fertilizer demand in china's reforming economy

17
Fertilizer Demand in China’s Reforming Economy Qiaolun Ye1 and Scott Rozelle2 ‘Postrdoctoral research associate, Food Research Institute, Stanford University, Stanford, California. 2Assistant professor, Food Research Institute, Stanford University, Stanford, California. Received 16 June 1993, accepted 1 December 1993 INTRODUCTION As a crucial input in China’s land-scarce farming systems, fertilizer has played a key role in the strong and steady growth of agricultural production in China’s rural economy. During the planning period 1954-78, fertilizer distribution policy was considered a powerful policy instrument (Stone 1986). When China launched its efficiency-seeking reform drive in the late 197Os, the leadership did little to change the fertilizer sector. Fertilizer distribution policy was seen as crucial to help agriculture supply sufficient quantities of low-cost food to both rural and urban consumers, one of the rural sector’s primary contributions to the national modernization process (Lin 1993). High fer- tilizer demand, created both by producers searching for high yields and by policy makers controlling fertilizer distribution, made China the number-one importer and number-two consumer of fertilizer in the world during the 1980s. As the reforms have progressed, however, questions have begun to arise regarding the effectiveness of these long- standing measures (World Bank 199 la). The close relationship between expanding grain production and fertilizer consumption has begun to break down. In the eighth five-year plan, planners have begun to ask questions about the future role of fertilizer policy (Liu 1991). Chinese agricultural and chemical industry officials are currently interested in assessing the future of the sector (Mei 1992). Groups in the international community - both those concerned about China’s markets and those involved in assisting the nation’s development effort - are likewise concerned about the future trends of this key input (Stone 1989; World Bank 1991a). As the second lar- gest exporter in the world, Canada’s sectoral leaders are concerned with understanding factors which affect China’s demand for fer- tilizer. In 1991, Canada shipped $169 million of chemical fertilizer to China, one-eighth of its total exports (GACPRC 1992). Given the importance of the fertilizer sector, surprisingly little is known about the microeconomic impacts of China’s domestic fertilizer policies on the behavior of farmers in China’s rural areas. Based on an extensive household survey of China’s rapidly developing coastal region, this paper exa- mines the impact of government fertilizer dis- tribution policy on farmers’ decision making in the increasingly liberalized environment of the late 1980s. In particular, the paper addresses the following questions: What is the impact of fertilizer distribution policy on farmer production behavior in the reform environment? What are the major deter- minants of fertilizer demand in China’s reforming rural economy? What changes have occurred in China’s economic environment that have decreased the effectiveness of fer- tilizer distribution policies? Insights into these Canadian Journal oj Apriudlural Economic.\ 42 (I 994) I91 -207 191

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Page 1: Fertilizer Demand in China's Reforming Economy

Fertilizer Demand in China’s Reforming Economy

Qiaolun Ye1 and Scott Rozelle2

‘Postrdoctoral research associate, Food Research Institute, Stanford University, Stanford, California.

2Assistant professor, Food Research Institute, Stanford University, Stanford, California.

Received 16 June 1993, accepted 1 December 1993

INTRODUCTION

As a crucial input in China’s land-scarce farming systems, fertilizer has played a key role in the strong and steady growth of agricultural production in China’s rural economy. During the planning period 1954-78, fertilizer distribution policy was considered a powerful policy instrument (Stone 1986). When China launched its efficiency-seeking reform drive in the late 197Os, the leadership did little to change the fertilizer sector. Fertilizer distribution policy was seen as crucial to help agriculture supply sufficient quantities of low-cost food to both rural and urban consumers, one of the rural sector’s primary contributions to the national modernization process (Lin 1993). High fer- tilizer demand, created both by producers searching for high yields and by policy makers controlling fertilizer distribution, made China the number-one importer and number-two consumer of fertilizer in the world during the 1980s.

As the reforms have progressed, however, questions have begun to arise regarding the effectiveness of these long- standing measures (World Bank 199 la). The close relationship between expanding grain production and fertilizer consumption has begun to break down. In the eighth five-year plan, planners have begun to ask questions about the future role of fertilizer policy (Liu 1991). Chinese agricultural and chemical

industry officials are currently interested in assessing the future of the sector (Mei 1992). Groups in the international community - both those concerned about China’s markets and those involved in assisting the nation’s development effort - are likewise concerned about the future trends of this key input (Stone 1989; World Bank 1991a). As the second lar- gest exporter in the world, Canada’s sectoral leaders are concerned with understanding factors which affect China’s demand for fer- tilizer. In 1991, Canada shipped $169 million of chemical fertilizer to China, one-eighth of its total exports (GACPRC 1992).

Given the importance of the fertilizer sector, surprisingly little is known about the microeconomic impacts of China’s domestic fertilizer policies on the behavior of farmers in China’s rural areas. Based on an extensive household survey of China’s rapidly developing coastal region, this paper exa- mines the impact of government fertilizer dis- tribution policy on farmers’ decision making in the increasingly liberalized environment of the late 1980s. In particular, the paper addresses the following questions: What is the impact of fertilizer distribution policy on farmer production behavior in the reform environment? What are the major deter- minants of fertilizer demand in China’s reforming rural economy? What changes have occurred in China’s economic environment that have decreased the effectiveness of fer- tilizer distribution policies? Insights into these

Canadian Journal oj Apriudlural Economic.\ 42 (I 994) I91 -207

191

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192 CANADIAN JOURNAL OF AGRICULTURAL ECONOMICS

questions will ultimately help in assessing the future of the demand for fertilizer by producers in China’s rapidly changing economy.

The next section of the paper describes China’s fertilizer distribution policy and demonstrates its effectiveness in the pre- reform years. The following section reviews changes in the policy environment since the economic reforms, raising a series of issues addressed in the subsequent analysis. Then the paper presents the empirical approach, a representative household programming model, and the data used for the analysis. The final two sections discuss the results of a series of simulations of some of the key determinants of fertilizer demand and assess the implica- tions of the empirical results.

