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Resources for policy making

Module 046
EASYPol Module 046

Commodity Chain
Analysis
Impact Analysis Using Shadow Prices
Bockel, L., 1 Tallec, F.,2

Policy Officer, Agricultural Policy Support Service, Policy Assistance Division, FAO
Consultant, Agricultural Policy Support Service, Policy Assistance Division, FAO

FOOD AND AGRICULTURE ORGANIZATION OF THE UNITED NATIONS, FAO

See also the Value Chain Analysis software


The FAO-VCA software tool carryies out value-chain analyses for agricultural and rural development
policies. By storing relevant data it can calculate flows of physical outputs and inputs, flows of
aggregated costs, value-added and net benefits. In addition, it allows users to directly compare
different hypothetical scenarios. FAO-VCA Software Tool Value Chain Analysis for Policy Making:
Methodological Guidelines for a Quantitative Approach

See all VCA material on EASYPol resource package: Value Chain Analysis

About EASYPol
EASYPol is a multilingual repository of freely downloadable resources for policy making in agriculture,
rural development and food security. The EASYPol home page is available at:
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The designations employed and the presentation of the material in this information product do not imply
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United Nations concerning the legal status of any country, territory, city or area or of its authorities, or
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Commodity Chain Analysis
Impact Analysis Using Shadow Prices

Table of contents

1 Summary .....................................................................................1
2 Introduction .................................................................................1
3 Principles of shadow pricing............................................................2
3.1 Constructing segments of the chain .................................................... 3
3.2 Efficiency price analysis .................................................................... 4
4 Empirical estimation ......................................................................8
4.1 Establishing the segments of the chain ............................................... 9
4.2 Analysis using parity prices ............................................................... 9
5 Comparing economic policies ........................................................ 13
6 Analysis ..................................................................................... 13
6.1 The impact of transfers ................................................................... 14
6.2 Economic profit .............................................................................. 17
7 Conclusion ................................................................................. 18
8 readers Notes ............................................................................ 18
8.1 Time requirements ......................................................................... 18
8.2 Frequently asked questions ............................................................. 19
8.3 EASYPol links ................................................................................. 19
9 Further readings ......................................................................... 19
Commodity Chain Analysis 1
Impact Analysis Using Shadow Prices

1 SUMMARY
This module provides a presentation of the impact analysis using shadow prices.
It belongs to a set of modules which discuss how to proceed step by step on commodity
chain analysis.

The module starts by a presentation of the principles of shadow prices. It is followed by


an empirical estimation which shows the two possible approaches: analysis using parity
prices and social price analysis. It then tries to compare economic policies on the basis
of economic analysis, thereby finishing by the analysis of impact assessment.

2 INTRODUCTION
This module 1 deals with the impact analysis within the commodity chain analysis. It is
an analytical tool which uses the shadow prices.

To find relevant materials in these areas, the reader can follow the links to other
EASYPol modules or the references 2. This module belongs to a set of modules which
discuss how to proceed step by step on commodity chain analysis. EASYPol
Module 043: Commodity Chain Analysis. Constructing the Commodity Chain:
Functional Analysis and Flow Chart introduces commodity chain analysis as a
framework. The reading of Module EASYPol 044: Commodity Chain Analysis:
Financial Analysis, before this one is advised to understand the principles of financial
analysis.

Objectives
This module shows analytical tools which can be used to evaluate the impact analysis.
The objective of using shadow prices is to correct for the distortions between market
prices and economic value.

This module can be used in different contexts such as:


reference materiel for policy analysts in carrying out their on-the-job tasks,
in academic courses.

1
It is based on a translation from French of FAO Training Materials for Agricultural Planning, No. 35,
Note de mthodologie gnrale sur lanalyse de filire: Utilisation de lanalyse de filire pour lanalyse
conomique des politiques, Pierre Fabre, 1994, (initially translated into English by Anne M. Thomson,
1998).
2
EASYPol hyperlinks are shown in blue, as follows :
- training paths are shown in underlined bold font;
- other EASYPOL modules or complementary EASYPol materials are in underlined bold
italics;
- links to the glossary are in bold; and
- external links are in italics.
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Targeted audience

This module is intended for a wide audience, ranging from policy analysts and decision
makers, to development practitioners, training institutions, and media. It is of particular
relevance to senior and mid level officials and professional officers in ministries of
agriculture, livestock, forestry, rural development, and cooperatives, including line
departments and training institutes/units. It should also be of particular interest to senior
executives of parastatals, financial institutions, and NGOs/CBOs. Suitably adapted, it
may also be used as a reader in undergraduate courses in development.

