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Food and Agriculture Organization of the United Nations, FAO

Commodity Chain Analysis
Impact Analysis using market prices

Module 046

Commodity Chain Analysis
Impact Analysis Using Shadow Prices

Commodity Chain Analysis
Impact Analysis Using Shadow Prices
by Fabien Tallec, Consultant, Agricultural Policy Support Service, Policy Assistance Division, Food and Agriculture Organization of the United Nations, FAO, Rome, Italy Louis Bockel, Agricultural Policy Support Service, Policy Assistance Division, Food and Agriculture Organization of the United Nations, FAO, Rome, Italy for Food and Agriculture Organization of the United Nations, FAO

About EASYPol EASYPol is a an on-line, interactive multilingual repository of downloadable resource materials for capacity development in policy making for food, agriculture and rural development. The EASYPol home page is available at: www.fao.org/tc/easypol. EASYPol has been developed and is maintained by the Agricultural Policy Support Service, FAO.

The designations employed and the presentation of the material in this information product do not imply the expression of any opinion whatsoever on the part of the Food and Agriculture Organization of the United Nations concerning the legal status of any country, territory, city or area or of its authorities, or concerning the delimitation of its frontiers or boundaries. ? FAO December 2005: All rights reserved. Reproduction and dissemination of material contained on FAO's Web site for educational or other non-commercial purposes are authorized without any prior written permission from the copyright holders provided the source is fully acknowledged. Reproduction of material for resale or other commercial purposes is prohibited without the written permission of the copyright holders. Applications for such permission should be addressed to: copyright@fao.org.

Commodity Chain Analysis
Impact Analysis Using Shadow Prices

Table of contents
1 2 3 Summary ...................................................................................1 Introduction................................................................................1 Principles of shadow pricing ..........................................................2
3.1 Constructing segments of the chain ...................................................3 3.2 Efficiency price analysis....................................................................4

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Empirical estimation.....................................................................8
4.1 Establishing the segments of the chain ...............................................9 4.2 Analysis using parity prices...............................................................9

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Comparing economic policies....................................................... 13 Analysis ................................................................................... 13
6.1 The impact of transfers .................................................................. 14 6.2 Economic profit ............................................................................. 17

7 8

Conclusion ................................................................................ 18 readers’ Notes........................................................................... 18
8.1 Time requirements ........................................................................ 18 8.2 Frequently asked questions............................................................. 19 8.3 EASYPol links................................................................................ 19

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Further readings ........................................................................ 19

Module metadata.............................................................................. 21

Commodity Chain Analysis
Impact Analysis Using Shadow Prices

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SUMMARY

This module provides a presentation of the impact analysis using shadow prices. It belongs to a set of modules which discuss how to proceed step by step on commodity chain analysis. The module starts by a presentation of the principles of shadow prices. It is followed by an empirical estimation which shows the two possible approaches: analysis using parity prices and social price analysis. It then tries to compare economic policies on the basis of economic analysis, thereby finishing by the analysis of impact assessment.

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INTRODUCTION

This module1 deals with the impact analysis within the commodity chain analysis. It is an analytical tool which uses the shadow prices. To find relevant materials in these areas, the reader can follow the links to other EASYPol modules or the references2. This module belongs to a set of modules which discuss how to proceed step by step on commodity chain analysis. EASYPol Module 043: CCA: Constructing the Commodity Chain, Functional Analysis and Flow Charts introduces commodity chain analysis as a framework. The reading of Module EASYPol 044: CCA: Financial Analysis before this one is advised to understand the principles of financial analysis.
Objectives

This module shows analytical tools which can be used to evaluate the impact analysis. The objective of using shadow prices is to correct for the distortions between market prices and economic value. This module can be used in different contexts such as: reference materiel for policy analysts in carrying out their on-the-job tasks, in academic courses.

It is based on a translation from French of FAO Training Materials for Agricultural Planning, No. 35, Note de méthodologie générale sur l’analyse de filière: Utilisation de l’analyse de filière pour l’analyse économique des politiques, Pierre Fabre, 1994, (initially translated into English by Anne M. Thomson, 1998).
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EASYPol hyperlinks are shown in blue, as follows : - training paths are shown in underlined bold font; other EASYPOL modules or complementary EASYPol materials are in italics; - links to the glossary are in bold; and - external links are in italics.

underlined bold

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Targeted audience

This module is intended for a wide audience, ranging from policy analysts and decision makers, to development practitioners, training institutions, and media. It is of particular relevance to senior and mid level officials and professional officers in ministries of agriculture, livestock, forestry, rural development, and cooperatives, including line departments and training institutes/units. It should also be of particular interest to senior executives of parastatals, financial institutions, and NGOs/CBOs. Suitably adapted, it may also be used as a reader in undergraduate courses in development.
Required background

To understand the content of this module, basic elements of micro-economics and a basic knowledge of agriculture commodity sector trade functioning are required. No specific technical background, beyond reasonable language skills, is required for this module. It is anticipated that individuals with a degree in economics, and agricultural or rural development related areas, and those with several years of experience in agricultural policy analysis or development planning and implementation, at a mid to senior level position, should have little difficulty in grasping the module’s content.

