Economic Reform in Europe and the Former Soviet Union: Implications for International Food Markets

Policy reforms in the wake of the Uruguay Round of the General Agreement on Tariffs and Trade (GATT) are expected to reduce food exports in Western Europe. Will the transition to market- oriented policy regimes in Eastern Europe and the former Soviet Union expand agricultural production there, eventually offsetting the reductions in Western Europe and leading to food surpluses for the region as a whole? What effects will these changes have on the rural sectors of developing countries? Addressing these questions quantitatively, Rod Tyers, in Economic Reform in Europe and the Former Soviet Union: Implications for International Food Markets, Research Report 99, concludes that agricultural exports in Eastern Europe and the former Soviet Union countries could expand enough to more than offset decreases in exports from reforms in Western Europe. Tyers estimates that the combined grain exports of Europe and the former Soviet Union could increase world supplies by as much as 44 million metric tons by 2000, leading to a reduction in world food prices.

Reasons for Reforms

In recent years the relocation of manufacturing from the industrialized countries, including Western Europe, to developing countries, combined with slow output growth in other sectors, has brought immense pressure to bear on developed-country governments to generate new growth and employment opportunities. In the 1980s Western Europe responded to the challenge by increasing economic integration through incorporation of more countries into the European Union (EU). At the same time, the governments of the EU came under pressure to reduce traditionally high levels of agricultural protection. These had raised land productivity, resulting in food surpluses that were disposed of via costly export subsidies. The EU is now committed to less distortionary agricultural policies, roughly consistent with the agreements reached in the Uruguay Round of negotiations on the GATT.

Beginning in the mid-1960s, the Soviet Union adopted policies designed to expand production of meat and dairy products. By the late 1980s, two decades of artificially low cereal prices and subsidies to livestock production had substantially distorted the patterns of food production and consumption. While Western Europe was expanding its food exports, the Soviet Union was becoming a large net importer. This trend was accentuated by waste in the distribution and processing of agricultural products and limited access to Western technology.

By the 1980s, problems of low productivity growth and pressures to provide more consumer goods were exacerbated by huge military expenditures (one-quarter of all output). The answer--ultimately--was to discard the system of central planning in favor of a market-oriented economy. With the dissolution of the union, the countries of Eastern Europe and the former Soviet Union lost most of their intraregional export markets, while trade with the West opened only slowly. Although embarked upon to boost economic activity, reforms have thus far depleted most of the region's economies. (Eastern Europe in this report includes the former Czechoslovakia, Hungary, and Poland--called the EE3--and the Balkan countries.)

Outlook

A key premise of the report is that policy reforms in Eastern Europe and the former Soviet Union will continue to be market-oriented. Even if this is not true, however, the collapse in aggregate economic output will continue to reduce purchasing power and hence consumption, especially of income-elastic foods such as livestock products. This in turn will limit the size of the livestock herd. This change alone could reduce grain imports enough to reverse the direction of trade in staple foods.

Three other reasons support the possibility of large grain exports by 2000. First, the transfer of technology (such as high-yielding varieties) from the developed market economies could substantially improve food productivity. For example, 67 percent more beef could be produced for each unit of feedgrain, using modern breeding and raising techniques (Figure 1). Once improvements in the food distribution and marketing system are made and technological parity with the West is achieved, the region encompassing the former Soviet Union could become a large net exporter of staple foods.

Second, the prereform policy regimes subsidized food consumption more than production (Figure 2). Reducing incentive distortions should therefore retard consumption more than production. And third, although it is possible that a boom in another tradable goods sector, such as minerals or energy, could retard agricultural growth, it is more likely that the agricultural sector will recover early. This is because its recovery will depend less than that of other sectors on foreign direct investments, since the technology needed for food productivity improvements is comparatively inexpensive.

