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ISSN : 1225-8504(Print)
ISSN : 2287-8165(Online)
Journal of the Korean Society of International Agriculture Vol.33 No.2 pp.101-112

Reducing the Effectiveness of Agricultural Policy by Information Asymmetry: the case of the Compensation Program for Farm Closure for FTA

Seongtae Ji
Graduate School of International Agricultural Technology/Institutes of Green Bio Science and Technology, Seoul National University, Gangwon 25354, Korea
Corresponding author (Phone) +82-10-2378-8073 (E-mail)
January 13, 2021 February 24, 2021 March 18, 2021


In this paper, we analyzed the case of government failure of the Compensation Program for Farm Closure, which is being promoted as part of the domestic supporting measures against FTAs. We identified the causes and suggested several ways to improve the program. The Compensation Program for Farm Closure is one of the policies implemented by the government to enhance the competitiveness of domestic agriculture and stabilize farm household income in the process of FTA implementation. However, during the course of the operation of the program, the government failed. The main reason for government failure is information asymmetry and lack of information among policy stakeholders. As a result, it is necessary to resolve the problem in order to overcome the government failure and improve the effectiveness of the Compensation Program for Farm Closure. As a concrete alternative, it is necessary to improve the accessibility of stakeholders to production, price, and income information, and provide management consulting services at the same time. Only farmers who prove the damage caused by the FTA should be supported through the program.

정보 비대칭에 따른 농업정책 효과성 저하: FTA 폐업지원제도를 사례로

서울대학교 국제농업기술대학원/그린바이오과학기술연구원



    South Korea has signed 20 FTAs with 58 nations, from Korea-Chile FTA in 2004 to Korea-UK FTA in 2020. While several FTAs with many countries have been going effect simultaneously, South Korea has implemented the Domestic Countermeasures for FTA (DCF) to minimize the import damages of domestic agriculture from the market opening and strengthen the competitiveness improving its constitution. This is legally based on the ‘Special Act on the Support of Farmers and Fishermen in the Implementation of Free Trade Agreements (FTA agriculture-fisheries Law),’ which was enacted in 2004. The budget for DCF following the major FTAs was allocated based on the estimated amount of the import damages that the FTAs would cause. DCF includes nighties sub-programs and is categorized as Medium and Long-term Investment and Loan Programs (MLILP) and Short-term Protection Measures (SPM). MLILP consists of sub-sectors, such as the improvement of competitiveness of livestock, fruit, and horticulture, the capacity building for farmers and the promotion of man-agement stabilization, and the creation of new growth engines. And SPM as a program of Direct Protection for FTA Damages (DPFD) consists of Direct Payment Program for FTA Damages (DPPF) and Compensation Program for Farm Closure (CPFC). DPPF and CPFC, which were introduced to compensate for direct damages from FTA, are hard to find similar programs in other countries. Although there are similar programs with DPFD, such as ‘Compensation Program for import damages of agricultural products (農産品進口損害救濟制度)’ in Taiwan and ‘Trade Adjustment Assistance for Farmers’ in the U.S., there is a big difference in the scope of the support target and the operation ways.

    If we look at the budget execution performance of DCF in the agricultural sector, from 2008 to 2016, a total of 26.83 trillion Korean won was allocated, and a total of 23.58 trillion was executed. In the proportion of budget execution for each program group during this period, we can find that the highest is in improving the competitiveness of the livestock industry at 38.4%. The followings are the capacity building for farmers and the promotion of management stabilization (35.7%), the creation of new growth engines (15.9%), and the improvement of the competitiveness of fruit and horticulture (6.9%). The portion of the budget spent on DPFD was only 3.0% (MAFRA, 2017a).

    Although the budget allocated to DPPF and CPFC is small, beneficiary farms have a relatively high satisfaction level because the programs support direct import damages. Since 2013 direct import-damaged items have been continuously selected as market opening expands with the implementation of the FTAs. From 2013 to 2016, DPPF had covered 19 items (including duplicate items), and among them, 11 items had been selected as target items of CPFC. It means that the damages to domestic agriculture become more tangible due to the FTAs. And it’s doubtful whether DCF, including DPPF and CPFC, are working well and fully functioning as countermeasures of FTAs.

    DCF is one of the measures by which the government actively intervenes in the production and market stages to cope with the import damages of the agricultural sector and compensate for direct damages to farms. However, at the same time, unexpected results or operational problems can be produced while achieving its intended purpose through the implementation of DCF. This study analyzed what problems were caused and what caused them by government intervention through the CPFC. In particular, we focused on what kinds of government failures caused by information asymmetry and lack of information among stakeholders, including the government, in the program implementation.

    CPFC with DPPF is also a temporarily adopted program to minimize damage to the domestic agricultural sector during the early stages of the FTA implementation. It is assessed that CPFC has contributed to restructuring target items for CPFC and establishing a stable living foundation for closed farms to some extent. On the other hand, there are also some negative opinions that it has caused outward shrinkage of the domestic agriculture, distortion of the market and inefficient distribution of resources, and adding to the financial burden on the government. Therefore, this study is of great significance in that it analyzed the cases of government failure in CPFC and their causes and suggested ways to improve the program based on them.