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PRINCIPLES OF SHADOW PRICING

As mentioned above, there are a variety of reasons for undertaking CCA. Examining contributions to growth and identifying the distribution of flows of income are two issues which the analyst might wish to explore. It is acceptable, and indeed desirable for the analyst to use market prices as reflecting actual flows in the economy. However the analyst might also want to explore issues of efficiency in either an economic or social context. Here the use of market prices is not appropriate as actual market prices do not reflect the true economic value of the goods and services to which they are attached. There are numerous reasons for this distortion between market prices and economic value. The most important are: the absence of pure and perfect competition (due to the existence of monopolies or oligopolies and to imperfect information among economic agents); the intervention of the state, and other factors beyond the strictly economic sphere, disturbing the economic process (by taxes, regulations, quotas, and all types of economic policy measures). For these and other reasons, real life economies do not correspond to the model economy developed in neo-classical theory, and therefore distortions result. Prices no longer play their role of information and market regulation. Agents no longer behave in such a way as to maximize national income, quantities produced and consumed move away from the equilibrium point, resource allocation is no longer efficient, and flows and income are no longer optimal.

Commodity Chain Analysis
Impact Analysis Using Shadow Prices

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The objective of using shadow prices is to correct these distortions, by estimating a hypothetical set of accounting or efficiency prices, and then to show the discrepancies between the accounts as re-estimated in this way and the actual financial accounts of the agents (whether individual accounts or the overall consolidated account).
Box 1. Shadow prices Shadow prices are the values which replace market prices in theoretical calculations when it is felt that market prices do not represent the true economic value of the good or service. These are also referred to as economic prices, accounting prices, "real" prices or reference prices. They can be divided into two major categories, efficiency prices and social prices (see below for definitions). Originally, the expression shadow price was only used for the prices calculated by a mathematical model (the dual in linear programming) but the term is now in more general usage.

Once the accounts of the chain have been re-estimated, there are two important steps to consider: efficiency analysis, which essentially consists of valuing factors of production and goods and services at international parity prices3; social price analysis, which incorporates the impact on consumption and savings, and policy objectives of income distribution. Social price analysis involves the application of a complex economic model, and requires the analyst to make difficult choices in terms of weighting factors. This is rarely undertaken, and therefore will be discussed in Annex 3, rather than in the main body of the text.
3.1 Constructing segments of the chain

Before estimating and applying shadow prices to a commodity chain, it is necessary to divide the chain into autonomous segments.
Box 2. Autonomous segments These are fractions of the chain which link two potential stages of marketing, such that the input demand and the output demand can be met by sources other than within the chain, whether by domestic production or imports and exports. In other words the input into the segment is a traded product, as is the output.

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The use of parity prices is only one method of calculating shadow prices. Other possibilities are to use opportunity cost, marginal productivity of factors, or consumer willingness to pay.

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Once these segments have been defined, they can be used to calculate appropriate import and export parity prices for each level of the chain, and as such are the basic units of analysis in shadow pricing (as discussed in section 4.2.2). The next step is to set up consolidated accounts for each segment, using market prices (financial accounts)4.
3.2 Efficiency price analysis

We now have to calculate the relevant efficiency prices (export and import parity prices) and apply them to segment accounts, keeping the flows of goods and services, in physical quantities, the same as they are in the financial accounts. We can then examine the differences made when we substitute efficiency prices for market prices.
Box 3. Efficiency price An efficiency price reflects the true economic value, as given by: the marginal productivity, or opportunity cost (in parity prices or otherwise), for factors of production, use value for final goods and services (parity prices or willingness to pay). Efficiency prices are supposed to maximize the overall economic output and revenue by achieving the optimal use of factors.

The prices of goods and services consumed or produced by the chain: (i) are valued at their parity prices (import or export parity depending on whether they are inputs or outputs) either directly or built up from the parity values of their components, as shown in the production-trading accounts;

Box 4. Border price The border price of a good or service is the price of this good at the point of entry (for imports) or exit (for exports) from the country. This is the FOB price for exports and the CIF price for imports, whether intermediate inputs or import substitute products.

All the accounts we shall be discussing in the remainder of this module will be the consolidated accounts of different segments within the chain being studied.

