Agricultural Development and Economic Growth

I start with the big question: the role of agriculture in the broader process of economic growth and development. This macro perspective introduces key linkages between the agricultural sector and the rest of the economy, often via the rural non-farm economy, and pursues the dynamic evolution of structural transformation. The economic and demographic pathways inherent in this transformation present strategic challenges and opportunities to development policymakers, which leads as well to a discussion of the political economy of agricultural policy design and implementation during the structural transformation. And the tremendous heterogeneity of countries’ experience of productivity growth and the pace of agricultural development (Mundlak 2000, chapter 3) binds these issues closely to associated questions of global poverty and food insecurity (Dercon 2009, chapter 9).

Agricultural development as an analytical topic, with economics as an organizing framework, dates to the rapid emergence of Western Europe from the late 18th century. Economic historians have documented the critical role of agriculture in the development of virtually all the now-rich countries in the world, an experience drawn upon by W. Arthur Lewis when he wrote: “industrial and agrarian revolutions always go together, and … economies in which agriculture is stagnant do not show industrial development” (Lewis 1954, p. 433).

A. Inter-sectoral Linkages and Agriculture in the Macro economy

These insights by Lewis stimulated three lines of thought about the role of agriculture in economic development. First, the direct outgrowth of Lewis’ analysis of dual economies was formal two-sector modeling (Ranis and Fei 1961, chapter 4; Jorgenson 1961, chapter 5), with its focus on structural changes. Hayami and Ruttan (1985) explain how the dual economy literature marked an important break, introducing a “dynamic dualism” to replace prior, “static dualism” approaches that had mostly followed a descriptive, sociological and structural approach. Hayami and Ruttan concluded that neither modeling approach significantly advanced the understanding of how agricultural modernization actually takes place, although they acknowledged that the models help explain why it is necessary if overall economic growth is to take place. “The very simplicity of the models, a major source of their insight into the fundamental process of development, however, has led to substantial underestimation of the difficulties that face poor countries in achieving such a transformation” (Hayami and Ruttan 1985, p. 30).

Second, the macro perspective and the importance of two-way linkages between rural and urban economies were stressed by Johnston and Mellor (1961, chapter 6). Johnston later became increasingly concerned about the size distribution of farms and the “uni-modal” lessons from East Asia for Africa and Latin America (Johnston and Kilby 1975; Johnston and Clark 1982). Mellor continued his focus on South Asia and the difficulties for the agricultural sector on its road to industrialization (Mellor 1966, 1976, 1986). Both saw higher productivity on small farms as the key ingredient to rapid poverty reduction and a healthy structural transformation.

Third, T.W. Schultz (1964) stressed the need for an “agrarian revolution,” or higher productivity through technical change in agriculture. He emphasized the importance of human capital, especially the education of rural workers, in facilitating productivity growth, and governments’ failure to provide appropriate policy environments (Schultz 1975, chapter 7, 1978).

Masterfully synthesizing the main lessons from nearly five decades of such analysis, Staatz and Eicher (1998, p.31, chapter 2) explain:

By the end of the 1990s, development thinking had come nearly full circle. In the 1950s and 1960s, many development economists analyzed how the agricultural and nonagricultural sectors interacted during the process of economic growth, using simple two-sector models. This abstract theorizing was sharply criticized by dependency theorists, among others, who argued that such work abstracted from the institutional and structural barriers to broad-based growth in most low-income countries. During the 1970s and 1980s, the focus of research shifted to developing a more detailed theoretical and empirical understanding of the rural economy. But the emphasis on structural adjustment in the 1980s forced reexamination of agriculture’s relationship to the macroeconomy. By the late 1990s, economists were again focusing on how the rural economy was linked to the broader world market, but they demonstrated a renewed recognition of how important institutions are in determining a country’s pattern of growth and the distribution of the benefits of that growth.

