An economic analysis of coffee plantings in Vietnam CALS Impact Statement

Despite Vietnam's significant role in the world coffe market, little research has been completed to help understand Vietnam's coffee supply response. We analyzed Vietnamese coffee growers' investment and disinvestment decisions using real option analysis techniques, where the entry and exit decisions of Vietnamese coffee growers were modeled as real options, which refer to the rights to begin or discontinue a physical investment project. These rights have value, and analogous to options on financial assets, can be quantified using financial option pricing methods.

In 1989 Vietnam held a market share of only 1.2 percent of the world coffee market. Ten years later Vietnam with a market share of 12.4 percent, surpassed Colombia to become the world's second largest coffee exporter after Brazil, earning approximately $600 million and accounting for 17 percent of all Vietnam's commodity exports. The massive increase in Vietnam's coffee supply is widely believed to be the main factor leading to the coffee price crisis of 2001. This price collapse substantially devastated the livelihoods of 25 million poor coffee producing households in more than 50 developing countries including Vietnam. Despite Vietnam's significant role, little research has been completed to help understand Vietnam's coffee supply response.

We analyzed three groups of Vietnamese small-holder farmers, a high-cost group, an average cost group, and a low cost group. Empirical results show that when coffee price increases to 39.1 cents/lb, low cost Vietnamese farmers enter production. If price continues to rise to 47.2 cents/lb, average cost farmers enter. High cost farmers enter if price hits 63 cents/lb. Conversely, when price drops below 19.6 cents/lb, high cost growers would start to exit, but low cost farmers would stay until price drops to about 11 cents/lb.

The existence of price-below-cost periods following intervals of super-normal profits is inevitable in coffee growing due to large establishment costs and large variability of coffee prices. During price-below-cost periods such as the one in 2001-2002, only the most efficient coffee growers made profits, while the vast majority of producers experienced losses. Among those loss-making producers, however, there were two distinct groups. The first group contains those who would have a negative profit even in the long run. The second group comprises those producers who on average would generate a positive profit in the long run. At times of price-below-cost, although both groups appear to be in the same situation - suffering losses, they differ in that the second group is optimally running their farms by enduring losses and waiting for price to rebound, while for the first group it is optimal to exit. A clear realization of the difference between the two groups is particularly important for policy makers and credit providers, since it allows them to channel credit and land in such a way that "truly" efficient farmers are encouraged to stay in the coffee business, and inefficient farmers are encouraged to shift to other crops.

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