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Ayush Agarwal

Prof. Anisha Sharma

ECO 302 Development Economics

08 December 2017

What is the Impact of Agricultural Productivity Growth on Economic Growth and Poverty

Alleviation?

There exists a wide range of literature on economic development and roles different

sectors play in prospering a developing or underdeveloped economy through different

strategies. Recently, the finance minister of India, Arun Jaitley, in pre-budget talks with

unions and farmer groups, showed his desire to achieve the goal of doubling farmers’ income

by 2022. “Farmers groups suggested that India has constantly pursued ‘Food Policy’ and

Budget 2018-19 is an opportunity to shift to ‘Farmers’ Policy’. There is need to reduce

pressure on the land by creating off-farm jobs,” (cite) reported an article published in the

Economic Times. Current World Bank data suggests that India employs more than 48% of its

labour force in agriculture; however, agricultural sector accounts only a little over 17% of the

GDP. (cite) It is not unreasonable to assume that most of the poor in India or in other

developing countries with surplus labour is engaged in agriculture. Almost half of the

population in the developing world depend on agriculture for their basic needs, and it is

widely argued that the poor benefit much more from GDP growth caused by agriculture than

from an equal or greater amount of GDP growth generated by non-agricultural sectors. This

paper______

Historically, policy makers have seen agriculture as a sector with large amounts of

cheap resources, mainly labour and capital, which can be extracted and utilised in the non-

agricultural sectors. Therefore, pro-agricultural growth has mainly been neglected by them,
since they perceived agriculture as having low productivity, and little or no ability to promote

economic growth. However, W. Arthur Lewis famously argued that agriculture must play a

major role in the early phases of development. By this he means that surplus labour and

increased agricultural productivity will lead to the spillover of labour and capital to different

sector, i.e. structural transformation, which in turn leads to industrialisation and helps the

overall economy grow at a much faster rate. As economies grow, agriculture accounts for a

much smaller share in both, GDP and employment. This process can be enumerated by the

Engel law, which states that income elasticity is positive but less than 1. It implies that as

income grows faster than the demand for food, it results in the declining share of agriculture

in the GDP. This can be clearly seen in the case of land-abundant countries like Canada and

the USA, where labour employed in agriculture was around 40% in both the countries in

1900. Almost after a century, the numbers fell down below 2.5%. This was because of the

growth in agricultural productivity “that spawned and sustained industrialization in these

countries.” (cite)

These first world nations achieved this by not only promoting agricultural exports

through increased productivity and output that financed imports of machinery needed for

industrialisation but also by inducing spillovers to other sectors and an increased demand in

the industrialised goods. Further, kotwal and Eswaran also suggest that anything we correlate

with economic development would not have been possible if agricultural productivity had not

reached a tremendous level to absolve labour and capital for industrialisation. This can be

better understood with the help of the Labour-Surplus model, which was developed by the

eminent economist, David Ricardo, which assumed two things. First, he assumed that

agricultural production was subject to diminishing returns (since land is scarce) and second,

industrial sector could extract surplus labour from the agricultural sector without affecting
total agricultural production. The modern version of this model was first developed by Lewis

in 1954.

(c)

Figure 1
The model consists of three panels. First is the agricultural production function.

Figure 1–a represents that with a flipped horizontal axis flipped. Moving towards the right of

the horizontal axis shows a decrease in the number of agricultural workers. The figure shows

output as a function of labour per unit of land as oppose to the neo-classical production

function. The function illustrates diminishing returns to labour. Whats unique in this model is

that, it assumes that marginal productivity of labour (MPL) can be zero or negative too. In the

figure, this is beyond point g. So an additional labour either causes no increase in output or its

reduction. Interestingly, the wages does not fall beyond average product of labour since a

labour would not want to work outside her/his farm unless s/he earns more than what s/he

earns by sticking to farming her/his own land. This is called the “subsistence level.”

Second, figure 1-b shows the Marginal Product of Labour in Agriculture. Here too,

the horizontal axis is flipped. As the quantity of agricultural labour decreases, the marginal

product increases. The subsistence level of wage is represented by the dotted line hi. Wages

in agricultural sector remains at this level until point i is reached in the figure. Henceforth,

wages increase as labour is extracted by the non-agricultural sector. The curve shows the

agricultural wage and also the minimum wage the industrial sector should give the farmers to

hire them. Thus, this could be also seen as a supply curve of the labour for the industrial

sector.

