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China’s New Farm Subsidies

by 5m Editor
11 February 2005, at 12:00am

By Fred Gale, Bryan Lohmar, and Francis Tuan for the USDA's Economic Research Service - In 2004, China entered a new era in its approach to agricultural policy, as it began to subsidize rather than tax agriculture. China introduced direct subsidies to farmers, began to phase out its centuries-old agricultural tax, subsidized seed and machinery purchases, and increased spending on rural infrastructure.

China’s New Farm Subsidies - By Fred Gale, Bryan Lohmar, and Francis Tuan for the USDA's Economic Research Service - In 2004, China entered a new era in its approach to agricultural policy, as it began to subsidize rather than tax agriculture. China introduced direct subsidies to farmers, began to phase out its centuries-old agricultural tax, subsidized seed and machinery purchases, and increased spending on rural infrastructure. USDA Economic Research Service

The new policies reflect China’s new view of agriculture as a sector needing a helping hand. The subsidies are targeted at grain producers, but they do not provide strong incentives to increase grain production.

Introduction

During 2004, China introduced a number of policies intended to benefit farmers, a reversal of its centuries-old practice of taxing agriculture. Agriculture was for centuries China’s primary source of employment and tax revenue. In the 21st century, China has evolved into an industrial economy in which agriculture accounts for just 15 percent of gross domestic product and less than 5 percent of tax revenue. However, agriculture still employs roughly half of the labor force and rural incomes are just 30 percent of the urban average (Shane and Gale, p. 14). With a widening gap between rural and urban living standards and the threat of political instability in the countryside, Chinese policymakers now see farmers as a segment of society that needs a helping hand.

Policies instituted in the 1950s taxed farm production to subsidize urban consumers and industrial production, but those policies were abandoned by the early 1990s (Tuan, Zhong, and Ke). During the 1990s, China subsidized the procurement, storage, and export of grain, but these policies were very costly and little of this money reached farm producers. After entering the World Trade Organization in 2001, China began exploring ways to directly subsidize farmers, who were believed to be vulnerable to foreign competition (Liu, Ouyang, and Zhang). In 2004, China introduced its first national direct subsidies to farmers, began to phase out a centuries-old tax on farmers, began to subsidize seed and machinery purchases, and increased funding for agricultural infrastructure and research.

The Chinese Government has dual, often conflicting, rural/agricultural policy goals. Policies originally intended to raise rural incomes were given a secondary goal of promoting grain production when Chinese authorities became alarmed by rapid increases in grain prices following the fall 2003 grain harvest, the smallest since 1989.2 The government is trying to raise rural incomes while also trying to encourage grain production. Grain typically provides relatively low returns to Chinese farmers.

This report describes what is known about China’s new agricultural policies and how they will affect rural incomes and agricultural production. The subsidies are spread thinly over the huge agricultural population and have had only a minor impact on rural incomes. While many news reports from China credit the policies with increasing grain production, the design of the subsidies does not appear to give strong incentives to producers to alter planting decisions. High grain prices both in China and world markets during early 2004 were likely the chief inducement to plant more grain. Favorable weather also boosted grain yields. The effectiveness of the policies will become more apparent in years when world grain prices are lower.

New Policies Benefit Farmers

The Chinese Communist Party issued a “No. 1 Document” in early 2004 that gave top priority to the policy goal of increasing rural incomes. A whole range of policies has been introduced, but the two most prominent are direct subsidies for farmers and elimination of taxes on farmers (table 1). The stated goal of the policies is to raise the income of farmers, but the document also emphasizes the importance of increasing grain production.

Direct Subsidies Paid to Farmers

After several years of experimenting, China introduced its first nationwide direct subsidies for farmers during 2004 (see box, “China’s Evolving Approach to Grain Subsidies”). China’s Finance Ministry reported the total grain subsidies at 11.6 billion RMB ($1.4 billion) (Jiang). China allocated 10.28 billion RMB ($1.25 billion) from provincial “grain risk funds” to directly subsidize farmers in 13 major grain-producing provinces.3 Officials in 16 of China’s other provinces, municipalities, and autonomous regions provided an additional 1.3 billion RMB ($158 million) in subsidies to farmers in grain-producing counties under their jurisdiction.

Local authorities were urged to ensure that subsidies reached farmers before the 2004 spring crops were sown. Information about the subsidies was widely published in news media to ensure that farmers knew how much they were entitled to receive.4 Each province could set its own method for granting subsidies. The standard practice seems to be to pay farmers a set amount, generally around 10 RMB per mu (approximately $7.33 per acre), for area planted in grain.5 The method for calculating a farmer’s acreage base apparently varies from province to province, or even from county to county within the same province. In most cases, the payment appears to be based on historical production records. In a few areas, payments were tied to actual production or marketings of grain.

