Transcript Slide 1

Risky Agriculture, Farm
Earnings, and Development
Preliminary
Antonio Ciccone
ICREA-UPF
Economic Development as
Structural Transformation
AGRICULTURE
MANUFACTURING
What determines whether this transformation
takes place or not?
2
Determinants of Structural Transformation
-- Policy barriers
- barriers to moving resources to manufacturing;
- barriers that inhibit manufacturing growth
-- Productivity levels in agriculture (Murphy, Shleifer,
Vishny QJE 1988; Matsuyama JET 1992)
-- Income distribution (Murphy, Shleifer, Vishny QJE
1988)
-- …
-- ADDED HERE: Agricultural risk (soil, weather,
crop diseases…)
3
Dual Economy
-- Agriculture
-- Manufacturing
- “technologically backwards”
- “modern”
- “decreasing returns”
- “increasing returns/
learning-by-doing”
- “low earnings/
productivity”
- “high earnings/
productivity”
Duality sustained by policy barriers
4
Dual Economic Development
LOW EARNINGS/PRODUCIVITY
HIGH EARNINGS/PRODUCIVITY
AGRICULTURE
MANUFACTURING
Earnings/productivity differentials
are sustained by policy barriers
5
Dual Nobel Prize Winners
Arthur Lewis
Theodore W. Schultz
1979 Nobel Prize for work between late 1940s and early 1960s
6
Nobel Press Release: Theodore Schutz
-- The main characteristic of Schultz's studies in
agricultural economics is that he does not treat
agricultural economy in isolation, but as an integral
part of the entire economy.
-- Schultz's analytical interest has been focused on the
imbalance between relative poverty and
underdevelopment in agriculture compared with the
higher productivity and the higher income levels in
industry […].
7
Nobel Press Release: Arthur Lewis
-- [Lewis’] first model is based on the dual nature of a
developing economy. There is an agricultural sector
[…] primarily based on self-support […] and a modern
market-oriented sector primarily engaged in industrial
production.
-- [...] the low productivity of agriculture is, in Lewis's
analysis, a causal factor for the poverty of the
developing countries and a restriction on growth […].
8
Today’s Development Accounting
Literature
-- average labor productivity in NONAGRICULTURE is much greater than in
AGRICULTURE in many poor countries
(this observation appears to go back to Kuznets)
-- this could be an indication of barriers that, once
removed, would lead to less dispersion in
international incomes
(e.g. Restuccia, Yang, Zhu JME forthcoming)
9
25
capita
per
Real income
10
20
15
USA
NOR
DNK
CAN
SWE
AUT
AUS
FRA DEU
NLD
JPN
FIN
GBR ITA
NZL
BRB
ESP
GRC
IRL
PRT
TTO
HUN
ARG
0
5
VENZAF
MUS
URY
MEX
KORBRA
CRI CHL
MYS
DZA
COLECU
PRY
NIC
IRN
JORTUN
PER
DOM
TUR
GTM JAM MAR
PNG THA
ZWE
PHL
CMR
EGY
BOL
COG
HND
LKA IDN
PAK
SYR
IND BGD
SLE
KENGMBNPL
MRTCAF
CHN MOZ
GHA
SOM
MDG
NGA BEN
TGO
BDI
MLI
TCD
UGA
GNB MWI
0
10
BWA
SEN
ZMB
NER
RWA
20
Productivity NON-agric/agric
in the 1980s
Data on y-axis for 1980s from PWT; on x-axis from WDI
BFA
30
View examined here
Perfect labor mobility
RISKY AGRICULTURE
LOW EXPECTED EARNINGS
(RISKY) MANUFACTURING
HIGH EXPECTED EARNINGS
Could earnings differentials be sustained by aversion to risk
11
of food consumption below some thereshold?
Model
-- with 2 sectors: agriculture and
manufacturing
-- households are free to move between
sectors
-- households are avers to the risk of food
consumption falling below some threshold
12
Can low agricultural productivity
… lead to food (price) risk that give rise to a
large earnings premium in the
manufacturing sector (low farm earnings)?
 low agricultural productivity could explain
- large agricultural sectors
- low farm earnings compared to
manufacturing
13
Trade openness
-- the argument will require that domestic food
prices are linked to the domestic supply of
agricultural goods
 maybe model most relevant as one of
urbanization in “early civilizations”?
 but even as late as in the 1980s there are
“closed economies” -- and they appear to have
high productivity in NON-agriculture relative to
agriculture
14
25
20
5
10
15
Closed countries
0
Real income per capita
Open countries
0
10
20
30
Productivity NON-agric/agric in 1980s
(open/closed according to Sachs-Warner criterion)
15
Model presentation outline
-- Household preferences
-- Production
-- Equilibrium
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Household’s (non-homothetic)
preferences: income and food &
manufactures
spending on
manufactures
spending on food
O
pF
income (manufacturing
units)
17
Household preferences: aversion to
food risk (I)
utility
O
FOOD RISK AVERSION
F1
F
F2
food consumption
18
Household preferences: aversion to
food risk (II)
utility
O
INCREASE IN
FOOD RISK AVERSION
F1
F
F2
food consumption
19
High aversion to risk of food below F
-- Denote by m the amount of manufactures
households are willing to pay to eliminate
food risk
-- Focus on the case of high m
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Household preferences
  qa

