metadata: authors: 0: author: Dethier, Jean-Jacques
1: author: Effenberger, Alexandra
count: World
docna: 0: docna: Agriculture and development : a brief review
            of the literature
docty: Policy Research Working Paper
subtopic: Climate Change and Agriculture,Economic Theory & Research,Industrial Economics,Agricultural Research,Nutrition,Food Security,Economic Growth,Inequality,Armed Conflict
teratopic: Agriculture,Macroeconomics and Economic Growth,Poverty Reduction,Rural Development
abstracts: cdata!: After 20 years of neglect by
            international donors, agriculture is now again in the
            headlines because higher food prices are increasing food
            insecurity and poverty. In the coming years it will be
            essential to increase food productivity and production in
            developing countries, especially in Sub-Saharan Africa and
            with smallholders. This however requires finding viable
            solutions to a number of complex technical, institutional
            and policy issues including land markets, research on seeds
            and inputs; agricultural extension; credit; rural
            infrastructure; storage; connection to markets; rural
            nonfarm employment and food price stabilization. This paper
            reviews what the economic literature has to say on these
            topics. It discusses in turn the role played by agriculture
            in the development process and the interactions between
            agriculture and other economic sectors; the determinants of
            the Green Revolution and discuss the foundations of
            agricultural growth; issues of income diversification by
            farmers; approaches to rural development; and finally issues
            of international trade policy and food security which are at
            the root of the crisis in agricultural commodity volatility
            in the past few years.
repnme: repnme: Agriculture and development : a brief
            review of the literature
display_title: Agriculture and development : a
            brief review of the literature
listing_relative_url: /research/2011/01/13709767/agriculture-development-brief-review-literature
topicv3: Agriculture and Food Security m1326205 435,Agricultural Research m1326207 197,Economic Growth m1326241 471,Poverty m1326687 695,Revolutionary Violence m1327774 2465
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Agriculture,Macroeconomics and Economic Growth,Poverty Reduction,Rural Development
no_of_pages: 60
model_extractions: WPS5553 Policy Research Working Paper 5553 Agriculture and Development A Brief Review of the Literature _Jean-Jacques Dethier Alexandra Effenberger_ The World Bank Development Economics Research Support Unit January 2011
Policy Research Working Paper 5553

# **Abstract**

After 20 years of neglect by international donors, agriculture is now again in the headlines because higher food prices are increasing food insecurity and poverty. In the coming years it will be essential to increase food productivity and production in developing countries, especially in Sub-Saharan Africa and with smallholders. This however requires finding viable solutions to a number of complex technical, institutional and policy issues including land markets, research on seeds and inputs; agricultural extension; credit; rural infrastructure; storage; connection to markets; rural nonfarm employment and food price stabilization. This paper reviews what the economic literature has to say on these topics. It discusses in turn the role played by agriculture in the development process and the interactions between agriculture and other economic sectors; the determinants of the Green Revolution and discuss the foundations of agricultural growth; issues of income diversification by farmers; approaches to rural development; and finally issues of international trade policy and food security which are at the root of the crisis in agricultural commodity volatility in the past few years.

This paper is a product of the Research Support Unit, Development Economics. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The authors may be contacted at jdethier@worldbank.org and Alexandra_Effenberger@brown.edu.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# **Agriculture and Development. A Brief Review of the Literature**

Jean-Jacques Dethier and Alexandra Effenberger<sup>1</sup> January 2011

## **Table of Contents**

|Introduction................................................................................................................................................... 2|
|---|
|The Role of Agriculture in Development..................................................................................................... 6|
|_Agriculture, Growth and Poverty Reduction_............................................................................................ 6|
|_Agriculture and the Urban Bias_.............................................................................................................. 11|
|The Foundations of Agricultural Growth.................................................................................................... 13|
|_Green Revolution and Technology Adoption_.......................................................................................... 13|
|_Agricultural R&D and Appropriate Technologies_.................................................................................. 15|
|_Extension Services as a Means to Foster Adoption_................................................................................ 18|
|_Environmental Challenges_...................................................................................................................... 19|
|_Barriers to Technology Adoption_............................................................................................................ 21|
|_Farm Size and Land Tenure_.................................................................................................................... 23|
|The Rural Non-Farm Sector and Rural Development................................................................................. 27|
|_Income Diversification in Rural Areas_................................................................................................... 27|
|_Changing Approaches to Rural Development_........................................................................................ 30|
|Agricultural Policy and Food Security........................................................................................................ 35|
|_Market Distorting Policies of Developed Countries_............................................................................... 35|
|_Food Security, the Recent Food Price Crisis and Its Consequences_...................................................... 38|
|_Price Transmission and Stabilization Policies_....................................................................................... 41|
|_Mitigating Food Price Volatility and Ensuring Food Security_............................................................... 43|
|Conclusion.................................................................................................................................................. 44|
|References................................................................................................................................................... 47|

> 1 Jean-Jacques Dethier (jdethier@worldbank.org) is with the World Bank, Washington, and Alexandra Effenberger (Alexandra_Effenberger@brown.edu) with Brown University, Providence.  We are grateful to Jock Anderson, Alain de Janvry, Shiva Makki and Will Martin for useful comments and suggestions.  Any errors remain entirely ours.

1
# **Introduction**

The agricultural sector continues to play a crucial role for development, especially in low-income countries where the sector is large both in terms of aggregate income and total labor force. The World Bank‘s 2008 World Development Report, _Agriculture for Development_ , explained why the decline in the support of agriculture by international donors (see Figure 1) was so damaging for the progress of growth, development and poverty reduction in poor countries. The report was a landmark document that described masterfully the various dimensions of the challenge and helped rekindle interest in agricultural policy. But with the food, financial, and climate crises of the past three years, much has changed since the report was released in late 2007. A major concern has been increased exposure to shocks, worsening food insecurity and vulnerability to poverty.<sup>2</sup> It seems to be an appropriate time to review the economic literature on agriculture, focusing on the issues that are critical for agricultural productivity and poverty reduction. This is the modest ambition of this paper.

In the first section, we discuss the role played by agriculture in the development process and the interactions between agriculture and other economic sectors. Agriculture contributes to both income growth and poverty reduction in developing countries—by generating income and employment in rural areas and providing food at reasonable prices in urban areas. The sector matters greatly in low-income countries where about 60 percent of the labor force is employed in agriculture: it accounts for 25 percent of GDP (but only 9 percent in middle-income and 1 percent in high-income countries). Of the 5.5 billion people who live in developing countries, 3 billion live in rural areas. Agriculture is the main source of livelihood for 86 percent of these rural households. Some 75 percent of poor people still live in rural areas and derive the major part of their income from the agricultural sector and related activities. Agriculture provides food, income and jobs and hence can be an engine of growth in agriculture-based developing countries

> 2 In an interview with Newsweek magazine (January 23, 2011), the President of the World Bank, Robert Zoellick, stated that the largest challenge facing most developing countries in 2011 is the risk of a big boost in food prices. He saw two challenges related to agriculture. First is the need to increase food productivity and production in developing countries, especially in Sub-Saharan Africa and with small-holder farmers. To achieve this, a number of problems need to be addressed: property rights; R&D for seeds and inputs; irrigation; fertilizer; agricultural extension; credit; rural infrastructure; storage; and connection to markets. The second problem is the volatility of food prices, often because of events outside the control of poor countries. An interconnected combination of steps could help ensure that the most vulnerable countries and people get the nutrition they need.

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and an effective tool to reduce poverty in transforming countries.<sup>3</sup> Balancing agriculture and industry is an important—though difficult—dimension of development policy. Recently ―agropessimist‖ views—based on the observation that agriculture in developing countries is often the least productive sector—have been voiced in the literature.<sup>4</sup> In the second section, we look back on the determinants of the Green Revolution and discuss the foundations of agricultural growth. In developing countries that have experienced sustained increases in yields, the mode of agriculture has been intensive and has involved adoption of new varieties by farmers, irrigation and massive use of fertilizer—with predictable environmental consequences—which presupposes good institutions. In the coming decades, massive productivity increases in Sub-Saharan Africa will be necessary if the subcontinent is to catch up with the rest of the world. The challenge is thus of a different nature than before. Further cropland expansion (which was the basis for the slow yield increases that took place in the past), with a few exceptions, is really not possible. New seeds that are resistant to climate risks and adapted to local conditions will need to be developed and sustainable irrigation systems expanded. The most difficult challenges are institutional and economic. Often smallholders cannot internalize the benefit of their efficiency (compared with large farms) because of missing markets for insurance and credit, low education levels, limited market access and market information, and insecure property and usage rights. Hence, although new advances in R&D— such as genetically modified organisms and extension services—are important for future growth and poverty reduction, getting fundamental institutions right is a prerequisite for growth and a priority on the agricultural development agenda.

> 3 The 2008 World Development Report establishes a typology of countries (World Bank 2007). In agriculture-based economies, agriculture contributes on average 32 percent to overall economic growth and the majority of the poor live in rural areas, In transforming countries, agriculture contributes on average 7 percent to overall growth but poverty is still mostly rural. In urbanized countries, agriculture accounts for only 5 percent of economic growth and urban poverty is higher than poverty in rural areas.

> 4  Of course, at the early stages of development, agricultural growth is an important source of overall economic growth and a major driver behind structural transformation of the economy. But authors like S. Dercon or D. Gollin, while accepting this fact, observe that linkages between agriculture and industry are less important for overall growth in open economies (in which goods from productive sectors including agriculture are traded) than in more closed economies. Their main argument is that, in an open economy, importing food and focusing efforts on other sectors might be more beneficial to a country‘s development if it is difficult to increase the productivity of agriculture.

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In the third section, we broaden our focus and look at the rural sector as a whole, examining why rural households diversify their income and reviewing various approaches to rural development. Non-farm employment is an important income source for the poor and an effective way out of poverty for rural households, as well as a means to cope with missing insurance and credit markets. However, while the rural non-farm sector is a source of additional employment opportunities and an instrument to reduce poverty, diversification of income by farmers does not necessarily guarantee upward mobility. In order for this to happen, proper education and information about and access to non-farm jobs are necessary. As a consequence, rural development programs have to incorporate such needs into their strategies. Past experiences have shown that private provision of certain goods and services can easily fail and therefore it is important to have an ―enabling state‖ to orchestrate and initiate these activities without being their sole purveyor. Their implementation should take advantage of private sector initiatives and local civil society expertise. New approaches such as community-driven development can be successful in managing common resources and local projects. But the lesson from the past is that they fail in the absence of egalitarian preferences and social capital among community members. Balancing centralization and decentralization of program implementation—a difficult undertaking—is hence the key for successful rural development.