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Commodity Chain Analysis
Impact Analysis Using Shadow Prices

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Box 5. Parity price

The import parity price of a product is equal to its border price plus transport costs (including any processing and transformation costs) and all expenses (other than taxes and subsidies) intervening between the point of entry and the place of consumption. The export parity price of a product is equal to its border price minus transport costs (including any processing and transformation costs) and all expenses (other than taxes and subsidies) intervening between the place of production and the point of exit. (ii) eliminating all transfers5;

Box 6. Financial transfers Transfers are financial flows made without a corresponding flow of goods or real consumption of economic value. Basically they include: redistribution activities by the government (taxes, duties, subsidies); financial charges (interest payments); certain types of rents. These are direct movements of liabilities (entitlements) from one agent to another and have no impact on national income as such.

(iii) and, correcting the cost of non-tradable factors of production included in the overall value6. In efficiency analysis, each resource consumed in the process of production is valued at its opportunity cost, that is the value it would produce if used in its next best alternative. Goods and services produced are valued at their use value.
Box 7. Opportunity cost This is the value of a good or service when used in its next best alternative use (compared to its current use in the chain). The opportunity cost of a factor of production is equal to its marginal productivity in its best use in the production of another good or service.

However, financial charges linked to international loans do constitute a real cost to the national economy of the country. Given the scarcity of short and long-term capital, ignoring these charges would distort calculations in favour of using scarce national resources. Such financial charges must be taken into account and not excluded. A similar case could be made for loans from national banks which are heavily indebted on the international market. How this is done depends on the method of calculation adopted by the analyst: whether a standard conversion factor is used or a shadow exchange rate. See paragraph (c) below.
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Box 8. Use of value The opportunity cost of a good or service produced is equal to its use value, i.e. to the value that the final consumer is willing to pay.

a. Parity prices for goods and services

It is commonly accepted that, for the majority of goods and services, international prices are the best reflection of the efficiency price, because overseas trade generally offers the best possible alternative use of inputs and outputs. This is the basis for using parity prices in efficiency analysis. It is possible to distinguish four cases7: goods and services which are internationally traded or which could be traded internationally8: they are valued at international market prices at their point of entry into or exit from the country. These prices are then adjusted by the necessary transport and processing costs (valued at shadow prices) between the border point and the point of production or utilization; goods and services which are indirectly traded internationally: their value is subdivided using the production-trading account into tradable (imported inputs or import substitutes) and non-tradable items (see below); non-tradable goods and services: goods and services which cannot be traded internationally (such as land9) are valued, in the case of factors of production according to their marginal productivity, and for final goods and services, according to consumers’ willingness to pay; goods and services which could be traded internationally: these goods and services which are not traded because of existing regulations are similar to non-tradable goods and services and are valued on the basis of their marginal productivity or according to consumers’ willingness to pay.
b. Parity prices for factors of production

When it comes to measuring the cost of factors of production, in practice it is very difficult to estimate the marginal productivity of factors of production. It is hard to identify their alternative employment and we are unable to estimate their marginal contribution to production, without using detailed models. Lacking an alternative, we generally assume that the marginal productivity of a factor is equal to its market price, except in the case of unskilled labour, which, in certain types of employment, may receive higher payment than their alternative marginal productivity would indicate.

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Adapted from J. P. Gittinger, The Economic Analysis of Agricultural Projects, 1992. These goods and services are referred to as “tradable”, which means tradable internationally.

And, more generally, factors of production which create value-added, such as labour and capital. See the following paragraph.

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Impact Analysis Using Shadow Prices

