

Scenario Conventional

NPC estimator Unbiased

NPC estimator

1. 2. 3. 4. 5.

6.

NPC,,’ = P,lP”zt NPC* = P,*lP* NPC,,, ’ = P<,iP,nc NPC,’ = P‘,lP,’ NPC‘,’ = PJPef NPC* = PJP* NPC,’ = P,lP*.’ NPC,’ = P<iP,,, ’ NPCe’ = P*lP<,t NPC;,,’ = P<iIP,,, ’

or NPC,,,’ = P‘,lP,’ NPC,,,’ = P,/P,“n NPC,’ = P,,IP,.’

or NPC;,’ = P*lPt.r


Two additional points should be noted about the biases in conventional measures of protection which can result from the failure to recognize that a country’s trading status has been altered by policy distortions. First, the potential bias in conventional estimators of protection depends not only on the size of the wedge between P,,,’ and P,‘, but also on the elasticities of supply and demand. A more elastic demand or supply curve will generally lead to a greater bias for conventional estimators (this will be shown below in the empirical example from Pakistan). Second, conventional measures of protection may incorrectly indicate the direction of protection in the presence of different policies for producers and consumers. Figure 3 depicts the case of an importing country in which P,’ < Pdr < P* <

pdp ( pm,‘, where P+ is the producer price and P& the consumer price. In this case, the government subsidizes imports by the amount [(P,’ -

P&) (Q2 - Ql)] and domestically produced output by the amount [(P+ - P&) Q,]. The conventional calculation of the NPC is based on the country’s current status of an importer, so that NPC,,,’ = P&P,,,’ < 1. In fact, the correct measure of protection is given by NPC* = Pdp/ P* > 1. In this example, the conventional measure of the NPC suggests that producers are taxed, when in fact they are subsidized.

5. AN EMPIRICAL EXAMPLE: THE CASE OF WHEAT IN PAKISTAN

The case of wheat in Pakistan demonstrates how the conventional method of calculating protection measures can lead to incorrect estima-

Price 3

o* 0, 0,

Quantity

Figure 3. Case of an importing country with producer price support and a consumer subsidy in which the conventionally calculated NPC provides an incorrect

indication of the direction of protection.

tion of the true prevailing level of protection. Since Pakistan imports wheat in most years, NPCs traditionally have been calculated as NPC,,,‘, i.e., using the import parity price in the denominator. This approach generates some of the lowest NPCs for wheat in the world, leading to the universal conclusion that Pakistan heavily taxes wheat producers (e.g., Ender, 1990; Apple- yard, 1987; Haque, Khan and Ahmad, 1988; Bale and Lutz, 1981; Eckert, 1990). These low estimated NPCs have been cited by a number of international donors in an effort to pressure the government of Pakistan to raise the price of wheat sharply to the level of the import parity price (e.g., Eckert, 1990).

The low NPCs are misleading, however, because the wheat market in Pakistan closely resembles Scenario 1 described above. The government of Pakistan maintains a controlled producer price (Pd) which is considerably lower than the import parity price (Pm’) and slightly higher than the export parity price (P,‘). If the controlled price were removed, the domestic price would certainly rise, but the market would clear at a price (P*) well below the import parity price.

To show the magnitude of the error which occurs when the NPC is calculated using P,,,’

instead of P*, supply and demand functions for wheat in Pakistan were taken from Morgan (1989) (Figure 4). The point elasticity of demand at the controlled domestic price (Pd) is -0.24, and the point elasticity of supply is 0.2. Given these estimated supply and demand functions, estimated wheat imports at the prevailing domestic producer price (Pd) of US$ 135/tori were around 1.7 million tons (12% of supply) in 1989- 90. This wheat was imported at a price (Pm’) of around US$ 22Yton (projected CIF import price

Price

Quantity 1 million tans)

Figure 4. Supply and demand sifuafion and price parameters for wheat in Pakistan, 1989-90.

812 WORLD DEVELOPMEN

plus internal transport costs to Lahore).” The conventionally estimated NPC based on the import parity price was thus 0.60 (NPC,,,’ = P,,/ P ’ m 3 or 135/225). Since the theoretical market- clearing price (P*) was around US$ 17O/ton, however, the correct NPC should have been 0.80 (NPC* = P,lP*, or 135/170). Based on this higher NPC*. one would still conclude that the government was taxing producers, but the tax was only half as large as that suggested by the conventional NPC,‘.“’ If the domestic price had actually been set at P,,’ = US$ 22S/ton, as advocated by many analysts, supply would have increased dramatically, and the country would have had a large wheat surplus which would have to have been stored or exported at a considerable loss. (Note that the estimated export parity price P,’ was around US$ llS/ton. so that Pakistan appeared to have no comparative advantage in exporting wheat. ” Policy reforms aimed at in- creasing domestic efficiency in wheat production therefore should seek to increase producer prices by about 33X, not 67% as suggested by the conventionally estimated NPC.

