Rethinking Agriculture and Growth in Ethiopia:By Stefan Dercon and Andrew Zeitlin

1. Introduction: Planning for the role of agriculture in growth


This paper sets out a conceptual framework for understanding the role of smallholder

agriculture in Ethiopian growth prospects. It seeks to answer two questions: first, what

economic conditions are required to foster growth in smallholder agriculture? And second,

how does growth in agriculture relate to growth in other sectors: to what extent can

agriculture spur growth elsewhere, and to what extent does it depend on other sectors for

its own continuation?


The current growth and development strategy in Ethiopia has its genesis in the policy of

agricultural development‐led industrialization (ADLI). This strategy is well captured by its

name: in essence, growth has to start from growth in agriculture, which then stimulates

growth in other sectors of the economy, most notably industry. It was first very eloquently

articulated in a paper by the then Ministry of Planning and Economic Development in 1993

Much of the intellectual justification for a model of industrialization via agriculture

stems from various interpretations of the historical accounts of the industrial revolution in

Europe, not least in England [4]. Much recent policy work, including the 2007 World

Development Report effectively underwrites the primacy of agricultural development to

stimulate growth in many poor countries such as Ethiopia [53]. Agriculture has retained a

leading role in the recent evolution of the Government of Ethiopia’s conceptualization of

growth, embodied in the Planned for Accelerated and Sustained Development to End

Poverty (PASDEP). In this current framework market mechanisms have taken on increasing

prominence. For example, PASDEP proposes a two‐pronged strategy to the achievement of

a “massive push to accelerate growth”: the commercialization of agriculture, and the

acceleration of private‐sector development ([19], p. 45).


In this paper, we offer a conceptual framework for understanding whether and how

agriculture‐led growth can work in Ethiopia. We combine theory and evidence from other

growth experiences to discuss both some of the key factors relevant for stimulating growth

in smallholder agriculture in Ethiopia and the role it can play in overall growth.

Much of the evidence on the primacy of agriculture stems from research arguing that

multipliers from growth in agriculture are higher than from any other sector [33, 53]. We

argue in this paper that this approach is incomplete. It is misleading to formulate policy by

comparing multipliers from hypothetical, exogenous increases in the growth rates of

different sectors for two reasons. First is a simple issue of calibration: since we are

ultimately interested in the multipliers stemming from government policy, marginal growth

rates should be weighted by the fiscal cost of bringing about these increments to growth.

Second and more fundamentally is the presumed exogeneity of growth in a ‘driving’ sector:

where this growth comes from cannot be asked independently from what is happening in

other sectors.


To address the second of these, we draw upon the workhorse dual economy models that

have their roots in the seminal work of W. Arthur Lewis [30]. We consider alternative

specifications of such models, their relevance for the Ethiopian case, and their consequences

for the interplay between agriculture and other sectors in the growth process. We also draw

upon the vast empirical literature that estimates (typically static) linkages between sectors.


Putting these elements together, we present a case that modest consumption linkages from

agriculture to industry necessitate policies that actively promote other sectors, ideally

strengthening inter‐sector linkages in the process. The economic incentives required to

sustain agricultural growth require either high and rising urban demand or access to export

markets. Conversely, growth in urban economic activity requires low food prices, which can

be sustained by strategies of imports (which frees agriculture to focus on higher value‐added

products, but which requires improvements to the effective tradability of cereals); by raising

land productivity in cereals production; or by creating more efficient links between urban

and rural sectors. The latter in particular will help provide the incentives required to sustain

agricultural growth, while sustaining low food prices required for this agricultural

productivity to impact the growth of the economy as a whole.


The remainder of the paper proceeds as follows. In the remainder of this section, we

describe the theoretical underpinnings of ADLI. Section 2 distinguishes alternative

mechanisms to growth in agriculture. Section 3 considers the relationship between

agricultural growth and growth in other sectors. Brief conclusions – and a discussion of

policies that aim to change the structure of relationships between sectors, rather than taking

them as given – are presented in Section 4.


Background: the role of agriculture under ADLI

Current policies towards the development of the agricultural sector and its role in the

Ethiopian economy as a whole are guided by the strategy of Agricultural Development Led

Industrialization (ADLI), put forward by the Government of Ethiopia in 1993. ADLI has as its

aim “to bring about a structural transformation in the productivity of the peasant agriculture

and to streamline and reconstruct the manufacturing sector, so that it makes extensive use

of the country’s natural resources and manpower” [18]. Since 1993, this strategy has been

developed further and fine‐tuned, most recently in the more nuanced Plan for Accelerated

and Sustained Development to End Poverty (PASDEP), Ethiopia’s strategic framework for the

five‐year period 2005/06‐2009/10.


This emphasis on structural transformation is reflected in ADLI’s phased approach to

development policy. Under ADLI, the government set out: first, to improve agricultural

technologies, particularly seeds; second, to expand irrigation, infrastructure, and the use of

modern inputs, including fertilizers and pesticides; and third, to expand rural nonagricultural

opportunities. ([18], p. 19).


What is the understanding of growth process that gives birth to this framework? The basis is

put forward unapologetically as the agricultural sector: “agriculture should be the starting

point for the structural transformation of the economy” ([18], p.5). A key assertion is that

the primary driver of demand for industrial output will be domestic, rather than foreign,

demand, based on first initiating growth in agriculture. With an eye toward domestic

demand as a constraint on the growth prospects of that sector, it is suggested that incomes

should be a focus (presumably, both of agricultural policy, which is not mentioned, and of

industrial policy). The implication is that labour‐intensive technologies play an important

role. “While agriculture constitutes the primary market, the services sector should not be

ignored as a market for industrial products.” (p. 21). But the role of industry is evidently

quite secondary: it is relegated to creating employment for “redundant” rural labour, and to

providing an “expanding market for other sectors of the economy.”


However, part of the agricultural orientation of Ethiopian development strategy under ADLI

reflects the view that the process of industrialization should build on domestic inputs. While

such a strategy is doubtlessly useful as a means to add value to agricultural production,

recent global trade patterns cast doubt on whether processing of domestic products will

suffice to gain Ethiopia a more substantial point of entry into industrial trade. In particular,

the model of domestic processing is contrary to the growing pattern of trade in tasks [21],

whereby trade in manufactured goods has increasingly relied on imported inputs. Recent

research has shown that when countries are unable to export goods that are produced using

imported inputs, their ability to export is significantly hampered: Collier and Venables [8]

show that differences in Rules of Origin across trade agreements have significant effects on

trade flows. Against this backdrop, the case for focusing export activity only on those

products that can be produced using entirely domestic inputs is weakened – a strategy of

exporting only entirely domestically produced goods is akin to self‐imposing the very same

restrictions that have been shown to restrict exports when imposed by other countries.

