Enhancement of governance in the agro-industrial sector at regional level

Adukov R.H., Doctor of Economic Sciences, Professor; Head of Division; All-Russia Research Institute of Agriculture Economy, Labor and Governance (VNIETUSH)

This article was published in the proceedings of the Second All-Russia Economic Forum “Structural Policy and Economic Development of Food Processing Industries” (December 12–13, 2007)

Current situation in the sector

The profound reforms in the agro-industrial sector have been implemented for nearly 17 years, actually without any external or internal encumbrances. However, only the minor part of regions succeeded to reach or to surpass the pre-reform output level and only in several types of products (wheat, sunflower, poultry, etc). Therefore, the agricultural situation can not be considered as satisfactory.

In Russia the successes and failures of the agricultural sector are commonly unjustifiably associated only with the RF Ministry of Agriculture. But actually many governance functions are outside the scope of this government agency and are allocated to numerous authorities. This evidences that the agro-industrial sector development is not the ministry-specific, but the national task.

In the recent years thanks to strengthened government’s attention to agricultural producers the agricultural situation has been stabilized to a certain extent. For instance, according to the RF Ministry of Agriculture in 2001 — 2005 the share of profitable large-scale farms had increased by 4% (from 54% to 58%). However, the number of such farms had decreased by 3% or by 501 entities (from 16 041 to 15 540).

According to accounting records in the period from 2001 to 2005 the farm profits before tax (including subsidies) had increased by 45% (from RUB 23 922 million to RUB 34 778 million). At the same time the overall profitability level had decreased from 8.8% to 7.6%. That was because the losses of unprofitable large-scale farms increased faster than profits of profitable farms.

As it is known, in the market environment the cattle breeding became the most unprofitable industry in the Russia agricultural sector. This entails dramatic decline in cattle herd numbers and leads to undermining of this important industry with all relevant implications. For instance, while in 2001 the cattle population on large-scale farms comprised 16 509 000 heads, in 2005 — 12 117 000 heads (the decline by 26.6%). There are grounds to suppose that it is the herd number decline that contributed to increased profits of large-scale farms. Anyhow, the greatest growth of farm profits was monitored in the Central, North-Western and Ural Federal Districts, where the greatest reduction of cattle numbers was experienced.

Currently the domestic agrarian sector suffers from other negative trends as well: high growth rates of indebtedness, curtailment of arable land area (including per farm area), ongoing outflow of human resources from rural areas. Overall, these processes demonstrate that resource potential of the sector tends to decline.

Causes of the sector lagging

Agricultural officials tend to refer to various reasons of the sector lagging, such as unfavorable climate, national specifics, the socialist past, etc. However, the analysis demonstrates the groundless of these arguments and indicates that agro-industrial sector challenges are associated with inadequate governance in the sector. The world experience shows that if the governance system in the agro-industrial sector meets the requirements, 85-90% of agricultural producers operate efficiently. In Russia the majority of large-scale farms — backbone entities in the sector — demonstrate some signs of bankruptcy. This is the convincing evidence that the government agricultural policy does not meet the market economy requirements.

It can not be said, that the agricultural authorities do not undertake measures to overcome the crisis in agriculture. For instance, the federal law “On Financial Revitalization of Agricultural Producers” and the federal law “On Insolvency (Bankruptcy)” were enacted in 2002; the RF President Decree “On Supplementary Measures to Improve Financial Position of Agricultural Producers” was enacted in № 784; “Agro-Industrial Sector Development” priority national project was initiated in 2005, the federal law “On Agricultural Development” was enacted in 2006; the Government Program of Agricultural Development and Agricultural and Food Market Regulation for 2008-2012 was adopted, etc.

However, these and other measures have not produced the desirable outcome, since they were not oriented on survival and efficient operation of farms headed by managers with average capabilities. As experience demonstrates, if this requirement is not addressed the agrarian sector in any country experiences crisis.

Overall, the existing situation necessitates profound adjustments in the Russian agricultural policy. The practice demonstrated that cosmetic measures undertaken in the context of the minimization of the government role in the national economy, which were counted on until recently, were unable to foster agricultural competitiveness and efficiency. This is convincingly evidenced by the global trend towards strengthened government role in agricultural development.

In order to identify ways to encourage agricultural development, first of all, it is necessary to reveal barriers. Our studies show that the sector development is hindered largely by two major factors: lack of acceptable business environment and lack of rural local self-government. These underlying factors are closely interlinked: the agricultural growth contributes to social rural development; the modernization of self-government contributes to social infrastructure and agriculture development.

