Agriculture Sector and Capital Formation in Developing
The world history reveals that the agri. sector contributed towards
capital formation, hence it became helpful for economic development. Now we
establish a link between agri. sector and capital formation. It is reminded that
such relationship exists in case of
Lewis Model and
Ranis-Fei Model, which we have studied earlier. However, it is restated that the process
of capital formation depends upon elasticity of food supply and elasticity of
food demanded. As it has been seen that in case of developing countries the
elasticity of demand for food items is very high, as according to Johntson and
Mellor its value is 0.6, while it is 0.2 in DCs. The change in annual demand for
food items can be estimated from
the following formula:
AD = 1 + εY
Where AD represents the annual changes
in demand for food items, 1 shows the growth rate of population and ε denotes
the income elasticity of demand for agri. goods.
As the population growth rate
is higher in UDCs, hence income elasticity of demand for agri. or food goods
remains higher. Accordingly, there exists the possibility of increase in prices
of food items, particularly when in these countries elasticity of supply is very
low as there exist so many obstacles in the way of raising the level of agri.
outputs. This state of affairs was observed during the year-2004 in Pakistan
when wheat prices soared up. This led to promote inflation on the one side,
while on the other side the precious foreign exchange had to be spent on the
importation of one million tons of wheat. Thus, when the demand for food items
went on increasing, but the supplies could not match, the costs of production of
the farmers will increase as they have to pay a higher price for agri. inputs
due to inflation. As a result, the supplies of agri. sector will decrease, and
the agri. sector will not play a positive role in economic development.
The fiscal and monetary policies also become helpful in the mobilization
of resources. As, during 1893-97, in Japan, 80% of total tax revenues were
raised through agri. sector, while its ratio was 50% in the period of 1913-17. But in Pakistan like countries, due to political and administrative
reasons the agri. sector could not be taxed. As a result, the surplus would not
rise and thus the agri. sector could not be able to contribute towards
As agri. and industrial sectors are complementary, yet the growth of
industrial sector depends upon the provision of surplus by agri. sector. But we
have said above that in the developing countries the agri. sector is unable to
play a positive role in capital formation through resource transfer etc.
Therefore, the experts are of the view that if we enhance productivity in agri.
sector, i.e., the production of food items is increased the market surplus or
the difference between production and consumption of food will come into being.
Such market surplus could be used for capital formation. Now we discuss it in
Concept of Marketed Surplus:
Adam smith, in 1776, said:
"When due to
improvement and cultivation of land the whole of the society could be provided
with half of laborers the other half of the society can be used to meet the
desires and fantasies of the whole society".
In the same way, we find from Nurksey and Lewis models that the economies which have surplus agri. manpower
can shift their surplus labor to other projects without any fall in agri.
output. Again, through such shifting the overall consumption of labor force
remaining in agri. sector and those migrated to other sectors remains the same.
As the marketed surplus is the difference between total output and total
consumption of food, if the per capita consumption remains the same, the
marketed surplus could be used for real capital formation. Accordingly, the
greater is the amount of market surplus more will be the capital formation, But
if the consumption increases the capital formation may suffer. The marketed
surplus could also rise if the terms of trade between agri. goods and industrial
good is kept low, or the terms of trade go against agri. sector. This is
possible only when the prices of agri. goods remain lower. Now we see how the
marketed surplus rises due to adverse terms of trade of agri. goods.
Market Surplus and Terms of Trade:
Through the following methods the terms of trade can be kept against agri.
(i) Through price controls the prices of
agri. goods should not be allowed to
rise in the same proportion to rise in prices of industrial goods.
(ii) Those manufactured goods which are used by villagers should be taxed.
(iii) By providing protection to domestic industrial sector the prices of
manufactured goods be allowed to rise while the prices of agri. goods be kept
(iv) The state trading be promoted in manufacturing sector.