    Government failures are a case in which the government had intervened to complement an imperfect market function but failed to achieve the intended purpose (Kim, 2004: 276). When a government policy or activity fails to reach its goals or expectations due to certain restrictions, it might be referred to as government failure (Kim, 2004: 137; Lee, 1994: 56-57). Price does not necessarily make resource allocation efficient and fair in the market. The Pareto optimality also could fail. In the end, the government comes to intervene through several policies to solve these market failures. In fact, Pareto optimality in itself is not easy to reach. To achieve this, the following conditions must be met: that means there should be no economies of scale that undermine perfect competition, no external effects, and the factors of production should move freely between companies, industries according to the change in price and converge quickly into a balance through the competition (Jo & Chung, 1996: 316). But realistically, it is impossible to meet all of these conditions. This also represents the limits of ‘the invisible hand’ of the market, which Adam Smith advocated. Lee (2003: 86-89) divided market failures into static and dynamic failures. He concluded that the former is caused by the failure of a fully competitive market because of external effects, remarkable effects of economies of scale, and monopolies, and the latter are caused by the imperfection of the financial capital market, the rigidity of the labor market, the existence of information cost, and the imperfection of the technology market.

    Then, could the ‘visible hand’ of the government be a perfect alternative to overcome these market limitations? Of course, moderate levels of government intervention could make up for market failure to some degree. But it is not easy to regulate levels of government intervention. Too much intervention or regulation of the government could lead to inefficient or unfair distribution of resources, thus rather undermining the vitality of the market. Stiglitz cited as the causes of the government failure 1) the imperfect future prediction because of limited information, 2) the government's limited control over the responses of private markets, 3) the issues of responsibility and control of public officials, 4) the complexity of the policy environment structure because of the influence of various interest groups in the political process (Kim, 2004: 276). The possibility of failure may be latent in the government’s administrative system itself. In other words, there is every possibility that the distortion of the allocation of resources in the private and public sectors, the imbalance of power centered on administrative functions, the evils of uniform administration, the dogmatism of administration, the passiveness of people, the abuse of power and the possibility of corruption will cause government failure (Kim, 2004: 137-138). Pierce (1981) divided types of government failure by ‘political failure’ in policy formation and ‘bureaucratic failure’ in the policy implementation process. Moreover, Wallis & Dollery (2001) added ‘rent-seeking failure' to the types. ‘Political failure’ means irrational policy actions in the policy-making process, from setting the policy agenda to selecting the final policy alternative. And ‘bureaucratic failure’ means that in policy implementation, the original purpose is turned into another one by the bureaucracy. ‘Rent-seeking failure’ means that the government's intervention will lead to policy-driven profit-seeking behavior; thus, ‘rent interest’ belongs to a particular interest group (Kim, 2004: 277-279).

    The justification and the degree of the government’s intervention differ by each industry sector. The government tends to intervene more actively in the relatively vulnerable sector such as agriculture. Especially, agriculture is protected by the government based on social consensus because it has the characteristics of public goods such as food security and other multi-functions. Moreover, with the wider opening of the domestic agricultural market, the government tries to support the less competitive agricultural sector in the global market within WTO's international norms. The ways the government intervenes are subsidies, regulations, and so on. The ultimate purpose of the government's intervention is to strengthen the competitiveness of the agricultural industry and stabilize farms’ income. However, it is hard to achieve the goal; instead, it can cause side effects. That is exactly the government's failure. ‘Paddy farming direct payment’ program is a typical case. The program, originally aimed at protecting the rice industry and stabilizing the rice prices, resulted in an oversupply of rice as domestic rice consumption continued to decrease. Besides, the government’s direct intervention in the market includes ‘purchase-storage program of agricultural products’ and ‘production stability program’ and so on. Like these, the government directly participates in the market and acts as a supplier while acts as a meditator are establishing, interpreting, and executing the related systems and rules so that the market economy could operate smoothly (Kim, 2001: 35).

    However, it is not easy to achieve the original purposes because of asymmetry of information between the market players, ‘rent-seeking’ and capture phenomenon, improper timing of policy enforcement, time gaps between policy implementation and production of results, the rigidity in policy implementation, and the derivative external effects. In other words, each market player, such as producers, consumers, and the government, has different quality and quantity of information, and there are ‘rent-seeking’ activities and capture phenomenon of players with higher quality information. If the procedures from policy-making to implementation and the coordination between stakeholders are needed, it could take a certain amount of time to launch a policy program, and it is hard to achieve the expected initial effects. Even if problems are found in the policies being implemented, the policies tend to remain rather than immediate modification or supplementation when the interests are complicatedly intertwined in the policy programs. If unexpected side-effects occur in the policyenforcement, they could reduce the welfare of the whole society and the outcome of the policy.

