Processing and distribution functions

2.31 Several types of infrastructure, information, and other resources needed for efficient food processing and distribution functions have characteristics which may inhibit private investment in specialized activities, contribute to non-competitive market structures, and/or weaken the competitiveness of a commodity system. For example, certain types of infrastructure necessary for marketing have either public good properties or are subject to such large economies of scale as to result in natural monopolies in all but very large countries. Roads are an example of the former and rail and port facilities of the latter. Private firms engaged in food marketing will generally lack the capacity to invest in such facilities, the absence or poor quality of which will reduce producer incentives, raise marketing costs and restrain trade in certain directions.

2.32 While not featuring economies of scale as significant as for rail and port facilities, others types of marketing infrastructure do nevertheless entail 'lumpy' investments which can serve as a major barrier to entry. Investments in certain modern processing, storage, transport, and trading facilities provide the investor, at least initially, with an operational capacity far in excess of current supplies or supplies expected within a few years. The large unit operating costs in these initial years, together with uncertainty about future raw material or commodity supplies, may inhibit many private firms from undertaking such investments. In the absence of a well functioning stock or financial market, there may be few local means to pool the risk associated with such investments. Hence, in certain cases, private firms may not be able to perform the necessary risk-bearing function. For some infrastructure, there are also possible negative externalities as with the environmental effects of marketplaces and abattoirs.

2.33 Uncertainty will be especially strong for a new or highly specialized product which requires specialized processing or other facilities and equipment. In the short run, while supplies of the targeted product(s) are being built up, the specialized equipment may not be applicable to other, currently available, raw materials and commodities. Under such a condition of 'asset specificity', the processor/storer/transporter is locked-in to a certain type of operation and becomes vulnerable to the bargaining pressures of raw material suppliers and product buyers who possess alternative production, trading, or consuming options.

2.34 The processing, transport, and storage of raw materials and commodities takes time. The ability to participate in such activities thus depends on access to finance, both to pay for raw materials/commodities purchased and to cover the interest and other costs of goods held in storage or transit. The availability and cost of credit is thus an important factor in the entry and viability of firms and individuals in the marketing system.

Many private financial institutions have limited experience lending for agricultural marketing and processing. Limited recognized collateral and information asymmetries are again a potential problem.

2.35 Several additional functions are associated with economies of scale which may inhibit entry and therefore result in concentrated market structures. Both crop intelligence and market research feature economies of scale and scope with certain 'lumpy' investments in assets (e.g. computers, databases) and with advantages accruing to those with information sources in several locations and those trading in multiple commodities. Product promotion is also associated with economies of scale or scope, with a certain threshold level of trade and supply capability being necessary for such promotion to be worthwhile. There are both large sunk costs and large commercial risks associated with launching a new product, this again serving as a potential barrier to entry or sustained competitiveness.

2.36 Product promotion may also give rise to externalities, although this may depend upon the specificity of the promotion. Promotion of generic products (as opposed to individual brands) presents 'free rider' problems as some producers/traders can benefit from promotion without contributing to its costs. A related issue is the promotion of an overall industry or country within international markets. This too features economies of scale and externalities. For some product groups, especially fresh produce, there are potential advantages in promoting a national image for quality. This image or reputation is a public good: all firms in the industry are associated with it and new entrants into the trade inherit it. The reputation needs to be protected. The supply of substandard produce by one producer/exporter can jeopardize a whole commodity system's reputation, with adverse affects on market access or realized prices.

2.37 In an international context, transaction costs alone may serve as a major barrier to trade for many individuals and firms. In setting up a trade, exporters are likely to incur higher search and bargaining costs than domestic market traders. Physical distance to the target market(s) constrains access to information about trading opportunities, while an expectedly less dense information network will yield less complete information regarding the capabilities, financial solvency, and other characteristics of buyers or agents. Physical distance and/or language barriers may prevent face-to-face negotiations and contribute to an extended bargaining process. International traders may be unfamiliar with the standard trading practices in the opposite country and this may contribute to misperceptions about respective bargaining positions and tactics. Large geographical distances between traders increases logistical costs and risks and limit the scope for direct monitoring of trade partner performance. The enforcement of international contracts may prove very difficult and costly due to weak legal integration of countries and to the more limited scope for social group or trade association pressures on contract defaulters.

2.38 Table 3 summarizes some of the economic properties of major marketing infrastructure and functions. The table indicates that while relatively few of the facilities and services have public good properties, many are associated with externalities, economies of scale/scope, and/or moral hazard problems. Such properties, together with the important problems of risk, transaction costs, and logistics management might inhibit private investments in specialized production and marketing activities and/or reduce the degree to which such investments are privately and socially efficient. Table 4 summarizes the discussion in an alternative way by identifying possible gaps or bottlenecks in the flows of physical commodities, information, and/or financial resources within commodity systems which might stem from the inherent technical and economic characteristics of food products, production, processing, and marketing.

2.39 This analysis leads to the conclusion that while direct public sector involvement in the production and marketing of high-value foods can be economically justified in only very limited circumstances (e.g. in 'infant industry' contexts), the public sector may have important roles in commodity system development through the provision of physical infrastructure, the supply of market and technical information, the design and enforcement of standards (for inputs, products, and facilities), the implementation of programs and other measures to reduce or spread risks, and/or the encouragement of entry and competition.

Table 3: Economic Properties of Infrastructure and Functions Associated with Food Marketing

Table 4: Generic Barriers to Commodity System Flows