In the fourth section, we review trade policy and food security concerns in the light of the deadlock in the Doha round, the 2008 crisis in agricultural commodity prices, and today‘s volatility in food prices. We argue that insulating poor people from world food price swings and the elimination of trade barriers for developing country agricultural exports, in the context of the WTO trade negotiations, are both of utmost importance for the reduction of poverty in lowincome countries. Developed countries should reduce these trade barriers further as low-income country exports are mainly agricultural goods and these countries lose most from current protectionism. For the negotiations to succeed, this must go hand-in-hand with a reduction in trade barriers by developing countries. Price volatility and beggar-thy-neighbor policies to stabilize prices and guarantee national food security by some countries during the 2008 food price crisis have harmed vulnerable and poor populations and reversed some past gains in the global effort to reduce chronic poverty. Trade and market interventions to stabilize agricultural prices have failed or met with very limited success. Even when unilateral policies have succeeded in stabilizing domestic prices, they have increased the volatility of international prices 4
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The Role of Agriculture in Development

# _Agriculture, Growth and Poverty Reduction_

Having been a key preoccupation of developing country governments, donors and the international community during the 1960s and 1970s, agriculture disappeared from the development agenda in the 1980s and 1990s, only to reappear in the first decade of the 21<sup>st</sup> century because of neglect and underinvestment (see Figure 1). There is now renewed interest in the problems of the sector—not to a small extent, thanks to the 2008 World Development Report. For example, the G8 countries promised $22 billion for investment in agriculture during their meeting in Aquila, Italy in 2009 (de Janvry 2010).

Developing economies have generally been described as dual economies with a traditional agricultural sector and a modern capitalist sector.<sup>5</sup> Productivity is assumed to be lower in agriculture than in the modern sector. The canonical model was put forward by Lewis (1954) and subsequently extended by Ranis and Fei (1961). Lewis‘ model rests on the idea of surplus labor existing in the agricultural sector. With lower productivity in agriculture, wages will be higher in the modern sector, which induces labor to move out of agriculture and into the modern sector, which in turn generates economic growth. Other precursors, such as Schultz (1953), also point out the importance of food supply by the agricultural sector. In Schultz‘s view, agriculture is important for economic growth in the sense that it guarantees subsistence for society without which growth is not possible in the first place. This early view on the role of agriculture in economics also matched the empirical observation made by Kuznets (1966) that the importance of the agricultural sector declines with economic development. In this view, agriculture‘s role in economic development is to supply cheap food and low wage labor to the modern sector. Otherwise, both sectors have few interconnections. Growth and higher productivity in the agricultural sector can contribute to overall economic growth by releasing labor as well as capital to other sectors in the economy. However, industrialization is seen as the ultimate driving force behind a country‘s development and agriculture as a traditional, low productivity sector.

> 5 For a more detailed treatment of such models see, for example, Cypher and Dietz (2008), Diao et al. (2006) or Barrett, Carter and Timmer (2010).

6
Improving on the Lewis model, Johnston and Mellor (1961) account explicitly for agriculture as an active sector in the economy. In addition to labor and food supply, agriculture plays an active role in economic growth through important production and consumption linkages. For instance, agriculture can provide raw materials to nonagricultural production or demand inputs from the modern sector. On the consumption side, a higher productivity in agriculture can increase the income of the rural population, thereby creating demand for domestically produced industrial output. Such linkage effects can increase employment opportunities in the rural non-farm sector, thereby indirectly generating rural income. Moreover, agricultural goods can be exported to earn foreign exchange in order to import capital goods.

The importance of such linkages was further stressed by Singer (1979) and explicitly embodied in Adelman‘s general equilibrium idea of ―agricultural demand led industrialization‖ (ADLI), according to which, because of production and consumption linkages, a country‘s development strategy should be agriculture-driven rather than export-driven and increased agricultural productivity would be the initiator of industrialization. Moreover, emphasis should be placed on small-to-medium-size farmers because they are more likely to use domestically produced intermediate goods as opposed to large-scale producers who might import machinery and other inputs, which would weaken the linkages between agriculture and other sectors (Adelman 1984).

The fact that there are important linkages between the traditional and modern sectors in developing countries makes agricultural growth an important instrument for decreasing poverty. The contribution to poverty reduction takes place directly, through the effects of agricultural growth on farm employment and profitability, and indirectly because increases in agricultural output induce job creation in upstream and downstream non-farm sectors as a response to higher domestic demand. Potentially lower food prices increase the purchasing power of poor consumers. The magnitude of these effects for poverty reduction depends on the specific circumstances of an economy. If, for example, technological progress in the agricultural sector is labor-saving, farm-employment might not necessarily increase (Irz et al. 2001).

While most of the literature views agriculture as an active and dynamic economic sector, some authors reach quite different conclusions. As pointed out by Gollin (2010), the large share of agriculture in many developing economies does not immediately imply that overall growth 7
has to be based on an ADLI-type strategy. Matsuyama (1992) suggests that the relation between agricultural growth and overall economic growth depends on the openness of a country to international trade. Whereas agricultural growth goes hand in hand with economic growth in small, closed economies—where gains in agricultural productivity will lead to the linkage effect described above—the relation might be reversed in the case of an open economy. If the country has a comparative advantage in agriculture, openness to trade will draw resources away from the modern sector into agriculture, which might be less productive than industry. The importance of the degree of openness of a country was pointed out early on by proponents of ―agriculture-first‖ approaches to development. For instance, Fei and Ranis (1961) acknowledged that imports could potentially substitute for domestic agricultural products. Adelman (1984) suggested that ADLI would work best for low-income countries that are not yet export-driven; and Foster and Rosenzweig (2003) stress that the tradability of rural non-farm sector goods can have different implications. In a general equilibrium perspective, productivity gains in the agricultural sector have a negative impact on the tradable non-farm sector. This is because agricultural products as well as rural non-farm non-tradables have a relatively inelastic demand for labor, whereas tradable goods have more elastic labor demand. If wages increase due to greater agricultural productivity, factories producing tradable goods, which are assumed to be operated by external producers, will move to escape the higher wages.

There is also a vast literature ranging from critical contributions that do not support ―agriculture-first‖ approaches to more recent ―agro-pessimism‖ views. The latter are based on the observation that agriculture in developing countries might be the least productive sector in the economy. Dercon (2009) derives his conclusion from a two-sector model elaborated by Eswaran and Kotwal (1993). He explains that, in an open economy, in which both agricultural and modern-sector goods can be traded, linkages between the two sectors become less important for overall growth. As a result, there is less of a necessity to increase agricultural productivity to induce overall growth and reduce poverty. Both sectors can contribute to growth. But if agriculture is less productive than other sectors, importing food and focusing efforts on other sectors might be more beneficial to a country‘s development. Both Dercon and Gollin admit that, under certain circumstances, the agricultural sector can be crucial for economic growth. If countries are landlocked and closed to international trade, agriculture can be a main driver behind overall growth and should be supported actively.

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Although various theoretical models suggest quite opposing roles for agriculture in development, they do not necessarily contradict each other. The models are derived under different economic assumptions (e.g., openness to trade). Therefore, it is not surprising that they derive different policy implications. Because developing countries differ with respect to their economic environments, the role of agriculture for development might be re-evaluated in each specific case. This is in line with the 2008 World Development Report‘s message (World Bank 2007), which suggests that in agriculture-based economies, agriculture can be the main engine of growth, whereas in transforming countries, agriculture is already less important as an economic activity but is still a major instrument to reduce rural poverty. In urban countries, by contrast, agriculture plays the same role as other tradable sectors and subsectors with a comparative advantage can help to generate economic growth.

So far our discussion has mostly considered theoretical models. We now turn to the empirical investigation of the relation between the agricultural sector and economic growth, which has a long history. Early contributions by Kuznets, Chenery and others focused on sector changes accompanying economic development. In 1966, Kuznets observed that as economies develop, the share of agriculture in output and employment diminishes, which later empirical data have reconfirmed. Other important early contributions include Chenery and Syrquin (1975), who combined cross-section and time-series data over 1950 – 1970.

More recently, Timmer (2002) used a panel of 65 developing countries over 1960 – 1985 to show a positive correlation between growth in agricultural GDP and its lagged values and nonagricultural GDP growth. He suggests that this correlation can be explained by ―first-order‖ effects of agricultural growth on lower food prices, labor migration and capital flows from agriculture, as well as ―second-order‖ effects such as improved nutritional intake, which improves workers‘ productivity. Similarly, Self and Grabowksi (2007) established a positive relation between different measures of agricultural productivity and average growth of real GDP per capita over 1960 – 1995 for a cross-section of countries. However, on the basis of panel data from 52 developing countries during 1980-2001, Gardner (2005) concluded that agriculture does not seem to be a primary force behind growth in national GDP per capita.

The recent empirical literature considers that the effect of agricultural progress on poverty alleviation is highly positive. Mellor (2001) goes as far as arguing that it is not economic 9
growth in general that reduces poverty in developing countries, but the direct and indirect effects of growth in agriculture. In their study of poverty in India over a 35-year period, Datt and Ravallion (1996, 1998) find that higher farm productivity reduces both absolute as well as relative poverty. This is partly due to a direct channel of higher household income operating in the short run and partly due to indirect channels, such as higher wages and lower food prices in the longer run. Other empirical studies also suggest that these are the main channels and not labor migration from agriculture into other sectors. This strengthens the argument for supporting agricultural growth.<sup>6</sup> Similarly, Loayza and Raddatz (2010) show for a cross-section of developing countries that growth in more labor-intensive sectors such as agriculture has a larger impact on poverty reduction than less labor-intensive activities. Christiansen and Demery (2007) estimate that 1 percent per capita agricultural growth reduces poverty 1.6 times more than the same growth in industry and three times more than growth in the service sector. Case studies confirm these cross-country findings. For example, Dercon and Christiaensen (2005) estimate that among 15 villages in Ethiopia consumption per adult equivalent is 8.5 percentage points higher if households use fertilizers, i.e., inputs to increase farm productivity. Another channel through which agricultural growth can reduce poverty is employment generation in the nonagricultural sector. Mellor (2001) finds that this effect is mostly driven by increased consumption demand and not so much by production linkages. Hence, it can be said that agricultural growth is a central instrument in helping the poor in developing countries.

However, although these empirical investigations establish correlation between agriculture and GDP growth, they do not imply causation in either direction. The correlation observed could be spurious if both sectors have been growing independently from each other or as a result of a common third factor. As a result, studies that have argued a causal effect of agricultural growth on economic growth have been criticized. To address this issue of endogeneity in empirical work, Tiffin and Irz (2006) use Granger causality tests to establish that agricultural value added per worker has a positive effect on GDP per capita in developing countries. Bravo-Ortega and Lederman (2005) also employ panel data tools such as GMM and Granger causality tests to re-estimate the effect of agricultural growth on the overall growth rate.

> 6  The 2008 World Development Report suggests that the recent reduction in rural areas in developing countries has been driven by improvements in conditions in rural areas rather than by migration to urban areas (World Bank 2007).

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Using 1960-200 panel data, they find that an increase in agricultural GDP raises non-agricultural GDP in developing countries, whereas a reverse relation exists for developed countries. The authors suggest that there exist regional differences of the positive relation in developing countries, where the effect is higher in non-Latin American and Caribbean countries.

