Eastern and Central Africa Programme for Agricultural Policy Analysis ************************************************************************* *********************************** A Programme of the Association for

Strengthening Agricultural Research in Eastern and Central Africa ********************************************** Electronic Newsletter August 25, 2006Volume 9 Number 16 AGRICULTURAL GROWTH AND ECONOMIC DEVELOPMENT: A VIEW THROUGH THE GLOBALIZATION LENS There is overwhelming empirical evidence that agricultural growth contributes to overall economic development. However, the presence of persistent inter-regional differences even where agricultural growth has occurred calls for a re-examination of the relationship between agriculture and economic development. Prabu Pingali, Director, Agricultural and Development Economics Division, Food and Agriculture Organization of the United Nations, in the Presidential address to the 26th International Conference of Agricultural Economists held in Gold Coast, Australia, 12-18 August 2006, examines the factors that influence the process of agricultural transformation.

EVELOPMENT economists in general and agricultural economists in particular have long focused on how agriculture can best contribute to overall economic growth and modernization. Many early analysts highlighted agriculture because of its abundance of resources and its ability to transfer surpluses to the more important industrial sector. The conventional approach to the roles of agriculture in development concentrated on agricultures important market-mediated linkages, namely: providing labour for an urbanized industrial work force; producing food for expanding populations with higher incomes; supplying savings for investment in industry; enlarging markets for industrial output; providing export earnings to pay for imported capital goods; and producing primary materials for agro-processing industries. There are good reasons why these early approaches focused on agricultures economic roles as a one-way path involving the flow of resources towards the industrial sector and urban centers. In agrarian societies with few trading opportunities, most resources are devoted to the provision of food. As national incomes rise, the demand for food increases much more slowly than other goods and services. As a result, value added from the farm households own labour, land and capital, as 1

a share of the gross value of agricultural output falls over time. Farmers increasing use of purchased intermediate inputs and off-farm services has led to the relative decline of agricultural production in terms of overall Gross Domestic Product (GDP) and employment. Rapid agricultural productivity growth is a pre-requisite for the market mediated linkages to be mutually beneficial. Productivity growth that resulted from agricultural research and development (R&D) has had an enormous impact on food supplies and food prices, and consequent beneficial impacts on food security and poverty reduction. Agricultural productivity growth also triggers the generation of nonmarket mediated linkages between the agricultural sector and the rest of the economy. These include the indirect contributions of a vibrant agricultural sector to: food security and poverty alleviation; safety net and buffer role; and the supply of environmental services. While agricultures direct, private contributions to farm households are tangible, easy to understand and simple to quantify, its numerous indirect benefits tend to be overlooked in assessing rates of returns. Ignoring the whole range of economic and social contributions of agriculture underestimates the returns to investment in the sector. Substantial empirical evidence exists on the positive relationship between agricultural growth and economic development. The transformation of agriculture from its traditional subsistence roots, induced by technical change, to a modernizing and eventually industrialized agriculture sector is a phenomenon observed across the developing world. However, there are also a large number of countries that have stalled in the transformation process or have yet to get agriculture moving. These are almost always countries that are classified as the least developed. Even within countries that are well on the pathway towards agricultural transformation there are significant inter-regional differences. Some of the reasons for the poor performance of their agriculture are: i. ii. iii. iv. v. Low and inelastic demand for agricultural output due to low population density and poor market access conditions; Poor provision of public good investments in rural areas; Lack of technology research and development on commodities and environments important to the poor; High share of agro-climatically constrained land resources; and Institutional barriers to enhancing productivity growth.