CHINA’S FERTILIZER DISTRIBUTION POLICY

China’s current fertilizer distribution policy was developed initially in the 1950s when fer- tilizer was in critically short supply (Stone 1984). In those years, the government monopolized fertilizer production, importa- tion and distribution. Trading fertilizer on the free market was strictly prohibited.

The government distributed all fertilizer in rural areas at prices set initially at levels higher than the world market price (Stone 1984). While the state domestic price remained fairly stable over time, the world market price rose considerably. The state price is now substantially below the world market price, resulting in a subsidy to Chinese farmers (World Bank 199 la).

The purchase of subsidized fertilizer in China is constrained by maximum allocation quotas. Rationing of “plan fertilizer” is administered by various levels of government, and distribution is monopolized by the Agricultural Means of Production Corpora- tion (AMPC). Actual allocation formulae are complicated, the rules differing by the type of fertilizer as well as the source of its subsidy.

The largest category of allocation is the ‘ ‘procurement-linked fertilizer’ ’ (gua goufei),

its uniform price nationwide being set by the central government. The central leadership allocates this fertilizer, which, as its name suggests, is directly linked to the quantity of state crop procurement. As a result, most of the subsidized urea flows into prosperous areas where the state purchases most of its grain, cotton and oilseed crops. In contrast, farmers in poorer areas receive little or no subsidized urea because they have few surplus crops (Stone 1989).

As a matter of policy, the fertilizer dis- tribution system successfully concentrated scarce chemical fertilizer into the most productive areas with high supply response during the early years of the program. Figure 1 compares the growth rate of China’s fer- tilizer consumption (in nutrient weight) with that of grain production. ’ The figure illus- trates that the two variables were highly cor- related before the mid- 1980s. Stone (1989) believes that increased fertilizer consumption played a significant role in the growth of grain production in those years. Production studies have consistently found high returns to fer- tilizer use in the pre-reform period (Fan 1991; Tang 1984).

The relationship between grain produc- tion and fertilizer consumption changed sharply in the 1980s. The growth rate offer- tilizer use surpassed that of grain production early in the post-reform period. Moreover, the gap between the growth rates has con- tinued to widen. Why has the recent growth in fertilizer consumption not continued to generate the increases in grain production that were enjoyed in the 1960s and 197Os? Has fertilizer policy become less successful since the reforms? These questions are addressed below.

MAJOR SHIFTS IN CHINA’S RURAL POLICY ENVIRONMENT

This section examines the major changes in rural China in recent years and focuses primarily on elements that may be responsible for the changes in the nature of fertilizer demand as well as the apparent ineffective- ness of China’s fertilizer distribution strategy.

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FERTILIZER DEMAND IN CHINA’S REFORMING ECONOMY 193

1950 1955 1960 1965 1970 1975 1980 1985 1990 Year

I----- Fer t. Consumption -+- Grain Production 1

Figure 1. Growth rates of fertilizer nutrient consumption and grain production (1978 = 100). Source: China State Statistical Bureau (1991, 331, 346).

Three dramatic shifts occurred during the 12 years of economic reforms: the relaxation of the supply constraint on fertilizer at the aggregate level, the emergence of a dual- pricing system in the economy, and the rapid expansion of the rural industrial sector.

Changes in Aggregate Supply of Chemical Fertilizer Before the mid-1980s, levels of fertilizer use did not reflect fertilizer demand but, rather, restricted fertilizer supply (Desai and Stone 1987). Consumption of chemical fertilizer was minuscule in the early 1960s. The nation’s farmers used less than 0.7 million tonnes of nutrients in 1960, an average of less than 6 kilograms (kg) of nutrients per hectare (ha) of cultivated land (China State Statistical Bureau 199 1). This level was far below the world average at that time and is less than 3 % of China’s fertilizer application rate today (China CAAS 1986; China Ministry of Agriculture 1989; FA0 1979; China State Statistical Bureau 199 1).

Since the supply of chemical fertilizer was severely restricted by China’s limited domestic production capacity and insufficient imports, organic fertilizer was the primary source of nutrients for crop production.

Organic fertilizer has always been central to traditional Chinese farming technology. Due to the nation’s adverse land/worker ratio, Chinese farmers historically have adopted a number of other land-saving/yield-increasing technologies such as irrigation (currently at 46% of cultivated land nationwide) and high levels of multiple cropping index (currently at 1.51 nationwide - China State Statistical Bureau 199 1)) which intensify the need for nutrient application. Farmers commonly used a wide variety of organic fertilizers, including human and animal manure, decomposed grasses and household waste products, river and lake sludge, and various green manures. Although collecting, transporting and applying organic fertilizer required massive amounts of labor, rural China’s abundant labor force was able to meet this demand. Supply of chemical fertilizer has increased at the national level since the mid- 1960s. The construction of over a thousand small-scale nitrogen plants in the 1960s and 1970s provided great quantities of much needed, albeit poor-quality, ammonia bicarbonate (ABC) fertilizer. In the 197Os, planners imported 13 large, modern synthetic ammonia complexes that more than doubled the nation’s nitrogen output. The rapid growth of fertilizer

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194 CANADIAN JOURNAL OF AGRICULTURAL ECONOMICS

imports in the early 1980s also expanded aggregate fertihzer supply. Fertilizer use grew by over 20 times, from less than 1 million tonnes of total nutrients in 1962 to over 17 million tonnes in 1984 (China State Statistical Bureau 1991). This growth con- tinued through the late 1980s. By 1990, China consumed 26 million tonnes of fertilizer nutrients, averaging 263 kg/ha. Today, China is the largest consumer and importer as well as the second largest producer of chemical fertilizer in the world (China State Statistical Bureau 1991; FA0 1990).

