notes agriculture & rural development Land Policy and Administration foreign investment in agricultural production: 47430 opportunities and challenges issue 45 January 2009 By vera songwe and Klaus deininger The recent surge in food and fuel prices has prompted over $1,037. Between January and March, wheat countries with high dependence on food imports to export prices increased from $196 to $440 per ton.1 try and lock in future food supplies through direct Countries' attempts to isolate themselves from these investment in agricultural production in other coun- trends through measures such as export restrictions tries. The price surges also led to a wave of proposals only worsened volatility. The price increases threatened to invest in biofuels investments in agricultural land. food security and welfare among the poorest, par- While such investment can provide large benefits, it ticularly in countries that depend on food imports. In also carries considerable risks both to investors and countries where the poor could no longer afford food, citizens in the locality of the investment. To ensure and where state budgets could not absorb the costs of that investments provide broad benefits and effec- increased subsidies, price increases raised the specter tively contribute to larger development outcomes, of social unrest. Food importers were compelled to enforceable property rights and contractual agree- explore alternative means of securing adequate food ments in many developing countries need to be supplies, such as acquiring land or investing in agri- strengthened. This Note considers how development culture in countries with abundant agricultural land. partners can help countries create the pre-conditions Food prices however were not the only force at play in for investment and proposes a governance framework increasing the demand for land. High fuel prices were to establish minimum standards for it. simultaneously leading to greater demand for planta- tions on which to grow biofuel crops such as oil palm. context and The availability of large amounts of unutilized or under- gloBal drivers utilized land in some developing countries together It is widely agreed that the combination of increased with fears about food supplies and a secular trend demand for biofuels, increased incomes, and shifting of shifting demand, has led to a re-emergence of the patterns of demand will lead commodity prices to be issue of direct foreign investment for commercial agri- higher and more volatile in the future than they have culture. Although reliable global figures are lacking, the been in the past. Between January and May 2008, magnitudes involved are very large. In Mozambique the price of rice increased from US$389 per ton to the World Bank estimates that applications for land by foreign investors amount to more than twice the total area of land that is cultivated in the country. Similarly large investments are reported to have occurred or are being negotiated in Brazil, Cambodia, Ethiopia, Sudan, Mozambique, Pakistan, and Russia. A variety of issues need to be addressed if such investments are to lead to substantial social benefits and contribute to rather than hinder economic development. specific elements to Be considered Foreign direct investment that engages in sustain- able commercial agriculture can generate significant benefits. Investing to bring hitherto uncultivated land into production can generate jobs and increase local incomes directly and through forward and backward market linkages that attract complementary invest- ment. It can deepen export markets, improve access to technology, inputs, and output markets such as through Photo: Erick C.M. Fernandes the world BanK bulk purchases or sales agreements. Direct investment and new make significant advances in land use planning that could be agribusiness ventures can also help to diversify rural econo- adopted by other countries. mies.2 In the past many investments by agribusinesses relied on outgrowers for production and supply rather than direct land Property rights. Even in apparently land-abundant settings, acquisition. More recently however, agribusinesses often see there is little truly `unoccupied' land. User rights are often land acquisition as an essential element of investment. informal and recognized through customs and traditions. To be able to respect and fairly compensate existing users at a larger For society to realize the potential benefits of large-scale scale, it may be necessary to record them and verify them on the land acquisition and to avoid common risks, two things are ground. Whether land rights are held by individuals, groups, or required. First, a variety of technical challenges that are associ- the state, a sound investment climate requires them to be clearly ated with this kind of investment needs to be overcome. Failure defined and verifiable and transfers to be governed by clear and to address the technical challenges associated with agricultural enforceable rules. In the case of group rights, mechanisms are production, especially when the crops have a low margin, has required to facilitate decision making and enforcement between often undermined the viability of such investments. Second, groups, and to provide clarity as to who is authorized to enter arrangements need to be in place for benefits to be shared into agreements on behalf of the group. In areas where demand in a way that is perceived to be fair by all involved. Access to for land is likely to increase, systematic recording of local rights infrastructure and services, handling of labor issues, contract should include potential as well as actual land uses. Systematic