7.3 Macroeconomic environment and agricultural growth

Contents - Previous - Next

Macroeconomic policies and economic performance: the experience of the 1980s

In the 1980s, there was a drastic change in the international economic environment facing developing countries. In the wake of the second oil shock, most developed countries opted for tighter monetary policies that resulted in higher real interest rates and a severe contraction in their economies, the negative effects of which were felt by developing countries in the form of declines in their aggregate exports. In addition, international commodity prices fell sharply for a number of reasons: (a) decrease in demand due to economic slowdown; (b) contraction in world liquidity itself; and (c) increases in supplies following the earlier surge in agricultural commodity prices and the support policies in some developed countries. High interest rates, lower export receipts and the increasing interest burden on the accumulated debt, worsened the creditworthiness of a number of developing countries and limited their ability to borrow from private credit institutions. Credit to developing countries from private sources essentially dried up. The declaration of a moratorium on debt repayment by Mexico in 1982 had spillover effects to countries which under "normal" conditions would have been able to borrow.

While external negative shocks were catalytic for the economic crisis in the developing countries, the severity and duration of the crisis varied significantly among countries. Countries which modified their macroeconomic policies during the crisis years suffered less than those which did not and were able to take advantage of the economic recovery of the developed countries and of international trade in the latter part of the 1980s. Among the countries that faced serious economic difficulties were also those that had experienced (at least temporary) increases in their terms of trade either as oil exporters or as exporters of other commodities. The latter observation demonstrates that lower international terms of trade is probably only one of the many factors, and perhaps not the most important one, responsible for the economic decline of many developing countries in the late 1970s and early 1980s.

Country studies searching for causes of poor growth performance could not identify a single macroeconomic or trade characteristic that could explain this performance in all countries. Thus, while most poor performers were characterized by inward-looking economic policies, some could be found with relatively open economies. Similarly, while there is a strong correlation between "acute" inflation and growth collapses, one could find countries with moderate inflation that experienced growth collapses and countries that did not. Instead, studies at the country level seem to indicate that at the root of the growth crises were policy "packages", the main element of which was the unsustainable large fiscal expansion associated with the substantial capital inflows to developing countries during the 1970s. The cessation of those inflows resulted in severe economic crisis (Condos, 1990; Corden, 1990; Lal, 1990).

The sources of capital inflows varied from country to country. Borrowing in the international capital markets was a significant source of foreign exchange inflows (total long-term debt of developing countries increased from US$63 billion to US$562 billion between 1970 and 1980) as were international aid and favourable swings in the international commodity terms of trade (minerals, oil, coffee, etc.). Some countries experienced increased foreign exchange inflows from a combination of sources, i.e. from both export earnings and borrowing against expected future earnings.

The growth implications associated with (cessation of) foreign capital inflows are not uniform across sources. Borrowing in international capital markets (including borrowing against future earnings) could have the most serious implications. If invested in non-productive projects, or consumed, repayment obligations could make the countries, all other factors constant, worse off than if the inflow had not occurred. Temporary export booms become a problem to the extent that the inflows are spent on consumption and/ or unproductive investment and treated as if the foreign exchange boom is permanent. In such cases the additional resources from these inflows can be completely wasted. A comparison between the experiences of Indonesia, Nigeria and Botswana in handling export windfalls is instructive in that respect (Pinto, 1987; Hill, 1991).

Although it would be an unwarranted conclusion to say that foreign resource inflows are bad for development, their mismanagement can be outright detrimental. It happened in a number of developing countries when such inflows were translated into high budget deficits, high inflation, overvalued real exchange rates and a worsening of the current account balance. This seems to have worked as follows.

Often the fiscal expansions associated with such inflows were directed towards domestically produced non-tradable goods and services (including expansion of services of the public sector itself, expansion of services of agricultural parastatals, urban construction, large and possibly hasty infrastructural projects), as well as towards imports. The resulting excess demand caused increases in prices and wages which, combined with a fixed or slowly adjusting nominal exchange rate, resulted in an overvalued real exchange rate. The combination of higher domestic costs, and an overvalued real exchange rate, shifted incentives away from tradables towards nontradables and imports, and worsened the trade balance, exacerbating the effects of increased direct spending on imports. The inability to match increases in domestic fiscal expansion with increases in fiscal revenues resulted in large budget deficits financed mainly by money creation and the inflation tax. The magnitude, timing and duration of domestic and external imbalances varied with the distribution of spending between consumption and investment, the efficiency of investments undertaken, the flexibility of exchange rates, the response of output to increased spending and the ability of governments to collect revenues.

