Factors Influencing Agriculture’s Contribution to GDP:

Latin America and the Caribbean

Abstract
This paper identifies the factors that influence agriculture’s percentage contribution to gross domestic
(GDP) for a group of Latin American and Caribbean (LAC) countries that belong to the medium category
of the UNDP Human Development Index (HDI). In line with theories of economic growth it was
hypothesized that the percentage contribution of agriculture to GDP is influenced by factors associated
with the level of economic development of the country and the degree of competitiveness of its
agricultural sector. The analysis employed the use of a Random Effects panel regression model for a 30
year period (1980-2009) for the study countries. Based on the analysis, it was found that rural population,
life expectancy, foreign direct investment, the rate of inflation, level of exports of all goods and services
and the ratio of agricultural exports to agricultural imports significantly determined the percentage
contribution of agriculture to GDP in the selected countries.

Introduction
Data obtained from the Human Development Reports (2009) show that for Latin American
(LAC) nations categorized as Medium Human Development (MHD), agriculture’s contribution to
GDP tends to be very low for some countries, while for others within the same category,
agriculture’s contribution to GDP is much higher (Figure 1). This paper explores the causes of
the variation in agriculture’s percentage contribution to GDP in these countries, which could
shed some light on the factors causing the agriculture sector to decline in developing countries.
The objective of this paper therefore is to identify the macro-economic factors which determine
the percentage contribution of agriculture to GDP in Latin America and Caribbean countries.
Background/Theoretical Framework
Explanations of the importance of the agricultural sector in the economy as economic growth
progresses have benefitted greatly from the dual sector theory of Arthur Lewis (Lewis 1954). In
this theory, the modern or industrial sector
Factors Influencing Agriculture’s Contribution to GDP 2
utilizes the surplus labour in the
agricultural or primary sector as its source
of growth, along with capital generated by
the investment of savings, to expand its
production and thus the gross output of the
economy. As the industrial (modern) sector
expands in importance, there is a
concomitant reduction in the percentage
contribution to gross output by the
agricultural sector. This growth process
thus generally requires the movement of
labour from rural areas to the urban areas
with a decline of the rural population as a
percentage of the national population.
In recent years however, there has
been increasing concern about the
declining contribution of the agricultural
sector to Gross Domestic Product (GDP),
especially in developing countries. While
as discussed it is established that as a
country develops, its agriculture sector is
expected to decline, in recent times, this
decline has been rapid rather than gradual.
This decline has been taking place not
only in developing countries, but in
developed countries such as the United
States. This situation is evidenced by
Yamashita (2008), who provided statistics
for Japan, which showed that agriculture’s
contribution to GDP fell by 8% between
1960 and 2005, Table 1 provides further
details of the decline in the agricultural
sector of Japan, where it can be seen that
the number of farming households, the
area cultivated, as well as the agricultural
labour force have all been declining.
Another concern about the decline of
the agricultural sector stems from the
constant upward movement of food prices
over the last few years, which is depicted
using the international food price index in
Figure 1. As seen in Figure 2 and
confirmed by USAID (2009), global food
prices peaked between March 2007 and
March 2008, showing an increase of 43%
over the period. This marked increase was
felt most in developing countries and by
the poorest members of the population,
who spend the majority of their income on
food. The impacts of these high food prices
did not only reduce the buying power of
persons but also threatened food and
nutrition security (USAID 2009). For
instance, in the Democratic Republic of the
Congo, cassava which constitutes 55% of
calorie intake had prices increase by 60%
in 2008-2009. Although food prices have
since declined, the international food price
index of 2009 was still 17% lower than
2008 but still higher than 2007 (The World
Bank 2010). Global prices are expected to
continue to remain high due to increasing
fuel prices, one of the factors that
contributed to the spike in 2008.In recent
years, there has also been increased
concern about agriculture’s contribution to
GDP as the number of undernourished
persons in the world has steadily increased
from 792 million (14% of undernourished
persons in the world), 1995-1997 to 850
million (13%), 2005-2007 (FAO 2010b).
It is general knowledge that agriculture
does not just contribute food and fiber to
the economy, but also labour, capital and
foreign exchange, which all go toward
economic development. As Rao (1989)
puts it, if agriculture fails to develop at a
suitable pace, this could prove to be a
critical constraint to the growth of the
industrial sector as well as other sectors of
the economy.
Methodology
This section presents the regression model
as well as theoretical arguments that justify
the eight variables used. The regression
model was formulated as follows (the
sources of the data for the variables are
given in brackets):
it it it it
it it it it it it
EGS EDS EXIMa
AGDP PT RP LEB FDI ICP
   