Required background

To understand the content of this module, basic elements of micro-economics and a


basic knowledge of agriculture commodity sector trade functioning are required.
No specific technical background, beyond reasonable language skills, is required for
this module.

It is anticipated that individuals with a degree in economics, and agricultural or rural


development related areas, and those with several years of experience in agricultural
policy analysis or development planning and implementation, at a mid to senior level
position, should have little difficulty in grasping the modules content.

3 PRINCIPLES OF SHADOW PRICING


As mentioned above, there are a variety of reasons for undertaking CCA. Examining
contributions to growth and identifying the distribution of flows of income are two
issues which the analyst might wish to explore. It is acceptable, and indeed desirable for
the analyst to use market prices as reflecting actual flows in the economy. However the
analyst might also want to explore issues of efficiency in either an economic or social
context. Here the use of market prices is not appropriate as actual market prices do not
reflect the true economic value of the goods and services to which they are attached.
There are numerous reasons for this distortion between market prices and economic
value. The most important are:
the absence of pure and perfect competition (due to the existence of
monopolies or oligopolies and to imperfect information among economic
agents);
the intervention of the state, and other factors beyond the strictly economic
sphere, disturbing the economic process (by taxes, regulations, quotas, and
all types of economic policy measures).

For these and other reasons, real life economies do not correspond to the model
economy developed in neo-classical theory, and therefore distortions result. Prices no
longer play their role of information and market regulation. Agents no longer behave in
such a way as to maximize national income, quantities produced and consumed move
away from the equilibrium point, resource allocation is no longer efficient, and flows
and income are no longer optimal.
Commodity Chain Analysis 3
Impact Analysis Using Shadow Prices

The objective of using shadow prices is to correct these distortions, by estimating a


hypothetical set of accounting or efficiency prices, and then to show the discrepancies
between the accounts as re-estimated in this way and the actual financial accounts of the
agents (whether individual accounts or the overall consolidated account).

Box 1. Shadow prices

Shadow prices are the values which replace market prices in theoretical
calculations when it is felt that market prices do not represent the true economic
value of the good or service.

These are also referred to as economic prices, accounting prices, "real" prices or
reference prices. They can be divided into two major categories, efficiency prices
and social prices (see below for definitions).

Originally, the expression shadow price was only used for the prices calculated
by a mathematical model (the dual in linear programming) but the term is now
in more general usage.

Once the accounts of the chain have been re-estimated, there are two important steps to
consider:
efficiency analysis, which essentially consists of valuing factors of
production and goods and services at international parity prices 3;
social price analysis, which incorporates the impact on consumption and
savings, and policy objectives of income distribution.

Social price analysis involves the application of a complex economic model, and
requires the analyst to make difficult choices in terms of weighting factors. This is
rarely undertaken, and therefore will be discussed in Annex 3, rather than in the main
body of the text.

3.1 Constructing segments of the chain


Before estimating and applying shadow prices to a commodity chain, it is necessary to
divide the chain into autonomous segments.

Box 2. Autonomous segments

These are fractions of the chain which link two potential stages of marketing, such
that the input demand and the output demand can be met by sources other than
within the chain, whether by domestic production or imports and exports. In other
words the input into the segment is a traded product, as is the output.

3
The use of parity prices is only one method of calculating shadow prices. Other possibilities are to use
opportunity cost, marginal productivity of factors, or consumer willingness to pay.
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Once these segments have been defined, they can be used to calculate appropriate
import and export parity prices for each level of the chain, and as such are the basic
units of analysis in shadow pricing (as discussed in section 4.2.2).

The next step is to set up consolidated accounts for each segment, using market prices
(financial accounts) 4.

3.2 Efficiency price analysis


We now have to calculate the relevant efficiency prices (export and import parity
prices) and apply them to segment accounts, keeping the flows of goods and services, in
physical quantities, the same as they are in the financial accounts. We can then examine
the differences made when we substitute efficiency prices for market prices.

Box 3. Efficiency price

An efficiency price reflects the true economic value, as given by:


the marginal productivity, or opportunity cost (in parity prices or
otherwise), for factors of production,
use value for final goods and services (parity prices or willingness to
pay).
Efficiency prices are supposed to maximize the overall economic output and
revenue by achieving the optimal use of factors.

The prices of goods and services consumed or produced by the chain:

(i) are valued at their parity prices (import or export parity depending on
whether they are inputs or outputs) either directly or built up from the
parity values of their components, as shown in the production-trading
accounts;

Box 4. Border price

The border price of a good or service is the price of this good at the point of
entry (for imports) or exit (for exports) from the country. This is the FOB price
for exports and the CIF price for imports, whether intermediate inputs or import
substitute products.