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Unskilled labour, particularly agricultural labour, is generally considered to have, as an alternative occupation, either traditional agricultural production or casual labour (either in rural or peri-urban areas). If there are no obvious particular characteristics, it is standard practice to adopt unit marginal productivities for other factors of production. The analyst faces an additional problem, that of choosing of the unit of measurement. Goods and services and factors of production must be analyzed on the same basis. The choice of a single unit of measurement has to be consistent with the decision to use parity prices: thus the value currency used is that of international prices, whether expressed in terms of foreign exchange or domestic currency. This has to be applied with care. For the community as a whole, the cost of using a factor of production is the alternative output foregone, which should, under appropriate market conditions, be valued at the price of the factor being utilized. It is this “output foregone” which has to be measured in international prices. The following example10 illustrates the possible importance of this correction. Consider a project which employs a worker who was previously paid US$ 2 in a coffee plantation. Let us accept that his wage in this plantation measured his marginal productivity, or, in other words, that his previous employer made a normal profit out of employing him. This means that in a day’s work, the additional output of coffee made a profit of US$ 2 for his employer. However, if the coffee was subject to an export levy of 100%, sustainable because of the gap between the world price and the cost of production, this day’s work would benefit the community much more: society gains US$ 4 paid by the overseas importer, of which half goes to the state in levies and the rest is paid to the producer. Thus the conversion factor (in shadow prices) to apply to the wages of this worker would be 2, as a result of measuring his alternative marginal productivity in international prices. This example assumes that the worker that is taken away from the coffee plantation is not replaced, and that his alternative output is actually lost. If he were replaced, and if we were able to follow the chain of successive hirings and firings, eventually we could value the marginal cost as the productivity of the first unreplaced worker, or even less if a previously unemployed person was employed in the course of the chain. It is impossible to undertake these speculative simulations: the analyst is forced to rely on common sense rules of thumb, which may have little theoretical basis. Therefore, except for exceptional cases where it is possible to identify the nature of the production foregone, we apply a conversion coefficient in international prices which measures the value of a “basket of marginal products” in international and domestic prices. On the assumption that an additional unit of production results in additional exports, or avoids additional imports, the average structure of external trade will be used to quantify this conversion coefficient.

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This is taken from J. Vercueil and G. Ancey, Prix de référence pour les projets agricoles, 1988.

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The formula is as follows: MPCC = Imports + Exports Imports + Exports + Entry duties ? Exit taxes + Export subsidies

where MPCC = the Marginal Product Conversion Coefficient.
c. Shadow exchange rate

These economic calculations can be carried out in two ways: either by using the standard conversion factor to translate all market prices of non-tradable goods and services into border price equivalents, or by applying a shadow exchange rate for the domestic currency to internationally traded goods and services. Both methods should give similar results if carried out rigorously. If a standard conversion factor (the marginal product conversion coefficient) is applied to factor incomes and non-tradable goods, there is no need to apply a shadow exchange rate to traded goods. The standard conversion factor translates values measured in domestic prices to their border price equivalents, making allowance for the effects of external trade distortions on domestic prices. The calculation is effectively carried out in international price units. On the other hand, the shadow exchange rate must be categorically applied to border prices when parity prices are calculated, if factor incomes and non-tradable goods are to be measured in domestic prices. Here the calculation is carried out in domestic price units. The procedures are equivalent as a result of the following mathematical identity: Shadow exchange rate = Official exchange rate Standard conversion factor

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EMPIRICAL ESTIMATION

As indicated in the section above, there are two possible approaches to analysis using shadow prices: Analysis using parity prices, efficiency analysis using international prices. Social price analysis, efficiency analysis which incorporates the use of relative weightings to reflect the distribution and use of income. Although the first type of analysis is simpler and should be within the capacity of many analysts, the second one requires either a certain theoretical competence to develop a system of equity weightings adapted to the statistical data available in the country, or the availability of previous work undertaken in similar context which can be used to provide shadow prices for the principal income streams. As indicated earlier, social pricing will be discussed in Annex 3.

Commodity Chain Analysis
Impact Analysis Using Shadow Prices

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4.1

Establishing the segments of the chain

These are determined by the technological characteristics of the product and those of the corresponding markets (see Annex 2). Once this is done, the consolidated financial accounts of each segment must be established.
4.2 Analysis using parity prices

The following steps should be undertaken in sequence: Step 1: Calculate either the shadow exchange rate for domestic currency or the standard conversion rate. Alternatively, find a previous estimation which can be used. Step 2: Calculate conversion factors from market prices into parity shadow prices.
Box 9. Conversion factors Conversion factors enable the analyst to calculate the shadow price (or total shadow value) of a good or service by multiplying its market price (or the total sum expressed in market prices) by a simple coefficient.

Conversion factor =

Shadow price Market price

Conversion factors can be calculated for efficiency prices or social prices.

a)

The parity price for all tradable intermediate inputs is calculated:

Parity price = border price + transport costs b) Then the analyst derives the production account for non-tradable intermediate inputs in order to extract from it the tradable components, valued at parity prices.

Theoretically, the residual non-tradable elements should, in their turn, be decomposed into tradable and non-tradable elements. In practice, it is worthwhile ascending the production chain further only if the relative value of the residual non-tradable elements justifies it11. The collection of data comprises a large part of the work, in particular data on international prices of tradable import substitutes and data on the production-trading accounts of businesses supplying or processing goods and services. The businesses

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For an exhaustive analysis, follow the methodology given in EASYPol Module 045:

CCA: Impact

Analysis Using Market Prices.