As stated earlier. the extent to which NPC* differs from NPC,n’ (or NPC,‘) depends in part on the elasticities of supply and demand. These relationships are shown in Figure 5. in which the NPC* for wheat in Pakistan has been calculated over a range of supply and demand elasticities commonly observed for food staples in developing countries. With modestly elastic demand and supply of -0.5 and 0.5, respectively. NPC* = 0.9, indicating that domestic wheat prices would rise only by about 10% were price controls eliminated. This is very different to the conventionally calculated NPC,,,‘. which suggests a price distortion of 40%.

0.9 ________----,:--

.., ..

x _.*- .,. .. z 0.6 - E-,=-o.5 ,: ...” $

..-.

t; al 0.7 - ‘. Ed = -0.2

k

6 Uncorrected

0.6 ~---------__ rL’__ _“”

c’

0 0.2 0.4 0.6 0.8 1.0

Elasticity of supply (Es)

Figure 5. Relationship between the uncorrected NPC for wheat in Pakistan (based on the import parity price) and corrected NPG under various assumptions about sup-

ply and demand elasticities. IYHY-90.

6. CONCLUSION

In recent years, calculation of protection coefficients and subsidy equivalents has become routine as a means of identifying the direction and magnitude of policy-induced price distortions. Although they are strictly speaking valid only at the margin, such protection measures have come to be widely interpreted in a nonmar- ginal context as a measure of the extent to which domestic prices need to be changed to bring them into line with international prices, thereby elimi- nating taxes or subsidies on domestic producers and/or consumers.

Protection measures are conventionally calculated using world reference prices as a measure of the “free-market” prices that would prevail in the absence of policy distortions. These world reference prices are selected based on current trading status. This paper has identified a condition - the presence of policy distortions which alter the trading status of a commodity - which can cause this method to lead to incorrect estimation of the level and sometimes even the direction of protection. Although cases of potential “trade reversal” have occasionally been noted in the trade literature, the implications for applied price policy analysis in developing countries have apparently been ignored by most practitioners.

Significantly. policy distortions which change the trading status of a commodity are not uncommon. Consumer prices for basic food staples are heavily subsidized in many developing countries, frequently leading to imports that would not occur with freely determined prices (Byerlee, 1987). Less commonly, producer prices are supported in some industrialized countries above world price levels. leading to overproduc- tion that can be disposed of only through subsidized exports that otherwise would not occur.‘7 The probability that policy distortions will alter the trading status of a commodity increases the closer the country is to self- sufficiency in that commodity. Once the country’s trading status is altered, the degree of potential distortion in conventionally estimated protection measures increases the larger is the wedge between the import and export parity prices. This wedge, which is comprised of the costs involved in shipping a commodity between the domestic production or consumption zone and world markets, can be particularly large in the case of commodities characterized by a low value : weight ratio (e.g., most cereals). since transport costs for these commodities make up a relatively large proportion of the total value. The wedge can be especially large in big countries with high internal transport costs, or in land-


locked countries with no direct access to an ocean port; in such cases, the import parity price is often double or more the export parity price.

Data from Pakistan have been presented to illustrate how the conventional method of calculating NPCs leads to serious misestimation of the true prevailing level of protection. Similarly biased measures of protection have been estimated for major food staples in India, China, Turkey, Mexico, and several African countries. All of these countries maintain low consumer prices, are close to self-sufficiency (although usually net importers), and are characterized by high transport costs because of their large size, poor transportation infrastructure, and/or lack of access to an ocean port.

Under what conditions does the type of distortion described in this paper become important enough to worry about in applied policy analysis? Although protection measures recently received a lot of attention in the Uruguay Round of the GATT negotiations, we suspect that the theoretical point raised in this paper will be of limited usefulness for trade policy analysis, since calculation of the correct (unbiased) protection coefficients depends on the supply and demand elasticities which are difficult to estimate empirically in a general equilibrium context. On the other hand, we believe that the type of distortion described in this paper can be extremely important in many developing countries where attempts are underway to achieve increased efficiency by bringing domestic prices in line with “free market” prices. Specifically, by failing to recognize the condition described in this paper, many analysts have considerably overstated the degree of taxation of grain producers in large developing countries, including India, Pakistan, and Turkey. As a general rule, for large (or landlocked) countries that are at least 8.5% self- sufficient in a commodity, and where producer and/or consumer price controls are in effect, caution should be used in interpreting conventionally calculated protection measures, and corrected measures based on the methods developed here should be calculated (Table 4).

