What Effect Does Free Trade in Agriculture Have on Developing Country Populations Around the World?

What Effect Does Free Trade in Agriculture Have on Developing
Country Populations Around the World?


Jacinto F. Fabiosa


Working Paper 08-WP 466
April 2008




Center for Agricultural and Rural Development
Iowa State University
Ames, Iowa 50011-1070
www.card.iastate.edu










Jacinto Fabiosa is a scientist in the Center for Agricultural and Rural Development and co-director
of the Food and Agricultural Policy Research Institute, Iowa State University.

This paper was presented at the Annual Trilateral Academic Conference on Trade and
Investment in the Americas at Michigan State University, College of Law, Institute for Trade in the
Americas, on the topic, “Understanding the Growing Complexities of International Trade and
Agriculture,” September 27-28, 2007, East Lansing, Michigan.

This paper is available online on the CARD Web site: www.card.iastate.edu. Permission is
granted to excerpt or quote this information with appropriate attribution to the authors.

Questions or comments about the contents of this paper should be directed to Jacinto Fabiosa,
579 Heady Hall, Iowa State University, Ames, IA, 50011-1070; Ph.: (515) 294-6183; Fax: (515)
294-6336; E-mail: jfabiosa@iastate.edu.

Iowa State University does not discriminate on the basis of race, color, age, religion, national origin, sexual orientation,
gender identity, sex, marital status, disability, or status as a U.S. veteran. Inquiries can be directed to the Director of Equal
Opportunity and Diversity, 3680 Beardshear Hall, (515) 294-7612.

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Abstract


Highlighted in the “battle in Seattle” in 1999, anti-trade sentiments still persist, even
with development considerations placed at the core of reform negotiations at the World
Trade Organization, in which two-thirds of the members are developing countries.
In this paper, the impact of agricultural trade liberalization on food consumption
through changes in income and prices is considered. First, agricultural trade liberalization
is estimated to raise economic growth by 0.43% and 0.46% in developing and
industrialized countries, respectively. Since food consumption of households with lower
income are more responsive to changes in income, their food consumption increases
more under a trade liberalization regime.
Second, trade liberalization is expected to raise world commodity prices in the range
of 3% to 34%. Since, in general, border protection is much higher in developing countries
and the level of their tariff rates are likely to exceed the rate of price increases, 87% to
99% of the 83 to 98 countries examined would have lower domestic prices under
liberalization. Again, given that low-income countries are more responsive to changes in
prices, food consumption in these countries would increase more.
Finally, empirical evidence shows that if there is any harm on small net selling
producers in a net importing country, it is neither large in scale nor widespread because
the substitution effect dominates the net income effect from the lower domestic prices.

Keywords: agricultural trade liberalization, income and price elasticity, income
distribution, developing countries.

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Introduction

The Doha Development Agenda was launched at the Doha Ministerial Conference in
November 2001. World Trade Organization (WTO) members, of which two-thirds of the
current 151 members are developing countries, have placed this agenda’s development
issues at the core of the WTO’s reform negotiations.
However, as was brought into sharp focus during the so-called “battle in Seattle” in
1999, opposition to the reforms of the WTO still persist. Although the mass protest did
not speak with a single voice, an anti-trade sentiment was clearly prominent. It is at these
gatherings where blanket accusations that multilateral trade reforms are harmful to
underrepresented stakeholders—such as net food importing countries; small farmers;
indigenous, rural, and developing populations; and other small stakeholders—gain
currency and are received and circulated without question. As a result, shaping public
consensus favorable to the WTO reform can become an up-hill challenge.
This paper focuses on developing countries because it is here that most of the
underrepresented groups can be found in large numbers, and they share a common
characteristic of having low incomes. Specifically, the discussion here focuses on the
impact of liberalization on low-income households, particularly on small farm
households in net food importing countries. The objective of the paper is to review the
major economic impacts of free trade in agriculture on developing countries and trace
their likely consequences on low-income and underrepresented population groups. The
objective is to provide empirical evidence as to whether low income and
underrepresented stakeholders are better off or worse off under a free trade regime.
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The paper is organized as follows. Section 1 examines the impact of agricultural trade
liberalization on economic growth (i.e., income) and prices of agricultural commodities.
This is followed by sections 3 and 4, which trace the impacts of income and prices on the
food consumption of the population group of interest. Section 4 presents a summary and
conclusion.
1. Impact of Free Trade in Agriculture
The impact of liberalization in agriculture on income and prices is of particular
consequence to developing countries because low-income countries derive a significant
share of their incomes from the agricultural sector, and at the same time they allocate a
significant share of their consumption expenditure budget on food. We illustrate this
relationship for 158 countries based on their 2006 per capita GDP,1 income share by
sector, and consumption expenditure share by expense categories. Figure 1 shows an
inverse relationship between the share of income derived from the agricultural sector and
the level of per capita income. For example, countries with per capita income that is
higher than $21,323 derived less than 10% of their income from agriculture. As countries
with lower per capita income are considered (say, $5,228), the household share of income
from agriculture correspondingly rises to 10% to 20%. The share rises further to 20% to
30% for countries with lower per capita income of $3,383. Countries in the lowest per
capita income category of $1,668 had households deriving more than 30%, the highest
share of their income from the agricultural sector. The same inverse pattern emerges