By following first and third proposal the profits of private producers will
increase. Then by taxing such profits through fiscal policy govt. will be able
to enhance its revenues which could be utilized for capital formation. While by
following second and fourth proposals govt. will be able to raise its' revenues
directly which could be used for the capital formation. This must be kept in
mind that the greater the population is shifted from agri. to non-absorbed
sectors more should be the terms of trade against agri. sector so that more
prospective saving could be observed.
Limitations of Market
This policy has the following
(i) When surplus labor is shifted from agri. to non-agri. sector, the persons
remaining in the agri. sector may start consuming more food than earlier as they
will be feeling better than earlier . This is called Income Effect which may
have the effect of decreasing marketed surplus.
(ii) When the terms of trade are kept against agri. sector it will give rise to
further two effects which are known as Derived Income effect and Substitution
Effect. As because of adverse terms of trade the real incomes of the farmers
will fall. As a result, they may decrease the demand for goods and services
including their own. This will increase marketed surplus. But as because of
adverse terms of trade the agri. goods are cheaper than manufactured goods, they
may start exchanging the agri. goods with other agri. goods, rather with
manufactured goods. Therefore, if the direct income and substitution effects are
powerful than the derived income effect the marketed surplus will decrease.
(iii) When the terms of trade are made against agri. sector, the people engaged
in agri. sector may be discouraged, as:
"It will reduce the incentive to work
more and increase output. Again, this may also happen that because of depressed
wages in agri. sector, the agri. labor could start shifting to other sectors of
the economy. This will increase unemployment and underemployment, particularly
in urban areas. Again, due to adverse terms of trade when the resources of agri.
sector are shifted to industrial and commercial sectors of the economy, their
profits will increase. This will develop inequalities in income distribution.
Such situation may increase".
Marketed surplus but this will also encourage
socio-economic unrest. This was practically observed in Pakistan during 60s and
70s when economic policies aimed at keeping the terms of trade against agri.
(iv) When terms of trade go against agri. sector, it may happen that the
farmers could start selling less than earlier. As a result, the marketed surplus
will decrease. But this is possible where economic and financial position of
farmers is strong as they could retain their surplus output for some period.
This has been observed in Pakistan that big farmers earned a lot despite
unfavorable terms of trade for agri. sector as they gave wages to the labor
even less than subsistence, particularly, when the population was increasing and
industrial sector was not capable enough to provide jobs to rising manpower.
These landlords got the cheapest water, got the new varieties of seeds when the
small farmers were hesitant to use them and they remained exempt to income tax.
In such situation, the adverse terms of trade affected the small and medium
farmers. While whole of the
advantage was taken away by the industrialists and the businessmen, whereas
govt. failed to get enough revenues as they neither paid tax against such
profits nor reinvested in industrialization. Moreover, this led to reduce the
welfare of both agri. and non-agri. consumers, as because of higher prices, the
consumer surpluses decreased. Again, the domestic consumers had to purchase the
From the above discussion we find that the effects of adverse terms of trade
are concerned with the size or land holdings. Again, the favorable terms of
trade led to provide the food cheaper to urban consumer whereas it decreased the
incentives amongst the farmers. As a result, Pakistan like country, except the
years 2001 to 2003, had to import wheat in a bulk amount. The wheat crisis
became more acute in 2007-08.
(v) So many experts are of the view that
rather keeping terms of trade against agri. sector, the agri. sector be provided with subsidies in order to purchase agri.
inputs like fertilizers, seeds, tube-wells, tractors, threshers, sprays,
pesticides and other agri. implements. This will increase agri. productivity on
the one side, while on the other side, the demand for non-agri. goods will
increase. This will also lead to promote capital formation in the country. This
was particularly observed with positive results during 60s in the period of
But the policy of subsidies have always been objected that they lead to
un-optimal allocation of resources as here outputs are increased mere on the
ground of monetary incentives. Moreover, the subsidies will lead to have an
additional burden on the part of govt. which will ultimately be .borne by urban
consumer and govt. and non-govt. employees engaged in services sector whom upon
the taxes will be imposed or govt. will have to follow the policy of deficit