Given the growing importance of trade in tasks, it may be sensible to free the focus of

agricultural policy from its role as supplier of inputs to industry.


In sum, ADLI can be seen as a phased development strategy, starting in the agricultural

sector, which then will offer labour, inputs and a source for demand for the non‐agricultural

sector. Growth in the agricultural sector is expected to be driven by yield (output per

hectare) increases, stemming from technology first, and then further infrastructure,

irrigation and other modern input increases. In what follows we will discuss the theoretical

and empirical basis of each of these key aspects in more detail: how growth in agriculture

comes about and how growth in agriculture and the non‐agricultural sector can relate.


Planning for strategic support in a dynamic context


In reconsidering both the role of agriculture in Ethiopian growth, and the role of policy in

improving this performance, a conceptual distinction appears. There is an important

difference between the drivers of growth, on the one hand, and the optimal government

decisions to invest in one sector or another. Many analysts of growth prospects have

concentrated on the growth multipliers of narrow, single‐sector growth, to argue that a

given growth rate in one sector has the greatest impacts on the growth rate of the economy

as a whole. But this does not imply that this is the best area for government intervention:

policy intervention should be guided by comparison of the returns – at the margin – to

transferring an economy’s physical resources across sectors.


This approach represents a departure from traditional use of CGE models to guide policy.

Consider for example a recent study by Diao et al. [14], who present a pair of economy‐wide

models for Ethiopia, based on parameterizations of input‐output coefficients, demand

elasticities, and other estimated parameters of the economy. These models are used both

to explore the growth impacts of a given, exogenous rate of technological improvement in

one sector or another, and to compare growth rates required in specific subsectors in order

to achieve a given target rate of growth for the economy as a whole. However, these

models do not set out to consider the causes of growth in these agricultural subsectors; nor

(since they generally make simplifying assumptions about the elasticity of supply from

industry or other sectors) do they emphasize the tradeoffs in resource allocation and the

complementarities in demand and production implied.


The causes of agricultural productivity growth cannot be divorced from the study of growth

outcomes and linkages – fundamentally, incentives to innovate in any sector depend on

relative prices, themselves a function of growth rates elsewhere in the economy. Moreover,

and equally important as a guide to policy, it is important in a world of finite budgets to

consider the tradeoffs made in allocating government investments across sectors. The

relevant question is not one of which combinations of sectoral growth rates suffice to

produce a given target growth rate. Rather it should be the question of which allocation of

the physical and human resources available – both in the private sector and in the

government ‐ produces the highest possible growth rate.2 The answer to this question will

depend on equating marginal growth impacts across potential investments, for which it is

necessary to understand the multipliers from policies to single‐sector growth rates.


The choice to allocate public resources across sectors involves several complications over

and above the problem of choosing policies to achieve growth within a single sector. For

instance, the choice faced by policymakers is not simply one of choosing between

investments that have direct impacts on a single industry: indirect effects on other

industries, operating through consumption, production, and investment decisions, are

equally important. Second, there may be important complementarities between alternative

forms of investment – so that gains are only achieved by policies that are well coordinated,

both in terms of sectors, geography, and sequencing. Third, whereas equity considerations

will tend to promote balanced total investments across geographic space, in an environment

of increasing returns it is not necessarily the case that this will lead to balance in sectorspecific

spending across space. Instead, equitable growth may best be achieved by focusing,

e.g., on education in one location and on infrastructure in another. Finally, public

investments may in general play one or both of two functions: to foster growth in a specific

sector, or to strengthen growth linkages across sectors. The second‐order effects of

strengthening linkages may be equally important to overall growth prospects; such public

goods may also be particularly poorly served by the market.


While most analysts have taken these linkages, or multipliers, as given features of the

economy, it may be the case that important growth implications of particular types of

investment – transportation infrastructure being perhaps the most obvious example –

function to strengthen linkages across sectors. This point will be explored in greater detail



The remainder of this paper proceeds as follows. Section 2 discusses routes to growth in

agricultural output. A key contribution of the theoretical framework considered here is to

recognize the endogeneity of agricultural growth: alternative routes to growth in the

agricultural sector, broadly defined, may result from different incentives in the economy.

Not all of these are equal in their implications for long‐run growth within the sector, or in

their implications for growth multipliers to other sectors. Section 3 takes up this issue,

investigating the relationship between growth in agriculture and that in other sectors. This

framework has the broad implication that, while agricultural growth must be a part of any

long‐term strategy for growth in Ethiopia, a balance may be struck between the desire to

increase agricultural production and to increase agricultural earnings and wages; moreover,

given the need to harness market forces to incentivize agricultural growth, there is an

important role to be played, both by policies that link agricultural output to domestic and

international markets, and by policies that grow urban incomes, which will play an

increasingly important role as a source of demand for agricultural goods.


It should be clear by now that simple viewpoints on the role of agriculture in development

are then based on fallacies, misunderstanding essential economic interlinkages. For example,

an ‘agriculture first’ viewpoint on growth priorities cannot be simply justified by stating that

most of the labour force is active in the agricultural sector at this moment or because the

share of agriculture in GDP is high. Even more sophisticated analyses rarely take into account

the economic incentives required to induce growth in agricultural sectors. That agriculture

should be the main driver of growth and that it should be the focal point for government

investment should be proven, not stated. Such a proof requires us to examine the means by

which agricultural growth is sustained as well as its ability to stimulate growth in other



2. Sources of growth in smallholder agriculture


Central to the role of agricultural growth in Ethiopia is an understanding of the mechanisms

by which the agricultural sector itself can grow. This is a partialequilibrium exercise, taking

such factors as prices and demand in other sectors as exogenously given, in order to

understand the relationship between the general economic context and the progress of the

agricultural sector. Taking agricultural growth to be endogenous – and understanding how 7

incentives in other sectors drive the direction of agricultural growth – is fundamental: these

incentives provide the multipliers that sustain impacts of well designed policies over time.

Within smallholder agriculture, we focus on two sources of growing productivity: adoption

of new technologies – be these inputs or crops – by smallholders, and increasing of the landlabour

ratio among smallholders.3 The economic conditions associated with each are

discussed in turn below.