     
   
     
678
012345

(1)
where:
it AGDP = agriculture’s percentage
Factors Influencing Agriculture’s Contribution to GDP 3
contribution to GDP for country i in
year t (the ratio of Agriculture’s
total value added to GDP of the
country) (UNSTAT 2010).1
it PT = the population of the country i in
year t (World Bank 2010).
it RP = the percentage of the population
of country i that is rural (rural
population = people living in rural
areas = the total population – the
urban population of country i )
(World Bank 2010).
it LEB = the life expectancy at birth of the

population of country i (World

Bank 2010).
it FDI = the foreign direct investment into
country i (World Bank 2010).
it ICP = the rate of national inflation
(World Bank 2010).
it EGS = the exports of goods and

services from country i (expressed

as a percentage of GDP) (World
Bank 2010).
it EDS = the total external debt stocks of
country i (expressed as a
percentage of GNI) (World Bank
2010).
it EXIMa = the ratio of agricultural trade.

This is the ratio of exports and

imports of total agricultural
merchandise for country i
(FAOSTAT 2010).
it  = the stochastic disturbance or
error term.
Factors Associated with the Level of
Economic Development
(i) Rural Population as a
Percentage of Total Population
(RP)
1 Agriculture refers to agriculture, hunting, forestry
and fishing.
In general if a country has been able to
maintain a high percentage of its
population in the rural sector then it could
be expected that its agricultural sector
would constitute a larger percentage of its
gross output. In accordance with the Lewis
Model, this will imply a large proportion of
the country’s labour has not transferred to
the modern sectors and being resident in
the rural sector is still engaged in the
agricultural sector, which could be
expected to be making a greater
percentage contribution to GDP.
(ii) Population Growth (PT)
If a country experiences high population
growth and therefore has a larger
population base, then it can transfer labour
to the expanding modern sectors, without
reducing the agricultural labour supply. In
fact a rapidly expanding population could
allow a country to expand its labour
surplus and thus allow a prolonged period
of economic growth by expansion of both
the agricultural and modern sector,
particularly if there are technological
innovations taking place in the agricultural
sector, such as improved genetic planting
material. Population growth could therefore
allow the rural sector to play a role in
fostering economic growth (Pemberton
2002). Under these circumstances PT
could be expected to have a positive
influence on the percentage contribution of
agriculture to GDP.
However, according to Pender (1999),
increasing pressures from population
growth may result in land degradation, as
these pressures encourage expansion of
agricultural production onto marginal lands,
causing lower land productivity. Thus
increasing population is expected to
adversely affect agriculture’s contribution
to GDP. Thus countries with larger
populations could be expected to have
lower agricultural contribution to GDP and
the coefficient of PT can be hypothesized
to have a negative sign. Thus the sign of
Factors Influencing Agriculture’s Contribution to GDP 4
the coefficient of PT could depend on the
relative influence noted and hypothesized
to be either positive or negative.
(iii) Life Expectancy (LEB)
As the process of economic growth
proceeds it would be expected to be
accompanied by a process of economic
development, as the increasing gross
output of the country is utilized by its
citizens to improve the standard of living of
the citizens. One important aspect of
improved standard of living is the health
status of the population and in particular
the levels of maternal and child care. As
these aspects of the population improve,
they will have a direct impact on the life
span of citizens, improving the life
expectancy at birth of the population.
Thus it could be expected that the
higher levels of life expectancy would be
associated with countries at a higher state
of economic development and hence
countries with a lower percentage of
agriculture sector in the gross output of the
country, as argued above. Hence, the
coefficient of LEB is expected to have a
negative sign.
For countries where the foreign direct
investment is largely into food and
agriculture, the coefficient of FDI is
hypothesized to have a positive sign.
However, if the foreign direct investment in
a country is into the non-agricultural sector,
it is hypothesized that the coefficient of FDI
