Text 34: stranded on the farm?

"Economic development" is more a slogan than a term with a precise definition. But in the thinking of politicians and economists around the world, it has long been synonymous with "industrialisation". Today's advanced economies grew rich by shifting resources from agriculture into industry, so it is no wonder that emerging economies from India to Brazil have sought to emulate that trick by fostering manufacturing.

This belief in the importance of industry has come into conflict with one of the fashions of the 1990s, freer trade. In principle, reductions in trade barriers could open new markets for manufactured exports from developing countries. But there is no assurance that this will happen. Under free trade, after all, each country will tend to specialize in those products in which it is relatively most efficient, compared with other countries. This might mean that some countries would end up producing coffee and cattle rather than computers and cars. If they get "stuck" in agriculture, are they condemned to poverty and slow growth?

This is a question that some economists have taken seriously. Kiminori Matsuyama, a professor. at Northwestern University in America, showed that under free trade countries richly endowed with arable land and natural resources might grow more slowly than others. Such natural wealth would encourage the growth of agriculture at the expense of industry. This matters because in Mr Matsuyama's model manufacturing is special. He assumes there are economies of scale in manufacturing: the more resources employed in the sector, the faster productivity will grow. But is it not possible that agriculture, too, can have large productivity improvements as more capital and other resources are invested? If this were to happen, agriculture could have a special role in stimulating growth, just as Mr Matsuyama assumes manufacturing does.

The empirical evidence on this point is mixed. As Mr Matsuyama's model assumes, the relative importance of manufacturing in Latin America has been shrinking over the last decade as trade liberalisation has taken hold. However, the consequences may not be as bleak as he expected. This is because, so far, productivity growth in agriculture has been as fast as in manufacturing. Chile provides a good test case. Since the country opened up to trade in 1976, the relative size of its manufacturing sector has declined. Manufacturing accounted for 27% of Chile's GDP in 1973; in 1995 its share was only 16.8%. Agriculture, on the other hand, has not declined - as traditional models of development would have predicted - but instead has grown modestly as a share of GDP.

The decline of manufacturing has not meant slow growth, however. Chile's economy has expanded at an average rate of 7.2% since 1987. Exports have been the engine of growth and agricultural products have been star performers. Chile went from being a small player in the global fruit market, exporting just apples in the 1960s, to become one of the world's largest fruit exporters in the 1990s. Such exports may not be manufactured, but the businesses that make and export them have been using increasingly sophisticated production technology and management methods. Although grapes are by far the main fruit export, Chile began exporting wines in a significant way in the 1980s and achieving important world market shares in the 1990s. Similarly, fish exports, once produced almost entirely by an ocean-going fleet, are now seeing the growth of salmon farms. This sort of technological advance has meant marked productivity increases in agriculture and higher incomes.

So does agriculture offer an alternative path of economic development? "We used to think that countries would develop by climbing ladders of production that would go from textiles, to clothing, to toys and eventually electronics," says Ricardo Hausmann, chief economist at the Inter-American Development Bank. "Now we know that there are different ladders and countries can grow by going from fruit to wine, furniture, salmon..." Fair enough, say some advocates of industrial policy. But even if agriculture is highly productive, emerging economies need to industrialise because there is a limit to the demand for foodstuffs. This contention is based on the well-established finding know as "Engel's law", which hold that people tend to spend a smaller share of their budgets on food as their incomes rise. Engel's law, however, does not mean that agriculture will, sooner or later, become a slow-growth sector. Rather, it implies that producers must constantly adapt to changing tastes: wealthier societies may consume less manioc and potatoes, but spend more on beef, fruits and oven-ready frozen foods.

There is one final argument against the idea that countries will end up getting "stuck" in agriculture. This worry assumes that a country's comparative advantage is static, so that a country that grows bananas today will inevitably grow bananas in 20 years' time. This need not be the case. If a country does what it does best and sees its incomes grow as a result, it can afford better education and infrastructure. These, in turn, will give an advantage in other products in future.