    It means that the government's intervention to prevent the market failure could rather cause side-effects. To reduce these side-effects, the government should intervene at the optimal level, and the functions of the government and the market should be harmoniously combined. For this, the government needs to reduce excessive government intervention and regulations on the market and establish a feedback system that can overcome the government failure (Kim, 2004: 299-300).


    Overview of the program

    As the Korea-Chile FTA went into effect in 2004, the government has developed and implemented so-called the Domestic Countermeasures for FTA (DCF) in order to minimize the damages to the agricultural sector, which is based on ‘the FTA agriculture-fisheries Law’ enacted in the same year. The main purpose of DCF is to strengthen the competitiveness of agriculture, improve the constitution, and support the farmers for the direct import damages. And it is categorized into Mid-long term investment and loan programs and Support Program for FTA Direct damages (SPFD). SPFD consists of Direct Payment Program for FTA damages (DPPF) and Compensation Program for Farm Closure (CPFC). DPPF is a program that supports the farmers who produce items damaged by the price decline due to the sharp increase of imports from FTA partner countries for a certain portion of the declined price. CPFC is a program that pays corresponding compensation if a farm closes its businesses that are approved difficult to grow or raise items such as fruits, horticultural products, and livestock due to the FTA implementation. These measures aim to increase competitiveness by stimulating the restructuring of the industry concerned and guarantee stable economic activities and living conditions for closed farms (MAFRA, 2017a).

    CPFC is linked to DPPF. Among items subject to DPPF, the government selects items subject to CPFC only for items that cannot retrieve the investment due to the high initial investment costs or that take more than two years to grow or raise, such as fruits and livestock. In fact, from 2004, when CPFC was introduced to 2008, items expected to be damaged (kiwis, greenhouse grapes, peaches) were designated beforehand. Afterward, as it changed to a postdesignating way, the government selects items subject to CPFC only for items that had proved to be damaged. During the same period, the payment calculation criteria had shifted from a three-year net income to a three-year net profit. CPFC is a temporary program as with DPPF. When the Korea-Chile FTA went into effect in 2004, CPFC was introduced as a one-time program, and it was extended to 2011 when Korea-EU FTA took effect. And it was extended for five years as of the Korea-China FTA in 2015 again.

    Implementing Performance

    From 2004 when the Korea-Chile FTA went into effect to 2016, a total of 14 items were given compensation for Farm Closure, and the total payment amounted to 790 billion Korean won. The items subject to payment were all fruits and livestock products. From 2004 to 2008, the compensation was paid to the farmer who produced greenhouse grapes, kiwis, and peaches for five years. This program has been working as a part of domestic countermeasures to Korea-Chile FTA in a proactive response to the potential damages not based on the actual import damages. As the FTA agriculture-fisheries law was revised in 2007, farm closure compensation was paid for farmers who produced items that actually suffered from import damages. In 2012 some of the requirements for DPPF activation eased through the revision of the law, and items subject to compensation for farm closure have begun to appear. Among them, Korean beef calf (breeding beef), outdoor grapes, and greenhouse grapes had been proven to be damaged by import for the second consecutive year. In addition, the farmers who produced the items received compensation for two years.

    CPFC was first introduced as a domestic countermeasure for Korea-Chile FTA, and for five years from 2004 to 2008, the farms of peaches, greenhouse grapes, and kiwis received compensation if they were closed or transferred to other farmers. In the early stages of the program implementation, the government received farmers’ application for closure and supported the aged farmers or unproductive farms for the closure by stages. Closed farms were provided an equal amount to the 3-year net-income, and transferring farms received an amount equal to the 1-year netincome. As a result, subsidies for farm closure amounted to 237.7 billion won, among which the sum paid to the peach farms was 179.6 billion won, accounting for 75.6%. The size of closed farms was a total of 5,812 ha, and the number of beneficiary farms was 106,860.

    With the total amount of beef imports in 2013 increasing compared to the average year, the increase in imports from the U.S., one of FTA partners, led to the drop in domestic beef and calf prices. Thus cattle became the target item of the CPFC. Accordingly, since before 2012, when the Korea-U.S. FTA took effect, all farms that raised Korean beef could be the beneficiaries of CPFC. As a result, about 18,000 farms accounted for 15.1% of the total number (119,000) of breeding-cow farms and applied for the farm closure. The number of breeding cows subject to be closed reached about 250,000. The number of breeding cows owned by farms that applied for CPFC was about 180,000, which accounted for 10.3% of the total number of the breeding cow. And the number of fattening cattle that belonged to the closed farms was about 70,000, which accounted for 6.5% of the total number of fattening cattle. The payment per one breeding cow/fattening cattle was respectively 900,000 won and 810,000 won, and a total of 218.3 billion won was spent as the compensation for farm closure, which was far more than the allocated initially budget of the compensation. Thus it added to the government’s financial burden, forcing it to split and support for two years. In 2013, 81.9 billion won was paid for the first time, and the remaining 114.3 billion won was paid in 2014.