The subsidy varied across both regions and commodities (table 2).6 For example, in Hubei Province, the subsidy was 10 yuan per mu ($7.33 per acre) for early rice (usually a lower quality crop), but 15 yuan ($11 per acre) for summer-sown rice. In Shanxi Province, the subsidy was 10 yuan per mu for wheat and 5 yuan ($3.67 per acre) for corn. In the relatively wealthy Beijing municipality, subsidies were higher, at 50 yuan per mu ($37 per acre), with higher per mu subsidies for larger farms. Generally, oilseeds, cotton, and other crops were not subsidized, but Anhui Province did announce subsidies for rapeseed to be planted in fall 2004. Subsidies were not implemented in several poor western provinces or on the island province of Hainan. In some areas, reductions in agricultural tax were given in lieu of cash payments. The subsidies amount to roughly $2-$5 per ton of output. The subsidies per farm were also small since the average farm plants only 3-4 mu of each crop (table 2).

Table 1: Summary of China’s new agricultural policies in 2004
Estimated cost1 Description Probable effects
Grain subsidies
$1.4 billion
Direct payments of roughly $7.33 per acre planted in grain. Modest income gains for farmers. Effect on grain production is uncertain.
Agricultural tax reduction
$5-7 billion
Elimination of agricultural tax within 5 years.
Elimination of tax on specialty crops (except for tobacco).
Modest income gains for farmers. May encourage planting of specialty crops, somewhat offsetting effect of grain subsidy.
Seed subsidies
$193 million
Subsidies for high-quality grain and soybean seeds of $7-$10 per acre planted. May encourage planting of certain crop varieties.
Machinery subsidies
$5 million
Subsidies for purchase of machinery in targeted areas. Increased mechanization but little effect on output. Frees labor for off-farm work.
Rural infrastructure spending
$18 billion
Improvement of irrigation facilities, electricity generation, roads, testing facilities, other rural infrastructure. Improve productivity and marketing efficiency.
1The Chinese currency is the renminbi(RMB) or yuan. Dollar values throughout this report are calculated using the official exchange rate, currently fixed at RMB 8.28 = U.S.$1. See Shane and Gale for a discussion of Chinese exchange rates. Source: Various news reports.

China’s Evolving Approach to Grain Subsidies

In the late 1990s, China’s government-owned grain bureaus began purchasing grain from farmers at “protection” prices (see Tuan, Zhong, and Ke for details). A protection price for each type of grain was set for each local area, usually above local market prices. Grain bureaus received a modest subsidy from the government to procure grain from farmers at the protection price. Farmers could sell a set quota of grain at the protection price, and above-quota grain could be sold at market prices (usually below the protection price).

The protection price program proved to be very costly. A sharp decline in market prices between 1997 and 2001 left grain bureaus with large stocks of grain they could not sell without taking substantial losses. Much of the stockpiled grain was exported at subsidized prices, auctioned at a loss, or allowed to deteriorate to unsalable quality. Grain bureaus still have large unpaid debts from purchasing grain at protection prices. In recent years, China has eliminated protection prices in many parts of the country. Grain prices are set in free markets. Commercial grain trading has been largely privatized, often by selling grain bureau assets to local managers.

After the shortcomings of protection prices became evident, authorities began experimenting with various approaches to directly subsidize grain producers (Liu, Ouyang, and Zhang). In 2002, experimental policies were put in place in selected major grain-producing counties of Jilin, Anhui, Henan, and Hubei Provinces. Each of the provinces used a different subsidy method, including fixed subsidies not tied to the current year’s production or marketings as well as subsidies that are tied to market prices or production.

Fixed subsidies were based on either (1) historical household deliveries of grain to the government or (2) historical grain production from the household’s allocated land based on local tax records. Price subsidies paid farmers the difference between a “protection” price set by government authorities and a market price. One method used the previous year’s market price, and a second method used the expected current year’s market price. Other subsidies gave farmers a set payment per kilogram of grain delivered to government grain procurement stations. The methods for calculating these subsidies are complex, and they require extensive record-keeping on millions of small farms. As such, they are difficult to implement and administer.

In most areas, the national subsidy program in 2004 appears to have followed the fixed-subsidy model, as the payments were based on historical grain plantings. However, in some areas, subsidies apparently were tied to prices, production, or grain deliveries. Price subsidies or per unit payments possibly could be implemented more widely in future years to give producers stronger incentives to plant grain. China faces no limit on subsidies that fit in the World Trade Organization’s “green box” category. Under its commitments as a member, China can pay “amber box” (potentially market-distorting) subsidies up to a maximum of 8.5 percent of the value of its agricultural production. The limit could be has high as $30 billion based on the value of agricultural production in 2003.

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Source: U.S. Department of Agriculture, Economic Research Service - February 2005