4
All the accounts we shall be discussing in the remainder of this module will be the consolidated
accounts of different segments within the chain being studied.
Commodity Chain Analysis 5
Impact Analysis Using Shadow Prices

Box 5. Parity price

The import parity price of a product is equal to its border price plus transport costs
(including any processing and transformation costs) and all expenses (other than
taxes and subsidies) intervening between the point of entry and the place of
consumption.
The export parity price of a product is equal to its border price minus transport costs
(including any processing and transformation costs) and all expenses (other than
taxes and subsidies) intervening between the place of production and the point of
exit.

(ii) eliminating all transfers 5;

Box 6. Financial transfers

Transfers are financial flows made without a corresponding flow of goods or real
consumption of economic value. Basically they include:
redistribution activities by the government (taxes, duties, subsidies);
financial charges (interest payments);
certain types of rents.
These are direct movements of liabilities (entitlements) from one agent to
another and have no impact on national income as such.

(iii) and, correcting the cost of non-tradable factors of production included in


the overall value 6.

In efficiency analysis, each resource consumed in the process of production is valued at


its opportunity cost, that is the value it would produce if used in its next best alternative.
Goods and services produced are valued at their use value.

Box 7. Opportunity cost

This is the value of a good or service when used in its next best alternative use
(compared to its current use in the chain).

The opportunity cost of a factor of production is equal to its marginal


productivity in its best use in the production of another good or service.

5
However, financial charges linked to international loans do constitute a real cost to the national
economy of the country. Given the scarcity of short and long-term capital, ignoring these charges would
distort calculations in favour of using scarce national resources. Such financial charges must be taken into
account and not excluded. A similar case could be made for loans from national banks which are heavily
indebted on the international market.
6
How this is done depends on the method of calculation adopted by the analyst: whether a standard
conversion factor is used or a shadow exchange rate. See paragraph (c) below.
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Box 8. Use of value

The opportunity cost of a good or service produced is equal to its use value, i.e.
to the value that the final consumer is willing to pay.

a. Parity prices for goods and services


It is commonly accepted that, for the majority of goods and services, international prices
are the best reflection of the efficiency price, because overseas trade generally offers the
best possible alternative use of inputs and outputs. This is the basis for using parity
prices in efficiency analysis.

It is possible to distinguish four cases 7:


goods and services which are internationally traded or which could be traded
internationally8: they are valued at international market prices at their point
of entry into or exit from the country. These prices are then adjusted by the
necessary transport and processing costs (valued at shadow prices) between
the border point and the point of production or utilization;
goods and services which are indirectly traded internationally: their value is
subdivided using the production-trading account into tradable (imported
inputs or import substitutes) and non-tradable items (see below);
non-tradable goods and services: goods and services which cannot be traded
internationally (such as land 9) are valued, in the case of factors of production
according to their marginal productivity, and for final goods and services,
according to consumers willingness to pay;
goods and services which could be traded internationally: these goods and
services which are not traded because of existing regulations are similar to
non-tradable goods and services and are valued on the basis of their marginal
productivity or according to consumers willingness to pay.

b. Parity prices for factors of production


When it comes to measuring the cost of factors of production, in practice it is very
difficult to estimate the marginal productivity of factors of production. It is hard to
identify their alternative employment and we are unable to estimate their marginal
contribution to production, without using detailed models.

Lacking an alternative, we generally assume that the marginal productivity of a factor is


equal to its market price, except in the case of unskilled labour, which, in certain types
of employment, may receive higher payment than their alternative marginal productivity
would indicate.

7
Adapted from J. P. Gittinger, The Economic Analysis of Agricultural Projects, 1992.
8
These goods and services are referred to as tradable, which means tradable internationally.
9
And, more generally, factors of production which create value-added, such as labour and capital. See the
following paragraph.
Commodity Chain Analysis 7
Impact Analysis Using Shadow Prices

Unskilled labour, particularly agricultural labour, is generally considered to have, as an


alternative occupation, either traditional agricultural production or casual labour (either
in rural or peri-urban areas). If there are no obvious particular characteristics, it is
standard practice to adopt unit marginal productivities for other factors of production.

The analyst faces an additional problem, that of choosing of the unit of measurement.
Goods and services and factors of production must be analyzed on the same basis. The
choice of a single unit of measurement has to be consistent with the decision to use
parity prices: thus the value currency used is that of international prices, whether
expressed in terms of foreign exchange or domestic currency.