Changes in technologies and changes in factor ratios can both bring about productivity gains,

in the sense of increasing the returns to land or labour. But these sources of growth do so in

distinct ways. Technological change can increase the productivity of both factors, though in

practice it will of necessity be biased in one direction, changing the ratio between returns at

the margin to one factor or the other. Large‐scale mechanization, for example, may

decrease the marginal return to labour relative to capital and land inputs. By contrast,

adoption of high‐value crops, or of inputs such as fertilizer that require intensive cultivation

techniques, may be seen as labour‐augmenting. Like technology, changes in factor ratios

alter the relative returns to land and labour. An increase in the land‐labour ratio in

agriculture implies rising (average and marginal) productivity of labour, but falling land

productivity (assuming other inputs are held constant). Such changes in factor inputs have

characterized a perhaps surprising share of recent agricultural changes in Ethiopia [1]. The

Government of Ethiopia has long recognized the importance of the land‐labour ratio to the

growth of rural incomes in the face of mounting population pressure; in ADLI [18], for

example, it is argued that the expansion of non‐farm activities should be promoted “… there

by [sic] increasing holding sizes for rural families.” [p. 19]


This distinction will be important in considering the form of stimulus that agriculture will

provide to other sectors. These will be discussed in detail in Section 3, but the importance of

labour‐versus‐land bias in technological change is briefly foreshadowed here. When labour

markets are competitive, increases in labour productivity represent growth in and of

themselves: they result in higher wages in both rural and urban sectors.4 Increases in the

productivity of land that are not labour‐augmenting, such as mechanization, do not have the

same effect on wages across the economy. Indeed, this seems to have been the case in the

Philippines. Describing the process of rapid agricultural growth in that country, Bautista [7]

writes that “[a]gricultural labour has not been helped by the substantial mechanization of

some farm operations, particularly the preparation of land for rice and threshing of the crop”

(p. 126). However, a greater supply of agricultural output may itself have effects on the

growth potential of other sectors by maintaining favorable domestic terms of trade that 8

preserve high returns to capital, which are subsequently reinvested to create industrial

growth. This effect may obtain even if rural wages do not rise (for example, if the increased

agricultural revenue accrues to owners of capital or land in a mechanized agricultural sector).

Given the focus of this paper on the role of smallholder agriculture in Ethiopian growth, we

will not discuss in any detail the determinants of large‐scale, commercial farming. Here we

will simply reiterate the basic point that the growth framework must not take the expansion

of commercial farming as exogenous, just as it must seek to understand the determinants of

smallholder productivity growth. At times, similar forces may drive the two: growth of

commercial farms will also require appropriate and sustained price incentives, for example.

Recent emerging successes in Ethiopia and elsewhere do permit a few suggestive

generalizations, however. Commercial farming can employ technologies that achieve

economies of scale not accessible with smallholder technologies; they may also be profitable

under some agronomic and environmental conditions that characterize parts of Ethiopia

where smallholder agriculture has not been viable. For some crops, well integrated

outgrower schemes may provide a means to increasing the impact of high‐value crop

production for rural incomes. As a source of increased cereals output, it is important to

recognize the limitations of commercial agriculture – which is typically characterized in this

case as a land (but not labour)‐augmenting technological improvement. Commercial cereals

production may not be a large source of employment, and as such may not have large

impacts on rural wages; however, as discussed in Section 3 the increased supply of food may

be crucial to the growth of other sectors.

Adoption of new technologies and crops by smallholders


Drawing on Green Revolution experiences, the standard view of agricultural growth is

founded upon intensive improvements by smallholder farmers. This may take the form of

farmers either adopting new technologies for the production of existing crops, as in the

Green Revolution case, or of farmers adopting new crops altogether (e.g., moving into higher

value‐added crops, such as fruits and vegetables).


What exactly is required for this to take place? We highlight two conditions: the supply of

appropriate technologies, and the magnitude of economic returns to adoption by


First, as the experience of the Green Revolution showed, the availability of agricultural

innovations plays an important role. The obvious first requirement is that scientific work to

develop agricultural innovations takes place. As Kei Otsuka [38] has emphasized, the

availability of innovations requires more: not only agricultural innovations at the level of

global public goods, but also the adaptation of the resulting modern varieties (MVs) to local

growing conditions. In the case of Vietnam, Otsuka argues that the “serious efforts to

nurture… researchers at the national programs” of IRRI and CIMMYT played an important

role in translating global innovations into locally profitable technologies. Similarly, while the

orthodox story of England’s own agricultural revolution typically emphasizes the role played

by enclosure, an important role was played by the development of new systems of crop

rotation and other techniques (see, e.g., Timmer [51] for an early discussion of the historical



Beyond the research stage, the effective supply of agricultural innovations to smallholder

farmers clearly requires both a network of extension officers and an efficient distribution

network, which reliably delivers desired seeds to farmers.


Of note here is the importance of simultaneous improvement in the distribution systems

across seeds, fertilizers, and other inputs. Evidence on the returns to improved seed

adoption in Africa (see Otsuka and Kalirajan [39, 40] for a helpful overview, and see Dercon

and Hill [24] for recent evidence) suggests that these returns are significantly higher when

farmers also adopt fertilizer. For example, Kei Otsuka and Takashi Yamano [41] find that in

Kenya, maize yields on high yielding variety (HYV) areas are 24% higher when farmers use

typical levels of organic fertilizer than when they do not, and 34% higher when farmers use

typical levels of chemical fertilizer than when they do not. The economic returns to sustain

improved seed adoption may be present when a broad set of complementary inputs are

available, but may not be obtained by farmers in the absence of efficient and reliable

delivery channels for fertilizer and other inputs.


This first requirement, the availability of inputs, is hardly controversial. A second

requirement is often overlooked: the first stages of agricultural innovation in a population

require strong economic incentives. The returns to adoption of new technologies and crops

must be high; the returns required to induce adoption are higher than those required in

order to sustain use of new technologies once they have secured a firm foothold in the

population. Input prices, fertilizer requirements, uncertainty about production techniques:

all of these factors combine to make adoption of new agricultural technologies a costly and

risky proposition, particularly for early adopters.


There are various ways of creating these high returns, most notably high yields, high output

prices or low input prices. The Green Revolution in India and Southeast Asia appears to

deserve its name not least because of the massive yield gains that were on offer by using

new varieties. Wheat technologies developed at CIMMYT, with suitable complementary

inputs, offered a more than fivefold increase in yields on small farmer demonstration plots

in India [50]. Rice yields on offer via IR8 rice were early on estimated to be 5 times the

traditional variety using traditional methods and 10 times using optimal input packages [9].

Often, such high yield gains are not immediately available, or difficult to immediately

replicate on farms. Accordingly, periods of widespread improvement in smallholder yields

are often led by high prices, which generate the required high returns to adoption.


Historical examples are legion: Robert Allen [4] argues that the expansion of Paris in the

nineteenth century led to intensification of production techniques in its surrounds, and,

similarly, that the growth of London caused enclosure of grain lands and their conversion to

pasture in its surrounds. Turning to modern cases, China’s agricultural growth since 1985

was precipitated by measures that offered a strong increase in returns on offer to farmers

via (i) the liberalization of agricultural prices, resulting in a significant increase at the outset

of the economic reform process, and (ii) the freeing of households to specialize in crops with

high returns [42]. In Vietnam, the highly fertile and widely irrigated land created agronomic

conditions conducive to large returns at the outset of that country’s green revolution [38].

