The economic consequences of an open trade policy for rice in India

DISCUSSION PAPER Report No,: ARU 39 The Economic Consequences of an Open Trade Policy for Rice in India Jaime Quizon and James Barbieri June 1985 Research Unit Agriculture and Rural Development Department Operational Policy Staff World Bank The views pre3ented h1ee are those of the author(s), and they should not be interpreted as reflecting those of the World Bank. The authors are consultants of the World Bank. However, the World Bank does not accept responsibility for the views expressed herein which are those of the authors and should not be attributed to the World Bank or to its affiliated organizations. The findings, interpretations, and conclusions are the results of research supported in part by the Bank; they do not necessarily represent official policy of the Bank. The designations employed and the presentation of material in this document are solely for the convenience of the reader and do not imply the expression of any opinion whatsoever on the part of the World Bank or its affiliates concerning the legal status of any country, territory, area or of its authorities, or concerning the delimitation of its boundaries, or national affiliation. The Economic Consequences of an Open Trade Policy for Rice in India Jaime Quizon and James Barbieri In India, trade in foodgrains since independence has always been a government activity. For the last two decades, the government has exported some food on its own account and licensed a few private exports. It has also imported larger amounts of foodgrain, particularly wheat. These trade decisions however have not explicitly followed developments in the world foodgrain market. Rather, Indian trade policy has been governed by domestic availability, importing wheat at times of domestic foodgrains scarcity and exporting rice at times of ample aggregate foodgrains supplies. Two earlier papers, Quizon and Binswanger (1984) and Binswanger and Quizon (1984), have already shown the importance of trade policy in deter- mining the distributional outcomes of any policy intervention in Indian agriculture. In these earlier papers, India was treated as a closed economy. Only state trading was allowed. Decisions to export or to import any amount )f foodgrians rested solely on government. Implicit in these exercises was the notion that whatever India exported or imported could be so done at some exogenously given world price. In the case of exports this price was the domestic equilibrium price that would then prevail if the exported commodity were withdrawn from the domestic market. In the case of imports, this price was taken to'be the world price prevailing at the time the imports were made. This notion of a constant price was made for convenience. The studies showed that government withholding or dumping of foodgrains in the domestic market (via exports and imports, but also via buffer stock operations) would have significant domestic -2- income distributions consequences. However, the constant price assumption does not allow proper analysis of the real potential that a large country like India has if it pursues free trade in foodgrains with the rest of the world. India can neither export all that it wants at a domestically determined price nor import any amount of foodgrains at a constant world price, because it is both a large producer and consumer of foodgrains. With open trade, the size of India's participation would depend on supply and demand conditions prevailing in the world fo6dgrain market where world prices are determined. The main purpose of this paper is to show how the opening of India to the world trade in rice can be modeled into the All-India model described in Quizon and Binswanger (1984).-1/ Although this extension of the Q-B model can be used to analyze the opening of trade in other agricultural commodities (e.g., wheat, sorghum, oilseeds, etc.) as well, we only illustrate it for the rice trade because in the past the domestic price of rice in India has been significantly different from the world rice price. 2/ Hence the opening of India to the world rice trade is likely to lead to large initial domestic displace- ments. How large these initial displacements will be depends on conditions prevailing in the world market vis-a-vis India. Because rice prices have been and continue to be lower than world rice prices, the domestic rice price will increase given a free trade regime in rice. Net rice buyers, or the rural poor and the urban class, will lose and net rice sellers will gain. How large will India's share in the world rice trade be in a free trade environment? By how much will world rice prices change given that India unilaterally adopts an open trade policy? Can real positive net 1/ The empirical model used in this paper is an extension of that in Quizon. (1985) which is itself an extension of the model in Quizon and Binswanger (1984). 