Agricultural Transformation and Rural Development

EC 390 - Development Economics

Jose Rojas-Fallas

2025

Motivation

As of 2018, over 3 Billion people live in rural areas in developing countries and about 25% of them in extreme poverty

Why do we discuss agriculture so much?

Many people in developing nations work in agriculture
We would like to address subsitence economies
There is a “somewhat” positive relationship between growth in agriculture and growth in GDP

Africa

Asia

Latin America

Motivation

Percent of people living in rural communities across the world:

Sub-Saharan Africa 64%
South Asia 69%
India > 67%
Ethiopia, Nepal, Nepal, Niger, Papua New Guinea, Rwanda, South Sudan, Sri Lanka, Uganda >80%

Over 2/3 of the world’s poor live in rural areas

Where Income = Subsistence Agriculture

Agriculture

Farming Across the World

We can juxtapose farmers in the developing world to farmers in the US, to better understand the scale of the difference

Farmers in Developing Countries

Very small farms Less than 10 acres (on average)
Less farming technology
Need to adapt to hotter and more humid climates
Farmers supply food for themselves

Farmers in the US

Farms are large 441 acres (on average)
Farming technology is highly advanced
Technology is well-aligned with local climates
Farmers supply food for many people 144 people per farmer (on average)

Farming Across the World

Farming in Sri Lanka

Farming in the US

Malthusian Trap

Malthus (1789) argued that population growth would lead to mass shortages of food

This is thought to describe how population growth tends to outpace the growth of resources
This was called the “Malthusian Trap” or Malthusian Theory of Population

Malthusian Trap

Assumptions used for this argument:

Population grows exponentially (1, 4, 9, 16,…)
Diminishing returns to land, labor, capital, etc. means that resources grow linearly (1,2,3,4,…)
There exists a limit to the amount of food that can be produced
So there is a carrying capacity due to the food supply limit

Malthusian Trap

The assumptions are relatively true, but still we don’t see any Malthusian Trap

Why is this?

Technological advancement

Green Revolution

Green Revolution \(\leftarrow\) I made it green

Boost in grain production associated with the scientific discovery of new hybrid-seed varieties of wheat, rice, and corn that resulted in high yields in many developing countries

Key Elements

High-yield crop varieties
Chemical fertilizers and pesticides
Irrigation expansion
Modern farming techniques

New Seeds

Resistance to drought and pests
Give higher yields

Agrarian Systems in Developing Countries

There are different agricultural practices in developing economies

We can think of three separate stages

1. Agriculture-based countries

2. Transforming countries

3. Urbanized countries

1. Agriculture-Based Countries

About 417 Million people live here

More than 66% of the poor in these countries live in rural areas
Agriculture accounts for 32% of GDP growth (on average)
Rely heavily on traditional agricultural practices
- “Slash-and-Burn” No Bueno

Slash-and-Burn

Rotating plots of land

Here is the process:

Remove trees and vegetation
Burn the area (increases nutrients in the soil)
Plant crops directly into nutrient-rich ash
Cultivate until plot becomes infertile
Abandoment and fallow

Very old agricultural process and it is not very efficient if you are not moving around the world

Also leads to deforestation and erosion

2. Transforming Countries

Largest concentration of people living in a rural setting (2.2 Billion)

As the name implies, its a transition toward urbanization

Rural poverty is high, but agriculture contributes about 7% to GDP growth
Labor begins to move out of agriculture and into other sectors (manufacturing, services, and construction)
Urbanization accelerates as people migrate to cities for jobs
Potential for income growth
- Increased probability of income inequality

3. Urbanized Countries

Half or more than the country’s poor live in cities

Very few working people are in the agricultural sector
Agriculture contributes even less to GDP growth
Typically will find an industrial agricultural sector (US)
Typically countries with large urban centers
Technological innovation and human capital drive growth

Three Systems of Agriculture

Problems in Agricultural Development

As with everything, there are issues of inequality

Here we are talking about inequality in land holdings (specially in LATAM)

Huge farms employ many people
- However, land owners care more about maintaining market power than increasing output
Medium sized farmers are rare
- Farms these size potentially have a better mix of capital and labor, are more productive, have lower transaction costs than larger farms
Some very small farms
- These are household farms
- Because they are small, there are no economies of scale

Land GINI

Problems in Agricultural Development

Subdivision of land in Asia

Pre-colonial Asian cultures prefer cooperation, sharing resources within villages
Colonial institutions assigned property rights to land
Most landlords live elsewhere, and rely on sharecroppers to produce agricultural goods
- Sharecroppers: Renter farmers, which kickback a percentage of the crops in exchange for lease of the land
Land is scarce, so rents are high
At the same time, labor is abundance, so wages are low