In the ensuing decade, the profession finally got agriculture back on the broader development agenda. A key breakthrough was the publication by the World Bank (2007) of the World Development Report 2008: Agriculture for Development. Coordinated and drafted by Derek Byerlee and Alain de Janvry, this WDR was the first in a quarter century to focus specifically on agriculture. Its publication late in 2007, just as the world food crisis was heating up, looked prescient. Still, none of the major donor agencies have figured out how to gear up quickly to

support more spending on agricultural development, partly because there remains deep uncertainty over what to do and how to do it.

From a macro perspective, this uncertainty stems from two dimensions of the agricultural development process that remain poorly understood: (1) the dynamic role of the rural non-farm economy and how it mediates the linkages between the farm sector and the macroeconomy during the structural transformation; and (2) the political economy of agricultural policy and how that too evolves. Both topics have received substantial research attention almost from the beginnings of the field, but the research began to show new empirical depth and policy impact by the end of the 2000s (Haggblade, Hammer and Hazell 1991, chapter 10; Haggblade, Hazell, and Reardon 2007; Timmer 2009).

Formal two-sector models typically assumed the smooth functioning of the linkages that placed the fate of urban workers and farmers in each other’s hands. The actors who mediate these linkages in a real economy, and how their role and structure change over the course of economic development, only became a topic of serious analysis in the 1970s. Then a veritable cottage industry sprang up to conceptualize and measure the “multipliers” implied by market-mediated linkages between agriculture and industry. Haggblade, Hazell, and Reardon (2007) nicely synthesize this literature, stressing the crucial and changing role of the rural non-farm economy.

The rural non-farm sector provides the bridge between commodity-based agriculture and livelihoods earned in the modern industrial and service sectors in urban centers. Most rural households earn a large share of their incomes from non-farm sources, and often this sector is the “ladder” from underemployment at farm tasks to regular wage employment in the local economy, and from there to jobs in the formal sector (Delgado, Hopkins and Kelly 1998; Mellor 2000; Barrett, Reardon and Webb 2001, chapter 15). The firms and activities in the rural non-farm sector mediate many of the two-way linkages between agriculture and the macroeconomy that are at the core of the development process. These linkages can be summarized in three categories (Timmer 2002, chapter 8).

The “Lewis linkages” between agriculture and economic growth provide the non-agricultural sector with labor and capital freed up by higher productivity in the agricultural sector. These linkages work primarily through factor markets, but there is no suggestion that these markets work perfectly in the dualistic setting analyzed by Lewis (1954). Chenery and Syrquin (1975) argue that a major source of economic growth is the transfer of low-productivity labor from the rural to the urban sector. If labor markets worked perfectly, there would be few productivity gains from this structural transfer, a point emphasized first by Jorgenson (1961, chapter 5) and later by Syrquin (2006).

 

The indirect “Johnston-Mellor linkages” allow input-output interactions between the two sectors so that agriculture can contribute to economic development. These linkages are based on the agricultural sector supplying raw materials to industry, food for industrial workers, markets for industrial output, and the exports to earn foreign exchange needed to import capital goods (Johnston and Mellor 1961, chapter 6). As with the Lewis linkages, it is difficult to see any significant role for policy or economic growth unless some of the markets that serve these linkages operate imperfectly. Resource allocations must be out of equilibrium and face constraints not immediately reflected in market prices if increases in agricultural output are to stimulate the rest of the economy at a rate that causes the “contribution” from agriculture to exceed the market value of the output, i.e., the agricultural income multiplier is greater than one (Timmer1995).

 

 

Writing in the mid-1960s, Mosher (1966) assumed that “getting agriculture moving” would have a high priority in national plans because of its “obvious” importance in feeding people and providing a spur to industrialization. That assumption has held only in parts of East and Southeast Asia, and has been badly off the mark in much of Africa and Latin America. Indeed, the widespread lack of progress in both agricultural productivity growth and poverty reduction has prompted serious scholars to question whether agricultural growth really is crucial as an engine for growth (Dercon 2009, chapter 9). One key obstacle in Africa and Latin America has been that a historically prolonged and deep urban bias led to a distorted pattern of investment. Too much public and private capital was invested in urban areas and too little in rural areas, especially in more remote, “less favored areas” (Fan and Hazell 2001, chapter 14). Too much capital was held as liquid and non-productive investments that rural households use to manage risk. Too little capital was invested in raising rural productivity.

