Small Farms as the Engine for Emerging Market Economies
javier ekboir is a Buenos Aires-based consultant to multilateral agencies (the World Bank, the United Nations Food and Agriculture Organization and the Inter-American Development Bank), governments and private firms on issues ranging from organizational innovation to agricultural development.
Published July 15, 2016.
A renewed debate about the role of agriculture in economic development is brewing. It's widely accepted that the early successes in development – for example, Britain's Industrial Revolution in the 18th century – were sparked by radical changes in rural economies. Extrapolating from these experiences, many economists and international organizations still argue that expansion of agriculture, especially small farms, in developing countries, is necessary to trigger growth in other sectors.
But an increasing number of economists believe that today's socioeconomic dynamics are completely different from those prevailing even 40 years ago and that a new set of factors, ranging from globalization to technological and organizational advancement, links agricultural change to development.
While at the beginning of the Industrial Revolution, rising productivity in agriculture was the source of capital and labor for manufacturing, today the focus is on how a variety of factors are poised to transform agriculture. The most important changes in the developing countries' rural sector include the emergence of new markets for farm products, the progressive differentiation of a heretofore homogeneous rural population and changes in the livelihood strategies of the rural poor.
For many decades the name of the game in rural development has been the expansion of the supply of foods and fibers to meet the demand of swelling urban populations, increase the incomes of poor farmers and generate export revenue. Today, reductions in malnutrition and improvements in sustainability have also become major development goals. Malnutrition around the globe is less a problem of insufficient food production than of low incomes and price volatility.
Everyone agrees that over the next half-century, the supply of agricultural products will have to continue to grow rapidly to meet the demands of an increasingly affluent global economy. The disagreements arise over how to achieve such growth while attending to the new priorities. This challenge will be not only a matter of increasing yields per unit of land (or water) through scientific discovery, but also of mobilizing investments in infrastructure, establishing effective financial instruments for risk management and making changes in institutions and attitudes that foster the rapid diffusion of new technologies and flexible business models. One benchmark of success: the merger of small farms into larger units. Another: a generational transition that allows entrepreneurial farmers to buy land from traditional landowners.
Public policy can guide and accelerate the process. But to get from here to there with minimal social and political dislocation, policymakers will have to recognize that change will largely be driven by forces beyond their direct control. Therefore, an important concern ought to be the creation of safety nets for those displaced by change, rather than intervention that too often has the effect of freezing methods of production.
Before the 1980s, most developing countries were in the initial stages of urbanization, communication was difficult and transportation was both slow and expensive. This meant that poor rural households were effectively bound to their farms, deriving most of their income from tilling the soil and raising animals. Because local markets were small and isolated, increases in production (due to technological change or good weather) often led to precipitous declines in commodity prices that undermined incentives to invest in productivity enhancements. Rural poverty was synonymous with agricultural poverty.
Economists generally believed that this poverty was largely a product of overpopulation and lack of capital that prevented adoption of modern technologies – that rural households were compelled to support more laborers than could be used effectively. Hence the marginal product of labor (the output that could be added by another worker) was zero, or at least below the level that could support subsistence. This conviction shaped agricultural policies in developing countries for almost three decades. Researchers focused on improving labor-intensive technologies to absorb excess labor supply while governments discouraged mechanization in order to avoid aggravating underemployment and driving the rural poor to urban shantytowns.
Note, too, that agricultural-development programs were generally based on the assumption that productivity jumps could only come from modern technologies (for instance, combinations of improved seeds and chemical fertilizers) that were designed by scientists who knew better than the farmers. Because farmers' insufficient understanding of the benefits of the modern technologies was seen as the greatest limitation on agricultural growth, efforts were focused on the transfer of the new technologies by extension agents. The success of the Green Revolution – a catchall term embracing a variety of policies that included price subsidies and productivity-enhancing technological improvements that almost doubled grain production in the developing world in the 1960s and 1970s – was perceived as confirmation of the wisdom of this focus. Indeed, this approach, with some variations, is still embraced by most development organizations.
As is the case with most complex processes, change was about to come from a different, largely unanticipated direction. After the debt crisis of the 1980s in Latin America and beyond, most developing countries implemented structural-adjustment programs that included market liberalization and downsizing the public sector. These policies, combined with technological change in production, transportation and marketing, enabled the rapid expansion of agricultural markets.