In the Philippines, Hayami [22] shows the green revolution from the 1960s, linked to the

high yield rice varieties gradually resulted in rice price declines, resulting in only slow

agricultural income increases, but started at a relatively high level of prices.


A further caveat is important to understanding the relationship between returns and

adoption: the returns required to induce early adopters may have to be higher than the

returns required to sustain a pattern of aggregate productivity growth in agriculture. The

aggregate process of adoption itself is characterized by increasing returns. This is true for

several reasons.


Importantly, farmers learn from one another, leading to well established S‐shaped curves

characterizing adoption. These have been documented since the seminal work of Zvi

Griliches [20] on the adoption of hybrid corn in the USA in the first half of the twentieth

century. Munshi’s recent empirical work on the green revolution in India [35] and has

affirmed the importance of learning externalities in the adoption of HYVs in that case,

although this work also suggests that cross‐farmer learning varies by crop. Munshi argues

that rice‐growing conditions in India were more variable across individuals than were wheatgrowing conditions, making it more difficult to learn from the experiences of others in thecultivation of this crop. This provides a useful lesson for the diffusion of improved varieties

and new crops in Ethiopia: the more variable are growing conditions for these technologies,

the higher the sustained returns required in order to further their diffusion.

In light of the value of learning from neighbours’ experiences, some farmers may

strategically delay the process of adoption in order to benefit from watching those around

them [6]. This further explains why early adoption is more difficult to induce than late, as at

later stages of adoption the strategic incentive for delay is reduced.


Even in the absence of learning externalities across farmers, it may still be true that farmers

– once they have adopted an individual technological improvement – find it easier to

continue to adopt newly improved varieties as these become available. In Vietnam, for

example, aggregate productivity gains in rice were sustained over a twenty‐year period. The

speed of diffusion suggests that this sustained growth was not attributable to the steady

process of bringing new farmers ‘into the fold’. Instead, the consensus [38] for that country

is that its green revolution was brought about by a series of improved technologies,

introduced in succession. Fixed costs in learning new production techniques may make it

easier for farmers – having undertaken one form of agricultural innovation – to progress to



Taking these three broad considerations into account, our partial‐equilibrium story of

agricultural growth is thus: at early stages, there are two key constraints to technology

adoption, in the form of the availability of appropriate technologies on the ground and

appropriately high returns to the adoption of this technology. Once initial adopters have

been induced, then cross‐farmer learning about techniques and profitability, within‐farmer

increasing returns to innovation, and alleviation of strategic adoption considerations all relax

the level of returns required to sustain adoption. Dercon and Hill [24], the companion piece

on sources of agricultural growth in Ethiopia, show that despite some rhetoric to the

contrary, the availability of appropriate and high return technologies on the ground is

limited at present in Ethiopia, affecting the scope for fast agricultural growth via adoption,

although current high cereal prices should offer a window of opportunity for adoption



Increases in land labour ratio among smallholder farmers


A second route to rising labour productivity is through an increase in cultivated land per

worker in the smallholder agricultural sector. By definition, this can come about either

because of an expansion in cultivated land or because of a reduction in the agricultural

labour force. While many zones will have only limited scope for area expansion, it is possible

that rising labour productivity may come about in this sector nonetheless, as non‐farm

economic activity draws labour out of the agricultural sector.


Adenew [1], Seyoum Taffesse [49] and Dercon and Hill [24] critically address the extent to

which expansion in cultivated area is responsible for recent improvements in agricultural

output in Ethiopia. This evidence suggests that a considerable share of recent cereal

production growth has come from area expansion, even though this remains contentious.

Furthermore, the area expansion has not led to larger farms per worker compared to 10

years ago, as during the same period the rural population continued to grow considerable.5

Finally, even if output growth was largely driven by area expansion, however, resource

constraints imply that the continued expansion of cultivated area is not a route to sustained

growth in agricultural labour productivity.


In the absence of area expansion, rising land‐labour ratios may be the result of the transfer

of labour to other sectors. Some of this may occur through rural non‐farm activities; as

studied by Loening et al. [31] and discussed by Rijkers et al. [46], rural non‐farm activities are

integral to the Government’s Plan for Accelerated and Sustained Development to End

Poverty (PASDEP) [19].


Such a reduction in the agricultural labour force can indeed be associated with increased

agricultural incomes per capita. Allen [2, 3] has shown the effect of the removal of labour on

agricultural productivity in England. This is also shown by historical evidence in Italy [5],


where the impact of the Black Death in the middle of the 14th century is associated with a

rise in labour productivity in agriculture.


Growth implications of a rising landlabour ratio


Either of these mechanisms to increasing the land‐labour ratio will raise the average product

of labour. In the case of land expansion, total output will increase, whereas in the case of a

reallocation of land resulting from out‐migration, the effect on total output is ambiguous, as

will be explained below.


In general, the marginal product of labour will rise in both cases. As will be discussed in

Section 3, when labour markets are competitive across urban and rural areas, such an

increase in the marginal product of labour will result in rising real wages across the

economy; this in and of itself can be a source of growth.


In the case of increasing the land‐labour ratio through labour transfer, an important

question is the implication for total agricultural output. Declines in total agricultural output

can, as discussed in Section 3, retard growth in other sectors by driving up wages paid there.


Extensive debates of the 1960s and 1970s regarding the existence of pure surplus labour –

the extreme case in which the marginal product of labour is zero over some range ‐ have

largely been regarded as a “red herring” [43]. If economies of scale are sufficiently powerful,

it is even possible the consolidation of small farms can generate a positive net effect on total

agricultural output when labour moves out of that sector. But what is important, and

broadly accepted as a characterization of labour markets in many developing countries, is

that the marginal product of labour in smallholder agriculture lies below its opportunity cost

in other sectors. Factors including the availability of risk‐coping mechanisms create

incentives for household members to remain in that sector, even when a transfer of labour

would increase aggregate output in the economy. Irreversibility in the decision to relocate

to urban areas – which may be brought about, for example, by imperfections in the market

for land – will also exert a pull, keeping labour in rural areas.


In an economy that is not completely open, a decline in total agricultural output will tend to

turn terms of trade against other sectors. This results in rising nominal wages in, e.g., the

industrial sector; even if the economy is closed, this decreases (accounting) profits, while if

industry competes on international markets then its competitiveness will be hurt. Either

mechanism has the potential to retard growth of non‐agricultural sectors.

For this reason it is important to understand whether and to what extent the withdrawal of

labour will reduce total agricultural output. If there are economies of scale in smallholder

farms, it may in fact be the case that these will offset the reduction in labour supply – so that

total output can increase as a consequence of labour withdrawal. As Dercon and Hill [24]

shows, there is inconclusive evidence for the presence of such economies of scale in

Ethiopia; despite a few papers showing their presence, there is no convincing evidence for

scale economies. 6 If anything, this same evidence suggests that scale economies are

stronger in food deficit areas, which would support a strategy of supporting off‐farm

activities in these areas.


