The Policy Analysis Matrix method deals with three issues of agricultural policy analysis. First, whether a farming system is competitive at given price and technology levels—that is, whether farmers, traders, and processors are profitable at actual price levels— A price policy will change the value of output or input costs and, therefore, private profitability. The difference in private profitability before and after the policy change shows the effect of the policy change on competitiveness at the actual price level (market price).
The second is related to the level of efficiency of the farming system. Efficiency is measured by social profitability, which is the rate of profit calculated based on efficiency prices. Successful public investment (for example, investment in irrigation or transportation networks) will increase the value of output or decrease input costs. The difference in social profitability before and after public investment indicates an increase in social profitability.
The third is closely related to the second issue, which is the impact of new investments in agricultural research or technology on the efficiency level of the farming system. A public investment in new seeds, cultivation techniques, or processing technologies will increase farm yields or processing outputs, thereby increasing revenues or decreasing costs. The difference in social returns before and after the investment in research indicates the benefits of the investment.
Table of the Policy Analysis Matrix: Private Gains, Social Gains, and Transfer Effects
The three main objectives of the PAM method are essentially to provide information and analysis to assist agricultural policymakers on these three central issues. A PAM table for a farm allows one to calculate the level of private profits—a measure of the farm’s competitiveness at the market or actual price level. Doing the same for various other farming systems allows us to rank their competitiveness at actual prices. The calculation of private profits or competitiveness is placed in the first row of a PAM table.
The second objective of the PAM analysis is to calculate the social profitability of a farm, generated by valuing outputs and costs at efficiency prices (social opportunity costs). Doing the same for other farming systems allows us to rank the efficiency levels of different farming systems. The calculation of the social profit rate is placed in the second row of the PAM table.
The third objective is to calculate transfer effects, or the impact of a policy. By comparing revenues and costs, henceforth referred to as budgets, before and after the implementation of a policy, we can determine the impact of the policy. The PAM method calculates the impact of policies that affect both output and factors of production (land, labor, and capital). The determination of the transfer effect of a policy is placed in the third row of a PAM table.
Calculation of Price Parity as the Social Price of Tradable Goods
As stated above, the PAM table basically presents data on farm income and costs valued according to actual prices [first row], according to social prices [second row], and the transfer effect, which is the difference between the two rows [third row]. The actual price is the price prevailing in the market, while the social price, according to Pearson, Gotsch, and Bahri , is the efficiency price, which is the social opportunity cost of the commodity produced. For tradable outputs and inputs, the social price is the parity price. For imported goods, the social price is the import parity price, while for export commodities, the social price is the export parity price. The following table is a guide to the calculation of import parity and export parity prices for both outputs and inputs.
For example, to calculate the import parity price for rice [output], start by finding its FOB [free on board] price, add the cost of freight and insurance to obtain its border price [CIF: cost of insurance and freight], then add the cost of transportation and handling to obtain the parity price at the wholesaler level. Subtracting the transport, handling, and processing costs gives the import parity price at the farm level, which will be used as the social price for output in the second row of the PAM table.
In the case of rice and some other food crops, the social prices of domestic factors [land, labor, and capital costs] are assumed to be equal to their private prices on the basis that in Indonesia there are no market distortions for land, labor, or capital costs. Further details can be found in Monke and Pearson, 1995, “The Policy Analysis Matrix for Agricultural Development” and Pearson, Gotsch, and Bahri, 2004, “Application of the Policy Analysis Matrix in Indonesian Agriculture”.
Parameters in PAM
There are seven parameters commonly used in policy analysis using the PAM approach, namely private cost ratio [PCR], nominal protection coefficient on output [NPCO], nominal protection coefficient on input [NPCI], effective protection coefficient [EPC], profitability coefficient [PC], subsidy ratio to producers [SRP], and domestic resource cost [DRC].
PCR [private cost ratio] is the ratio of domestic resource cost [factor cost, C] to value added at private price [A-B], or, referring to the PAM table above, PCR = C/[A-B]. This ratio measures the competitiveness [at the private price level] of a commodity system. The system is said to be competitive if PCR < 1.
NPCO [nominal protection coefficient on output] is the ratio of the domestic market price of a product to its parity price, or NPCO = A/E. NPCO > 1 indicates that the private price of the product is more expensive than its parity price; in other words, the producer is protected. Conversely, NPCO < 1 indicates that the producer is implicitly “taxed”. NPCO = 1 indicates a neutral [intervention-free] situation.
NPCI [nominal protection coefficient on inputs] is the ratio of the tradable cost of private inputs to the tradable cost of social inputs, or NPCI = B/F. NPCI > 1 indicates that producers are “taxed” on the cost of their tradable inputs. Conversely, an NPCI < 1 indicates that the producer receives a “subsidy”. NPCI = 1 indicates a neutral situation.
While NPCO and NPCI account for government policy distortions on both output and tradable inputs, EPC [effective protection coefficient] measures the total effect of government intervention on both output and tradable inputs. EPC is the ratio of value added at the private price level to its social price, or EPC = [A-B]/[E – F]. EPC > 1 indicates that, overall, policies have provided positive incentives for producers. EPC 1 indicates disincentives. EPC = 1 indicates no intervention or distortionary effects on either input or output markets, or, in other words, is neutral.
PC [profitability coefficient] measures the impact of the overall transfer on private profits, which is the ratio of private profits to social profits, or PC = D/H.
SRP [subsidy ratio to producers] is a measure of the overall transfer effect. Referring to the PAM Table above, SRP = L/E = [D – H]. SRP shows how much income increases or decreases due to the transfer. If the market failure is insignificant, the SRP shows the impact of the policy distortion on income.
DRC [domestic resource cost] is the ratio of domestic resource cost valued at the social price level to social value added. Referring to the PAM Table above, DRC = G/[E – F]. In essence, DRC is a social benefit-cost ratio that shows the excess economic efficiency of the domestic production system relative to the international market. Social costs are the opportunity cost of domestic resources used in the production process. Social benefits are the added value generated by domestic resources valued at the social price level. If costs are greater than benefits, or DRC > 1, the production of the commodity is not socially desirable. Conversely, if costs are less than revenues, or DRC < 1, the production system is capable. If costs are equal to revenue, then the production system is only sufficient to cover its costs.
The exercise file above can be downloaded below: