Agriculture

and
Structural Transformation
W4 – Economics of Development
ECS 244 FEB-UAJ 2018
Chapters 16-17 (Perkins-etal-2013.pdf)
Chapters 16 dan 20 (Schaffner-2014.pdf)
Chapter 9 (Todaro-Smith-2015.pdf)
Introduction
“It is in the agricultural sector that the battle for long-term economic
development will be won or lost.”
—Gunnar Myrdal
Nobel laureate in
economics 1974
with
Friedrich von Hayek

6 December 1898
17 May 1987
 Characteristics of
Why Agriculture? agriculture:
• Seasonality
• Geographic dispersion
• 2/3 of the world’s poorest people are • Sources of risk
• in rural areas
• engaged primarily in subsistence agriculture
• Production = Consumption No surplus
• Old: Agriculture plays a passive and supportive role
• to provide sufficient low-priced food and manpower to the expanding
industrial economy
• the dynamic “leading sector” in any overall strategy of economic
development (Lewis’s two-sector model)
Why Agriculture?
New: Agriculture play an indispensable part in any overall strategy of
economic progress
• Accelerated output growth
• through technological, institutional, and price incentive changes designed to
raise the productivity of small farmers
• Rising domestic demand for agricultural output
• derived from an employment-oriented, urban development strategy
• diversified, nonagricultural, labor-intensive rural
• Development activities that directly and indirectly support and are
supported by the farming community
Labor Surplus Model of Ricardo
Agricultural production was subject to diminishing returns
• Arable land is limited
• To increase production:
• farmers would have to move onto poorer and poorer land
• each new acre of land matched with the same amount of labor would produce less grain
• Diminishing return
Rural unemployment, underemployment, or disguised unemployment
• Agriculture’s seasonality: Rural employment fluctuate
• from nearly full employment during planting and harvesting times
• to substantially lower levels of employment at other times,
• even though the total number of workers remains more or less constant
Lewis two-sector model: V1 (T&S, 2015, p. 124-127)

Note: Labor surplus in agriculture

All rural workers share equally in the
output
• Wage, w = APLA = TPLA/LA
• the rural real wage is
determined by constant average
product of labor
• Not MPL = TPL/L like in
modern sector not the marginal
product of labor
• MPL = 0: labor surplus
Question: what next? What happens
then to the labor surplus?
• Transfers of resources (labors) from
low-productivity to high productivity
activities
• From agricultural to non-agricultural
and industrial economies
• From rural to urban activities
Lewis two-sector model: V2
Diminishing return, but after
this point (g), no more
additional output is produced,
albeit labor is increased
• MPLA is zero (or even
negative)
Lewis two-sector model: V2
• Rural wages do not fall below the
average product of farm labor
• Total production is equally divided
among labors (household members)
• Subsistence level
• Institutionally fixed wage
• ‘Institutions’ (norms) arrange
rural lives

Line hij is the supply curve of

agricultural labor
• At hi the curve is perfectly elastic
Lewis’s two-sector model: V2
•

Demand m is derived from

the industrial production
function.
Lewis’s two-sector model: V2
• Labor surplus economy starts with its
• entire population in agriculture
• It can remove a large part of that
population (pg) and move it to
industry; no reduction in farm
output
• Industry pays workers a wage a above
subsistence (the difference between
the vertical distance pk (panel c) and
ph (Panel b)
• Industry, industrial labor demand
increases (from s to m, Panel c), labor
moves from agriculture, industrial
wage, demand for food, price of
food , terms of trade improves, and
labor supply (g” to I”, Panel c)
Neoclassical two-sector model
• MPLA is never zero
• No institutionally fixed minimum wage
• w = MPL
• The agricultural production function is never flat (Panel a )
• the MPL curve is always rising (Panel b)
• The supply curve of labor to industry no longer has a horizontal
section (Panel c)
• At every point, the removal of workers from agriculture reduces agricultural
production
• Increases the MPL for those remaining in agriculture
• Industry must pay an amount equal to that marginal product (plus a
premium) to get workers to move
Neoclassical two-sector model
In the neoclassical model:
• An increase in industrial
production can take place only
alongside a decrease in
agricultural production.
• As labor is removed from
agriculture, farm output falls
• to extract enough food
from the agricultural
sector to pay its workers,
industry must pay higher
and higher prices for good.
Economic Transformation
Structural transformation as a feature of modern economic growth
• When economy moves from agriculture to industry:
• Aggregate income raises, economy transforms its structure
(Structure means sectoral composition, ie., in VA and labor absorption)
• The share of agricultural output (or value added) in aggregate output (value added)
declines
• The share of manufacture output (or value added) in aggregate output (value added)
increases
• The share of agricultural labor absorption in total employment declines
• The share of manufacture labor absorption in aggregate employment declines
• Y  then YA/Y , YNA/Y  and LA/L , LNA/L 
As countries develop, the shares of output and labor in agriculture tend to decline

