Optimizing Public and Private Investments in Agricultural Innovations: Policy implications
Johannes Roseboom, Innovation Policy Consultancy, The Netherlands
Agricultural policymakers are usually too busy with day-to-day problems and lack the time for real reflection on their role in agricultural innovation vis-à-vis the private sector and on how to optimize public as well as private investments in agricultural innovation. In this section we want to explore the policy implications of the ideas discussed in the previous two sections.
Defining the public role
As we have argued in the second section, in a market economy, the responsibility for (agricultural) innovation lies principally with the private sector. It is only when markets fail that the government should step in – either by trying to resolve the market failure (the preferred option) or by assuming direct public responsibility for certain agricultural innovation activities (the last resort option). This market economy definition of the public role in agricultural innovation is substantially more limited than the centrally-planned economy definition, which places the responsibility for agricultural innovation squarely in the hands of government.
In order to resolve or moderate the market failure, it is important to understand the cause and depth of the market failure at stake. The private sector failure to invest sufficiently in agricultural innovation (at least from a societal point of view) is caused primarily by the fact that often a substantial part of the potential benefits of the private innovation investment spills over to others, either horizontally (the spillover of benefits to competitors) or vertically (the spillover of benefits to the consumer). These spillover effects seriously undermine the expected private profitability of investment in agricultural innovation in general and hence have a negative impact on the economically optimal volume of investments. Moreover, there is the problem of duplication of effort.
The horizontal and vertical spillover losses are not the same for all agricultural innovation activities. The horizontal spillover loss, for example, depends on the relative excludability that one can impose. Such excludability tends to be quite weak for research (although this can be improved by introducing IPR), but is stronger for innovation activities such as knowledge acquisition, training, marketing and promotion.
Measures to reduce the horizontal spillover of agricultural innovation benefits include: (i) the introduction and enforcement of IPR legislation (including plant breeders’ rights); and (ii) the promotion of collective action by the economic actors in agricultural value chains. In the latter instance, one can reduce horizontal spillover to nominally zero (at least at the national level) by imposing an obligatory levy or cess to finance innovation activities.
In the case of vertical spillover, a high share of the innovation benefits spilling over to consumers (e.g., in the form of lower prices or better quality) reduces the profitability of innovation for private actors in agriculture – both individually as well as collectively. This is in particular so for food staple crops, which tend to have a price elasticity of demand that is relatively inelastic (i.e., a change in price has a relatively strong effect on demand). The consequence of this is that any increase in supply resulting from innovation is met by a decline in price and so passing on a large part of the innovation benefits to the consumer.
There is little that one can do about the price elasticity of demand itself. Only when people get richer does the price elasticity of the demand for food products becomes more elastic – rich people eat a more diverse diet and therefore have more substitution options.
One important measure that governments can take in order to dampen the effect of inelastic demand is trying to improve the link between the local and international market. In this way, any deficit or surplus in the local supply can be moderated and extreme fluctuations in price avoided. It basically puts a price floor and ceiling in the market. Much of such integration into regional and international markets depends on the transport infrastructure. Successful market integration reduces the vertical spillover problem and thereby makes it more attractive for the private sector to invest in agricultural innovation.
Vertical spillover of benefits can also be strong for innovations that target societal issues such as the environment, animal welfare, etc. The private incentive to invest in these topics is usually quite minimal, as most if not all benefits accrue to the society at large. This is another case where public investment in agricultural innovation seems to be warranted. Another possibility, however, is to announce the implementation of stricter environmental or animal welfare standards and this led the private sector to innovate and develop its own solutions.
Table 1 summarizes in a very stylized way, the possible combinations of public, public-private, and private implementation and funding of agricultural innovation in a market economy that matches with the horizontal and vertical spillover of innovation benefits. The table can help to differentiate government support to agricultural innovation and tie it more strongly to the level of market failure in generating agricultural innovation. For example, the traditional export crops (such as coffee, tea, cocoa, palm oil, sugar, rubber, etc.) tend to fit in the bottom right quadrant. There is no (or minimal) spillover of innovation benefits to local consumers and the problem of horizontal spillover of innovation benefits is usually countered by strong collective action in the form of commodity boards that have the right to collect a tax and organize their own innovation activities.
Table 1: Differentiation of government support to agricultural innovation based on expected market failure to invest in agricultural innovation
|Spillover of innovation benefits to other producers|
|Spillover of innovation benefits to consumers or society at large||High|| |
Executing agency: public
Funding: predominantly public
Executing agency: public-private
Executing agency: public
Executing agency: private
Funding: predominantly private
In the case of extension or advisory activities, it is important to differentiate between approaches that bank on the horizontal spillover effect (such as the classic training and visit approach, but also radio broadcasting, demonstration farms, etc.) and approaches that aim to give tailor-made advice to individual farmers. In the latter instance, the excludability is a lot stronger and hence it is a lot easier to charge farmers for it individually.
