Reforming the leasing and the use of agricultural land in Fiji

APPENDIX 1

Estimating the Shadow Price of Native Land in the Sugar Belt

A "shadow price" is an estimate of the price that would exist were native land actually to be traded in a market. It can be computed by estimating how much the land is actually worth on the basis of the income it can generate when worked by an average farmer. To do this, the net revenue contribution that land can generate each year must be estimated by subtracting from gross revenues the total costs of production, including labour. The resulting figure for land’s annual net revenue contribution can then be converted into a net present discounted capitalised value. The procedure is outlined below.

First, however, it is important to emphasise that the calculations below are for an average parcel of native land, so that they can be compared with average rentals. In practice, both market based rentals, the actual price of freehold title, and the shadow price of native land will all vary according to:

Consequently, before our calculations proceed, we must establish the characteristics of an average farm on native land.

In a recent document (World Bank Report No. 13862 – Fiji, "Fiji Restoring Growth in a Changing Global Environment", June 20, 1995) the World Bank reported that the average cane farm in Fiji had the following characteristics:

Gross revenues, of course, depend on the average price of cane, as well as the average tonnage harvested, but the World Bank figures are in line with the official Bureau of Statistics figures which show average cane farm income to range, in recent years, from $9,732 in 1995 to $7,456 in 1997 (Current Economic Statistics Jan-Oct. 1998, Bureau of Statistics). Consequently, $8,314 will be taken as reasonable gross revenue of our average or representative farmer.

Concerning production costs, these will vary according to whether ploughing and seedcane are used as the basis for production or whether cane is produced from a ratoon. Taking the former which is the highest cost case, the Asian Development Bank (Fiji Agriculture Sector Review, July 1996) estimate the production costs per ha to be $1,289. This figure includes seedcane, millmud, ploughing, harrowing, fertiliser, weedicide, furrowing, harvesting and loading, and cartage (though were rail to be used, there would be no cartage cost). Consequently, total production costs for the 3.11 ha actually devoted to cane would be $4,009.

Subtracting total production costs from gross income leaves a figure of $4,305. This represents the net annual income the farmer can receive when investing his labour in farming an average farm. To obtain the net contribution of land alone, the labour costs of the farmer would have to be deducted. This, of course, is problematic. The true labour cost depends on its opportunity cost. In this respect, cane is often described as a ‘lazy man’s crop’ since the labour input is not that great and can often be done at odd hours when the opportunity cost of cane farm labour would be leisure, not other productive work. Also, children or other family members often help out too. Consequently, the true economic value of the labour expended is likely to be rather low. But again, for illustrative purposes we can take a labour cost figure that is likely to err on the high side, say $2,305.

Consequently, the net revenue contribution of land alone, in our example, would be $2,000. The land embodied in our representative farm, then, would be able to generate indefinitely a stream of profit of $2,000 annually.

Applying the formula (x/i)+x used for calculating the present value of a perpetuity, where x is the annual revenue generated by land alone (ie. $2,000) and i is the rate of interest), the capitalised value of the indefinite income stream can be computed. Of course, another critical issue is the interest rate, the discount factor, to be used. There are several possibilities here. Perhaps the best measure for illustrating the true opportunity cost of capital would be the real rate of interest payable on long term Reserve Bank of Fiji bonds. Currently, the nominal rate here is 7.48%. Alternatively, and of more direct interest to farmers, is the rate charged by the FDB on loans. These rates are 8% for the first $20,000 and 13.5% for anything in excess of $20,000. Again, these are nominal rates. To properly estimate true asset prices, these rates should be reduced to real values, by deducting the rate of inflation. Since the theoretically desirable RBF level is close to the FDB lower level, we can make computations using simply 5% and 10% real interest rates. Doing this we get the following calculations:

Using a 5% interest rate

Here the shadow price of 4.2 ha of native land would be:

2000/0.05+2000 = $42,000.

This yields a value per ha of $10,000, a figure very close to currently advertised prices for freehold agricultural land.

Using a 10% interest rate

Here the shadow price of 4.2 ha of native land would be:

2000/0.10+2000 = $22, 000.

This yields a value per ha of $5,238.

There is no single best way of judging which of these values is most appropriate. However, faced with this dilemma, it seems reasonable to take the average of the two figures as a rough indication of the effective value of a typical 1 ha parcel of native land. Taking the average, then, we obtain a shadow price of $7,619 per ha.

Interestingly, the above analysis has further important implications. Given that the average farmer on the average farm would be able to earn $2,000 in net profit per year, this figure will also represent the maximum rental the tenant would be willing to pay per year for his lease. This amounts to $476 per ha. Consequently, if rents were set at our conservative estimate of a fair market rate, namely $300 per ha, the tenant would still be enjoying a healthy margin of consumer’s surplus.

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