    In 2014, the imports of beef increased compared to the average year, and the price of Korean calf went down. For this reason, the breeding cow was selected as an item for CPFC again. The number of farms applying for CPFC was 3,010, accounting for 4.4% of the total breeding cow farms(69,000), and the number of cows belongs to the farms who applied for CPFC was 23,000, accounting for 3.5% of the total number of the breeding cow(653,000). The compensation for each cow was about 890,000 won, similar to that of 2013, and the total amount of compensation for closure was 19.6 billion won.

    In 2015, 9 items were selected as target items for DPPF, such as soybeans, potatoes, sweet potatoes, cherries, melons and outdoors grapes, greenhouse grapes, chickens, chestnuts. Among them, five items, such as cherries, outdoors grapes, greenhouse grapes, chicken, and chestnuts, became the target items for CPFC. The total number of farmers who applied for CPFC was 4,610, among which the number of farms growing outdoors grapes was the largest at 3,702, followed by greenhouse grapes (681), chestnuts (144), chickens (70), and cherries (13). As for the payment unit price by item, the greenhouse grapes were the highest at 87,410,000 won per 1ha, followed by outdoors grapes (58,980,000), cherries (33,140,000), chestnuts (2,500,000), and chickens (561). The budget required for greenhouse grapes was 83 billion won, accounting for 72.2% of the total amount, and the size of farms for closure was 1,406ha, accounting for 11.1% of the total growing areas. Meanwhile, the application rate of chicken farms was very low because most of the farms did not meet the requirements for application. As for chestnuts, the payment unit price was also quite low, that it was difficult to induce farm closure.

    In 2016, outdoor grapes and greenhouse grapes were selected as target items for CPFC for two years, and among the items which farmers suggested themselves, blueberries were selected as one of the target items. The payment unit price of outdoors grapes and greenhouse grapes was similar to that of 2015, and the application area for closure accounted for 11.9% and 10.0% of the total cultivation area, respectively, almost the same as the previous year. Because the net income of blueberries is relatively higher than that of other fruits, the payment unit price was 106.57 million won per 1ha, far higher than that of the outdoors grapes (90,150,000 won). The size of blueberry farms for closure was 529ha, accounting for 8.6% of the total cultivation area of blueberries. The total amount of payment for closed farms of blueberries was 9.11 billion won, the largest ever paid for crops.


    Reduction of Policy Effects due to the Entry of New Farms

    The primary policy goal of CPFC is to strengthen the competitiveness through restructuring the particular industry. It is to improve the overall constitution of the concerned industry by encouraging the closure of the less competitive farms in the market. Another goal is to stop aggressive investment in the concerned industry by signaling the potential import damages caused by the FTA implementation to farms planning a new entry. Consequentially, the cultivation areas of the target items tend to decrease due to the CPFC. However, even though some of the farmers are uncompetitive, they may not close, hoping that a decrease in the cultivation areas due to other farms’ closure will reduce supply volume, and the reduction of supply is expected to lead to higher prices.

    For this reason, the total cultivation areas may instead increase after CPFC is implemented because the number of new-entry farms increases. This is so-called ‘Adverse Selection.’ If ‘Adverse Selection’ becomes universal, it becomes difficult to achieve the original policy goals of restructuring the industry and strengthening the competitiveness.

    In reality, comparing the cultivation areas of peaches and outdoors grapes in 2003 before implementing the CPFC with those in 2008 when the CPFC ended, the cultivation areas of peaches had decreased by 3,243ha, far less than the size of closed farms, 5,225ha. It is assumed that the sharp increase in the new cultivation areas offset the areas of closed farms during the CPFC. Of course, the size of closed cultivation areas may have been overstated because some farms transferred farms to other farms without closing them. During the same period, the areas of greenhouse grapes increased by 368ha and assuming that all 482ha that applied for closure were closed, the actual increased areas were 850ha.

    Besides the policy effect degradation caused by ‘Adverse Selection,’ ‘Moral Hazard’ may also be seen around the potential beneficiaries. Because the support continues for the same item for five years, the potential beneficiaries could sometimes neglect their efforts to strengthen the competitiveness to minimize the import damages from the FTA implementation. Because during that time there is an exit, the so-called ‘CPFC’ to avoid risk.

    There is also some criticism that the spread of awareness of the crisis caused by the FTA could undermine the rational choice of farmers when deciding to close their farms. It also could lead to the loss of opportunities to increase income for the farmers who took part in the CPFC. And customers who have to consume items whose prices have risen after the CPFC must bear the burden of declining welfare. Another criticism inducing the farm closure while providing compensation to farmers who will be naturally closed due to aging or other management problems will eventually waste their budget. There could be a view that social losses were larger than the policy goal of restructuring the concerned industry through the farm closure. Lee & Cho (2013) estimated that CPFC implementation during 2004~2008 had caused a decrease in social welfare, worth 180.5 billion won per year, due to the imbalance between supply and demand in the market caused by falling production. The utility loss for each item of greenhouse grapes, peaches, and kiwis was 57.0 billion won, 118.2 bil- lion won, and 5.3 million won, respectively. Of course, the results of these analyses are limited to static analysis, which ignores the substitution effects of consumption or production. However, there is only a difference in the scale of social losses, including the decline of producer and consumer welfare and a waste of the budgets, and it is difficult to deny that there is no loss at all.