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themselves, fiscal authorities and economic information centres are the principal sources of information12. (3) Once these various elements have been fragmented, we can divide the market price into: a foreign exchange cost (consisting of an actual cost where the good or service is imported, or otherwise the opportunity cost); any element of tax or subsidy; a labour cost (further broken down into skilled and non-skilled); the return to capital or to the enterprise. It is possible, though unusual, to obtain a more detailed breakdown. (4) The shadow price is then calculated by adding: the cost of foreign exchange, converted using the shadow exchange rate; the cost of labour; the income of productive agents. N.B.: The same result is achieved by adding: the cost of foreign exchange at the official exchange rate; the cost of labour multiplied by the standard conversion factor; the income of productive agents multiplied by the standard conversion factor. (5) Then the ratio, Shadow price ÷ Market price, is calculated to give the conversion factors for each good or service.

Finally, the elements of value added in the consolidated trading account for each segment are included as follows: the labour costs remain unchanged (a conversion factor equal to 1 is applied to them)13; transfers to and from the state (taxes and subsidies) are omitted (a conversion factor equal to 0 is applied to them); other transfers such as financial charges and insurance are omitted (a conversion factor equal to 0 is applied);
The problem of information is not specific to this methodology. A satisfactory solution to this depends on the experience of the analyst leading the study, on the theoretical framework adopted to resolve the problems and on the capacity of both research and statistical organizations to develop effective data banks.
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If the official exchange rate for the domestic currency is retained for foreign exchange costs, they are multiplied by the standard conversion factor.

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Impact Analysis Using Shadow Prices

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the capital elements (technical and economic depreciation) remain unchanged (a conversion factor equal to 1 is applied)14. Step 3: Apply the conversion factors in parity prices to cost items in the production account and to the components of value added (except profits).
PRODUCTION CHAIN FOR THE DOMESTIC MARKET: IMPORT PARITY PRICE PRODUCTION CHAIN FOR THE
INTERNATIONAL MARKET: EXPORT PARITY PRICE

World price at foreign port (fob) + Brokerage, freight, insurance (at cif) = BORDER PRICE (cif) at port of entry + Customs, transit, storage + Transport + Packaging, final processing + Transport + Possible additional processing, transport + Marketing costs + Assembly costs = FARMGATE PRICE Production costs = PRODUCER MARGIN (gross output)

World price at foreign port (cif) Brokerage, insurance, freight (at cif) = BORDER PRICE (fob) at port of exit Customs, transit, storage Transport Packaging, final processing Transport Possible additional processing, transport Marketing costs Assembly costs = FARMGATE PRICE Production costs = PRODUCER MARGIN (gross output)

This diagram shows only the chain for the principal product. The value of other possible products must be subtracted when calculating import parity prices and added when calculating export parity prices. It may be necessary to develop similar flow diagrams for each sub-chain formed by these products. The costs included in this flow diagram, such as processing and transport, are valued at the parity prices of their factors and inputs, analogous to the calculation for the final product.
If the official exchange rate for domestic currency is retained for foreign exchange costs, they are multiplied by the standard conversion factor.
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Step 4: Value any other elements of value added, specifically, for agricultural chains, taking into account the opportunity cost of family labour in peasant farming and the opportunity cost of land used. Step 5: Calculate the parity value of output for each segment of the chain. Step 6: Constructing a Policy Analysis Matrix (PAM): The Policy Analysis Matrix (PAM) is an organizational framework in which shadow price calculations can be presented. To construct a PAM, it is necessary to include the total amount of the principal categories of goods and services studied: outputs, internationally traded goods and domestic factors (and non-tradable goods)15. As shown below, the PAM contains a row “market prices” which takes the figures from the financial analysis, another row “shadow prices”, and a row of divergences between the first two rows.
Tradable inputs PAM for segment Output Within the chain Outside the chain Domestic factors Profits

Market prices Shadow prices Divergence

The format of the PAM presented here differs slightly from the traditional presentation, insofar as it distinguishes, in the column “Tradable inputs”, between the flows of the major commodity (which defines the chain) and the flows of other intermediate inputs. This is because we are analysing segments of the chain. For the overall PAM, the column “Tradable inputs within the chain” will be empty by definition. Step 7: Aggregation of the PAMs for the different segments into a PAM for the complete chain. The data shown by the PAMs, both for the complete chain and its segments, provide the basis for further analysis.

To systematize this we could say that tradable goods correspond to all intermediate inputs which can be measured at international prices (directly or by ascending the chain). Domestic factors cover those factors which directly create value added (and amongst which value added is divided: labour, capital etc.) as well as those intermediate inputs which are impossible to value at parity prices.