will be negative.
(iv) Factors Associated with
International Competitiveness
The Lewis Model considered a fairly closed
developing economy with “some scope for
international trade” (Pemberton 2002).
However, in the recent international trade
scenario international competitiveness has
emerged as the major factor in determining
the directions of international trade.
Competitiveness on a whole refers to “the
extent to which the goods of a firm or
industry can compete in the marketplace;
this competitiveness depends on the
relative prices and qualities of products”
(Carbaugh 2002). Thus, countries that can
produce commodities at lower levels of
cost have a definite competitive advantage
over higher cost producers as they will be
able to offer lower export prices. Any factor
contributing to higher domestic production
costs, therefore reduce the international
competitiveness of domestic production,
reducing or eliminating prospects of
exporting and also allowing imports of
cheaper priced commodities into the
domestic market further eroding prospects
for domestic production. Especially in this
era of the World Trade Organization
(WTO), it has become increasingly difficult
for developing countries to apply tariffs and
non-tariff barriers to limit imports.
(v) Inflation Rate
Economic theory states that there are two
sources of inflation, cost-push and
demand-pull inflation (Lipsey and Chrystal
2003). When in a country there is demandpull
inflation, due to increasing demand for
food, producers are expected to invest
more in the agricultural sector, resulting in
increased production and as a
consequence increasing demand pull
inflation should lead to increasing
percentage contribution of agriculture to
GDP. ICP ’s coefficient in this case is
hypothesized to be positive. However,
where cost-push inflation results, because
of a decrease in aggregate agricultural
supply, which may be caused by either an
increase in wages or an increase in the
prices of raw materials, the greater costs of
agricultural production result in the amount
of agricultural production falling, thus
reducing the percentage contribution of
agriculture to GDP. The coefficient of ICP
in this case, is expected to be negative.
Thus, the coefficient of ICP is
hypothesized to have either a negative or a
Factors Influencing Agriculture’s Contribution to GDP 5
positive sign depending on the source of
inflation in the countries.
(vi) Exports of All Goods and
Services (EGS)
Similarly, the coefficient of exports of
goods and services is hypothesized to be
either positive or negative. The coefficient
of EGS is expected to be positive, if the
developing countries implement an
outward-oriented trade policy with respect
to agriculture. According to Carbaugh
(2002), this policy initiates international
competition to domestic markets, which in
turn discourages inefficient ones. As a
result of this more competitive
environment, greater productivity is
promoted and thus the greater the exports
of goods and services, the greater the
percentage contribution of agriculture to
GDP.
By the same token, the coefficient of
EGS is expected to be negative, if a
developing country implements an inwardoriented
trade policy for agricultural goods
and an outward policy with respect to nonagricultural
products. In this instance, the
country is not focused on the export of
agricultural commodities, but rather on
non-agricultural commodities. Therefore,
the agricultural sector becomes less
competitive and productivity declines and
ultimately agricultural output declines
resulting in a reduction of the percentage
contribution of agriculture to GDP.
(vii) Agricultural Exports as a Ratio of
Agricultural Imports (EXIMa)
The coefficient of EXIMa is hypothesized
to be positive, that is it is expected for a
developing country that as the ratio of
agricultural exports to agricultural imports
increases, so will agriculture’s percentage
contribution to GDP.
(viii) External Debt (EDS)
It is expected that as the external debt of a
country increases, perhaps caused by the
international uncompetitiveness of its
domestic production limiting exporting the
country may not be able to import as much
agricultural and food products, due to
lower availability of foreign currency
(Valazco 2001). Thus the country would be
forced to produce more of its own food,
resulting in increased agricultural
production and an increased contribution
of agriculture to GDP. Therefore, the
higher the external debt of the country the
greater the contribution of agriculture is
