CHAPTER TWO
2. ECONOMICS OF AGRICULTURAL DEVELOPMENT
2.1 Changing views/perspectives of the role of agriculture since 1950
Economists traditionally have analyzed agricultural development in terms of its relationship to
the growth of the overall economy. The first notable Physiocrats viewed agriculture as the
engine of economic growth, arguing that agriculture was the only activity capable of generating a
surplus large enough to stimulate growth in other sectors of the economy.
Most Western Development Economists of the 1950s did not view agriculture as an important
contributor to economic growth, and assigned passive role of agriculture to economic
development. Those economists of course knew little about tropical agriculture or rural life, and
thus equated development with the structural transformation of the economy, i.e., with the
decline of agriculture’s relative share of the national product and of the labor force and the
dominance of the industrial modern sector.
Agricultural and development economics both emerged as sub-fields in the middle of the
twentieth century. Since then, the view of the role that agriculture can play in economic
development has shifted over time. Early perspectives in the 1950s and 1960s emphasize a
largely passive role of the agricultural sector. In this view, agriculture’s contribution to
development is to reallocate labor and indirectly contribute to much-needed savings and
investments in the modern sector; the sector was mainly regarded as a reservoir of labor and
transferable surplus.
Many development economists of 1950s and 1960s concluded that since economic growth
facilitated the structural transformation of the economy in the long run, the rapid transfer of
resources (especially surplus labor) from agriculture to industry was an appropriate short-run
economic development strategy.
2.2 The classic role of agriculture in Economic Development
Agriculture makes its contribution to economic development in several ways:
1. Contribution to National Income: The lessons drawn from the economic history of many
advanced countries tell us that agricultural prosperity contributed considerably in fostering
economic advancement.
2. Source of Food Supply: Agriculture is the basic source By earning valuable foreign exchange
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through the export of agricultural products By earning valuable foreign exchange through the
export of agricultural products By earning valuable foreign exchange through the export of
agricultural products e of food supply of all the countries of the world whether underdeveloped,
developing or even developed.
3. Pre-Requisite for Raw Material: Agricultural advancement is necessary for improving the
supply of raw materials for the agro-based industries especially in developing countries. The
shortage of agricultural goods has its impact upon on industrial production and a consequent
increase in the general price level.
4. Shift of Manpower: Initially, agriculture absorbs a large quantity of labour force. In Ethiopia
still about 80% labour is absorbed in this sector. Agricultural progress permits the shift of
manpower from agricultural to non-agricultural sector. In the initial stages, the diversion of
labour from agricultural to non-agricultural sector is more important from the point of view of
economic development as it eases the burden of surplus labour force over the limited land. Thus,
the release of surplus manpower from the agricultural sector is necessary for the progress of
agricultural sector and for expanding the non-agricultural sector.
6. Creation of Infrastructure: The development of agriculture requires roads, market yards,
storage, transportation railways, postal services and many others for an infrastructure creating
demand for industrial products and the development of commercial sector.
7. Relief from Shortage of Capital: The development of agricultural sector has minimized the
burden of several developed countries that were facing the shortage of foreign capital. If foreign
capital is available with the ‘strings’ attached to it, it will create another significant problem.
Agriculture sector requires less capital for its development thus it minimizes growth problem of
foreign capital.
8. Helpful to Reduce Inequality: In a country which is predominantly agricultural and
overpopulated, there is greater inequality of income between the rural and urban areas of the
country. To reduce this inequality of income, it is necessary to accord higher priority to
agriculture. The prosperity of agriculture would raise the income of the majority of the rural
population and thus the disparity in income may be reduced to a certain extent.
10. Create Effective Demand: The development of agricultural sector would tend to increase
the
purchasing power of agriculturists which will help the growth of the non-agricultural sector of
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the country. It will provide a market for increased production. Therefore, it will be helpful in
stimulating the growth of the non- agricultural sector. Similarly, improvement in the productivity
of cash crops may pave the way for the promotion of exchange economy which may help the
growth of non-agricultural sector. Purchase of industrial products such as pesticides, farm
machinery etc. also provide boost to industrial dead out.
