‘Domain’ for Levy-Funded Research and Extension: General Notions with
Particular Applications to the Australian Dairy Industry
of Agricultural and Resource Economics
University of California, Davis
Musings on Efficiency and Equity Aspects
Ideas on Levy-Funded Research in the Dairy Industry
In Australia, a variety of
institutions are engaged in providing funds for agricultural research and
extension, and making decisions about the allocation of those funds among
alternative research and extension programs.
These institutions are intertwined in complicated ways.
In dairy research, for instance, the Dairy Research and Development
Corporation (DRDC) combines levy-based funds with matching funds from the
federal government to provide partial funding support for research and
extension programs conducted by state-government agencies (such as
Victoria’s Department of Natural Resources and the Environment, DNRE), by
federal agencies (such as CSIRO or ABARE), and by private firms in Australia
as well as some overseas research bodies.
The fact that most of the projects funded by the DRDC are in some
sense joint ventures (involving a mixture of federal funding, levy funding,
and other funding) adds complications to the problem of defining the
appropriate division of labour between the DRDC and the other agencies
engaged in dairy industry research¾the
R&D “domain” for the DRDC.
Musings on Efficiency and Equity Aspects
In beginning to broach
this topic, let us abstract from the joint-funding aspect and consider the
DRDC as though it were a stand-alone enterprise, funded entirely using levy
funds, and ask a question in principle: What should be the scope of its
research portfolio, and which lines of research ought to be left to other
sources of funds? In addressing
this question, a reasonable starting point is to acknowledge that there are
both economic efficiency and equity dimensions to the issue.
A simple economic efficiency rule is that the DRDC ought to allocate
its funds so as to maximize the total benefits¾but
whose benefits (and costs) ought to be counted, benefits to all Australians
or just benefits to the Australian dairy industry?
And within the industry, should we count benefits just to dairy
farmers or benefits accruing to processors and manufacturers as well?
Should they count equally, or should farmer benefits get more weight?
It is not trivial to separate the equity and efficiency issues.
It is reasonable to define
economic efficiency in terms of the benefits to Australia as a whole.
Further, under a reasonable simplifying assumption¾that,
under the recently deregulated market structure, DRDC research has a
negligible impact, if any, on world prices, and thus on prices paid and
received for dairy products in Australia¾it
is a reasonable approximation to equate industry benefits with Australia’s
benefits (i.e., there are no consumer benefits and no optimal trade-tax
arguments to bother about). The remaining equity issues concern the
distribution of the benefits and costs of levy-funded research within the
industry, between dairy farmers and other participants in the marketing
input suppliers as well as processors, manufacturers, and retailers¾and
among farmers (and others) depending on the extent to which they can adopt
new technology resulting from the levy-funded research.
These can be thought of as vertical and horizontal dimensions of the
distributions of costs and benefits of levy-funded research.
First, consider the
vertical dimension. One result
from the literature is that, under commonly made assumptions, the benefits
from research at one stage of a multistage production system will be
distributed up and down the production-marketing chain in the same
proportions as the cost of a levy collected at the same stage of production
(e.g., see Alston and Mullen 1992). This
result leads to the conclusion that it would be both fair and efficient to
finance commodity-specific industrial research entirely using commodity
levies. Moreover, if the
production technology across the stages of production is of a
fixed-proportions nature, the research could apply at a different stage than
the levy and yet the benefits would be distributed in proportion to the
A breakdown of the
congruence (or concordance) between the distribution of benefits from
research and the distribution of the costs of a levy used to finance it
could arise from several sources, individually or combined.
These sources include:-
factor proportions in production, with research results applicable at a
different stage of production than that where the levy is collected,
competition among processors or retailers, or
non-parallel research-induced supply shift (the perfect matching of
incidence of costs of a levy and benefits from research requires that
the levy-funded research reduces average and marginal costs by the same
amount per unit, such that the supply curve shifts down in parallel).
