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Home Agriculture and Economic Development Agriculture Sector and Capital Formation in Developing Countries


Agriculture Sector and Capital Formation in Developing Countries:


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 Nurksey Model, 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 development.


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 detail.


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. sector.


(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 fixed.


(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 Surplus Policy:


This policy has the following limitations:


(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. sector.


(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 inferior products.


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 Green revolution.


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 financing.


Relevant Articles:


Role of Agriculture Sector in Economic Development of a Developing Country
Structure of Third World Agrarian System
Economics of Agricultural Development/Stages of Agricultural Development
Strategy for Agricultural and Rural Development
Economics of Small Scale Agriculture
Economics of Agriculture Specialization
Role of Agriculture in Economic Growth
Agriculture Surplus as a Source of Capital Formation and Economic Development
Surplus Labor as a Source of Capital Formation and Economic Development
Agriculture Sector and Capital Formation in Developing Countries
Land Reforms or Agrarian Reforms
Land Reforms Measures
Effects of Agrarian Reforms
Agrarian Reforms and Economic Development
Green Revolution (GR)
Nature of Green Revolution (GR)
Causes or Importance of Green Revolution (GR)
Effects of Green Revolution (GR) on Income
Problems/Demerits of Green Revolution (GR)
Relationship Between Farm Size and Farm Output with Respect to Productivity
Productivity of Lands
Relationship Between Green Revolution and Size Productivity

Principles and Theories of Micro Economics
Definition and Explanation of Economics
Theory of Consumer Behavior
Indifference Curve Analysis of Consumer's Equilibrium
Theory of Demand
Theory of Supply
Elasticity of Demand
Elasticity of Supply
Equilibrium of Demand and Supply
Economic Resources
Scale of Production
Laws of Returns
Production Function
Cost Analysis
Various Revenue Concepts
Price and output Determination Under Perfect Competition
Price and Output Determination Under Monopoly
Price and Output Determination Under Monopolistic/Imperfect Competition
Theory of Factor Pricing OR Theory of Distribution
Principles and Theories of Macro Economics
National Income and Its Measurement
Principles of Public Finance
Public Revenue and Taxation
National Debt and Income Determination
Fiscal Policy
Determinants of the Level of National Income and Employment
Determination of National Income
Theories of Employment
Theory of International Trade
Balance of Payments
Commercial Policy
Development and Planning Economics
Introduction to Development Economics
Features of Developing Countries
Economic Development and Economic Growth
Theories of Under Development
Theories of Economic Growth
Agriculture and Economic Development
Monetary Economics and Public Finance

History of Money

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