expected to be and therefore the
coefficient of EDS is hypothesized to be
positive.
Country Selection
A panel regression model was used to
determine the factors that influence the
percentage contribution of agriculture to
GDP. Secondary data on for the eight (8)
variables noted in the model above were
obtained for ten (10) Latin American and
Caribbean countries (Table 2) for the
period 1980-2009.
Approach to Regression Analysis
In estimating the above model, a number
of steps were undertaken. Firstly, the data
for the nine variables for all ten countries
were collected and set up as a panel.
Given that regression of a non-stationary
time series on another non-stationary time
series may produce a spurious regression
(Gujarati 2003), it is imperative to
determine if the series are non-stationary.
Thus, the time series of the nine variables
were tested for stationarity using the
augmented Dickey-Fuller test. If the series
are non-stationary, then it is important to
determine whether they are cointegrated.
Thus, the augmented Engle-Granger test
was carried out to determine whether a
cointegrated regression existed. Next,
given that cointegrating vectors exists, the
Factors Influencing Agriculture’s Contribution to GDP 6
Fixed Effects (FE) and Random Effects
(RE) models were both estimated and the
Hausman test was carried out to determine
which of the two models was more
appropriate to estimate the regression. The
results of the Hausman test favoured the
RE model.
Thus, the RE model was estimated
using maximum likelihood estimation
(MLE), which avoided problems associated
with autocorrelation and
heteroscedasticity. Next, hypothesis
testing of the individual regression
coefficients was carried out. Additionally,
the Likelihood Ratio (LR) test was carried
out on the regression results to determine
the overall significance of the model. Then,
using the information generated from the
MLE, the McFadden R-squared value was
obtained. Finally, the elasticites for the
variables were calculated using the results
obtained from the regression.2
Results and Discussion
This section presents the results obtained
from the estimation of equation (1) using
the statistical programmes EViews 6 and
Limdep (NLOGIT 4.0) . Based on the
augmented Dickey-Fuller test, AGDP (the
dependent variable), FDI, ICP, EGS, EDS
and EXIMa were found to be nonstationary
while PT, RP and LEB were
found to be stationary (Table 6). The
results of the augmented Engle-Granger
test for cointegration (Table 7) found that
there was a long term or equilibrium
relationship between the variables. These
results indicated that the null hypothesis of
no cointegration was rejected, leading to
the conclusion that the regression was not
2Elasticity was calculated as
Y
X
j
  , where j  is
the coefficient of the specific variable j and
j
X
andY are the means of the specific variable j and
the mean of the dependent variable, respectively.
spurious, that is, there was a meaningful
long-run relationship between the
percentage contribution of agriculture to
GDP and the eight independent variables.
Additionally, the Hausman statistic 18.32
(p-value: 0.0189) indicated that the null
hypothesis ( 0 H = the fixed effects model is
suitable) be rejected. That is, the Random
Effects model was favoured over Fixed
Effects model.
The estimated equation results are
given in Table 3.Using a 10% level of
significance, only national population (PT)
and external debt (EDS) were found to be
statistically insignificant (Table 3). Life
expectancy (LEB), foreign direct
investment (FDI), exports of goods and
services (EGS) were found to be negative
and statistically significant. While rural
population (RP), the rate of inflation (ICP)
and the ratio of agricultural exports to
imports were found to be positive and
statistically significant.
Table 4 presents the results obtained
from the calculation of the elasticities for
the significant variables used in the
regression model, based on the results
obtained in Table 3. The results show that
10% increases in life expectancy at birth,
foreign direct investment and the exports
of all goods and services would result in a
20%, 0.3% and 2% decreases in the
percentage contribution of agriculture to
GDP in this group of Latin America and
Caribbean countries. However, for rural
population, inflation and the ratio of
agricultural exports to imports it was found
that 10% increases in these variables
would result in 4%, 0.03% and 0.7%
increases in the percentage contribution of
agriculture to GDP respectively.
Displayed in Table 5 are the results of
