Agricultural trade liberalization, price changes, and environmental effects

Agricultural Trade Liberalization, Price Changes, and Environmental Effects ERNST LUTZ Environment Department, The World Bank, Room S-3049, 1818 H. Street, NW, Washington, DC 20433, U.S.A. Abstract. Many analyses of agricultural trade liberalization have been undertaken but few have considered the effects on the environment. For the developed countries, reducing the degree of protection would result in less intensive production; therefore, environmental stress would be reduced. A reduction of trade barriers in industrial countries would result in higher world prices and in a somewhat lower world price variability. Assuming initially no policy changes for developing countries, the question is how the liberalization would affect the environment. Higher prices in developing countries increase the level of production by intensifying production, particularly in the commercial sector, and by an area expansion. Both result in negative environmental effects. These could be partly offset by an increase in hired labor in the commercial sector, which might reduce pressure at the frontier and on marginal lands, as well as by the income effect. These off-setting effects may be small; however, the direction of the overall environmental effects cannot be determined unambiguously without empirical examination. At the global level, the beneficial economic effects of agricultural trade liberalization probably outweigh the expected negative environmental effects in developing countries, but this cannot be unambiguously established without valuation. Key words. Environmental effects, agricultural trade liberalization, agricultural price changes.

Introduction

A large number of theoretical and empirical studies have dealt with the issue of trade liberalization in general and agricultural commodities in particular. The various empirical studies done on the subject deal with sometimes different liberalizing areas, different numbers of commodities being liberalized, they assume partial or complete liberalization, they assume various commodity and country supply elasticities, and make their computations based on single years or the averages of several years.1 In general, an agricultural trade liberalization in the industrial countries would lead to lower farm prices, reduced production and reduced exports or higher imports, depending on the commodity in question. Consumers would benefit from lower prices, while producers would lose income, unless their shortfall was made up by direct income payments. Also, the liberalization would lead to increased price variability in industrial countries. Trade liberalization would reduce world market price instability. Average world market prices for various commodities would increase, according to various studies, from 0.1 to 29 percent depending on the commodity in Environmental and Resource Economics 2: 79--89, 1992. 9 1992 KluwerAcademic Publishers Printed in the Netherlands.

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question (Valdez, 1987). The IIASA model, considering 10 commodities, predicts a long-run increase in world prices of about 9 percent under a trade liberalization scenario (Valdez, 1987). The effects of an agricultural trade liberalization in industrial countries on the developing countries are not uniform, but depend on whether a country is a net importer or a net exporter in a particular commodity, and what the commodity mix is. Importers would lose from trade liberalization and exporters would gain. Interest in trade reform can therefore differ from country to country and commodity to commodity, which makes it difficult for these countries to act as a group, such as in international trade negotiations. The empirical studies referred to above did not consider what, if any, the effects of a liberalization would be on natural resources use and the environment. Perhaps these effects were, a priori, judged to be negligible, or environmental effects were not yet viewed as important at the time the studies were done. The discussions about economic policies, environmental management and resource use have clearly intensified in the recent past. (See, e.g., Sutton (1988), Schuh (1990).) This is to be welcomed, but given that in some discussions various disciplines are represented, at times contradictory and/or undifferentiated statements are being made. For example, low agricultural prices in developing countries (e.g., as a result of various distortions) are being identified as a cause of degradation; at the same time, high prices are identified as a cause of the same problems. The purpose of this paper is to discuss, in a preliminary manner, the environmental effects of an agricultural trade liberalization in industrial countries on the one hand and in developing countries on the other hand. Consideration is given to short-run and long-run effects, and an attempt is being made to qualitatively assess their impact. Rather than being a comprehensive piece on the subject, the paper attempts to review a few key pieces of literature, suggest linkages between macro and sectoral policies and the environment, outlines tentative results, and proposes further research in this area.

Conceptualization A back-to-back two-country model can be used to conceptually discuss some of the issues (Figure 1). While the model is simple, it nevertheless helps to clarify some issues. A trade liberalization would result in a drop in prices in industrial countries from P1 to Pw, and supply would contract from D to A, demand would expand from C to B, and imports would increase from DC to AB. On the other hand, in developing countries, the price would increase from P2 to Pw, supply would expand from E to H, demand contract from F to G, and exports increase from EF to HG. The key to assessing environ-

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Agricultural Trade Liberalization Develop~lg Countries

Industrial Countries

DT

o/

P1

R, P~

81 $2 Q1

QI

Fig. 1. Agricultural trade liberalization in a two-country model.

mental effects, in industrial and developing countries alike, is to estimate changes in the amounts of factors of production used.