enforcement, and links to markets are just some of the issues recording is generally more cost-effective, pro-poor, and com- that are critical for the viability of any large scale land acquisi- patible with incentives than delineating rights in response to tion. A variety of means are available to reduce unnecessary specific investment proposals. It increases accountability and risks to investors and to ensure that the benefits and returns transparency in the approval of investments and expands and to investment are shared with local communities. improves available information for everybody.5 Agricultural and land use potential. The large areas of Benefits sharing. Public investment in infrastructure and suitable but unused or underused agricultural land in many complementary services is generally needed to fully realize developing countries naturally attracts the interest of outside potential benefits, and this investment relies on appropriate investors. In Mozambique, Tanzania, and Zambia for instance, mechanisms for revenue-collection and sharing. If these mech- an estimated 12 percent of arable land is actually cultivated. anisms cannot be negotiated, public services and infrastructure In some regions such as Central Asia, land is abundant but are unlikely to materialize and local populations are unlikely to water is extremely scarce. Establishing local land use plans benefit from the development of the land holding. Failure to to help bring the interests of communities and investors into plan or negotiate with interested investors also makes it less line, and in a way that is consistent with sustainable resource likely that local communities will enjoy the potential direct use, is an essential element in ensuring that the most suit- benefits of development, such as employment and income able land is selected for a given purpose. It can also reduce generation. When the investment does generate employment, the danger that highly productive or ecologically sensitive compliance to accepted standards for wages and working con- land will be diverted to marginal uses, and provide inves- ditions becomes an important issue. Poor planning can easily tors with critical information on agro-ecological conditions lead to conflict between investors and those with existing user on a given tract of land, and the status of existing rights to rights, while the lack of a regulatory framework or enforce- that land. The use of high resolution satellite imagery by the ment capacity can lead to a number of environmental hazards private sector has recently enabled countries such as India to and overuse or misuse of the natural resource base. dangers associated with large-scale land acquisition While attracting investment is an important priority for land-abundant African countries, caution is warranted to pre- vent speculative investments or arrangements in which local land rights are lost or landholders are excluded from the benefits of the investment. Large-scale land acquisitions during commodity booms can be particularly detrimental to social and economic development, as evidenced in Central America during the coffee boom of the late 19th century when privatization of previously customary lands led to rapid land concentration.In countries such as Guatemala and El Salvador, the coffee boom led to the expropriation of land on a massive scale, followed by decades of conflict and civil war that undermined economic, human, and social development. By contrast, in Costa Rica and Colombia, increasing coffee prices fostered the emergence of vibrant smallholder coffee economies.Although the four countries started in very similar conditions, the latter now enjoy a per capita income double that of the former, rank much higher on the human development index, and have been democracies for more than 50 years rather than little more than a decade.3 More recently, large land transfers to investors in Cambodia and Kenya failed to help modernize agriculture and instead generated conflict and allegations of corruption. In Cambodia, few of the large holdings, which are measured in tens of thousands of hectares, are used productively. In Kenya,"land grabs" by public officials reached systemic proportions between 1980 and 2005. One government report singled out land grabbing as "one of the most pronounced manifesta- tions of corruption and moral decadence in our society."4 2 Outgrower versus plantation. Different contractual forms roles for development are appropriate for different types of investment and dif- partners ferent returns to investment. Long-term leases tend to be more appropriate in situations in which land is abundant Investments in commercial agriculture are a private sector activ- ity. They are negotiated by the parties involved. Multilateral and investments in clearing and installation of infrastructure institutions such as the World Bank can however contribute in such as irrigation is required. Operations in these situations a number of ways to make such arrangements more likely and often entail large-scale mechanization and the production of bulk annual commodities. In situations in which land is less ensure they meet a set of minimum standards. abundant, labor costs are low, and the quality of the product Help countries establish secure property rights. Many is a practical priority, contracts that provide producers with countries fail to realize the full benefits of outside investment technical assistance and access to markets, specialized inputs because their institutions cannot define, enforce, or effec- and financial instruments are often preferred. This type of tively negotiate property rights. The World Bank has