Since we cannot rule out
these elements altogether, we cannot be sure that benefits from levy-funded
research will be distributed vertically among participants along the supply
chain in proportion to the costs of a levy borne by participants along the
supply chain. This uncertainty
means that an industry group (such as an RDC) is likely to opt for a rate of
levy that is less than the social optimum.
In an extreme scenario Arrow’s ‘impossibility’ theorem would
imply a levy rate of zero. An
industry RDC is likely to opt for a mix of research programs that gives up
some economic efficiency in exchange for more equity.
This observation provides a theoretical basis for (i) multiple levies
to fund different lines of research collected at different stages in the
system (on both equity and efficiency grounds), and (ii) some matching grant
support from the government (on efficiency grounds).
In the case of dairy research in Australia, vertical distributional
issues are muted to some extent by the important role of farmer-owned
cooperatives in the processing and manufacturing sector.
Next, consider the
horizontal dimension of the distribution of benefits and costs of levies
collected to fund research. A
milk levy falls initially on all producers according to the amount of milk
they sell but some of the levy cost is passed on, up and down the marketing
chain, through induced changes in prices that depend on relative
elasticities of supply and demand and so on, to be borne by individual
middlemen and consumers according to the amounts of milk they buy.
Every dairy farmer bears a cost in proportion to their individual
production regardless of whether they adopt new dairy farming technology
that is generated by the research funded by the levy.
If prices were lowered as a result of productivity gains and supply
increases deriving from adoption of new technology deriving from the
research, non-adopting farmers would be made worse off by both the new
technology and the levy used to fund it.
(Non-adopters can be hurt by any new technology that causes prices to
fall, but the injury is greater if they have had to help pay for the
research that gave rise to the technology.)
Even if price did not fall as a result, innovators would gain cost
savings and in due course would expand while laggards would continue to move
out of the industry.
In an inter-temporal
variation on this theme, horizontal inequities can arise between generations
of dairy farmers. The incidence of the levy is immediate, whereas the
incidence of the benefits from research may take 20 years or more to affect
beneficiaries. Only in the best
of all worlds is it likely that the current levy payer will be entirely
convinced that the future benefits¾to
be collected by his successors¾will
be capitalized fully into his current asset values.
In such a case the temporal aspects of agricultural R&D would be
irrelevant to the issue of who benefits when relative to who pays when.
If doubt exists about the extent to which future benefits from
research will be capitalized, in practice, into farm assets, then
levy-funded research may be less oriented towards longer-term research
(i.e., that will take a relatively long time to yield a payoff) than
efficiency alone would dictate.
Horizontal inequity occurs
when levy-funded research and extension is only narrowly applicable within
the industry. That is, applicable in a certain geographical region only; or
applicable for only certain types of farmers (e.g., irrigated versus
non-irrigated or very large versus small; or applicable only for farmers
eligible to participate in a particular extension program versus
non-participants). An extreme
form of horizontal inequity would be if levy funds were used to finance
research that did not have any benefits within the industry but benefited
other members of the society. For
instance, this might occur if levy funds were used to finance research into
environmental issues with a view to generating environmental benefits not
confined to the industry or its participants.
Further, in a similar
manner to the effects of vertical market mismatches between the
distributions of costs and benefits, perceived horizontal inequities too are
likely to give rise to under-funding of research overall (i.e. some
potential efficiency benefits foregone in exchange for some hoped for equity
gains). This observation
provides a theoretical basis for: (i) multiple levies to fund different
lines of research collected from different (horizontal) subsets of the
industry (on both equity and efficiency grounds), defined spatially or in
terms of the nature of their technology, and, (ii) perhaps some matching
grant support from the government (on efficiency grounds).
More generally, on equity
and efficiency grounds, levy funds ought not to be used to fund private
goods such as those provided by narrowly focused extension (or research)
programs and for which there is no prima
facie evidence of a market failure.
Such activities ought to be funded privately.