An additional problem that arises with cross-country studies is that differences in country conditions do not allow for a general relationship between agricultural and aggregate economic growth. Factors such as openness to trade could alter the relation between agriculture and nonagriculture. Global markets can be a substitute for what Timmer (2002) calls first-order effects of agricultural growth (because they provide international capital flows and food imports). This might explain the different magnitudes of the positive relation found by Bravo-Ortega and Lederman (2005) for Latin America compared with other regions. Hence, the importance of linkages between the agricultural sector and the rest of the economy differs across countries. Some authors have tried to shed light on the importance of such linkages in different developing countries. As shown by de Janvry and Sadoulet (2009b) for China over 1980 – 2001, a 1 percent agricultural growth had an effect on aggregate growth of 0.45 percent, whereas the indirect effect through the non-agricultural sector represents half this effect. In line with Mellor‘s findings for non-agricultural employment, multipliers from agriculture to the rest of the economy have been mainly driven by consumption linkages (Thirtle et al. 2003, Tiffin and Irz 2006).

# _Agriculture and the Urban Bias_

Probably the most important contribution to development made by the agricultural sector in poor countries in the past has been to provide the savings, i.e., the surplus—extracted through various means—over and above what is required for the reproduction of agricultural producers, which allowed industrialization to take place. The tax and price policies that are necessary to bring about surplus extraction have been extensively discussed in the literature (see Sah and Stiglitz 1984, Carter 1986). They were made famous by the policy discussions between Preobazhensky and Bukharin during the 1920s about the so-called ―primitive‖ forms of socialist accumulation in the Soviet Union where farmers faced artificially low prices for their output and punitive taxation throughout the 1920s and 1930s (Conquest 1987). Consistent with these early models of agriculture as a sector generating a surplus that can be extracted for the benefit of industry, in the recent past, governments in developing countries have imposed a heavy burden 11
on agriculture by implementing urban-biased policies. A World Bank multi-country study led by Anne Krueger, Maurice Schiff and Alberto Valdès provides empirical support for the view that price policy, trade policy and exchange rate policy in virtually all developing countries have discriminated against agriculture, either directly through food subsidies or taxes on agricultural exports, or indirectly through manufacturing protection and exchange rate overvaluation. Over 1960 – 1984, these policies extracted an average of 46 percent of agricultural GDP from this sector in 18 developing countries (Krueger, Schiff and Valdes 1998). This massive study confirmed the hypothesis of T.W. Schultz who, in his famous 1964 book _Transforming Traditional Agriculture,_ argued that peasants in poor countries were not backward and ―traditional,‖ but, on the contrary, rational decision-makers who maximized the return from their resources. Their apparent unwillingness to innovate, he argued, was rational because governments of developing countries often set artificially low prices on their crops and taxed them heavily. In other words, peasants respond to incentives.

The Krueger, Schiff and Valdès study was recently updated, under the direction of Kym Anderson. The new study reaches similar conclusions but shows that, since the mid-1980s, the inter-sector bias against agriculture and the antitrade bias have been substantially reduced (Anderson 2009). Many developing countries have undertaken a great deal of policy reform and opened to trade and benefited proportionately more (relative to GDP) than high-income economies from those trade-related policy reforms. Developing countries would gain nearly twice as much as richer economies by completing the reform process – with 72 percent of those prospective gains to developing countries coming from agricultural and food policy reform. In developing countries, net farm income (agricultural value added) is estimated to have been 5 percent higher in 2004 than it would have been without the reforms since the mid-1980s. And if policies remaining in 2004 were removed, net farm income would rise by another 6 percent (far more than the proportional gain to nonagricultural households). These reforms could further alleviate global inequality and poverty, since three-quarters of the world‘s extreme poor are in farm households in developing countries. One way to look at policy changes over the past 25 years would be to say that developing countries follow the example of higher-income countries in moving from anti to pro-farmer policies as they develop. The Anderson study shows that import-competing farmers in developing countries are being increasingly protected over time.

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Agricultural production has been directly supported by subsidies to farm inputs such as fertilizers and irrigation in many developing countries, such as India. Such policies generally benefit more large farmers than smallholders (de Gorter and Swinnen 2002). Bezemer and Headey (2008) argue that public policies that actively support agriculture, such as pricing or support to agricultural research and extension, are a necessary prerequisite for agricultural growth and that agricultural market liberalization has not benefited small farmers due to market failures and distortions.

Asia‘s Green Revolution was supported by government interventions sustained for long periods, such as fertilizer subsidies that reduced prices to 25 percent of their world market price. Indonesia‘s rice growth of 5 percent over 1970 – 1988, for example, was mainly been achieved by government pricing, research and investments in the rice sector (Gonzales et al. 1993). But such public large-scale interventions put a heavy burden on government budgets, are not a good use of public funds and are not sustainable over time. They also have other detrimental effects. For instance the subsidization of fertilizer in Asia has led to misuse and soil degradation.

Hence, although urban biases seem to be detrimental for agricultural growth by fostering industry, agricultural market interventions such as input subsidies or price support are costly and lead to mismanagement of resources. The liberalization of the market for agricultural outputs, while it does not impose a bias on either sector, can affect the competitiveness of smallholders.

The Foundations of Agricultural Growth Having reviewed the role that agriculture can play in economic development, we now look at the performance of the agricultural sector in different regions of the world, the foundations of agricultural growth and the challenges faced by farmers in developing countries today that might diminish the returns to agricultural technologies. These include the structure of agricultural production, environmental factors, and barriers to technology adoption.

# _Green Revolution and Technology Adoption_

Between 1980 and 2004, the agricultural sector grew at an average rate of 2.6 percent worldwide, with two-thirds of this growth contributed by Asian economies. Agricultural yields in Asia increased at an average rate of 2.8 percent between 1961 and 2004, an outcome largely 13
explained by the adoption of high-yielding varieties and the intensive use of fertilizer. In SubSaharan Africa, the average rate of agricultural growth was 3 percent over the same period but growth per capita of the agricultural population (a broad measure of agricultural income) was 0.9 percent, less than half the growth rate in other regions. Moreover, whereas agricultural growth during the Green Revolution in Asia was driven by intensification, agriculture in Sub-Saharan Africa has been growing mostly as a response to land expansion and yields have been stagnant. Since the potential for land expansion will soon be exhausted, further agricultural growth will have to come from increased yields.<sup>7</sup> What needs to be done in order to achieve higher yields and, hence, agricultural growth in Sub-Saharan Africa?<sup>8</sup> The consensus about the need for a Green Revolution for Africa is universal but the characteristics of the African continent call for a different approach to the transformation of agriculture. In comparison with Asia, Africa is heterogeneous in terms of agro-ecological conditions, farming systems and types of crops planted. The FAO considers that there are 14 main farming systems in Sub-Saharan Africa. They depend rather weakly on rice or wheat, which have been the drivers of the Asian Green Revolution. Moreover, most agriculture is rainfed (de Janvry and Sadoulet 2009a) whereas the Green Revolution in Asia was partly driven by intensive irrigation. In fact, only 4 percent of crop area in Africa is irrigated, versus 34 percent in Asia. Another factor that makes the Sub-Saharan African context different is the underdevelopment of infrastructure, which hinders market access and leads to high transportation costs. As a consequence of the heterogeneity across Sub-Saharan Africa, several geographically separate revolutions will have to take place, in contrast to the Asian Green Revolution, which was based on wheat and rice (Staatz and Dembele 2007).

In order to understand past developments in agriculture and predict future ones, the mechanisms behind agricultural development and growth must be identified. Schultz (1964) formulated the idea that peasants are rational decision-makers maximizing the returns from the resources at their command and responding to incentives. Many of them remain poor not because they are ―backward‖ but because their government provides them with few technical and

> 7 The source of agricultural growth also matters for its impact on poverty reduction. Agricultural growth in East Asia has been achieved with technologies increasing labor productivity and has led to large reductions in poverty. By contrast, in Africa, where labor productivity gains in agriculture have been small and most growth has come from land expansion, poverty reduction has also been low (de Janvry and Sadoulet 2009b).

> 8 This discussion owes much to Binswanger-Mkhize and McCalla (2010).  Numbers are from the 2008 World Development Report.

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economic opportunities. Schultz stressed the importance of making inputs available to farmers (and increasing the capacity of industry to supply these inputs), generating new locally specific knowledge, and improving education about new seeds and technologies via extension services. Schultz‘s model did not specify which institutions could influence this process and facilitate the adoption of new technologies by farmers. This shortcoming was addressed by Hayami and Ruttan (1971, 1985), who developed a model of induced innovation to explain the factor bias of technological change. The causal sequence begins with changes in relative factor scarcities leading to changes in relative factor prices (under the assumption that markets actually exist and work). Prices, in turn, guide technological advances toward saving on the factors that become relatively more expensive. Since agricultural research is largely a public good, the government is the entity that needs to respond to market signals and factor endowments by allocating funds to alternative research programs. This occurs partly in response to producer demands for technologies that allow them to save on the factors that are becoming relatively more expensive and partly as a response to changing recourse constraints, such as the current environmental challenges described below. In comparing the long-run history of technological change in Japanese and US agriculture, for instance, Hayami and Ruttan found that, in labor-abundant but land-scarce Japan, technology has been mainly land-saving, allowing for rapid increase in the productivity of land. In the United States, where land was abundant and labor scarce, technology was mainly labor-saving and allowed rapid increases in the productivity of labor (see Ruttan 1998, 2002).

# _Agricultural R&D and Appropriate Technologies_

Identifying the characteristics of agriculture in Africa does not explain why yields are low. There are two broad problems. The first one is lack of appropriate technology and the second is lack of adoption. Whereas the former calls for better targeting of research to African countries and their conditions, the latter demands a reduction of the barriers to technology adoption. Of course, the problem of low yields can also be a combination of both inappropriate technology and barriers to adoption.

Agricultural R&D and its capacity to produce more productive technologies are at the heart of long-run agricultural growth. Such new technologies triggered the Green Revolution in Asia, and in light of the limited potential for land expansion in Sub-Saharan Africa such 15
inventions are also strongly needed for African farmers. Due to the heterogeneity of the countries and differences with, say, Asian countries, crops that have been planted in other regions might not be appropriate for Africa. Technological spillovers from high-income countries to lowincome African countries are unlikely. Moreover, regional differences are large within the continent and prevent technology spillovers among African countries (Pardey et al. 2007). The slow growth in yields can be partly explained by the slow introduction of suitable high-yield varieties during the 1980s and 1990s (Everson and Gollin 2003). This seems to be changing recently as a consequence of better targeting of international research directly at the subcontinent. In 2006, for example, the CGIAR spent 48 percent of its total budget on activities directly related to Sub-Saharan Africa. But the contribution of CGIAR research to total yield growth has been much smaller in Sub-Saharan Africa than in other regions. Yield growth itself has been much lower in Sub-Saharan Africa than in other regions due to lower adoption rates and lower use of fertilizers and other inputs, although new varieties have been introduced (Binswanger-Mkhize and McCalla 2010).