long contract can generate substantial employment and other provided technical and financial support to help countries local opportunities, and enable farmers to manage the risks develop the institutions and instruments needed to secure involved in producing nontraditional crops.6 land rights and to define land uses. Given the risks implied Contract enforcement. The confidence among entrepre- by the size and speed of current developments, this focus on long-term institutional development now needs to be neurs and prospective entrepreneurs that contracts will be complemented with an emphasis on fast, cost-effective, and enforced and disputes will be resolved quickly, judiciously, and transparent ways to secure local land rights. It also requires authoritatively is an essential element of a sound investment inclusiveness, and mechanisms to increase the voice of right climate. Their alternative is to resort to unconventional chan- holders, especially those such as women and herders, who nels of dispute resolution, often at high political levels, where have not traditionally participated in negotiations about decisions are seldom transparent and their results are often investments. By providing information on land availability unsustainable. Investments that involve production for food and use that is often unavailable at present, this will also yield exports can also be particularly vulnerable to policy changes, significant benefits for investors. such as export bans on certain crops to stabilize domestic prices. Political risks relating to sudden shifts in policy have Reduce transaction costs and manage governance been common, particularly in areas that are chronically food risk. Many countries have centralized and complex processes insecure, and where exporting sizeable amounts of food can for approving land acquisitions or ensuring compliance with be acutely politically sensitive. Governments in these situations planning norms. These increase costs to investors, and often may be unwilling or unable to grant investors exemptions from end up fostering corruption and undermining the safe- policies that are politically popular or widely perceived as serv- guards that many of the procedures are intended to provide. ing important purposes with regard to social welfare. In some Decentralizing approval processes, within a larger framework countries this represents a risk even for very large investments, of good land governance, increases accountability and the such as the acquisition of some 800,000 hectares of farmland quality of investment, especially if potential investors subscribe in Pakistan by investors in the United Arab Emirates.7 to a set of agreed social and environmental standards. Land does `modern' agriculture require large farms? An argument commonly used to advocate allocating large tracts of land to investors is that `modernized' agriculture, especially in Africa, will by definition entail a transition from small holdings to large farms.The argument often includes a critique of "smallholder romanticism" as a source of naivety that distracts people from the hard economic realities of progress and growth, which rely on achieving economies of scale.This is a myth with little foundation in reality.While activities related to processing and marketing of agricultural produce are indeed characterized by significant economies of scale--the importance of which is further increased by phytosanitary restrictions--a large body of literature demon- strates that there are no economies of scale in agricultural production.All over the world, family-operated farms have been shown to be economically much more efficient than plantations operated by wage labor.This is one reason that even large agri-business firms often rely on outgrowers, and do so almost exclusively for produce that has to meet the highest quality standards. Smallholder production moreover has a massive employment effect that is not seen in the case of large mechanized farming.This employment effect is critically important for poverty reduction in situations in which non-agricultural economic growth is insufficient to draw workers out of the agriculture sector.A useful illustra- tion of this relationship between farm size, poverty, and employment can be found in the contrast between Brazil and China from 1991 to 2001. During that period, China doubled its cereal yields based on a smallholder sector with an average plot size of less than 0.2 hectares,and in so doing raised some 400 million people out of poverty.Over the same period,Brazil achieved slightly lower rates of growth based on mechanized large scale farming ­ but the number of rural poor actually increased.The conclusion is that agri-business investments that require implicit subsidies in the form of unrealistically low land prices or exemptions from taxation in order to become viable are unlikely to be a good idea. 3 governance frameworks such as the Extractive Industries for investment. This often leads to results that are quite similar Transparency Initiative (EITI) or the Equator Principles estab- to heavily centralized procedures for the approval of land trans- lished by the IFC for good practice in project financing can fers. It encourages political interference, disrupts negotiations, help reduce transaction costs for governments and investors in encourages corruption, and often produces outcomes entirely a way to ensure fair sharing and thus sustainability of benefits. contrary to those that were envisaged. Where this is the case, Adherence to such principles could be used to establish eligi- the scope for transferring responsibility and accountability to bility for insurance