The Role of Compensation in Policy Reform

Governments reform policies in order to improve their efficiency and respond to changing social priorities. Reform is resisted when concerns exist about those who may lose out in the process, or when other policy goals are negatively impacted. Compensation can remove barriers to reform by addressing this resistance, and can contribute to adjustment by speeding its process but may itself impede the reform process if it masks the market signals that lead to adjustment. Compensation is not always necessary or appropriate, and should not be seen a prerequisite for reform. Even if their overall effect is positive, policy reforms can generate losses for some affected groups. Agricultural policies can become capitalized in asset values, notably for land and for policy assets such as quotas. Sector participants, including farmers, farm workers and upstream or downstream industries may lose income or face displacement as a consequence of policy reform. Farmers may be unable to recover the cost of their investments if a policy reform changes returns, especially when the reformed policy promoted investment. Affected groups can have differing levels of public sympathy, political influence, and legal rights, all of which influence the design of compensation policy. Compensation offered as a corrective to the loss of income or asset values, or for costs incurred as a consequence of reform are social transfers much like any other and should therefore follow the guidelines set out in the document Agricultural Policies in OECD Countries: A Positive Reform Agenda (OECD, 2002). That is, compensation should be directly targeted to the affected groups, tailored to the objectives of the policy, temporary, and cost effective. Effective policies reduce deadweight losses by minimising market distortions—lump-sum transfers are an obvious choice. This also ensures that adjustment subsequent to policy reform is not impeded by distortions in input or output markets. In some cases, affected groups have sufficient political influence to block or alter policy reform. Compensation can be critical in obtaining the consent of these groups and allowing reform to take place. In this manner, compensation can be seen as enabling policy reform. The overall welfare gains of policy reform are balanced against the costs of providing compensation to negatively affected but influential groups; compensation is given and the policy reform undertaken when the net welfare gains remain positive. This may be thought of as a requirement to turn a potential Pareto improvement into an actual Pareto improvement, although the …