Functions of public governance in agro-industrial sector

The purpose of the public governance in agriculture is to create conditions for efficient operation of agricultural producers. To achieve this purpose the government should assume a considerable number of responsibilities, which it does not perform appropriately now. In particular, this refers to formation of inter-industry (input-output) balance and intra-industry balance. For instance, in the last 5 years due to input-output disproportions the average growth of prices on farm machinery, equipment, fuel & lubricants and other inputs has amounted to 15%. As a result, for example, wheat production costs have increased by around 2 times in in-kind terms (from 0.8 — 1 tons of grain per ha to 1.5 — 1.8 tons). In this context it has become quite problematic to ensure sustainable operation even for financially strong large-scale farms. Russia’s accession to the WTO is likely to aggravate the situation in the sector.

The main tool to optimize the input-output balance is the government financial support to agricultural producers. The analysis shows that in the current context the minimum level of such assistance should exceed 5-6% of the Russian budget expenses, moreover, provided the current level of tax withdrawals from agricultural producers is maintained (the amount the government support can not be considered separately from taxes). In 2005 the farm taxes reached RUB 36.2 billion and including statutory charges — around RUB 56.8 billion or RUB 1 360 000 and RUB 2 135 000 per farm and RUB 407 and RUB 637 per 1 ha of arable land correspondingly.

The agricultural input-output disproportions are largely generated because in this country the agricultural producer cooperation tends to develop too slowly. The reasons include the lack of confidence in the society (ownership rights are not adequately safeguarded) and the fact that the majority of large-scale farms have lost processing and servicing enterprises, as a result the latter have become the monopolists.

The role of agricultural cooperation in establishment of civilized, i. e. fair market relationships is extremely high. The German experience is indicative in this respect. For instance, in Germany the farmers’ share in retail milk price is around 60% (in Russia this indicator is 25-30% at best).

The practice shows that without the pressure of cooperative sector that contributes to establishment of a certain market balance, it is impossible to form optimal distribution proportions between agriculture and food processing. Surveys of agricultural specialists indicate that the most of them tend to limit government support measures only to financial assistance for agricultural producers. At the same time, the successes of advanced economies in the agrarian sector are associated with the comprehensive nature of the government support of own farmers. For instance, the USA, Canada and other countries provide information, legal, innovation, marketing, insurance and other support to their farmers (in addition to the financial assistance).

For example, federal authorities actively promote farmer interests in the foreign markets, finance creation and maintenance of expensive market and social infrastructure facilities required for sustainable operation of agricultural producers.

In the recent years the advanced countries have paid special attention to innovation support of the sector. For instance, in the USA there is the extension system that, like a strong pump, collects, systematizes and disseminates new research and technologies that contribute to modernization of the agricultural sector. The core element of this system is the US Department of Agriculture — one of the largest public bodies. The USDA collects and processes huge amounts of information; considerable part of it is used to enhance farm innovative development. It is the active role of the government that has become one of main drivers of high efficiency and leading positions of the USA in the world agricultural and food market.

Overall, the investigation of advanced agricultural policies enables to conclude that in the current context the agricultural competitiveness is feasible only provided the government performs a considerable part of agriculture development functions. In other words, the creation of acceptable business environment for agricultural producers requires the government engagement in a wide range of functions: political and administrative support, creation of inter-industry and intra-industry balance, protection of ownership rights, legal support, innovation support, etc (Table 1).

Table 1. Functions of public governance in agriculture

#	Functions
1	Political and administrative support (creation of favorable environment)
2	Financial support, insurance (direct and indirect assistance)
3	Information support
4	Innovation support
5	Marketing support
6	Legal support
7	Provision of access to inputs within reasonable terms (to financial, physical and information inputs)
8	Professional development of agricultural human resources
9	Access to marketing outlets
10	Protection of domestic market, encouragement of internal competition
11	Support of food market equilibrium (government procurement, interventions)
12	Protection of ownership rights (including small owners)
13	Encouragement of agricultural research
14	Supply of elite seeds and animal breeding stock
15	Construction and maintenance of expensive infrastructure facilities
16	Establishment of acceptable and stable rules of play
17	Control and enforcement of established rules of play

As it was noted above and is clear from the table the most government functions are outside the scope of the RF Ministry of Agriculture. Therefore, the formation of acceptable business conditions in the agricultural sector is the national task that requires consolidated efforts of many ministries in charge of: local government support (political and administrative support), economic policy of the RF Government (creation of input-output balance), enforcement (protection of ownership rights, etc).