 

Such distortions resulted in strikingly different marginal productivities of capital in urban and rural areas (Lipton 1977; Timmer 1993; Fan and Hazell 2001, chapter 14). New growth strategies — such as those pursued in Indonesia after 1966, China after 1978, and Vietnam after 1989 — altered investment priorities in favor of rural growth and benefited from this disequilibrium in rates of return, at least initially. For example, in Indonesia from the mid-1960s to the mid-1990s, real value added per farm worker increased by nearly half, whereas it had apparently declined from 1900 through the mid-1960s. In China, the increase from 1978 to 1994 was nearly 70 percent, whereas this measure had dropped by 20 percent between 1935 and 1978 (Prasada Rao, Maddison and Lee 2002). A switch in investment strategy and improved rates of return on capital increase factor productivity (and farm income) by improving efficiency in resourceallocation.

 

 

The contribution of agricultural growth to productivity growth in the non-agricultural economy stems from several other sources as well: greater efficiency in decision making as rural enterprises claim a larger share of output; higher productivity of industrial capital as urban bias is reduced; higher productivity of labor as nutritional standards are improved; and a link between agricultural profitability (as distinct from agricultural productivity) and household investments in rural human capital, which raises labor productivity as well as facilitates rural-urban migration. These mechanisms capitalize on the efficiency of rural household decision making, the low opportunity cost of their labor, the opportunity for on-farm investment without financial intermediaries, and the potential to earn high rates of return on public investments that correct for urban bias. In combination, these mechanisms translate faster agricultural growth into measurably faster economic growth in aggregate, after controlling for the direct contribution of the agricultural sector to growth in GDP itself (Timmer 2002, chapter 8).

This structural transformation is the defining characteristic of the development process, both cause and effect of economic growth (Syrquin 2006). Four relentless and interrelated processes define the structural transformation: a declining share of agriculture in GDP and employment; rural-to-urban migration that stimulates urbanization; the rise of a modern industrial and service economy; and a demographic transition from high birth and death rates common in backward rural areas to lower ones associated with better health standards in urban areas (Timmer 2002, chapter 8, 2009). The final outcome of the structural transformation is an economy in which capital and labor productivity in agriculture is equalized with other sectors through well-functioning labor and capital markets.

 

As Chairman Mao crudely but correctly put it, “the only way out for agriculture is industry”. Unless the non-agricultural economy grows, there is little long-run hope for agriculture. At the same time, the historical record is very clear on the key role that agriculture plays in stimulating the non-agricultural economy (Timmer 2002, chapter 8). This bidirectional feedback has sparked a long-contested literature on the role of agriculture in economic development (Johnston and Mellor 1961, chapter 6; Hayami and Ruttan 1985; Mundlak 2000, chapter 3).

 

Part of the controversy stems from the structural transformation, a general equilibrium process not easily understood from within the agricultural sector. Over long historical periods, agriculture’s role seems to evolve through four basic stages (Timmer 1988): the early “Mosher” stage when “getting agriculture moving” is the main policy objective (Mosher 1966); the “Johnston-Mellor” stage when agriculture contributes to economic growth through a variety of linkages (Johnston and Mellor 1961, chapter 6); the “Schultz” stage when rising agricultural incomes fall behind those in a rapidly growing non-farm economy, inducing political tensions (Schultz 1978); and the “Johnson” stage where labor and financial markets fully integrate the agricultural economy into the rest of the economy (Johnson 1997, chapter 12; Gardner 2002). Efforts to “skip” the early stages and jump directly to a modern industrial economy have generally courted disaster.