11. Helpful in Phasing out Economic Depression: During depression, industrial production can
be stopped or reduced but agricultural production continues as it produces basic necessities of
life. Thus, it continues to create effective demand even during adverse conditions of the
economy.
12. Source of Foreign Exchange for the Country: Most of the developing countries of the
world are exporters of primary products. These products contribute 60 to 70 per cent of their
total export earning. Thus, the capacity to import capital goods and machinery for industrial
development depends crucially on the export earning of the agriculture sector. If exports of
agricultural goods fail to increase at a sufficiently high rate, these countries are forced to incur
heavy deficit in the balance of payments resulting in a serious foreign exchange problem.
13. Contribution to Capital Formation: Underdeveloped and developing countries need huge
amount of capital for its economic development. In the initial stages of economic development, it
is agriculture that constitutes a significant source of capital formation. Agriculture sector
provides funds for capital formation in many ways as:
(i) Agricultural taxation,
(ii) Export of agricultural products,
(iii) Collection of agricultural products at low prices by the government and selling it at higher
prices. This method is adopted by Russia and China,
(iv) labour in disguised unemployment, largely confined to agriculture, is viewed as a source of
investible surplus,
(v) Transfer of labour and capital from farm to non-farm activities etc.
14. Employment Opportunities for Rural People: Agriculture provides employment
opportunities for rural people on a large scale in underdeveloped and developing countries. It is
an important source of livelihood.
15. Improving Rural Welfare: It is time that rural economy depends on agriculture and allied
occupations in an underdeveloped country. The rising agricultural surplus caused by increasing
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agricultural production and productivity tends to improve social welfare, particularly in rural
areas. The living standard of rural masses rises and they start consuming nutritious diet including
eggs, milk, ghee and fruits. They lead a comfortable life having all modern amenities a better
house, motor-cycle, radio, television and use of better clothes.
Generally, Simon Kuznets categories the agricultural sector contributions to economic the
development in to four major elements:
1. Product contribution
- Principal source of food for domestic consumption,
- Supply of inputs for industries, such as textile and food processing
2. Foreign-exchange contribution
- Using agricultural export revenues to import capital goods agriculture as a growth sector.
3. Market contribution
- Increased rural purchasing power caused by expansion of agricultural output and productivity
will tend to raise the demand for manufactured goods (the demand for such inputs like fertilizer,
better tools, tractors, irrigation facilities, etc. in the agricultural sectors).
- An increase in rural incomes create more demand for consumer products
4. Factor market contribution
- Labour contribution: Providing productive employment to industrial sectors
Providing raw material for domestic agro-processing industries which is used for consumption
or production of intermediate goods.
- Capital contribution: Increasing rural incomes result in transformation of capital resources
from agricultural sector to non-agricultural sectors. Some farm profits could be invested in
industry. Today, most development economists share the consensus that besides playing a
passive role, the agricultural sector and the rural economy play an indispensable role in any
overall strategy of economic progress, especially for the low-income developing countries.
In addition, the agricultural sectors increasing farm capital formation through agricultural
taxation, land taxes, agricultural income tax, land registration charges, fee for providing
agricultural technical services and other types that cover the cost of services provided to the farm
population.
2.3. Agricultural Transformation & Development
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The need for agricultural transformation
Agricultural transformation is the process by which individual farms shift from highly
diversified,
subsistence-oriented production towards an integrated economy, more specialized and
commercialized production oriented towards the market and the capturing of economies of scale.
The process involves a greater reliance on input and output delivery systems and increased
integration of agriculture with other sectors of the domestic and international economies. Many
functions formerly conducted on the farm, such as input production and output processing, are
shifted to off-farm elements of the economy.
Agricultural transformation is a necessary part of the broader process of structural
transformation, in which an increasing proportion of economic output and employment are
generated by sectors other than agriculture.
• Phases of agricultural transformation
Structural transformation thus involves a net resource transfer from agriculture to other sectors of
the economy, over the long term. Based on the historical perspectives, economists identified four
evolutionary stages of agricultural transformation that calls for different policy approaches.
Stage One: The Economic Growth and Modernization Era of the 1950s and 1960s.