2/ Table 1 in a later section shows this. -3- welfare benefits be obtained from some judicious mix of policies given free trade? These are some of the important questions we seek to answer in this short paper. Section 1 of this paper shows how the basic Q-B model can be extended to accommodate the opening of India to the world rice trade. This mathematical section explains and derives the equations we later append to the basic Q-B model. Section 2 describes the origins of the parameter estimates used in this extension of the basic Q-B model. Section 3 shows and interprets the results from some simulation exercises. In this section, we also briefly consider India's wheat trade and the potential for free trade in this commodity. Section 4 shows how India can further benefit from state trade without having to recourse to open borders. Finally, Section 5 concludes with a summary of our main findings. 1. The Model In this section, we show how the basic Q-B All-India model can be extended to accommodate open international trade in rice. The case for open trade in wheat, or in any other agricultural product, can be incorporated using this same procedure. Let us first define the following variables: P = world price of rice PR = domestic price of rice QD = domestic demand for rice QS = domestic production (supply) of rice ER = Indian trade in rice, ER > 0 for exports, ER < 0 for.imports QDW = world demand for traded rice = world supply of traded rice Q = world demand for traded rice attributable to India QSI - world demand for traded rice attributable to India -4- We denote the rate of growth of any of these variables with a prime () nota- tion and actual base year values of these variables with a superscript 0 (0) notation. We also define the following base year (fixed) parameters: (h) aW = world price elasticity of demand for rice exports, and (i) e = world price elasticity of supply for rice exports. Finally, we assume that both the world rice export market and the domestic rice market are in equilibrium at the base year and that India has not rice imports or exports at this time. We first have the following equations: (1 QD? = - P+ Q, aW > 0 (2) QS =WPW I > 0 (3) QSW =D Equations (1) and (2) are the world demand and supply equations for rice exports respectively. Equation (3) equates world supply with world demand for rice exports. In equations (1) and (2), QD and Q refer respectively to the rates of change in the world demand for and the world supply of rice exports arising from India's new open participation_in the world rice market. These variables are defined as follows: -ER x 100 if PR Pw'$ (4) QI = SW R R 0 otherwise -E x 100 if Po < pO Q = SW SI t0 otherwise where 1/ This assumption of zero exports at the base period is only for notational convenience. Non-zero exports at the base period can be easily accommodated in the model. -5- Equation (4) defines whether India will be an importer or an exporter of rice. If at the base year, the domestic price of rice were greater than the world price (Po > P?), then India can only import rice and the world.demand for rice 1/ exports will increase by Q1. There will be no Indian rice exports- and QSI = 0. The reverse holds if PR P0. In this instance, India will export SIR W. rice and the world supply of rice will increase by Q' India will not import SI rice and Q' = 0. Equation (5) shows the equilibrium level of Indian rice DI imports or exports (ER) as the difference between what will be domestically produced and what will be domestically demanded. Both QS and Q are endogenously determined in the basic Q-B All-India model. Finally, let the world price be indexed such that P0 100. Also, W let the domestic rice price be indexed in relation to P0 at the base year. We W then have the following two equations. (6) P = 100 + P' W (7) PR J W R 100 Equation (6) says that the world rice price is equal to the base year price (=100) plus the rate of change in the world price (P'). Equation (7) computes the rate of change in domestic rice price on the assumption that with the opening of India to the world rice trade, the domestic fice price will equal the world rice price. 1/ Of course, India may import coarse grain rice and export fine grade rice. We, however, assume that rice is a homogeneous commodity. -6- Equations (1) to (7) are linear even though the unknown variables are expressed either in levels or in rates of growth. This seven-equation system has seven unknowns, i.e., Q , QSW P' QS (or QDI), ER, PW and P' The variables QS and QD in equation (5) are also unknown but are determined in the Q-B All-India model.1 Equations (1) to (7) can therefore be appended to this model and these extended Q-B systems can be solved. Note, however, that in these extended systems, domestic rice supply (QS) is no longer equated to dcmestic rice demand (QD) to determine the domestic rice price (PR). Rather, Q' # Q' although both QS and QD are still functions of P which is determined in the appended seven equation sytem. 