Recent Changes in Fertilizer Pricing and Marketing A two-tier pricing scheme has emerged in many sectors of the Chinese economy, including the fertilizer sector. Under this system, both state-set and free market prices exist for a single commodity at the same time and the same location.* While the traditional state planning system still imposes quantita- tive restrictions on farmers’ access to subsi- dized fertilizer, free markets provide farmers with alternative sources of chemical fertilizer. Moreover, as the aggregate supply of fertilizer increases, farmers face fewer restrictions on their ability to purchase this input.

How does the appearance of this new source of fertilizer in unlimited quantities - albeit at higher prices - affect the behavior of farmers? This question is the focus of a long-running debate among economists studying China’s two-tier pricing system. The controversy has centered primarily on how pricing policy has influenced the govern- ment’s grain procurement activities. Under the assumption of complete factor markets, Sicular (1988) shows in a partial equilibrium framework how producers respond solely to the high free market price. Among others, Lin (1993) and Rozelle and Liang (1992) describe different conditions leading to a breakdown of Sicular’s ‘ ‘marginal price’ ’ argument, implying that in some situations government officials can influence producer behavior by adjusting the price or quantity of the house- hold’s delivery quota.

Changes in Off-farm Employment Opportunities The rapid expansion of rural industries, which varies from region to region, has increased alternative employment opportunities for farm households. Typically, farmers in coastal regions - especially those areas with good transportation networks - have better access to off-farm jobs and receive higher off-farm wages than residents in the inland provinces. One explanation for these regional wage and access differentials is the lack of labor mobility in China. In part, the discrepancies arise from a historical legacy of poor infras- tructure and strict government regulations on labor migration; they are also related to the relatively egalitarian system by which land is distributed in rural China. In many developing countries, landless workers are drawn to large, urban and frequently distant industrial centers. But in China, rural residents prefer to search for off-farm employment in nearby towns or villages, since they are able then to continue to cultivate their own plots. Conse- quently, non-agricultural enterprises in rural areas have become the center of off-farm employment in China.

As a consequence of the rural industri- alization movement, rural wages have risen rapidly in recent years. Rising wages have increased the opportunity cost of farm labor, causing producers to change the way they allocate labor, capital, fertilizer and other factors. Rozelle (1993), Ye (1992) and Rozelle and Jiang (1993) have documented cases in prosperous areas where organic manure application has fallen, or is applied only in response to administrative fiat. Despite already high absolute levels of fer- tilizer consumption, farmers in the east coast provinces have continued to increase fertilizer usage.

THE EMPIRICAL MODEL AND THE DATA

An empirical model was built to capture the farming systems, economic conditions, and policy environment in central Jiangsu Province, a region in China’s fast-growing

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Table 1. Schematic tableau of the Jiangsu farming systems model

Animal

production Labor employment

Obli- Con- Crop

Crop and Hire- Hire- Off- gation Chem. fert

Organic sumption marketing Financing

production marketing in out farm labor Quota Market fertilizer Own Buy Quota Market Savings Loan RHS

Objective function

Resource constraints

Land

Labor

Capital

Balance rows

Nutrient

Crop marketing

Consumption

Policy constraints

Crop procurement

Urea purchase

ABC purchase

Minimum use of organic fertilizer

Minimum obligation labor day

Labor market restrictions

Hire-in

Hire-out

Off-farm job

Credit market restriction

+ -++ - - - + + - - MAX

1 =L=

1 1 -1 1 1 1 1 CL= 1 1 1 -1 -1 1 1 1 -1 -1 =L=

1 -1 -1 -1 EG=

-1 1 1 1 EG=

1 1 =G=

-1

-1

1 EG=

-1 =L=

EL=

=G=

=G=

1 =E=O

1 =E=O

1 =E=O

1 =E=O

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196 CANADIANJOURNALOFAGRICULTURALECONOMICS

coastal zone. Similar to other linear program- ming models, this representative household model consists of three components - an objective function, a set of productive activi- ties, and a series of constraints. Table 1 con- tains a schematic tableau of the farming system model.

The objective function includes revenues from crop and animal production, agricultural labor activities and off-farm employment. Costs of crop and animal production, fertilizer purchase, labor hiring, interest payments and purchased crop consumption are included with negative signs. Leisure and returns to organic fertilizer application enter into the objective function with positive values. In the model, ABC and urea are assumed to be per- fect substitutes as nitrogen fertilizer. In prac- tice, however, many farmers prefer to use ABC as a basal fertilizer and urea as a top dressing. These different uses are based largely on relative prices and labor require- ments. ABC is cheaper than urea on a pure nutrient basis, but requires more labor when used as top dressing.

The model contains cropping and animal husbandry enterprises, off-farm employment in both the nearby rural areas and distant urban cities, activities for the purchase and utilization of chemical fertilizer, and the preparation and application of organic fer- tilizers. The model also includes activities allowing for crop consumption, output mar- keting and credit transactions.

The model includes piece-wise produc- tion functions (using 12 levels for each of two inputs and interaction terms) to approximate the non-linear relationship between fertilizer application and crop yields (Hazel1 and Norton 1986). The production function coeffi- cients are econometrically estimated by the authors using farm-level survey data on output and inputs. The results of the production func- tion estimates and the piece-wise approxima- tion are included in Appendix Table A. The model also specifies a number of constraints that embody important policy measures and structural barriers faced by the farm house- hold. One set of constraints is developed to simulate the situation where the representa-

tive farm faces mandatory crop procurement and subsidized fertilizer allocation restric- tions. The farmer’s access to subsidized fer- tilizer is linked to the crop delivery quota. Both crop marketing and fertilizer purchase decisions are made under a two-tier pricing system.

The model is designed to allow the farmer to make substitutions between chem- ical and organic fertilizers as well as between high-grade (e.g., urea) and low-grade (e.g., ABC) fertilizers. Although ABC and urea are technically close substitutes, their cash costs and labor requirements vary substantially. The major tradeoff between labor and capital in Chinese farming is tied to the fertilizer decision. Organic fertilizer application activi- ties are constructed on the basis of extensive survey data. The choice of the quantity of organic manure to be applied also affects the labor and capital input of the farm household. The labor required for organic manure is not trivial. In many households, nearly half of the labor spent on the cultivation of certain crops is devoted to the production, transportation and application of organic manures. In some households, a large fraction of the nutrient input for farming is derived from organic manure, and clearly reduces the need for cash-using chemical fertilizer. The model does not allow for the substitution between labor and land because such an exchange is not important in China’s current agricultural system.