The value of international trade in farm products has increased five-fold since 1965. And not surprisingly, the vastly larger markets and new institutional climate favoring free markets induced major changes in rural economies. Twenty years ago, agriculture in developing countries was largely in the hands of traditional land-owning elites and of small, poor farmers who sold their crops in local markets. Today, two new types of farmers can be identified: large commercial farmers producing grains and livestock with cutting-edge technologies and farmers specializing in high-value crops like perishable fruits, vegetables and flowers.
Beginning in the 1980s, grain production in Latin America underwent a major revolution built on a variety of market-driven changes that included the introduction of soybeans as an export crop, no-till practices, larger machinery and new financing mechanisms. These changes generated economies of scale, which induced an increase in the size of operations. Today, these Latin American farmers use methods that are similar to those of their counterparts in the American Midwest.
Livestock production has also been changing rapidly. Thirty years ago, most beef in Latin America was pasture-fed and integrated into multiyear cycles with cereal production; relatively small herds were economically viable. But technological change in both grain and beef production fostered both specialization and greater scale.
Grain farms now occupy the most fertile lands, while livestock has been displaced to marginal lands where crops cannot be grown – sometimes at the expense of rain-forest preservation. Hence the rise of the feedlot, with scale efficiencies that make it practical to fatten 10,000 steers at a time. All the beef is exported or consumed domestically in cities. There are signs, moreover, that these supersized North American-style ranching operations will eventually dominate livestock production in developing countries outside Latin America. Meanwhile, large-scale commercial farming producing cereals and oil seeds is already spreading to Africa to take advantage of the improved business climate, similar ecological conditions and cheap land.
High-value agriculture in developing countries has evolved in three stages. The first started more than 100 years ago and included the rise of export crops such as coffee, tea, rubber and bananas that were produced on plantations and marketed by large companies.
The second stage, which supplied developed countries with fresh fruits and vegetables, fish, nuts, spices and floriculture, started in the early 1960s and picked up speed in the 1980s. This stage was initiated by American traders who, taking advantage of trade liberalization and dramatic improvements in logistics, contracted Mexican farmers to produce fresh vegetables in the winter for American markets. The approach later expanded to other products and other regions – think of fish farming in Southeast Asia, along with growing grapes, berries and peaches in Chile and fresh produce in Africa. International traders usually work with large farmers, buying from small farmers only when they have no other option (due to the nature of the crop) or to avoid dependence on a single supplier. In the 1980s, most development agencies started to finance projects to help small farmers gain access to these high-value markets. This strategy was known as market-led development and was built on the assumption that a majority of small farmers could thrive in competitive markets.
The U.S. Agency for International Development was one of the first and strongest supporters of this strategy, because it opened a way to create economic alternatives for small farmers in war-torn Central America and, as part of drug eradication programs, in South America. However, this strategy did not work as expected; few farmers have proved to be good enough managers and innovators to be able to compete in demanding international markets characterized by strong economies of scale in commercialization.
The third stage, which has been called the supermarket revolution, was triggered by a combination of urbanization and rising incomes in developing countries that fueled domestic urban consumption, along with the expansion of fast-food chains and supermarkets, like Walmart and Carrefour, in these developing countries. The companies coordinate the whole supply chain through specialized, dedicated wholesalers who buy mostly from preferred suppliers.
Farmers selling in this channel tend to be in the upper end of the small-farmer category (whereas sellers in traditional channels are in the lower end), have more capital (notably, irrigation systems) and are more specialized in commercial horticulture than traditional farmers. Their rise is both economically and politically important since they constitute a new rural middle class. But note that no more than 10 percent of small farmers have been able to flourish in these markets. Moreover, once the supply chain has been established, few new farmers can break in, since buyers tend to stick with the farmers they trust in order to minimize risk and variations in quality and quantity.
Both the large farmers producing for export and the small farmers supplying supermarkets and fast-food chains have been buying land and water rights from small farmers who remain in the traditional markets. This process has had an important impact on the rural economies, which are discussed in more detail below.
The ways poor rural households make a living in developing countries have been changing rapidly. A minority of small farmers has made the leap to producing for high-value markets. But for most, the end of trade protectionism in food products that came as part of the 1980s structural reforms meant that they had to compete in the local grain markets with large farmers from the United States, Australia, Argentina and Brazil.
