Implementation of Income Objectives in Farm Policies: A Japanese Experience

Senior Fellow, RIETI

1. Japanese agricultural policy after World War II

The growing disparity between farm household and non-farm household incomes due to the rapid development of the industrial sector following the Second World War led to the enactment of the first Agricultural Basic Law in 1961. By this law, the Japanese government sought to increase farm household incomes so that they would be equal to those of workers in the industrial sector.

Figure1 Rectification of income disparity between the farm sector and the industrial sector

There are two ways of increasing agricultural incomes: either by raising prices or by reducing production costs (or increasing productivity). This can be explained by the specific-factor model in international trade theory. Let us assume that the industry employs the specific factor, capital, and that agriculture employs land as a specific factor. If the price of products or the productivity of industry increases, the curve of the marginal-value-product of labour shifts upward from I to I. If we assume the perfect factor mobility of labour, labour shifts from agriculture to industry. The total income of industry expands from GALoOi to FBL1Oi, while the total income of agriculture shrinks from CALoOa to CBL1Oa and the income accruing to landowners decreases from CAE to CBD. This is the income disparity between the two sectors caused by unequal sectoral development. In order to rectify this, we must shift the curve of the marginal-value-product of labour in agriculture, either by raising prices or increasing productivity.

The 1961 Agricultural Basic Law tried to take the latter path, reforming the small-holding-based agricultural structure to improve agricultural incomes by reducing costs by expanding the scale of farms and improving productivity. In reality, however, agricultural policy increased incomes by raising the price of rice. The result was that consumption decreased, production increased, and a surplus of rice emerged.

Why did the Japanese government resort to price support rather than structural reform? Simply because price support is politically popular as it does not harm anyone. Structural reform policy, however, would have eliminated jobs in the agricultural industry.

Why did the Japanese government resort to price support rather than direct income support or deficiency payments? There are several reasons. First, there are no administrative costs, including those for planning and implementing policies. Secondly, farmers do not want to receive money from the government, but rather earn their income by selling their own products. Third, with the increase of per capita income, Japanese consumers have become indifferent to increases in food prices. On the other hand, a taxpayer-borne income payment policy entails a difficult negotiation with the Ministry of Finance.

Has the objective of the Agricultural Basic Law - that is, rectification of the income disparity between the farm sector and the industrial sector - been achieved? Surprisingly, yes. This is in part thanks to price support and even more so to the remarkable increase of non-farm incomes of the farm households which has been accompanied by economic expansion; indeed, most farm household incomes are higher than non-farm household incomes.

Structural reform of the agricultural industry, however, has not been achieved. Faced with high rice prices, which are greater than the high production costs of small-scale farms, small-scale farmers have preferred to produce rice rather than buy expensive rice in the market, and have not handed their land over to full-time farmers. In addition, the industrialization of rural areas enabled small-scale farmers living in a village to commute to near-by factories or offices. They have become part-time farmers yet remain in the farm sector. As a result, although the average size of French farms has increased by 150% over the past forty years, that of Japanese farms has increased by only 36% (only 17%, excluding Hokkaido). Consequently, while the household incomes of small-scale farmers are much greater than the non-farm household incomes, the household incomes of large-scale farmers are smaller. Contrary to Europe, large-scale farmers do not benefit from price support in Japan. Price support, which is the indirect and inefficient policy that supports income, has created serious side-effects; a surplus of rice, prevention of structural reform, less international competition for Japanese agricultural products and less self-sufficiency in regard to food.

2. Is direct income payment, which is decoupled and targeted, easy to implement?

If income objectives are clearly defined and if targeted household are precisely identified by taking into account all sources of income, then theoretically, a decoupled and targeted direct income payment will be the most effective, efficient and equitable policy.

In reality, however, there are serious problems in the planning and implementation of this policy. First, it is desirable to know the income of every household. We have to know all sources of income: farming income, income from non-farming activities, income from investment, wind-fall profits from selling land, which is usually owned by the farm sector more than any other in the economy, and social transfers, such as pensions which are given to aged farmers who have retired from non-farm sectors. But for this to succeed, a lot of human resources are required and Japan has not accomplished this 'mission impossible'. In addition, farmers tend to under-declare their incomes. The administration must have the ability to check these false declarations.

