The Price Linkage

The relationship between agriculture and the macroeconomy gives rise to a number of important questions for policy making and strategic planning. Can a successful agricultural policy be designed and implemented independently of the macroeconomic framework? Conversely, are there circumstances in which macroeconomic policy must be modified if agricultural policy is to achieve its aims? If so, what are the tradeoffs at the economy-wide level? Would it be in the broader interest of society to accede to those modifications in the macroeconomic framework? Are there other sectors, such as industry, that also would benefit from an adjustment of macroeco-

nomic policies in a direction favorable to agricultural growth, or do some macroeconomic choices pit agriculture against the rest of the economy?

In the long run, all sectors of the economy benefit from a macroeconomic environment characterized by relatively stable prices and which is conducive to savings and investment and opportunities for foreign trade. However, to date many developing and transitional economies have not yet reached an optimal macroeconomic configuration in this sense, and the paths taken in attempting to reach that optimum differ across countries. Hence, it is important to ask whether different macroeconomic strategies have different implications for agriculture.

Classically, the tradeoff between macroeco-nomic goals and agricultural development was thought to be a choice between stability and growth. Greater fiscal expenditures for agriculture were presumed to stimulate expansion of the sector, even at the risk of creating or deepening a fiscal deficit and therefore feeding inflation. In reality, this tradeoff was more imagined than real, for two reasons. First, experience worldwide in the last decade has confirmed that economic stability, through its reduction of economic uncertainty and its stimulus to saving and investment, is a powerful influence for growth in its own right.

Secondly, it is apparent that many fiscal expenditures in the sector have been inefficient in achieving their aims. They often have not been

Agricultural Development Policy Concepts and Experiences. R. D. Norton

© 2004 Food and Agriculture Organization of the United Nations

ISBNs: 0-470-85778-1 (HB) 0-470-85779-X (PB) FAO Edition: 92-5-104875-4

targeted on the poorest groups in rural areas, and their stimulus to production has been weak in relation to the volume of expenditure. A common example is subsidized credit, which frequently is characterized by a poor repayment record, thus creating the need for further subsidies to sustain the same amount of lending, and which also is diverted in part to non-agricultural end-uses. Another typical example is expenditure on State-owned grain storage facilities, which tend to be operated at low rates of capacity utilization and therefore generate a low or negative return on the funds invested.

In reality, the tradeoffs for the sector are different than stability versus growth. The type of macroeconomic policies adopted can have a strong influence on the development prospects of the agricultural sector in the following ways: (a) they can affect the intersectoral terms of trade, or intersectoral relative prices, and hence both the incentives for production and the real incomes of agricultural households, (b) they can create greater or lesser incentives for agricultural exports, and (c) they can also influence levels of capital formation in agriculture by creating an economic environment which is more or less conducive to ruralfinancial activity and investment. In addition, sound fiscal policies can generate funding for vital infrastructure investments in rural areas.

A stable macroeconomic environment favors investment in the sector provided that the rates of return are sufficiently high. These returns depend more than anything else on the trends in real agricultural prices, that is, agricultural prices relative to non-agricultural prices. Usually, macroeco-nomic policy has a decisive effect on real agricultural prices. The linkage between macro and sectoral levels via relative prices is powerful and is often the dominant one. In other words, the main policy tradeoff for the sector is not agricultural growth versus the rate of inflation, but rather relative prices which are favorable or unfavorable for agriculture. Normally, macroeco-nomic policies that favor agriculture in this sense also favor manufacturing, including agro-industry, at the expense of the service sector.

The fact that both agriculture and agro-industry can see their real prices improved by some types of macroeconomic policies bears emphasis, for normally their preferences are mutually opposed, because agro-industry wishes to see lower prices for its raw materials and agriculture, and higher prices for its output. This tension will always be present, but classes of policies exist which will improve the profitability of both sectors.

From the viewpoint of the agricultural sector, the principal instruments of macroeconomic policy are the following: (i) exchange rate policy,

(ii) trade policy (the degree of openness of the economy to international trading possibilities),

(iii) tariff policy, (iv) taxation policy, (v) fiscal expenditure policy, (vi) interest rate policy (or monetary policy, which influences interest rates), and (vii) the regulatory framework for finance and contractual relations in general. All of these instruments can affect the real returns to agricultural production, but the first four are especially important in determining real prices of agricultural outputs. The relationships between macro-economic policies and the sector's performance are explored further in Chapter 4, but first it is worth devoting some attention to a common assertion about agricultural prices.

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