At the same time, improving telecommunications and easier travel opened national and foreign labor markets, which accelerated migration from rural areas. The net result has certainly been more good than bad: household incomes are up and rural poverty is down. But the social dislocation, with the resulting increased dependence of local agriculture on women and older stay-at-home family members, has hardly been costless.
After the deregulation of food trade and the increase in international food aid (mainly donated grains produced in developed countries), the profitability of growing staple crops in small farms fell. But contrary to what was expected, small farmers continued to produce them. The most plausible explanation for this phenomenon is that the share of the income that poor rural families derive from agriculture is declining as off-farm employment and remittances from family members abroad (or in domestic cities) become the main sources of income. These households keep their farms as retirement insurance for the members who migrate (although many decide not to return) and farm only to secure their own consumption of staples or to produce the ingredients of traditional foods that cannot be easily bought in local markets.
The scale of this dislocation is striking. In 2015, some 250 million international migrants sent home $600 billion – four times as much as transfers through foreign aid. There are no estimates of domestic migration and remittances, but rapid urbanization indicates that they are quite large.
Note, moreover, that unlike foreign aid, remittances go directly to households. Most of the money is invested in education, health or housing, with only a small proportion going to agricultural improvements. This pretty clearly indicates that most poor rural households no longer entertain hopes of raising their incomes by investing in agriculture. And the fact that the farm is valued less as a productive asset than as a retirement retreat is preventing more-entrepreneurial farmers from consolidating land holdings to reach efficient scale, which in turn is delaying the growth of agricultural production and forcing developing countries to rely more on food imports.
Migration and remittances are changing rural consumption patterns, and rural economies are changing in response. Thanks to rising income (largely through remittances), even poor rural households are demanding a greater variety of goods and services (for example, prepared foods), which is stimulating small-scale local enterprises (such as stalls that sell junk food and soft drinks). What's more, greater exposure to foreign cultures is creating demand for a vast array of goods never seen in once-isolated regions. It is now possible to buy the same packaged foods in remote parts of Ghana that fill the shelves of the 7-Elevens in Grand Rapids. But the good news goes beyond the wider availability of Cheetos and Oreos. The Pew Research Center recently reported that the percentage of the population in seven African countries that owned a mobile phone had reached the percentage in the United States.
Scrambling For a Living
Before the rapid widening of international agricultural markets in the 1980s, poor rural households had few alternatives to farming only for local consumption. When new opportunities emerged, the households with a little capital and more than a little enterprise took advantage of them, dividing a largely homogeneous population into three clearly separated groups: better-off rural households producing for high-value markets, poor rural households with at least one migrant member sending remittances and poor rural households with no alternatives to scratching a living out of traditional agriculture (which includes a large number of farmers who rent land or work for wages).
Surviving in high-value markets requires strong managerial and business capabilities to meet sophisticated technical and commercial standards for the products. Research shows that capabilities (in all domains of life, including art, sports, science or business) have an asymmetric distribution, with a few people having very strong capabilities and the vast majority relatively weak ones, offering a partial explanation of why only a small fraction of small farmers have successfully made the leap. The uneven distribution of business acumen also suggests that inequality in the distribution of assets is more likely to increase rather than decrease, a reality with profound implications for development and poverty alleviation policies.
The households with weaker business capacities usually depend on off-farm employment, including migration, but even this option is not open to everybody. Migration depends critically on social connections, since migrants tend to go to places where other people from their villages or families have gone before. Families with weak social capital (often the most marginalized populations, like the Mayas in Mexico or the lower castes in India) are unable to find opportunities far from their villages.
Even those families are slowly integrating into the globalized society. But until they develop enough knowledge of the external world, they will be condemned to the most abject poverty. Public policy should aim to establish safety nets and to help marginalized groups to develop capacities to better access new opportunities for earning – and not just in farming.
Rural Development 2.0
While, many decades ago, rural development was seen as vital to bringing economies out of poverty, between the mid-1970s and mid-2000s it took a back seat to urbanization and export-oriented manufacturing in long-term planning. But it's coming back to the fore for a variety of reasons. For one thing, the dominance of Asia in global manufacturing and the fast robotization of industrial production have made it far harder to envision a similar path for the late starters. For another, the potential for sustained growth of agriculture seems greater, thanks to increasing urbanization and dramatic improvements in transportation, communication and finance, even as issues of overtaxed infrastructure and pollution have begun to limit economic growth from continuing urbanization. The 2007 food crisis – a perfect storm of drought, low global food stocks, rapid escalation in energy and synthetic fertilizer costs and diversion of crops to biofuels – also drove attention to the problems caused by the long neglect of agricultural production, food access, the sustainable use of natural resources and climate change.