Globalization and the transformation of food systems

Globalization has resulted in the rapid growth of world trade, internationalization of production by multinational corporations and declining information and communications costs. The potential trade benefits for agriculture therefore arise from three aspects. The first is the possibility of direct increased exposure of agriculture to international competition; and the ability to access global markets and specialize in areas of comparative advantage could yield high gains for this sector. The second stems from the indirect effects of increased international trade on the growth of non-agricultural sectors changing the domestic demand for agricultural goods both quantitatively and qualitatively. The third, and often unrecognized, are lifestyle changes including diets, particularly among the urban middle class, as a result of increased global inter-connectedness through travel and communications. The diet transition is characterized by diversity, convenience, and a break from tradition. Consumers in large urban centers are more exposed to non-traditional foods as a result of their access to food retail outlets and marketing campaigns. Large urban markets create the scope for the establishment of large supermarket chains, and they attract foreign investments and advertising from global corporations. Nontraditional foods are more accessible as a result of trade liberalization and declining costs of transportation and communication. As more women enter the labour force, an increase in the consumption of processed food, ready-made meals, or meals that cut the long preparation time of traditional dishes is expected. Food markets in developing countries are undergoing profound changes that are fuelled by rapid urbanization, diet diversification, trade integration, and the liberalization of foreign direct investment in the food sector. The most commonly observed changes are: rising food imports; vertical integration of the food supply chain; and commercialization and diversification of domestic production systems. Rising food imports FAOs study on agriculture towards the year 2015/2030 indicates that the trends in international trade of foodstuffs, which have seen developing countries turn from net exporters to net importers of food commodities, are expected to continue in the future. In 1961/63 developing countries as a whole had an overall agricultural trade surplus of US $ 6.7 billion, but this gradually disappeared so that by the end of the 1990s trade was broadly in balance, with periodic minor surpluses and deficits. In the case of the least developed countries (LDCs) the deficit was much more pronounced. By end of the 1990s, agricultural imports were more than double their exports. The outlook to 2030 suggests that the agricultural trade deficit of developing countries will widen markedly, reaching an overall net import level of US $ 31 billion. The net imports of the main commodities in which the developing countries as a group are deficient (mainly cereals and livestock 3

products) will continue their rapid rise. At the same time, the net trade surplus in traditional agricultural exports, for example, tropical beverages, bananas, sugar and vegetable oils and oilseeds, is expected to rise less rapidly or to decline. Over the past three decades the share of gross food imports in GDP more than doubled for an average developing country. The increase was most pronounced for the LDCs, where the value of food imports rose from 1 percent of GDP to over 4 percent. Over the past thirty years the countries most vulnerable to food insecurity (the LDCs) have spent, on average, an increasing share of their limited foreign exchange earnings on commercial food imports. Increased developing country imports of cereals and livestock products are due to increased demand combined with the low competitiveness of their domestic agriculture, though the relative weight of these factors varies across countries. Low competitiveness is often the result of insufficient resource mobilization for the enhanced competitiveness of poor rural communities, the sustainable use of natural resources, the provision of market infrastructure and research. Growing food imports are also the result of inflows of lower priced food from subsidized agriculture in developed countries. Rapid urbanization, especially the growth of mega-cities on the coast, has added to the competitiveness of food imports relative to transporting it from the hinterlands. With regard to agricultural exports, markets for traditional exports are generally saturated, but there is potential for significant gains by developing countries if the processing and marketing of value-added tropical products is moved from consumer to producer countries. However, lack of capacity on the part of the exporters and the presence of tariff escalation in the importing countries both contribute to the loss of potential export revenue. Capacity limitations are particularly felt in markets where access depends on increasingly strict sanitary and phytosanitary standards. Much is said about the developing countries responding to niche markets, but they will always be just thatniche markets, small, highly variable and subject to the vagaries of changing consumer demand. The vertical integration of the food supply chain The change in urban food demand is almost simultaneously accompanied by consolidation in the retail sector. The result is an impressive increase in the volume of food marketing handled by supermarkets, but also substantial organizational and institutional changes throughout the food marketing chain. Such changes include the setting up of private grades and standards for food quality and safety, and the adoption of contracts between buyers and sellers at various points along the food marketing chain. Sub-contracting for products of specified quality and traits is likely to proliferate as a form of interaction between retail food chains and 4