1 GDP is measured using purchasing power parity (PPP). A nation's GDP at PPP exchange rate is the sum
value of all goods and services produced in the country valued at prices prevailing in the United States.
Data is taken from the 2006 World Fact Book (CIA, 2006).
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with the share of expenditure spent on food (see Figure 2). That is, starting at a high-
income category, countries with per capita income of $34,854 had households allocating
less than 15% of their expenditure budget on food. As countries with lower per capita
income (say, $22,680) are considered, the allocation of expenditure on food
correspondingly rises to 15% to 30%. The share rises further to between 30% and 50%
with household income at $8,327. Countries in the lowest per capita income category of
$2,799 or less had allocations of more than half of households’ expenditure budget on
food. So for countries (and households), the agricultural sector is of significance both as a
source of income as well as a major expenditure item (i.e., food) in their total budgets.
Hence, any policy reform in this sector, such as trade liberalization, will affect more the
population groups within a given country, such as indigenous, rural, and developing
populations who are more dependent on the agricultural sector.
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We use changes in food consumption as our metric in assessing the impact of
agricultural trade liberalization on developing country populations. Of the many
ramifications of the impact of agricultural trade liberalization, we only consider the direct
impact from changes in income and prices.2
2. Impact of changes in income
The impact of the Uruguay Round Agreement on Agriculture (URAA) had many
facets. This paper focuses on the impacts of the URAA on economic activity and world
commodity prices. On the impact of the URAA on economic activity we use the study by
Harrison, Rutherford, and Tarr (1997). They used a numerical general equilibrium model,
which incorporates increasing returns to scale, 24 regions, 22 commodities, and steady-
state growth effects. For developing countries, the impact of the URAA was 1.4% of

2 Other studies have examined the institutional impacts (i.e., on market efficiency and integration) of the
WTO (see Fabiosa, 1999).
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GDP. Isolating only the impacts of agriculture-related reforms such as the URAA and the
Multi Fiber Agreement (MFA), the economic impact is estimated at 0.43%. Some regions
showed larger impacts, such as Latin America at 0.93% and South Asia at 0.72%. For
industrialized countries, the total impact was 0.8% of GDP. The combined impact of the
URAA and MFA was 0.46%. Although these magnitudes of economic impacts are not
very dramatic, they are not trivial either, given that in 1996 the average growth rate for
developing countries was 5.8%, while for industrialized countries the growth rate was
2.8%.
Next, we trace and quantify the likely impact of this improvement in income on food
consumption by using the income elasticity of food in the respective countries. We
borrow the estimates of Seale, Regmi, and Bernstein (2003), who examined 114 countries
and their responses to changes in income and prices. Figure 3 shows their estimates of the
income elasticity of food across different countries. It shows that food is a normal good;
that is, more is consumed with higher income. Moreover, it shows that food consumption
of poorer countries (or households) is more responsive to changes in income. Persons
with an income of $32,967 or above have an income elasticity that is less than 0.50. That
is, as their income rises by 1%, the quantity of food consumed rises by less than 0.50%.
However, persons with a lower income level of $6,436 have income elasticity that is
larger than 0.50. Assuming the gains from the URAA are distributed equally among
households and persons in a given country, the more responsive behavior of persons with
lower income suggests that they benefit more from the trade liberalization in terms of the
rate of increase of their food consumption.
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However, it is common knowledge that the assumption of equal distribution is
suspect. A Gini ratio is commonly used to measure the distribution of income
(Wikipedia). It ranges from 0% to 100%, with 0% indicating extreme perfect distribution
while 100% indicates extreme imperfect distribution. Figure 4 seems to suggest that
income distribution deteriorates (or becomes more unequal) as we move from countries
with higher income per person to countries with lower income. That is, countries with
average per capita income of $32,967 have a Gini ratio of less than 50% (a relatively
more equal distribution) when compared to countries with much lower per capita income
of $6,436, which have a Gini ratio of more than 50% (a relatively more unequal
distribution). Moreover, what is more troubling is that in the last decade the Gini ratio has
increased in many counties, suggesting a deterioration of the distribution of income. This
has been the case in Brazil, the United States, China, India, the United Kingdom, and
Japan (“Income Disparity Since World War II—Gini Index”). Although it can be claimed
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that because of their greater responsiveness to changes in income, poorer countries (and
households) improve their food consumption more from the economic gains of
liberalization, the more unequal distribution of wealth that characterizes these countries
may impede the widespread impact of this improvement.3
3. Impact of changes in prices

The second major economic impact of liberalization in the agricultural sector is
the changes in world commodity prices. In general, as agricultural trade reforms compel
countries to reduce their protection at the border, their domestic prices fall, inducing an
increase in quantity demanded and a decrease in domestic quantity supplied, which raises
the countries’ excess quantity demanded (or imports). Consequently, the rise in world
import demand exerts pressure on world commodity prices, causing them to rise. Table 1


3 The impact of liberalization on income distribution is not addressed in this paper.
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summarizes the average price increase from agricultural liberalization for several
commodities reported by Fabiosa et al. (2005). For feed grains, world prices increase
between 6% and 8%, while food grain prices increase by 8% to 11%. With relatively
lower protection, oilseed prices increase by only 3% to 7%. Meat prices increase by 3%
to 11%. The largest price change is in dairy products, which increase by 28% to 34%
because of the high level of protection in these commodities. Sugar, another highly
protected commodity, increases by 33%.
The impact of the change in world commodity prices on the consumption of
households would depend first on how the world price changes are transmitted to the
domestic market, particularly the effects on the domestic price. The impact of higher
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