Welfare effects of a change in the trade policy regime for rice in Costa Rica Carlos E. Umaña-Alvarado

Author and policymaker  Author: Carlos E. Umaña-Alvarado, Academia de Centroamérica  Policymaker: Henry Benavides, Ministry of Foreign Trade of Costa Rica, Agriculture policies

Why to focus on rice?  Rice is an essential staple in the Costa Rican diet, particularly for the poorest.  Costa Rica has implemented a mix of policies: tariffs, a performance requirement for imports of paddy rice – which links import permissions to an obligation to first purchase rice from domestic producers – and a price-fixing mechanism for all stages of the rice production chain.  These policies have created significant rents for importers and rice millers who have been benefiting from the difference between low international prices and high domestic prices.

Why this topic?  These measures have resulted in an increase in domestic paddy rice prices to double that of international prices. Consumers in Costa Rica have therefore been paying a high price for a key commodity in their daily consumption basket.

Why this topic?  Costa Rica is also in breach of its WTO commitments. By providing a subsidy to producers in the form of a minimum price, the country has been exceeding the maximum level of authorized annual support to its agriculture.  CAFTA-DR will eliminate import quotas and provide unlimited duty-free access to imports from the United States – Costa Rica’s main supplier of rice – by 2025.

Objectives of the study  What will be the effects of the CAFTA-DR on rice- consuming Costa Rican households as a consequence of a reduction in rice prices due to cheaper imports?  Will the CAFTA-DR be an opportunity to effectively reduce rice prices in the domestic market and thus improve the welfare of consumers?

Methodology  Estimation of non-parametric regressions of the welfare effect on Costa Rican households due to a price decrease of rice following the phasing out period for the CAFTA-DR.  Following Deaton (1989), welfare effects from a price change can be assessed using budget (consumption) and income (supply) shares of the good on household income.  Assumption: direct link between the tariff phasing- out process from CAFTA-DR and a price reduction of rice in the internal market.

Data  Costa Rica’s 2004 National Income and Expenditure Survey provides information on: a)Education level, employment, income, and transfers of household members. b)Household characteristics, e.g. type of dwelling, number of rooms, persons who receive government aid, household incomes. c)And household expenditures by product.

Welfare changes in the 2025 scenario compared to 2009–2012, at the national level and by urban and rural areas Welfare gains will be positive for urban and rural households. The poorest households will benefit the most (1% in 2025) from a decrease in the price of rice.

Welfare change in the 2025 scenario compared to 2009–2012, by region The highest welfare increases (at least 0.5%) are found in Chorotega, Huetar Atlántica, and Brunca Regions which have consistently had high poverty levels.

Welfare change in the 2025 scenario compared to 2009–2012, by household size The largest households (6 or more members) would enjoy the most significant welfare effects. Those households are concentrated in districts with a higher incidence of resource gaps, based on the unmet basic needs approach.

Welfare change in the 2025 scenario compared to 2009–2012, by education level Households whose heads have not received an education show the largest increase in welfare from a reduction in the price of rice.

Caveats, limitations  Assumption: perfect pass-through of tariff reductions. Results are an upper-bound estimate of the benefits of the phasing-out of tariffs under the CAFTA-DR.  Estimation of pass-through may face factors that influence the internal price that are exogenous (political decisions).  International prices may not accurately explain evolution of internal rice prices in Costa Rica: prices paid to producers are based on a cost structure that includes the value of inputs.

Caveats, limitations  Analysis only considers consumption effect, not income effect: reduced number of domestic producers precludes running a complete analysis of producer welfare.  Other channels for the impact of price changes on welfare: workers in rice-related sectors (e.g. retail and industrialization), since this source of income may be substantial in parts of the country.

Policy recommenda tions  The phasing-out schedule under the CAFTA-DR will progressively reduce the relevance of the performance requirement and the import quota since industries will no longer need to purchase domestic paddy rice in order to be able to import duty-free from the USA. This might serve as an automatic price-control mechanism: rice imports becoming progressively cheaper.  However, for this to take place, institutions in charge of defending the interests of consumers, and those that supervise the functioning of the domestic market must develop an active stance towards surveillance of price behaviour for the imported product, in particular after 2016 (starting phasing out process outside quota).

Policy recommenda tions  Large producers, which are also millers, may have an incentive to import most of the paddy rice they will process. If large producers have better business opportunities by importing most of their rice and reducing their own production, this may require an active policy of stocks and safety nets to address international market price spikes.

Policy recommenda tions  The CAFTA-DR may also increase pressure on local producers to reduce their prices to avoid losing market share. The local rice sector will face the challenge of improving its competitiveness, in areas of productivity, capacity building, improved and cheaper access to inputs, and strengthening of credit mechanisms.

Policy recommenda tions  Costa Rica has to continue its efforts to comply with its commitments to the WTO. A continuous dialogue between producers, millers and the government is needed to enhance productivity levels, avoid the application of trade-distorting policies, and prevent welfare losses for consumers.  The possibility of fixing prices should not be politicized. Even if the internal law allows the government to regulate prices of goods and services in exceptional situations, the need for such a measure has to be properly established and justified, and applied only temporarily.

Possible future directions of the work  Use most recent Survey of Income and Expenses of households in Costa Rica ( ), not available at the moment of the research.  Is there a possibility to develop a reasonable pass-through estimate between price of imported rice and price at the internal market?  Depending on availability of information, try to estimate income effects for producers and workers in rice-related sectors.

Welfare effects of a change in the trade policy regime for rice in Costa Rica Carlos E. Umaña-Alvarado (506)