Problems in Agricultural Development

Subsistence farming in Africa

Most farming takes place on small plots to produce for one family
Three main reasons for this persistence:
- Most farming is done by individuals using traditional tools
- Farming usually involves shifting cultivation once land nutrients have been used
- Leads to inefficencies since individuals must wait for nutrients to replenish
This causes large swings in employment
- During farming times, labor is scarce
- During non-farming times, labor is in excess
It is hard to sustain populations with the amount of food grown in these economies

Microeconomics of Farming

Classical Theory has two factor models of production where capital is fixed, but labor is variable

Households can adjust how much they work on their farm, but not what tools they use
Gives rationale for low productivity
Does not explain why small farm owners are resistant to technological innovation
Theory says they will choose the method of production that gives the lowest cost
Also implies perfect knowledge of types of technology, needed inputs, the weather, etc.

Microeconomics of Farming

The problem is that classical theory of agricultural production does not consider farmer’s uncertainty

Which would you prefer?

10 dollars with certainty

50% chance of getting 30 dollars and 50% chance of paying 10 dollars

Both have the same expected payoff
But the first has more consistent outcomes
People tend to be risk-averse
- Do not like uncertaincty/variance in their outcomes

Microeconomics of Farming

Take the following farming techniques

Technique A

Offers a lower average yield
Low variance

Technique B

Offers a higher average yield
Higher variance

Suppose you need a consistent food supply, which technique will leave you starving more often?

Risk-averse farmers will tend to choose the safe option rather than gamble on a new method

Microeconomics of Farming

But we are leaving potential higher yields on the table

Crop insurance helps with this problem
- This can be an actual insurance policy
This would mean that farmers get paid when they have low yield
Alternatively, diversification of crops can work as insurance
- Farmers would still have some y ield even if one crop does not work out
The goal is to allow farmers to take risks

Microeconomics of Farming

Let’s do math

Consider my crop yield is \(X\) and my neighbor’s is \(Y\)
If I rely on my own crops, I get \(E[X]\) on average with a variance of \(Var(X)\)
If my neighbor and I share our yields we each get:

\[ \dfrac{E[X] + E[Y]}{2} \]

on average with a variance of

\[ Var\left(\dfrac{X + Y}{2}\right) = 0.25 * Var(X) + 0.25 * Var(Y) + 0.5 * Cov(X,Y) \]

\[ \text{We can get this from:} \; Var(aX + bY) = a^{2}Var(X) + b^{2}Var(Y) + 2ab Cov(X,Y) \]

Covariance

\[ Var\left(\dfrac{X + Y}{2}\right) = 0.25 * Var(X) + 0.25 * Var(Y) + 0.5 * Cov(X,Y) \]

The last term in the equation is very important
Covariance is a measure of joint variability
- When variables behave similarly, we call that positive covariance
- When variables behave dissimilarly, we call that negative covariance
An example is the daily temperature and how sunny it is
- We should suspect that when it is sunny, the temperature is also high
- This would lead us to think that the sun and temperature have a positive covariance

Covariance in our Farming Example

\[ Var\left(\dfrac{X + Y}{2}\right) = 0.25 * Var(X) + 0.25 * Var(Y) + 0.5 * Cov(X,Y) \]

Imagine you and your neighbor are growing crops

You share a common goal: to produce a high amount of consistent food
What should you and your neighbor do to accomplish this?

Grow crops that have a negative covariance
This would be a form of insurance (informal insurance)

Consumption Smoothing

Definition: Maintaining a consistent level of consumption over time

Why might the goal be to maintain a consistent level of consumption?
- We prefer to maintain a stable standard of living over time
How do we consumption smooth?
- Savings accounts, social security, insurance, etc.

If a farmer has a really bad year, insurance kicks in and helps maintain consumption levels
But in many developing countries, saving is difficult and there is no formal insurance
What can individuals do?