Because of the importance of off-farm employment in the local economy, a series of farm and off-farm labor constraints is included. Agricultural labor use is broken down by crop and by time period to capture seasonality of labor use for cultivating different crops. The farm household has a choice to participate in one of two off-farm employment contracts; one requires long-term migration to a remote urban center, whereas the other allows household members to be employed in a nearby township- or village-run enterprise. Wages are higher for the former job than for the latter. Farmers employed in nearby rural enterprises can return to their farming activities throughout the season.

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FERTILIZER DEMAND IN CHINA’S REFORMING ECONOMY 197

Data used in the model are from house- hold surveys and interviews with local offi- cials conducted by the authors during seven site visits carried out between 1988 and 1992. A total of 115 farm households were selected randomly from four villages in two counties in central Jiangsu Province. The household survey, carried out during the initial 15 months of fieldwork in 1988 and 1989, con- sisted of three separate visits to the sample households. The survey collected data on production practices, labor allocation, off- farm employment activities, prices and wages, as well as the quantities and labor requirements for all types of chemical and organic fertilizers. Enumerators also ques- tioned the farmers closely about the nature of their mandatory crop procurement contracts and about the amount and sources of all sub- sidized fertilizer allocations. The authors also made trips to the villages in 1991 and 1992 to collect supplemental information and to conduct a series of intensive, follow-up inter- views with farmers, local leaders and agricul- tural officials regarding fertilizer use and policy.

The study sites are representative of a genre of rural areas in eastern and central China that have a well-developed agricultural infrastructure and a rapidly developing rural industrial base. Crop yields and per capita income in the survey area are above the national average. The growth rate of rural industry and its share in the rural economy, however, are similar to national averages. Over 80% of cropland was dedicated to grain in the pre-reform years. But area devoted to cash crops followed national trends and expanded to more than 30% by 1988 (China Jiangsu Provincial Statistical Bureau 1990). Application rates for chemical fertilizer are similar to the provincial average, but are 58% higher than the national average.

POLICY EXPERIMENTS AND RESULTS

To test the validity of the farming systems model, the optimal solution of a basic version of the model is compared with average house- hold based on the observed data in the survey

area. The “basic version” of the Jiangsu model simulates all policy restriction that a farmer faces in the survey area, including government policies of fertilizer subsidies, crop procurement, and various local rules and regulations. This version of the model also simulates labor market imperfections by not allowing the farm household to spend more than 50 days in the off-farm labor market, and by restricting the number of days farmers can rely on exchange labor (i.e., labor from neighboring farmers, for whom the farmer must also work) to no more than five days per peak production period. These parameters are based on the results of the household survey. The basic model is closest to the fully res- tricted model (Model 4), but contains fewer restrictions on activities in the labor market.

Major activities of farm and off-farm operations in the model’s solution are found to be similar to the observed data. Almost all important local crops as well as other com- monly observed activities (such as hog raising, organic fertilizer application, and off- farm employment) are included in the final solution. Key variables in the model, such as labor use, fertilizer consumption, and profit levels, deviate from the sample’s mean levels by 6%) 7 % and 29%) respectively (see Ye 1992 for detail).

Three series of policy experiments exa- mine the impact on farmer’s fertilizer use decisions (as well as on the household’s production, marketing, and income perfor- mance) on changes in various policies and economic opportunities in the rural economy. In particular, the investigation focuses on the impact of government policy interventions (including fertilizer subsidy, crop procure- ment and village rules), and factor market imperfections (such as restrictions on labor and capital markets). Table 2 summarizes the construction of three simulations. The first two “experiments” individually investigate the effect of government policies and factor market imperfections. The third experiment examines the joint impact of imposing both government policy restrictions and labor market restrictions on farm households.

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198 CANADIAN JOURNAL OF AGRICULTURAL ECONOMICS

Table 2. Simulation models in the policy experiments

Restrictions

Unrestricted

Fertilizer policy restriction

Labor and capital market restriction

Fertilizer policy and labor and capital market restrictions

Model 1 Unrestricted

Model

X

Model 2 Policy-

Restricted Model

X

Model 3 Restricted

Factor Market Model

X

Model 4 Fully

Restricted Model

X

X

Model 1 is unrestricted in that the representative farmer operates in a perfect world without government policy intervention or market imperfections. Model 2 simulates the implementation of government fertilizer policy where three fertilizer-related measures are imposed on the otherwise unrestricted model. These restrictions are:

l A mandatory procurement quota con- straint: the representative farmer is required to deliver 1000 kg of rice, 123 kg of cotton, 315 kg of wheat, and 25 kg of rapeseed to the state at quota prices.

l A “linked” fertilizer subsidy constraint: in return for fulfilling the procurement quotas, the farmer is entitled to purchase the following quantities of plan fertilizer at quota prices: 6 kg and 50 kg of urea for each 100 kg of grain and cotton, respectively, sold to the state under con- tract; and 225 kg each of ABC and single superphosphate (SSP) for every hectare of grain sown.

l Minimum organic fertilizer and cash crop constraints: the farmer is required to apply a minimum of 34 tonnes of organic fertilizer to each hectare of sown rice and cannot plant more than 0.07 ha of cash crops (e.g., mint).” Columns 1 and 2 in Table 3 present the

results of the first policy experiment. The

farmer in Model 1 (the Unrestricted Model) does not use any organic fertilizer or ABC. Although organic fertilizer requires no outlay of cash, collecting, transporting and applying organic fertilizer are extremely labor- intensive. Similarly, although the market price of ABC is lower than that of urea on a nutrient basis, the labor cost of applying ABC is higher. The farmer in Model 1 does not use any of the more labor-intensive nutrient sources because the household has access to off-farm employment, and its shadow price of labor is high. Under the assumptions of free product and factor markets, the farmer produces over 5800 kg of grain and earns an income of 5368 yuan. 4