Domestic and foreign imbalances could be sustained only to the extent that foreign exchange inflows continued to be available (ability to borrow, autonomous inflows of aid and investment, a lasting export earnings windfall). As this was not the case in the 1980s, those imbalances and the underlying spending were unsustainable and had to be reversed. Immediate policy responses by some countries to deteriorating budget deficits and current account imbalances included the imposition of import restrictions and cuts in domestic spending. Which sectors were affected most from such cuts was often a matter of relative political leverage rather than of economic efficiency considerations. Available evidence shows that in a sample of 24 countries, expenditure cuts from 1974 to 1984 resulted in capital expenditure declines of about 28 percent, while the declines in subsidies and transfers to parastatals were 11 percent and in the public sector wage bill 14 percent. Expenditure in infrastructure experienced a steep decline (25 percent), while defence and social sector spending declined by 7 percent and 11 percent respectively. Within the capital budget, infrastructure declined by 41 percent (Knudsen et al., 1990).

The inability of several countries to meet their debt repayment obligations and the incipient crisis raises some questions as to the investment selection criteria used to allocate inflows generated during the "boom periods". Some rough estimates indicate that for the low- and middle-income countries as a group, productivity of investment fell by one-third between the 1960s and the 1970s, although part of the decline should be attributed to the drastically changing international economic environment (Fardoust, 1990). The important conclusion of the analysis above is that a distinction should be made between sustainable, productivity-based growth spells, and "demand driven" ones generated through increased public spending during periods of increased capital inflows. Several of the growth experiences of the 1970s belonged to the second category, could not be sustained, and they have had detrimental effects on the agricultural sector and overall development, a topic taken up in the next section.

The above scenario describes the policy-related aspects of the crisis, and should not be taken to mean that external factors were unimportant. Both the severe decline in the (barter) terms of trade of developing countries and the increase in world real interest rates would have had negative effects on growth even in the absence of highly expansionary fiscal and monetary policies. Among the external factors should be counted the eagerness of private lenders to provide loans to the developing countries. The world banking system was inundated with liquidity and tended to "recycle" funds through bank consortia without adequate "creditworthiness" controls, sometimes in the conviction that banks would be bailed out by their own governments in case of default. In conclusion, although unpredictable exogenous factors have been important, the analysis above shows that, given the severity of such factors, unsustainable public spending expansions (often under donor blessing) exacerbated the situation transforming it (for a number of countries) from an economic slowdown to a growth collapse.

Asia was the only region with no declines in per caput incomes during the 1980s. Countries in Asia followed diverse development strategies and experienced diverse patterns and rates of growth. The extent and modalities of government intervention in the economies of Asian countries span a wide spectrum ranging from heavy interventionist to highly liberal (World Bank, 1993b). In terms of the macroeconomic framework discussed above, the large economies that make up most of the region have not experienced growth collapses due to a combination of several factors: (a) low debt ratios; (b) maintenance of creditworthiness that permitted them to finance the negative effects of the external shocks; (c) prudent fiscal policies; and (d) quick responses to the initial shocks.

For instance China, and to a smaller extent, up to quite recently also India, are clearly among the countries with low external debt. Thailand, by following prudent fiscal policies, is a classic example of a country that has managed to maintain creditworthiness, as has Indonesia. Indonesia, Korea Republic and Thailand responded quickly to external shocks although the time paths of adjustment were different with Thailand following a more "gradualist" adjustment path (Corden, 1990).

Macroeconomic imbalances, sectoral policies and agricultural incentives

The preceding discussion on the emergence of fundamental macroeconomic disequilibria provides the background for examining their impacts on agriculture. The importance of macroeconomic policies in affecting agricultural incentives through the four major "macro-prices" (interest rate, exchange rate, the general price level and the wage rate) has been the focus of attention in the 1980s. The detrimental effects of adverse developments in the international terms of trade were compounded by macroeconomic and trade policies that caused declines in overall economic growth. Spending increases directed towards domestic non-tradable goods and services caused decreases in the relative prices of agricultural commodities, mainly exportables or import substitutes, vis-a-vis those of non-tradable commodities (including those of services and domestically produced capital goods). Those adverse effects on the agricultural terms of trade were reinforced by overvalued exchange rates maintained through capital controls and foreign exchange rationing. Although overvalued exchange rates constitute (in principle) disincentives for both agricultural and non-agricultural tradables, the latter were protected through tariffs and quantitative restrictions. Thus, macroeconomic and trade policies had detrimental (indirect) effects on the terms of trade of agriculture vis--vis both non-tradables and non-agricultural tradables.