Conversely, on equity grounds commodity levy funds should not be used
to finance programs for which the group of beneficiaries extends far beyond
the group bearing the major incidence of the levy.
These activities ought to be funded publicly, using more broadly
Because of (real or
imaginary) horizontal and vertical equity problems, given the role of
‘democratic’ processes in setting the levy rate and research priorities,
levy-funded programs left to their own devices are likely to under-fund
commodity-specific research overall, and to under-fund certain types of
research in particular. Curiously
it is likely that both research for which the benefits may be narrowly
confined within the industry and research for which the benefits are only
partially confined to the industry, will be funded at less than optimum
One correction for a
problem of under-funding of research may be to provide supplementary
(perhaps matching) funding from general government revenue, but the
provision of supplementary funding might not correct the distortion in the
mixture of types of research preferred because of the ‘democratic’
processes involved in setting levy rates and research priorities.
(On the other hand, we ought to give some consideration to the
possibility that commodity levies might provide a relatively cheap source of
research funds, and what that implies.
For instance, see Alston and Mullen 1992.)
Ideas on Levy-Funded Research in the Dairy Industry
Why does it make sense for
the Australian government to delegate its taxing powers to an organization,
such as the DRDC, that represents the interests of a small, narrow group in
society? Presumably it is
because this is seen as a reasonably fair way of achieving the economic
efficiency objective of reducing the under-investment in dairy research that
would otherwise take place. It
would appear to have been successful from that point of view (see Alston,
Harris, Mullen, and Pardey 1999). This
is an example of the use of hypothecated (or earmarked) taxes (rather than
general revenues), which can be a fairer and more-efficient way of financing
certain types of collective goods. A
general problem with this type of approach is that, because of heterogeneity
in the industry and the Research and Development (R & D) outputs (and
their applicability and economic impacts inside and outside the industry),
the ‘ideal’ tax base will vary across research projects and programs.
The ‘efficient jurisdiction’ varies among projects and programs,
as will the optimal rate of matching support from the federal (or state)
As a practical matter, it
makes sense to have a single institution that aggregates across all of these
possibilities (in terms of parts of the marketing chain and parts of the
country), partly because it would be too costly administratively to have
multiple programs. Realistically
speaking, we are not looking for an ‘ideal’, perfectly fair and
efficient structure and cannot precisely optimize every element.
Instead, we seek reasonably to draw generally sound distinctions and
rules of thumb that are not grossly at odds with the notions of fairness and
efficiency. From that
standpoint, we can try to delineate those lines of dairy industry R&D
that are more- or less-appropriately financed and conducted using levy-based
funding, and rules of thumb for determining how much to do and perhaps on
As a starting point,
consider the following four broad criteria:
dairy industry share of total benefits.
If this is not high, then the research ought to be funded using
odds that the benefits are privately appropriable either because of
property rights protection or trade secrecy, or because the benefits
accrue to a small group. If
these odds are high, then the research ought to be funded privately by
odds that the private sector in Australia or overseas will invest in the
area, which is related to the idea that the benefits are appropriable.
If these odds are high, then there is no case for
odds that overseas governments will invest in the area.
If these odds are high, then Australia can free ride on this
activity and concentrate on other research areas.
The examples below
illustrate how these criteria can be applied to draw inferences about who
should do what in relation to different elements of related types of work,
such as different types of extension, as well as between unrelated types of
work, such as farm management extension versus food processing R&D.
It is generally accepted nowadays, although it was not always so,
that individual farm management advice ought to be left to the private
sector. On the other hand,
broader-based farmer education-cum-extension programs might be funded in
part by a combination of, say, DRDC funds, state-government funds, and
private funds, depending on the details of the programs.
The extent to which
education activities should be the subject of collective action or
government action is a critical question.
Theory suggests that much of such activity is the domain of a
well-functioning private sector. For
example, there is a substantial private-sector role in educating farmers
about technologies and management practices that will assist them to meet
private sector objectives. Some
may argue that there is a potential market failure from lack of knowledge or
failures of the capital market to lend for human capital creation.