The fertilizer constraints imposed in the Policy Restriction Model (Model 2) only mar- ginally affect the level and mix of fertilizer utilization. The farmer increases the use of organic fertilizer by an amount that equals exactly the village-imposed minimum require- ment. The farmer also increases ABC pur- chases, but only to a level equal to the farmer’s allocation of the subsidized ABC. After fulfilling the requirements for organic fertilizer use and taking advantage of the ABC fertilizer subsidy, the farmer uses urea for additional applications of fertilizer . Further- more, nutrient application rates for individual crops do not change between these

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FERTILIZER DEMAND IN CHINA’S REFORMING ECONOMY 199

Table 3. Comparison of optimal solutions in the four simulation models

Model 1

Unrestricted

Model

Model 2 Model 3 Model 4 Policy- Restricted Fully-

Restricted Factor Market Restricted Model Model Model

Fertilizer consumption (nutrient weight, kg): Total nutrients” 245 Chemical 245

N 154

P 91 Organic 0

Purchase of chemical fertilizer (kg):

Urea 335 Ammonium bicarbonate (ABC) 0

Single superphosphate (SSP) 607

Nutrient application rate (nutrient weight, kg/ha): Hybrid rice

Indica rice Japonica rice 263 Cotton Wheat 263 Rapeseed

Barley Mint

Crop mix (ha):

Hybrid rice Indica rice

Japonica rice Cotton

Wheat

Rapeseed

Barley Mint

Land idle in the winter

Total grain production (kg)b

R;et revenue (yuan)

Shadow price of labor (yuan)’

Shadow price of capital (yuan)

0.00

0.00 0.47 0.00

0.47

0.00

0.00 0.00 0.00

5803

5368

23.49 0.10

258 215 223

236 103 84 144 78 65 92 25 19 22 112 139

279 0 140 94 459 0

610 164 128

375

263

390 263

300

375

263

233

263 300

330 330

435

300

300

390 360

300 330

330

0.01

0.00 0.37

0.09

0.46

0.01

0.00 0.00 0.00

5096

4163

23.49 0.10

0.07

0.03 0.14

0.00

0.07

0.11

0.07 0.22

0.00

2606

3873

6.23 0.26

0.01

0.05

0.25 0.09

0.07

0.06

0.09 0.07

0.18

3134

2599

4.74

0.10

“Nutrient contents of chemical and organic fertilizers are listed in Appendix Table B. ‘Total grain production in the total amount of grain harvested from the entire farm. which has 0.94 ha. ‘The shadow price of labor: it is the imputed value of the constrained resource. or the potential gain in the objective function value if that resource would increase by one unit. The shadow price for labor

is calculated for the entire peak season in which the shadow price varies daily.

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200 CANADIAN JOURNAL OF AGRICULTURAL ECONOMICS

two models, as can be seen by comparing the rates for japonica rice and wheat, the two crops appearing in both models. 5 Therefore, policy restrictions in this simulation do not significantly affect the farmer’s fertilizer utili- zation decision.

The restrictions included in the Policy Restriction Model (Model 2) generate lower income and production levels than those of the unrestricted model. Revenues drop by 22 % from 5368 yuan to 4163 yuan. Grain produc- tion, because of the requirement to produce cotton and oil crops, declines by more than 10%. With such changes, why do government fertilizer policies have such little influence on of farmer’s fertilizer use? Part of the expla- nation is that the shadow price of labor remains unchanged after the imposition of government policies. The farmer still has full access to off-farm employment with and without policy restrictions. Moreover, in both models the farmer has unlimited access to fer- tilizer supplied at market prices in both models. Since the household’s marginal con- ditions (i.e., the marginal costs of labor and fertilizer) do not change after the imposition of policy restrictions, the farmer has no incen- tive to adjust fertilizer usage at the margin. Small changes in aggregate fertilizer con- sumption arise only because of the minor alterations in the crop mix induced by crop procurement quotas.

The Factor Market Restricted Model (Model 3) imposes a series of restrictions on factor markets, but does not include the policy constraints of Model 2. The factor market res- trictions that are imposed on the otherwise unrestricted model are: the farmer has no access to off-farm employment of any kind; the farmer cannot hire-in or hire-out labor for farming; and there is no credit market and thus the farmer cannot borrow money. The results of this second experiment are highlighted by comparing columns 1 and 3 of Table 3. 6

The utilization of organic fertilizer jumps from zero to 112 kg in the Factor Market Res- tricted Model (Model 3), even though there are no village rules requiring a minimum application of organic fertilizer in the model. In contrast, consumption of chemical fertilizer

declines by 58 % , since a large portion of the chemical fertilizer is replaced by organic fer- tilizer. Moreover, in Model 3 the farmer pur- chases a large quantity of ABC and no urea, whereas in the Unrestricted Model (Model 1) the farmer purchases exclusively urea and no ABC. Furthermore, the nutrient application rate for japonica rice (a major crop in all of the models) drops by 11%.

These dramatic changes reflect a sharp decline in the shadow price of labor, which falls by 73% after the imposition of restric- tions on labor markets. With access to off- farm employment eliminated, the shadow price of labor is determined solely by the profitability of farming, an enterprise with a lower return to labor relative to the off-farm wage. The decline in the shadow price of labor is accompanied by a 166 % rise in the shadow price of capital (see Model 3, the last row). In the absence of credit markets, when the household’s off-farm income stream dis- appears, working capital to finance farming activities becomes scarce. Farmers are forced to turn to less capital-intensive (and less profitable) production methods, such as applying organic manure instead of chemical fertilizer and substituting labor-using ABC for the more expensive urea.