The negative effects of macroeconomic policies, especially on exportables, were often compounded by agricultural-sector-specific pricing policies, such as border taxes on agricultural exports, price controls, and the wedge between border prices and those at the farm level created by the monopsonistic behaviour of government parastatals and state marketing boards. Such direct interventions in agriculture have been uneven across commodities and, in some cases, they have benefited some agricultural commodities.

The effects of pricing policies on agricultural price incentives were attenuated by the increases in aggregate absorption (i.e. total expenditure by domestic residents) generated by increased public spending, a share of which was spent on agricultural commodities, and by spending on public infrastructure investments in agriculture." Input (mainly fertilizer) subsidies also tended to attenuate the negative effects of macroeconomic policies although their impact varied across classes of farmers as often subsidized inputs had to be rationed. While such counterbalancing forces may have been operating in the 1970s in some countries, in many cases they were reversed in the 1980s in the wake of the economic recession and associated reductions in aggregate demand.

The combined effects of macroeconomic and sector-specific policies for agriculture were largely negative. In the World Bank study on the direct and indirect sources of protection of major tradable agricultural commodities, the authors reached a number of important conclusions:

1. The indirect effects were much stronger than the direct effects. Namely, policies directly affecting prices resulted in a positive protection (on the average) of imported food products at an approximate rate of 20 percent and the taxation of exported commodities resulted in a negative of 11 percent. Incorporation of the effects of macroeconomic and trade policies resulted in a negative total protection of 7 percent for imported food crops and 35 40 percent for exported agricultural products.

2. The degree of total negative protection of exported commodities was in most countries higher than for imported ones (mostly food staples). The widespread drive for food self-sufficiency accounted for the lower negative (and sometimes positive) protection of food staples. A summary of the findings by region is shown in Table 7.1.

The study showed that for the 18 countries examined, the income losses of the agricultural sector due to taxation were substantial. Net average direct taxation (i.e. after the subtraction of subsidies) amounted to 4 percent of agricultural GDP between 1960 and 1984. Including indirect taxation brings income losses to 46 percent of agricultural GDP, the percentage varying between 37 percent for the "average taxers" to 140 percent for the "heavy taxers" (in the sense that an agricultural GDP of 100 with the interventions would have been 240 without them). In only two countries it was found that price-based negative protection was compensated by increased infrastructural investment in agriculture. The major beneficiaries from income transfers out of agriculture were the government sector, urban consumers and industry.

Table 7.1 Direct, indirect and total nominal protection rates, by region, 1960-84 (%)

Region Indirect protection Direct protection Total Direct protection of importables Direct protection of exportables
Asia* - 22.9 -2.5 - 25.2 22.4 - 1 4.6
Latin America** -21.3 - 6.4 - 27.8 13.2 - 6.4
Mediterranean -18.9 - 6.4 - 25.2 3.2 - 11.8
Sub-Saharan Africa - 28.6 - 23.0 - 51.6 17.6 - 20.5

Source: Reproduced by permission from Krueger et al. (1991).

Note: The period covered is generally from 1960 to 1984, but it varies somewhat in a number of countries.
* Republic of Korea, Malaysia, Pakistan, Philippines, Sri Lanka and Thailand.
** In South Asia (Pakistan, Srit Lanka), the indirect nominal protection rate was-32.1 percent, while in East Asia (Korea Rep., Malaysia, Philippines, Thailand) it was-18.1 percent.
*** Argentina, Brazil Chile, Colombia and Dominican Republic.
Egypt, Morocco, Portugal and Turkey.
d'Ivoire, Ghana and Zambia.

The taxation of agriculture, and the subsequent decline in the performance of the sector, had feedback effects on the rest of the sectors and the macroeconomic system. Direct and indirect taxation of export commodities resulted in a shift by producers away from export crops, which, combined with lower world commodity prices, resulted in a collapse in export earnings and reduced the ability of countries to import in support of industrialization. Thus, industrialization strategies based on agricultural taxation often turned out to be self-defeating. Likewise, losses of parastatals constituted a substantial burden on the government budget in a number of countries. The problem was more pronounced in Africa where marketing boards established by colonial powers were expanded by governments and were assigned the task of regulation and control of most aspects of agricultural marketing activities. Parastatals were often assigned functions going beyond performing marketing activities, e.g. management of commodity stocks, subsidization activities, etc.

They were also used (along with other parts of the public sector) as employers of last resort. Provision of those services by parastatal organizations contributed to their big deficits which were financed by increasing marketing margins or from the public budget. The combination of parastatals' marketing with their other functions contributed to the lack of transparency, made controls difficult and increased the costs of providing such services. Whatever welfare gains they generated for some parts of the population (not always the most needy parts) were bought at a heavy cost and proved unsustainable.