What factors bring about an increase in the landlabour ratio?


As already noted, there has been an increase in cultivated land over the past decade.

However, the potential for continued area expansion as a source of growth is limited.

Incentives for a shift in labour from agricultural to non‐agricultural occupations, on the other

hand, may be harnessed as a means to increasing agricultural incomes among those who

remain in the sector.


Returns to non‐farm activities – both rural non‐farm activities and urban industrial and

service employment – will naturally increase over the course of the development process, as

domestic demand for non‐agricultural goods rises. Policies that can accelerate this process

include investment in education: for example, Mogues et al. [34] find substantial

consumption increases to be correlated with such public investments, although these results

should be treated with caution given the challenges inherent in drawing causal inference

from correlations in this context. Given the importance of informal rural insurance and

other safety nets particular to rural settings [12, 26], the migration of labour to urban areas

may be incentivized by government policies that strengthen safety nets in urban areas.

There may be a role for land policy here: since land is among the most important assets for

income security, measures that protect migrants’ claims to land may reduce the risks

inherent in rural‐urban migration.

3. Agricultural growth in an economy wide context


Agricultural growth does not occur either in isolation or exogenously. Multipliers from

public investments in agriculture will depend not only on their ability to generate growth

within that sector, but also on linkages to other sectors. Moreover, given the scale of the

Ethiopian economy and given finite government resources, policies promoting growth

should seek to harness market forces that can provide a continued source of incentives for

innovation. In the tradition of endogenous growth models, one may view the highest

thereby speeding the arrival of the point at which this marginal product exceeds the

institutional wage paid to surplus labourers, and real wages can rise. But in early stages of

development, it will be only improvements in land productivity (or, equivalently, the average

product of labour) that matter, given the surplus labour assumption.


By contrast, in a neoclassical dual economy, the surplus labour condition does not hold.

Workers in the agricultural sector have positive marginal products. Moreover, labour

markets are assumed to be competitive in the neoclassical model. Under this condition, this

marginal product of labour in agriculture determines incomes. With agricultural incomes

determined this way, increases in the marginal product of labour in either the urban or rural

sector plays an immediate role in the growth of nominal wages. The importance of the

marginal product of labour as a source of real income growth is a key distinction of the

neoclassical model.


The way in which this translates into growth in real wages depends on income levels.

Neoclassical models such as those of Jorgenson [27, 28] and Eswaran and Kotwal [16] have

typically assumed that workers have hierarchical preferences: below some threshold level of

consumption, they are unwilling to substitute industrial output for agricultural output, that

is, to “eat shirts”. Consequently, workers do not benefit from increases in labour

productivity in the industrial sector, which merely increase the supply of a good that they do

not consume. On the other hand, advances in agricultural productivity are required to

release labour into other sectors, and these productivity advances – by increasing the supply

of food – are a source of real wage growth at low levels of income [16].

Below we examine the empirical relevance of the surplus labour assumption. In Section 0

we re‐examine the role of agriculture in an open economy, and consider evidence of the

openness of Ethiopia’s cereals market. In Section 0 we also consider the implication of

Hirschman’s [25] notion of linkages in this context. Such linkages are often overlooked in

models of dual economies.



Surplus labour


As highlighted above, the contrast between classical and neoclassical models of a dual

economy highlights the importance of the question of surplus labour in determining

agriculture’s contribution to growth. If labour markets are competitive, then increases in

rural incomes can translate into real wage growth in urban areas. Otherwise this will not

occur until a combination of labour transfer to other sectors and agricultural technical

change increase the marginal product of labour above current income levels.


If there is a surplus of rural labour, growth in other sectors may be accelerated by increasing

the marketed surplus of agricultural output. If this marketed surplus increases less than

proportionally with the growing urban labour force, relative food prices will rise, and urban

growth with slow. Two key reasons explain the failure of the marketed agricultural surplus

to rise in this way. First, if the marginal product of labour(ers) in agriculture is not zero, then

growth; the figure plots a regression line and 95% confidence interval for this relationship

among regions outside of Addis.


In regions where there has been significant transfer of labour from rural to urban areas, food

prices have risen more sharply than national trends. This is consistent with the view that (a)

the withdrawal of labour has had a non‐negligible impact on the marketed surplus from

agriculture, and (b) urban consumers are unwilling to substitute the consumption of services

or industrial goods for agricultural output.


total output of that sector will decline with the migration of the rural workforce. Second, if

rural smallholders choose to consume rather than to sell the increment in the surplus of

food per capita that accrues when family or neighbors migrate, then this absorption by the

rural sector will decrease the supply of food per capita to urban areas.7

Below we present evidence from Ethiopia. We argue that, while it is possible to increase the

allocation of labour to rural, non‐farm activities without diminishing agricultural output, the

movement of labour to urban economic activities does come at a significant cost to

agricultural output (or at least to marketed agricultural output per urban worker). There is

limited evidence on the relationship between agricultural and non‐agricultural incomes in

Ethiopia, but what is available is consistent with the view that labour markets are not



Marginal product of labour


In theory, it is possible that the withdrawal of labourers from the agricultural sector would

not diminish its output. Two mechanisms may support this. On the one hand, an increase in

the labour inputs of those who remain behind may compensate for lost labourers – this is

the argument first put forward by Sen [48]. Alternatively, consolidation of rural landholdings

may result in economies of scale that have a net positive impact on production. This

possibility is discussed further by Dercon and Hill [24], but as reported above, the evidence is

at best mixed.


Evidence suggests that marginal product of labourers is not zero in Ethiopia. Rural‐urban

migration, in the absence of technological progress in agriculture, will result in a decrease in

total agricultural output. The evidence examined below is consistent with either of the two

mechanisms suggested above: that agricultural production declines in response to the

transfer of labour, or that the marketed surplus simply fails to rise in proportion with the

growing urban labour force. However, significant transfer of labour to the rural non‐farm

sector appears to be possible without decreasing the effective supply of labour to



Competitiveness of labour markets


The potential for increases in the marginal product of labour to be a source of real wage

growth in other sectors depends on the competitiveness of labour markets. This

competitiveness may potentially operate differently between rural farm and non‐farm

labour markets, on the one hand, and between the rural and urban labour markets more

generally, on the other. Rijkers, Söderbom and Teal [46] shed some light on the tightness of

the rural (farm and non‐farm) labour market. They argue that seasonal participation in nonfarm

enterprises is common. Consequently, these authors find no strong evidence of a

relationship between wages in the rural farm and non‐farm sectors. Given their different

seasonal demands, the rural farm and non‐farm sectors do not compete for the same

effective pool of labour: these labour markets are segmented by time. So long as this is the

case, increases in the marginal product of labour in one type of rural activity need not

translate into real income gains in the other.


