0821-C2
Peter Lowe 1
This paper recognizes the potential contribution of forest plantation development to poverty alleviation, especially in the African context, but challenges the orthodoxy of economic instruments used to promote investment by small-scale growers. It criticizes reliance on incentives such as planting subsidies and the illogicality of expecting growers to carry inflated market interest costs when their investor preference is focused on shortest pay-back to minimize risk exposure.
Instead, the paper argues for an incentive approach based on "demand-pull", supported by a series of intermediate goals that segment investment decisions into short spans. Specifically, it proposes the introduction of post-planting establishment grants and, later, timber dedication grants that would provide options to recoup initial investments, opt-out or hang in.
Moreover, the paper notes that the registration of private planting after establishment will include only crops that will make a permanent contribution to the forest resource supply database; likewise, the dedication of timber crops at a later stage represents an even stronger commitment of supply potential. The importance of reliable and complete resource information on which to profile harvest production is a vital incentive to potential investors in processing capacity which, in turn, is a vital incentive to plantation investors.
The importance of closing the perceptual gap between market rates of interest and the real rate of return on plantation investment is emphasized. One option is identified as inter-temporal arbitrage markets in immature plantation crops. But, recognizing that such capital market sophistication is lacking in most emerging African economies, another more institutional solution is sought. The paper outlines how a national or foreign-based forest fund might operate a scheme whereby growers would sell plantations at timber dedication age to the fund, with a buy-back option some ten years later, thus dramatically reducing accumulated market interest rate charges.
Finally, the paper reminds us that plantations are an important generator of value-added to alleviate poverty, and can serve as an important regional growth multiplier, with particular and tangible benefits at the household level in terms of food security and women's roles in rural societies.
Whether at commercial or small grower level, forest plantation development can be a key player in uplifting rural livelihoods and contributing to food security. It can also provide a powerful brake on rural-urban migration, by injecting cash into local economies.
Forestry Departments in Africa have traditionally motivated tree planting by reducing up-front costs with planting subsidies, mainly in kind. Even though this has usually been accompanied by technical assistance, often sponsored through social forestry projects, the results have not always met expectations.
Such an approach suffers from economic misconceptions, and the objective of the paper is to change focus to a market-led plantation development programme, assisted by more functional subsidies, and to propose new ways of empowering the private sector to take over the leadership role from government.
(i) Free Loans Good - Cheap Loans Bad
In many cases, African forestry departments have been assisted in efforts to subsidise tree-planting by development projects and NGOs which distribute tree seedlings and other material inputs free, or below-cost. The main attraction of planting subsidies is the offsetting of initial costs, thus reducing the accumulated interest charges borne by the private investor. In the developing country context, where market interest rates commonly exceed 20%, this has been one way of persuading growers to lock up their capital for periods often exceeding twenty years.
Latterly, there has been a partial shift away from planting subsidies towards loans. Paradoxically, however, cheap loans by or through government to tree-growers attract greater opprobrium than do free loans (i.e. outright direct planting subsidies).
(ii) Borrowers aren't economists
Classical economic capital theory should teach growers that their market interest charges will be recouped by a combination of wealth creation and capital gains arising from long term inflationary trends. Thus, they should make their investment decisions on the basis of the real interest rate, which is the market rate deflated by the expected inflation rate, rather than be deterred by an apparently prohibitive market rate.
Whereas it may be relatively simple to convince growers about value increment based on physiological processes - and, even to persuade them to accept physical risks or pay insurance - it is quite another matter to ask them to shoulder the financial risk implicit in assuming that the markets today have correctly anticipated long term inflation over a tree crop's lifetime. Growers are more inclined to adopt a sanguine view that the longer they hang on to an investment, the more likely some calamity is to occur. Thus, fastest pay-back is the least-risk option. The second misconception to be addressed by this paper is, therefore, that borrowers should be willing to underwrite the gap between real and market rates of interest, as classical economists would have them do.
