The Ukrainian grain sector has witnessed a series of public interventions within the last years. They took the form of export quotas, export taxes, installation of a policy-business agreement, and partial reimbursement of Value Added Taxes (VAT). One argument for justifying these interventions has been the policy objective of domestic food security. Compared to a free trade scenario, however, any trade restriction generates costs to the society under some specific assumptions. This report aims at quantifying the welfare losses and compares them across the three trade measures applied by the Ukrainian government.

Based on the theoretical analysis it has been shown that although consumers might benefit from export restrictions, overall welfare of the country decreases when export restrictions are introduced. Theory predicts that a quota absorbs market reactions more than a tax and will, therefore, lead to higher welfare losses. Furthermore, a number of additional factors which are highly relevant in the case of Ukraine cannot be captured by the theory:

• Traders and producers, committed to export, don’t expect stable agricultural trade policy. They might keep more grain in stocks and wait for better prices or they find other ways to export instead of supplying to the domestic market.
• Millers and other processors exert their market power and capture the benefits from the export restriction.
• Government buys out (too much) grain to the state reserves and, thus, exaggerates market reactions.

In light of these factors, in the case of Ukraine, empirical analyses have shown that domestic prices for wheat, flour and bread kept growing even during export restrictions. Whether price increases would be even higher without any trade restriction cannot be determined in the framework of this study.

The results of our empirical analysis confirm theoretical predictions and show that export taxes in 2011 were less distorting than export quotas in 2006-2008 and 2010-2011. During the export tax regime, signals from the world market have been still transmitted on the domestic market and traders could react to them.

In October 2011, grain traders and the Ukrainian Ministry of Agricultural Policy and Food signed the Memorandum of Understanding (MoU). Although the MoU imposes no general restriction of grain exports, the following effects represent potentially distortionary incentives which will affect the future development of grain trade:

• The rules for new entrants are not transparent. New traders might increase competition and might introduce technical progress. Both aspects would potentially reduce margins of traders in place and could benefit farmers and consumers.
• There is uncertainty regarding the changing limits of the “allowed” export. From the perspective of potential importers of Ukrainian grain, several revisions of the limits are not favourable to the image of Ukraine as a reliable partner. Obviously, statements of the governmental officials that the limit is approaching and there could be measures (like an export ban) implemented, may raise uncertainty on the market and might cause price fluctuations.

As a key summary, any type of trade restriction leads to welfare losses. Therefore, free trade is the first-best scenario. While the argument has been often made that consumers will suffer from free trade, we will illustrate such a situation here. Under the assumption of complete absence of barriers to grain exports and homogeneity of Ukrainian grain, exports from Ukraine will increase as soon as prices abroad net of transport costs exceed domestic prices. Increasing export activity will result in increasing domestic prices. Obviously, in the welfare economic setting above farmers will benefit from such a situation and consumers will experience a declining welfare. However, these static effects neglect a number of adjustment processes, characteristically for mature free markets. In the short-run, grain will be released from stores and economically less valuable uses of grain will look for substitutes. Subsequently, the additional quantity available on the market will constrain a further increase of prices. At the same time, more expensive Ukrainian grain will be less competitive on the world market. Thus, demand for Ukrainian exports from abroad should decline, too. An important long-run consequence will be the incentive for farmers to increase grain production in the next season. If we relax the assumption of homogenous grain quality, there will be even more opportunities for substitution of higher quality (more expensive) grain with lower quality grain which additionally will buffer the transmission of increasing world market prices to the Ukrainian consumers. Thus, price spikes which harm consumers might appear in the short-run but cannot last, under the assumptions stated above, more than a few months. Here the Ukrainian government should focus their policy in helping the most vulnerable consumers directly instead of distorting market mechanisms.

The following key recommendations aim at supporting the development of a more competitive Ukrainian grain market while at the same time realising food security for the most vulnerable households:

• Stop the practice of unannounced official and unofficial export restrictions. This could be done by amending the Law of Ukraine ‘On State Support to Agriculture’.

The Ukrainian policy of export restrictions over recent years did not have the desired effect on the consumer prices and does not solve the declared policy target of food security. Therefore, the government should avoid implementing such export restrictions in the future. Any state intervention brings uncertainty to investors and traders, who constrain their market activities accordingly. Undesired losses in a society’s economic prosperity and development prospect will be the consequence.

One example of unintended cross-effects of an unstable agricultural policy is the disincentive to store grain. Price stability could be easily enhanced by a transparent and predictable market environment. Storage fulfils a crucial function in this respect. However, storage only pays if the policy environment is stable and managers are assured of being able building up expectations over the near future.

• Decrease grain marketing costs by reviewing marketing regulations in the grain value chain, from inputs to export markets.

The role of the government in the market should be mainly to ensure equal rights to all market participants and eliminate incentives for corruption. It is advised to facilitate trade and to not create additional administrative barriers, like grain quality certification. This requires a comprehensive approach and revision of the legal framework of functioning seeds, agrichemicals, agro-machinery, grain storage and transport logistics, and bioengineering products markets. Additionally, the need for phytosanitary measures as well as some sanitary measures should be assessed.

• Design safety nets for the poor to compensate them for bread prices increases; and shift to targeted food support system.

As an alternative policy option for the Ukrainian government to respond more efficiently to increasing world market and domestic prices in the future it is advised to use consumer-oriented measures for the people in need, for example, direct income transfers.

• Design and introduce a set of indicators to monitor food security in the country. This could be achieved by drafting the Law of Ukraine ‘On Food Security’, whereby the exceptional introduction of export restrictions should be contingent on specific thresholds.

The status of food security in Ukraine can be monitored by using transparent and clearly defined indicators. It is suggested to the Ukrainian government to put more efforts and resources into the improvement of state agricultural statistics, including the development of a reliable operational monitoring system for grain balance.

The full text of the paper can be downloaded at http://apd-ukraine.de/images/APD_APR_01-20134_Getreidehandelspolitik_eng.pdf

An article by Iryna Kulyk, Thomas Herzfeld, Oleg Nivievskyi, German-Ukrainian Agropolitical Dialogue at the Institute for Economic Research and Policy Consulting.