The crop mix also changes in the Factor Market Restricted Model (Model 3) when res- trictions on labor markets are imposed. The highly concentrated cropping pattern in the Unrestricted Model (Model 1) diversifies to seven crops. In particular, the sown area of the region’s major cash crop, mint, increases from zero to 0.22 ha, accounting for 3 1% of total cropped land. Since mint is a year-round crop and has different production cycles from those of rice, cotton and wheat, the cultiva- tion of this crop releases labor at peak produc- tion periods. Similarly, expanding mint production increases on-farm labor employ- ment in off-peak seasons when the farmer’s access to off-farm employment is restricted.

The impact of these factor market restric- tions on income and grain production is more severe than that in the first experiment. Income falls to under 4000 yuan, nearly a 30% drop compared with the unrestricted

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FERTILIZER DEMAND IN CHINA’S REFORMING ECONOMY 201

model. Grain production is less than half of what it would be under free market conditions.

The final experiment combines the policy constraints in the Policy Restriction Model (Model 2) and the labor market restrictions in the Factor Market Restricted Model (Model 3) (column 4 of Table 3). By comparing the results of the Fully Restricted Model (Model 4) and Model 3, one can measure how government fertilizer policies affect the farmer’s fertilizer usage in the absence of factor markets.

In the absence of labor and capital markets, there is a sharp shift in cropping pat- terns after fertilizer policies are imposed. In addition to the forced planting of mandatory procurement crops, there are three prominent changes: a drop of area planted to mint from 0.22 ha to 0.07 ha; a rise of land left fallow from 0 ha to 0.18 ha, equivalent to 26% of total farm land; and an adjustment of planted area among different rice varieties.

These changes arise mainly because the farm household cannot hire labor or work off the farm in the absence of factor markets. As before, the farmer needs to diversify produc- tion activities to release the labor constraint at peak production seasons and to use family labor fully during off-peak seasons. However, the mandatory procurement policy and res- trictions on cash crop area do not allow the farmer to select the combination of crops resulting in the most optimal allocation of labor (especially since mint area, which uses labor in different seasons, must be reduced). Hence, these policies exacerbate the labor constraint at peak periods.

One adjustment to use labor more effi- ciently is to re-balance the area sown among different rice varieties. In terms of both prices and yields, indica rice varieties in this region of China are inferior to both japonica varie- ties and hybrid rice cultivars. The harvest time for indica rice, however, is two weeks earlier than that of the other two varieties. Conse- quently, indica rice increases in the optimal solutions in the Fully Restricted Model (Model 4) because of the need to diversify the farmer’s varietal mix to spread labor use during the peak season. ’

After government policies are imposed, the new shadow price for capital in the Fully Restricted Model (Model 4) drops from 0.26 to 0.10, and is the same as that in Model 1 (the unrestricted model). This result indicates that capital is more available in the Fully Res- tricted Model (Model 4) and plays a less con- straining role. Although the allocation of state-subsidized fertilizer is insufficient to alter the marginal price of fertilizer, the avail- ability of fertilizer at a lower price reduces the household’s expenditure on fertilizer .

The level of household income in this most restricted model is the lowest (33% lower than in the Factor Market Restricted Model (Model 3) and less than half of that of the Unrestricted Model (Model 1)). But grain production in the Fully Restricted Model (Model 4) increases by over 20% compared with Model 3. This may explain why the government implements these policies in spite of their adverse income effects. China’s leaders may be interested in maximizing grain production to ensure grain supply for urban residents. In a system without functioning product and factor markets, China’s fertilizer policy increases grain production at the expense of rural incomes.

Efficiency Losses Induced by Policy and Factor Market Restrictions The relative impacts of policy and factor market restrictions on farm household wel- fare are embodied in the revenue losses they suffer due to the restrictions imposed on their behavior (Table 4). The revenue loss is the difference between the income level earned by the farm household in Models 2, 3 or 4 and what the farmer could have earned in the Unrestricted Model (Model 1). The losses are divided into two components, a net tax, which is calculated by subtracting the implicit fer- tilizer subsidy from the implicit procurement quota tax, and a dead weight loss, which is computed by subtracting the net tax from the total loss in the farmer’s net revenue. Although the dead weight loss is a loss to society, it is the farmer who bears the loss.

To quantify the impact of these con- straints on the farmer’s welfare, a series of

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202 CANADIAN JOURNAL OF AGRICULTURAL ECONOMICS

Table 4. Impact of policy and factor market restrictions on farmers’ revenue

Model 2 Model 3 Model 4 Model4 Model 1 Policy- Restricted Fully Dead

Unrestricted Restricted Factor Market Restricted Weight Model Model Model Model Loss

Net revenue

Loss in farmer revenue Tax on the farmer Subsidy to the farmer

Net tax on the farmer Dead weight loss

Sources of dead weight loss Fertilizer policy restrictions

Restrictions on factor markets Interaction of the above two

(yuan)

5368 4163 3873

0 - 1205 - 1495 0 -875 0 0 101 0 0 -774 0 0 -431 - 1495

-431 - 1495

2599

(o/G of total)

-2769 - 809

91 -718

-2051

-431 21 - 1495 73

-125 6

assumptions and calculations is necessary. First, it is assumed that the farmer would be able to sell crops on free markets at existing market prices if there were no procurement obligations. Then, the difference between the market and quota prices multiplied by the quantity of grain required by the crop procurement quota is the tax on the farmer. Second, it is assumed that the farmer would have to purchase all chemical fertilizer from free markets if there were no allocation of subsidized fertilizer. Therefore, the gap between the market and quota prices multi- plied by the amounts of fertilizer purchased at quota prices is the fertilizer subsidy. Finally, by assuming that the current free market price represents a social price, a dead weight loss is found by subtracting the above two items from the total loss in the farmer’s net revenue. Of course, if taking into account the possible price adjustments when planning intervention is completely eliminated. the esti- mated welfare loss may be less.