Effects of an Agricultural Trade Liberalization in Industrial Countries on Their Own Environment and Resource Use

A trade liberalization in industrial countries would reduce prices of agricultural commodities. According to various empirical studies surveyed by Binswanger (1989), the policy response of aggregate output is small in the short-run with elasticities generally ranging from 0.05 to 0.20. Long-run elasticities can range from 1 to 2. If, for example, the average rate of protection in industrial countries was 30 percent, and if trade was fully liberalized, output would decline by only 1.5 to 6.0 percent in the short-run but 30 to 60 percent in the long-run. This is only an illustrative example, and since the level of protection differs from country to country (or trading bloc) and from commodity to commodity, one would have to undertake individual country studies to be able to predict specific effects. In addition, if agricultural trade was liberalized simultaneously in all industrial countries, the small country assumption would not hold any longer and world prices would be affected. Specifically, if output in industrial countries fell, world prices would increase and partly offset the initial decline in internal prices brought about by the liberalization.

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In our illustrative example, if domestic prices initially decreased by 30 percent but world prices later increased by, say 10 percent, the price decline would only be 20 percent on a net basis, and output therefore would be expected to fall only 20 to 40 percent in the long term. From an environmental/resource use perspective, one would want to know how the demand for factors of production changes under a trade liberalization scenario. Using information from Johnson (1950) as presented by Binswanger (1989) (see Table I), one could predict that in the short-run the strongest adjustment would take place in variable inputs such as in fertilizers, pesticides, and in the wages of hired laborers .2 This is significant from an environmental point of view, since nitrate pollution of drinking water and pesticide contamination of groundwater are serious environmental problems in intensive agricultural production areas. Inputs of total labor used in agriculture as well as power and machinery would be reduced slowly, and land under cultivation would decline even more slowly. Using estimated elasticities from Cavallo (1988) as presented in Binswanger (1989) (see Table II), a drop in prices of 30 percent would reduce land under cultivation by 2.1 percent in year 3 and 14.4 in year 20. The speedy and significant reduction in input usage would clearly be beneficial for the environment.- Also, a gradual idling of "marginal lands" would be expected to reduce erosion. Heimlich (1989) makes the point that one needs to distinguish between land that is marginal from an economic point of view (low productivity) and land that is marginal from a physical point of view (e.g., because of high erodibility). His empirical research for the United States showed that there is no practical significance to differences in average productivity between highly erodible and nonerodible land. If Heimlich's results are applicable for other industrial countries, it means that a withdrawal from production of economically marginal land does not necessarily remove land from production with the highest levels of erosion. Nevertheless, erosion can be expected to be reduced on economically marginal land that is not being cultivated any longer, as weeds, shrubs, etc. stabilize the soil, and/or therefore erosion would be less than what it would be under continued cultivation. An idling of marginal lands would permit wildlife habits to again expand. Over the longer term some ecological properties would be restored, which were lost during the earlier expansion. But some changes may not be reversible such as wetlands that have been drained and cultivated, and of course species that were lost. An increased economic marginalization, however, would also mean a loss of fixed investments that were made and could have some social drawbacks, in the sense that viability of some villages would be jeopardized, or that the scenic beauty of the landscape could suffer (with possible negative results on tourism). In the long run, production technologies change in response to the change in prices and the lower profitability. Whether the new technologies would be

100 86 60 46 48 60

Year

1929 1930 1931 1932 1933 1934

100 105 72 61 66 72

Relative farm prices 100 98 107 104 96 81

Agricultural output 100 82 68 52 62 67

Manufactured output 100 10I 103 104 103 93

Land planted

Note: All figures reindexed so that 1920 = 100. a Index with volume in terms of 1935--89 average dollars. Sources: Johnson (1950) and U.S. Bureau of Census (1945), as presented in Binswanger (1989).

Price of agricultural output

Table I. United States: the response of agriculture to price dechnes in the depression

100 99 99 98 97 97

Total labor 100 93 72 53 47 53

Wage rates

Fertilizer used 100 103 79 55 61 70

Power and machinery a 100 101 100 97 89 84

E-

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Table II. Argentina: price elasticities in agriculture Number of years after price change

Output

Labor

Physical capital

Land

1 3 5 10 15 20

0.07 0.16 0.36 0.71 1.19 1.78

0.00 0.07 0.17 0.42 0.82 1.52

0.05 0.18 0.38 0.90 1.39 1.80

0.03 0.07 0.12 0.23 0.34 0.48

Note: The elasticities are computed by assuming a 10 percent permanent increase in the price

of agricultural goods but adjustments were made in the price of government services in order to keep the general price level at historical levels. The price is increased in the same proportion as the agricultural price, and government wages are reduced in the same proportion as the price of government services. Source: CavaUo (1988), as presented in Binswanger (1989).

