So perhaps there really is no such thing as a free lunch. According to today’s NYT, CARE is turning down in-kind funds for food aid. Why would they ever do this? Well, this is the lowdown, as I get my head around it:
1. The American government buys agricultural products from American farmers. However, the government pays above market prices to the farmers as a form of subsidy. (This creates allocative inefficiency in that too much of the agricultural products are being produced in the U.S.)
2. The government then ships said agricultural products to Africa using American shipping companies. This again creates inefficiency, since now not only are the farm products being produced where it’s more expensive to produce, but resources are being spent to ship them almost halfway around the world when they could be grown in Africa.
3. The government gives these agricultural products to CARE, which sells the farm products to people in Africa and uses the proceeds to finance antipoverty programs.
My head is not around this yet, since as an economist I think my brain might explode as a result of reading the article. My problems with it, in order of descending ease of explanation: (Note that the problems don’t even have to start with the fact that the gifts are making life more difficult for African farmers.)
1. Mental accounting issues aside, economists would argue that cash gifts are always better, since the giver in that case doesn’t have to know anything about what the receiver needs or wants. Therefore, in order for this in-kind gift to be efficient, there must be some cost advantage to providing agricultural products rather than direct monetary funding. Looking, looking…nope, don’t see a cost advantage. It is worth noting, however, that giving a subsidy of $100 is better in terms of U.S. surplus than just giving $100 to CARE directly, since domestic farmers and shippers do see a bump in surplus from the subsidy. The caveat is that the $100 subsidy to $100 cash gift is not the relevant comparison- $100 worth of U.S. agricultural products could be grown (and thus purchased) in Africa for much less than $100.
2. This plan seems like a sneaky way of making subsidies look good…how can people get mad about agricultural subsidies and business being thrown to the shipping companies when the output of this is going to feed poor people in Africa? Unfortunately, there is friction in this process, since $100 in subsidy for the farmer or shipper results in less than $100 of extra profit, or surplus, for them. The difference goes to cover marginal costs, obviously, so the government is subsidizing an entire value chain, the extent of which it may or may not be aware of. (Maybe subsidizing shovel manufacturers doesn’t sound so bad, but what about the fuel that goes to power the ships?) Furthermore, the government is giving farmers a disincentive to find an industry where their labor and capital could be better used.
3. Giving the farm products to CARE essentially means that CARE’s marginal cost of “production” is constant at zero, so it can sell the product at any positive price and be happy (or at least be sustainable). So CARE is basically the Wal-Mart of Africa, and has a difficult decision to make: does it charge low prices so that people can eat more cheaply, and undercut local production in the process? Even if it doesn’t specifically undercut, one can visualize a supply and demand diagram to understand that the increased supply from the U.S. drives down market prices, which hurts African producers. This is where the article focuses, but it’s not the whole story.
Taking the subsidy process as given, it is unclear why this free gift is automatically detrimental to the African people- how can a product that is useful and free be harmful? By definition, if you are endowed with something that provides positive marginal utility, you are better off than you were without the endowment. I hate to say it, since I know that CARE means well, but they really need to be smarter about their operations, at least in this case. Let’s examine the situation economically to see what the organization could do:
In Africa, there are both poor producers and poor consumers to think about. The consumers are better off with the agricultural gifts, since they are getting more product at a lower market price. The African producers are worse off, since they are getting a lower price (because of the increased supply) and selling a lower quantity (since the gift is flooding the market and satisfying part of demand). CARE is better off, since it’s collecting money to put back to the African people. In this way, the African producers and consumers are the ultimate beneficiaries of CARE’s surplus. As long as the gains to African consumers and CARE are larger than the losses to producers (which they are, and I have the diagram to prove it!), one can devise a transfer system that ends in everyone being better off. This seems to be the piece that CARE is missing- if it compensated the producers for their losses, then everyone could be happy. Essentially, the African farmers could be getting the same profit that they were before, inclusive of the transfer from CARE, and not having to grow as much as before to get it. In fact, this is easier to implement than a transfer from consumers to producers, since CARE inherently has the coordinating mechanism to make it happen. (Counterintuitive as it may be, CARE could be doing good for Africa even if it just hands its revenue 100% back to the farmers, since the consumers still benefit from lower prices.)
Final note: it is important to think about these issues in a dynamic context, since the free farm products probably won’t last forever. The above transfer would allow the African farmers to stay in business so that their societies wouldn’t be left in the lurch when the aid goes away.