We do not claim that the problem described in this paper is the only one which must be addressed in empirically calculating levels of protection. Other difficulties will inevitably arise to confound estimation of the likely relationship between domestic prices and international prices in the absence of policy distortions, including

Table 4. Developing countries in which trading status for cereals may be affected by government policies+

Percentage self-sufficiency (1985-90)

Bangladesh China India

Wheat Rice

$ 96100 85-93 99-101 9&101 IO@101

Indonesia e 99100 Nepal OS-98 99-101 Pakistan

Burundi Malawi Mali Nigeria Uganda Zaire

x7-97 $_

: Y I-189 8&174

:

53-92 74-87

: 67-100

100

Bolivia $ OS-106 Brazil 59-86 8>99 Colombia $ 97-104 Mexico 78-96 62-100 Venezuela $ 8@102

Afghanistan 86-95 98100 Morocco $ 54-100 Turkey 91-l 14 j:

Maize

99-100 103-108 9x-100 96-103

100-101 100

100 94-107 88-100 97-100 99-100 89-95

100-107 89100 96100 75-87 66-100

100 48-89 79-97

*The countries appearing in this table meet the following criteria: (a) they are close to self-sufficient in one or more major cereals (self-sufficiency percentage between 85%-115%). (b) they are either physically large countries or landlocked countries (i.e., high transport costs involved in trading on world markets), and (c) producer and/or consumer price controls are in effect. tcalculated using FAO data as: (production)/(production + net imports). *Less than 85% self-sufficient.

quality differences between domestically produced and traded commodities, seasonality in price movements, marketing bottlenecks, exchange rate distortions, and possibly even general-equilibrium effects (if the country involved has the potential to affect international prices). We do argue, however, that failure to recognize instances in which policy distortions have altered the trading status of a commodity introduces a potentially significant source of additional bias which can frequently be eliminated.

NOTES

1. In addition to policies which affect domestic domestic prices indirectly. For a review of recent prices directly, exchange rate policy frequently affects empirical work on the indirect effects of exchange rate

814 WORLD DEVELOPMENT

misalignment on cereals prices in developing countries, set Krueger, Schiff and Valdes (1988) and Taylor and Phillips (1991).

2. Factors other than transport costs mav also contribute to the observed difference between import and export parity prices, e.g.. quality differences between domestically produced and imported grain. Such factors must also bc taken into account in calculating levels of protection, but they are not the focus of this paper.

3. The analysis can easily be extended to the case in which producing and consuming regions are different (Westlake. 1987).

4. Koester (19X6) also estimates CIF-FOB spreads for maize, wheat, and sorghum at East African ports. His figures indicate that throughout most of Eastern and Southern Africa, roughly 50% of the difference between import and export parity prices consists of external transport costs, while the remaining 50% is made up of internal transport costs.

5. The most comprehensive analysis of the problem of establishing appropriate price policy where trading status may vary depending on supply and demand conditions has recently been provided bv Buccola and

number of authors. For example. see Scandizzo and Bruce (1980).

7. Although some of these scenarios are more likely to arise than others, for expository purposes we present ail six.

8. An implicit assumption here is that removal of domestic price distortions does not shift the supply and demand functions in the domestic market.

9. Prices relate to the 1989 crop year. The estimated CIF and FOB prices in Karachi were US$lXO/ton and US$lhO/ton. respectively. Transport and handling costs from Karachi to Lahore were estimated as US$45/ton.

10. Here we consider only direct estimates of NPC at the official exchange rate. Indirect effects through an overvalued exchange rate may impose even larger taxes on producers (see Krueger. Schiff and Valdes. 1988).

Il. Based on estimated FOB price of US$lhO/ton minus USMYton internal transport and handling costs.

12. For these countries, use of export parity prices to calculate protection levels also gives misleading results. For example, the World Bank and USDA calculate

Sukume (1991). These authors, however, do not NPCs for-wheat in several European countries using address the issue of calculating protection coefficients. export parity prices (World Bank, 1982; USDA, 1987:

Webb. Lopez and Penn. 1990). even though recent 6. For countries which are not price takers in studies suggest that some European wheat exporters

international markets, the trading status of a commod- would either cease exporting or actually begin import- ity need not be altered for conventionally calculated ing were trade liberalization to occur (for example. see NPCs to be distorted. This has been recognized by a Harwood and Bailey, 1990).

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