Third, figure 1-c shows the industrial demand and supply curves. The demand curves

are denoted by the symbol s, m, and n. They display the downward-sloping demand curve

and exhibits levels of wages that the industry is willing to pay at different quantities of

labour. To draw agricultural workers towards industry, k, on the vertical axis is little above

than h (subsistence level) in figure 1-b.

These three figures collectively give us the Lewis Labour-Surplus model. If a

developing economy with labour surplus starts by engaging completely in agriculture, it can
extract pg in figure 1-b (where the MPL starts rising) to employ them in the industrial sector

with no reduction in total agricultural output. The author argues that as long as the MPL is

greater than zero, if there is a way to transport the food consumed by pg from rural to urban

area, GDP will increase without reducing agricultural output. (cite) However, the excess

labour will be exhausted and will eventually lead to shrinkage of farm output (leading to rise

in prices of agricultural products). This will compel the industrial sector to pay higher wages

to compensate for higher prices. Therefore, there should be a clear set of terms of trades

between agriculture and industry. Thus, there should be attempts to insure agricultural growth

through technological changes to aim at higher level of output to fulfil the demands of both

the rural and industrial workers. In absence of this, the agricultural sector will languish and

prices will rise swiftly and lead to a reduction in the profits of the industrial sector (cite). This

two-sector model exhibits clearly the effects of productivity growth in agriculture which

leads to industrialisation and growth in GDP.

The ratification of the Millennium Development Goals (MDGs) by the UN member

states shifted the attention in development occurring from economic growth per se to poverty

alleviation. Kotwal and Eswaran argued that, “agricultural productivity growth is the key to

poverty alleviation.” Many economists have hence, calculated the impact of growth in

agricultural productivity on the reduction of poverty empirically and have estimated the

degree to which they are correlated. Theoretically Irz et al have argued that there is a direct

impact of agricultural productivity via generating higher incomes for the farmers (cite).

Since, in developing countries, majority of the population works in the agricultural sector, it

is a major determinant of poverty alleviation. They also argue that an increase in output

reduces the price of agricultural products, hence aiding consumers, especially who are net

consumers of food (since both the urban and rural poor spends majority of their income on

food) than the better off households (cite). Although this highly depends on the trade easiness
and the price elasticity of demand. The more inelastic the demand, the larger the fall in price

and consumers benefit mainly. The producers gain largely when the demand is elastic.

Johnston and Mellor have also theorized the pathway to poverty reduction through

agricultural sector. They believe that a “secular decline of the agricultural sector” aided with

an income elasticity of demand for food that is below unity and declining, and increasing

agricultural output with a preferably declining or constant agricultural employment share.

(cite) The authors further claim that the Lewis two-sector development model fails as he

assumes that there is unlimited supply of labour. Therefore, the extraction of the farm

workers by the industrial sector is driven by the demand for labour in that sector, which they

argue is “limited by the rate of capital accumulation.” They are required to be paid a wage

more than the subsistence level (average product of labour). Thus, they assert that “when

capital catches up with labour supply” the Lewis model fails.

transfer of manpower to the capitalist sector is determined by the demand for labor in that sector, which in turn is limited by the rate of

capital accumulation. In the capitalist sector it will normally be necessary to pay a wage determined by the average product per man in the

traditional sector, plus some margin dictated by transfer frictions, social views of minimum subsist- ence, trade union pressure, and other

institutional forces

Empirically, Irz et al use the following identity to measure reduction in poverty by

increase in agricultural productivity:

They break down labour productivity into two components: land productivity (or yield), and

the land labour ratio, which the author believes can be perceived as an estimator of a

country’s resource endowment.

They then use the following regression model on a sample of forty developing nations’ data:
The results (which are statistically significant) suggest that a percent increase in the land–

labour ratio reduces poverty by 0.82%, which the authors find surprising since a percent

increase in yield decreases poverty by 0.91% for the population living on less than a US

Dollar per day. The research suggests that agricultural productivity growth driven by

increasing land productivity can provide an efficient way of reducing poverty, especially for

the poorest of the poor. They also run the regression to check the impact on Human

Development Index (HDI) and find that a percent increase in yields increases the HDI by

0.12%. (cite)

Kotwal

developing countries, the land-to-labor ratio is thus a crucial determinant of the productivity

of the poor in agriculture. Indeed, one reason they are poor is precisely because the land-to-

labor ratio is low

The important point to note is that, improvement in the agricultural technology

unambiguously betters the lot of the poor (workers): It allows them to consume more Grain

and, possibly, more Textiles

Eswaran and Kotwal do not require surplus labor (and thus come closer to

the neoclassical model described in Figure 16–6) but add an assumption that consumer

preferences are such that people begin to consume textiles only once they

are able to afford at least a subsistence level of food. It is assumed that most of

the workers have not reached this subsistence level and thus will spend all incremental

income on food until they reach that subsistence level of consumption. In


contrast, landlords (the only other actors in this model besides workers) are richer

and consume both food and textiles.

A developing country with a productive and diversified agriculture is in a better position to

take advantage of the technological progress and taste for variety in developed countries in

order to initiate its own industrialization

Many previously colonial countries in Africa, South Asia and Latin America regarded their

lack of industrial development as the main reason for their subjugation, and concentrated on

industrial development as soon as they became independent. Not only was far too small a

share of total public investment allocated to agriculture but policies were implemented that

artificially rendered the industrial sector relatively more profitable than the agricultural

Policy makers are inevitably more responsive to the demands of the urban class, which gets

used to making exorbitant claims on the public treasury

The price of food, however, is a double-edged sword. The poor, as we have already seen,

spend a considerable part of their household income on food. A twenty-percent rise in food

prices would reduce their food intake by nearly twenty percent, unless their wages also rise'.

How a given policy affects the wellbeing of the poor will depend on how the wage rate

responds to the enhanced opportunities. If the increased profitability of agriculture results in a

surge of investment, the productivity of workers would increase and so would the wage rate.

If the wage rate increases by a greater amount than the price, the poor will benefit

Support-

The most direct contribution of agricultural growth is through generating higher

incomes for farmers

The second condition is the extent to which output growth raises incomes. Should
increased output drive down product prices, or costs of production rise as the demand

for inputs increases, the rise in gross margins may be small. In particular, if land is

scarce, increased returns to agriculture may be reflected in higher land rents. In cases

where the poor till land belonging to others, the capitalisation of benefits into higher

rents could seriously undermine the contribution to poverty reduction.

The adoption of the

first wave of green revolution cereal varieties was largely confined to irrigated areas

with good soils, and even then required major inputs of pesticides and fertiliser

Increased agricultural production should have effects on other sectors in the rural

economy through a series of linkages.

an increase in output tends to drive down the price of food,

hence benefiting consumers and all net purchasers of food (N1). Since the poor, both

urban and rural, spend a greater proportion of their incomes on food than better-off

households (see, for example Musgrove (1985) on the case of the Dominican Republic),

they benefit relatively more

more inelastic the demand,

the greater the fall in price and hence the share of the benefits accruing to consumers.

On the other hand, if demand were perfectly elastic, only producers would gain. The

elasticity of demand that producers face depends largely on the size of the market

supplied –and hence on tradability. Thus, recent liberalisation of trade probably means

that producers are capturing an increasing share of the benefits from agricultural

growth, while any consumer gains become increasingly global. That said, where

markets are poorly integrated and infrastructure underdeveloped, farm produce becomes

effectively non-tradable so that increased output is likely to cause substantial falls in


output prices with consequent gains to consumers

Agricultural growth can contribute to overall national growth and through this to

poverty reduction. The dual-economy models of Lewis (1954) and followers (Fei and

Ranis, 1961) stress the importance of capital formation2 and wage costs for

development. Furthermore, in spite of the recent liberalisation of capital markets,

investment in developing countries still relies largely on domestic savings

In their 1998 paper,

the same authors explain further the pro-poor character of agricultural growth by

estimating a simultaneous equation model of poverty determination. The results show

that land yield is inversely related to a variety of poverty measures, with an elasticity

ranging from one to two. As expected, yield growth contributes to poverty alleviation

both directly and by inducing a rise in the wage rate as well as a decline in the price of

food, although these price effects take several years to materialise.

Equation (1) decomposes labour productivity into the product of two components:

land productivity, or yield, and the land labour ratio, which can be viewed as an

indicator of a country’s resource endowment

. A 1% increase in

the land–labour ratio reduces poverty by 0.82%, which is surprisingly low relative to the

effect of the land productivity term, which indicates that a 1% improvement in yields

decreases the percentage of the population living on less than US$1 per day by 0.91%.7

Again, the variables are highly significant and this is the preferred model

The two agricultural productivity variables alone explain 76% of the variance
in the HDI and both are highly significant. Thus, this regression confirms the apparently

solid link between agricultural productivity growth and poverty reduction. Raising

yields by 1% increases the HDI by 0.12%, which is the right direction, but an increase

in the value of a composite index is more difficult to interpret than a reduction in the

numbers of poor falling below US$1 per day..

In summary, the regressions presented strongly suggest that agricultural

productivity is an important determinant of poverty, and that increases in yields have

the potential to lift a large number of individuals out of poverty.

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