    New farms enter into the industry in the process of supporting the farm closure is information asymmetry among the market players. That is, the government and beneficiary farmers have judged that the implementation of the FTA would cause significant import damages for domestic greenhouse grapes, peaches, and kiwis. In contrast, the non-beneficiary farms or new entry farmers have predicted that the target items would become more profitable as the decreasing cultivation areas due to the CPFC would decrease the products and the increase in the prices. Thus each market player has different information on the same situation, which leads to moral hazard and adverse selection, causing the government failure. To minimize these side effects, corresponding regulations should be applied. Lee & Ryu (2013: 1) insist that even when faced with information asymmetry, resources could be distributed effectively through the proper regulations.

    The Distortion of Value Chain by the Excessive Restructuring

    The purpose of CPFC is to encourage the farmers whose management is challenging to maintain due to the increase of imports by FTA implementation to close their farms. The small-scale marginal farms, the aged farmers planning to retire, and large-scale farms with difficulties of management are expected to apply for CPFC. In 2013~2014, the Korean cattle (breeding cow, fattening cattle) was selected as the target items of CPFC, and compensation was paid to about 270,000 Korean cows. Among them are included about 200,000 breeding cows. Most of the closed farms were the small-scale and aged farmers who raise breeding cows (Choi, 2014: 106). It is assessed that the average number of breeding heads per farm increased due to the closure of small-scale farms, which contributed to the scaling of breeding.

    The closed farms slaughtered their cow or sold them to other farms. It is not easy to track the proportion of each disposal method. According to the statistics on the number of breeding cows, it can be only estimated that a considerable number of breeding cows disposed by the closed farms were slaughtered. It means that the number of the breeding cow in 2014 and 2015 decreased by 6.0% and 6.7%, respectively, compared to the previous year. Since the closure had been taking place in late 2013 and throughout the year 2014, the closure results are expected to be reflected in the statistics of the breeding heads in early 2014 and 2015, respectively.

    Assuming that the number of breeding cow decreased significantly due to the closure of the numerous smallscale farms of the breeding cow that functioned as the supplier of calves in the value chain of the Korean cattle industry, it is expected that CPFC led to a decrease in the supply of calves and a rise in prices. In reality, the cost of male calves rose by 31.9% in 2014 and by 20.0% in 2015 compared to the previous year. The rise in calf prices resulted in a rise in production costs of fattening cattle and affected the entire value chain of the Korean cattle industry. It is unexpected results before the CPFC was carried out. If CPFC had not been implemented, the farm closure would have taken place voluntarily by the marginal farms, and there would not have been a sharp decline in the number of the breeding cow. In the end, it cannot be completely denied that it is a side effect caused by the government's intervention in the market.

    Agricultural products can create value when each stage of value chains from production to consumption is well linked (Kim et al., 2010: 102). The government's intervention in the market would distort the specific stage of value chains and hinder the development of the concerned industry. Because the government is only interested in the shortterm policy effects, and it cannot accurately predict the long-term market changes caused by the implementation of that policy. This results from not being fully aware of the operation principles of specific goods’ market and information about the formation of the value chains in the concerned industry. That is, it is the limit of decisions made by the government under the limited information. After all, the beneficiary farms are forced to make decisions based on the government's secondary information. It somewhat reduces the overall utility. Of course, although it cannot be denied that policy effects may depend on several external factors, the government should obtain sufficient information and reflect it in the decision-making process to minimize unexpected side effects.

    Indirect Damages caused by Balloon Effect

    Most of the beneficiary farms of CPFC, except retired farmers who absolutely gave up farming, would convert into other crops to continue farming. According to a survey of grape farmers who were closed as part of CPFC in 2015, 38.3% answered that they would convert into other fruit trees, followed by outdoor vegetables (19.7%) and rice (17.0%). Among the farms planning to transform into other fruits after closing their grape farms, 32.5% said they would convert into peaches. The proportion of farms who wanted to convert into plums and apples are 22.2% and 13.9%, respectively (MAFRA, 2016b). The proportion of those who choose fruits as an alternative was such high because fruit farmers’ expected profit is higher than that of other crops, so they want to select an alternative among profitable fruits. And when farmers choose new crops, securing distribution channels and acquiring production technology are crucial factors. Therefore, farmers will prefer to choose fruit items that are easy to sell out their products through the existing distribution system and convenient to share market information through existing farmers’ organizations such as cooperatives. As a result, fruits commonly produced in the region will likely be selected by the beneficiary farms as an alternative. Meanwhile, since the initial investment costs are high and take at least two to three years from planting to harvest, small and old-aged farmers tend to avoid fruits as alternative crops.