This has to be applied with care. For the community as a whole, the cost of using a
factor of production is the alternative output foregone, which should, under appropriate
market conditions, be valued at the price of the factor being utilized. It is this output
foregone which has to be measured in international prices.

The following example 10 illustrates the possible importance of this correction. Consider
a project which employs a worker who was previously paid US$ 2 in a coffee
plantation. Let us accept that his wage in this plantation measured his marginal
productivity, or, in other words, that his previous employer made a normal profit out of
employing him. This means that in a days work, the additional output of coffee made a
profit of US$ 2 for his employer. However, if the coffee was subject to an export levy of
100%, sustainable because of the gap between the world price and the cost of
production, this days work would benefit the community much more: society gains
US$ 4 paid by the overseas importer, of which half goes to the state in levies and the
rest is paid to the producer. Thus the conversion factor (in shadow prices) to apply to
the wages of this worker would be 2, as a result of measuring his alternative marginal
productivity in international prices.

This example assumes that the worker that is taken away from the coffee plantation is
not replaced, and that his alternative output is actually lost. If he were replaced, and if
we were able to follow the chain of successive hirings and firings, eventually we could
value the marginal cost as the productivity of the first unreplaced worker, or even less if
a previously unemployed person was employed in the course of the chain. It is
impossible to undertake these speculative simulations: the analyst is forced to rely on
common sense rules of thumb, which may have little theoretical basis.

Therefore, except for exceptional cases where it is possible to identify the nature of the
production foregone, we apply a conversion coefficient in international prices which
measures the value of a basket of marginal products in international and domestic
prices. On the assumption that an additional unit of production results in additional
exports, or avoids additional imports, the average structure of external trade will be used
to quantify this conversion coefficient.

10
This is taken from J. Vercueil and G. Ancey, Prix de rfrence pour les projets agricoles, 1988.
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The formula is as follows:

Imports + Exports
MPCC =
Imports + Exports + Entry duties Exit taxes + Export subsidies

where MPCC = the Marginal Product Conversion Coefficient.

c. Shadow exchange rate


These economic calculations can be carried out in two ways: either by using the
standard conversion factor to translate all market prices of non-tradable goods and
services into border price equivalents, or by applying a shadow exchange rate for the
domestic currency to internationally traded goods and services. Both methods should
give similar results if carried out rigorously.

If a standard conversion factor (the marginal product conversion coefficient) is applied


to factor incomes and non-tradable goods, there is no need to apply a shadow exchange
rate to traded goods. The standard conversion factor translates values measured in
domestic prices to their border price equivalents, making allowance for the effects of
external trade distortions on domestic prices. The calculation is effectively carried out in
international price units.

On the other hand, the shadow exchange rate must be categorically applied to border
prices when parity prices are calculated, if factor incomes and non-tradable goods are to
be measured in domestic prices. Here the calculation is carried out in domestic price
units.

The procedures are equivalent as a result of the following mathematical identity:

Official exchange rate


Shadow exchange rate =
Standard conversion factor

4 EMPIRICAL ESTIMATION
As indicated in the section above, there are two possible approaches to analysis using
shadow prices:
Analysis using parity prices, efficiency analysis using international prices.
Social price analysis, efficiency analysis which incorporates the use of
relative weightings to reflect the distribution and use of income.

Although the first type of analysis is simpler and should be within the capacity of many
analysts, the second one requires either a certain theoretical competence to develop a
system of equity weightings adapted to the statistical data available in the country, or
the availability of previous work undertaken in similar context which can be used to
provide shadow prices for the principal income streams. As indicated earlier, social
pricing will be discussed in Annex 3.
Commodity Chain Analysis 9
Impact Analysis Using Shadow Prices

4.1 Establishing the segments of the chain


These are determined by the technological characteristics of the product and those of the
corresponding markets (see Annex 2). Once this is done, the consolidated financial
accounts of each segment must be established.

4.2 Analysis using parity prices


The following steps should be undertaken in sequence:

Step 1: Calculate either the shadow exchange rate for domestic currency or the
standard conversion rate. Alternatively, find a previous estimation which
can be used.

Step 2: Calculate conversion factors from market prices into parity shadow prices.

Box 9. Conversion factors

Conversion factors enable the analyst to calculate the shadow price (or total
shadow value) of a good or service by multiplying its market price (or the total
sum expressed in market prices) by a simple coefficient.

Shadow price
Conversion factor =
Market price

Conversion factors can be calculated for efficiency prices or social prices.

a) The parity price for all tradable intermediate inputs is calculated:

Parity price = border price + transport costs

b) Then the analyst derives the production account for non-tradable


intermediate inputs in order to extract from it the tradable components,
valued at parity prices.