The first misconception arises out of the long-held belief that growers need a planting incentive - a supply-push - to motivate tree planting by reducing up-front costs. In many African countries, experience has shown that seedling production and out-planting based on such approaches is, more often than not, grossly inefficient in terms of established tree crop and its unit cost. This unsatisfactory outcome arises from the lack of recognised value of the trees, leading to neglect of maintenance, tending, protection and poor survival - notwithstanding ambiguities in ownership and tenure.
It is not easy to substantiate the above claims of gross wastage in seedling production and out planting - for the simple reason that recording mechanisms for small-scale plantation establishment are, if at all, based on the crudest of measures, such as seedling out-turn to farmers rather than on systematic recording of numbers planted and surviving. The actual amount of established tree crops, and their spatial location, are in most cases unknown.
This lack of reliable information - quantitative, qualitative and spatial - does not necessarily indict informal planting as an irrecoverable failure. But, without such information, no substantive investment in processing, marketing or distribution can be countenanced by down-stream investors. To invest, they need to assess the reality of potential resource supply, now and for the future.
Indeed, too little attention has been given to demand-pull factors in plantation development. How can markets signal over such long periods to the planting decisions and infer the value of tree crops established? Moreover, as highlighted above, the economic calculus is likely to be overwhelmed by market price uncertainties which are completely beyond the remit of tree growers.
Farmers who already plant without subsidy may do so in response to the pull of the markets, as well as for reasons of land tenure. But, their planting goes unrecorded and therefore does not weigh in calculations underpinning investment in processing capacity. Moreover, their perception of markets may be short-term for fastest pay-back, rather than tuned to longer-term, higher-value and more profitable end-uses.
This paper will show how, in quite simple terms, a reorientation of orthodox thinking away from planting decisions to strengthening market signals, reinforced by an effective mechanism to mitigate non-grower risk, can help unravel the planting subsidy misconception and engender a self-sustaining "virtuous circle" planting programme.
The second misconception is that forest plantation development should thrive in a market interest rate environment. Given that growers need to minimise the period of their exposure to risk, they generally seek short payback periods on forest investments. What is needed is a series of goals that segment the long journey to final crop maturity. In the first instance, growers need to recoup their initial investment; thereafter, they need options to cash-in their crop before maturity, to get liquidity as well as reduce the risk of losing their winnings.
There are at least two goals for which growers can aim without any form of subsidy. Farmers in developing countries can obtain early recovery of costs by cultivating a compatible annual crop within an agroforestry combination; this will typically bring returns for up to three years. Depending on initial spacing and crop combinations, there are also options for thinning returns during, say, years 5, 10 and 15.
(i) Establishment Grants
Removing up-front planting subsidies ensures that growers have a stake in the survival and successful establishment of their tree crops. But, it is argued here that there is a strong case for paying retrospective grants for tree crops that have been well established, say at 5 years. These grants would provide an added incentive for growers to ensure that what is planted out shall also be tended, protected and nurtured through to become fully established. Also, of course, such an approach would avoid wasting subsidies on trees which never survive their early years.
From a practical standpoint, it is far easier to administer subsidies for established crops than for seedling crops. Not only is the workload confined to successful crops, but also inspection and verification are relatively easy - either by field visit or from remote sensing.
(ii) Post-planting Registration
With a system of establishment grants, the forest administration need not be concerned with the where and how of private planting operations. Only at the time of payment of the establishment grant, would the need arise for registration. Unlike subsidised planting schemes, the gathering of information at this later stage is likely to more complete and, also, will include only crops that will make a permanent contribution to the forest resource supply base. This registration can justify not only details of area, species and planting date, but also spatial positioning on a GIS database.
(iii) Timber Dedication
As soon as a crop can yield thinnings, it is susceptible to premature felling. Thus, even though the main thrust of Ghana's plantation development strategy is to supply timber logs to the sawmill industry, its teak growers plant to harvest poles. Although there may exist a market for timber logs, offering a greater rate of return, growers prefer to recover their investment as early as possible.