This stage is about “getting agriculture moving” and this is the period where development was
defined largely in terms of growth in average per capita output (growth was defined only as
quantitative increase). Although, the growth of agricultural surplus was acknowledged at the first
stage of agricultural transformation, in 1950s most development economists did not view
agriculture as an important contributor sector to economic growth, by raising the following
arguments:
The income elasticity of demand for unprocessed food is less than unity; hence, the demand for
agricultural products grows more slowly than consumption of nonagricultural products. Because
agriculture’s share in the economy was assumed to be declining. Economists of that time neglect
the need to invest in agricultural sector.
Others also argues that the scope of growth through agriculture and other primary exports were
very limited since the terms of trade turn against countries that export primary products and
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import manufactured goods. These economists advocate that priority be given to import
substitution of manufactured goods rather than to production of agricultural export products.
However, in1960s, other scholars argued the need to invest in agricultural sector since
agriculture has a potential positive force in development and agriculture and industry are inter-
dependent for economic growth and development. The analysis given by those economists
showed that:
Food shortage could chock-off the growth in the non-farm sector, by making its labor supply
infinitely elastic. In the early stages of development, a country needs to make some investment in
agriculture to accelerate the growth of agricultural surplus.
Agriculture could provide labor, capital and foreign exchange to the developing economy and
specifically to the industrial sector.
It could also supply market for domestically produced industrial goods.
The “Green Revolution Model” was instrumental in convincing policy makers and international
donors to devote more resources to the development of new inputs for Third World Farmers,
such as high yielding and fertilizers responsive grain varieties. Intensification of agricultural
production based on high yielding cereal varieties offered the opportunities to provide productive
employment and outputs for the rapidly growing rural labor force. During this phase, agriculture
becomes a key contributor to growth. Thus, the policy interventions focused on establishing
market links with industry, technology and incentives to create a healthy agricultural sector, and
improving factor markets to mobilize rural resources.
Stage Two: The Growth-With-Equity Era of the 1970s
This stage is concerned with the interaction between income distribution and rate of economic
growth. The attention was given to income growth, income distribution and health and education
services. It was also concerned with employment generation and possible existence of
employment. It had become apparent that urban industry in most developing countries could not
expand quickly enough in the short run to provide employment for the expanding rural labor
force. Hence, the concern of development economics and planners shifted to finding ways to
hold labor force in the countryside.
The surplus generated in agriculture can be utilized to develop the non-agricultural sector
through a combination of factor inputs. For this matter, rural factor and product markets must
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become better integrated with those in the rest of the economy. This is because improved
functioning of labor markets speeds up the process of extracting labor and capital from
agriculture, where returns are low and shifting to industry or service with higher productivity.
Therefore, in the early 1970s, rather than simply waiting for increase in average per capita
income to solve the problem of poverty and malnutrition, the greater attention has been paid to
employment, income distribution and basic needs such as nutrition and housing.
Stage Three: The Economic Growth and Policy Reform Era of the 1980s
In the third stage, agriculture is progressively integrated with the macro-economy through
improved infrastructure. At this stage, the relative importance of agriculture in the economy
substantially declines and economic dualism disappears. More attention was given to
macroeconomic policies related to income generation, agricultural sustainability and market
liberalization. The policy synthesized how to trace effects of macroeconomic adjustments as well
as sectoral level policies on food production, income generation and the consumption patterns of
the poor.
Stage Four: The Policy Role in Agriculture and Rural Development Period since 1990
The fourth stage of agricultural transformation was the immediate result of the third stage in
which serious attention was given to macroeconomic and agricultural policies. For
macroeconomic and agricultural policies to succeed it requires:
Sufficient domestic and international effective demand
Public investment in research and rural development/Infrastructural facilities
Stable political environment, peace, security, etc., which was the focus areas of
this stage.
Generally, it was aimed at building a more dynamic and integrated rural economy, through
attaining more rapid, broad based agricultural growth and sustainable rural development. The
following few points are the focus areas of the coming decades which are required to attain
sustainable agricultural and rural development:
Agriculture and rural development require strong rural institutions and well-
trained individuals, to relate smallholder agricultural farmers with research, training and
extension.
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Public and private investment policies should be in such a way that promote and
accelerate agriculture and rural growth.