Theoretically, the residual non-tradable elements should, in their turn, be decomposed


into tradable and non-tradable elements. In practice, it is worthwhile ascending the
production chain further only if the relative value of the residual non-tradable elements
justifies it 11.

The collection of data comprises a large part of the work, in particular data on
international prices of tradable import substitutes and data on the production-trading
accounts of businesses supplying or processing goods and services. The businesses

11
For an exhaustive analysis, follow the methodology given in EASYPol Module 045: Commodity
Chain Analysis: Impact Analysis Using Market Prices.
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themselves, fiscal authorities and economic information centres are the principal
sources of information 12.

(3) Once these various elements have been fragmented, we can divide the market
price into:
a foreign exchange cost (consisting of an actual cost where the good or
service is imported, or otherwise the opportunity cost);
any element of tax or subsidy;
a labour cost (further broken down into skilled and non-skilled);
the return to capital or to the enterprise.

It is possible, though unusual, to obtain a more detailed breakdown.

(4) The shadow price is then calculated by adding:


the cost of foreign exchange, converted using the shadow exchange rate;
the cost of labour;
the income of productive agents.

N.B.: The same result is achieved by adding:


the cost of foreign exchange at the official exchange rate;
the cost of labour multiplied by the standard conversion factor;
the income of productive agents multiplied by the standard conversion
factor.

(5) Then the ratio, Shadow price Market price, is calculated to give the conversion
factors for each good or service.

Finally, the elements of value added in the consolidated trading account for each
segment are included as follows:

the labour costs remain unchanged (a conversion factor equal to 1 is applied


to them) 13;
transfers to and from the state (taxes and subsidies) are omitted (a conversion
factor equal to 0 is applied to them);
other transfers such as financial charges and insurance are omitted (a
conversion factor equal to 0 is applied);

12
The problem of information is not specific to this methodology. A satisfactory solution to this depends
on the experience of the analyst leading the study, on the theoretical framework adopted to resolve the
problems and on the capacity of both research and statistical organizations to develop effective data
banks.
13
If the official exchange rate for the domestic currency is retained for foreign exchange costs, they are
multiplied by the standard conversion factor.
Commodity Chain Analysis 11
Impact Analysis Using Shadow Prices

the capital elements (technical and economic depreciation) remain


unchanged (a conversion factor equal to 1 is applied) 14.

Step 3: Apply the conversion factors in parity prices to cost items in the
production account and to the components of value added (except profits).
PRODUCTION CHAIN FOR THE DOMESTIC PRODUCTION CHAIN FOR THE
MARKET: IMPORT PARITY PRICE INTERNATIONAL MARKET: EXPORT
PARITY PRICE
World price at foreign port (fob) World price at foreign port (cif)
+ -
Brokerage, freight, insurance (at cif) Brokerage, insurance, freight (at cif)
= =
BORDER PRICE (cif) BORDER PRICE (fob)
at port of entry at port of exit
+ -
Customs, transit, storage Customs, transit, storage
+ -
Transport Transport
+ -
Packaging, final processing Packaging, final processing
+ -
Transport Transport
+ -
Possible additional processing, transport Possible additional processing,
+ transport
-
Marketing costs Marketing costs
+ -
Assembly costs Assembly costs
= =
FARMGATE PRICE FARMGATE PRICE
- -
Production costs Production costs
= =
PRODUCER MARGIN PRODUCER MARGIN
(gross output) (gross output)

This diagram shows only the chain for the principal product. The value of other possible
products must be subtracted when calculating import parity prices and added when
calculating export parity prices. It may be necessary to develop similar flow diagrams
for each sub-chain formed by these products.

The costs included in this flow diagram, such as processing and transport, are valued at
the parity prices of their factors and inputs, analogous to the calculation for the final
product.

14
If the official exchange rate for domestic currency is retained for foreign exchange costs, they are
multiplied by the standard conversion factor.
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Step 4: Value any other elements of value added, specifically, for agricultural
chains, taking into account the opportunity cost of family labour in
peasant farming and the opportunity cost of land used.

Step 5: Calculate the parity value of output for each segment of the chain.

Step 6: Constructing a Policy Analysis Matrix (PAM):

The Policy Analysis Matrix (PAM) is an organizational framework in which shadow


price calculations can be presented. To construct a PAM, it is necessary to include the
total amount of the principal categories of goods and services studied: outputs,
internationally traded goods and domestic factors (and non-tradable goods) 15. As shown
below, the PAM contains a row market prices which takes the figures from the
financial analysis, another row shadow prices, and a row of divergences between the
first two rows.