The levels of procurement tax and fer- tilizer subsidy in Policy Restricted Model (Model 2) and the Fully Restricted Model (Model 4). where fertilizer policies are imposed. are similar (Table 4). Factors that

contribute to the dead weight loss, however, vary across the models. The dead weight loss in Model 2 is solely due to the less-efficient cropping mix resulting from procurement requirements. The loss in Model 3 arises exclusively from the absence of factor markets - from lower off-farm earnings and from deviations in optimal cropping patterns because of labor constraints during peak production seasons. The dead weight loss suffered under Model 4’s experiment is caused by policy constraints (21% of the loss), factor market constraints (73%) and an inter- action between the two (6%).

Sensitivity Analysis of the Impact of Off- farm Employment How can the results above be reconciled with the changes in the trends in grain production and fertilizer consumption in Figure l? Sen- sitivity analysis is conducted to examine the impact on grain production of increasing the opportunities for off-farm employment. By easing the conditions of the Fully Restricted Model (Model 4). which keep farm members from seeking employment in the off-farm sector, the household is allowed to increase progressively its use of family labor in the off-

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FERTILIZER DEMAND IN CHINA’S REFORMING ECONOMY 203

farm sector. This exercise simulates the work (and labor hired in for agricultural response of farm households to the increasing activities), the off-farm job opportunity can availability of rural employment opportuni- approach one. In the presence of policy res- ties that have arisen during the 1980s. trictions and factor market imperfections, the

The results of the sensitivity analysis are results demonstrate that as off-farm employ- summarized in Figure 2. The vertical axes of ment opportunities expand, use of chemical Figure 2 indicate chemical fertilizer con- fertilizer rises rapidly while grain production sumption (left-hand axis) and total grain virtually stagnates. Notably, the trend lines production (right-hand axis). The horizontal generated by these experiments look remark- axis represents a proportional increase of off- ably similar to those documented in Figure 1. farm employment opportunities. When the The figure also helps to explain why such off-farm employment opportunity is zero, a large gap has arisen in the 1980s between farmers are not able to work off the farm (as the growth rates of fertilizer consumption and is imposed in Models 3 and 4); when all of grain production. Given the fact that much of the family’s labor can be devoted to off-farm China’s high-grade plan fertilizer continues

.-3250

0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 Opporturity for Off-farm Employment

-)- Chemical Fertilizer + Grain Production

Note: “Opportunity for Off-Farm Employment” refers to the proportion of labor that the farm family is able to spend working in non-agricultural activities. The left-hand end of the horizontal axis (the point 0) represents the situation where there the family is not able to work off the farm. The right-hand end of the horizontal axis (the point 1) is where all of family labor is used in off-farm activities, and labor is hired in for all of the agricultural work.

Figure 2. Sensitivity analysis: Impact of off-farm employment on fertilizer consumption and grain production

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204 CANADIAN JOURNAL OF AGRICULTURAL ECONOMICS

to be concentrated in richer areas where rural wages have risen steeply in recent years (Ye 1991), fertilizer appears to be used as a sub- stitution for labor. It may be that some of this additional fertilizer is being put onto the expanding cash crop area. The gap, however, appears to have been widening most rapidly in the late 1980s when the proportion of sown area devoted to grain did not fall and that sown to cash crops rose only slightly (China State Statistical Bureau 199 1). Thus, as a result of the labor-chemical fertilizer substi- tution effect, the growth in fertilizer consump- tion should not be expected to increase grain production at rates experienced before 1985.8

While other studies based on data from an earlier time period show the complemen- tarity between fertilizer and labor (Lin 1992), this paper provides evidence that Chinese farmers are entering a new period of agricul- tural production in some areas. Parts of rural China seem to have recently entered a transi- tional stage experienced by other rapidly growing Asian economies (e.g., by Japan in the 1950s and 1960s - Hayami 1964). During the early stages of rural development in prewar Japan, chemical fertilizer was adopted primarily as a land-saving and labor- using technology. As development proceeded and labor became scarce in postwar Japan, the agricultural sector reached a turning point when fertilizer began to be adopted more as a labor-saving input (Hayami 1964: Ngliep 1979; Kawagoe et al 1986; Archibald and Brandt 1991).

CONCLUDING COMMENTS

The overall objective of this paper is to show the impact fertilizer distribution policy has had on the production behavior of farmers and to understand the impact of these policy changes in the effectiveness of different eco- nomic environments. At the household level. the results clearly show that the effectiveness of fertilizer policy in China varies depending on the level of the development of factor markets. When factor markets are restricted. fertiliser distribution policy increases the use

of fertilizer by farmers and leads to higher grain production. On a more liberalized environment, fertilizer policies do not affect either chemical fertilizer use or grain production.

To the extent that one can extrapolate from a representative farm model to aggregate behavior, the results are suggestive of how fertilizer policy has lost its effectiveness between the early 1980s and the current time. In the early 198Os, markets for labor and cap- ital in China had still not been liberalized, as depicted by the factor market restrictions (which are applied in both Models 3 and 4). With imperfect factor markets, the govern- ment’s fertilizer policies (which were imposed in Model 4 but not Model 3) induce farmers to apply higher rates of chemical fertilizer (for nearly all crops) and increase grain produc- tion (from 2606 kg to 3 134 kg). Unfor- tunately for the farmer. despite receiving low- cost fertilizer, such policies impose a “tax” as net incomes fall (from 3873 to 2599 yuan). It is in this sense that when the government is trying to decide to implement (or remove) fertilizer policy in an unliberalized economy, they are faced with a tradeoff between grain production and household incomes.

This tradeoff, however, disappears as factor markets have developed in recent years (as they are modeled in Models 1 and 2). When China’s fertilizer subsidization and grain procurement policies are used in the presence of complete labor markets. grain production falls (from 5803 kg to 5096 kg) and household income declines (from 5368 to 4 164 yuan). These policies also do not affect nutrient application rates (farmers apply 263 kg/ha of nutrients on japonica rice and wheat, the only two crops that are produced in both scenarios). These results help explain why local officials have complained of the impotence of government’s traditional measures in recent years.

