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Research on Poverty Alleviation (REPOA)

Assessing market distortions affecting poverty reduction efforts on smallholder tobacco production in Tanzania

Dennis Rweyemamu and Monica Kimaro

Research on Poverty Alleviation (REPOA)

2006

SARPN acknowledges REPOA as a source of this document: www.repoa.or.tz
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Abstract

This study attempts to analyse the efficiency of production, the degree of distortion in the markets and the pattern of incentives for smallholder tobacco growers in Songea, Tanzania.

A survey was conducted on a sample of tobacco growers in Songea district, and secondary data collected from key organisations in the industry. A Policy Analysis Matrix (PAM) of the tobacco production and marketing system was constructed so as to determine the private and social profitability of the system, distortions in the markets and the efficiency of resource use in the pursuit of maximizing income. Since PAM is a static model, a sensitivity analysis to explore the effect of potential changes in various factors that influence profitability of the enterprise was also conducted.

The analysis revealed that although tobacco production is potentially a profitable enterprise relative to the international market, smallholders are paid less than the actual value of their product. The overall effect is a net taxation of tobacco production at the farm level. Thus the existing marketing arrangements have made it appear uncompetitive with low resource allocation efficiency. There is a net disincentive to produce the crop. In the absence of distortions, smallholder farmers in the region would have realised more to their average annual income from tobacco production alone. These findings reveal the importance of the crop in poverty reduction efforts, and the significant effects of market distortions.

Sensitivity analysis indicated that an increase in producer prices resulted into a sharp increase in producer incentives and smallholders will be more protected with profits realised in excess of normal returns to domestic resources increasing. With a decrease in the parity price of the product, indicators depict that production of the crop becomes undesirable from the social point of view. However, efficiency indicators were insensitive to an increase in parity prices of tradable inputs implying that tobacco production will still be a desirable enterprise from the social point of view.

The study concludes that although liberalization opened up markets by formally allowing private leaf dealers to invest in marketing of tobacco, operational arrangements have not provided adequate incentives to tobacco growers in terms of pre-harvest services and marketing efficiency in general. Many problems have been noted which indicated gross inefficiency in the entire production and marketing system. These problems alter costs and revenues in the input/output markets and prevent realization of potential income gains by tobacco growers. Intervention is, therefore, necessary in the operation of liberalized markets to increase incentives and comparative advantage in costs, revenues and efficiency of resource use.

Introduction

Background information

In most sub-Saharan countries, there appears little immediate rural industrialization or other non-farm engines of growth and poverty alleviation. This implies that smallholder agriculture is likely to remain the major source of rural growth and livelihood improvement for a long time to come (World Bank, 1997; Platteau, 1996). The 1998 OED argues that well-meaning efforts in Tanzania by the government, civil society and donors were not focused on the root causes of income poverty, but on its symptoms. This issue interacts with agriculture to the extent that, in Africa the poor are typically concentrated in rural areas, and within the rural areas relatively better-off persons normally get a higher share of income from non-farm sources (Reardon et al., 1994). Thus, problems in achieving poverty alleviation are linked to problems in achieving higher agricultural performance. Also problems in achieving higher agricultural growth are linked with problems of access to markets. According to the Participatory Poverty Assessment carried out in Tanzania by the World Bank (“Voices of the Poor”, 1995), one of the factors of importance to the poor was access to markets. Also views from the grassroots expressed at zonal workshops during the preparation of the Poverty Reduction Strategy Paper (PRSP), identified limited access to markets as one of the key causes of income poverty.

Within the context of agricultural performance, export crops have a key role to play. Export crops are defined as those cash crops, which are often traded on international commodity markets and/or are grown primarily for export markets (Shepherd and Farolfi, 1999). Development of smallholder export crop production has the potential to bring direct benefits to a large number of farm households, hence contribute to poverty reduction initiatives. Even households that do not benefit directly may reap indirect benefits through the increased demand for hired labour, often a valuable source of income for the poorest. The 1998 OED report claims that failure to recognise export cropping as the engine for growth has led to overall economic distress and jeopardized the success of Tanzania’s hard fought and painful structural adjustment efforts.

Export crops are high value commodities, which are handled through reasonably concentrated marketing systems. Production usually relies on the use of some purchased inputs such as improved seeds, fertilizers and chemicals. They are internationally tradable, such that under ideal conditions, their domestic prices are closely linked to world market prices. Currently, the export crops industry in Tanzania, particularly at the farm level, is constrained by several factors, some of which are attributed to market failure, resulting from imperfections in the marketing system.

Tobacco is an export crop grown worldwide in more than 120 countries (ITGA, 1998). In Tanzania, it is one of the major agricultural export crops, being the third largest foreign exchange earner after coffee and cashew nuts (BOT, 2003). It is the main source of income to some 72,000 smallholder farmers who are striving to get out of or stay out of poverty. It also offers employment opportunities in both tobacco farms and in the three processing factories in Morogoro and Ruvuma regions. In addition, the crop provides raw material for cigarette manufacturing factories, thus offering further employment opportunities in the country.

Problem Statement

Over the years, Tanzania has experimented with a wide variety of agricultural marketing policy regimes, from unregulated markets to cooperative-based marketing to centralized crop authorities and back to relatively unregulated markets. Export marketing has experienced similar changes, as well as dramatic shifts in the real exchange rate. Agriculture markets are influenced by government interventions mostly through price and trade policies. The agriculture sector cannot be treated in isolation, as it is substantially influenced by macro-economic factors. Some of the problems facing the sector could be attributed to market distortions. A distortion, in this case, is a degree of divergence between a situation with a particular intervention and a situation without the intervention.

Currently, problems facing the tobacco industry might be an indication of market failure or gross inefficiency in the marketing system, which could be a result of a number of reasons (Shapiro and Staal, 1992). First, market failure could result from an imperfect competition where a small number of buyers are able to influence aggregate demand and therefore affect market prices. Secondly, failure may result from externalities in which producers are unable to capture the full benefits for the crops they produce. Finally, “institutional” market failures can be experienced in a situation where markets do not function efficiently because of inadequate development due to lack of infrastructure and institutions. Market failure alters costs and revenues and prevents the realization of potential income gains. Prices that farmers come across are altered and this affects their income and welfare, hence poverty status. Price incentives are captured in commodity, domestic factor and input markets. It is therefore important to examine the effects of market distortions on the economic incentives of export crop growers and identify institutional forms of market failure.

In some recent literature, knowledge on quantitative effects of market distortions on tobacco production in Tanzania is still insufficient. Given this background, it is the objective of the study to analyse the direction and extent of distortions and therefore, empirically fill the gaps in the literature. The study will identify patterns of incentives and analyse the economic efficiency of smallholder tobacco production.

Objectives of the Study

General Objective

The broad objective of this study is to assess market distortions affecting poverty reduction efforts through tobacco production.

Specific Objectives

Specifically the study seeks to:

  1. analyse the economic efficiency of tobacco production;
  2. assess the degree of distortion in the input/output markets; and
  3. trace the role of institutions and organisations in the production and marketing systems and identify institutional forms of market failure.




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