Tradable inputs

PAM for Output Within the Outside the Domestic Profits


segment chain chain factors

Market prices

Shadow
prices

Divergence

The format of the PAM presented here differs slightly from the traditional presentation,
insofar as it distinguishes, in the column Tradable inputs, between the flows of the
major commodity (which defines the chain) and the flows of other intermediate inputs.
This is because we are analysing segments of the chain. For the overall PAM, the
column Tradable inputs within the chain will be empty by definition.

Step 7: Aggregation of the PAMs for the different segments into a PAM for the
complete chain.

The data shown by the PAMs, both for the complete chain and its segments, provide the
basis for further analysis.

15
To systematize this we could say that tradable goods correspond to all intermediate inputs which can be
measured at international prices (directly or by ascending the chain). Domestic factors cover those factors
which directly create value added (and amongst which value added is divided: labour, capital etc.) as well
as those intermediate inputs which are impossible to value at parity prices.
Commodity Chain Analysis 13
Impact Analysis Using Shadow Prices

5 COMPARING ECONOMIC POLICIES


It is difficult to assess the economic efficiency of a policy in isolation. As with the
growth and distributional impacts discussed in section 3, it is more useful to compare
alternative policies to give a better perspective on their relative costs and benefits.

All other things being equal, the net benefit of policy A compared to policy B is
measured as follows:

Net advantagepolicy A over policy B = Impactpolicy A - Impactpolicy B

The policies under comparison may have differing economic implications (for example
on prices or on the evolution of salary scales) and technical implications (for example in
terms of the use of factors of production by agents). These, strictly speaking, are
exogenous to the impact calculation, but their consequences for flows of goods and
services, in both volume and value terms, are taken into account in the calculations.

The comparison of two situations resulting from alternative policy measures must be
undertaken with care. If the economic impact of two different policy measures results in
the same volume of production for the domestic final market at the same price, then the
comparison is reduced simply to the difference:

Net Benefit policy A over B = Profits policy A - Profits policy B

Here we are measuring overall impact by the profit on the row Shadow prices of the
PAM. However, this same procedure can be applied to all the elements (tradable goods,
domestic factors), or to their divergence, for example:

Divergence in domestic factors A/B = Divergence policy A - Divergence policy B


The significance of these additional impacts is discussed in section 6 below, on analysis.

New sets of policies adopted (or under consideration) frequently influence both the
volume of output and/or its price. In this case it would be better to undertake a detailed
analysis in terms of opportunity cost or use value (willingness to pay) of the additional
(or reduced) output.

6 ANALYSIS
Analysis using shadow prices can be based on absolute data, comparative data or
analytical criteria.

The absolute data are the new accounts estimated from the application of shadow
prices (either efficiency or social) to the various items in the production-trading
accounts of segments of the chain. These are incorporated in the second row of the
PAM.
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The comparative data are those given in the third row of the PAM which measures the
divergence between the values in market prices and the values in shadow prices:

Divergence = Value at market prices - Value at shadow prices

Comparative data are also provided by comparison of different economic policies.

Analytical criteria are indicators developed to give an overall picture of significant


economic costs and benefits and their implications for the relevant development policy
objectives. These indicators allow comparisons to be made between policies, between
chains and even between countries; they are tools which aid the assessment of policies.

The analytical criteria presented below do not form an exhaustive list. They have been
included as the most useful indicators of policy impact, particularly when considering
the objectives of development strategy16. Those presented in boxes are the most
commonly used. The others give information on more narrowly defined issues.

Tradable inputs
PAM for the Output Within the Outside Domestic Profits
chain chain the chain factors
Market A B0 B C D
prices
Reference E F0 F G H
prices
Divergence I J0 J K L

The following discussion describes the economic significance of a commodity chain


using the PAM technique. The notation refers to the PAM given below. The brief
description of the principal elements of the analysis applies equally to an efficiency
analysis as to a social analysis, although the economic significance is somewhat
different in the two cases.

6.1 The impact of transfers


The Profits column of the commodity chain PAM shows the profit for the community as
a result of the operation of the chain and the transfers which are the outcome of price
distortions due to market imperfections and the effects of economic policy.

Private profit: this is the overall result of the financial trading in the chain i.e. trading
at market prices.

Private profit = Output - tradable inputs - domestic factor input

or
D=A-B-C

16
It is even possible, for specific economic policy measures, where the individual costs are known, to
calculate an indicator of profitability (such as a benefit-cost ratio or payback period).
Commodity Chain Analysis 15
Impact Analysis Using Shadow Prices

For financial analysis in CCA, overall private profit has less significance than the
trading profits of individual businesses.