The studies show that the quality of implementation of the considerable part of the above listed functions does not meet the requirements. This means that the government does not appropriately perform its functions in the agro-industrial sector.

Financial assistance and its priorities

The experience shows that the agricultural situation depends not only on the amount of support, but its efficient use as well. This is confirmed by situation in a number of regions, which are leaders in the agricultural financial support, but their farming performance indicators do not exceed the average level. The investigation of this issue draws to the conclusion that the weakest component in the agricultural production is human resources. The acute deficit of professional managers, subject-matter specialists and farm workers impede wide application of advanced practices. Therefore, the key priority in finance allocation should be to strengthen human resources in the agricultural sector.

The second important issue is the availability of high-performing and high-quality machinery and equipment. In other words, a person equipped with modern knowledge and machinery is the main factor to foster productivity and to reduce unit costs in agriculture. It is important to note that the treatment of the government financial support as “gratification”, as has been cultivated in Russia over the whole reform period, is inadmissible. The financial assistance is only one of government tools used to create an objectively required input-output equilibrium, taking into account the sector specifics, i. e. to ensure parity in the national economy, since without it the crisis is inevitable.

The priority areas of this assistance, in addition to the direct financial assistance, include: control of prices on products and services of natural monopolies, reasonable tax, lending, investment, pricing and insurance policies. It should be noted that market mechanisms of regulation of business entities are much more complicated than administrative ones, and, consequently, require higher professional qualification of decision-makers, first of all, at the federal level, and stronger efforts of those, who implement these decisions at government authorities of all levels.

Governance structure in agro-industrial sector

The foreign experience suggests that the AIS governance system should be based on eight functional blocks. To ensure comparability the table 2 presents the existing, previous and recommended structure of the RF Ministry of Agriculture. As one may see, the current structure has more similarities with the recommended one than the previous structure (that was predominantly industry-centered).

Also it is easy to note that the functional blocks of the recommended structure reflect problems, which hinder the sector development. Therefore, the methodology used by us to justify the governance structure, was called “the problem-functional” one. This methodology has a universal nature and may be used not only to design sector-specific, but also production and territorial management systems.

In the recommended structure all activities associated with strengthening of human resources and physical inputs supplies are integrated into a single block — “resource supply”. This is done in order to address these challenges more efficiently, including rational investment and loan use to enhance the sector resource base.

It is recommended to consolidate all government support forms in “optimization of business environment” block and to consolidate all types of government control over business entities in “government control” block. As for “government property management” block it is proposed to focus attention on development of seed production, pedigree livestock, etc.

Table 2. Comparative analysis of institutional structure of the Ministry of Agriculture of the Russian Federation

Structure of Departments of the RF Ministry of Agriculture
prior to 10.01.2006	existing	recommended
1. Administrative and Civil Service Department	1. Administrative and Civil Service Department
2. Region Relations Department	2. Administrative and Region Relations Department
3. Control and Audit Department		1. Government Control Department
4. Legal Department	3. Legal Department	2. Legal Department
5. Crop Production Department	4. Industry Development Department
6. Chemicalization and Plant Protection Department
7. Pesticide and Agrochemical Testing and Government Registration Division
8. Livestock Production and Breeding Department
9. Veterinary Department
10. Land Improvement and Agricultural Water Supply Department	5. Land Improvement and Technical Support Department
11. Forestry Department
12. Hunting Resources Protection and Enhancement Department
13. Economic and Finance Department	6. Finance and Accounting Department	3. Resource Supply Department
14. Accounting Department
15. Agribusiness, Food Processing and Baby Food Department	7. Agribusiness, Food Processing and Product Quality Department
16. Agricultural Policy and Property Relations Department	8. Agricultural Policy and Rural Development Department	4. Business Environment Optimization Department
17. Technological Policy Department
18. Research and Development Department	9. R&D Policy and Education Department	5. Innovation Support Department
19. Education Department
20. External Relations Department	10. International Cooperation Department
21. Entrepreneurship, Private Farming and Cooperation Department
22. Federal Government-Owned Entities Department	11. Economic Programs, Analysis and Government Property Management Department	6. Government Property Management Department
23. IT, Analysis and Forecasting Department		7. Analysis and Strategic Planning Department
24. Food Market and Product Quality Regulation Department	12. Agricultural and Food Market Regulation Department	8. Marketing and Market Development Department
25. Social Development and Labor Safety Department
26. State Engineering Supervision Inspection
27. Department for Emergency Situations, Liquidation of Consequences of Radiation Accidents and Civil Defense
28. Executive Department
	13. Fisheries Department

Overall, the specifics of the recommended governance structure is that it is oriented to focus attention of agricultural authorities on key areas, to minimize a dispersion of responsibilities, overlapping and dispersion of functions; to maximize use of benefits of specialization and to streamline ministerial governance activities.