producers. If regions where supermarket retailing is more developed are a precursor of what will follow elsewhere, then supermarkets and largescale distribution will progressively dominate the food marketing chain in urban areas. Vertically integrated supply chains have also been focusing on the export market. There are numerous examples of successfully integrated food supply systems that are managed from the farm to the consumers plate. However, concentration of food trade in the hands of a few retailers and large market intermediaries threatens the existence of small traders and small businesses, central spot food markets and neighbourhood stores. On the production side, these trends may mean the gradual disappearance of those smallholders who are unable to meet the private standards on health and safety set by large retailers and wholesale buyers as well as neighbourhood stores and spot wholesale markets. Changing agricultural production systems There are five issues at stake in this area. First, an increasing commercial orientation of production systems is expected due, inter alia, to rapidly rising urban food demand, changing consumption patterns and the increasing integration of domestic and international markets for agricultural products. Some of the resulting changes include: larger operational holdings; reduced reliance on non-traded inputs; and increased specialization of farming systems. While the speed of these transformations differ substantially across countries, they are all moving in the same direction. As economies grow, the returns to intensive production systems that require high levels of family labour are generally lower than those from exclusive reliance on purchased inputs. With the expected rise in operational holding size, the ability of the household to supply adequate quantities of non-traded inputs declines. Power, soil fertility maintenance, and crop care are the primary activities for which non-traded inputs are used in subsistence societies. With the increased opportunity costs, family labour will be used less as a source of power and more as a source of knowledge (technical expertise), management and supervision. Farm decisions become increasingly responsive to market signals, domestic as well as international, and less driven by traditional practice. While at a regional or sub-regional level, trends towards diversification out of cereal monoculture systems are being observed, at the individual farm level the trend is towards product specialization. In China, for example, while livestock production was traditionally a sideline activity for farm households, more farms are now specializing in livestock production. Chinese households that specialize in livestock production accounted for 15 percent of national livestock production in 2000. Second, in the process of commercialization, rapidly increasing scales of production are being observed particularly in the livestock sector, trying to supply rapidly growing markets for meat, milk and eggs. Both global analyses and country case studies conducted by FAO in Brazil, India, 5

Thailand and the Philippines confirm that advanced technology embodied in breeds and feeds appears to be critical to the success stories for poultry around the world, and the same is likely to become true for hogs over time. Much of this technology appears to be transferable, but only at relatively large-scales of operation, at least for poultry. Thus there is strong reason to believe that technology itself is a prime driver of the displacement of smallholders from the livestock sector. Small-scale producers obtain lower financial profits per unit of output than large-scale producers, other things equal. This suggests that, in the absence of deliberate action, small-scale producers will eventually be put out of business by competition from large-scale producers, especially since the better-off producers will scale up. Third, the observed negative relationship between farm size and productivity may not hold as agricultural systems become more vertically integrated. On this basis, it is argued that small farms, if they can overcome some constraints; tend to be more productive than large farms. The major reason cited for higher levels of efficiency is the higher productivity of farm family labor and lower supervision costs compared to large farms. However, this efficiency is often rooted in traditional labour intensive cereal crop production where the opportunity cost of family labour is low. It is unlikely that small farms sustain this advantage in a vertically integrated food supply system because of the transactions costs involved in participation. Also, rising wages and the decreasing relevance of traditional knowledge systems further reduce the advantage for small farms. Fourth, declining competitiveness of marginal lands could be expected with increased integration of global food markets. Marginality could be a consequence of remoteness to sources of demand, such as mega cities, or because of poor agro-climatic conditions, such as drought prone environments. Global integration of food markets makes availability of food through imports, particularly for cities on the coast, cheaper than bringing food from the hinterlands. Moreover, low productivity and lack of technology for marginal lands make them harder to compete against better endowed environments. Fifth, preserving the natural resource base will be a formidable challenge. Policies for enhancing food security through the promotion of intensive agriculture production systems, such as irrigated rice systems in Asia, have had significant environmental costs which in turn limit productivity. The problem was not intensification, per se, but rather the limited incentives at the farm level for efficient and judicious use of inputs such as fertilizers, pesticides, and water. Also, the costs associated with the loss of environmental goods and services were not reflected in agricultural input and output prices. Further intensification and yield growth are subject to limits for reasons of plant physiology, but also because of environmental stresses associated with crop choice, improper input use and poor management practices. Examples of 6

