The State of Food and Agriculture 2023

Chapter 1 Factoring the Costs and Benefits of Agrifood Systems into Decisions

Market, institutional and policy failures underpin the unsustainability of agrifood systems

As seen in Figure 1, the activities of agrifood systems cause changes in the capitals through inflows and outflows. Some of these changes have certainly been positive, such as the provision of food security and nutrition and livelihoods to many. However, negative impacts have become an increasingly significant issue, driven in most cases by markets, institutions and policies falling short of the ideal – in other words, market, institutional and policy failures (see Glossary). These failures generate losses to society that are not reflected in the market price of a product or a service, or are not included in GDP – referred to in this report as hidden costs. These failures inhibit the proper functioning of agrifood systems and, if left unaddressed, can hinder the transition towards sustainable, resilient and inclusive agrifood systems.

Markets are supposed to facilitate the efficient allocation of resources, but there are many cases of market failure in which they fail to do so.16 These are missed opportunities to improve people’s lives without negatively impacting others. Take the case of water pollution from pesticides and fertilizers: their use can be avoided or reduced with the right practices, but polluting farmers may not be aware that current techniques lead to water pollution or they may not know which alternatives to use. The presence of such imperfect information prevents farmers from making an optimal decision from a social point of view.17 Another driver of such polluting behaviour is the fact that avoiding pollution may come at a private cost that they prefer to externalize to avoid reducing profit.17 This choice reduces the quantity of safe water, with negative consequences for human health and the environment. Further, water pollution affects people’s human rights, including their rights to adequate food, water and sanitation. Box 2 discusses various types of market failure, giving examples of how they affect the functioning of agrifood systems.

Box 2Market failures and agrifood systems: definitions and examples

Externalities – the effects of transactions on third parties – are a form of market failure that may negatively affect human and/or environmental health. For example, water pollution from pesticides and fertilizers can be avoided or reduced by limiting and optimizing the type, amount and timing of applications.18 Such optimization can come at a cost to producers, however, who may choose profit over water quality.17 This reduces the quantity of water that is safe to use, with negative consequences for society and the environment, generating hidden costs that are not reflected in the price of the goods or services produced.19 Therefore, negative externalities – including air and water pollution, soil erosion, antimicrobial resistance and emissions of greenhouse gases – are not accounted for in GDP.

Externalities can also be positive when certain practices, such as regenerative agriculture or agroforestry, have public benefits, such as a clean environment and biodiversity. Such benefits, however, are likely to be internalized into other economic activities. For example, a clean environment can stimulate tourism, while biodiversity can spur greater crop productivity. Therefore, unlike the hidden costs arising from negative externalities, the effects of positive externalities are likely to be reflected, at least partly, in a country’s GDP. Consequently, addressing positive externalities is likely to be more of a distributional issue, as those producing them may not be reaping the benefits.

Imperfect information is another form of market failure and can lead to suboptimal levels of investment in nutritious foods. It can also facilitate fraud or other forms of misrepresentation.20 This can lead consumers to unknowingly consume ingredients that are harmful to their health or the environment. Poor information can also drive polluting behaviour by farmers who are unaware that certain techniques pollute water, for instance, or who are unfamiliar with alternative techniques that avoid pollution.

Demerit goods, such as highly processed foods of minimal nutritional value, are linked to externalities and poor information. These market failures have negative impacts on consumers, but these impacts may be unknown due to imperfect information. Sometimes, consumers ignore the negative impacts due to the satisfaction derived from consuming them.21 They feature heavily in unhealthy diets (such as those lacking diversity and rich in fats and sugars and low in nutritional value) and can affect human health through their well-established link to obesity, malnutrition and non-communicable diseases. Consequently, they create hidden costs in the longer term, mostly in the form of labour productivity losses, and can generate externalities if the health system is sustained by taxpayers, putting a direct burden on society as a whole. Governments can discourage the consumption of demerit goods in a similar way to addressing externalities, for example, through awareness campaigns or taxes. However, there is generally less agreement on regulatory or fiscal actions to limit the consumption of demerit goods than there is on typical externalities.19

Market power – the relative ability of an actor to manipulate the price of a product or input22 – is associated with market concentration and can also cause losses to society. An example is when agricultural inputs are provided by one or only a few companies, allowing them to set input prices above their marginal costs. Another example is when many farmers need to sell their outputs through a very limited number of traders, say, in wholesale markets, where wholesalers can set the output price below the marginal benefit. In both cases, market power puts agricultural producers at an economic disadvantage and can contribute to their economic marginalization, pushing them into poverty. Furthermore, social well-being is reduced, as agricultural producers are forced to operate at a suboptimal level of output, in this case, affecting food availability, an important dimension of food security in any society.

Missing markets, or market failure driven by the complete absence of a product or service, can also cause social losses, especially to vulnerable groups, increasing their marginalization. For example, in many low-income and middle-income countries, insurance and credit markets are often lacking or fail to function for smallholder producers. This affects their investment decisions and forces them to operate at a suboptimal level, with direct negative consequences for their food security and livelihoods. It also has broader implications for society in terms of lower-than-optimal output. Moreover, they do not have the opportunity to finance the adoption of technologies that enhance environmental sustainability.