If the individual income of every household were given less attention, then the income patterns of some categorized groups of farmers based on farm size, production type, region and other factors could be given greater scrutiny. This method does not, however, lessen our burden very much. Some farmers specialize in single products, some specialize in multiple products and others change products every year. There are numerous combinations of production types. Even when two farmers with the same farm size produce the same products, their farm incomes may differ due to land fertility or some geographical reasons such as the slope of the land or the distance from markets. Furthermore, non-farm incomes differ significantly.

If you invested many resources, then you might obtain accurate figures for various types of farm household incomes. In order to compare the farm-household incomes and non- farm-household incomes in real terms, you have to take into account the differences in the costs of living in urban and rural areas. Although price levels tend to be lower in rural areas, there are fewer hospitals, schools and libraries which makes it difficult to live there. We need to obtain accurate, precise and comprehensive data so that we can avoid any criticism of the income payment policy, such as overcompensation, by the non-farming population or by farmers who are not eligible for income payments. In order to know enough to implement income payments, the costs would far outweigh the benefits. Administrative and transaction costs are involved not only for implementation but also for planning.

Just after I returned from Brussels in 1998, I was assigned the position of director of rural development in the Ministry of Agriculture, Forestry and Fisheries. I was asked to introduce direct income payments to the farmers in less advantaged areas, which was the first time direct income payments had been made in Japan. There was a strong belief that farmers' incomes in these areas should be on par with ordinary non-farm household incomes. I found, however, that there are various kinds of farming and non-farming activities; some grow apples, some grow cucumbers, some keep cows, some work for factories and some work for local governments. The incomes from these farming activities fluctuate every year, too. It was next-to-impossible to identify their income levels. I stopped investigating farmers' incomes and also stopped trying to equate them in these areas with the ordinary non-farm household incomes. I read through paragraph thirteen of Annex II of the WTO's Agreement on Agriculture which states that 'the payment shall be limited to the extra costs or loss of income involved in undertaking agricultural production in the prescribed area.' I noticed that all I had to do was rectify the disadvantage of farming activities in the area which is mostly characterized by land slope. Paddy fields are an instrument for producing rice and rice is the representative product growing there. We had data for the production costs of rice. I had the sample data rearranged according to the degrees of land slope and measured the cost difference between flat land and sloped land. I let 80% of the cost difference be the amount of payment to a paddy field to avoid overcompensation.

3. My suggestions

Since I am not an expert in the field of statistics, there may be ways to increase the efficiency of data collection and enhance its accuracy or credibility that are unknown to me.

Even when perfect data is obtained, however, if a farmer changes his production type, it is difficult to find an accurate amount for a direct payment to him. Or if you change the amount of direct payment for each farmer, it will entail higher administrative costs. Also, if a farmer is satisfied with his direct payment, he may not wish to adopt a more efficient method of production.

Previous OECD work mentions that targeted measures to correct market failures linked to the provision of public goods should be introduced before making an income direct payment. Or when there is plenty of room for improving the efficiency of the farm sector, a policy to enhance it is a way to reduce costs and increase incomes. This sequence of introducing policies is important in order to diminish the difficulties of introducing income direct payments.

In addition, we have to keep in mind that income direct payment is not the sole instrument for improving farmers' incomes. When people in rural areas find it difficult to access medical facilities, the best and most targeted policy is building an infrastructure - roads or hospitals - which enables people to have access to them. Income direct payment is an indirect and inefficient policy for addressing this issue. When I planned the direct payment policy for less advantaged regions, I told Japanese politicians and leaders of farmers' groups that this policy was not a panacea, that we should give different kinds of medicine to different patients according to their illness and that it was not appropriate to give eye-drops to a patient whose stomach aches.

When the introduction of income direct payment becomes inevitable, we should keep the scheme simple and avoid overcompensation. For example, when the income direct payment is made to compensate price reductions, the amount of price reduction should be measured and the normal ratio of income included in the amount of price reduction based on the statistics of production costs should be specified. The forgone income should then become the amount of the direct payment. Farmers who are not affected by price reduction, such as part-time farmers whose main sources of income are from non-farm activities, should be excluded from this scheme.

* Source: The article was reprinted from Proceedings of OECD/PACIOLI Workshop on Information Needs for the Analysis of Farm Household Income Issues [PDF:1.0MB], edited by Moreddu, C. and K. J. Poppe, Den Haag, LEI (Report 8.04.04), published on October 27, 2004 (Chapter 4, pp.35-38).

October 27, 2004 Proceedings of OECD/PACIOLI Workshop on Information Needs for the Analysis of Farm Household Income Issues

November 22, 2004

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