In Western Europe, it is uncertain if agricultural reforms will succeed in promoting efficiency in the overall economy and in reducing the fiscal burden on governments. The EU's program of reforms includes graduated reductions in the regulated consumer and producer prices of crops and cattle. Farmers are partially compensated for these price changes, but large landholders are required to set aside 15 percent of their land to qualify for compensation. Beef and dairy producers will benefit from lower feed prices and receive a subsidy for culling their herds, while quotas will be tightened on dairy output. This program of reforms should alter incentives sufficiently to slow the growth of staple food production and raise consumption.

Potential Gains and Losses

The report analyzes two scenarios, one assuming a delayed and ultimately slow recovery in food demand and production in Eastern Europe and the former Soviet Union and the other assuming a more prompt general economic recovery, combined with some productivity convergence with Western Europe. According to the analysis, uni- lateral reforms in Western Europe would reduce the whole region's net grain exports by 30 million metric tons and net beef exports by more than 2 million metric tons. By itself, such a change could cause international grain prices to be higher by 10 percent and an index of international staple food prices to be higher by about 7 percent.

The reforms in Eastern Europe are less straightforward. The former Czechoslovakia, Hungary, and Poland (the EE3) have Association Agreements ensuring that an increasing share of their products can be sold to the EU at internal prices. Although these agreements offer only gradual expansion in access to EU markets, they represent the likely future policy direction for the EE3. By 2010 their agricultural policies should fully conform to those of the reformed EU. This will not cause major changes in international trade of grains and meats, but the dairy sector will expand due to higher internal EU prices. Even if this surge is constrained by quotas, it could raise subsidized milk exports, reducing the index of international staple food prices by 3 percent by 2000.

Based on the experience of other reforming socialist economies (such as China), a surge in output in agriculture could follow liberalization, helping cushion the inevitable slump in other tradable goods sectors. Because departures from the objective of economic liberalization cannot be reliably forecast, the only policy reform considered in this report is a phased liberalization of all distortions facing agriculture throughout the Balkans and the former Soviet Union. According to the analysis, this would shift these states as a group from a net cereal deficit to a surplus of 30-50 million metric tons per year. When these surpluses are combined with those of the EE3, net grain exports could reach 61-74 million metric tons (Figure 3).

When the effects of all the simulated changes in Europe and the former Soviet Union are combined, the international staple food price index is predicted to fall between 7 and 11 percent during this decade. Thereafter, as overall economic growth again accelerates in the postsocialist world, food absorption will begin to catch up with output.

Implications for Other Countries

Provided the trend toward reform continues, exports from Eastern Europe and the former Soviet Union will exert downward pressure on international food prices, which will hurt net food-exporting industrial countries, such as Australia, Canada, New Zealand, and the United States, and help industrial countries with no comparative advantage in agriculture, such as Japan. How it will affect developing countries is uncertain because the incentive distortions in many developing countries already discriminate against agriculture. Without those distortions, more developing countries would export food than do so today. And it is the undistorted pattern of trade that determines whether a country gains from a change in its international terms of trade. Clearly, farmers in developing countries would lose if food could be more cheaply imported. The majority of the developing world's poor live in rural areas, and cheaper food would reduce the economic activity from which they earn their living.

But the most important impact on developing countries may come through capital markets. The projected net effect of the food price changes on their balance of payments is small compared with the effect of the increased demand for capital in Eastern Europe and the former Soviet Union. Net transfers to developing countries could decline by US$30 billion a year or more. The crowding out of investment and hence slower output growth in industrial countries (except Germany) would cause slower growth in demand for the exports of most developing countries. Such changes would clearly be more significant than direct effects on international trade in food products.

Epilogue

Since this analysis was completed, the agricultural policies of the former Soviet Union states have tended to remain insular. Export quotas have kept the relative domestic prices of exportable foods such as grains low. High tariffs on imported food products have afforded the farm sector some compensation while earning governments needed revenue. Although such policies have thus far retarded agricultural growth relative to the simulations in the report, the potential remains great.