The RF Ministry of Agriculture functions should be end-to-end. Therefore, structurally the bodies within this system should be similar at the federal, regional and local levels. According to such approach the system will be composed of eight problem-functional blocks that will form the governance vertical in the agro-industrial sector (figure 1).

The administrative reform, in particular, the effectiveness of the federal law “On Underlying Principles of Local Self-Government in Russia” (2003) resulted in unclear status of the district agricultural authorities. As a result, some regions attempt to liquidate the district agricultural authorities; and that is inexpedient. A feeling of usefulness of this governance level appears because the government has not started to appropriately perform its regulatory functions in agriculture. One should not forget that it is actually impossible to implement agricultural policy efficiently without district agricultural authorities. The transfer of these functions to district administrations will not solve the problem, since they are overloaded with their own problems.

To encourage efficient performance of government authorities it is necessary that everybody should deal with its own challenges, but not with delegated, i. e. outsider’s functions — the trend experienced at the district level in the recent years.

The industry-specific blocks are excluded from the structure because they are not market-oriented and only monitor the situation, but not actually contribute to agro-industrial development. At the same time, the necessity of establishment of industry-specific blocks within the RF Ministry of Agriculture system (at the Innovation Support Department) is evident. In this case they should be involved in collection of world best practices and transfer of this information to regions for further application. Such transformation of industry-specific divisions will considerably increase their efficiency and will provide sound contribution to agricultural development in Russia.

It is expedient that each functional block (department) of the RF Ministry of Agriculture is headed by Deputy Minister.

In our opinion, the application of the recommendations on optimization of governance functions and structure of the RF Ministry of Agriculture system will enable to reduce the number of its levels, to unify the structure of regional agricultural authorities (currently these exist apparent discrepancies, which complicate liaison with the RF Ministry of Agriculture). Overall, the proposed modifications will contribute to innovative development and increased performance of the agro-industrial sector.

Tax Policy

The tax system is one of the most important governance tools in the national economy. The examination of this issue enables to suppose that the tax system should be simple, understandable, stimulating, transparent, liberal, not burdensome, stable and linked with the size of government financial support. It should be noted that liberal nature does not mean tax concealment or “legitimate” tax evasion (the common understanding), but creation of conditions that do not infringe upon interests of those commercial farm operations, which achieve the highest performance, including unit cost reduction. Figuratively speaking, economic leaders should not meet any extra barriers. This can be achieved, if the key priority of the agricultural policy will be the interests of agricultural producers and of the government, rather than the fiscal component. Taxes and other economic instruments, first of all, should be oriented to encourage development of agriculture and other industries and not to support budgets. Moreover, with such “governance”, rather than “accounting” approach the budgets of all levels will grow more than in the first case.

Studies show that in order to modernize the tax system appropriately it is expedient to implement one of two alternatives:

Alternative 1. Product taxes (with differentiated rates depending on current profitability of products; in this case, for instance, the cattle production will be taxed at a lower rate than the grain production). The adoption of this taxation system will ensure flexibility in planning and regulation of outputs of certain products.

Alternative 2. Tax on revenues from sales of products and services instead of 3 taxes: VAT, enterprise profit tax and gross income tax, including single agricultural tax (for enterprises in all industries, maintaining the existing tax exemptions).

The expediency of this proposal is explained by the following arguments:

• VAT is quite an inconvenient tax for enterprises, moreover it allows tax abuses;
• profit is the main indicator of the “economy welfare”, but enterprises hide it, that is why the government is unable to assess the economic situation objectively and to elaborate efficient development programs; in addition, the profit tax reduces business activity of enterprise managers, since it strengthens fiscal aspects of the tax system, making it inadequately liberal, transparent and stimulating;
• gross income tax has 2 alternatives; the first one does not differ significantly from the recommended tax on revenues; and the second — from the profit tax.