    If closed farms’ alternative is concentrated on a particular crop, the area of production and output of that crop will increase greatly, and it would lead to a decrease in prices, which could affect the profits of existing farms. Based on the survey of closed farms’ willingness to convert items in 2015, the additional production area of peaches is expected to be 209ha, estimated to increase the output in 2020 by 27% over the average year. It was estimated that during the same period, the production area of plum would increase by 143ha, increasing the output by 16% and the production area of cultivation by 89ha, increasing the output by 12%. (MAFRA, 2016b)

    In a survey of farmers’ willingness to covert items after grape and blueberry farms were closed in 2016, 31.9% of farms would like to convert into fruits, followed by greenhouse vegetables (24.7%), special crops (21.0%), and rice (7.7%). If we look at the details item by item, the proportion of farms that want to convert to peaches was the highest at 11.5%, followed by soybean (9.3%), wild sesame (9.2%), rice (8.7%), sesame (8.0%), and chili peppers (7.4%). As only for the farms who would plan to convert into fruits, 28.4% of them want to convert into peaches, while 14.9%, 12.6%, and 6.9% want to convert into aronias, plums, and apples, respectively. With two years of support for CPFC in 2015-2016, as the number of farms that have converted into fruits such as peaches, aronias, plums, and apples had significantly increased, the production of such items is also expected to increase. After all, this system could lower the prices of the target items, resulting in lower income for existing farms. This is the socalled ‘Balloon Effect’.

    The cause of indirect damage due to the balloon effect is that the beneficiary farms of CPFC decide without sufficient information about the alternative crops. The beneficiaries are preferred highly profitable items at that point when selecting alternative items right after farm closure. However, if an alternative item is concentrated on a particular item, it is challenging to ensure future profitability due to the oversupply of that item. Because if the alternative crop supply is fairly elastic, the relatively high profitability will stimulate the greater supply (Laffiteau, 2011: 1).

    The balloon effect occurs in the follow-up management process after farm closure for CPFC and could lead to more serious government failure in that the damage could be caused not only to the beneficiaries but also to the nonbeneficiaries who have already produced alternative crops. To minimize the balloon effect, the government needs to increase the beneficiaries’ access to information such as changes in the production structure of alternative crops and the future profitability, etc., and should support the closed farms to help them reasonably decide based on this. As a part of this process, the consulting program should help select new crops and establish farming plans after the closure.

    Natural Reduction of Production Scale and Inefficiencies of Budget Inputs

    Various factors change the production weight of each item within a particular industry. Those factors include physical constraints such as labor shortages and the aging of farm owners, increased productivity and profitability through technological innovation, and the increase or decrease in demand due to a rise or fall in consumers’ preferences. In general, if demand increases, prices, and profitability would stimulate the expansion of the production scale. Conversely, if demand decreases, prices and profitability would go down. Naturally, it leads to a reduction in the production scale. In the end, consumer demand is reflected in the producer's decision-making, determining the scale of production.

    The cultivation area of other fruits, including plum, blueberry, raspberry, mulberry, kiwifruit and citron, is on the fast-increasing trend. It shows that consumers’ preferences are changing, and the pattern of fruit consumption is diversifying.

    One reason why the cultivation area of grapes has continually decreased in the 2000s may be the increase in imports. Domestic grapes are distributed in the market in July-October, while grape imports are concentrated in February- May and November-October. As a result, there is not much competition between domestic and imported grapes in the market. Therefore, the main reason for the decrease in the domestic grape cultivation area is the effect of the change in fruit consumption pattern rather than the increase in imports. Thus, even without artificially adjusting the production structure through CPFC, the grape cultivation area is expected to decrease naturally. This point can be criticized for inputting unnecessary budgets by the government intervention.

    The grape cultivation area showed a rapid decline of 7.2% annually, with the grape cultivation area decreasing to 17,406ha in 2006 after reaching a peak of 29,462ha in 1999. In 2015 just before implementing CPFC, the cultivation area was 12,690ha, with an average annual decline rate of 3.5%. It was still decreasing, although the trend of decline had slowed.

    The reason for the decline in the efficiency of budget inputs is that information about changes in domestic consumption patterns and the changes in production structure has not been fully reflected in selecting target items of CPFC. If the consumption of particular items decreases because of the domestic consumption pattern changes, the price goes down, which is directly related to the farmers' profitability. It is immediately reflected in the farms’ decision- making. There are even farms that give up farming itself. In addition to the decline in profitability, labor shortages and difficulties in selling also are the main factors of the natural decrease of the cultivation area. Therefore, it is necessary to reconsider whether adjustment of the production structure through artificial means of CPFC is beneficial to society's welfare. Before implementing CPFC, the information on the consumption patterns, the changes in the production structure, and import substitution status should be reviewed comprehensively. Hong (2003: 63-64) analyzed the paths that led to inefficiency in inputting policy funds under information asymmetry through game theory. And he mentioned that the efficiency of the policy funds would be improved only when various wasteful factors between the beneficiaries and government in the funding process were removed.