 

In the early stages there is typically a substantial gap between the share of the labor force employed in agriculture and the share of GDP generated by that work force. This gap narrows over time as incomes rise; the convergence reflects better integrated labor and financial markets. But this structural gap often widens during periods of rapid growth, as is evident in the history of OECD economies (Timmer 2009). When overall GDP grows rapidly, the share of agriculture in GDP falls much faster than the share of agricultural labor in the overall labor force. The turning point in the gap generated by these differential processes, after which labor productivity in the two sectors begins to converge, has also been moving “to the right” over time, requiring progressively higher per capita incomes before the convergence process begins.

B. The Political Economy of Agricultural Development

This lag inevitably presents political problems as farm incomes visibly fall behind incomes earned in the rest of the economy. The long-run answer is faster integration of farm labor into the non-farm economy, including the rural, non-farm economy. But such integration takes a long time. It was not fully achieved in the United States until the 1980s (Gardner 2002), and the productivity gap appears increasingly difficult to bridge through economic growth alone (Timmer 2009). Lagging real agricultural earnings growth fosters deep political tensions over the course of the structural transformation, and those tensions grow with the lag. The standard government response to these tensions has been to protect the agricultural sector from international competition and ultimately to provide direct income subsidies to farmers (Lindert 1991).

 

Modern political economy has its roots deep in agriculture. Explaining the evolution of agricultural policy has long been difficult for models that use democratic institutions, median voters, or other forms of representative governance. Two aspects of agricultural policy are especially puzzling: the “development paradox,” whereby the sector is discriminated against when a large share of the population works in agriculture but is protected when the number of farmers becomes much smaller; and the “trade paradox,” whereby both agricultural imports and exports are taxed. Such strategies neglect economic laws of comparative advantage based on factor endowments and typically lead to higher prices and greater inefficiency and environmental damages than does reasonably free international trade in agricultural goods (Anderson 1986, Stiglitz 1987, chapter 33; Krueger et al. 1988, chapter 13, 1991; Johnson 1997, chapter 12). Neither of these patterns makes sense in a democratic society where rational voters elect officials who defend their interests.

Consequently, policy analysts and political theorists have long tried to understand whose interests officials defend and why. Olson (1965), Bates (1981), Anderson (1986), Lindert (1991) and Kreuger, Schiff and Valdes (1991) documented trends in historical biases and offered explanations based in “positive” political economy that explains public policy formation based on the assumed self-interested rationality of policymakers. Bates (1998, pp. 238-9) explains:

“I have moved away from a form of analysis which views policy as the result of efforts to maximize the social welfare. I have moved instead to a set of approaches that looks at public policy as a solution to political problems. The general theme … is that politicians are rational actors, but they are solving problems that do not take a purely economic form. What appear as economic costs may offer political benefits: noncompetitive rents or inefficient projects, for example, may be politically attractive in that they offer tools for building loyal organizations. What economists may evaluate as bad policy, then, is not necessarily the result of poor training, obduracy, or other deficiencies on the part of policy makers. Rather, policy makers may simply be solving a different problem than are economists. As policy analysts, it behooves us to represent explicitly the political problem as perceived by the policy maker and to use our analytic techniques to solve it, both in order to offer better explanations of government behavior and to advocate better policy more effectively.”

 

So what drives the decisions of these self-interested policymakers? DeGorter and Swinnen (2002) provide a long list of factors found empirically to influence agricultural policies over time and across space. They identify four key elements that political economy models of agricultural policy have considered: individual preferences of the citizenry, collective action by lobby groups, preferences of politicians, and political institutions. In the end, deGorter and Swinnen (2002) conclude that the extensive empirical work on agricultural policies needs to be better integrated into political economy theory.

 

The difficulty with this integration, however, is that the current theory is built almost exclusively on neo-classical foundations that have dubious assumptions about how individuals behave in the face of uncertainty and economic change. Two of the most pervasive policy tendencies have been for governments to stabilize their staple food prices and to provide price protection to a sector with lagging incomes. Both tendencies are hard to explain within the neo-classical paradigm (Barrett 1999), but are obvious political choices from a behavioral perspective if most individuals base welfare judgments on “reference points”, and so dislike instability (Timmer 2009). Similarly, if individuals judge incomes based on relative standing, then lagging incomes generate direct political pressures for assistance.

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