2. Parameter Estimates The model described in the previous section shows that the economic consequences of opening India to the world rice trade depend crucially on estimates of (a) the world price elasticities of demand for and supply of rice exports (aW and eW respectively), (b) the initial size of the world rice trade (QS) and its size relative to domestic rice production (Qo) and (c) the initial difference between the domestic rice price (P0) and the world rice price (P). RW Below, we discuss each of these in turn. Although the international rice market has been dominated by government to government contracts and long-term trade agreements, different empirical studies still suggest varying degrees of responsiveness of international rice supplies and demands to the world price. Whereas Falcon and Monke (1979-80), for example, conclude that the price mechanism is important in clearing the world rice market, Siamwalla and Haykin (1983) show that the role of prices, though positive, is extremely limited. It is therefore difficult to justify any single estimate of either 1/ Note that in the basic Q-B model, both Q' and Q' are functions of P'. S D R' -7- the demand price elasticity or the supply price elasticity for traded rice. Existing empirical evidence,. however, agrees that the demand for and supply of rice exports are fairly inelastic, i.e., both 1 and e are less than one. In later simulations, we assume two extreme sets of elasticity values. The first set of elasticity estimates, i.e., a = -.08 and e = .14, are a lower bound and correspond to Siamwalla and Haykin's (1983) estimates of the world demand and supply elasticities for rice for the year 1980. The second set of estimates, i.e., a = -.87 and e = .55, are much higher. These correspond to the own price elasticities of demand and of supply for rice in India (Quizon and Binswanger (1984)). The world rice trade has always been small, particularly when compared to India's own rice production. Annual world gross exports of rice averaged only 11.24 million metric tons (m.m.t.) for the period 1978-80 whereas India's own rice production was 49.74 m.m,z. for the same period.. Therefore, even if India exported only a small percentage of her rice produc- tion, say 5% or 2.49 m.m.t., this alone could already depress world prices severely, given that the world demand for and the world supply of rice exports are fairly inelastic. Evidently, the amount of rice India can Zrade is restricted by the size of the world rice market. In later simula- tions, we alternately assume gross world exports of rice to be 9.60 m.m.t., the annual average for 1976-78, and 11.24 m.m.t., the E7erage for 1978-80. The difference between the domestic rice price in India and the world price of rice exports is also an important determinant of the eventual size of India's-rice trade given that India adopts a free trade policy for rice. Ceteris paribus, the larger this price difference, the larger will be India's rice trade. In Table 1, we list the average domestic price of fine rice in Ic TABLE 1: WHOLESALE PRICE OF RICE (US$/NT) 1963 TO 1981 11 (1) (2) (3) (4) (5) WHOLESALE PRICE WHOLESALE PRICE PRICE OF THAI OF FINE RICE AT OF FINE RICE AT 5Z BROKENS; (1)/(3) (2)/(3) YEAR NELLORE, ANDHRA PRADESH CUTTACK, ORISSA F.D.B.,BANGKOK 1963 145.53 136.04 143.30 1.02 0.95 1964 154.90 141.16 137.70 1.12 1.03 1965 156.56 135.98 136.30 1.15 1.00 1966 125.02 134.78 163.20 0.77 0.83 1967 106.41 135.44 205.80 0.52 0.66 1968 142.16 158.91 201.60 0.71 0.79 1969 159.24 149.67 186.90 0.85 0.80 1970 152.27 142.89 144.00 1.G6 0.99 1971 175.93 152.45 129.00 1.36 1.18 1972 175.84 174.32 147.00 1.20 1.19 1973 177.99 172.64 350.00 0.51 0.49 1974 249.19 238.55 542.00 0.46 0.44 1975 . 242.02 273.87 363.10 0.67 0.75 1976 192.05 203.28 254.50 0.75 0.00 1977 246.21 203.59 272.20 0.90 0.75 1970 225.65 204.63 367.50 0.61 0.56 1979 234.13 231.34 334.20 0.70 0.69 1980 297.20 280.73 433.90 0.68 0.65 1981 292.12 264.21 482.80 0.61 0.55 \1 ALL PRICES ARE IN US$ AND WERE ARRIVED AT USING OFFICIAL MARKET RATES OF EXCHANGE SOURCES: AGRICULTURAL PRICES IN INDIA, 1963-1974,1975-1982, DES,HAI,601. WORLD BANK EXCHANGE RATES USED TO CONVERT RS/QUINTAL TO US$/MT. WORLD BANK, EPD, COMMODITY TRADE AND PRICE TRENDS, 1983. FAD TRADE YEARBOOK, 1963-1982. FAD PRODUCTION YEARBOOK, 1976-1982. two different Indian rice producing states for the period 1963 to 1981. We compare these with world rice prices, i.e., the price of Thai 5% brokens (f.o.b. Bangkok), for the same period. In the period 1963 to 1972, Indian domestic rice prices average to about the same level as world rice prices, But for the period after 1972, domestic prices have been significantly below world prices. Because of the absence of free open trade, this difference has been as large as 55% and has remained high. In the simulations of the next section, we alternately assume that the domestic rice price is either 70% or 90% of the world rice price prior to the opening of India to free trade in rice. 3. The Simulation Results In Table 2, we report results from simulating the opening of India to the world rice trade. Each column in this table corresponds to a particular assumption regarding (a) the magnitude of the world demand and, supply elasticities ior rice exports, (b) the existing size of the world rice trade and its proportion to domestic rice production, and (c) the existing difference between the domestic rice price and the world price. Thus, for example, the first column assumes that the world demand and supply elasticities (a and c ) are equal to -.08 and .14 respectively; the world rice trade is 9.595 m.m.t.; and the domestic rice price is currently 70% of the world rice price. All other parameters of the simulation model are from the version of the Q-B model described in Quizon (1985). In general, the numbers under each column in Table 2 are estimates of the likely percentage difference in the endogenous variables (from their l/ actual base-year levels- ) caused by India's open rice trade policy. 