Optimizing public support to agricultural innovation
In addition to the differentiated support strategies discussed above, it is important to make sure that the available public resources are invested in the most promising agricultural innovation opportunities. In an ideal market economy setting, the selection of economic-growth-oriented agricultural innovation opportunities should be based on expected profitability. The use of cost-benefit analysis in the selection of agricultural innovation projects is quite common in the private sector (and certainly so in the bigger companies), but is still quite rare in the public sector and it is rather unlikely that this will change in the immediate future. Nevertheless, there are some important developments in public management that are conducive to a more optimal (i.e., economically rational) allocation of resources: 
- The introduction of performance-based budgeting. Performance-based budgeting aims to improve the efficiency and effectiveness of public expenditure by linking the funding of public sector organizations to the results they deliver, making systematic use of performance information collected and validated through monitoring and evaluation (M&E). This definitely comes at a cost of more administration and paperwork. The benefit side, however, is that: (a) performance-based budgeting forces government programmes to look more critically at their own activities and performance as they have to formulate more explicit and quantitative performance targets; and (b) information about expected and actual results should help policymakers to make better informed (budget allocation) decisions. These performance targets are definitely an improvement over the old situation in which the control focused on the use of inputs, but hardly on the outputs and outcomes of government programmes. Performance targets are not perfect, but they are a step in the right direction. Moreover, performance targets can be refined over time. However, several important conditions have to be fulfilled in order to reap the benefits of performance-based budgeting, including: (a) a strong political commitment to government transparency; (b) sufficient administrative capacity at both the budget holder and the implementing government programme to operate a performance-based budget; and (c) on time release of approved budgets (largely dependent on macro-economic stability) and greater managerial flexibility at government programme level.
- The introduction of competitive funding schemes for agricultural innovation activities. Although initially primarily used to allocate public funding to basic research, the competitive funding instrument has become increasingly popular in recent years as a way to allocate public funding to economic-growth-oriented innovation activities. One reason for this popularity is that these schemes can accommodate shared public-private financing of innovation activities more easily. Another reason for their popularity is their ability to facilitate cross-institutional collaboration. Some of the economic-growth-oriented competitive schemes request a cost-benefit analysis and an ERR as part of the proposal, but this is not common practice. Instead, the selection is usually based on a multi-criteria analysis performed by a panel of experts. The end result of this selection may come close to the economic optimum, assuming that: (a) the selection criteria are sufficiently conducive to economic rationality; and (b) there is sufficient economic expertise in the selection panel to evaluate the economic dimension of the project proposals.
- The stronger focus on the outputs and outcomes of publicly financed agricultural innovation activities also gets translated into a greater involvement of the ultimate beneficiaries in identifying and prioritizing agricultural innovation opportunities. This can range from the use of consultations (in various forms of intensity) to appointing beneficiaries on the boards of the executing agencies. A tool that is being used quite frequently to ensure that the agricultural innovation services provided are reflecting farmers’ needs is to require from farmers a small contribution (either in cash or in kind) to the project.
Characteristic for many of the recent public management reforms is that they change the way public resources are being allocated across competing priorities. They put far more emphasis on the outputs and outcomes generated by government-funded programmes and projects than the more traditional budget allocation processes. As a consequence, public agricultural research and extension agencies have to learn how to measure and document the (expected) impact of their activities, define clear performance indicators, keep track of these indicators through M&E and feed that information back into the budget allocation process. Instituting this process is not always easy, because it may trigger resistance. Performance-based budgeting and competitive funding are often rejected as overly bureaucratic, only creating a lot of paperwork with little or no direct benefits to show for it. Such resistance may also lead to poor implementation of the process, which then turns into a self-fulfilling prophecy (a classic example is the failure to set up a properly functioning M&E unit). There is still a lot of work to do to get these public management reforms implemented properly.
In addition to the increased focus on results, recent public management reforms are also trying to improve the relevance of those results by involving farmers, consumers and other stakeholders in the identification and prioritization of innovation opportunities. The idea is that funding requests gain in strength when they are based on such joint action.
In terms of mobilizing resources for agricultural innovation activities, it is important to master the new rules of the game. Those agencies that fail to do so will lose out. Moreover, at the aggregate level, one can still lobby for more resources to be invested in agricultural innovation activities, but this should be complemented with a portfolio of well-prepared agricultural innovation project and programme proposals that are worthwhile funding.
Chema, S. Gilbert, E. and Roseboom, J. 2003. A Review of Key Issues and Recent Experiences in Reforming Agricultural Research in Africa.ISNAR Research Report No. 24, ISNAR, The Hague, Netherlands.
 See also Chema et al. (2003) for a more comprehensive discussion of the public management reforms in agricultural research.
 For example, a performance target for a plant breeding programme can be initially defined as the number of new varieties released. At a later stage, one can refine this by requesting information on the uptake of these varieties by farmers.
 Common problems with the selection criteria in competitive funding schemes are: (a) too many criteria, many of which tend overlap; and (b) not using minimum thresholds for essential criteria.
 It is also a classic case of incongruence between costs (more paperwork for research and extension officers and administrators) and benefits (a more optimal allocation of resources at the aggregate level).
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