Private profit is normally assessed in terms of a normal rate of return to capital. If D is


higher than this rate then there are excess profits, and if profits are lower than this rate
then the return is inadequate.

Social profit 17: this is the return to the activities of the chain, calculated using true
economic values as represented by the shadow prices used.

Social profit = Output - Tradable inputs - Domestic factor inputs

or
H=E-F-G

If social profit is positive, this indicates an efficient use of resources and a positive
contribution to national income. Where a normal rate of profit has been included in the
column for factors of production 18, a positive profit, H, indicates an excess profit on the
part of the agents of the chain, and a negative profit means an insufficient return, that is
a chain which is producing at a higher cost than the opportunity cost of importing, as a
result of state transfers.

The divergence between private profit and social profit measures the net transfer in
operation:

Net transfer = Private profit - Social profit

or
L=D-H

This gives the net impact of market imperfections and policy measures.

A Profit ratio makes it easier to assess the importance of transfers, particularly when
making comparisons between chains:

Private profit
Profit ratio =
Social profit

or
Profit ratio = D H

This ratio of return measures the proportion by which private profit exceeds social profit
because of transfers resulting from market distortions and economic policies. In other

17
Although this is normally called social profit in the PAM literature, it is calculated using economic
efficiency prices.
18
As measured by opportunity cost.
16 EASYPol Module 046
Analytical Tools

words, this ratio measures the overall incentive which producers have to participate in
the chain.
As a complement to this, the subsidy rate of producers is an indicator of net transfers,
which can similarly be used to make comparisons between chains:

Net transfers
Producer subsidy rate =
Shadow value of output

or
Subsidy rate = L E

This rate shows the value of the transfer to productive agents in the chain in relation to
the monetary value of output valued at their true economic price. Again this is an
indicator which can only be assessed subjectively or in relation to other chains.

Calculating the Nominal Protection Coefficient (NPC) is another way of establishing


the relationship between the market price and the shadow price of the main commodity
in the chain:

Output market prices


Nominal Protection Coefficient =
Output shadowprices

or
NPC = A E

If this rate is less than 1, the domestic price is below the international price. The chain
therefore gives rise to lower income than would be the case in an economy which
applies international parity prices, by the proportion of the NPC; and vice versa when
the NPC is greater than 1. In this latter case, producers face higher incentives than they
ought to from the point of view of opportunity cost and in the international market.

Where chains produce a number of commodities, the overall NPC for the chain can be
calculated by using the total financial value and the sum of shadow prices for each of
the products. This is independent of the NPCs of the individual products which can also
be calculated.

Output i
i
market prices
NPC overall chain =
Output i
i
shadowprices

The Effective Protection Coefficient (EPC) is a measure of the ratio of value added to
tradable goods by the production process in market prices relative to shadow prices:

(Output Tradable inputs)market prices


Effective Protection Coefficient =
(Output Tradable inputs)shadow prices
Commodity Chain Analysis 17
Impact Analysis Using Shadow Prices

or
EPC = (A - B) (E - F)

The value added in question here (that given in the PAM) is not necessarily exactly the
same as that calculated in the production-trading account of the financial analysis. Some
intermediate inputs could be internationally non-tradable and thus be entered in the
column domestic factors. Nonetheless, the notion of value added is the same in the
two approaches, a measure of the wealth created by the chain which will remunerate the
other domestic factors, including a normal return on capital.

By measuring the relationship between value added in domestic and international prices,
the EPC gives an indicator of the level of incentives created by national economic
policy in favour of the chain. While the NPC only looks at gross revenue (the gross
value of output), and thus only gives a measure of commodity price policy, the EPC
integrates the role of tradable inputs - and thus price policies affecting them - into the
measure of protection of the chain with respect to the international market. It is
therefore a more precise indicator of the real level of incentive relative to the world
market.

An EPC of less than 1 means that the combination of transfers affecting the commodity,
on the one hand, and the intermediate inputs (tradable goods) on the other, result in an
effective distribution of income less than would be the case if, all things being equal 19,
international prices applied.

The analyses presented in this paragraph on incentives and protection have been
approached from the perspective of the chain as a whole. Reading the columns of the
PAM can give a deeper analysis and show specific mechanisms. Thus the calculation of
a Nominal Protection Coefficient for inputs (tradable goods) 20 can highlight transfers
which reinforce or counteract those related to the commodity price (NPC of output),
showing the overall balance in the EPC.

To understand better the phenomena at play, the analyst can look in turn at transfers
associated with output, then tradable inputs and finally with domestic factors. It is
sensible to keep an analytical approach to the results of calculations and not interpret
them mechanically.