The heterogeneity of African countries calls for less reliance on international research and more on regional and domestic research; but expenditure on agricultural research in Africa is low and this has also contributed to stagnating yields (Binswanger-Mkhize and McCalla 2010). Public expenditure on agricultural research grew only by 1 percent during the 1990s (some countries have even seen negative growth). Around 40 percent of total agricultural research spending comes from donors and private agricultural research is very limited in Sub-Saharan Africa. In 2000, it contributed only 2 percent to overall research investment (Beintema and Stads 2008). In stark contrast to these low spending numbers, the number of agricultural researchers in Sub-Saharan Africa is 50 percent higher than in India and 30 percent higher than in the United States. But these researchers have less training than those in other regions of the world. Spending per researcher is much lower in Sub-Saharan Africa than in India or the United States, and lower compared with its past value. In real terms, it is now less than 50 percent of its level in 1981 (Pardey et al. 2007). Universities have not been integrated into national agricultural research systems (Staatz and Dembele 2007). Although international research organizations such as the CGIAR have shifted to more regional approaches and collaborations with national agricultural research organizations, universities seem to have been neglected, although they employ more PhD degree holders than other research organizations.

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Future research will need to have a regional focus and target specific needs. In fact, many regional initiatives have already been established. The New Partnership for African Development emphasizes heavily the role of agricultural R&D. Another important form of regionalization is participatory plant breeding, which supports especially the needs of smallholders. According to Ceccarelli and Grando (2007), this approach is different from normal plant breeding on stations in three ways: the testing and selection of seeds take place on the farm, the farmers are involved in the decision making, and it can be implemented at many different locations. The participation of farmers is expected to increase the rate of adoption of new seeds.

An important agricultural R&D question is what recent biotechnology advances can do for African agriculture and if it is the route to the continent‘s Green Revolution. Poor farmers might especially benefit from transgenic food crops because they are particularly diseaseresistant. Estimations by Edmeades and Smale (2006) show that transgenic bananas would be mostly adopted by poor, subsistence-oriented farmers and are therefore a ―pro-poor‖ variety. So far, however, transgenic crops are grown commercially only in South Africa (Eicher et al. 2006), where in 2006 transgenic white maize covered 44 percent of the total white maize area (World Bank 2007).

Although there is a broad consensus that biotechnology could be a driving force behind Africa‘s Green Revolution, several constraints have prevented its fast adoption so far. Until now, the private sector has done most of the research on transgenics and it does not necessarily suit the interests of poor farmers. Since private agricultural research plays only a very limited role in Africa, to promote broad adoption of transgenic crops, public research would have to adopt a stronger focus toward these new technologies. But strong intellectual property rights on existing technology could deter public research efforts. Another hurdle is the absence of biosafety regulations. Weak regulatory capacity in developing countries slows these processes (World Bank 2007). Many African policy makers are skeptical about biotechnology as a result of European consumers‘ concerns about health and environmental issues. Eicher et al. (2006) conclude that transgenic crops will be available for use by smallholders only in 10 to 15 years.

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# _Extension Services as a Means to Foster Adoption_

Even if new and more productive technologies are available, farmers might lack information about their existence and knowledge about proper implementation techniques. Extension services are educational devices that are meant to teach and provide information, enabling farmers to use and effectively manage new technology. These services have been used as a means to diffuse new technology in developing countries since the Second World War. Extension services also include related services, such as health and nutrition services. When they began after World War II, extension services mostly included education about new technologies, as well as input and credit provision (Birkhaeuser et al. 1991). However, most field staff lacked the necessary technical training and field experience to effectively deliver the services to farmers. During the 1970s, a new approach—mainly driven by the World Bank—called the ―training and visit‖ (T&V) approach began to spread. It included, in addition to teaching farmers about new technologies, obtaining their feedback about the problems they encountered. The feedback was forwarded to supervisors who were then supposed to solve such problems. Extension staff meets with only a limited number of contact farmers on a regular schedule. The cost of the new system, because of its greater staff requirements, was very high and this made it unsustainable. Anderson and Feder (2007) suggest that the impact of extension services has been rather mixed, with some projects having very high returns to investment and others only negligible success. A general problem with the T&V approach is that extension agents—who are civil servants—often lack accountability.

As described in two excellent review papers—Anderson and Feder (2007) and Alex et al. (2002)—the decentralization of the system, putting farmer groups or the private sector in charge of service provision, has been the response proposed to overcome these accountability problems. Farmer groups can in fact engage on both sides of the market for extension services. On the demand side, they can increase overall demand for information because they reach more farmers and can negotiate for their demands more successfully. On the supply side of the market, they can deliver services to their members and finance them.

In addition to increasing accountability and quality of service provision, privatizing extension services has also reduced the financial burden on the public sector and made services more financially sustainable. Nevertheless, globally only 5 percent of extension services are 18
provided by the private sector. Private extension services could respond better to demands from commercialized farmers but smallholders might be unaware of their own needs, unable to articulate them, and unable to afford services. Therefore, they might demand fewer services than they need. In this situation, provision by only the private sector to different group of farmers might not be the best solution. A better approach in this case would be a private-public partnership to provide services as well as a publicly funded but privately managed system. This would increase the efficiency of the system and cater to all groups of farmers.

The environment in which farmers operate today is changing and requires new ways to provide extension services. A recent idea is the introduction of information and communication technologies (ICTs) into extension services and rural development projects in general. ICTs can deliver information that is important for the development of rural areas in the long term (such as education) and in the short run (such as market information). For example, ICTs can be used for long-distance learning programs and thereby help to accumulate human capital. They can provide information on weather, price and profitable income diversification possibilities (Chapman and Slaymaker 2002). An important technology is cell phones, which can improve both private as well as public information. With mobile phones, agricultural extension services can be supplied at a lower cost and higher quality information can be provided. For example, increased mobile phone coverage has increased the efficiency of local markets in Niger (Aker 2010a,b).

# _Environmental Challenges_

The need for agricultural R&D and extension services is not new and their impact has been witnessed in Asia in the past. However, any agricultural revolution today will face environmental constraints that were not considered during the Green Revolution. The issue of the sustainability of agricultural systems is now high on the agenda and the preservation of ecosystems and biodiversity will be important for the potential of agriculture in the future. Most African yield increases have been achieved through expanding land under cultivation, which has led to deforestation and land degradation. Soil degradation can have a negative impact on the future productivity of land. In the highlands of Ethiopia, these negative effects have been so strong as to offset any gains from technological progress. In extensive areas, more intensive production can help establish a sustainable system. But since Africa‘s agricultural revolution will 19
have to come from increased use of inputs, intensification will need to be sustainable over time both economically and ecologically. African farmers have used low levels of fertilizers compared with farmers in other developing countries. Although some authors (e.g., Marenya and Barrett 2007) argue that once land is degraded, fertilizer will be ineffective, Matsumoto and Yamano (2009) do not find a diminishing yield effect of fertilizers as soil fertility decreases.

Reardon et al. (1999) suggest that intensification will have to be capital-led instead of being accomplished by employing more labor, and that abstaining from using fertilizers and other non-labor inputs can lead to soil mining and is hardly profitable. But capital-led intensification of agricultural production has its own negative environmental effects and has to be properly managed to be sustainable. Inappropriate use of fertilizers can, for example, lead to poisoning of humans and animals and water pollution, which in turn can have indirect consequences for larger ecosystems. Such negative effects have been observed in rice-wheat systems in South Asia (World Bank 2007). Hence, what is called for is well managed, capital-led intensification of agriculture, taking into account agro-ecological factors and avoiding environmental damage—what Conway and Toenniessen (2003) call the ―Doubly Green Revolution.‖ Global climate change will also have to be taken into account. Increasing global temperatures could lead to a drop in agricultural output mostly in tropical countries; and less rainfall could damage rain-fed agriculture and cause more frequent droughts. This is a special concern for Sub-Saharan Africa where most agriculture is rain-fed, so that climate change implies an increased risk for farmers. Compared with a no-climate-change scenario, agricultural GDP in Sub-Saharan Africa could decline by 2 to 9 percent. Adapting to the changing climate is, hence, a necessity for African farmers. New crop varieties that are more drought resistant and greater investment in irrigation systems are needed (World Bank 2007). Such adaption efforts should be part of the overall agricultural development strategies. Thanks to agricultural R&D, new technologies to cope with climate change already exist; but many households in Africa do not adjust their planting techniques (World Bank 2007). This is partly due to various barriers to adoption, an issue we now address.

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# _Barriers to Technology Adoption_

Despite some adoption of new crop varieties in Africa, adoption rates remain far below Asian rates. For example, in 2000, African adoption rates of modern varieties of rice, wheat and maize per area harvested were less than half those of rates in East and Southeast Asia (Gollin et al. 2005). To understand low adoption rates of new technologies, one needs to keep in mind the factors that determine a farmer‘s adoption behavior. While low adoption rates might seem irrational when looking at promised yields, they may well be a result of rational decision making by farmers given the various constraints they face (Brooks 2010). Technology adoption in general is positively related to a farmer‘s schooling and wealth and the adoption of the same technology by neighbors (Foster and Rosenzweig 2010a). Although this does not establish causality, it suggests that low education, missing credit markets and externalities could be major barriers to technology adoption.

The channel through which education can affect technology is learning. Higher levels of education increase the return to experience with a new technology, which makes a technology profitable after a shorter period of time for more educated farmers. Foster and Rosenzweig (2010a) find that, in India, the returns to previous planting of high-yield variety seeds are higher for educated than for illiterate farmers. The potential to learn about new technologies depends also on the available information about new technologies and their profitability. Extension and other services can – if properly implemented as discussed above – deliver the information a farmer needs to profitably adopt a new technology. Access to market or weather information is also important for producers. For example, Goyal (2010) finds that an Internet kiosk providing prices as well as a new marketing channel to soy farmers in India increased the share of soy cultivated area and concludes that improved information leads to higher returns. Weather information is important for adopting to climate change today. A program initiated in Mali in 1982 helped farmers to better control climate risk by providing timely weather information (World Bank 2007). The introduction of ICT is also closely related to the issue of learning and can facilitate and enhance the distribution of important information (Byerlee et al. 2010).

Another barrier to adoption is the lack of well functioning credit markets. If new technologies require initial investment, farmers who lack sufficient funds and cannot take out loans might be unable to adopt the technology even if it is highly profitable to them.

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Croppenstedt et al. (2003) find that credit constraints in Ethiopia severely restrict fertilizer adoption by farmers. Farmers‘ lack of collateral may be the cause of their restricted access to loans. Property rights for land can therefore be an important determinant of adoption. And, as discussed below in the section on land tenure, property rights are important for farmers‘ incentives to plant new varieties.