If the ability of labour to move flexibly from the urban (non‐farm) sector to rural sectors is

not fully constrained, then the labour‐market equilibrium may create a competitive link

between sectors. Barriers to labour mobility may break this link; e.g., Deininger and Jin

provide some evidence of a relationship between migration and land rental markets in China

[10]. Greater costs involved in rural‐urban migration suggest that expansion of urban

employment will draw meaningful amounts of labour away from rural farm and non‐farm

enterprises – and thereby will decrease total agricultural output, at least in the absence of

substantial technological change.


Agricultural growth increases the supply of educated labour to other sectors


Finally on the supply of labour, there may be an important and often‐overlooked

relationship between agricultural productivity growth and the supply of semi‐skilled labour

to industry. If part of the increased agricultural revenues are invested in children’s

education – whether this investment is undertaken by households or by the government –

then this will ultimately increase the supply of skilled labour to other sectors. Mao and

Schive [32] argue that this was important to the absorption of Taiwan’s immigrants in nonfarm

employment during that country’s agricultural boom (a boom in which migration from

rural to urban areas grew from 19,000 individuals per year during the period 1952 – 1964 to

more than 93,000 individuals per year in the period 1963 – 1973). See Estudillo and Otsuka

[15] and Hayami [23] for related evidence from the Philippines.


Conclusion: classical domestic markets for food and labour


Taking this evidence together, we suggest that much of the evidence is consistent with the

characterization of the Ethiopian economy as a classical, rather than neoclassical, dual

economy. High transaction costs involved in migration to urban centres – including limited

rural land markets – allow a disconnect between wages in these sectors. The household

basis of smallholder production means that the incomes of smallholder farmers are linked to

the average product of their labour (since the returns to land typically accrue to the same

individuals); consequently, labour markets will not equate marginal products of labour

across sectors as in the competitive, neoclassical model. The empirical relationship

between labour transfer from rural to urban areas and local food price inflation is also

consistent with the importance of total agricultural output as a determinant of urban wages.


In this case, technological change in agriculture plays two roles. In the short term, its most

important contribution to growth is through an increase in total food supply. This helps to

keep down cost of living in other sectors, allowing greater capital accumulation in industry

even when its goods are produced for the domestic market alone, and maintaining

competitiveness if industrial output is exported. Second, agricultural technological progress,

by increasing the marginal product of labour, helps to accelerate the arrival of what Ranis

and Fei [44] call the ‘commercialization point’: the point at which this marginal product

exceeds the institutionally determined (i.e., not competitive) rural wage. It is only from this

point, at which the labour surplus is exhausted, that gains in productivity in any sector

translate into real wage growth.


The supply of educated labour to industry provides an important caveat to this argument

about domestic markets for labour and for agricultural products. First, the market for skilled

labour may be considerably more competitive, given that educated workers may find it

easier to migrate in search of employment. Second, and perhaps more importantly, since the

proceeds from agricultural productivity gains are partially invested in human capital,

progress in agricultural technology may further contribute to growth through the supply of

skilled labour.


It is appropriate to qualify these arguments with poverty reduction in mind. In Ethiopia,

growth is obviously needed for sustainable poverty reduction, but the nature of the growth

process will matter for poverty reduction. While we may need agricultural output growth as

part of a balanced growth strategy to keep the growth of nominal industrial wages in check,

poverty reduction requires real wage growth. The extent to which agricultural growth and

labour migration involves growth in the marginal product of labour is then relevant.

Furthermore, to ensure more poverty reduction for the next generation, education, health

or other means of increasing the skills of the labour force will contribute to both growth and

poverty reduction, as it will reduce the segmentation of labour markets and increase

migration from rural to urban areas.


Open economy considerations


Openness to trade changes the relationship between agricultural productivity and growth in

both the classical and neoclassical models. In the classical dual economy model of a closed

economy, increases in agricultural (land) productivity were important in order to stave off

deterioration in domestic terms of trade. When the classical dual economy becomes an

open one, then relative prices of agricultural and industrial goods are pinned down by

international markets. In a perfectly open economy, if rural‐urban migration brings about a

decrease in the marketed surplus available per non‐agricultural worker, this will no longer

result in rising relative prices for food.

This reduces the importance (from a growth perspective) of technical changes in agriculture,

such as mechanization, that increase land productivity and the average product of labour

but have a limited effect on the marginal product of labour. On the other hand, this

decoupling of food prices from domestic supply frees smallholder agriculture to act as a

source of real wage growth in and of itself. Labour‐intensive technological changes, which

may include the adoption of fertilizers and shifts to high value added crops, can speed the

growth in labour’s marginal product, which will ultimately drive real wage growth in

agriculture and beyond.


A priori, there is no reason why Ethiopian cereal markets should not be integrated with

world markets, so an open dual economy model could offer guidance. However, this ignores

a key feature of Ethiopia: that it is landlocked with a relatively large distance from the main

cereal and demand areas from the nearest port. For example, until the last few years, maize

prices in Addis Ababa were fluctuating around $15 per quintal for many years, with transport

and handling costs to Djibouti near $6 per quintal or 40% of the mean market price. The

result is that even if there were no trade distortions, for a wide range of domestic market

conditions, prices would move independently from world prices. As a result, within some

broad bounds, cereals are best considered non‐tradable goods, suggesting that the

discussion in the previous section, on the importance of domestic food production to food

price inflation, remains relevant.


The evidence supports this. As argued by Rashid et al. [45], domestic cereals in Ethiopia are

generally considered to be a non‐tradable sector. Substantial within‐country variation in

cereal prices, as presented in Figure 1 and in evidence for unexploited spatial arbitrage

opportunities presented by Negassa and Meyers [36] further supports the view that prices

for cereals, at least outside of Addis Ababa, do not effectively compete with imports.

This does not mean that cereal prices have not exceeded import parity prices.

Rashid et al. [45] show that, after accounting for price distortions created by food aid,

domestic prices for wheat and maize have on several occasions exceeded import parity

prices since the mid‐1990s. This is definitely the case since September 2007 up to now (see

Dercon and Hill [24]). Trade barriers, market imperfections, macroeconomic and foreign

exchange constraints are responsible for these deviations (as food imports should have been

able to keep prices on parity prices). It also shows that the status of cereals as de‐facto nontradable

commodities can be changed via a review of policy parameters, and trade barriers.

But as a land‐locked country with considerable transportation costs to the nearest harbours,

food prices will be largely domestically determined and the analysis in the previous section

will remain valid.