    Excessive Closure by High Payment Unit Price

    The payment unit price of CPFC is three times the last five-year average net revenue (excluding the minimum and maximum values) of the target item. Therefore, the payment unit price for each item is different. Farm owners decide whether to close their farms by comparing the compensation amount paid in a lump sum with the expected income earned by continuing farming over the next five years. It will also take into account that the same crop cannot be grown for five years after the farm is closed and that it should be converted to other crops with comparative advantages due to their high profitability and convenience in farming. In addition, because the payment unit price of CPFC is calculated based on the national average income data, the farm owners' satisfaction with the payment unit price may differ depending on the actual profitability of each farm, even if they produce the same item.

    The payment unit prices for highly profitable items will inevitably be high. Therefore, the farmers who grow highly profitable crops will decide to close their farms if they are no longer guaranteed expected profits in the future. If the payment unit price of CPFC deems to be higher than expected, farmers may close their farms regardless of the scale of damages caused by imports. These kinds of cases could lead to excessive closures and shrinkage of the industry. In addition, it can be assumed that the crops with a high unit price of payment for CPFC are relatively profitable. There will be many new farmers entering the industry, even if the CPFC is underway. This does not comply with the basic purpose of CPFC to restructure the industry through the farm closure.

    The payment unit price of blueberry, selected as a target item of CPFC in 2016, was 16.57 million won per 10a, far higher than the greenhouse grapes (9.92 million won) and outdoors grapes (5.84 million won) that were selected in the same year. This shows that blueberries are relatively profitable compared to other fruits. In fact, blueberry farmers’ average revenue was 7 million won per 10a, down 9.7 percent from the previous year, but far higher than that of outside grapes (3.59 million won), apples (3.58 million won), peaches (3.4 million won) and pears (2.82 million won) in 2015. Even if the FTAs have caused import damage, it does not seem easy to find alternative crops equivalent to blueberry’s profitability after the farm closure. This is because blueberry is more than twice as profitable as other fruits. In the end, about 9% (550ha) of 6,155ha, the total cultivation areas of blueberries were closed down, and the compensation payment of blueberries cost 9.1 billion won. It added to the government’s financial burden due to a lack of budget initially allocated. In addition, some closed farms of blueberries got high compensation, creating jealousy and unfair feelings for other fruit-growing farmers.

    The high unit price of payment causes excessive closures due to the beneficiaries’ pursuit of short-term profits and lack of information about alternative crops. Marginal farmers who are no longer able to continue farming might be included in the beneficiaries of CPFC, but most farms are trying to sustain farming. Under the constraints that it is not permissible to grow the same crops or raise the same livestock for five years after closure, it is not easy to find a more profitable item if a farm has grown crops or raised livestock relatively profitable. Because these farmers' expected revenue is high, alternative items that meet the conditions are inevitably more limited. Of course, they also switch their items to reduce labor input, seek convenience for farming, and secure sales channels rather than pursuing profit. Also, in this case, information about the alternative items is essential.

    In order to prevent excessive closures caused by the high unit price of payment, the government can set an upper limit on the payment or provide the minimum cost for the farm closure.


    Government intervention is a policy measure to resolve market failure, but sometimes it fails to achieve the desired results and leads to government failure. The main reasons for the government’s failure are the information asymmetry among policy stakeholders, the uncertainty about policy outcomes due to lack of information, and the limitations of the government's market control. Among them, information asymmetry and lack of information are also causes of market failure. This means that the information necessary for market operation and government actions and the new information generated in market and government operations have essential effects on the smooth operation of the market and the effective implementation of government policies.

    Stiglitz (1975) offered ‘screening theory’ and Spence (1973) proposed ‘signaling theory’ as an alternative to overcoming information asymmetry. Screening theory states that a person in the information inferiority may make up for some of the limitations of the information shortage by using supplementary information to filter out unworthy information or make decisions with a third party's help. Signal theory is also referred to as ‘market signaling theory,’ meaning that a person in the information inferiority may narrow the gap in information reserves by relying on the information acting as a 'signal' for rational decisionmaking.

    It is also vital to solving the information asymmetry or the lack of information among the policy stakeholders to resolve the government failure in the operation of CPFC addressed in this study and enhance its effectiveness. Because after farm closure, the beneficiary farmers do not have enough information about alternative crops, focusing on a particular item. In this case, it is difficult to guarantee their future profitability, and even the balloon-effect can affect the income of the beneficiary farms, finally leading to secondary damage. Even farm income could be lower than before the closure because it is difficult to select alternative crops corresponding to the expected revenue of the beneficiary farms due to lack of information about the profitability of alternative crops before the closure. If the profitability of closed items is relatively high, the range of alternative items with higher profitability will be inevitably narrower.

    There is information asymmetry between the government and farmers who applied for CPFC. It is not easy for the government to judge whether the farmers suffered any actual damages from imports. As a result, side effects such as 'moral hazard' and 'reverse selection' of farmers are shown in the policy operation. In the end, the entry of new farms reduces the effects of CPFC, and the support for non-import-damaged farmers adds a financial burden. This is the reason why the government is criticized for the inefficient use of resources.