Agricultural development must satisfy the food requirement of rapidly growing
population to achieve food self-sufficiency.
Government should invest in expansion of public services to the rural economy
such as road construction, irrigation, water supply, etc.
Improved management and governance can also use economic resources
economically, effectively and efficiently.
2.4. Conditions for agricultural development
i. Technology and innovation
Technological change is one of the most important forces which alter the structure of agricultural
production processes. These technological advances emerged in the form of:
Factor-saving technologies or cost reducing technology such as development of tractors and
machines, etc.
Yield increasing technology such as development of hybrid seed
Both factor saving and yield increasing technologies such as artificial insemination
Fig A. Technology impact on production function
Figure 2.1. New and old technology
Through agricultural technological change, the production function will shift over some range
due to:
i. More output can be produced using the same quantity of inputs
ii. The same output can be produced with a smaller quantity of inputs
The shift in production is depicted by the two total product curves, old and new. The given level
of inputs is xo and the gain in output resulting from technological change is Oqn - Oq0 =q0qn .
Development also involves innovation, which economists call “technical change”:
New physical things (seeds, chemicals, etc.)
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New ideas (crop rotations, etc.)
New institutions (Ethiopian Commodity Exchange (ECX), etc.)
Innovation makes it possible to produce more of what people want, from the resources they have.
But innovation doesn’t happen automatically. To innovate, people must be able to change what
they do. The impact of this technical improvement is, therefore, an important area of analysis in
production function.
ii. Conducive institutional and pricing policies
Agricultural product prices are the major determinants of producer incentives and real incomes
in developing countries.
Political leaders in developing countries devise policies to meet society objectives and the
demand of interest groups. Governments can influence agricultural prices through:
ceiling or floors price
enforcing them with subsidies, taxes, storage programs,
quantity restriction and other policy instrument
These intervention influence producer and consumer prices and incomes, production and
consumption, foreign exchange earnings, price stability, government revenues, the efficiency of
resources allocation, employment, capital investment, health and nutrition.
Developing countries often have marketing system characterized by deficient
- infrastructure,
- inadequate information,
- weak bargaining position for producer for certain commodities
- government induced distortions. The government can solve certain marketing
deficiencies, particularly the lack of roads and information; avoid the larger parastatal
marketing agencies that tend to introduce marketing distortions.
- The public sectors can provide a system of grades and standards and other
regulations. E.g. Ethiopian commodity exchange (ECX)
III. Research, Education and Extension services
Agricultural research generates new and improved technologies and institutions that
increase agricultural productivity, moderate food prices, generate foreign exchange, and
reduce pressure in the natural resources base.
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The result of agricultural research should be supported by providing education and
extension services to the farming society to reach the result effectively at the farmer
level.
So the government and other non-governmental institution will be disseminating
research, education and extension services to the development of agricultural sectors.
IV. Conducive inputs and credit supplier institutions
Successful agricultural development requires increased output per hectare and per worker. This
agricultural intensification depends on the availability of new, often manufactured, inputs such as
seed, fertilizer, pesticides, irrigation, mechanical power and supplementary minerals and feeds,
etc. Manufactured inputs can substitute for inelastic supplies of land to increase production at a
lower per-unit cost. Credit is essential as the country move from traditional to modern
agriculture. It is used as sources of fund for farmer to purchase new and improved inputs to
increases farm productivity. So government should expand the availability of agricultural inputs
and credit to the farmers for the development of the agricultural sectors.
V. Good land policies and labor market
Land tenure refers to the right and pattern of control over the land resources. Land rights
determine social and political status as well as the economic power of a large proportion of the
population in the developing countries. A land reform is an attempt to change the land tenure
system through public policies. Land tenure systems vary in farm size and organization, affect
incentive to produce and invest, and influence the distribution of benefit from agricultural
growth. Land tenure reform, including more secure rights over land, is needed for improved
economic efficiency, equity, and political and economic stability.
Labor is often the most valuable resource the rural poor posses. Labor markets in developing
countries often contain imperfection due to power imbalances, imperfect information and
transaction costs. Government interventions in to the labor markets are often justified based on
this observed poverty. All these discussed in the above shift in the production function and
farmers will face new sense of decision to move to development.
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