This would not justify the provision of programs funded by the DRDC,
although it might justify government action to address such market failures
directly. The possibility of a
net payoff to collective action by the industry or by government will be
greater for components of education-cum-extension programs that have more
important public-good elements. For
instance, there might be a public-good component in the development of
materials or the training of staff to provide education services, where the
cost would not be recovered by fees for participation that cover only
incremental costs. Alternatively,
in a setting in which private incentives are distorted, an education program
might have consequences for other public goods, such as the rate of land
degradation or environmental pollution arising from dairy waste.
Or, we might be able to justify the public or collective provision of
services to facilitate the organisation of private activities that might
otherwise not be developed because of high individual transaction costs.
Management clubs may be one example.
This justification would require, of course, that the transactions
costs are lower for the collective action than for individuals.
The case for supporting research into pasture production using DRDC
funds is strong, more particularly as the research relates to
Australia-specific issues, and more particularly as it relates to pasture
production issues specific to dairy rather than, say, beef or sheep
production systems. More
general research into pasture production might be financed by a combination
of dairy industry and other industry funds and general revenue funds, for
instance. Similarly, there is a
case for the DRDC supporting research into Australia-specific dairy genetic
issues (such as fertility of cows). There
is less of a case for using the same funds for supporting more-general dairy
genetic research that might be applicable anywhere in the world.
There is no support for any case for using dairy levy funds to
support general biotechnology research that might be applicable anywhere in
agriculture, anywhere in the world.
Given the multinational nature of dairy processing and manufacturing
companies and the worldwide applicability of much of the technology, the
case is weak for using levy funds for supporting research into milk
processing and dairy products manufacturing.
The case for using general revenue funds for such research is even
weaker. One funding option might be to use a combination of levy funds and
matching support from dairy processors or manufacturers, with appropriate
treatment of the intellectual property issues.
The case for obliging the DRDC to finance research into general
environmental issues such as global warming¾even
if they are associated with dairy production¾is
weak, given the relatively small share of any benefits or costs attributable
to Australia, let alone the dairy industry (see Edwards (1989) for
instance). On the other hand, a
reasonable case can be made for using DRDC funds to address actual or
potential pollution problems associated specifically with dairy production,
such as livestock waste management or irrigation-based salinity problems.
Although the dairy industry might be a major beneficiary from
economic research that leads to reductions in agricultural trade barriers,
it is hard to separate the dairy industry from other industries in the
context of WTO negotiations and analysis of their impacts.
The beneficiaries from such ‘transparency analysis’ are
widespread within Australia and among countries, and the dairy industry
ought not to be asked to pay more than its fair share for such work.
Product Development. The private sector has reasonably strong commercial
incentives to develop new products, where intellectual property can be
protected by both trade secrecy and patents.
Moreover, when product innovations are applicable in other countries,
not just Australia, multinational firms involved in dairy processing and
manufacturing are in a comparatively good position to appropriate the
returns to investing in product development R&D.
It is difficult to make a case for collective action by Australian
dairy farmers, or for intervention by the Australian government, on the
grounds of a private under-investment this type of research.
Collective Actions. Levy funds also might be used in future, as they have in the
past, to finance other activities such as generic commodity promotion and
industry public relations. In
either of these cases, the justification for the use of any matching support
is weaker than for most types of R&D, even though the problems of
heterogeneity of interests and mismatching of the incidence of benefits and
costs within the industry are likely to be significant.
The real issue is that in such activities there might no longer be a
strong link between the national interest and the collective industry
interest. This raises doubts
about whether it is appropriate even to allow the use of levy funds for
promotion or public relations. The
issue is whether in such activities ‘self help’ translates into ‘help
yourself’, such that any industry benefits from this type of collective
action are being achieved only at the expense of the nation as a whole.