1/ Following Quizon (1985), we use 1980-81 as our base year. - 8a - Table 2: INDIA Scenarios with Open Trade in Rice 0- o 0- 0 0- P=70 P =70 P R=70 P =70 P =90 Assumptions 0Q43 Q 43 Q 49.75 Q 49.75 Q 49.75 cn enuQ =9.595 Q -9.595 Q =9.595 Q W=11.236 Q =11.236 SW SW S SW SW Variables a =-.08 a= -.87 a= .87 -.87 a = -.87 E W= .14 6e = .55 s W= .55 e W= .55 6 W= .55 (2.1) (2.2) (2.3) (2.4) (2.5) Real national per capita income 0.095 0.458 0.413 0.462 0.142 Total agricultural output 0.060 0.286 0.258 0.289 0.089 Quantity of rice produced 0.534 2.567 2.314 2.589 0.794 wheat produced 0.496 2.385 2.150 2.406 0.738 Coarse cereals produced -0.678 -3.261 -2.940 -3.289 -1.009 Other crops produced -0.122 -0.585 -0.527 -0.590 -0.181 GNP deflator 1.480 7.114 6.413 7.176 2.200 Price of rice 2.693 12.945 11.668 13.056 4.004 wheat 2.693 12.943 11.667 13.055 4.003 coarse cereals 1.398 6.721 6.058 6.779 2.079 other crops 1.512 7.266 6.550 7.329 2.247 Real wage rate 0.062 0.297 0.268 0.300 0.092 Labor employment -0.021 -0.099 -0.089 -0.099 -0.030 Real wage bill 0.041 0.199 -0.179 0.200 0.061 Real residual profits 2.882 13.853 12.487 13.972 4.285 Real per capita income of R1 -0.420 -2.020 -1.821 -2.037 -0.625 R2 0.058 0.278 0.251 0.281 0.086 R3 0.368 1.768 1.593 1.783 0.547 R4 1.071 5.146 4.639 5.190 1.592 U1 -1.265 -6.081 -5.482 -6.134 -1.881 U2 -1.427 -6.860 -6.183 -6.919. -2.122 U3 -1.215 -5.838 -5.262 -5.888 -1.806 U4 -0.702 -3.374 -3.042 -3.403 -1.044 World rice exports 2.249 18.216 18.994 18.149 5.565 World rice price (index) 71.885 79.062 78.168 79,139 93.603 Indian rice exports (in M.M.T.) 0.593 2.852 2.975 3.328 1.020 -9- For example, scenario 2.1 shows that total domestic agricultural output will increase by 0.06%, domestic rice prices will increase by 2.69%, the real per capita income of the poorest rural group (Rl) will decrease by 0.42%, and so on. The last two rows of Table 2, however, refer to the actual new levels of the world rice price (an index) and of Indian rice exports (in millioh metric tons) resulting from India's open rice trade policy. We first note that our Table 2 simulations do not capture the effects of open rice trade on the market for foreign exchange and vice versa. With open trade, rice exports will increase the supply of foreign exchange and therefore also the value of the rupee. This will in turn reduce the difference between world and domestic rice prices and will decrease the actual domestic rice exports which we obtain in our simulations. Our Table 2 scenarios therefore describe the upper bounds with regard to Indian rice exports, i.e., they describe the maximum impact of an Indian open trade policy in rice in the absence of repercussions in the foreign exchange market. Table 2 shows that the opening of India to the world rice trade would lead to higher domestic agricultural output but also to a worsening of the rural income distribution. India will be a rice exporter and total gross world exports of rice will increase. As expected, all these effects are larger (a) the larger are the world own price elasticities of demand and supply for rice exports, (b) the larger is the existing world trade in rice anid/or the ratio of the world rice trade to domestic rice production, and. (c) the larger is the initial difference between the domestic rice.price and the world rice price. Among the scenarios shown in Table 2, scenario 2.4 best fits this extreme case where open trade effects are largest. In this instance, India will export 3.33 m.m.t. of rice and world rice exports will - 10 - increase by 18.15%. The world rice price will drop from an initial level of 100 to 79.14 while domestic prices will increase from a level of 70 to 79.14. These lead to large domestic outputs and higher profits. Rich farmers will gain. However, because of the domestic food price increases, the poorest rural group and the urban class will lose. In all Table 2 scenarios, wheat output significantly increases, but outputs of coarse cereals and of "other crops" decrease. The increase in demand for rice from international sources is transmitted to wheat. The resources for the extra wheat and rice production come from coarse cereals and other crops which are less good substitutes for rice than wheat. These cross-effects are quite powerful. We usually think of rice production as being labor intensive. In our Table 2 scenarios however, labor employment declines and real rural wages do not significantly rise even with higher domestic outputs of rice due to free trade. These counterintuitive labor market effects arise because, as already noted, the outputs of all crops other than rice change as well. With open rice trade, the labor resources that are absorbed in rice and wheat are smaller than those which are released out of the production of coarse cereals and "other crops". This is the major reason why the real per capita incomes of the poorest rural group, who are mostly landless agricultural laborers, do not increase even with larger domestic rice production. The rural poor also suffer from higher domestic food prices, as reflected in the rise of the GNP deflator in all scenarios. The major gainers are the rural rich, but their real income gains under the most optimistic scenario is only about 5% of real income. 