Sharecropping

Definition: A form of agriculture in which a landowner allows a tenant to use the land in return for a share of the crops produced on their portion of land

Popular form of agriculture in many parts of the world
Risk-aversion helps explain why we observe it so frequently, even though it is inefficient
To understand why, we need to think about the incentives of the farmer and landlord

Sharecropping

Let’s recall some microecon terms

1. Maringal Product of Labor (MPL)

2. Value of Marginal Product of Labor (VMPL)

3. Opportunity Cost

Sharecropping

Let’s recall some microecon terms

1. Maringal Product of Labor (MPL)

The change in output resulting from one more unit of labor
Example: The change in rice yield resulting from working one more hour on your farm

2. Value of Marginal Product of Labor (VMPL)

3. Opportunity Cost

Sharecropping

Let’s recall some microecon terms

1. Maringal Product of Labor (MPL)

2. Value of Marginal Product of Labor (VMPL)

How much the output from an additional unit of labor is worth
Wage is one way to think about VMPL

3. Opportunity Cost

Sharecropping

Let’s recall some microecon terms

1. Maringal Product of Labor (MPL)

2. Value of Marginal Product of Labor (VMPL)

3. Opportunity Cost

The value of the next best alternative
The opportunity cost of being in college is (in part) the wage you could be earning if you were working

Optimal Labor

If a farmer is working on their own plot of land, they will decide the optimal amount of hours to work

But how?

By finding where marginal product of labor equals the value of the next best alternative Why?
- If \(VPML < \text{Opportunity Cost}\), then the farmer should stop working and do something else
- If \(VPML > \text{Opportunity Cost}\), then the farmer should work more and dedicate themselves to this work
Because of this, there is clearly one optimal labor amount

Optimal Labor

Sharecropping Impact

Suppose the farmer does not own the farm

Further suppose that the farmer only gets to keep 60% of the VMPL
They give up 40% of their yield to the farm owner as a form of payment

Optimal Labor

Sharecropping Impact

If we think of profit in this market as the difference between VMPL and Opportunity Cost, then profit from working on the farm is given by

Sharecropping Impact

Under sharecropping, the farmer only gets profit while the landlord gets profit

Sharecropping Impact

Which leaves the awkward space known as deadweight loss from sharecropping

Sharecropping Impact

The existence of Deadweight Loss means that it is inefficient

But if it is inefficient, why do we observe it in the world?
Let’s think of the other alternatives:
- The landlord pays the farmer a wage to farm the land
- The farmer pays the landlord a fixed-rent to lease the land

Are the Alternatives Better?

Landlord pays a wage to the farmer

The landlord pays the farmer but monitoring the farmer is difficult
The farmer’s income is guaranteed, regardless of output
But output remains uncertain due to weather, pests, etc.
So the landlord bears all the risk of low-yields or crop failure
Even more important, the farmer has an incentive to neglect working
- Income does not depend on output leads to a moral hazard situation

So Moral Hazard + Full risk on the landlord makes this more inefficient

Are the Alternatives Better?

Farmer pays a fixed-rent to the landlord

The farmer keeps all profits from the farm (after paying the fixed-rent)
So the farmer bears all the production risks
If output was low, the farmer may lose income or not be able to pay rent
For a risk-averse farmer, this is very costly and makes them not want to take action
The landlord avoids all risk, but the farmer’s welfare suffers

Full risk being being on the farmer means that this is more inefficient

Summary

Sharecropping is the compromise

If both the landlord and the farmer are risk-averse, then share cropping is as close as we can get to efficiency
- If the farmer just payed fixed rent to the landlord, the farmer would bears all the risk of a poor crop
- If the landlord simply paid a wage to the farmer, the landlord bears all the risk of a poor crop
Sharecropping splits both the risk and income

Core Requirements for Ag Development

1. Changing Incentives to Promote Small/Medium Farmers

2. Pricing Policies for Agricultural Output

3. Supportive Policies for Integrated Rural Development

Core Requirements for Ag Development

1. Changing Incentives to Promote Small/Medium Farmers

Institutional Incentives like Crop Insurance
Scale-neutral Technological Advances: Leads to higher output for all size farms (better seeds, fertilizers, etc.)

2. Pricing Policies for Agricultural Output

3. Supportive Policies for Integrated Rural Development

Core Requirements for Ag Development

1. Changing Incentives to Promote Small/Medium Farmers

2. Pricing Policies for Agricultural Output

More employment in urban areas leads to increased demand for food
Increased demand for food leads to better prices for farmers’ output
- Smaller/Medium farmers benefit from their efforts

3. Supportive Policies for Integrated Rural Development

Core Requirements for Ag Development

1. Changing Incentives to Promote Small/Medium Farmers

2. Pricing Policies for Agricultural Output

3. Supportive Policies for Integrated Rural Development

Rural institutions being stronger (Banks, Seed and Fertilizer Distributors, Technical and Educational Programs, etc.)
Rural insfractructure (Storage and Marketing Facilities, Rural Transport and Feeder Road Quality, etc.)