    The non-beneficiary farmers will also face management uncertainties due to a lack of information to predict the future after the CPFC implementation. And the lack of information on the expected income of the CPFC target item could lead to secondary damage by newly entering the industry at the risk of import damage if the scale of farm closure increases, unexpected side effects such as distortion of the item’s value chain may occur. It could affect non-beneficial farmers who did not apply for CPFC. In addition, as alternative items were concentrated on a certain item after the CPFC implementation, the profitability of non-beneficial farmers who already grow the item could be reduced because of a lack of information.

    To solve the problem caused by lack of information, it is important to create reliable details on price, production, and income while increasing the accessibility of policy stakeholders. The price information is necessary for analyzing whether the requirements for selecting items subject to DPPF and CPFC are met, and income information is required in calculating the cost of paying for CPFC. All of the price, information, and income information are useful when farmers decide to close farms or select alternative items.

    It is important to make effective use of given information in order to resolve information asymmetry among stakeholders. However, there is a limit to accessing farming- related information and reflecting it in decision-making by individual farmers’ own efforts. Therefore, consulting services for farm management stability should be combined along with CPFC. It will maximize the effectiveness of CPFC and also has a ‘screening’ function that Stiglitz (1975) offered. Under the Trade Adjustment Assistance Scheme (TAAF), which the U.S. adopted to support farmers damaged by imports, in the first, the government operates a training program to increase productivity, improving marketing, and finding alternative crops, and in the second, provides ‘financial assistance to farmers to establish and implement a business adjustment plan for coping with opening domestic market. In particular, additional support is provided selectively through a feasibility study on the business adjustment plan.

    The main reason for the government’s failure in the course of the operation of CPFC is that the government is in a state of information inferiority. In other words, the government just relies on the information provided by farmers without fully grasping the information about individual farms. That is, the government takes an ‘authority principle’ approach that all farms who grow the target items and have other qualifications are supported, regardless of whether they get damaged by imports or not. However, both the TAAF of the U.S. and ‘Support Program for Import-Damaged Agricultural Products’ of Taiwan take an ‘Application principle’ approach that each government only supports farms who apply for the program. The TAAF of the U.S. even requires applied farmers to prove that the increase in imports has dropped or decreased either of price, output volume, or the amount of production of items by more than 15%. These requirements may have a ‘screening’ function offered by Stiglitz (1975). At the same time, it will be a ‘signal’ presented by Spence.

    적 요

    본논문에서는 FTA 국내보완대책의 일환으로 추진되고 있는 폐업지원제도의 정부실패 사례를 살펴보고 그 원인을 규명하 였으며, 더 나아가 이를 개선하기 위한 방안을 제시하였다.

    • 1. 폐업지원제도는 FTA 이행에 따른 시장개방과정에 국내 농업의 경쟁력 제고와 농가 소득안정을 목적으로 정부가 동원 한 정책수단의 하나임. 그러나 제도 운영과정에서 정부실패 사 례가 나타남.

    • 2. 폐업과정에서 신규 농가가 진입하여 정책효과가 저감되 고, 예상보다 많은 농가가 폐업함으로써 해당 산업의 가치사 슬이 왜곡되고, 폐업 후 타 작목으로 전환하면서 풍선효과가 나타나 간접피해를 유발하고, 생산규모가 자연적으로 감소하 는 가운데 인위적인 폐업지원으로 비효율적 예산 투입이 이루 어지고, 지원금 단가가 높아 과도한 폐원을 유도함.

    • 3. 이와 같은 정부실패의 주요 원인은 정책 이해관계자 사 이의 정보비대칭과 정보 부족임. 결국, 폐업지원제도의 운영과 정에서 나타난 정부실패를 해소하고 제도의 효과를 높이기 위 해서는 제도 이해관계자 사이의 정보비대칭 혹은 정보 부족문 제를 해소해야 함.

    • 4. 구체적인 대안으로 생산·가격·소득정보에 대한 이해관계 자의 접근성을 높임과 동시에 사후 컨설팅사업 병행, 수입피 해를 소명한 농가에 한해 지원하는 ‘신청주의’ 도입 등이 필 요함.


    This study was modified and developed from the paper presented at the 2020 International Joint Conference of Korea Trade Research Association (KTRA) and World Scholars in combination with First Jeju Global Business Summit.



    Changes in the cultivation area of major fruits in 1995-2016


    Income status of blueberry and major fruits


    The update process of CPFC

    Supported items and payments of CPFC

    The amount of payments for CPFC in 2004-2008 (unit: ha, 100 million won)

    Net change areas of peaches and greenhouse grapes in 2003-2008 (unit: ha)

    The number of breeding cows and the price of the male calves in 2010-2017 (unit: 10,000 heads, 10,000won/head, %)

    Survey results of the closed farmers’ willingness to grow alternative crops (fruit) in 2015-2016 unit: %


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