Since market-friendly deregulation swept through developing economies in the 1980s, goods and labor markets became more integrated into globalized markets, and poor rural households diversified their livelihood strategies, relying more on remittances and off-farm work and less on the production of staples. But the downside to these changes is evident, too: only a small proportion of small farmers has been able to take full advantage of the emerging opportunities to sell in high-value markets. These unequal responses are increasingly being recognized as the result of the highly skewed distribution of entrepreneurial capabilities. In other words, when technical and business opportunities emerge rapidly, only a few people can take advantage of the new openings, and societies become more unequal.
The consequences of this widening divide have yet to be recognized by international donors, philanthropists and multilateral organizations. For example, most agricultural programs and policies in developing countries are based on the assumption that because poor rural households produce most of their own food, and since they represent the majority of farms in the world, it will be possible to meet future increases in global food demand by increasing their productivity. The same development strategists have also assumed that the main constraint on the expansion of small-holder agriculture is lack of scale in procurement and marketing because it prevents the farmers from getting better prices for bigger volumes. Thus, development projects have strongly promoted the organization of farmers into groups for everything from the purchase of fertilizer and capital goods to collective management of watersheds or joint sales of their products.
However, as I suggested above, those policies do not take into consideration the unequal distribution of capacities and the alternative uses that rural households have for their labor and capital. This is confirmed by the fact that the vast majority of poor rural households are not investing their own resources in agricultural production (except for labor-saving technologies), while they are investing in human capital that can be used outside agriculture.
The result is that, in some cases, donor-driven advice (and funding) is actually undermining development prospects. Because subsidies from rural improvement programs change farmers' incentives, they often induce them to invest their own resources in activities that are not economically viable in the long run. And if the projects are not ultimately viable without subsidies, farmers are at risk of losing their already-scarce resources.
Note, moreover, that the emphasis on collective action has subtler drawbacks. For one thing, collective action is very difficult to enforce, especially when the benefits that can be gained from low-value sales or minor purchases are small. Consider, too, that since agricultural income is not their main goal, many farmers join collective efforts only to receive the subsidies offered by government and international donor programs. When a program ends, the farmers abandon the technologies and the groups promoted in order to join new groups and adopt new technologies just to receive new gifts. The implementing organizations (non-governmental organizations or public agencies) are reluctant to acknowledge this reality because they are evaluated by the numbers of participants in their projects. These perverse incentives generate competition among development projects, induce misallocation of public and private funds, and do little to help poor rural households create sustainable paths to income growth.
Full recognition of the trends discussed above would lead to different sorts of aid. First, donors would not promote commercial agriculture as a one-size-fits-all fix, but would offer a diverse menu of options so that individual households could choose according to their livelihood strategies, capacities and resources. For example, farmers with the strongest business abilities could be supported to enter high-value markets, but people with other capacities could receive education and training to become skilled workers in agriculture or in other sectors (for instance, learning how to use a computerized irrigation system or to repair sophisticated farm machinery).
To the same end, the interventions should develop the capacities of rural inhabitants so that they can find non-agricultural jobs in increasingly diverse rural economies – say, as shop clerks and health care workers – or to find work in the service economies of distant cities. Finally, the development of markets that facilitate the transfer of productive assets (like land and water rights) to more-entrepreneurial farmers should be supported. These policies should be complemented with safety nets that help those left behind by the changes induced in rural areas.
A broader lesson here: planners would be wise to place less emphasis on interventions that freeze the current productive and social structure of rural areas and more on policies that facilitate the transition to modern agriculture while reducing the adjustment costs. High-return projects, like all-weather roads connecting rural areas to market towns and potable-water systems, are critical to rural development. So, too, are education (especially of women), vaccination and sanitary campaigns, along with institutional reforms that improve governance, define and defend private property rights, enforce contracts and untangle regulations that raise transactions costs and undermine capital-market efficiency.
The development community is getting the message that the paths to growth in many countries depend on the transformation of relatively simple agricultural economies into complex business environments and the creation of new jobs in urban areas for those who are displaced. The hard part, though, is to figure out how external assistance and creation of a truly globally integrated labor market can aid adaptation of both developed and developing countries to the new realities of the global economy.