Agriculture under economic adjustment policies

As the resource inflows that sustained excess spending dried up by the early 1980s, several developing countries found themselves with low foreign exchange reserves, and unable to borrow from the private sector. Thus they were forced to turn to the international lending agencies (mainly the World Bank and the IMF) for their financing needs. Loans from those agencies were made conditional upon acceptance of comprehensive policy reform packages of macroeconomic stabilization and structural adjustment. Stabilization aims at reductions in domestic budget and current account deficits through reductions in public spending and credit ceilings especially to the public sector. As wages and prices of non-tradables were relatively inflexible, exchange rate devaluations were required to restore relative prices and switch incentives and the pattern of production towards tradables. Structural adjustment was to be achieved through medium-term supply-side policies to enhance efficiency and remove bottlenecks. The major thrust of structural adjustment reforms was the enhancement of the role of the markets in guiding resource allocation. Thus, a number of measures were proposed to liberalize markets for inputs and outputs, including reductions or elimination of subsidies, reductions in agricultural export taxation, elimination of marketing and transportation controls, etc.

The agricultural focus of structural adjustment programmes varies extensively across developing regions. For sub-Saharan Africa from 13 loans between 1980 and 1987,77 percent included conditions for agricultural policy. This percentage was matched only by trade policy conditions (77 percent). In other developing countries during the same period, 38 percent of loans (out of a total of 16 loans) contained agricultural policy conditions (World Bank, 1988). Price policy reforms included the reduction of the gap between border prices and those received by the producers for both inputs and outputs. Their effects in terms of incentives are diverse across product categories: while for exportable commodities it meant a reduction in taxes on prices levied by parastatals, for imports it meant the abolition of quantitative restrictions and/ or lowering of tariff levels. On the input side, it usually meant the abolition of subsidies with negative effects on all producers having access to them. In return for the implementation of import liberalization, donors undertook the financing of the importation of a list of essential items which often included fertilizers and agricultural chemicals. Agricultural parastatals and marketing boards were to be abolished or substantially reformed to increase their financial accountability and improve management structure. In most cases, parastatal support from the public budget ceased and the policy of employer of last resort was abandoned, often worsening the immediate problem of unemployment before the hoped-for positive effects from the policy reforms were generated. As a result of the reform of agricultural parastatals and marketing boards, barriers to inter regional movement of commodities were abolished, as were pan-territorial and pan-seasonal pricing schemes. Evaluating the effects of structural adjustment programmes undertaken by the countries themselves or imposed as part of conditionalities on the agricultural sector is difficult for several reasons:

1. The degree and consistency to which reforms were implemented and sustained varies widely among countries (inconsistencies include nominal devaluations not matched by supporting monetary policies, cuts in aggregate demand through reductions in government investment rather than consumption, etc.).

2. The occurrence of external shocks such as changes in the international prices of commodities, and other economic developments in the rest of the world complicate the isolation of the effects due to policies.

3. For regions such as Africa, the volatile political and ecological conditions and dependence on rainfed agriculture make difficult the apportionment of credit or blame for agricultural performance to policies, political instability or weather conditions when comparisons are made over short time periods.

4. Conclusions may vary with the evaluation method chosen: should performance be evaluated in a "before and after adjustment" manner or in a "with versus without adjustment" framework? The latter would require constructing a counterfactual scenario describing both the feasibility of continuing pre-adjustment policies and their effects on the sector.

5. Initial conditions in the adjusting countries vary, with countries implementing structural adjustment programmes "entering" the 1980s with weaker economies (see discussion below on price versus non-price incentives).

6. Large discrepancies exist between the performance of countries in different regions undergoing similar adjustment programmes. Evidence shows that middle-income countries have had a greater rate of success in resuming growth than low-income countries, especially the ones in sub-Saharan Africa.

7. There is often a confusion between policy adjustment and adjustment lending. Thus, what is often tested are the effects of adjustment lending rather than the effects of policy reforms. The two may be different since there are countries that undertook drastic reforms without adjustment lending and others that received adjustment lending but abandoned reforms (Summers and Pritchett, 1993).