Just as few could have predicted the dramatic grow spurt of East Asian economies 30 years ago, it is hard to forecast today how open, agriculturally rich economies will continue to develop. It may be that they will move towards a service economy without ever having a large industrial sector. Or they may find new ways to prosper from their natural resources. Although open trade may make it difficult for them to establish certain kinds of industries, this does not necessarily doom them to slow growth. But it does not guarantee fast growth either. Their own economic policies matter, but so do the trade policies of wealthier nations. Many of these are more protectionist towards farm products than towards manufactured goods. No wonder officials in many emerging economies worry about being stranded on the farm.

TEXT 35: EASTERN PROMISE

The demolition of the Berlin Wall in December 1989 removed the most potent symbol of Europe's post-war economic and political divisions. More than seven years on, however, the continent is far from united. Not only do huge disparities in living standards between Eastern and Western Europe remain, but eastern countries still face a long wait before they are admitted to the west's economic and political club, the European Union.

Although the easterners are eager to join, the EU's 15 current members are in no hurry to let them in. In part, this is because the EU is preoccupied with economic and monetary union. And with more members, decision-making in the EU would become more complicated. But the 15 worry about the economic costs of expansion as much as the political ones. Perhaps they should not. New research suggests that the net economic effects of eastward expansion on the EU's current members would be negligible - meaning that enlargement is much more a question of politics than of economics.

A paper by three economists, Richard Baldwin, Joseph Francois and Richard Portes, looks at the costs and benefits of enlarging the EU both for the Union's current members and for seven applicants (Bulgaria, the Czech Republic, Hungary, Poland, Romania, Slovakia and Slovenia). Not surprisingly, they find that the easterners would benefit hugely from joining the club. As for West Europeans, the authors say that there are small gains to be had from increased trade, to be set against small budgetary costs. The net cost is tiny.

The most obvious economic effect of admitting the eastern countries to the EU' s single market would be to make trade between east and west freer. This effect would not be enormous, because most exports from Eastern Europe to the EU are already tariff-free. But some east European exports, including steel, are subject to EU anti­dumping duties; quotas limit others, such as textiles and shoes, and trade in agriculture has barely been liberalised at all. On joining, the new members would have to scrap their tariffs on goods from the EU. They would also have to adopt the EU's common tariff on non-EU goods. This would cut their tariffs on most manufactured goods but would mean increased protection on farm products.

Messrs. Baldwin, Francois and Portes estimate that, even in the long run, all this would boost the annual GDP of current EU members by a mere 0.2%. Although the seven entrants' combined GDP would go up by proportionately more, their gains would also be modest: 1.5%. The main reason why the easterners gain relatively more than to the west: four of the seven countries send more than half of their exports to the Union, while the east is a small market for EU firms.

The possible benefits of EU membership for Eastern Europe, however, would be rather more impressive if the region became a less risky place to do business. The authors guess, for instance, that if investors saw the east as no more risky than Portugal, then eventually GDP would rise by more than 18% of its 1992 level. This will be an overstatement if investors think that the east is getting safer anyway. It may be: some countries already have credit ratings better than Greece's.

But the benefits to their eastern neighbours weigh less in EU ministers' minds than what it will cost their own countries. How much is that? The EU gives aid to regions where income per head is less than 75% of the Union average, for which Eastern Europe would qualify - partly at the expense of regions which receive aid now but would be relatively richer in a bigger EU. And the east would have to be brought into the Union's cumbersome system of farm support.

Suppose, say Messrs. Baldwin, Francois and Portes, that the newcomers received regional and agricultural support in line with current EU rules. Those rules would help keep the bill down. Regional aid has to be matched by payments from national governments: and even existing members, which are richer than the easterners, have had trouble coming up with the money. EU rules and international commitments cap farm subsidies. The EU's total spending would rise by about one-third. That may sound an enormous burden, but it is not. As a proportion of GDP, the net cost to existing members would be little more than the gains from trade.