The revenue tax rate will vary within limits of 3-15% for the most of business operators; that is quite acceptable. According to annual financial statements in 2005 agricultural producers’ taxes totaled RUB 36.2 billion or comprised 8.1% of farm revenues in that period. It should be noted that those farms, which have shifted to the single agricultural tax or streamlined taxation system, have reduced the share of taxes in sales revenues by 2 and more times. The share of three taxes to be replaced by revenues tax amounted to 4.15% of farm sale revenues.

Other ways to enhance AIS efficiency

Research enables to assume that the following measures can contribute to improved governance efficiency in the AIS in addition to the above listed ones.

1. To match functions and powers of the RF Ministry of Agriculture and its regional and district departments. Currently the number of powers is substantially lower than is required to perform functions of these agricultural authorities. The imbalance between functions and powers impedes the full realization of the RF Ministry of Agriculture system potential capabilities.

2. To create state-owned model farms to be specialized in application and dissemination of the most efficient world best agricultural practices. The respective efforts were undertaken during the initial reform period in Russia (establishment of agricultural technological parks), but later the program was terminated. Those activities were supervised by the RF Ministry of Economic Development and Trade and the RF Ministry of Agriculture and Food.

3. To establish state-owned federal holdings to be specialized in seed production and livestock breeding. In the reform period these basic sub-industries have declined that negatively affected the economic situation in the sector. It is expedient for the government to keep supervisory and support functions in respect of seed growing and pedigree livestock farms.

4. To produce “Food Map of Russia”. The Russian agrarian sector underutilizes one of the most important potential reserves of agricultural development associated with better adaptation to natural and climatic conditions. The food map will enable to assess the food potential of Russia, to upgrade agricultural planning system at all levels, to improve production efficiency and to create conditions for rational use of natural resources.

5. To optimize management personnel staffing and composition on large-scale farms. The management staffing schedules on large-scale farms are based on obsolete standards, designed by All-Russia Research Institute of Agriculture Economy, Labor and Governance (VNIETUSH) in 1973. The experience of Germany, where management personnel at former cooperatives has been decreased by nearly 10 times (without any detriment to the business) supports the need to apply new approaches in farm staffing.

6. To elaborate farm models. The diversity of farm sizes and specializations, as well as natural and climatic conditions, machinery and other factors evidences the need to design models of large-scale farms and private farms. Such models will enable to prepare well-justified business plans, to use inputs efficiently, to attract investors and highly professional staff to agriculture and to address other pressing challenges.

7. To enhance product marketing. In order to run business efficiently it is not enough to produce outputs at low cost; it is important to market the products profitably. The estimates show that taking into account inflation, risks and constant farm input price growth the farm profitability should be around 40-50%. This problem could be partially resolved, if the government purchases at least 50% of cereals produced by farms, if consumer markets in Moscow and in St. Petersburg are leased to regions, and if regional markets are leased to respective districts. Currently agricultural producers are compelled to sell their products at knock-down prices to foreign traders, who have occupied nearly all food markets in large cities in Russia thanks to unclean hands of government officials. As a result, annually billions of dollars that can be invested in the Russian agriculture are transferred abroad.

8. To create federal and regional clubs of best farm workers. In the market environment moral incentives are obviously underestimated in Russia. The opinion surveys evidence that the creation of such clubs will enhance prestige of farm operations, will induce efforts of farm managers, subject-matter specialists and ordinary workers.

Therefore, the agricultural development in Russia is hindered by the huge number of factors. Actually all of them are implications of improper performance of economic governance functions. Consequently, the main condition of the agricultural development is to improve the public governance in agriculture. This is because the public governance is the primary one in relation to business management. The experience demonstrates that as soon as the public governance system creates favorable business environment, the farms start to operate efficiently.

Earlier it was mentioned that the agricultural development is largely depends on effective local self-government in rural areas. The official data (based on monitoring of the Council of Federation and the RF Accounts Chamber) show that currently the local self-governments in Russia actually are non-existent. In this context we have designed the local self-government model that incorporates recommendations on improvement of budget relationships (the model has been highly acknowledged by experts).

We have also formulated recommendations on farm financial revitalization. The practical testing carried out on large-scale farms in Moscow, Oryol and other regions has proved their high efficiency.

It should be noted that all recommended measures do not require substantial financial investments; however, their implementation will enable to dramatically improve the situation in agriculture and in the agro-industrial sector as a whole.