A number of studies looking at raw data or using statistical techniques, have concluded that structural adjustment programmes halted the decline of, or even increased, agricultural production and exports, or increased agricultural growth (Lele, 1992; Faini, 1992). Data analysis presented in FAO's 1990 "State of Food and Agriculture" provided indirect support for this hypothesis by looking at 65 developing countries. Namely, it was found that, in general, countries which had gone through "healthy adjustment" processes and were meeting the basic objectives of stabilization programmes (reduction of budget and current account deficits, etc.) had also better agricultural performance. In another study, the overall agricultural performance of sub-Saharan African countries implementing policy reforms (including exchange rate adjustments and price and fiscal reforms) was compared to that of non-adjusting countries. The results show that among countries "starting out" with similar agricultural growth rates before adjustment, growth rates were increasingly higher for those that adjusted (Binswanger, 1989). Studies can also be found that dispute the proposition of an improvement in agricultural performance of countries undertaking structural adjustment reforms.

A recent World Bank study (World Bank 1994b) compared the performance of adjusting and non-adjusting countries in sub-Saharan Africa, taking into account the "degree of adjustment". It concludes that the overall growth performance was superior for the adjusting countries. However, the record is mixed for agriculture. There was no clear pattern of differences in agricultural growth between the countries which improved their macroeconomic situation and those which did not. But countries which experienced improved prices for their agricultural exportables (e.g. through devaluation) had a better agricultural growth record than those which did not.

Results derived from cross-country comparisons may be indicative but are not very informative or conclusive, as such comparisons mask wide differences in the experiences of individual countries, not only in terms of the effects of policy reform but also on the initial conditions at the initiation of reforms (extent of economic crisis, economic position, etc.), and modality of application of the reforms (timing, consistency, etc.). Given the methods used, what is often being tested is not only the correctness of the policies themselves (or of the principles underlying such policies) but also the effectiveness of implementation.

In addition to the issue of the effectiveness of policies in improving agricultural performance, serious concerns have been raised as to the effects of policy reforms on the more vulnerable parts of the population. Demand contraction, the abolition of parastatals or the reduction in their role, and the withdrawal of the state from certain activities, combined with rigidities in resource mobility and slow response by the private sector, may result in increases in unemployment due to delays in redeployment of labour. Given the fixity of the capital stock in the short run, an increase in the supply of labour due to the reduction in the public payroll coupled with an inelastic demand for labour may cause short-term reductions in both employment and the real wage. Reductions in public investment outlays may not be matched by increased private ones (at least in the short run), while expenditures for infrastructure, health services and social programmes may be affected by the overall budget reductions. Likewise, increases in food prices may affect adversely the food security of the more vulnerable parts of the population, while cuts in food and other subsidies have more pronounced effects on the poor and the unemployed (FAO, 1989b).

It is difficult to obtain definitive answers as to the exact causes of observed changes in social indicators by making aggregate cross-country comparisons. Policy reforms affect individual population groups in different ways and it is difficult (and dangerous) to generalize conclusions drawn from individual country analyses. Changes in the social indicators do not point always in the same direction and vary also among regions. While it is difficult to identify with precision the effects of policy reforms on social indicators from those that follow as a consequence of the full-scale economic crisis of the early 1980s, it is now well accepted that a new class of poor has been created by adjustment, although some of the "old" poor may have benefited from policy reform. Policy reforms that reduce macroeconomic imbalances, restore relative prices and halt economic decline do not necessarily reduce poverty by themselves. Often such policies must be supplemented by special programmes and interventions targeted at the poor (see Chapter 9 for developments in the incidence of poverty and discussion of anti-poverty policy interventions).

Reforms should a]so be analysed from the point of view of the alternatives that were available to the countries that faced the crisis of the 1980s. Policy reform programmes implemented through the initiatives of the adjusting countries themselves or under the pressure of international lending agencies, should be viewed as a response to the unsustainable policies characterizing development strategies for a long period of time. Thus, the issue of the sustainability of the previous policies should be considered. The countries that were facing very serious distortions and imbalances were the ones that sought to reform first, but also the ones in which the reforms were slow to produce results given the magnitude of distortions, suppression of private sector activities, etc.

In conclusion, while differences in opinion may exist on implementation issues (timing and sequencing of reforms, modalities of protection of weaker groups of the population, etc.) regarding policy reforms, there are very few arguments against their principal directions: (a) on the fiscal side, prudence should be exercised to avoid large and persistent deviations of spending from their sustainable means of financing; (b) careful screening of public investments is required to evaluate their economic and social returns; (c) conditions should be created for markets to work more efficiently and for prices to play their role as the major signals for resource allocation; (d) non-economic objectives should be pursued as much as possible by interventions aimed directly at the problem rather than by policies that distort economic incentives; (e) exchange rate reforms should be supported by proper macroeconomic policies.


Contents - Previous - Next