Production and consumption linkages


Traditional dual economy models focus on endowments of land, labour, and capital as

determinants of long‐run growth. They often overlook static multipliers created by linkages

between the production of intermediate goods and the market for the consumption of

domestic output. Their focus is typically on the supply side. However, the linkages

highlighted by Hirschman [25] may also play a role in determining agriculture’s contribution

to growth. Modern authors, while departing at times from Hirschman’s conclusions (see, for

example, Mellor [33]), have focused on two broad types of linkages from this sector to



• production linkages, whereby increases in agricultural output lead to greater supply

of inputs used in non‐agricultural production or, conversely, greater demand for

non‐agricultural outputs used in agricultural production;

• consumption linkages, whereby increases in agricultural income lead to increased

demand for non‐agricultural (as well as agricultural) consumption goods.


Much of the debate on the role of agriculture has focused on the magnitude of these

linkages relative to parallel linkages stemming from growth in other sectors. On one side,

Hirschman [25] has argued that weak backward production linkages and limited forward

production linkages in agriculture strengthen the argument for growth led by

manufacturing: according to Hirschman “the superiority of manufacturing in this respect is

crushing” (p. 110). On the other hand, proponents of agriculture‐led growth have

responded by emphasizing the importance of consumption linkages; for example, Mellor

([33], p. 13) argues that “it is consumption linkages that are most important. … [rural

people] will spend at least 70 percent of their incremental income on consumption goods.”


There is no reason to presume a universal answer to this debate. The strength of production

and consumption linkages will depend on many country‐specific factors. Some of these may

be taken as given – natural resource endowments, for example – while the strength of other

forms of linkages may themselves be amenable to policy intervention. The latter is an often

overlooked consideration in policy evaluation: not all forms of agricultural growth will have

the same multiplier effects, and these multipliers may depend on the way in which

agricultural growth is achieved. Growth attained by investment in roads that increases

returns to agricultural innovation, for example, may also affect the underlying linkages23

between sectors. In light of the country‐ and policy‐specificity of these linkages, we visit

below the theory and evidence for some key forms of linkage in Ethiopia, putting these in an

international context where possible.



Production linkages


Production linkages from agriculture can be ‘forward’ – where agriculture provides inputs

employed in other sectors – or ‘backward’ – where agricultural production creates demand

for the output of other sectors. There is a broad consensus that backward linkages from

agriculture have little power.13 In considering the forward linkages from agricultural

production to other sectors, it is common to focus on the direct use of agricultural inputs as

factors of production in industry. For this reason the ADLI strategy [18] focuses primarily on

the supply of raw materials from agriculture to industry. It sets out food self‐sufficiency and

the production of raw materials for industry as its first two policy priorities for the

agricultural sector.


Perhaps the most obvious mechanism by which agriculture can stimulate growth in other

sectors is by providing raw materials or intermediate inputs for industrial production. For

this reason, ADLI [18] (p. 27) emphasizes improvements in the quality and quantity of hides

and skins and raw materials for the textile industry as priorities for agriculture. A social

accounting matrix (SAM) developed by IFPRI (as presented in Diao et al. [14], p. 35) shows

the rationale for continuation of these efforts: 50.6% of forestry and fishing output is used as

an intermediate good, with coffee, tea, and chat (33.6%) and livestock (31.9%) not far

behind in terms of their use in other sectors.


However, two cautionary notes are important here. While relatively high shares of domestic

production of these raw materials may be used as inputs elsewhere, this does not

necessarily imply either (a) that these constitute a large share of the overall intermediate

goods requirements of industrial production; or (b) that domestic markets for industrial

goods provide opportunities for further expansion in sectors that rely heavily on local raw

materials. To the extent transport costs allow, export possibilities may help to resolve the

latter difficulty. However, trade and industrial production data suggest that Ethiopia has

made little progress since the early 1990s in reducing its dependency on imported inputs. As

of 2002, imported industrial inputs remain approximately 48% of total input content, almost

exactly their share (49%) in 1993.14 This is only slightly below the 2002 share of imported24

inputs for all of Sub‐Saharan Africa, although the remainder of the region shows a marked

upward trend not present in Ethiopia [47].


However, a simplified characterization of trade in manufactured goods as representing the

final output of sectors that produce using only domestic inputs seems no longer to fit well

with the global trade patterns. As discussed in Section 0, trade is increasingly done ‘in tasks’,

with countries relying heavily on imported intermediate inputs [8]. Recent work has shown

that, when economies are constrained to export only those products which are composed

entirely of domestically produced inputs, this dramatically reduces export volumes [8]. This

suggests that, under the modern fragmentation of trade, significant opportunities will be

missed by a strategy that does not allow industry to draw upon imported inputs. More

optimistically, this suggests that it is increasingly unnecessary to orient agriculture toward

the production of raw materials for use in industry as a precondition for successful industrial



Consumption linkages


A central tenet of the argument that agriculture leads development is that consumption

linkages, operating via farmers’ demand for industrial (and service) goods, create strong

linkages from agricultural growth to growth in other sectors. Mellor [33] epitomizes this



“[I]t is the consumption linkages that are most important. The savings rate of rural people

receiving increments to their incomes tends to be high but rarely exceeds 30 percent. Thus

they will spend at least 70 percent of their incremental income on consumption goods.

Albert O. Hirschman’s widely quoted statement that agriculture has very poor linkages to

other sectors and thus is not a sector to emphasize reflects a common tendency of

development economists to ignore the stimulative role of effective demand for consumption

goods and services.” (p. 13)


Mellor goes on to claim that “the producers of agricultural commodities spend little of that

incremental income on increased consumption of basic food staples.” If true, this suggests

that agricultural growth will tend to stimulate production in other sectors, via its demand

effects. Looked at in a dual economy framework, this could be interpreted as a solution to

Lewis’s deteriorating terms of trade: a small increase in the subsistence incomes of the

farming population would suffice to induce very large Engel effects – which would swing

domestic terms of trade in favor of industry once again.


However, it is important to recognize that the extent of such consumption linkages cannot

be expected to be present uniformly across all countries. Preferences of consumers may be

different. When income elasticities of demand are not constant, the starting incomes of the

agricultural sector will matter as well: marginal propensities to consume agricultural goods

are likely to be higher at lower levels of income. Moreover, transportation costs and the

physical and institutional linkages of markets will impact upon the marginal propensity to

consume out of industrial goods in rural areas: poor access to urban markets will dampen

any potential stimulative effects.


Evidence for Ethiopia suggests that consumption linkages are not particularly strong.

Estimates presented by Diao et al. [14] provide average and marginal budget shares for a

range of goods separately by occupational category.15 They find that the marginal budget

share of cereals is 19.2% for farmers, as compared to 4.8% for wage earners and 2.8% for

self‐employed ‘entrepreneurs’. Marginal budget shares for other types of food are similarly

high among farm households, who allocate 21.6% of their budget at the margin to such

expenditures. And farm households allocate only 22% of their marginal income to industrial

goods, as compared with 40.3% allocated at the margin by wage earners and 26.5% by the

self‐employed. Marginal expenditure on services is reasonably strong, at 37.4%, which

compares favorably with the 31.5% of marginal expenditure spent on services by wage

earners, but unfavorably with the 56.3% of marginal expenditure spent on services by the

self‐employed. Thus the effects on demand for industrial output are considerably lower for

growth in agricultural productivity (leading to increased agricultural incomes) than they are

for growth in urban incomes.