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Impact Analysis Using Shadow Prices

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COMPARING ECONOMIC POLICIES

It is difficult to assess the economic efficiency of a policy in isolation. As with the growth and distributional impacts discussed in section 3, it is more useful to compare alternative policies to give a better perspective on their relative costs and benefits. All other things being equal, the net benefit of policy A compared to policy B is measured as follows: Net advantagepolicy A over policy B = Impactpolicy A - Impactpolicy B The policies under comparison may have differing economic implications (for example on prices or on the evolution of salary scales) and technical implications (for example in terms of the use of factors of production by agents). These, strictly speaking, are exogenous to the impact calculation, but their consequences for flows of goods and services, in both volume and value terms, are taken into account in the calculations. The comparison of two situations resulting from alternative policy measures must be undertaken with care. If the economic impact of two different policy measures results in the same volume of production for the domestic final market at the same price, then the comparison is reduced simply to the difference: Net Benefit policy A over B = Profits policy A - Profits policy B Here we are measuring overall impact by the “profit” on the row “Shadow prices” of the PAM. However, this same procedure can be applied to all the elements (tradable goods, domestic factors), or to their divergence, for example:

? Divergence in domestic factors A/B = Divergence policy A - Divergence policy B
The significance of these additional impacts is discussed in section 6 below, on analysis. New sets of policies adopted (or under consideration) frequently influence both the volume of output and/or its price. In this case it would be better to undertake a detailed analysis in terms of opportunity cost or use value (willingness to pay) of the additional (or reduced) output.

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ANALYSIS

Analysis using shadow prices can be based on absolute data, comparative data or analytical criteria. The absolute data are the new accounts estimated from the application of shadow prices (either efficiency or social) to the various items in the production-trading accounts of segments of the chain. These are incorporated in the second row of the PAM.

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The comparative data are those given in the third row of the PAM which measures the divergence between the values in market prices and the values in shadow prices: Divergence = Value at market prices - Value at shadow prices Comparative data are also provided by comparison of different economic policies. Analytical criteria are indicators developed to give an overall picture of significant economic costs and benefits and their implications for the relevant development policy objectives. These indicators allow comparisons to be made between policies, between chains and even between countries; they are tools which aid the assessment of policies. The analytical criteria presented below do not form an exhaustive list. They have been included as the most useful indicators of policy impact, particularly when considering the objectives of development strategy16. Those presented in boxes are the most commonly used. The others give information on more narrowly defined issues. PAM for the chain Market prices Reference prices Divergence Output A E I Tradable inputs Within the Outside chain the chain B0 B F0 J0 F J Domestic factors C G K Profits D H L

The following discussion describes the economic significance of a commodity chain using the PAM technique. The notation refers to the PAM given below. The brief description of the principal elements of the analysis applies equally to an efficiency analysis as to a social analysis, although the economic significance is somewhat different in the two cases.
6.1 The impact of transfers

The Profits column of the commodity chain PAM shows the profit for the community as a result of the operation of the chain and the transfers which are the outcome of price distortions due to market imperfections and the effects of economic policy. Private profit: this is the overall result of the financial trading in the chain i.e. trading at market prices. Private profit = Output - tradable inputs - domestic factor input or D=A-B-C

It is even possible, for specific economic policy measures, where the individual costs are known, to calculate an indicator of profitability (such as a benefit-cost ratio or payback period).

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For financial analysis in CCA, overall private profit has less significance than the trading profits of individual businesses. Private profit is normally assessed in terms of a normal rate of return to capital. If D is higher than this rate then there are excess profits, and if profits are lower than this rate then the return is inadequate. Social profit17: this is the return to the activities of the chain, calculated using true economic values as represented by the shadow prices used. Social profit = Output - Tradable inputs - Domestic factor inputs or H=E-F-G If social profit is positive, this indicates an efficient use of resources and a positive contribution to national income. Where a normal rate of profit has been included in the column for factors of production18, a positive profit, H, indicates an excess profit on the part of the agents of the chain, and a negative profit means an insufficient return, that is a chain which is producing at a higher cost than the opportunity cost of importing, as a result of state transfers. The divergence between private profit and social profit measures the net transfer in operation: Net transfer = Private profit - Social profit or L=D-H This gives the net impact of market imperfections and policy measures. A Profit ratio makes it easier to assess the importance of transfers, particularly when making comparisons between chains: Profit ratio = or Profit ratio = D ÷ H This ratio of return measures the proportion by which private profit exceeds social profit because of transfers resulting from market distortions and economic policies. In other Private profit Social profit

Although this is normally called social profit in the PAM literature, it is calculated using economic efficiency prices.
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As measured by opportunity cost.