Risk and uncertainty about yields—especially high when a new technology is adopted— can also lead to low rates of adoption. Poor farmers often do not have assets they can rely on in case of low output (Jack 2009). Hence, incomplete or missing insurance markets represent an additional barrier to technology adoption for poor farmers. Dercon and Christiaensen (2007) show that downward consumption risk due to harvest failure reduces the adoption of fertilizers by farmers in Ethiopia. If the adoption of a new technology generates positive externalities for other farmers, this can reduce a farmer‘s incentives to be the first to adopt a new technology, especially if initial returns are expected to be negative (Jack 2009). Such externalities can lead to strategic adoption delay.

Finally one last major factor that can be a barrier to technology adoption is the lack of appropriate infrastructure, which is certainly the case in Sub-Saharan Africa (Foster and Briceño 2010). More than 30 percent of the rural population in Sub-Saharan Africa has poor access to markets, whereas this is the case for only 5 percent in South Asia (World Bank 2007). Rural roads and transport are under-developed mainly because of the low population density and other factors, giving rise to high transportation cost. In fact, lacking infrastructure drives up the price of fertilizer and other inputs, and this makes them too expensive for farmers to use. For example, Suri (2009) finds that farmers in Kenya, who have high potential returns to hybrid maize, do not adopt it due to the high cost of seeds and fertilizers caused by infrastructure constraints. Similarly, Matsumo and Yamano (2009) estimate that the very low use of fertilizer in Uganda is not profitable due to the high relative price of fertilizers. Moreover, they show that not only do high relative prices discourage the use of fertilizers, high prices also discourage the adoption of high-yield variety maize, which requires fertilizer as a complementary input.

The examples of adoption barriers, especially in Sub-Saharan Africa, stress that even if appropriate technologies do exist, poor farmers might not benefit from them. Therefore, 22
eliminating such barriers and providing farmers with better access to inputs must be an integral part of today‘s agriculture for development agenda.

_Farm Size and Land Tenure_ Many farmers in developing countries operate on a small scale. Increasing farm size is key for improved incomes in agriculture because it allows for the use of mechanization that has indivisibilities (with differences in access to credit by small and large farms favoring the latter), implying increasing returns to scale and higher profitability per hectare. In a detailed empirical paper, Foster and Rosenzweig (2010b) show that this is the case today in India, where most farms are too small to exploit the productivity and cost-saving advantages from mechanization. But land consolidation in larger farms with continued population growth and limited longdistance migration requires vigorous employment creation in the rural non-farm economy, basically in secondary towns and cities. Agriculture-for-development strategies need to focus on the smallholder sector, understand the challenges they face and find ways to make them more productive (World Bank 2007).

Much of the early discussion on smallholders revolved around the issue of efficiency of farm scale. Whereas there are potential economies of scale on large farms,<sup>9</sup> small farms have often been seen by family-farm theories as more efficient because they do not bear the cost of labor supervision and there are no moral hazard issues. Many developing country studies have found an inverse relation between farm size and land productivity even after controlling for other productivity determinants, such as land quality (Eastwood et al. 2010). However, in the presence of market failures, large farms can have an advantage over small farms. For example, they might be more able to take out loans and hence face lower capital costs. This would suggest a U-shaped relation between farm size and productivity (Chavas 2001). Moreover, even if economies of scale in production are outweighed by the labor costs borne by large firms, economies of scale in

> 9  In the past there were no inherent economies of scale in agriculture other than for plantation crops but new sources of economies of scale have emerged. They originate in technological change (new technologies such as zero tillage and genetically modified organisms, new management techniques, precision farming), new markets (product certification due to demanding sanitary and phyto-sanitary standards, contracts with supermarket chains for continuous and uniform deliveries), institutional changes (access to international finance and re-insurance) and public-private partnerships in the provision of public goods (infrastructure for access to low populated areas and opening of new lands).  See Byerlee, de Janvry and Sadoulet (2010).

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processing could render smaller farms less competitive (Binswanger et al. 1995). In addition, recent technology advances, such as zero tillage, render the supervision cost advantages of smallholders irrelevant. If smallholder disadvantages are based on market failures (and not diseconomies), an effort can be made to eliminate such biases against small farmers to reinforce their competitiveness in the market (Byerlee de Janvry and Sadoulet 2010).

New developments in the agri-business and food sector might shift the competitive advantage to large-scale producers and make it difficult for smallholders to participate actively in food markets. Two developments are of special importance: the supermarket revolution, and standards and certification. The wave of new supermarkets in developing countries has led to new procurement systems (Eastwood et al. 2010). Supermarkets usually demand standardized products in large quantities, which can put small farmers at a competitive disadvantage. Indeed, as reviewed in Reardon et al. (2009), supermarkets seem to favor large over small suppliers if they have the choice between them. However, some supermarkets prefer to source from small farmers as large farms have more market options and are perceived to be more risky suppliers than smaller farms. If the latter are included in the supermarket chain, however, non-land assets, such as irrigation or access to transportation infrastructure, are usually a prerequisite. Where supermarkets can only source from small farms, they have also provided resources such as equipment and technical assistance to contracted farmers. Hence, vertical coordination can also be beneficial for smallholders. In addition, new private standards for products and processes put small farmers at a disadvantage, as validation and certification of have economies of scale (Hazell et al. 2006). In order to help smallholders face these new challenges and include them in modern value chains, coordination among participants has to be improved. This could be initiated by the public sector as well as by the private sector through producer cooperatives, for example. Foster and Rosenzweig (2010b) propose a different solution. They suggest that in the light of today‘s mechanization of production, Indian farmers are too small to be competitive and land consolidation paired with increased employment opportunities in the rural non-farm sector – an issue addressed in more detail below – are necessary to increase incomes from agriculture.

It is not only farm size, however, that matters for efficiency of farm production. Property and user rights are also determinants of agricultural productivity. Different tenancy arrangements exist in developing countries. Tenants either pay a fixed rent for land use or engage in 24
sharecropping, transferring part of their harvest to the landlord. When it comes to efficiency, the question to ask is which arrangements lead to a less skewed land-use distribution and increase productivity. The extent to which fixed-rent and sharecropping are to be preferred over one another depends on the degree of asymmetric information between farmer and landlord.<sup>10</sup> Under perfect enforceability of effort, fixed-rent and sharecropping contracts should lead to the same productivity for a given farmer. But moral hazard can reduce the effort of the tenant under a share-cropping contract if the effort is not directly observable and contractible. Therefore, in terms of effort, fixed-rent contracts are preferred. If tenants are risk-averse, they might be unwilling to enter into a fixed-rent contract because the risk burden of a bad harvest would be completely shifted to them. In this case, sharecropping is the second-best solution in terms of efficiency. Empirical studies show that even if share-cropping reduces productivity compared with fixed-rent contracts, adjusting for the land quality of shared plots, the loss is small (Otsuka and Hayami 1988). One way landlords try to induce higher effort levels by tenants in sharecropping arrangements is interlinked contracts in which the landlord supplies credit and inputs to the tenant. For example, if the landlord provides cheaper credits while at the same time claiming a higher output share, tenants might be encouraged to borrow more. If the consequences of default are severe, higher borrowing will induce them to employ higher effort (Braverman and Stiglitz 1982). Another explanation for such interlinked contracts is credit constraints faced by the tenant (World Bank 2003). Laffont and Matoussi (1995), for example, find a positive relation between the tenant‘s own working capital and her crop share.

In Asia and Latin America, tenancy usually reduces farm size (Eastwood et al. 2010). Mearns (1999) shows that in India plot fragmentation is reduced, which increases productivity by reducing costs of production. In terms of tenancy reforms that try to strengthen tenants‘ rights, Besley and Burgess (2000) find that in India such tenancy reform is negatively related to agricultural productivity. However, Ghatak and Roy (2007) disaggregate the analysis to the regional level in India and conclude that in West Bengal, where the reform was implemented rigorously, there has been a positive relation between tenancy and productivity. They do not, however, find any effect on land distribution. Despite such positive findings, tenancy regulation

> 10  Binswanger et al. (1995) contains a detailed discussion.

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in favor of tenants can also lead to eviction of tenants and self-cultivation by less efficient landlords (Eastwood et al. 2010).

How have land tenure reforms that have been pursued in many developing countries affected both farm size and productivity? The success of land reforms in the past has been mixed, for both economic and political reasons (de Janvry 1981). Binswanger et al. (1995) argue that land reforms can redistribute land from large, less efficient units to smaller, more productive farmers, and that fixed-rent or shared tenancy contracts should be preferred to large farms. Titling of land can increase productivity in the agricultural sector if it increases investment incentives or relaxes credit constraints for landholders. Feder (1993) shows that in Thailand titled land has been more productive than untitled land; but Place and Hazell (1993) do not find a positive relation between rights and productivity among four African countries.

Titling programs can increase land concentration if more powerful individuals can claim more land or can do so faster. For example, in Bolivia during the 1980s, large farms got their titles much faster than smaller farmers. Nevertheless, if titling is done properly and concentration can be avoided, it can increase productivity by relaxing credit constraints for more efficient small farms. Direct land distribution implemented by imposing ceilings on land holdings seems to have achieved only little redistribution of land. As suggested by Eastwood et al. (2010), many redistribution efforts in Latin America left land mostly unreformed due to lack of proper implementation. Even where land was redistributed, it might not have had a positive effect on productivity. Mearns (1999) explains that ceilings in India have redistributed land to the poor, but Ghatak and Roy (2007) find the effect on productivity of this redistribution to be negative. They suggest that this is the case because redistribution leads to inefficient fragmentation of plots.

The discussion so far has focused on the efficiency of small farms and the role the latter can play in agricultural development. The social contribution that small farms can make is a separate issue. Hazell et al. (2006)—in a long tradition that goes back at least to Jefferson— argue that small farms can be an alternative for rural households until they can fully exit the agricultural sector and work in non-farm activities. And, related to the issue of food security, small farms can guarantee subsistence in rural areas, an issue that is addressed below.

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The Rural Non-Farm Sector and Rural Development

# _Income Diversification in Rural Areas_

The rural non-farm sector, perceived to be unproductive and of negligible importance, had in the past received much less attention from governments in the past than, say, the issue of urban bias (Lanjouw and Lanjouw 1995, 2001). Recent contributions point out that the rural nonfarm sector can serve as a bridge between agricultural-based livelihoods and industrial ones (Barrett et al. 2010), thereby playing an important role in a country‘s structural transformation. As pointed out above, further agricultural growth will have to come from capital-led intensification of production, which will limit the capacity of agriculture to employ a constantly growing rural labor force. Hence, rural and peri-urban sectors will play an important part in absorbing additional labor in the future. Employment in those sectors is stimulated by agriculture growth through the production and consumption linkages described above, and is an important complement to agriculture for rural poverty reduction (de Janvry and Sadoulet 2009b).

The rural non-farm sector—comprising, for example, home production of clothing as well as wage employment in rural factories—is heterogeneous. Of particular interest when studying this sector is the emergence of rural towns. As they offer a larger market compared with rural settlements, they allow rural enterprises to benefit from economies of scale and higher profits (Hazell and Haggblade 1993). Empirical evidence suggests that such towns have the potential to generate economic growth. China‘s Township and Village Enterprises are a leading example of this phenomenon (Lanjouw and Lanjouw 1995, 2001).