EAP: East Asia & Pacific

• LAC: Latin America &
Caribbean
SAS: South Asia
SSA: Sub-Sahara Africa
As countries develop, the shares of output and labor in agriculture tend to decline
As countries develop, the shares of output and labor in agriculture tend to decline

•
As countries develop, the shares of output and labor in agriculture tend to decline

Employment Value Added

Herrendorf et al 2013. https://www.imf.org/external/np/seminars/eng/2013/SPR/pdf/rrog2.pdf
As countries develop, the shares of output and labor in agriculture tend to decline

Employment Value Added

As countries develop, the shares of output and labor in agriculture tend to decline

Employment Value Added

 What explains economic transformation?
DEMAND SIDE: ENGEL’S LAW
• Proportion of income spent on food declines as
income rises
• Y, F/Y Log F =  +  Log Y
F = e( +  Log Y)
Log F =  +  Log Y dF/dY = (/Y).e( +  Log Y)
•  > 0, but  < 1 = (/Y).F
•  is income elasticity of food: 0 < YF < 1 = .(F/Y)

Income grows faster than the demand for food  = (dF/dY).(Y/F)

• Resulting in the decline of agriculture as a share of = YF
national income
What explains economic transformation?
SUPPLY SIDE: PRODUCTIVITY
• Differences in productivity
• Labor productivity in NA > Labor productivity in A
Ratio of non-agriculture output per
worker to agriculture output per
worker:
(YNA/LNA) / (YA/LA) > 1
• (YNA/LNA) > (YA/LA)
What explains economic transformation?
GOVERNMENT ROLES: Transfer of surplus from the agricultural to the
nonagricultural sector:
• Directly: taxation
• Indirectly: forms of government intervention
• Increasing integration of agricultural and nonagricultural factors and product
market linkages  Improving infrastructure
• intersectoral trade
• labor migration
Agriculture and Economic Growth
Y = YA + YNA

Y = YA + YNA

Y/Y = YA /Y + YNA /Y

= (YA /Y).(YA /YA) + (YNA /Y) .(YNA /YNA)
=  .(YA /YA) + (1) .(YNA /YNA)

GY =  GYA +  GYNA
Agriculture and Economic Growth
The role of agriculture
• increased supplies of food for domestic consumption
• released labor for industry
• a domestic market for industrial output
• a supply of domestic savings
• a source of foreign exchange
Agriculture and Technological Change

Why small-scale farmers

are often resistant to
technological innovation in
farming techniques or to
the introduction of new
seeds or different cash
crops?
• Self-perpetuating
poverty trap
• Increase inequality
Agriculture and Technological Change

The chances of starving are

much greater with technique
B, so risk-averse peasant
farmers would naturally
choose technique A, the one
with the lower mean yield
• Farmers pay for “self-
insurance” of this type
with much lower average
returns.
Closing remarks
A variety of characteristics differentiate
agriculture from other sectors of the
economy:
• Large share of GDP and employment
• Unique features of the agricultural
production function
• A large share of the sector’s output
consumed directly by its producers
• Agriculture’s role as a reservoir of
resources.
Structural transformation: economy’s
sector proportions systematically
evolve.
• At early stages of economic
development, agriculture dominates
both GDP and employment shares
in the economy.
• Shift of sector proportions away
from
• agriculture toward industry and
services.
Closing remarks

The decline in the relative size of the agricultural sector is driven, in part, by
Engel’s law, an implication of which is that the demand for food grows more
slowly than income.
• Growth in agricultural productivity plays a critical role in facilitating the release
of labor and capital from agriculture for employment in industry and services.