Public goods are goods and services that are desired and appreciated by society, but which markets fail to provide. The government, therefore, needs to step in with support or regulation. Public goods generally have a high degree (at least) of non-rivalry and non-excludability, leaving little or no incentive for private actors to provide them. Prominent examples in the context of agrifood systems are food security and food safety. Although food itself is a private good, ensuring food security and nutrition (the continuous availability, accessibility and affordability of nutritious food) is a public good, as guaranteeing it requires public support. The same goes for food safety, which requires a public authority to set standards and enforce them.23 Clean water, clean air and biodiversity are further examples of public goods, as adequate provision requires public support and regulation.

Institutional and policy failure can also drive the hidden costs of agrifood systems. These failures are interlinked and can overlap depending on the context. Institutional failures refer to when institutions – governments, markets, private property and communal management24 – fail to provide the necessary framework for development, whereas policy failures refer to when a policy, even if it is successful in some minimal respects, does not fundamentally achieve the goals that proponents set out to achieve.25

Institutional failures, for example, inhibit the provision of public goods. For instance, for food safety to be guaranteed, there must be institutions and authorities that set standards and enforce them. A lack of transparency and accountability in such entities – a type of institutional failure – reduces the response time from the discovery of contaminated foods, making it slow and difficult to recall unsafe food products.26

Similarly, corruption – the abuse of entrusted power for private gain27 – creates various degrees of inefficiency in resource use and injustice in the distribution of benefits. For example, the prevalence of corruption in institutions handling land titling creates a high informal cost for those trying to register or transfer land, making land administration services inaccessible to those unable to afford the illegal costs.28, 29

Inexistent or ill-defined property rights are another prominent type of institutional failure, as they discourage investment and can lead to unsustainable resource use. For instance, farmers may have few incentives to invest in soil-preserving techniques if the land they work is not their own or can be taken from them at any moment.17 Similarly, open-access resources can lead to the depletion of resources as a result of inexistent property rights. Fish are a case in point: they can be sustainable and replenished as long as the rate at which they are harvested is lower than the rate at which they reproduce. Without controls, every fishing vessel has an incentive to take as much fish from the ocean as it can, often at a faster rate than the fish can naturally replenish.17 Policies and institutional arrangements are needed to guarantee proper implementation, however. If quotas do not reflect the right rate of replenishment or if institutions lack the capacity to implement them, institutional and policy failure will ensue.

Free-riding behaviour can also cause institutional failure, for example, when individual farmers who are not members of a cooperative benefit from the efforts of that cooperative to improve their position in the market, but without contributing to cooperative efforts.

Institutional failures can also be driven by dispersed governance, where the subnational level has some degree of separate political authority and can reduce the degree of consistency in policy delivery, as well as its effectiveness, leading to policy failure.30, 31 For example, land and natural resource governance is often fragmented and contested by different actors, institutions and legal frameworks at local, national and global levels. This can result in conflict, insecurity, dispossession and degradation of land and natural resources, with disproportionately negative impacts on the most vulnerable.

Conflict between bureaucracies is another driver of institutional failure, which occurs when one part of the government undermines efforts by another to save resources,24, 32 creating distrust between institutions, with negative implications for their capacity to deliver and achieve their objectives in a timely manner.

Other factors can cause policy failures, including overly optimistic expectations by policymakers. This happens when policymakers underestimate the time, costs and risks involved in achieving certain objectives and/or overestimate the benefits of specific policies.30, 33 These ill-informed policies may not be based on robust scientific assessment. An example is when policymakers act on the assumption that aquaculture can continue to grow at its present rate or even faster, so there is no need to worry about sustaining wild fish stocks, as global fish demand can be met through fish farming.34

Vagaries of political cycles can also create certain policy failures. Policymakers may not be held accountable for policy outcomes, as they have "either moved on or moved out”.30 However, developing sustainable and resilient agrifood systems requires investments that take time until their impact is felt on the ground, for example, in agricultural research, integrated value-chain services, and smart and green production technologies. The vagaries of political cycles can result in these investments being at lower-than-optimal levels and more aligned with shorter-term objectives.13

A central type of policy failure in this report – particularly in Chapter 2 – is distributional failure. It refers to a situation in which public policies fail to guarantee for all the population a minimum level of decent income that can protect against different forms of deprivation, such as poverty, food insecurity and malnutrition, despite the availability of resources to do so. For example, many agrifood systems workers are poor despite an abundance of profits downstream in food supply chains. What is more, around 735 million people suffer from undernourishment despite the availability of sufficient calories in global agrifood systems.35

In sum, market, institutional and policy failures are interlinked and can overlap depending on the context. It is essential that the hidden costs of agrifood systems – many of them rooted in market, institutional and policy failures – are analysed, assessed and valued through rigorous accounting, and that this information is used to reduce or avoid them while maximizing the benefits.36 The consideration of evidence must, therefore, become integrated into the decision-making of governments, businesses and consumers, so that these costs to society can be managed and mitigated. The key challenge will be making this pairing part and parcel of day-to-day activities and transactions throughout agrifood systems.

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