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words, this ratio measures the overall incentive which producers have to participate in the chain. As a complement to this, the subsidy rate of producers is an indicator of net transfers, which can similarly be used to make comparisons between chains: Producer subsidy rate = or Subsidy rate = L ÷ E This rate shows the value of the transfer to productive agents in the chain in relation to the monetary value of output valued at their true economic price. Again this is an indicator which can only be assessed subjectively or in relation to other chains. Calculating the Nominal Protection Coefficient (NPC) is another way of establishing the relationship between the market price and the shadow price of the main commodity in the chain: Nominal Protection Coefficient = or NPC = A ÷ E If this rate is less than 1, the domestic price is below the international price. The chain therefore gives rise to lower income than would be the case in an economy which applies international parity prices, by the proportion of the NPC; and vice versa when the NPC is greater than 1. In this latter case, producers face higher incentives than they ought to from the point of view of opportunity cost and in the international market. Where chains produce a number of commodities, the overall NPC for the chain can be calculated by using the total financial value and the sum of shadow prices for each of the products. This is independent of the NPCs of the individual products which can also be calculated. Output market prices Output shadowprices Net transfers Shadow value of output

NPC overall chain =

∑ Output i ∑ Output i
i i

market prices

shadowprices

The Effective Protection Coefficient (EPC) is a measure of the ratio of value added to tradable goods by the production process in market prices relative to shadow prices: Effective Protection Coefficient = (Output ? Tradable inputs)market prices (Output ? Tradable inputs)shadow prices

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Impact Analysis Using Shadow Prices

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or EPC = (A - B) ÷ (E - F) The value added in question here (that given in the PAM) is not necessarily exactly the same as that calculated in the production-trading account of the financial analysis. Some intermediate inputs could be internationally non-tradable and thus be entered in the column “domestic factors”. Nonetheless, the notion of value added is the same in the two approaches, a measure of the wealth created by the chain which will remunerate the other domestic factors, including a normal return on capital. By measuring the relationship between value added in domestic and international prices, the EPC gives an indicator of the level of incentives created by national economic policy in favour of the chain. While the NPC only looks at gross revenue (the gross value of output), and thus only gives a measure of commodity price policy, the EPC integrates the role of tradable inputs - and thus price policies affecting them - into the measure of protection of the chain with respect to the international market. It is therefore a more precise indicator of the real level of incentive relative to the world market. An EPC of less than 1 means that the combination of transfers affecting the commodity, on the one hand, and the intermediate inputs (tradable goods) on the other, result in an effective distribution of income less than would be the case if, all things being equal19, international prices applied. The analyses presented in this paragraph on incentives and protection have been approached from the perspective of the chain as a whole. Reading the columns of the PAM can give a deeper analysis and show specific mechanisms. Thus the calculation of a Nominal Protection Coefficient for inputs (tradable goods)20 can highlight transfers which reinforce or counteract those related to the commodity price (NPC of output), showing the overall balance in the EPC. To understand better the phenomena at play, the analyst can look in turn at transfers associated with output, then tradable inputs and finally with domestic factors. It is sensible to keep an analytical approach to the results of calculations and not interpret them mechanically.
6.2 Economic profit

Profitability indicators allow the analyst to compare the performance of different chains. The factor cost ratio gives information on the relationship between domestic factor remuneration and the value added from tradable inputs: Factor Cost Ratio =
19 20

Domestic factorsmarket prices Outputmarket prices ? Tradable inputsmarket prices

In particular without changes in physical flows such as were indicated in the financial analysis. NPC of Tradable Goods = B ÷ F.

18

EASYPol Module 046
Analytical Tools

or FCR = C ÷ (A-B) This ratio is calculated at the prices the agents actually face, and shows a private profit if it is less than 1. It is possible to compare this to a similar “return” for other chains. The Domestic Resource Cost Ratio (DRC) is the equivalent of the previous indicator, measured in shadow prices: Domestic Resource Cost = or DRC = G ÷ (E -F) This is an essential indicator as it measures the overall economic efficiency of the chain by comparing the cost of domestic factors consumed in the production process with the benefit in foreign exchange as represented by the value added from tradable inputs21. This is the most relevant indicator of the economic “profit” created by the chain for society. A DRC greater than 1 means that the cost of domestic factors used is greater than the value created measured in international prices, i.e. overall there is a loss of welfare for society. Minimizing the DRC is equivalent to maximizing social profit. Domestic factorsshadow prices Output shadow prices ? Tradable inputsshadow prices

7

CONCLUSION

This module focuses on impact analysis using shadows prices. It belongs to a set of modules which discuss how to proceed step-by-step on commodity chain analysis (CCA) and shows analytical tools which can be used to evaluate the impact analysis. The objective of using shadow prices is to correct distortions between market prices and economic value. This is possible by estimating a hypothetical set of accounting or efficiency prices, and then to show the discrepancies between the accounts as reestimated in this way and the actual financial accounts of the agents.