The most important roles played by the rural non-farm sector are the generation of employment and income for the rural poor. Many households in rural areas today do not specialize in either agriculture or non-farm activities but derive their income from multiple sources. Income diversification plays an important role in the livelihoods of rural populations. Farmers grow different types of crops during the year. Families derive income from non-farm rural activities and receive remittances from household members who have migrated. The literature mentions several reasons why rural households and individuals—as opposed to their urban counterpart—diversify rather than specialize. Barrett et al. (2001) name four main causes for income diversification into non-agricultural activities: seasonality in employment opportunities, diminishing returns to factors of production, market failures and risk management.

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Due to seasonal variations in returns to labor in farm activities, individuals might work temporarily in the non-farm sector. Some household members might work off-farm if there are diminishing returns to labor in agricultural production. Simultaneous income generation from both farm and non-farm sectors can be a strategy to cope with income risk if appropriate insurance markets are not available. Engaging in activities independent from agriculture such as manufactures can counter farm-related risk. Households in Burkina Faso that diversified their income into non-farm activities were more able to cope with droughts during the 1980s (Webb and Reardon 1992). Being able to hedge against risk in this way may enable farmers to increase the adoption of more risky high-return crops (Lanjouw and Lanjouw 1995, 2001). Other market failures can also explain income diversification. If capital markets do not exist, households investing in farm equipment will engage in non-farm activities to raise the required capital. Nonfarm income in Burkina Faso increased farm productivity by stimulating the adoption of animal traction (Savadogo, Reardon and Pietola 1998).<sup>11</sup> Missing land markets might prevent individuals whose comparative advantage is in non-farm employment from fully specializing in these activities.

Rural non-farm employment is not an option for all rural households. Zezza et al. (2008), using survey data from 15 developing countries, identify patterns along demographic characteristics as well as asset possession of households by income source. They conclude that households are more likely to engage in on-farm work if they own land, have lower levels of education, have little access to infrastructure and a greater share of their labor force members is female. Households deriving income from non-agricultural wages are usually more educated and have better access to infrastructure. Households receiving income from remittances are more likely to have a female head. Reardon (1997), focusing on African countries, draws similar conclusions but stresses the fact that households with higher income from non-farm activities also have higher total income and larger landholdings. This raises the question of causality. Either income diversification into non-farm activities leads to higher income because they generate higher returns, or diversifying households are better endowed initially.

> 11 This argument could, however, also go the other way around. Instead of lacking credit supplies, wealthy farm households might not be able to find profitable saving opportunities in financial markets and therefore invest in rural enterprises (Lanjouw 2001).

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Several empirical studies (e.g., Barrett et al. 2001, Lanjouw and Lanjouw 1995, 2001) draw similar conclusions. Asset endowments of households determine their ability to diversify incomes by participating in non-farm activities. One of the most important determinants is the level of education among household members. Many high-return, non-farm jobs require a certain amount of human capital, creating barriers for less educated households to take advantage of such diversifying opportunities. For example, Estudillo and Otsuka (2010) show that secondary and tertiary education is positively related to non-farm income in the Philippines.

Social capital is another factor explaining the ability of individuals to work off-farm. Workers who lack strong social networks, such as women or immigrants, have less access to well-paid non-farm jobs. And limited access to infrastructure can leave households in remote rural areas unable to participate in non-farm income diversification (Barrett et al. 2001). In Africa, if access to urban areas is given, migration income becomes more important than nonfarm rural income in the total income of rural households (Reardon 1997). Access to proper infrastructure is not only important for households to access the non-farm employment sector, but also for this sector to function properly and be profitable, thereby guaranteeing job opportunities for rural households. For example, electricity shortages that make the use of generators necessary can raise costs and reduce profits for rural enterprises (Lanjouw and Lanjouw 1995, 2001).

Although there are barriers to high remunerative rural jobs, households that are poor in assets still engage into non-farm work. Lanjouw (2001) shows that there are two types of offfarm employment in El Salvador, one in which labor productivity and wages are high and another one that plays the role as a ―last resort‖ employment for poor households. Whereas the former can lead to upward income mobility of workers, this is not necessarily the case for the latter. Lanjouw argues that even low-paying, non-farm jobs support the poor‘s income if, for example, unemployment was the alternative. Himanshu, Lanjouw, Mukhopadhyay, and Murgai (2010) find that employment growth in the rural non-farm economy is strongly correlated with growth in neighboring urban centers, and that poverty reduction has occurred partly by generating employment opportunities for historically disadvantaged rural groups.

Although the literature suggests that richer rural households engage more in higherpaying non-farm activities, there is still a consensus that diversification improves the incomes of 29
such households and contributes significantly to poverty reduction in rural areas. Evidence from Africa shows that higher non-farm income leads to faster growth in income and consumption (Barrett et al. 2001), while evidence from rural Asia shows that household access to non-farm income is one of the main drivers of poverty reduction (Estudillo and Otsuka 2010). Hence a well functioning non-farm sector to which poor households have access is, next to agriculture, important for income generation and poverty reduction in rural areas.

The question that arises for policy is whether agricultural and rural non-farm sector activities are complementary or substitutes. If, for example, agriculture has little potential in certain regions (a view consistent with ―agro-pessimism‖), policies might need to be more tailored toward non-farm activities. Both consumption and (upward and downward) production linkages exist between agriculture and the non-rural sector, although the strength of these linkages varies across time and space.<sup>12</sup> The existence of linkages does not mean that a vibrant agricultural sector is a necessary condition for a successful non-farm sector. There are examples of agricultural growth limiting the tradable sector in rural areas—see, e.g., the study by Foster and Rosenzweig (2003) cited above. But what follows from the existence of linkages between agriculture and the rural non-farm sector is that policies targeted at one or the other should not be made in isolation but integrated in an overall framework (Lanjouw 1999). Although the traditional interpretation of the rural non-farm economy (Mellor 2001, Adelman 1984) was that it emerged though linkages with agriculture, new empirical studies have opened important new perspectives for poverty reduction and shown that more attention should be paid to small towns (as the India study by Himanshu et al. shows). Agricultural growth stimulates the growth of the rural non-farm economy through forward, backward and final demand linkages, located in rural areas due to the advantages of proximity to agriculture (Byerlee, de Janvry and Sadoulet 2010).

_Changing Approaches to Rural Development_ Of 5.5 billion people living in developing countries, 3 billion live in rural areas and 75 percent of today‘s poor are rural (World Bank 2007). The rural sector has contributed more than

> 12 Lanjouw and Lanjouw (1995, 2001) provide quantitative estimates of these linkages.

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50 percent to global poverty reduction during the past.<sup>13</sup> Rural development is of high importance for poverty reduction as well as for agricultural growth in developing countries. Rural development, concerned with improving the livelihoods of the rural population and especially the poor, is broader than agricultural development. Whereas the farm sector is the focus of the latter, rural households are the main preoccupation of rural development. Rural development is concerned with household income, resource allocation, poverty, and access to basic needs such as health, education and food security. The heterogeneity among households in rural areas with respect to these issues is important for the design of rural development strategies (de Janvry et al. 2002). Whereas households that derive their main income from farm activities can benefit from improved agricultural technologies, landless rural households that diversify toward the non-farm sector would generate greater welfare from policies that improve such employment opportunities. Agricultural development and rural development are often connected. This is, for example, where smallholders are important for guaranteeing food security. Rural development strategies often involve many different actors, such as the state, civil society and market participants. Defining a new approach toward rural development for today‘s developing world will require defining the roles and importance of the actors in the process. Understanding the positions they took in past approaches to rural development is an important first step.

Approaches to achieve the goal of rural development have changed significantly over the past decades.<sup>14</sup> During the 1950s and 1960s, community-based rural development strategies, in which members of communities were given joint responsibility to manage their community resources, were put in place. UN programs, for example, sent civil servants and experts from government agencies to support village communities, and the latter were supposed to establish their own development plans—involving infrastructure, education and agricultural improvements—while outside experts provided advice and grants. Community development (CD) was meant to enable cooperation between the state and the rural population. It decentralized development issues to encourage self-help efforts (Holdcroft 1978). During the heydays of the Green Revolution during the 1960s, the diffusion of technology to smallholders by government agencies was considered a key part of rural development. CD was very popular

> 13 De Janvry and Sadoulet (2009b) estimate that between 45 and 93 percent of worldwide poverty reduction over 1993 – 2002 can be attributed to a decrease in rural poverty, depending on the extent to which migration out of rural areas involves more poor or non-poor individuals. Under the poverty-neutral migration scenario, the contribution is 56 percent.

> 14 This account follows de Janvry, Sadoulet and Murgai (2002).

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and, by 1960, 60 countries had started to implement CD programs. But by 1965 many of these programs had been stopped or reduced. These early attempts at rural development failed because communities were not given additional resources, old power structures persisted, and traditional elites prevented the programs from reaching the poor (Holdcroft 1978).

As economic growth in developing countries slowed during the 1970s, it became clear that it would not trickle down automatically to the poor. The focus of rural development approaches shifted toward poverty reduction. The leading approach to achieve this goal in rural areas became Integrated Rural Development (IRD), supported by major donors such as IDA (the World Bank) and USAID. The programs had twin objectives: improving agricultural productivity and satisfying basic needs through health or education services (Staatz and Eicher 1978). Compared with the former CD approach, IRD was intended to focus directly on the poor. Again, the state played the central role in delivering public goods as well as subsidized inputs, credit or extension services. In the aggregate, IRD programs were not successful. For example, Lele (1975), who reviewed 17 projects in Africa, concluded that the main reason was that they did not incorporate local technical expertise, did not emphasize local institutions, and did not understand the constraints faced by small farmers. Moreover, most projects were too costly to be sustainable beyond the pilot phase. Other factors that led to the disappointing performance of IRD programs were the urban bias of price policies, the lack of access to land and other assets, and the lack of participation in the projects by beneficiaries. The support for IRD—both by governments and by major donors like the World Bank—decreased sharply in the early 1980s. These donors shifted their focus to extension, roads or education projects—these had previously been specific rural development areas and they were now dealt with in isolation (Binswanger 1998).

During the 1980s, rural development approaches also shifted toward more ―market oriented‖ solutions and public interventions in rural areas diminished—in line with the neoliberal belief that free-market forces would eliminate distortions and reduce poverty. It soon became clear that smallholders were not in a position to adapt to the new market rules and the ―de-institutionalization‖ of the agricultural sector contributed to the fact that smallholders were falling behind. The private provision of services could not easily replace their public provision due to the smallness of markets and information failures. Moreover, there were many market failures in developing countries, in particular in credit and insurance markets, and missing 32
markets can be a major barrier preventing smallholders from adopting new technology and internalizing the benefits.