U 
  F  qm
if qa  F
otherwise
-- utility linear in manufacturing good once
households have achieved F units of food
 will imply risk-neutrality w.r.t. manufacturing goods
once F is ensured
21
Aversion to risk of food below F
L
m
  F  qa ( L) 
H
-- as  becomes large, the aversion to food
consumption below F becomes large
22
A model with high and low
agricultural productivity
-- in agriculture:
- AL in state L (probability L)
- AH in state H (probability H)
-- feasible to ensure food F for everybody
(AL > F)
-- a household produces M in the manufacturing
sector (uncertainty would not matter)
-- must work in agriculture or manufacturing
23
Notation
-- l share of agricultural population
-- q ratio of agricultural to manufacturing
population (q= l/1 l
24
Is there an equilibrium that ensures
food F for everybody?
--
--
F
lˆ 
AL
F
qˆ 
AL  F
25
Equilibrium price in good
agricultural state (“excess food”)
pH *  0
-- at the allocation where everybody gets food F
farmers are willing to supply food at price zero
26
Is there a price of food in state L (pL) that
equalizes expected utils across sectors?
Expected utils in farming
W
farming
  F   L ( AL  F ) pL
27
Expected utils
farmers
F+LM(AL-F)/F
F
O
M/F
pL
Expected utils in manufacturing
W
manufacturing

  F   H M   L M  qˆ( AL  F ) pL

  F   H M   L  M  FpL 
29
F+M
Expected utils M-workers
F+HM
O
M/F
pL
NO-FOOD-SHORTFALL EQUILIBRIUM
F+M
Farmers
F+LM(AL-F)/F
F+HM
F
O
M-workers
pL*
M/F
pL
FOOD SHORTFALL IN LOW-PROD STATE
F+M
F+HM
F+LM(AL-F)/F
M-workers
Farmers
F
O
M/F
pL
NO-FOOD-SHORTFALL
EQUILIBRIUM if & only if:
 L AL  F
SHORTFALL
EQUILIBRIUM
F
ˆ
q* <q
NO-SHORTFALL
EQUILIBRIUM
F /L
q * = qˆ
AL
33
Agricultural population share
(for high aversion to risk of food below F)
l
Manufacturing share greater
where agricultural risk lower
O
F
AL
34
FERTILE CRESCENTS
35
Farm earnings relative to
manufacturing (in manufactures)
Farmers
L state
Expected
M-workers
AL pL *
M
 L AL pL *
M
36
NO-FOOD-SHORTFALL EQUILIBRIUM:
manufacturing wage premium
expected earnings
manufacturing/farming
1
AL
37
Proof
W manufacturing   F   H M   L  M  FpL *
 W far min g   F   L ( AL  F ) pL *

M   L AL pL *
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FOOD-SHORTFALL EQUILIBRIUM:
manufacturing wage premium
F
q * < qˆ 
AL  F
q *   qˆ
as aversion to risk of
food consumption below
F becomes large
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FOOD-SHORTFALL EQUILIBRIUM
q *   qˆ 

F
AL  F
M
pL * 

( AL  F )q *
M
F
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Farm earnings in L state
Earnings in
manufacturing
AL pL *  
AL
M
F
 when AL ≈ F
 farm earnings in L state close to manufacturing
earnings (M)
41
FOOD SHORTAGE EQUILIBRIUM:
expected agricultural earnings
<1
AL
 L AL pL *    L
M
F
 when L small
 expected farm earnings low compared to
manufacturing earnings
42
Proposition 1
When there is a small probability that agricultural
productivity is just above F,
and aversion to risk of food consumption below F
is high,
then:
-- farm earnings (in terms of manufactures) are 0
“most of the time”
-- farm earnings are just above manufacturing
earnings “some of the time”
-- farm earnings are low compared to
manufacturing earnings in expectation
43
The role of non-homothetic
preferences
U V


1
qa qm

M
l AS  (1  l )
 l AS
pS
0  1
-- food market clearing

pS AS is independent of agricultural productivity

pS AS  M
44
Proposition 2
Equilibria where expected farm earnings are
lower than expected manufacturing
earnings are Pareto inefficient
45
Proof
Consider the allocation with:
(i) enough farmers to feed everybody F in state L (l  lˆ)
(ii) food/manufactures split equally among households
 expected utils:
 AL  F 
ˆ
W   F  M (1  l )   F  M 

A
L


expected utils
In competitive equilibrium: W *   F   L ( AL  F ) pL *
M   L AL pL * 
W W *
46
Policy
• Tax M-workers and subsidize farmers
• Government failure in poor countries? Can
the government commit?
• Market (pre-tax/subsidy) earnings of Mworkers would continue to be above farm
earnings
47
A model with a continuous, uniform
distribution of agricultural productivity
f(AL)
O
F
AL
48
Endogenous small L
f(AL)
L= Probability of food shortage
O
F
AC
AL
49
As risk-aversion to food below F
becomes large
f(AL)
L
O
F AC
AL
50
Conclusion
• when aversion to risk of food consumption
below some threshold high
• and agricultural productivity in the worst
state is close to this threshold
then
• farm earnings very low compared to
manufacturing most of the time
• somewhat higher than manufacturing
earnings in instances of very bad harvests
• manufacturing better paid in expectation
51
Long distance trade
• trade among identical countries with
uncorrelated agricultural risk

• reduces food risk
• lowers agricultural population share
• increases manufacturing sector in all
trading partners
52
The Mediterranean: cheap trade across weather zones?