Deepananda P. Herath
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AN ECONOMIC ANALYSIS OF STRUCTURAL CHANGES IN SRI LANKAN TEA INDUSTRY A Thesis Presented to The Faculty of Graduate Studies of University of Guelph by DEEPANANDA P. HERATH In partial fulfillment of requirements for the degree of Doctor of Philosophy December, 2001 O DEEPANANDA HERATH, 2001 National Libtary Bibiiithèque nationaie 1+1 ,-da du Canada Acquisitions and Acquisitiorrs et B'iographic Services services bibliiraphiques The author has granted a non- L'auteur a accordé une licence non exclusive licence dowing the exclusive permettant à la National Lihqof Canaôa to Bibliothèque nationale du Cariada de reproduce' loan, distribute or sen reproduireyprêter, disûibuer ou copies of this thesis in microform, vendre des copies de cette thèse sous paper or electronic formats. la forme de microfiche/film, de reproduction sur papier ou sur format électronique. The author retauis ownership of the L'auteur consene la propriété du copyright in this thesis. Neither the droit d'auteur qui protège cette thèse. thesis nor substantial extracts fiom it Ni la îhèse ni des extraits substantiels may be printed or otherwise de celîe-ci ne doivent être imprimés reproduced without the author's ou autrement reproduits sans son permission. autorisation. ABSTRACT Deepananda P. Herath Advisor: University of Guelph, 200 1 Professor Alfons Weersink This study is an empirical investigation into the structural changes of the Sn Lankan tea industry. The industry has changed fkom one dominated by large, vertically integrated plantations to one where small famiers grow the green leaf tea and sel1 it to independent processors. The main contribution of this thesis is to develop the conceptual and ernpirical models to explain these structural changes as the cumulative outcomes of differential responses to changes in the economic incentives and constraints by the different economic agents in the tea industry. The findings of the research indicate that relatively lower labor wages facing the small fmsector compared to the unionized labor wages paid by large famis has been an important deteminant of the expansion in small fms relative to large plantations. Support services exclusively for srnaIl tea fmshave also contributed to the proliferation of small fanns. Despite the widely held notion that land reform policies, which took land fiom large plantations, have contributed to the reduction in large farms, these policies were found to have no effect on changes in the distribution of farm size. Taxing the exports of black tea has hurt al1 domestic growers of green leaf tea but particularly small farms. Results indicated that pncing intervention in the green leaf market promoted the growth in the nwnber of srna11 fams as the intervention may have served as a remedy for the hold up problem in the green leaf market facing these growers. The study also found that differences in labor-related production costs between vertically integrated plantations and independent producers were important drivers of the changes in vertical coordination arrangements. Green leaf pticing intervention has also increased market mediated green leaf trade between vertically independent growers and processors as the potentiai hold up threat in the arms length transactions appears to be remedied by the pricing intervention. The nature of ownership regime and the subsequent changes in the management incentives seerns to have had little effect on the movement away fiom vertical integration. The changes on the distribution of fm size and vertical coordination arrangements in the Sri Lankan tea industry have been influenced both by various government policies and other economic forces. in general, government progrmi and policies appears to be more influential on these changes relative to other economic forces. However, among these policies there are some contradictory effects such as between the effect of small farm support services and export taxation. A major driver affecting both dimensions of structural change has been the relative oppominity cost of labor as large vertically integrated plantations have had to pay higher wages for their unionized employees. ACKNOWLEDGEMENTS 1 would like to dedicate this thesis to my Appachchi and Arnma who encourage and appreciate my educational achievements from the early days. Many thanks are extended to my advisor, Professor Alfons Weersink, for his patience and encouragement. For the time he gave to reading the draft of this dissertation 1 am in his debt. 1 have been extremely privileged to have Professors Michael Hoy, Glenn Fox, and Rhakal Sarker in my supe~sorycornmittee. They help me to travel along the treacherous interface between the theory and fact. This dissertation owes a great deal to their insightfùl comments and criticisms. 