Failed attempts at rural development, which relied heavily either on state involvement or on market forces, raise the question of the respective roles the government and the market should play in rural development today. The limited success of market liberalization has been partly attributed to weak institutions that are essential for markets to work, such as clearly defined property rights and legal institutions that allow contracts to be enforced (Dorward et al. 2005). Therefore, one role for the state is to strengthen such institutions. Second, the state has to supply public goods such as R&D for agriculture, basic education or rural roads (World Bank 2007). Private expenditure for agricultural R&D is very low in developing countries and public provision of research and extension services is essential if innovative new technologies are to reach smallholders in developing countries. Education and access to employment opportunities are important prerequisites for successful income diversification in rural areas and should be available to rural households. Appropriate infrastructure and functioning markets are also important for rural non-farm sectors to emerge. This does not necessarily mean that public good projects have to be carried out by the state; but it means that the state must take the initiative, provide incentives for their provision and regulate the providers. Public-private partnerships, in which projects are publicly financed but provided by the private sector, can increase the efficiency of public good provision—although they can also lead to high public spending (Engel, Fischer and Galetovic 2008). Third, specifically targeted safety net policies to address the various risks faced by the vulnerable rural poor are also an important task for the state. Such programs can involve cash transfers or work-for-food programs (de Janvry et al. 2002). Fourth, markets can be inefficient because agents are disconnected because they lack transportation and communication infrastructure or complementary investments are not undertaken by other agents in the supply chain (World Bank 2007). This has been one of the reasons why market liberalization has often not been successful. Hence, a possible role for the state is help to overcome such coordination failures between different actors in the rural economy. Investments might be targeted at communication and information systems, supporting farmer associations, input or credit subsidies or extension services (Kydd and Dorward 2004).

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Governance is important for rural development policies to succeed (Dethier 1999). Political and social conflicts can be major impediments to development efforts. Moreover, decentralizing governance and empowerment might be important for successful rural development strategies. Such decentralization can increase access to local information, mobilization of social capital for effective cooperation, participation of beneficiaries in the decision-making process, the accountability of elected officials and the empowerment of poor minorities (de Janvry et al. 2002). Especially for the heterogeneous rural non-farm sector, where broad policies might not be the most appropriate to stimulate the sector‘s development, decentralization might be necessary to allow for locally adapted interventions (Lanjouw and Lanjouw 2001).This has led to a revival of previous community-driven development and participatory development ideas. The World Bank, for example, has adopted this approach in recent years by increasing its lending for such projects (Mansuri and Rao 2004). It is not clear that the problems that previous approaches faced will not occur again, in particular because of capture of program benefits by local élites (Bardhan and Mookherjee 2006, Lanjouw and Ravallion 1999). Community-based safety-net programs work best to target the poor if communities have egalitarian preferences, whereas heterogeneous communities can suffer from conflicting ideas (Cooning and Kenvane 2002). Incorporating civil society – farmer organizations or NGOs—into today‘s rural development strategies can benefit the poor. It can help to overcome market failures and deliver services locally. Such organizations can help their members reach economies of scale and thereby obtain credit or other services, which they could not otherwise obtain individually. In the proper management of common resources and/or of environmental resources to guarantee the sustainability of their agricultural system, communities and civil society can also play a key role. De Janvry et al. (2002) suggest that cooperation of such organizations with the public sector can lead to successful partnerships in which each party specializes according to its comparative advantage. Finally, institutions in which social capital among group members plays an important role are important in rural areas. This is the case for group lending in which peers are jointly responsible for the loans of individual members, since it can help overcome credit market failures due to moral hazard and adverse selection problems.

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# Agricultural Policy and Food Security

The discussion so far has focused on domestic concerns. We now turn to international dimensions of agricultural policy. The past decade has experienced a worrisome rise of protectionism—in spite of the ongoing World Trade Organization Doha Round of trade talks, launched in 2001, meant to foster trade liberalization, which put developing country needs at the top of the agenda. Both developed and developing countries maintain high protection for agriculture, which creates a drag on developing countries‘ agricultural exports. In addition, in the name of food security, some countries have reacted to food price increases with additional protectionist policies, such as export bans in Vietnam and India.

# _Market Distorting Policies of Developed Countries_

Trade flows have grown more than twice as fast as aggregate GDP over the past 30 years. The developing world‘s share of global trade increased from about one-quarter to more than onethird and the composition of their exports has been upgraded. For a long time they were exporters of primary commodities and importers of manufactured goods, but over the past two decades they have moved strongly into manufactured exports. The export share of developing countries in global manufacturing exports was 20 percent in 1990/91 and rose to 42 percent in 2006/07. For agricultural exports the numbers are 32 percent and 41.5 percent, respectively. Moreover, trade among developing countries also gained importance. While 4 percent of global manufacturing exports went from developing countries to other developing countries in 1990/91, it increased to 20 percent in 2006/07. For agriculture, the corresponding numbers are 7 percent and 20 percent (Aksoy and Ng 2010).

Despite these changes and several rounds of trade liberalization, many developing countries have been unsuccessful in integrating with the world economy. Nearly all the growth in developing country shares of trade has been driven by middle-income countries. By contrast, the 49 least-developed countries—most of which are in Africa—have gained no market share at all. Moreover, some regions have seen much smaller shifts in the composition of their exports. The manufactured share of merchandise exports is 80–90 percent in East and South Asia but only 60 percent in Latin America. Africa and the Middle East have yet to reach the 30 percent mark, and 35
many countries—particularly poor countries—remain dependent on exports of agricultural goods and natural resources.

Trade barriers in developed countries share the blame for this stagnation. True, in almost all slow or non-integrating countries the investment climate has not been favorable enough—for a range of reasons, including resource depletion, weak infrastructure, and poor economic management—to attract the investments needed to transform export patterns. Thus steps to strengthen the investment climate need to be a major element of any strategy to promote integration. But developing country exporters have also faced obstacles to developed country markets in every major sector—agriculture, manufacturing, and services.

Developed and developing countries alike maintain high protection especially for agriculture, creating a drag on developing countries‘ agricultural exports. In 2004, agricultural policies contributed 83 percent to the welfare cost of overall trade-distorting policies in developing countries (Valenzuela et al. 2009). Of particular concern are the pockets of protection against products of interest to developing countries, especially agriculture. Developed countries continue to impose substantial obstacles on imports from developing countries, despite pledges to remove or reduce them. High-income countries provide more than $300 billion a year in domestic agricultural subsidies—three times the amount of aid to developing countries—and block or discourage agricultural exports from developing countries in many other ways. Developed countries have tariffs and quotas on textile imports that cost developing countries an estimated 27 million jobs. Other tariffs and nontariff barriers further undermine manufacturing and employment in developing country industries.

Developed countries have an extensive network of protection and support for their agricultural sector, mainly border barriers and subsidies. Border barriers, such as tariffs and quantitative restrictions, are designed to support prices in domestic markets. This form of protection most distorts international markets and harms developing countries, and accounts for about 70 percent of protection in OECD countries. Production-related subsidies given to farmers under different schemes, called direct support, usually take the form of direct budget transfers and are much less distortive. Agricultural goods produced behind high tariff walls and with production subsidies often require export subsidies to be sold in world markets. These agricultural policies raise costs of $17 billion per year on developing countries, which is five 36
times the overall flow of overseas development assistance to agriculture. To export their agricultural goods to OECD countries, they must overcome tariffs at least 10 times those on typical intra-OECD exports (of all products). The average tariff that developing countries face for agricultural products in general is 16 percent compared with only 2.5 percent for manufactures (Anderson and Martin 2005). Moreover, OECD countries provide agricultural subsidies that drive down world prices for agricultural exports, undermining the livelihoods and markets of farmers in developing countries. Although efforts have been made over the past to reduce average support to agricultural producers from 37 percent of gross value farm receipts in 1986-88 to 30 percent in 2003-2005, the absolute amount increased from $242 billion to $273 billion a year over the same period (World Bank 2007). The issue here is not the support that developed countries provide for rural development; it is the size and form of that support and its pernicious effects on the prices of goods produced by developing countries.

Developed countries have made some efforts to address this problem, introducing preferential schemes that give the poorest countries—primarily those classified as leastdeveloped countries—duty-free access to their markets. Examples include the EU ―Everything But Arms‖ initiative and the U.S. African Growth and Opportunity Act. But these schemes have had limited impact. For example, Everything But Arms grants preferential access to exports from the least-developed countries but only half of eligible exports are actually granted preferences. Under the African Growth and Opportunity Act, the most generous provisions are granted to apparel exports from Sub-Saharan Africa. But 99 percent of apparel exports under the act come from just seven Sub-Saharan African countries, and only two of these are least-developed countries (Madagascar and Malawi). The low coverage of these schemes is primarily the result of complex rules of origin, complicated administrative requirements, and the weak trade capacity of developing countries. Finally, most of the world‘s poor people are located outside Africa and the least-developed countries. Thus preferential market access that targets these countries excludes a large share of the world‘s poor people—and could even hurt them through the trade diversion that may accompany these schemes. A more open global trade system would be far superior.

A more open trade system would generate enormous benefits for all countries—and particularly for the world‘s poor people. Removing all trade impediments would reduce poverty worldwide by 3 percent (Anderson et al. 2010). The bulk of the gains from liberalizing 37
merchandise trade would come from agriculture, not only in OECD countries but also in developing countries, where tariff barriers are often as or even more distorted as in OECD countries (although the degree of distortion on the production side, through subsidies, is generally much lower). Reducing agricultural protection—including trade-distorting tariffs, quotas, other export subsidies, and anti-development tariff escalation and tariff peaks—is the most important step for development.

Not all developing countries would benefit from liberalization of agriculture. Serious reforms in global agricultural trade policies would lead to higher prices for many products now protected, and these price changes could initially lead to balance of payments problems for lowincome countries that are net agricultural importers. But if we take out oil exporters and countries with temporary deficits worsened by conflict, only 14 low-income countries are net food importers (excluding oil exporters and countries in conflict). Three of these countries account for 80 percent of the net imports: Bangladesh, the Democratic People‘s Republic of Korea, and Pakistan. The other 11 countries have a deficit of just $565 million, a small percentage of their trade. These countries would also gain from price increases, because their exports are also predominantly agricultural, as well as from other aspects of multilateral trade negotiations. Still, the international community should be prepared to provide assistance to help countries adjust to and take advantage of new trade opportunities.

_Food Security, the Recent Food Price Crisis and Its Consequences_ The concept of food security covers not only the amount of food required to guarantee absence of hunger, but also the right choice of nutritional intake to avoid malnutrition and health issues (Barrett 2002). Although food insecurity can arise due to shocks at the national level putting entire populations in danger, it occurs at an individual level as a result of idiosyncratic shocks as well. At the height of the world food worries of the late 1960s and early 1970s (for instance, at the 1974 World Food Conference), the focus was on deficiencies in, and volatility of, production. Now the focus is clearly on access to food. Even when food is available in sufficient quantities, poor and vulnerable groups might be unable to consume food sufficiently and adequately because they lack access to it. Amartya Sen, for the first time in 1981, shifted the focus from supply side threats to food _availability_ to demand side issues that prevent households and individuals from _access_ to food products. Limited demand and access can arise, for example, 38
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Source: World Bank
short-lived, they have long-term effects for household food security and welfare. For example, households try to cope with such shocks by lowering calorie intake. Torlesse et al. (2003) show that the percentage of underweight children in Bangladesh is negatively correlated with expenditure on rice (because lower rice expenditure allows more income to be spent on higher quality food). Rice expenditure in turn rises with rice prices. In addition, households sell assets such as livestock and spend less on children‘s education as shown by a recent survey in Bangladesh (Wodon and Zaman 2008). Such coping strategies can lead in the long run to lower labor productivity and less accumulation of human capital, which can prevent households from getting out of poverty again once food prices are back to lower levels. As a result, households that are pushed into poverty because of temporary shocks may become chronically poor.