6.2 Economic profit


Profitability indicators allow the analyst to compare the performance of different chains.

The factor cost ratio gives information on the relationship between domestic factor
remuneration and the value added from tradable inputs:

Domestic factorsmarket prices


Factor Cost Ratio =
Outputmarket prices Tradable inputsmarket prices

19
In particular without changes in physical flows such as were indicated in the financial analysis.
20
NPC of Tradable Goods = B F.
18 EASYPol Module 046
Analytical Tools

or
FCR = C (A-B)

This ratio is calculated at the prices the agents actually face, and shows a private profit
if it is less than 1. It is possible to compare this to a similar return for other chains.

The Domestic Resource Cost Ratio (DRC) is the equivalent of the previous indicator,
measured in shadow prices:

Domestic factorsshadow prices


Domestic Resource Cost =
Output shadow prices Tradable inputsshadow prices

or
DRC = G (E -F)

This is an essential indicator as it measures the overall economic efficiency of the chain
by comparing the cost of domestic factors consumed in the production process with the
benefit in foreign exchange as represented by the value added from tradable inputs 21.
This is the most relevant indicator of the economic profit created by the chain for
society.

A DRC greater than 1 means that the cost of domestic factors used is greater than the
value created measured in international prices, i.e. overall there is a loss of welfare for
society. Minimizing the DRC is equivalent to maximizing social profit.

7 CONCLUSION
This module focuses on impact analysis using shadows prices. It belongs to a set of
modules which discuss how to proceed step-by-step on commodity chain analysis
(CCA) and shows analytical tools which can be used to evaluate the impact analysis.
The objective of using shadow prices is to correct distortions between market prices and
economic value. This is possible by estimating a hypothetical set of accounting or
efficiency prices, and then to show the discrepancies between the accounts as re-
estimated in this way and the actual financial accounts of the agents.

8 READERS NOTES

8.1 Time requirements


The delivery of this introductory module may fit for any audience of skilled staff
requiring to be introduced on Commodity Chain. In most cases, it may be presented in
one hour and a half session.

21
Or more precisely, the value of these flows in foreign exchange equivalent adjusted by the shadow
prices of the income generated by indirect intermediate inputs.
Commodity Chain Analysis 19
Impact Analysis Using Shadow Prices

8.2 Frequently asked questions


Frequently asked questions :
Who decides what is in and out of the commodity chain?
What is the difference between the commodity chain analysis and value
chain analysis?

8.3 EASYPol links


This module belongs to a set of modules about the Commodity Chain Analysis.
Commodity Chain Analysis. Constructing the Commodity Chain: Functional
Analysis and Flow Chart, EASYPol Module 043

Commodity Chain Analysis: Financial Analysis, EASYPol Module 044


Commodity Chain Analysis: Impact Analysis Using Market Prices, EASYPol
Module 045

Two case studies using the Commodity Chain Analysis are reported in the EASYPol
modules:
Case Study on Commodity Chain Analysis: Irrigated Rice Chain of the Nigers
Office (Mali): Financial and Economic Account, EASYPol Module 047

Commodity Chain Case Study: Analysis of the Suburban Horticulture Sub-Chain


of Bamako (Mali), EASYPol Module 048

See all Value Chain material on EASYPol resource package: Value Chain Analysis

9 FURTHER READINGS
There is virtually no Anglophone literature dealing directly with Commodity Chain
Analysis. It is however, discussed in the context of constructing Policy Analysis
Matrices, though there is little on financial analysis or even impact analysis.

Audette, R., Larivire, S., Martin, F., 1994. Analyse de filire dans le secteur
agro-alimentaire: guide de ralisation d'une tude filire, Rapport prliminaire
ACDI - Eco. rurale inc.

Bockel, L., 1996. Analyse de la sous-filire marachage pri-urbain de Bamako,


Document de formation pour la Planification Agricole, Division de l'Assistance aux
Politiques (TCAS), FAO.

Bourgeois, R., 1998. La constitution des filires et les institutions quaternaires.

Dasgupta P., Marglin S., Sen A., 1972. Directives pour lvaluation des projets,
ONUDI.

Fabre, P., 1994. Note de mthodologie gnrale sur l'analyse de filire, Document de
formation pour la planification agricole n 35, FAO ESPT.
20 EASYPol Module 046
Analytical Tools

Hugon, P., 1998. Avantages comparatifs, comptitivit et organisation des filires.

Gittinger J. P., 1982. Analyse conomique des projets agricoles, IDE/Economica.

Monke E. A., Pearson S. R., 1989. The policy analysis matrix for agricultural
development, Cornel University Press