the Likelihood ratio (LR) test, which show a
chi-squared value of 139.47 (p-value =
0.0000) was obtained, indicating that the
null hypothesis should be rejected. Thus,
together all the regressors have a
significant impact on the percentage
contribution of agriculture to GDP. In
Factors Influencing Agriculture’s Contribution to GDP 7
addition, the results of the McFadden- 2 R
gave a value of 0.2231, which was fairly
low, suggesting a fair fit of the model
(Amaya-Amaya, Gerard and Ryan 2008).
Conclusions
Several conclusions can be drawn from the
major findings presented in Table 3. Firstly,
the key factors that determine agriculture’s
percentage contribution to GDP in the LAC
countries are the size of the rural
population, life expectancy at birth, foreign
direct investment, the rate of inflation,
exports of all goods and services and the
ratio of agricultural exports to agricultural
imports. All the significant variables had
the expected signs as indicated in Figure
3.
The first conclusion is that the size of
the rural population positively determined
the percentage contribution of agriculture
to GDP. Thus for countries with larger rural
populations the percentage contribution of
agriculture to GDP was higher suggesting
the greater supply of rural labour was
responsible for relatively higher agricultural
production.
Countries with higher life expectancy
had lower percentage contribution of
agriculture to GDP. For developing
countries, like those in Latin America and
the Caribbean increased life span of
individuals is associated with higher levels
of development in the country. Thus, since
increased life expectancy can be viewed
as a measure of development, then it may
be associated with a greater shift of
resources from agriculture to services and
manufacturing sectors.
Exports of all goods and services had a
significantly negative impact on the
percentage contribution of agriculture to
GDP and in this instance the negative sign
suggests that countries with a higher level
of exports of all goods and services had a
lower agriculture percentage contribution
to GDP. Table 8 shows that the main
exports of many of these countries are
commodities such as oil, minerals, apparel
and natural gas. Thus, in these countries
with an export focus away from agriculture,
the sector may become less competitive
resulting in a decline in the percentage
contribution of agriculture to GDP.
The rate of inflation and the ratio of
agricultural exports to agricultural imports
are also determinants of the percentage
contribution of agriculture to GDP. In the
case of inflation, the implication of the
positive elasticity is that there is a high
demand for food commodities among the
LAC group which is contributing to
demand-pull inflation. In response
agricultural producers increase their
production to meet the high demand for
food which results in a larger percentage
contribution of agriculture to GDP with
higher inflation.
With respect to the ratio of agricultural
exports to agricultural imports, the positive
and significant coefficient for EXIMa
implies that countries with higher
agricultural exports relative to imports had
a higher percentage contribution of
agriculture to GDP. Table 8 shows that for
the LAC group, agricultural commodities
are the important exports, thus further
reinforcing the conclusion that agricultural
exports are fueling increased agricultural
production in these countries.
Recommendations
With the issue of food security at the
forefront, it is recommended that LAC
countries continue expanding their
agricultural sectors thereby reducing their
dependence on imported food products,
especially in light of the recent food crisis
situations. Furthermore, these countries
should try to diversify their exports, so that
the export focus is not just on nonagricultural
commodities, but also
agricultural commodities. This shift in focus
may help make the sector a more viable
option for investors and as a consequence
increase its overall productivity.
Factors Influencing Agriculture’s Contribution to GDP 8
Several Latin American and Caribbean countries that fall into the Medium Human Development
category were not included in this research as relevant data for them was not available. It is
hoped that improved data availability may allow these countries to be included in future
research in this area. It is therefore recommended that Latin American and Caribbean countries
strive to improve their macroeconomic collection and availability.

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