1 am gratefbl for my fnends and teachers in the Department of Agricultural Economics and Business. They provided excellent intellectually stimulating and exciting environment for higher leaming. I extend my gratitude to the Canadian Commonwealth Scholarship Program, which provided the financial support for my doctoral studies at Geulph. This dissertation would never have seen the light of the day without caring support and lirnitless endurance of Aruni, my best niend, best cntic, and wife. She has provided love, fiiendship, and a purpose for my endeavoa. Along with Amni, my two daughters, Isun and Thilini, and rny son Sachin waited (some time irnpatiently) to see my Ph.D. through to the end. They brought me the joy and pleasure in the darkest hours of my thesis work, 1 am in their debt. TABLE OF CONTENTS Page ACKNOWLEDGEMENTS 1 TABLE OF CONTENTS LIST OF TABLES LIST OF FiGURES CHAPTER 1. INTRODUCTION 2.1. Background 1.2. Motivation: Why this study is needed 1-3. Economic Problern 1-4. Economic Research Problern 1S. Purpose and Objectives 1.6. Outline of the Thesis CHAPTER 2. SRI LANKAN TEA INDUSTRY: DEVELOPMENT AND CHANGES 2.1. Economic Importance of Sri Lankan Tea lndustry 2.1 .A. The Importance of the Tea industry in the Sri Lankan Economy 2.1 .B. Importance of Sri Lankan Tea Production in Global Tea Market 2.2. How Tea is Grown, Processed and Marketed in Sri Lanka 2.3. Evolvement of Industrial Organization in Sri Lankan Tea Sector 2.3.A. Origin of Plantation Production Systern in Sn Lanka 2.3 .B.Origin of Larger Holdings in Sri Lanka with Co ffee Plantations 2.3.C. Establishment of Tea Plantations in British Colonial Penod: 1865 to 1920s 2.3 .D. Continuation of Plantation Companies and Agency Houses: 1920 to 1948 2.3.E. British Interests in Tea Plantations after Independence: 1948 to 1975 2.3.F. Nationalization & Land Refonn: Governent in Tea Industry: 1975 to 1992 2.3.G. Privatization and end of the State-Managed Tea Industry: 1992 to Present 2.4. Structural Changes In Sri Lankan Tea Industry 2.4.A. Changes in Farm size Distribution of the Sri Lankan Tea Industry 2.4.B. Changes in Vertical Coordination arrangements in Sri Lankan Tea Industry 2.5. Sumrnary CHAPTER 3. REVIEW OF ECONOMIC ANALYSES OF STRUCTURAL CHANGES IN AGRICULTURE 3.O. Introduction 60 3.1. Conceptual Exposition of FmStructure: Dimensions and Measurements 61 3.1 .A. Importance of FmSize Distribution as a Measure of Fann Structure 62 3.1 .B. Inadequacies of Farrn Size Distribution as a Measure of Structural Changes 63 3.1 .C. Farm Size Distribution and Changes in other Structutal Dimensions 65 3.1 .D. Importance of Coordination Arrangements as a Measure of Farm Structure 66 3.2. Models to Explain the Forces Affecting Farm Size Distribution Changes 68 3.2.A. Technology Models of Farm Size Distribution Changes 3.2.A. 1. Economies of size mode1 3.2.A.2. Technology Adoption Model 3.î.A.3. Labor-Capital Factor Prices Model 3.2.B. Human Capital Model 3 -2.C. Financial Model 3.2.D. Public Programs and Policies as a Causative Factor of Structural Changes 3.2.D. 1. Commodity Programs as a Causal Factor of Structural Changes 3.2.D.2. Credit Policies as a Causal Factor of Structural Changes 3.2.D.3. Tax Policies as a Causal Factor of Stmc tural Changes 3.2.D.4. Research and Extension Policies as a Causal Factor of Structural Changes 3.2.E. National Economic Conditions as a Causative Factor of Structural Changes 3.3. Models to Explain the Forces Affecting Vertical Coordination Changes 3.3 .A. Structure- Conduct- Performance Model 3.3 .B.Principal and Agent Model 3.3.C. Transaction Cost Economics Approach 3.4. Summary CHAPTER 4. CONCEPTUAL MODEL OF CHANGES IN FARM SIZE DISTRIBUTION IN SRI LANKAN TEA INDUSTRY 4.0. introduction 4.1. Technological Factors: Nature of Labor Capital Substitution 4.1 .A. Continuation of Labor Intensive Tea Production 4.1 .B-Implication of Labor Intensive Production in Fann Size Distribution Changes 4.1 .B. 1. Factor Shares in Green leaf Tea and Black Tea Production 4.1 .B.2. Simif ar Labor Requirements in Large and Small Tea Farms 4.1 .B.3. Opportunity Cost of Labor among Different Size Tea Fms 4.1 .C. Relationship between Changes in Labor Costs and Farm Size Distribution 4.2. Public Programs and Policies of the Changes in Farm Size Distribution 4.2.A. Land Reform Policies and Tea Fann Size Distribution Changes in Sri Lanka 4.2.A. 1. Land Redistribution and Changes in Tea Farm Size Distribution 4.2.A.2. Bureaucratic Management in Large Farms in Post-Re form Period 4.2.A.3. Relationship between Land Reform Policies and Farm Size Distribution 4.2.B. Small Tea Farm Support Services and Size Distribution Changes 4.2.B.1. Relationship between Srnall FmSupports and Farm Size Distribution 4.2.C. Tea Industry Taxation Policy and FmSize Distribution Changes 4.2.C. 1. Nature and Evolvement of Tea industry Taxation in Sri Lanka 4.2.C.2.