In order to evaluate the future potential of renewed food crises, the factors that caused the recent price spike have to be understood. The literature suggests that several causes have contributed to the price increases.<sup>16</sup> First, higher fuel prices have led to high production costs in agriculture by raising the cost of inputs such as fertilizers. Second, the depreciation of the dollar vis-à-vis previous years has led to higher prices of US$ priced commodities. Third, diet changes around the world, and especially in China and India, have caused a higher demand for meat and thereby for feed grains. Fourth, increased bio-fuel production in the United States, the European Union and Brazil increased the demand for feedstock and put pressure on the land area used for food production. The European Union and the United States subsidize production while Brazil is the only competitive producer of biofuel. Fifth, weather-related shocks leading to droughts and low harvests have hit countries like Australia and Russia. Finally, financial speculation in the agricultural commodity markets may have contributed to food price increases (von Braun and Torero 2009). Although some of these factors had more impact than others, all of them seem to have jointly contributed to the spike in food prices over the past years.

An additional factor that has amplified the rise in the level and volatility of food prices has been the low level of global stocks of food staples. In 2007, the stock-to-use ratio of grains and oilseeds reached the lowest level since 1970. Stocks can function as a buffer for market

> 16 See, for example, FAO (2008), Timmer (2008) and Trostle (2008). Timmer (2008) and FAO (2008) suggest that high bio-fuel production is one of the main reasons for increased food prices, whereas the diet taste changes in India and China seem to be less relevant for short-term price behavior.

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shocks and thereby dampen the effect on prices. However, as shown in the competitive storage model of Deaton and Laroque (1992), if stocks are very low, shocks in the market will be fully reflected in price behavior. Increased prices will then look like spikes although they reflect the normal price behavior that would exist in the absence of any storage. Since the middle of the 1990s, global food reserves have declined as countries such as China have deliberately reduced their stockholdings and, as a result, shocks to food markets could not be attenuated by releasing accumulated quantities.

Although the food price increase of 2006-2008 seems drastic compared with previous years, the peak was not higher than others during the past century (Baffes and Haniotis 2010). Sharp price hikes have been rather infrequent over the past 50 years—but recent forecasts suggest that prices could stay above their 2004 level for some time (Zaman et al. 2008), although wheat and rice prices are expected to decline in 2010 (FAO 2010b). Volatility is expected to be higher than at the beginning of the century (Headey and Fan 2008), although implied volatility from the derivate market seems to have stabilized and started to decline again, implying a possible decline in actual price volatility. Nevertheless, the recent crisis makes it clear that stable agricultural production is not only important for food availability, but also to allow poor households in developing countries to access food supplies at an affordable price.

# _Price Transmission and Stabilization Policies_

International food prices are an important indicator of the global food situation, but what ultimately matters for the poor and their food security in developing countries are the domestic prices they pay for their food. To measure the effect of international food price volatility on the poor, one needs to know how much of this volatility is transmitted to domestic markets and passed to consumers. If a country is well integrated into world trade and there are no policy interventions, international prices are fully transmitted to domestic markets. Evidence on price transmission is mixed. For example, Mundlak and Larson (1992), using a data set for 58 countries over 1968 – 1978, estimate that international agricultural prices are almost completely transmitted to domestic markets. A disaggregation of prices into single commodities shows that the transmission of wheat prices, for example, is lower than the average for agricultural commodities. Moreover, the authors find that the main part of domestic price instability is caused by volatile international prices. However, Baffes and Gardner (2003), investigating eight 41
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limited. For example, Srinivasan and Jha (2000) estimate that India‘s use of buffer stocks in the wheat market leads to more price volatility than would be observed under liberalized trade.

During the recent food crisis, export bans and other export controls were introduced in several countries, including India and Vietnam. Although they succeeded in stabilizing domestic prices, these export bans led to _more_ instability in international rice prices and contributed to the sharp increase in the rice price (Headey and Fan 2008). More generally, a country trying to isolate the domestic from the world market imposes more pressure on the international market and hence other countries to absorb shocks, which, in turn, increases international price volatility compared with the free-trade scenario (Bale and Lutz 1979). If international prices are only partially transmitted to domestic markets, policies meant to stabilize prices may be ineffective. Even if they successfully reduce volatility relative to international prices, the absolute effect on volatility may be negligible because global instability increases at the same time.

New price stabilization mechanisms have been proposed in the recent literature, including an international reserve to which member countries would contribute specified amounts (instead of domestic reserves). The international reserve would be released in times of emergency at the discretion of a supervising committee. Wright (2009), however, suggests that such a global agreement might fail due to lack of commitment by member states. Another related approach to prevent price hikes calls for a virtual reserve that would operate by engaging in the markets whenever prices are outside a specified band (von Braun and Torero 2009).

_Mitigating Food Price Volatility and Ensuring Food Security_ The main reason for price stabilizing efforts by governments and the use of export bans during times of crisis is to ensure food security. Given the mixed success of price stabilizing policies, the question arises if such policies are necessary to prevent adverse effects of volatile prices on the poor or if other measures, such as the improvement of social safety nets, might be more effective in helping individuals in developing countries to cope with unstable food prices and to guarantee food security.

Governments have used different domestic instruments to protect consumers from high food prices, including food subsidies. In the Middle East and North Africa, subsidies on bread and grain have existed for a long time. In response to the recent food crisis, Yemen and Pakistan 43
have introduced subsidies on wheat. Although food subsidies are meant to support the poor, they are often not well targeted. And subsidies are direct interventions in the market and can lower incentives for producers (World Bank 2008). Social safety net measures such as food-for-work programs, school feeding or in-cash or in-kind transfers are more targeted instruments to protect consumers from high food prices but are less common than market interventions or trade policy measures (Demeke et al. 2008). Bangladesh, for example, has recently extended its work-forfood program in response to natural disasters and higher food prices (Coady et al. 2003). It is important that such safety net arrangements be in place before a shock hits in order to be effective. In that case, they can prevent households from falling into chronic poverty by helping them cope with higher food prices. However, most social safety net policies only address longterm poverty and are not tailored to cope with transitory income shocks. Hence, new, innovative approaches have to be developed for social safety nets to respond quickly to unexpected shocks (Byerlee et al. 2010). As a positive example, recipient households of conditional cash transfers in the Progresa program in Mexico that suffered from income shocks have showed lower school dropout rates than non-recipients (Alderman 2008, de Janvry et al. 2006). This also suggests that, whereas trade policies or market interventions can only smooth aggregate shocks to food security, such as higher overall food prices, social safety net measures can also help to overcome idiosyncratic shocks to households and guarantee adequate food accessibility. Often, however, limited government budgets do not allow for extensive safety nets. As a result, increased productivity in subsistence farming is probably the most effective way to guarantee food security for small farmers. Moreover, investments to increase productivity are long-term instruments for agriculture for development. While short-term policies to cope with transitory shocks are important, the long-term measures described above – such as productivity increases, developing more shock-resistant crops, improving farmers‘ access to modern markets and creating employment opportunities in the rural non-farm sector – will be necessary to reduce the risk of shocks ex ante and guarantee food security in the future (Byerlee et al. 2010).

# **Conclusion**

Sadly, food and agriculture are now back in the headlines because of poverty linked to price volatility and high food prices is on the rise. In the past few years, there have been various attempts to address the issue of food security – including an international race for agricultural 44
land, large private investments in agriculture attracted by favorable markets, disruptive protectionist policies in food staples, revival of large-scale subsidies to agriculture in the name of food self-sufficiency, and new commitments by donors to increase spending on agriculture after 20 years of neglect.

This paper has reviewed the economic literature related to agricultural policy. Since the key question is how to use agriculture in support of a structural transformation of the economy, we began by examining the role played by agriculture in the development process and its interactions with other sectors. In poor countries, agricultural growth has a huge capacity to reduce poverty. Due to this potential, improving productivity in the agricultural sector in developing countries is critical and an essential step to reach the Millennium Development Goals. Some 75 percent of today‘s poor living in rural areas would benefit massively from higher incomes in agriculture. Moreover, agriculture also has the potential to generate economic growth in developing economies that depend to a large extent on this sector, for example in many Sub-Saharan African countries. But this presupposes major increases in productivity that depend on a range of factors—new technologies and their adoption; farm size and access to land; overcoming environmental challenges—for which we do not have ―silver bullet‖ solutions. The most difficult challenges are institutional and are related to market failures, missing markets and property rights. Agriculture can also be an engine of growth and provide employment opportunities for the rural non-farm economy because of its linkages with small cities and rural areas. Rural development and community-driven development can assist in this process. The government will need to play an important role for many of the tasks suggested in this paper. It should not, however, be the only purveyor. The private sector will be the main source of investment funds and a supplier of services. Donors, NGOs and civil society organizations (who benefit from local and external private expertise when implementing projects) will also play a key role. To identify the right mix of these actors and to establish an effective cooperation among them will be important.

New approaches to increase productivity in these countries have to be found. The possibility of further land expansion to increase agricultural output will soon be exhausted and intensification will be the only way to increase productivity in the future. For its Green Revolution, Africa therefore needs high-yielding varieties that are adapted to local conditions. In addition, to guarantee adoption of such crop varieties and to integrate small farmers into modern 45
value chains, existing barriers – such as low education, missing infrastructure, lack of credit and insurance markets – and insecure property rights have to be addressed. And new ways of information dissemination and learning methods, such as the use of communications technology in extension services, can foster adoption and profitable cultivation among farmers. Increasing productivity among smallholders in developing countries is also an instrument to guarantee food security in the long-run.

As if new evidence was required, the 2008 food crisis has demonstrated once again the vulnerability of the poor to income shocks due to food price increases. As commodity prices rise once again, it is important to adopt measures to limit volatility and put in place effective coping mechanisms. Macroeconomic approaches to stabilize prices in national markets are not promising. Policies such as social safety nets, which help the poor to cope with income shocks, have the potential to mitigate adverse effects and prevent households from falling into chronic poverty. Beggar-thy-neighbor trade policies to stabilize prices and guarantee national food security have been counterproductive: during the 2008 food price crisis, policies adopted by some developing countries have harmed poor populations and reversed some past gains. The best instruments to protect small farmers from income shocks are ex-ante measures such as increased productivity that reduce the risk of shocks in the first place.

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