Monday, September 21, 2015

Quit sugar for small holder banana economy...

Uganda is the ultimate banana republic (no pun intended). Ugandans consume more bananas per person than anyone else on earth. I have remarked in the past on the Jubilee administration’s penchant for skidding on banana skins. You might expect that while in Uganda, they would watch out for banana skins. No such thing.
It is difficult to fathom how the administration would have put out a message that could be construed to mean they had traded milk for sugar. Commercial dairying being a predominantly Kikuyu-Kalenjin affair, and sugar cane a Luo-Luhya one, even ignoring for the moment the President’s conflict of interest issues, the political dimension of it would still have made it the most slippery banana skin that the administration has stepped on to date. But such is the nature of mediocrity. Just when you think it could not get worse, it does.
Why is Kenya’s smallholder tea successful and cane sugar a dismal failure? There are three factors. The first is market orientation, the second is the nature of the products and the third is the business model.

Market orientation.
Tea is an export crop, while cane sugar production was established as an import substitution industry. Because Kenyan tea farmers have to sell their produce in the world market, they have to be globally competitive. That is, they have to produce profitably a product the tea consumers out there want, at a price that they are willing to pay.
If they were not able to, there is not much that the government could do to protect them from competitors. It could be argued that the government could subsidize them. Perhaps, but not for long. It would quickly fall foul of competitors, who would report to the WTO. If that did not work, the competitors would do the same and being more competitive to begin with, the subsidy war would bleed us more.
The sugar industry on the other hand is a classic case of the pitfalls of import substitution. There are two of them. The first is that import substitution industries were seldom based on viability. Rather the argument was, we are importing so much of this product, why can’t we produce it ourselves?
The question that was seldom asked when import substitution industries were started was: can we produce our own competitively?
More often than not, the size of the market was hardly big enough for a viable industry. In the case of sugar, there was also immense political pressure — central Kenya had cash crops, coffee and tea, while western Kenya had none.
The second pitfall is that of infant industries refusing to grow up. Once an industry was given protection, there was no incentive for it to become efficient. In fact, the reverse happens.
The industry acquires political clout that ensures it is never exposed to competition. One way of doing this is ensnare the policy makers so that they acquire vested interests in keeping the industry protected no matter how inefficient. In the 70s, foreign investors did this by making policy makers sleeping partners, suppliers and distributors.
The infant industry problem is compounded if the industry is State -owned as is the case with our sugar industry. The industry becomes a gravy train for the elites since they know the State will always bail it out. This is precisely the case with our sugar industry. For well over a decade, we have sought protection from COMESA imports and have done nothing to make the industry competitive. We are not about to.