1/ .1/ Government can of course intervene to correct these adverse effects on the income distribution by taxing producers and subsidizing consumers of food. To some degree, this constitutes state interference in trade and cannot be radically different from the forced procurement cum fair price shop schemes currently in operation in India. The effects of this particular government program has already been analyzed in Binswanger and Quizon (1984). As Table 2 shows, this is because the trade potential in rice for India is not as large as is often presumed. In the most optimistic of cases, India will export only 3.33 m.m.t. of rice or only 6.7% of its 1978-80 annual average rice production.- The potential gains of an outward looking policy in terms of overall output growth are therefore also quite small. With free trade in rice, total agricultural output will increase by only 0.3% at best. This is in contrast to the actual annual growth rate in agricultural production of 6.2% for 1974-75 to 1978-79 and of 7.4% for 1979-80 to 1983-84. On the whole, it appears then that although the undervaluation of Indian rtce production in the past has impaired the profitability and hence the growth of its rice production, this sacrifice has not been as large as often assumed. Moreover, this insulation of the Indian rice market from the rest of the world has in fact protected domestic consumers from the larger year to year fluctuations in the world rice price vis-a-vis the domestic rice price.1 It is, therefore, not so much the initial 13% increase in the domestic rice price due to free trade (scenario 4) as it is the likely event of a more than 100% increase in world rice prices (as was the case in 1972 to 1973) that India's trade policy has been able to avoid. Given the importance of rice in the diets of the poor and the poor's already low nutritional levels, such a dramatic increase in the price of rice would have been disastrous to many in a very poor country like India. 1/ This, however, is large by world rice export standards. India would then rank as the largest rice exporter in the world, although she will not easily dominate this market. In the period 1978-80, annual net rice exports averaged 2.5 m.m.t. for the U.S., 2.32 m.m.t. for Thailand and 1.15 m.m.t. for China. These were the three-largest rice exporters during this period. 2/ Siamwalla and Haykin (1983) report a coefficient of variation of 3,029 for the world rice price for 1961 to 1980 and a coefficient of variation of only 8.27 for the Indian domestic rice price for the same period. - 12 - The Wheat Trade Although India's trade position in rice has been rather favorable to its poor, its past trade position in wheat is more difficult to evaluate. Table 3 compares domestic wheat prices with international prices for the period 1963 to 1981. Prior to 1972, domestic wheat prices were on average about 75% higher than worldprices. After 1972, this difference dramatically dropped but by 1981, domestic wheat prices were equal, perhaps slightly higher than inter- national prices. Had India opted for free trade in wheat in the mid 60s, she would have been an even larger importer of wheat.1/ Domestic prices would have dropped. Net consumers would have gained and net wheat producers would have lost. Although it is debatable whether this price drop would have significantly affected later growth in wheat production, or the Green Revolu- tion, what is sure is that Indian wheat imports would have been substantial, given the then large difference in domestic and world prices and the large 2/ world trade in wheat.-- The potential for large consumer gains from free trade in wheat was considerably eroded by 1972 that currently, the opening of India to free trade in wheat will very likely have no large initial impact on domestic production and prices. Nonetheless, open trade in wheat appears to be a more viable option than open trade in rice if only because the potential output gains are larger in wheat. These are two good reasons for this. First, the world wheat market at approximately 97 m.m.t. in 1980 is significantly larger than that for rice. And second, India has gained considerable comparative advantage in wheat over the past two decades. Nevertheless, such commodity specific free trade proposals deserve more careful study. 1/ Under State trading, India in fact imported huge quantities of wheat during this period. 2/ World demand and supply elasticities for wheat are very likely in the same range as that for rice, its closest substitute. TABLE 3: WHOLESALE PRICE OF WHEAT (US$/HT) 1963 TO 1981 1l (1) (2) (3) (4) (5) WHOLESALE PRICE WHOLESALE PRICE PRICE OF CANADIAN OF WHEAT AT OF WHEAT AT NO.1 WESTERN RED SPRING (1)1(3) (2)/(3) YEAR HO0A, PUNJAB TONK, RAJASTAN F.O.B.,THUNDER BAY 1963 95.99 85.22 66.90 1.43 1.27 1964 116.63 110.11 70.20 1.66 1.57 1965 127.22 110.38 65.90 1.93 1.67 1966 117.29 132.15 70.40 1.67 1.88 1967 119.32 135.91 69.30 1.72 1.96 1968 101.28 117.47 66.60 1.52 1.76 1969 101.44 120.56 64.20 1.58 1.88 1970 101.33 118.77 62.80 1.61 1.89 1971 104.22 102.69 63.90 1.63 1.61 1972 104.01 112.52 71.30 1.46 1.58 1973 103.59 136.95 147.20 0.70 0.93 1974 145.30 206.16 208.70 0.70 0.99 1975 127.78 161.71 181.30 0.70 0.89 1976 127.37 118.58 149.10 0.85 0.80 1977 135.22 138.29 115.80 1.17 1.19 1978 141.71 149.61 134.80 1.05 1.11 1979 141.73 157.79 172.20 0.82 0.92 1980 159.64 185.14 190.80 0.84 0.97 1981 155.05 195.99 196.40 0.79 1.00 \I ALL PRICES ARE IN US$ AND WERE ARRIVED AT USING OFFICIAL MARKET RATES OF EXCHANGE SOURCES: AGRICULTURAL