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ICO economic report: Closing the gap

From the April 2019 issue.

New research shows variation in production costs and farm profitability. The International Coffee Organization reveals plans to globally benchmark costs to help farmers address low coffee prices and their volatility.

International coffee prices have been falling since 2016, with the International Coffee Organization (ICO) Composite Indicator breaking through the US$1 per pound mark in September 2018. Since then, the market has remained broadly at this level, which is almost 30 per cent below the average coffee price over the past decade. This is bad news for farmers around the world.

Low prices result in dwindling farm incomes and puts rural livelihoods at risk, especially those of smallholders. Prolonged periods of low coffee prices hamper growers’ ability to invest in productivity-increasing technologies and climate change adaptation. In the long run, production volume and quality may suffer, with serious implications for future supply.

Low prices for coffee increase pressure on high-cost origins and tend to accelerate concentration of production in a small number of highly competitive regions. Today, the top five producers already supply over 70 per cent of the world’s coffee. If the consolidation trend of previous years continues, this share could reach more than 80 per cent over the next decade or so. Less spatial diversification of production exposes the global coffee sector to greater supply risks. With fewer origins producing coffee, the likelihood increases that extreme weather events, infrastructure failure, or political instability in major growing areas could dramatically disrupt global supply.

We know that some coffee growers cope better than others with the cyclical downturn of coffee prices. At a global level, this tendency is a result of variations in production costs across countries. But we also find differences between regions within countries and even within the same village or cooperative. As a result, some farmers break even while others are unable to cover their cost of production at current price levels.

But what are the drivers of farm profitability? Can we learn something from carefully studying the most efficient producers? Are there ways to harness characteristics and success factors of top producers to help less profitable farmers to catch up? These are key questions economists have to answer in order to devise strategies that help to increase incomes derived from coffee production and to improve household welfare.

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Despite the importance of production costs as a determinant of farm profitability, the available literature on this topic is surprisingly scarce. Many of the existing studies have methodological shortcomings. For example, ignoring the opportunity cost of labour in family farms and other items required to calculate the full economic costs of coffee farming understates costs incurred by growers. Small or unspecified samples limit the extent to which findings can be generalised. If costs and profitability are calculated and assessed for an average producer, this clearly fails to take into account the heterogeneity of millions of coffee farmers.

In a newly published ICO study, co-authored by economists Andrea Estrella and Steve Boucher of the UC Davis Coffee Centre, and ICO economists, such issues are addressed, and new empirical evidence on profitability of coffee production in Latin American countries is revealed.

This economic analysis is part of the implementation of Resolution 465 on coffee price levels, which was adopted by the International Coffee Council (ICC) in September 2018.

ICO member countries and sector stakeholders discussed the first publication of the ongoing project at the 124th Session of the ICC, which took place during the last week of March 2019 in Nairobi, Kenya.

The in-depth farmer-level data, collected as part of the Transsustain research project from the University of Münster in Germany, examines the distribution of costs and profitability across farmers in three important coffee origins: Colombia, Costa Rica, and Honduras. The study authors then took advantage of a large sample that contains detailed information on almost 2000 farming households, demonstrating a high level
of heterogeneity and variability across individual growers.

Three results are striking. First, in this sample of Arabica-producing countries, a large variation in production costs between countries was found. In Honduras, the average production cost was US$0.79 per pound compared to US$1.39 per pound in Colombia and US$1.31 per pound in Costa Rica.

Second, the breakdown of production costs into labour (paid and unpaid), inputs, and fixed costs demonstrates that labour represents by far the highest share of costs for each of the countries. The highest fraction of labour costs is found in Colombia at 75 per cent, followed by Costa Rica at 57 per cent and Honduras at 56 per cent. This illustrates one of the key challenges faced by these production systems. In all three origins, terrain and farm size make it difficult to mechanise or, in more technical language, substitute labour by capital. Rising labour costs will inevitably make coffee from these countries more costly if labour productivity does not increase. One way out is to tap into higher-value market segments, a strategy pursued with some success by Costa Rica, and Colombia.

The third key result from the report is the break-even analysis. Figure 1 shows that Colombian farmers, in particular, struggle to cover their costs. One-third of the farmers in the Colombian sample did not cover their cash outlays, as indicated by negative gross margins. When the full costs of producing coffee are considered, a staggering 53 per cent of farmers were operating at a loss. These producers thus face both short- and long-term challenges to profitability. Farmers in the other two countries are doing slightly better.

There will be much to learn over the next months as the work continues. The research team will extend the econometric analysis by taking advantage of the rich dataset to explain observed differences in production costs and profitability between individual producers within and across the three Latin American countries.

But how do we extend the analysis to other coffee-producing regions? The discussions at the Council session in Nairobi clearly showed that there is a need to close the data gap with regard to production costs and farm profitability.

Hence, members decided that the ICO will start a global benchmarking of production costs. To systematically gather reliable and independent estimates of farm costs is a complex and costly enterprise. However, partnering with value chain actors, including traders, roasters and input suppliers, will enable us to collect and analyse the data and to make it available to the global coffee community, thereby providing the knowledge necessary for taking actions and helping farmers to address low coffee prices and their volatility.

This article is written by Christoph Sänger, a Senior Economist at the International Coffee Organization (ICO) in London, conducting research on coffee value chains in Africa, Asia, and Latin America. Prior to joining the ICO, Sänger was an economist at the European Bank for Reconstruction and Development, where he carried out sector and project evaluations to support the design of agribusiness investments in Eastern Europe, Central Asia, and Northern Africa. He has previously worked in the Division for International Cooperation at the Federal Ministry of Agriculture in Berlin. He received his MS degree from University of California, Davis, USA, and holds a PhD in Agricultural Economics from Georg-August-Universität Göttingen, Germany.

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