Issue 4, 2013. August-September

   

ISET - AGRICULTURE AND THE AGRIBUSINESS SECTOR: PROBLEMS AND THE NEED FOR CHANGE

ISET Staff

In addition to producing food, the agriculture sector in Georgia provides a social safety net to a very large part of the population, including those who are unemployed and whose qualifications are a poor match for current market needs. Any future reform of the Georgian agricultural sector has to take these facts into account. Failure to achieve coordination among small farmers and failure to coordinate between smallholder farmers and other market players is one of the biggest issues in the sector. While the private sector is able to solve these problems to some extent, the role of the government can be crucial. From promoting infrastructure and vaccination programs, to conducting research, establishing education and vocational trainings, and dealing with the cost of financing or promoting farmers' cooperatives, the government can play a significant role.

Productivity in the agricultural sector is embarrassingly low. Adam Pellillo, Ph.D., an assistant professor at ISET, noted that it is remarkable "that Georgia seems to be the only former Soviet republic in which agricultural productivity hasn't returned to or exceeded its level in 1992. As of 2010, agricultural productivity stood at only 77 percent of where it was at nearly two decades ago." This finding is even more puzzling if we consider that during the same period agricultural productivity has grown by nearly 200 percent in neighboring Armenia.

A major issue for Georgia's future agricultural development is fragmentation. This has several aspects: highly fragmented land ownership, as a result of the land privatization of the 1990s; and weak links, if any, between different actors in the various value chains. The result is depreciated or nonexistent machinery, obsolete and inefficient cultivation techniques, and poor storage, packaging and transportation — all of which lead to very low agricultural output.


Private Sector Capacity to Resolve Coordination Failures in Agriculture

From an economist's perspective, the persistence of fragmentation reflects two types of market failures: firstly, failure to achieve coordination among small farmers, and secondly, failure to coordinate between smallholder farmers and other market players (aggregators, processing plants, large retailers, hotel chains, etc.).

However, the truth is that in quite a number of cases the market has been able to fully "internalize" the issues plaguing the Georgian agricultural sector. The most prominent recent successes in overcoming the fragmentation impediment are associated with major international brands such as Hipp, Carrefour, and Ferrero Rocher. Launched in 2007, Hipp's plant in Gori makes organic apple juices for world distribution from Georgian apples. By acting as an integrator it has drastically improved quality standards and yields in organic agriculture. Likewise, the French hypermarket chain Carrefour is already procuring most of the fresh produce for its store locally, imposing its rigorous quality standards on the Georgian producers.

Aggregators such as Hipp and Carrefour provide guarantees of long-term demand and offer technical assistance with choosing crops, as well as with growing and post-harvest treatment methods. This provides farmers with stronger incentives to learn (i.e. to invest in their own human capital), to invest in improved facilities and machinery (i.e. to invest in physical capital), and very importantly, to cooperate. Cooperation allows the exploitation of economies of scale in many areas, including the procurement of inputs, cultivation, storage, and transportation. The presence of guaranteed demand reduces the market risk for related investment projects, lowers the cost of finance and speeds up the process of technological upgrading in agriculture.


Social Risk as an Externality

If the market is able to internalize coordination externalities in agriculture, are there any reasons for the government (government and foreign donors) to "meddle" with free-market dynamics to try and speed up the (inevitable) process of consolidation in Georgian agriculture?

The primary reason for intervention, in our view, has to do with the natural role of the agricultural sector as a buffer zone, which poses an important socio-political externality. The slow pace of productivity growth in agriculture has left large swathes of Georgia's rural population far behind the urban middle class, often in poverty and with no or limited access to high-quality education and healthcare. The result has been political uncertainty and risk through protest voting or worse, as reflected by Georgia's performance in the Global Competitiveness Index (GCI), country risk ratings, and FDI dynamics. Political risks, in turn, have translated into high lending interest rates, which have affected the entire economy. Not only do they slow down investment and job creation in the non-agricultural sectors (limiting its ability to absorb surplus agricultural labor), but these risks limit smallholder farmers' access to credit, stalling their productivity and disenfranchising them even further. We contend that the government should attempt to resolve this vicious circle.

Endorsed and supported by the international donor community, the new Georgian government's general strategy — to promote rural development and agriculture — is, indeed, consistent with our analysis.

The Role of Government in Addressing the Social Risk Externality

In considering potential interventions, we adhere to our general approach that, first, the government should spend its scarce resources in ways that address market failures and coordination externalities across the entire economy. One obvious example is the negotiation of free trade agreements and the use of WTO arbitration mechanisms to improve market access to the EU, Russia and other neighbor countries. Another example is investment in strategic transportation infrastructure, which has positive repercussions for the entire economy (e.g. see post by Eric Livny, "Roads and Rural Development: the Case of Samtskhe Javakhet," ISET Economist blog, http://www.iset.ge/blog/?p=1033).

Next in the order of priorities are interventions that address the cost of entry and market failures that are specific to the agricultural sector and yet are broad in nature. Examples of this are vaccination programs, and prevention, monitoring and control of animal and plant diseases. While already in place, relevant programs could be further strengthened to boost productivity and to meet the requirements for the Deep and Comprehensive Free Trade Agreement with the EU.

Other areas of concern include research, education and vocational training in relevant fields. Government-provided scholarships and the new Millennium Challenge Corporation multi-year agreement with the Georgian government, both targeting technical education, are excellent examples of the latter type of intervention. The agricultural-education component is also included in the EU's new European Neighbourhood Programme for Agriculture and Rural Development program that seeks to support Georgia's rural development, including agriculture.

Third, to complement investment in education, extension centers could help increase the general level of expertise available to the agricultural sector, facilitating the introduction of new crops, thus improving yields and incomes.

Fourth, investment in irrigation and drainage systems would increase the supply and quality of arable land. While the "last mile" of irrigation infrastructure could be undertaken by individual farmers (or farmer cooperatives), the construction of dams and irrigation canals are clearly a matter for government (or donor) attention.

Last, but not least, the government and donors could choose to address the cost-of-financing impediment affecting Georgia's agriculture.

Lending interest rates and collateral requirements are generally very high in Georgia. On top of that, given the very small volume of lending to the agricultural sector, the financial sector (banks and insurance companies) do not have the skills to properly assess agricultural risks.

The government could try addressing this obstacle by supporting relevant training and research to establish proper criteria for judging the agricultural risks that are specific to Georgia, like the different types of Georgian agriculture, soil and climate zones.

The possibility for the government to promote farmer cooperation, as a means of overcoming fragmentation at the level of the primary agricultural producer, is one of the most debated issues regarding Georgia's smallholder agriculture. Indeed, farmer organizations could exploit economies of scale by undertaking joint investment in machinery and equipment, procurement of inputs, processing, branding, bargaining and marketing.

However, successful farmer organizations are almost nowhere to be seen in Georgia because cooperation requires a common vision, mutual trust and excellent management skills - issues that will hopefully be tackled by the new government and aid programs.