8

READERS’ NOTES 8.1 Time requirements

The delivery of this introductory module may fit for any audience of skilled staff requiring to be introduced on Commodity Chain. In most cases, it may be presented in one hour and a half session.

Or more precisely, the value of these flows in foreign exchange equivalent adjusted by the shadow prices of the income generated by indirect intermediate inputs.

21

Commodity Chain Analysis
Impact Analysis Using Shadow Prices

19

8.2 Frequently asked questions

Frequently asked questions are the following: Who decides what is in and out of the commodity chain? What is the difference between the commodity chain analysis and value chain analysis?
8.3 EASYPol links

This module belongs to a set of modules about the Commodity Chain Analysis, available in English and in French.
English

EASYPol Module 043: EASYPol Module 044: EASYPol Module 045:
French

CCA: Constructing the Commodity Chain: Functional Analysis and Flow Charts CCA: Financial Analysis CCA: Impact Analysis Using Market Prices

Module d’EASYPol 043: L’approche filière: Analyse fonctionnelle et
identification des flux

Module d’EASYPol 044: L’approche filière: Analyse financière Module d’EASYPol 045: L’approche filière: Analyse des effets aux prix du
marché

Two case studies using the Commodity Chain Analysis are reported in the EASYPol modules:
English

EASYPol Module 047:

Exercise of commodity chain analysis: irrigated rice chain of the Niger’s Office. Financial and Economic Accounts

EASYPol Module 048: Case Study: Analysis of the Suburban Horticulture SubChain of Bamako (Mali)

French

Module d’EASYPol 047: Module d’EASYPol 048:

Exercice d’analyse de filière: Filière riz irrigué de l’Office du Niger, bilan financier et économique Etude de cas: Analyse de la sous-filière mara?chage périurbain de Bamako (Mali)

9

FURTHER READINGS

There is virtually no Anglophone literature dealing directly with Commodity Chain Analysis. It is however, discussed in the context of constructing Policy Analysis Matrices, though there is little on financial analysis or even impact analysis.

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EASYPol Module 046
Analytical Tools

Audette, R., Larivière, S., Martin, F., 1994. Analyse de filière dans le secteur agro-alimentaire: guide de réalisation d'une étude filière, Rapport préliminaire ACDI - Eco. rurale inc. Bockel, L., 1996. Analyse de la sous-filière mara?chage péri-urbain de Bamako, Document de formation pour la Planification Agricole, Division de l'Assistance aux Politiques (TCAS), FAO. Bourgeois, R., 1998. La constitution des filières et les institutions quaternaires. Dasgupta P., Marglin S., Sen A., 1972. Directives pour l’évaluation des projets, ONUDI. Fabre, P., 1994. Note de méthodologie générale sur l'analyse de filière, Document de formation pour la planification agricole n° 35, FAO ESPT. Hugon, P., 1998. Avantages comparatifs, compétitivité et organisation des filières. Gittinger J. P., 1982. Analyse économique des projets agricoles, IDE/Economica. Monke E. A., Pearson S. R., 1989. The policy analysis matrix for agricultural development, Cornel University Press

Commodity Chain Analysis
Impact Analysis Using Shadow Prices

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Module metadata
1. EASYPol module 046

2. Title in original language English Commodity Chain Analysis French Approche filière Spanish Other language 3. Subtitle in original language English Impact Analysis Using Shadow Prices French Analyse aux prix de référence Spanish Other language 4. Summary This module provides a presentation of the impact analysis using shadow prices. It belongs to a set of modules which discuss how to proceed step by step on commodity chain analysis. The module starts by a presentation of the principles of shadow prices. It is followed by an empirical estimation which shows the two possible approaches: analysis using parity prices and social price analysis. It then tries to compare economic policies on the basis of economic analysis, thereby finishing by the analysis of impact assessment. 5. Date December 2005 6. Author(s) Fabien Tallec, Consultant, Agricultural Policy Support Service, Policy Assistance Division, Food and Agriculture Organization of the United Nations, FAO, Rome, Italy Louis Bockel, Agricultural Policy Support Service, Policy Assistance Division, Food and Agriculture Organization of the United Nations, FAO, Rome, Italy 7. Module type Thematic overview Conceptual and technical materials Analytical tools Applied materials Complementary resources 8. Topic covered by the module Agriculture in the macroeconomic context Agricultural and sub-sectoral policies Agro-industry and food chain policies Environment and sustainability Institutional and organizational development Investment planning and policies Poverty and food security Regional integration and international trade Rural Development 9. Training path 10. Subtopics covered by the module 11. Keywords Commodity chain analysis



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