Such growers need an opt-out as soon as their crop is saleable, but also a clear incentive to retain the crop and aim for a future goal. This can be achieved through a system of timber dedication (e.g. at year 10) under which the crop is committed to eventual timber production in exchange for a dedication grant.
Like the establishment grant, such a dedication system would be easy to manage, because of relatively few agreements, which could be monitored remotely as well as through periodic ground visits by regulatory staff.
(iv) Trading Immature Crops
As soon as a crop becomes registered - either at establishment or dedication time - it acquires formal status and is identifiable as an asset that may be traded. This, then, can provide a further opt-out for growers to enable them to recover their investment, by selling an immature crop to a buyer willing to purchase a future. This is a familiar arrangement whereby sawmills or other processing units purchase harvesting rights up to five years in advance.
But, the concept needs to be extended back in time, so that intermediate traders might purchase or take options in crops of, say, ten or more years from maturity. There already exist many such traders of immature plantations in Ghana, often providing harvest share options for the farmer growers, (Agyeman, 2003). But, unless the state forest service can engender a significant number of transactions, and ensure a market data information service, investor confidence in such a goal may prove elusive.
In conjunction with returns from agroforestry (e.g. during years 1-3) and from thinnings (e.g. years 5,10 & 15), the proposals would offer further tranches of income from Establishment Grants (year 5), Dedication Grants (year 10) and sales of crop options to traders (year 15 onwards) or processors (year 20 onwards). Any, some or all of these make investment decisions to plant trees more attractive because of the earlier payback and the reduction of risk exposure. But, grants are a burden to governments and forestry is capable of sustaining itself without support.
(i) Financial Mechanisms
It has been argued that growers should not be expected to underwrite the gap between real and market rates of interest. Rather, it should be the job of financial arbitrage markets to bridge long term price uncertainties, and innovative solutions are needed to remove this aspect of risk from the growers, in order that they deal solely with the conventional agri-business risks - just as annual crop farmers do.
Currently, this would require a level of financial sophistication lacking in many African capital markets, but there has been a vibrant futures market for maize operating in South Africa since 1995. For annual crops, the emphasis is on hedging funds against short-term price volatility. On the other hand, plantation crop traders would be better placed to underwrite long-term price risks by virtue of holding and managing portfolios of plantation assets.
Otherwise, if this role were not played by local plantation traders, it could be fulfilled initially by a national forest fund, or even by one of the select number of foreign investment houses and companies which specialise in forestry investment in emerging markets (Crossley et al, 1997). The growers' exposure to risk could be limited to, say, the first ten years of crop growth, at which stage the fund would purchase the crop, subject to dedication survey and minimum quality conditions. This transaction would allow sellers to continue to maintain, protect and care for the plantations, and contain an option for them to buy-back ten years later at an agreed price, or retain a harvest share option.
The fund's value would be protected by acquiring a balanced portfolio of plantations of varying parameters (location, species and age), none of which would be held for more than ten years, and which would be maintained and protected by the growers. Like any bank, the fund would adjust its buying and selling rates to ensure solvency, and these would reflect the crop parameters, condition and prevailing price levels.
At one stroke, this financial device would segment the investment risk into manageable periods, provide the grower with an opportunity to clear accumulated debts and, most importantly, remove some of the long-term price risk from planting decisions.
The fund would need priming from external sources, most likely a regional development bank or a carbon sequestration fund. Once in balance - i.e. after ten years - the fund could also provide the establishment and timber dedication grants, adjusting their levels according to market needs.
(ii) Virtuous Circle
There is no stronger incentive to plantation investment and development than long term markets, with a choice of processing outlets offering prompt and reliable payment at prices which cover accumulated costs, risks and profit margin. An essential pre-requisite for investment in processing capacity and market development is an assured resource supply at stable and predictable prices. The challenge is to close this circle.