intensification induced degradation of the land resource base can also be found in sub-Saharan Africa, particularly in intensive maize systems. Rising opportunity cost of labor could lead to increasing herbicide use as a substitute for hand weeding in commercializing staple crop systems. Also, where property rights are not clearly established, high-value crop production in upland environments could lead to higher risks of soil erosion and land degradation. Increased trade liberalization will result in improved incentives for sustainable resource use to the extent that integration into international markets increases the pressure and capacity to consider environmental values in managing natural resources, and where domestic policy reform, especially the removal of input subsidies, encourages more efficient input use. Moreover, the need to reduce unit costs of production in order to enhance the competitiveness of domestic agriculture contributes to the drive towards input use efficiency. The quest for sustaining competitiveness could contribute to environmental sustainability. However, efficiency enhancing technologies are knowledge and time intensive, and in rapidly growing economies, rising opportunity cost of labour could work against their adoption. Where rapid overall economic growth draws populations out of the agricultural sector, the release of marginal lands from low productivity agriculture can contribute to increased supply of eco-system services, such as carbon sequestration and biodiversity conservation. How globalization impacts on the agriculture sector Whether particular countries, regions within countries and particular societies gain or lose in the process of globalization depends on where they are in the process of agricultural transformation and the extent to which they can adjust. Three categories of countries are considered bellow: a) Countries at the low end of the agricultural transformation process Countries in this category are invariably low income, least developed countries, and a vast majority of them are in Sub-Saharan Africa. Most of them are in the bottom half of the United Nations Development Programmes (UNDP) Human Development Index. They face low prospects for meeting the Millennium Development Goals (MDGs) of hunger and poverty reduction. These countries essentially lose out in the process of globalization because their low productivity agricultural systems are uncompetitive in an increasingly integrated global food market. While some may benefit from exports to niche markets, the volumes tend to be small and variable and the long-term prospects are for increasingly negative terms of trade in the primary food staples. The prospects for getting agriculture moving are limited by perennial obstacles such as low demand conditions, unfavourable agro-climatic 7

environments and poor institutions. A history of urban bias in macroeconomic policies and public good investments tends to dampen incentives for enhancing agricultural productivity growth. Structural adjustment policies of the late 1980s and 1990s have to some extent corrected the macroeconomic disincentives, including over valued exchange rates. However, the bias against the rural sector created by a historical discrimination in public good investments has generally not been corrected. The easy availability of lower priced food on the global market makes it unlikely that massive rural investments will be forthcoming, especially where urban centers are located on the coast. b) Countries in the process of agricultural modernization Countries in this category have successfully used agriculture as an engine of overall growth and are experiencing a steady decline in the share of agriculture in GDP and the share of agriculture in total labour force. Rapidly growing Asian and Latin American economies, mostly in the middle income level, are examples of countries that fall into this category. Small farm led staple food productivity growth, such as for rice and wheat, drove the process of agricultural transformation. Rising productivity in the agricultural sector has also stimulated growth in the non-agricultural sectors through forward and backward linkages. This category of countries witness widespread impacts of globalization, both positive and negative. Past investments in rural infrastructure, productivity enhancing technologies, as well as market institutions, make these societies more responsive to global market signals. Globalization and trade integration lead to both an improvement in the competitiveness of the staple food sector as well as a move towards diversification out of staples. Reducing unit production cost through efficiency improvements is the primary means by which the staple food systems sustain their competitiveness. For instance, the switch to conservation tillage reduced production costs by as much as 30 percent per tonne of wheat and soybean in Argentina and Brazil. At the same time, the staple food sector is re-orientated towards supplying the diversified urban diets and towards high value exports. The returns to diversification are, however, conditional on investments in post harvest technologies for processing, quality and food safety. The benefits from a global orientation of the agricultural sector can be pro-poor where the production and post-harvest activities continue to be labour intensive. On the negative side, it ought to be noted that there can be significant inter-regional differences, even within countries well on the path towards agricultural transformation, in terms of agricultural productivity and responsiveness to urban and global market signals. Eastern India, Western China, and Northeast Brazil are examples of regions that are being left behind even as they are making rapid economic progress. Relatively higher levels of poverty and food insecurity persist in these 8