Product characteristics.
The reason why Kenya’s smallholder tea is successful, in fact the most successful in the world, is because smallholder farmers are able to produce much higher quality tea than plantations. The reason is deceptively simple. The smallholder farmers pick ‘two leaves and a bud’ – the shoots that give the best tea. Plantation workers are paid by weight so they pick three or four leaves.
Even if the plantation wanted them to pick two leaves, the supervision costs of enforcing would be too high. It would need an army of supervisors to inspect every basket. And of course the supervisors could always collude with the pickers for a share of the additional earnings.
The only foolproof solution is for the plantation owners to inspect every basket. In economics, we call this a principal - agent, or incentive compatibility problem.
Sugarcane is the complete opposite. Smallholder sugar does not command any quality premium over plantation sugar. If anything, the labour value-added is very little. Labour is required during planting and harvesting. In the intervening period - close to two years—farmers do very little. The earnings from sugarcane production are in essence returns to capital and land rent.
To illustrate, let us suppose sugarcane is grown by an absentee landlord. The cane is sold in a competitive market. The alternative is to rent out the land at Sh5,000 per year. It costs Sh50,000 per acre to grow a crop which takes two years.
Even assuming a very generous return on capital at 20 per cent per year, in a competitive market, and equally generous “entrepreneurial rent’ at 10 per cent of capital employed. In a competitive market, the returns to the absentee landlord would be Sh35,000. An average smallholder farmer in Meru who picks her own tea will have made at least Sh300,000 on an acre of tea.
Of course the two are not directly comparable. The tea earnings include returns to labour (about 50 per cent), which for the telephone farmer is a cost. Half of the balance is the quality premium. Once direct costs such as fertilizers are taken care of, the returns per acre become comparable to the sugarcane growing absentee landlord. And that is precisely the point. The purpose of smallholder cash crop farming is to provide them with profitable self-employment—to make them small capitalists, not slaves of capital.
Business model.
The architects of Kenya’s smallholder tea industry were remarkably clever and foresighted. In the 60s, state ownership of enterprises was in vogue. They went against the grain and chose outgrower owned, private sector managed enterprises.
The State, through the Kenya Tea Development Authority (KTDA), guaranteed loans to the factories which were repaid by deductions from farmers earnings. The factories were managed by the multinational tea plantation companies on contract and progressively replaced by the KTDA as local capacity was developed.
This is why the privatization of the industry did not entail sale of assets. The farmers had financed the assets. The State had simply been a facilitator and custodian.
The sugar industry took the State- ownership route. The one exception to some extent was Mumias which was a joint venture between the government and Booker Tate, a multinational sugar company, which managed the company until it was privatized and management localized. The rest is history.
Privatization is not a solution. As noted, the contribution of sugarcane to the value of sugar is comparatively little. Most of the value is created at milling, which is capital intensive. Sugarcane today is politically priced at well above its economic value.
The cost is paid by consumers twice, directly through high prices, and indirectly as taxpayers through bailouts. Private millers will have no business paying for cane more than its economic value.
There is no business model I can think of where, in a regionally integrated competitive market, sugarcane would emerge as the best alternative for western Kenya’s smallholder farmers. The only one with a fighting chance is if the government gives the farmers the mills, debt free, but this entails a huge assumption—that the farmers would run the mills efficiently. Doubtful.
One of the arguments forwarded against the Uganda deal by among others, my good friends Prof Anyang Nyong’o and Dr Mukhisa Kituyi, is Uganda does not have a sugar surplus and the deal will be a conduit for barons to bring in sugar from farther afield. I don’t disagree that mischief could be afoot, but the surpluses argument should not arise.
The EAC Common Market Protocol was signed in November 2009. It became effective on July 1 2010, with a five-year transition period which ended on June 30 this year. The EAC is now legally a single market. In a single market, you produce where it is cheapest and sell where it is most profitable. The Ugandan millers are not obliged to satisfy the Ugandan market first before selling in Kenya or any of the other EAC countries for that matter.
They are not demanding market access because they have a surplus, but because the Kenyan market is more profitable. They are entitled to our market. Moreover, you don’t produce a surplus and then look for a market. You find a market and then produce for it.
We may be able to stave off external competition for a while, but the bell has tolled for western Kenya’s sugar industry. The Kerio Valley Development Authority (KVDA) estimates that it can grow sugarcane on large scale at a quarter of the western Kenya cost in the Turkwell basin. Tana River County can put more land under large scale irrigated sugarcane than the entire western Kenya sugar belt with plenty to spare. The Ugandan millers or other investors could, and probably will, invest in large scale production here. Are we going to stop them?
What are the alternatives for western Kenya? There is no shortage of them, and at any rate, the lesson the region should learn from sugarcane is that mono-cropping is a bad idea. As I hope I have demonstrated, the alternatives should be evaluated on two criteria. The first is that it is labour intensive, meaning, it enables the farmers to employ themselves.
The second is that the farmer accounts for a high percentage of the end value of the product. A good example is, lo and behold, milk! Dairying is labour intensive, cows (or goats) must be fed and milked every day. Second, milk comes from the cow ready to drink.
That is as high a percentage of end value as you are likely to get. Processing i.e. pasteurizing and packaging fresh milk does not add value to milk per se, it simply improves the logistics of getting it to a mass market.
Most Kenyans in fact prefer their milk straight from the cow. As it happens, there is a technology, the “milk ATMS”, which is making it possible for farmers and consumers to cut out the processors from the value chain.
The milk ATMS have taken the market by storm, in the US and Europe as well. It is a good example of a highly disruptive technology. In the US, the milk processor lobby has secured bans in several states.
The informal market controls 80% of the Kenyan milk market; may the guys who sell chopped sugar cane may soon have a dominant share....