Far from being a sign of government impotence. however. it appears that Chinese leaders are victims of the success of their overall reform plan. Fertilizer policy was originally designed both to ensure stable sup- plies of low-cost grain to the citie\ and for providing farmers with a subsidy. \incc high

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FERTILIZER DEMAND IN CHINA’S REFORMING ECONOMY 205

grain production was coming at the expense of income. While the strategy succeeded in its stability-seeking objectives during the early years of the reforms, the expansion of grain markets and rising urban incomes (which fol- lowed from other more liberalizing elements of the reforms) have made the state-run grain supply system increasingly redundant. In the meantime, factor markets have expanded in the rural economy and has made it so that the removal of fertilizer policies (a move from Model 2 to Model 1) may be followed by both a rise in grain production and rural household income.

But old perceptions of the importance of policy measures do not always fade away easily. In spite of these trends, even as late as 1992, some sectoral officials still believed that state control of the fertilizer distribution policy was required to ensure a stable environment for the overall development of the economy (China QYJB 1992). More recently, however, rising budget pressures may be finally inducing leaders to reassess fertilizer policy. Fertilizer subsidies and procurement quotas are currently being reduced or eliminated in a number of regions (Park 1993). This study’s results suggest that sectoral leaders may find themselves in the win-win situation, being able to reduce sub- sidies and free up markets with little change in either output or income.

Moreover, removal of these policies probably will not affect fertilizer demand. Fertilizer use by farmers will grow as long as rural wages continue to rise and off-farm employment opportunities expand. In the coastal areas where the rural economy is experiencing faster growth than ever, farmers will continue to substitute chemical fertilizer for labor-intensive organic fertilizers. They will also increase their utilization of high- quality nitrogen products, as well as improve the balance among nitrogen, phosphate and potash nutrients. Officials in the chemical industry in China would like to meet these demands by expanding domestic production. Capital shortages and the nation’s increasing integration into international markets (espe- cially its impending membership in the

General Agreement on Tariffs and Trade) means China will continue to be one of the world’s largest importers of chemical fertilizer. Canada and with major exporting nations should be prepared to take advantage of this expanding market.

NOTES

’ China’s grain producers currently consume over 70% of China’s total fertilizer annually (World Bank 1991a). During the self-sufficiency/pro-grain years before the 198Os, this proportion was higher. - In recent months, there has been serious discus- sion about a single national price system. This dis- cussion remains relevant, however, since many provinces are expected to continue the tier-price system. ’ Local rules covering planting decisions and input use such as these are common in many parts of China (see Rozelle 1993 for details). 4 4.8 yuan = USSl. 5 Application rates for some of the new crops in the basic solution of the Policy-Restricted Model (e.g., hybrid rice) are higher than those for japonica rice and wheat in the Unrestricted Model. These variations. however, result from technological differences among the crops, and are not due to policy. 6 While those restrictions represent the extreme case, factor markets in many parts of China are either non-existent or undeveloped (Rozelle 1993; Lin, Wen and Yao 1989). ’ This may explain why farmers in recent years have continued to plant high levels of low-quality rice (Mei 1992). In the current era of further reform (i.e., under conditions closer to Model l), higher- quality rices (typically japonica varieties) are begin- ning to dominate the cropping pattern. ’ Another factor explaining the unresponsive grain production to fertilizer use is the unbalanced application of nutrients with nitrogen over- whelming phosphates and potassium (Mei 1992).

ACKNOWLEDGMENT

The authors wish to thank Scott Pearson. Carl Gotsch, Wally Falcon. Richard Boisvert. Tom Lyons. Bruce Stone. Loraine West and two anony- mous Journal referees for making comments on earlier versions of this paper. Partial funding from the Rockefeller Foundation. the International Food Policy Research Institute. and the Department of Agricultural Economics. Cornell University. is acknow,ledged. The Ford Foundation supplied

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206 CANADIAN JOURNAL OF AGRICULTURAL ECONOMICS

funding for the computer hardware and software. The Committee for Scholarly Communications for the People’s Republic of China (CSCPRC) provided a grant for the research.

REFERENCES

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Appendix Table A. Approximation of wheat yield function

Phosphate Application

Nitrogen Application (kg/ha)

(kg/ha) 0 5 10 15 17 20 22 25 27 30 35 37 40

0

3 5

9 11

13 15 17 19 21

3518 3849 4106 4291 4344 4401 4425 4439 4433 4402 4292 4228 4109 3658 3997 4263 4456 4512 4575 4602 4621 4618 4593 4492 4430 4317 3739 4084 4356 4554 4613 4679 4708 4730 4730 4708 4612 4553 4443 3810 4161 4439 4643 4703 4773 4804 4830 4832 4813 4723 4666 4559 3872 4229 4512 4721 4784 4857 4891 4920 4924 4909 4824 4770 4666 3924 4286 4575 4790 4856 4932 4968 5000 5007 4995 4916 4864 4763 3967 4334 4629 4849 4917 4997 5035 5070 5079 507 1 4997 4948 4851 3999 4373 4673 4899 4969 5052 5092 4131 5142 5137 5069 5022 4928 4022 4401 4707 4939 5011 5097 5 140 5182 5196 5194 5132 5086 4996 4035 4420 4731 4969 5043 5133 5178 5224 5239 5241 5184 5141 5054 4039 4429 4746 4989 5066 5159 5206 5255 5273 5278 5227 5186 5103

Wheat yield = 3517.5 + 73.59 N - 1.47 N2 + 50.34 P - 1.215 P2 + 0.5625 NP

Appendix Table B. Nutrient contents of chemical and organic fertilizers

Nutrient Components ( ‘32 )

Type of Fertilizer Nitrogen Phosphate

Chemical fertilizer

Urea ABC SSP

0.46 0 0.17 0

0 0.15

Organic fertilizer

Human nightsoil 0.55 0.17 Hog manure 0.46 0.196 River sludge 0.30 0.18 Compost of grass and mud 0.14 0.30

Source: China NYJJS Editorial Board (1984. 119-22).