Perhaps surprisingly, marginal expenditure on industrial goods compares unfavorably, for

example, to the 37% marginal budget share spent on industrial goods by farm households in

Zambia, as estimated by Delgado et al. [11]. So the question becomes, why are

consumption linkages relatively weak in Ethiopia? Each of the reasons suggested above

plays a role. The work by Delgado et al. provides a further clue to the importance of poverty

in limiting consumption linkages: for example, they find that marginal budget shares for

tradables rise from 24%, in the bottom decile of per capita expenditure, to nearly 40% in the

top decile of per capita expenditure. Thus it is reasonable to suggest that low levels of

income create relatively low marginal propensities to consume out of industry. As we have

argued the observed consumption linkages are not exogenously determined, but given

current conditions—in particular, the poor transportation infrastructure and relatively

isolated urban markets—the evidence suggests that agriculture in Ethiopia cannot at current

levels of income be expected to play as full a role in stimulating other sectors as it would in

other countries.


4. Conclusion: agriculture in relation to other drivers of growth


Ethiopia has been following a particular vision on the role of growth in smallholder

agriculture, as reflected in ADLI: agriculture should be seen as the sector from which growth

should emanate, and growth in agriculture will lead to industrial growth, by offering labour,

inputs and demand for its products. In this paper, we have applied a ‘dual economy’

perspective to understanding the role of smallholder agriculture in Ethiopian growth,

reflecting on the foundations of the ADLI strategy. This framework starts from two premises.

First, agricultural innovation is not an exogenous process, but rather must be sustained by

virtue of its interaction with other sectors. Second, the contribution of agriculture to growth26

depends on the extent of surplus labour, of open markets for agricultural goods, and of

linkages (particularly consumption) between sectors.


Our discussion has led to a number of key insights relevant for understanding the scope and

constraints for growth in Ethiopia. First, the premise of endogenous agricultural innovation

requires us to consider sources of incentives for agricultural growth. Given government

budgetary limitations, significant agricultural productivity gains at an economy‐wide scale

will require high and sustained economic incentives. It requires high return technologies to

be available and to offer high economic returns, especially through the earlier stages of

adoption. Such incentives can be brought about in one of two ways. One approach is to

stimulate growth in the industry and service sectors, creating high and sustained domestic

demand for agricultural produce.


Another way to sustain incentives could be via international markets. High and, over the

long term, rising international food prices suggest that the latter may provide a source of

stimulus for domestic innovation, giving strong incentives to boost output when imports are

still required, while offering high export prices when harvests are successful. However,

Ethiopia’s scope to fully exploit the possibilities from international markets is limited by

being a landlocked economy, with high transport and handling costs to the borders. The

result is that for a wide range of prices, cereals are behaving as non‐tradable commodity,

with domestic demand and supply governing prices. Therefore, to fully take advantage of

the incentives offered by high international prices efforts should be made to reduce

transportation and other marketing costs in order to reduce import parity prices and

increase export parity prices, allowing farmer to receive higher shares of world prices, while

providing downward pressure on consumer prices.


Secondly, the evidence presented suggests that a classical model with largely closed markets

for cereals remains appropriate to the Ethiopian economy. Limited responsiveness in wages

to changes in other sectors is consistent with the existence of surplus labour in agriculture. A

positive marginal propensity to consume agricultural goods in rural households means that

rural‐urban migration can bring about sharp increases in food prices, even if the marginal

product of labour in agriculture is low. The available evidence suggests that urban

consumers’ unwillingness to substitute between consumption of agricultural and other

goods contributes further to high food prices – filtering through to high costs of labour – in

growing industrial areas.16 Given the high costs of import, not least in the current climate of

high international food prices, the total output of the agricultural sector remains then a

constraint to the growth of domestically oriented industry (through its effect on returns to

capital) and the competitiveness of export‐oriented industry.


Any means of boosting agricultural output remains therefore important during the process

of economic transformation with labour moving out of agriculture to urban areas. This

suggests that technologies enhancing land productivity have an important role to play in

maintaining low urban costs of living and facilitating growth in other sectors. This also

suggests a potential contribution of large‐scale, commercial farming to the growth of other

sectors through the supply of cereals. Either way, the impact on the marginal value product

of labour in smallholder agriculture would be limited, offering limited scope for real wage

and earnings growth in the rural sector.


Provided import parity prices can be kept sufficiently low (via better integration with

international markets and reduced transportation and marketing costs), an alternative

approach would rely more heavily on food imports. If feasible, this would allow smallholder

agriculture to focus on high‐value and exportable crops, utilizing economies of scale both

due to agglomeration (perhaps coordinated through outgrower schemes) and through the

marketing chain. Such technological changes would increase the marginal product of labour,

and so would accelerate the commercialization of agriculture, from which point further

technological improvements would provide real wage growth. While this may not be on the

cards immediately, it offers a route to allow agriculture to graduate from a focus on food

output to a diversified agriculture offering real wage growth and therefore poverty

reduction in the rural sector.


Thirdly, modest consumption linkages suggest that agricultural innovation will not be

sufficient to drive growth in industry. A growing consensus that agglomeration externalities

and other scale economies play an important role in industrial development suggests that it

will be difficult for industries that serve only the limited domestic market to compete with

foreign firms. More positively, the increasing frequency of trade ‘in tasks’ suggests that it

may not be necessary for Ethiopian agriculture to be oriented toward the supply of raw

materials for industry, nor for all industrial energies to focus on the processing of domestic

raw materials.


Finally, the above analysis largely takes the extent of these ‘linkages’ as given. However, the

most effective policies to stimulate growth may be those that strengthen domestic and

international linkages. Returning to the evaluation of sector‐specific government

expenditures, Mogues et al [34] find that the biggest gains in consumption are correlated

with investment in transportation infrastructure. Similarly, using micro data Dercon et al.

[13] find statistically significant and economically meaningful impacts of road access on

consumption and poverty outcomes: they find that households with access to a road capable

of carrying trucks and busses throughout the year increases consumption growth by 16%, for

example. Coupled with the prospect of increasing returns to scale in marketing activities –

considered in Dercon and Hill [24] – this suggests that government investments to

strengthen rural‐urban linkages should play a central role in growth strategy. Reductions in

the costs of transportation, for example, have the dual benefit of lowering urban food prices

– thereby stimulating industrial growth – and raising farmgate prices – thereby incentivizing

further growth in agricultural productivity. Investment in such linkages provides a means of28

stimulating agricultural innovation, as well as a means of maximizing the growth effects of

such innovation across the economy as a whole.





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