coverage by MIGA against political risks, the local level needs to be purposefully explored. including those of creeping expropriation or export bans. Tax idle land and impose appropriate lease payments. Best practices for dealing Many countries tax land-related investments but not the land with agricultural itself. This may make sense in contexts in which land is relatively investment abundant. Elsewhere however, taxing unimproved land above a certain size or value can be an effective way to prevent specu- Assess economic viability. Rigorous economic analysis of lative hoarding. Smallholders are easily exempted, and should land-related investments is important for two reasons. First, be, especially when the costs of collecting taxes are likely to many of the investments reported in the press appear to be exceed the tax yield itself. To encourage collection as well as motivated by non-economic factors, such as the security of updating of valuations, a major share of such payments should food supplies. Many are located in places that may not be suit- accrue to local communities. Taxing land is far superior to most able for producing the commodity involved. Second, investors alternatives, such as making investors' land rights conditional and some government bureaucrats may have an incentive to on investment being undertaken. However attractive this may underestimate the cost of the land or other factors of produc- seem in theory, in practice it is extremely costly to enforce and tion such as labor. If investments will not be economically prof- very often lends itself to discretionary application. itable, this reality needs to be factored into the design of the contract so that both sides acknowledge it explicitly and form reference their expectations accordingly from the beginning. 1 Figures are for Thai Parboiled 100%, Thai 25% increased from $368/t to $869/t over the same period and by end November 2008, Ensure that reliable information on land rights and dropped to $464/t. suitability is available. Information about the land being 2 Mayers, J. and S. Vermeulen. 2002. "Company-Community considered and the claims of existing rights holders are Forestry Partnerships: From Raw Deals to Mutual Gains?" London: principal concerns among most prospective investors, who International Institute for Environment and Development; Vermeulen, understand the often very real risk that competing claims may S. and N. Goad. 2006. "Towards Better Practice in Smallholder Palm surface when the acquisition is announced. Having a reliable Oil Production" London: International Institute for Environment and land registry in place and effective land use planning goes far Development, Cotula, L., N. Dyer, and S. Vermeulen. 2008. "Fuelling in addressing these concerns and in providing investors with Exclusion: The Biofuels Boom and Poor People's Access to Land" London: IIED and FAO. the information they need to make rational decisions. Even in situations where the coverage of existing land use planning is 3 Nugent, J. B. and J. A. Robinson. 2002. "Are Endowments Fate?" CEPR Working Paper 3206. Center for Economic Policy Research. London. currently limited, a number of countries have demonstrated the utility and cost-effectiveness of satellite images as refer- 4 Government of Kenya. 2004. "Report of the Commission of Inquiry into the Illegal/Irregular Allocation of Public Land." Nairobi ence material for consulting local communities about the pre- Government Printer, p. 192. cise areas they have claims to. This provides the groundwork 5 World Bank. 2002. "Mexico-Land Policy: A Decade after the Ejido for informed negotiation between the communities and inter- Reforms." Washington, DC. Report 22187-ME. Deininger, K. 2003. ested investors with no ambiguity over the demarcation of the Land Policies for Growth and Poverty Reduction. Oxford and New area or terms being discussed. It is also an ideal opportunity to York: World Bank & Oxford University Press. For recording of individ- generate basic land use plans. ual rights see Deininger, K., D. A. Ali, and T. Alemu. 2008. "Impacts of land certification on tenure security, investment, and land mar- Allow direct negotiation between communities and ket activity: Evidence from Ethiopia." World Bank Policy Research potential investors. Most countries now provide legal rec- Working Paper 4764. ognition (though often not automatic recording) of local land 6 Key, N. and D. Runsten. 1999. "Contract farming, smallholders, rights. This implies that direct negotiation between the parties, and rural development in Latin America: The Organization of Agro Processing Firms and the Scale of Outgrower Production." World if necessary supported by awareness-raising and training of local Development 27 (2): 381-401 for a more detailed analysis of out- communities, can help produce outcomes that are more suited grower and contracting options for agro-industry. to local conditions -and thus provide higher overall benefits- 7 Woerz, E., S. Pradhan, N. Biberovic, and J. Chan. 2008. "Potential and have these shared in a fairer way. However, many countries for GCC Agro-investments in Africa and Central Asia." Dubai; UAE: still require that government first expropriate land to be used Gulf Research Center The ARD Notes series on Land Policy and Administration aims to disseminate results from World Bank research and economic and sector work that depicts innovative operational practices, or points towards areas meriting further analytical attention. This ARD Note was written by Vera Songwe and Klaus Deininger, and edited by Gunnar Larson. the world BanK 1818 H Street. NW Washington, DC 20433 www.worldbank.org/rural