The system of post-planting registration which is proposed to accompany establishment grants presents an opportunity to publish details of the national plantation resource base and its projected yield profile, which serves as a confidence-booster to processors. The subsequent system of timber dedication would provide firm commitments of timber availability, reinforcing investment decisions in sawmills and other processing units.
When growers witness increased processing capacity, they will plant more and need subsidy less. The viability of the national forest fund will become firmer and plantation traders will become bolder. In turn, more processing capacity will evolve. The key is market confidence.
Although scarcely mentioned in the foregoing economic foray, there is a need to emphasise that the creation of value-added through plantation development is first and foremost about people's livelihoods.
Development in African countries has been marked by unsustainable migration to urban areas, which process is expected to accelerate. Experience in Southern Africa has shown that women get left behind in this migratory rush, and that they form a large proportion of forest plantation labour. Moreover, plantation employment opportunities can serve as a brake on migration.
Despite many bad examples of plantation development, there are outstanding success stories, particularly in Southern Africa, whereby local communities and towns have been transformed economically by the regional multiplier effects of pumping cash through wage labour that was previously non-existent, or only available through migrant labour with its attendant social dislocation and implications for the spread of HIV-Aids.
On an individual household level, wage income provides access to food through the lean season and even when harvests fail. The specific contribution to food security is ensured through the process of value-added which characterises plantation development, along with the processing industries that are attracted towards the forest areas. Even when families are not hungry, of course, wage income is essential for education and health fees, such expenditures often relying on women's employment.
The proposals to resolve misconceptions blocking plantation development are very much aimed at the small grower. They would therefore go further than industrial plantation development by empowering small farmers and labourers to become growers and owners of their capital stock. This is altogether more exciting a prospect than community woodlots, which offer few opportunities for household enrichment or increased living standards. One of the best-known examples from Africa has been "Project Grow" with 8,000 growers and an annual harvest of 80,000 tonnes of timber (SAPPI, 2003).
Different approaches to promoting plantation forestry in African countries are needed, and their governments can adopt new strategies to support the development of a market-led renaissance. The policy actions required boil down to three simple elements:
This incentive strategy will provide no panacea for insecure land tenure or macroeconomic instability, and nor will it persuade growers to plant trees where there may be better returns from alternative land uses (FAO, 2001). But, it is contended that the steps outlined can do more to unlock sustainable plantation development in Africa than any current approaches based on exaltations and inducements to plant.
Of course, there would be hurdles. First and foremost, there must be latent domestic market demand to drive plantation development. Then, the system of establishment and timber dedication grants proposed and the national forest fund must be well-costed and be guaranteed pump-priming funds for an initial ten years. Rough estimates for a model portfolio of 1,000 hectares of teak timber plantations built up over ten years suggest that annual grants would amount to $50,000, whilst the fund would need initial funding of around $130,000 annually to acquire crops. Thereafter, once in balance, the fund would be self-financing and worth in the region of $1.5 million, covering annual service charges of 2.5% for grant support and a further 2.5% to underwrite the buy-back options for growers.
Lastly, the private sector - small growers and processors - must be sophisticated enough to understand that, together, they can incentivate each other without government or donor persuasion.
Agyeman, 2003: Personal Communication. Dr. Victor Agyeman, Manager, Forest Plantation Development Centre, Ghana.
Crossley, R.A., Lent T., Propper de Callejon, D. & Sethare, C.: Innovative financing for sustainable forestry. Unasylva, no.188, Vol 48, 1997/1.
FAO, 2001: Financial and other incentives for plantation establishment. Report based on the work of J. Williams. Forest Plantation Thematic Papers, Working Paper 8. Forest Resources Development Service, Forest Resources Division. FAO, Rome (unpublished).
SAPPI, 2003: Project Grow: the Long Walk to Sustainability. Website feature www.sappi.com; South African Pulp & Paper Industry Pty.
UNECE/FAO Forest Products Annual Market Review 2001-02.
1 Forestry Planning Officer, FAO Regional Office for Africa, Ghana. [email protected]