regions. Marginal production environments face declining competitiveness. Migration to urban areas or to regions of higher agricultural productivity, such as the Indian Punjab, is one of the few viable options for small farm and landless labour populations in these areas. The prospects for smallholders depend on the extent to which staple food production can remain competitive and the extent to which they can participate in the market for high value products. Small holders, even in high potential environments, may lose out in the process of integration into the supply chains for high value products that serve domestic or export markets. Small farmers find an increasingly skewed structure in the food system, facing on the one hand a small and reducing number of large food companies and food retailers. On the other hand, at the point of input supply to farmers, large chemical and seed companies are creating patented input supply systems controlled by a small number of companies. Facing this structure, small agricultural producers will find it increasingly difficult to negotiate favorable terms of the contract. Thus, entering the food system on a competitive basis is problematic for small farmers because of physical investments needed to enter but also because of the transactions costs associated with the new agricultural market. The increasing disconnect between the modern food system and the established social networks and traditional institutions tends to aggravate the costs of market participation. Farmers will not enter markets when the value of participating is outweighed by the costs of undertaking the transaction. c) Countries at the high end of the transformation process These are mainly high income countries with relatively small rural populations. Their agriculture sectors are highly commercialized, vertically integrated and globalized. For these countries the big challenge is to create new opportunities for rural incomes while liberalizing trade. In this context the non-commodity roles of agriculture, such as biodiversity conservation, agro-tourism, carbon sequestration, provide opportunities for the emergence of markets. Preserving rural societies and landscapes becomes important not only for political and nostalgic reasons, but also as a matter of economics. This could become an increasingly important trend in middle income countries as they reach the end of the transformation process. Public policy needs to create an enabling environment for the emergence of markets for environmental services. Direct public support for sustaining the noncommodity roles of agriculture would only be necessary under market failure conditions. Fortunately the OECD countries have the money to pay for this support, if necessary.
In the second and last part of the series, Prabu Pingali argues that traditional policy agenda for promoting agricultural growth and economic development needs to be redesigned and adapted to the new realities of an increasingly inter-connected global economy.

This newsletter is an attempt to use e-communications to provide to a broad audience within and outside Eastern and Central Africa a mechanism for distribution and exchange of information relevant to agricultural policy issues. This newsletter is being sent to identified stakeholders of ECAPAPA. We want to respect your privacy and desire not to have your e-mail inbox filled with unwanted correspondence. If you do not want to receive this newsletter please send us a note at <[email protected] >, and we will remove your name from the distribution list. For back issues of this newsletter, go to View Archive at www.asareca.org/ecapapa ECAPAPA is a regional programme of the Association for Strengthening Agricultural Research in Eastern and Central Africa (ASARECA). ECAPAPA receives support from a number of organizations including, BMZ/GTZ, EU, IDRC, SDC, and USAID. This newsletter is supported by a grant from the Swiss Agency for Development and Cooperation (SDC). The editorial content of the newsletter is solely the responsibility of the Co-ordinating Unit of ECAPAPA.

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