PRICES IN INDIA, 1963-1974,1975-1982, DES,MAI,601. WORLD BANK EXCHANGE RATES USED TO CONVERT RSIOUINTAL TO US$/HT. WORLD BANK, EPD, COMMODITY TRADE AND PRICE TRENDS, 1983. FAD TRADE YEARBOOK, 1963-1982. FAD PRODUCTION YEARBOOK, 1976-1982. - 13 - First, there is the question of political feasibility. The prospect of importing foodgrains at times when world prices are lower than domestic prices (which was the case for wheat in the mid-60s) can be politically unpopular. In India, foodgrain imports are often (perhaps, mistakenly) viewed as a failure on the past of government to provide for the nation's own needs. Food security continues to be associated with having less foodgrain imports. Second, there remains the important question as to whether or not free trade in a specific agricultural commodity will lead to domestic price instability which is often to the detriment of the very poor. Though it is true that greater domestic price stability, vis-a-vis world price stability, in wheat and rice was achieved by state control of international trade, this same sort of stability was not obtained for coarse cereals, i.e., maize, barley and sorghum. - Compared to rice and wheat, coarse cereals are the more important foodgrains in the diets of the nutritionally vulnerable in India. Finally, unlike the case of rice, we are currently unable to examine the domestic consequences of other crop specific liberalization proposals in the absence of more information regarding the workings of these world commodity markets. Nonetheless, in this paper, we have already outlined a fruitful approach to thoroughly examining this matter. 4. A Policy Alternative to Free Trade International markets for agricultural commodities remain distorted because national policies in both developed and developing countries continue to interfere with the free flow of trade. 2/ It is therefore not surprising to find, for example, that the world rice trade is but a small fraction of 1/ See Johnson (1978) 2/ See, for example, Johnson (1978) - 14 - the total world rice output or that there are substantial price differences in many agricultural products across nations. Despite this strong indictment on the current workings of international agricultural markets, there still remains ample scope for gains in trade for a state trading economy like India. In fact, significant gains can be achieved by simply improving on the way Indian state trading is currently conducted. Though a state trading economy, India has not engaged in arbitrage operations in the world foodgrains market. Although, for example, the difference between the world rice price and the world wheat market has been considerably large and continues to increase, -/ India has not in the past exported rice to import wheat. In Table 4, we show the growth and income distribution effects of this simple trade alternative. We assume that India trades 1% of its average annual 1978-81 rice production (or 0,506 m.m.t. of rice) for an equivalent value amount of wheat (or 0.925 m.m.t of wheat) in the world market. We assume that India sells fine rice at US$434.52 per metric ton, i.e., 90% of the actual 1981 price of Bangkok 5% broken rice,-/ and imports wheat at US$237.89 per metric ton, i.e., the 1981 price of Canadian wheat plus a freight and insurance cost.-/ Table 4 shows that this simple exchange operation will result in slightly higher aggregate output (+0.02%) and higher aggregate real per capita income (+0.07%). All agricultural prices decline, even for rice whose supply is decreased by exports. This unexpected decline in the rice price comes about because wheat is a close substitute for rice in consumption. Because 1/ Siamwalla and Haykin (1983) show that the average ratio of rice and wheat prices was 1.19 for the period 1920-36, 1.91 for the period 1950-66 and 2.74 for the period 1967-74. 2/ Had India exported 0.506 m.m.t. of rice in 1981, the consequent drop' in the world rice price would be anywhere between 3% and 20%, the range implied by the two extreme world supply and demand elasticity assumptions in Table 2. In the simulation in Table 4, we assume a 10% decline in world rice prices. 3/ In 1981, the average price of Canadian wheat in the world market was US$196.40 per metric ton. Freight and insurance cost from Canada to India averaged about US$41.49 per metric ton for the same period. - 14a Table 4: India - A Scenario with State Trade of Rice for Wheat Endogenous Variables (4.1) Real national per capita income 0.07 Total agricultural output 0.02 Quantity of rice produced 0.36 wheat produced - 0.93 Coarse cereals produced 0.09 Other crops produced 0.07 GNP deflator - 0.42 Price of rice - 0.20 wheat - 2.43 coarse cereals - 0.56 other crops - 0.22 Real wage rate - 0.04 Labor employment - 0.01 Real wage bill - 0.05 Real residual profits - 0.83 Real per capita income of Ri 0.08 R2 0.04 R3 - 0.01 R4 - 0.05 Ul 0.48 U2 0.32 U3 0.30 U4 0.16 - 15 - more wheat is made domestically available due to imports, domestic rice demand declin-- and so does its price. The food price drops result in losses for the rural rich because farm profits decline. However, these same price declines benefit the rural poor and the urban groups who are net buyers of food. Thus, in the overall, the distribution of income improves. 