In any event, generic promotion is expensive folly in the current
dairy market setting. Given the
deregulation of the milk markets that was implemented in recent years, the
only remaining price premia are constrained by actual or potential arbitrage
within Australia, or between Australia and international markets. Hence, generic promotion mainly acts to shift sales from
export to domestic markets, with no gains to producers (e.g., see Alston,
Carman, and Chalfant 1994 or Hill, Piggott, and Griffith 2000). The same deregulation has also had implications for the
benefits from different types of research, especially the distribution of
the benefits (e.g. see Freebairn 1992).
These examples illustrate
the ideas that all of the options involve mixed signals and different
potential mixtures of funding approaches.
A single policy approach such as funding based on an all-milk levy
with 1:1 matching support is not likely to be the right recipe for most
cases. Some approaches call for this recipe in combination with
additional support from the federal or state government, or from the private
sector. In other cases levy
funding alone without the matching support, or some other different rate of
matching support, might be apt. Some
problems might call for broader-based industry funding (e.g., a levy on all
the grazing industries). This
funding could be raised by either a supplementary levy, or by using existing
levy funds in a joint venture among RDCs.
In some situations it might be (or at least perceived to be) more
efficient and equitable to have a separate pool of funds based on levies on
manufactured dairy products, as opposed to levies on milk.
Furthermore, and importantly, some actions ought to be ruled out as
not being in the national interest and thus not being a justifiable
application of the government’s taxing powers.
Questions about the
optimal levy rate, or the optimal matching arrangement, and thus ‘how much
funding’, are empirical questions that cannot be answered with
in-principle arguments. If we
believe that the ‘democracy’ problem continues to be an impediment to
achieving an efficient total amount of funding, then a higher marginal rate
of matching support from the federal government may be warranted on economic
efficiency grounds. This could
be achieved in a budget-neutral way by setting a lower rate of matching
support for inframarginal spending, which is the converse of the approach of
reducing the matching support at the margin that was recommended by the
Industries Commission. As a
practical matter, it is useful to look at the portfolio of recent past,
current, and proposed (but unfunded) projects and ask of each: was it (or
would it have been) a profitable investment from the national point of view,
and who in the nation would have received the benefits?
The answers to those questions ought to give guidance about the total
funding base and priorities for support using DRDC funds.
Alston, J.M., H.F. Carman,
and J.A. Chalfant. “Evaluating Primary Product Promotion: The Returns to
Generic Advertising by a Producer Cooperative in a Small, Open Economy,”
in E.W. Goddard and D.S. Taylor (eds) Promotion
in the Marketing Mix: What Works and Why? Proceedings from the NEC-63
Spring '94 Conference on Toronto, Ontario, April 28-29, 1994.
Alston, J.M., M.S. Harris,
J.D. Mullen, and P.G. Pardey. “Agricultural R&D Policy in Australia”
Ch. 5 in J.M. Alston, P.G. Pardey, and V.H. Smith, eds. Paying
for Agricultural Productivity, Baltimore
MD: Johns Hopkins University Press, 1999.
Alston, J.M. and J.D.
Mullen. “Economic Effects of Research into Traded Goods: The Case of
Australian Wool” Journal of
Agricultural Economics 43(1992): 268-278.
Edwards, G.W. “Big
Problems Facing Small Societies” Australian
Journal of Agricultural Economics 33,2(1989): 71-87.
“Evaluating the Level and Distribution of Benefits from Dairy Industry
Research” Australian Journal of Agricultural Economics 36,2(1992): 141-166.
Hill, D.J., R.R. Piggott
and G.R. Griffith. “Profitability of Incremental Generic Promotion of
Australian Dairy Products,” Agricultural
Economics, 1502 (2000): 1-14.
I am grateful for helpful comments on drafts, provided by Paul Donnelly,
John Freebairn, Rick Lacey, John O’Connor, Phil Pardey, Roley Piggott,
and Alistair Watson, as well as some workshop participants.