Which model of agricultural sector support does Ukraine need?

25 October 2018

Ukraine has been actively subsidizing national agriculture since the beginning of its independence. At that, according to OECD calculations, before 2017, a major share of state support for agriculture was transferred to enterprises not in a form of direct budget subsidies, but in a form of tax allowances.

In addition to the tax allowances, the state was using direct subsidies per ton of output as well as general subsidies. In 2017, in response to a request from IMF and World Bank, the state abolished the special tax regime and switched to direct subsidies. In 2017, distribution of such support was performed pro rata to paid VAT, while, in 2018, the state divided 6.3 billion UAH of the support funds into special “resource subsidies”. Currently, new payments are directed at:

  1. Development of farm enterprises — 1 billion UAH
  2. Partial compensation of expenses on construction and renovation of animal farms, including a credit financing — 2.3 billion UAH
  3. Support and purchasing of young cattle stock and subsidies for maintaining milk and dual purpose cattle — 1.2 billion UAH
  4. Credit support program — 200 million UAH
  5. Partial compensation of expenses on purchasing Ukrainian-made agricultural equipment — 945 million UAH

In 2017, a budget subsidy for animal husbandry was the largest in the agricultural sector. According to the Law of Ukraine “On state support of agriculture in Ukraine”, its main purpose is in maintaining actual demand level for consumers and protection of animal production enterprises from bankruptcy. From economic point of view, this means increase in domestic supply of consumer goods and increase in productivity, which provides a real protection from bankruptcy. Our analysis demonstrated, though, that it failed to work for Ukraine because the direct support:

  1. Negatively influenced companies’ development without providing a real protection from bankruptcy and hampering their development
  2. Reduced domestic stock of agricultural products due to reduced production volumes and exports increase;
  3. Increased a share of raw materials exports
  4. Impeded inclusive growth of the sector due to problems with rent seeking and provision of major share of support funds to four largest producers

Many countries of the world abandoned the policy of direct subsidies provision to agricultural producers. Instead, they are employing alternative state support models:

  1. Substitution of direct support with general support: Although a shock therapy and abolishment of direct transfers lead to bankruptcies of a large number of farmers, in 20 years’ time New Zealand became one of the most successful countries in terms of agriculture development
  2. Substitution of direct financial support with insurance benefits: Instead of paying agriculture producers for output, the U.S. and Australia governments conclude insurance contracts with farmers. Such contracts allow farmers to cover their losses from unfavorable environmental conditions and reduce effect of seasonal and cyclical fluctuations on prices
  3. Provision of loans on preferential conditions and financing of research in agricultural sector: This subsidies model was chosen by Canada and the Netherlands, they are assisting farmers’ development and provide extended access to financing

Ukrainian animal husbandry is unique not only due to a fact that is has been subsidized by the state during 8 years already, but also due to its high level of market concentration. According to the Head of the Antimonopoly Committee of Ukraine, three largest producers, PrJSC “Myronivsky Hliboproduct”, LLC “Agro-Oven” Corporation, and LLC “Complex Agromars”, hold 55% share of animal production market. When you see their financial standing, it is difficult to tell they are in need of any support. A subsidies’ distribution mechanism was constructed in such way, however, that, together with PrJSC “Ukrlandfarming”, these four giants has been consuming, on average, 44% of the state support on a monthly basis.

According to CES analysts, abolishment of the direct support for agricultural sector and promotion of new technologies is the model that would result in a qualitative breakthrough in the sector through promotion of a sustainable economic growth. The sooner such subsidies are abolished the less painful would be an economic reaction to this reform.

CES recommendations regarding the agricultural sector subsidies model are as follows:

  1. Direct financing support for agriculture is harmful to its recipients and should be abolished.
  2. The Law of Ukraine “On state support of agriculture in Ukraine” should be revised and reoriented to increasing production and accelerating real economic growth.