5. Summary and Conclusions In this paper, we aave shown how the opening of India to world agricultural commodity trade can be modeled within the basic framework of the Q-B model. We have specifically examined the likely consequences of a rice trade liberalization policy in India. Our simulations bring out the following conclusions 1. Under the current structure of international rice markets, there is but a limited potential for Indian rice exports. Our simulations show that if India adopted a free rice trade policy, the world rice price will drop by more than the increase in the domestic rice price within India. This results in relatively smaller benefits to Indian farmers than what we initially expected. 2. Free trade in rice leads to a considerable expansion in wheat output. This is because wheat is a close substitute to rice. However, the outputs of coarse cereals and "other crops" decline, Thus, the aggregate supply effects of rice trade liberalization are fairly small. 3. The rural rich who are not sellers of food will benefit the most from a free trade policy in rice. They will gain because of higher domestic agricultural prices and slightly increased agricultural outputs. 4. The rural poor will not benefit from a free trade policy in rice but will lose both as agricultural producers and consumers. Since the rural poor are mainly landless laborers, they will be hurt because agricultural - 16 - labor demand and use will decline with the shift of resources from the production of coarse cereals and "other crops" to that of rice and wheat. This is a conclusion which again runs-counter to our initial expectation. The rural poor who are net buyers of food will also suffer because of higher domestic food prices. 5 The above results, however, do not mean that there can be no output ga.is from trade, which also benefit the poor. Simple arbitrage operations, as in the exchange of rice for wheat in the world market is such a policy. The magnitudes of the gains from a single arbitrage are not very large. But they already show how a trade policy can be used to increase agricultural output and improve the distribution of income. There are other arbitrage opportunities in India, such as the exchange between different qualities of the same foodgrain as, for instance, the trading of fine rice for coarse rice in the world market, a policy already pursued by India. When put together, the total impact of these potential commodity exchange operations on domestic growth and equity can be more than trivial. Thus, world agricultural prices can be made to matter more in India's trading decisions. - 17 - References (1) Binswanger, Hans P. and Jaime B. Quizon (1984). "Distributional Consequences of Alternative Food Policies in India", World Bank, ARU Discussion Paper No. 20, August 1984. (2) Falcon, Walter P. and Eric A. Monke (1979-80) . "International Trade in Rice", Food Research Institute Studies, Vol. XVII, No. 3, pp. 279 - 306. (3) Johnson, 0. Gale (1978). "International Prices and Trade in Reducing the Distortion of Incentives". In Distortions of Agricultural Incentives, ed. Theodore W. Schultz, pp. 195-215. Bloomington: Indiana University Press. (4) Petzel, Todd E. and Eric A. Monke (1979-80). "The Integration of the International Rice Market", Food Research Institute Studies, Vol. XVII, No. 3, pp. 307 - 326. (5) Quizon, Jaime B. and Hans P. Binswanger (1984). "Income Distribution in India: The Impact of Policies and Growth in the Agricultural Sector", World Bank, ARU Discussion Paper No. 21, revised April 1985. (6) Siamwalla, Ammar and Stephen Haykin (1983). The World Rice Market: Structure. Conduct and Performance, International Food Policy Research Institute Research Report 39, June 1983. AGR/Research Unit Recoo. No.: ARU 1 Agricultural Mechanization: A Comparative Historical Perspective by Hans P. Binswanger, October 30, 1982. Report No.: ARU 2 The Acquisition of Information and the Adoption of New Technology by Gershon Feder and Roger Slade, September 1982. Reoort No.: ARU 3 Selecting Contact Farmers for Agricultural Extension: The Training and. Visit System in Haryana, India by Gershon Feder and Roger Slade, August 1982. Recort No.: ARU 4 The Impact of Attitudes Toward Risk on Agricultural Decisions in Rural India. by Hans P. Binswanger, Dayanatha Jha, T. Balaramaiah and Donald A. Sillers May 1982. Report No.: ARU 3 Behavioral and Material Determinants of Production Relations in Agriculture by Hans P. Binswanger and Mark R. Rosenzweig, June 1982, Revised io/5/33. Reort No.: ARU 6 The Demand for Food and Foodgrain Quality in India by Hans P. Binswanger, Jaime 3. Quizon and Gurushri Swamy, November 1982. Rzoort No.: ARTU 7 Policy Implications of Research on Energy Intake and Activity Levels with Reference to the Debate of the Energy Adequacy of Existing Diets in Development Countries by Shlomo Reuclinger, May 1983. Recort No.: ARU 8 More Effective Aid to the World's Poor and Hungry: A Fresh Look at United States Public Law 480, Title II Food Aid by Shloo Reulinger, June 1983. Retort No.: ARt: 9 Factor Gains and Losses in the Indian Semi-Arid Tropics: A Didactic Approach to Modeling the Agricultural Sector - by Jaime .3. Quizon and Hans P. Sinswanger, Septe.ber 1983, Revised May L984. Recort No.: ARU 10 The Discribucion of Income in India's Northern Wheat Region by Jaime B. Quizon, Hans P. Binswanger and Devendra Gupta, Augus- 1933. Revised June L984. Renort No.: ARU 11 Population Density, Farming Intensity, Patterns of Labor-Use and Mechanization by Prabhu L. ?ingali and Hans P. Binswanger, September 1983. Recort No.: ARU 12 . The Nutritional Impact of Food Aid?: Criteria for the Selection of Cost-Effective Foods by Shlomn Reutlinger and Judit Katona-Apte, September 1983. Discussio Papers (Cont'd.) Repor No.: ARU 13 Project Food Aid and Equitable Growth: Lncome-Transfer Efficiency Firscl by Shlomo Reuclinger, August 1983. Recort No.: ARU 14 Nuctritional Zmpact of Agricultural Projects: A Conceptual Framework for Modifying the Design and Zmplementation of Projects by Shlomo Reutlinger, August 2, 1983. Report No.: ARU 15 Pacterns of -Agricultural Protection by Hans P. Sinswanger and Pasquale L. Scandizzo, November 15, 1983. Reoort No.: ARU 16 Faccor Costs, lacome and Supply Shares in rndian Agriculture by Ranjan Pal and Jaime Quizon, December 1983. Report No.: ARU 17 Behavicral and Matecial Decerminants of Production Relations in Land Abundant 7rop-ical Agriculture by Hans P. Sinswanger and John ctracire, January 1984. Recorc No.: ARU 18 The Relation Becween Farm Size and Farm ?roductivicy: The Role of Family abor, Supervision and Credit Conscrainrs* by Gershon Feder, December 1983. Reoort No.: ARU 19 A Czmparactive Analysis of Some Aspects of the Traiaing and Visit System of Agricul:ural Excension in Endia by Gershon Feder and Roger Slade, February 984. Report No.: ARU 20 Distributional Consequences of Alternative Food Policies in India by Hans P. Binswanger and Jaime B. Quizon, August 31, 1984. Renort No.: ARU 21 Income Distribution in India: The Impact of Policies and Growth in the Agricultural Sector, by Jaime B: Quizon and Hans P. Binswanger, November 1984. Report No.: ARUT 22 Population Density and Agricultural Intensification: A Study of the Evolution of Technologies in Tropical Agriculture, by Prabhu L. Pingali and Hans P. Binswanger, October.17, 1984. Report No.: ARU 23 The Evolution of Farmining Systems and Agricultural Technology in Sub-Saharan Africa, by Hans P. Binswanger and Prabhu L. Pingali, October 1984. Report INo. AR U 24 Population Density and Farming Systems - The Changing Locus of Innovations and Technical Change, by Prabhu L. Pingali and-Hans P. Binswanger, October 1984. Report No.: ARU 25 The Training and Visit Extension System: An Analysis of Operations and Effects, by G. Feder, R.H. Slade and A.K. Sundaram, November 1984. -3- Reaport No.: ARU 2 6 The Rola of Public Policy in the Diffusion of New Agricultural Technology, by Gershon Feder and'Roger Slads, October 1984. Report No.: ARU 27 Fertilizer Subsidies: A Review of Policy Issues with Special Emphasis on Western Africa, by Haim Shalit and Hans P. Binswanger, November 1984. Report No.: ARU 28 From Land-Abundance to Land-Scarcity: The Effects of Population Growth on Production Relations in Agrarian Economies, by Mark R. Rosenzweig, Hans P. Binswanger, and John McIntire, November 1984. Report No.: ARU 29 The Impact of Rural Electrification and Infrastructure on Agricultural Changes in India, 1966-1980, by Douglas F. Barnes and Hans P. Binswanger, December 1984. Report No.: ARU 30 Public Tractor Hire and Equipment Hire Schemes in Developing Countries (with Special Emphasis on Africa). A study prepared by the Overseas Division, National Institute of Agricultural Engineering (OD/NIAE), by P.J. Seager and R.S. Fieldson, November 1984. Report No.: ARU 31 Evaluating Research System Performance and Targeting Research in Land Abundant Areas of Sub-Saharan Africa, by Hans ?. Binswanger, January 1985. Report No.: ARUJ 32 On the Provision of Extension Services in Third World Agriculture, by Alastair J. Fischer (Consultant), January 1985. Report No.: ARU 33 An Economic Appraisal of Withdrawing Fertilizer Subsidies in India, by Jaime B. Quizon, April 1985. Report No.: ARU 34 The Impact of Agricultural Extension: A Case Study of the Training and Visit Method (T&V) in Haryana, India, Gershon Feder, Lawrence J. Lau and Roger H. Slade, March 1985. Report No.: ARU 35 Managing Water Managers: Deterring Expropriation, or, Equity as a Control Mechanism, by Robert Wade, April 1985. Report No.: ARU 36 Common Property Resource Management in South Indian'Villages, by Robert Wade, ApriI 1985. Report No.: ARU 37 On the Sociology of Irrigation: How de we Know the Truth about Canal Performance? by Robert Wade, May 1985. Report No.: ARU 38 Some Organizations concerned with Animal Traction Research and Development in Sub- Saharan Africa, by Paul Starkey, April 1985. -4- Report No.: ARU 39 The Economic Consequences of an Open Trade Policy for Rice in India, by Jaime Quizon and James Barbieri, June 1985. Report No.: ARU 40 Agricultural Mechanization and the Evolution of Farming Systems in Sub-Saharan Africa, by Prabhu L. Pingali, Yves Bigot and Hans P. Binswanger, May 1, 1985. Report No.: ARU 41 Eastasian Financial Systems as a Challenge to Economics: The Advantages of 'Rigidity', with particular reference to Taiwan, by Robert Wade, June 1985. Report No.: ARU 42 Education, Experience and Imperfect Processing of Information in the Adoption of Innovations, by Alastair J. Fischer, June 1985. Report No.: ARU 43 A Review of the Literature on Land Tenure Systems in Sub-Saharan Africa, by Raymond Noronha, July 19, 1985. Report No.: ARU 44 Policy Options for Food Security, by Shlomo Reutlinger, July 1985.