environmentally more benign on a net basis than the old ones is, however, not clear. Further research is needed in this area. The reduced profitability along with an increased price variability may increase the farmers' discount rate and lead them to a m o r e short-run orientation at the expense of long-term sustainability concerns, but this has not been demonstrated empirically. If the reduced income from crop production was made up totally or partially with direct income payments, one could argue that farmers could m o r e easily afford to keep their discount rate unchanged. A liberalization would increase price variability, making the economic environment m o r e uncertain. Farmers in m a n y industrial countries are now used to fixed output prices; they would perceive the increased variability as a cost. F r o m an environmental point of view, the fluctuating prices would result in increased shifting among crops. This might reduce specialization and increase diversification, which would be better from an ecological point of view, but the m o r e frequent shifting into and out of crops could result in increased erosion. In summary, while some of the environmental effects of an agricultural trade liberalization are unclear, overall one would expect a reduction of negative environmental effects in industrial countries.

Effects of an Agricultural Trade Liberalization in Industrial Countries on the Developing Countries' Environment and Resource Base As a result of an agricultural trade liberalization in industrial countries (and

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assuming no policy changes in developing economics), the developing countries would face higher average world market prices and a reduced world price variability? In general, and from an economic point of view, this would be of economic advantage in the case of those agricultural commodities that are being exported, and of disadvantage of those being imported. What the environmental effects are is not obvious and very limited conceptual and empirical work has been done on the subject. The thesis by Mauro Lopes (1977) provides valuable insights into the issue. According to his model and his empirical estimation, a 10 percent across-the-board increase of agricultural prices in Brazil would lead to an increase in capital by 27 percent, agricultural employment by 18 percent and land area by 6 percent (Table III). These estimates are in the same order of magnitude as those by Cavallo, and therefore they tend to support each other. Lopes did the estimation for various farm sizes, which provides additional valuable insights on how price changes work their way through the farm sector and how they affect the environment. It is interesting to note that there are significant differences in how small and large farms respond to a change in incentives. The response of large farms is very significant. For example, a ten percent increase in prices will lead to an increase in employment of at least 22 percent for all farms larger than 10 hectares (see Table Ill). The corresponding wage increase is between 12 and 17 percent. Land use increases by about 7 percent for farms between 10 and 100 ha and by 16 percent for farms above 1000 ha. Use of capital in the form of fertilizers, pesticides, and machinery would not noticeably change for farms below 10 hectares, but would increase between 23 and 42 percent for larger farms. How this increase affects the environment depends, among other things, on how these inputs are used, their level, the soil type, topography, and local climate in question. The response of small farms is comparatively small and inelastic for all factors of production. Labor hardly changes because essentially family labor is used. Land under cultivation increases by only 2 percent, because small farms generally have little idle land available, compared to large ones that can easily adjust to different prices regimes by starting to cultivate previously idle land or by expanding the frontier. Overall, based on the work by Lopes, one can clearly see that in countries with a commercial farm sector, increased agricultural prices (such as because of a trade liberalization in the industrial countries) will result in more intensive resource use and associated negative environmental effects of that subsector. The increased absorption of farm labor by the commercial sector could potentially have some off-setting, positive environmental effects, if, for example, labor was being absorbed in the sector, which otherwise would be farming marginal areas and extending the frontier. The conclusions of Schuh

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Table III. Brazil: effects of a 10 percent devaluation of the exchange rate on employment, wage rates, land use, returns to land, capital use, and returns to capital, by farm size Resulting Change (Percent) Land use

Return to land

Capital use

Return to capital

Farm size

Employment

Wage rate

All farms Maximum Minimum

18.29 32.47 10.37

13.83 20.71 9.11

6.23 12.32 4.54

15.77 23.81 13.54

26.64 35.21 9.08

3.71 9.89 2.29

Up to 4.9 ha Maximum Minimum

3.25 4.88 1.96

7.23 10,12 6.51

1.66 2.70 0.66

9.08 11.67 7.57

1.01 1.06 0.98

9.59 10.01 9.24

From 5 to 9.9 ha Maximum Minimum

3.75 5.45 1.99

7.25 10.52 7.11

2.44 3.13 1.83

10.56 12.26 7.86

1.05 2.30 0.88

11.09 12.46 10.18

From 10 to 49.9 ha Maximum Minimum

24.62 27.57 22.24

13.39 18.64 12.49

6.79 7.91 3.47

19.01 21.99 16.68

25.94 31.44 19.49

2.55 6.76 2.08

From 50 to 99.9 ha Maximum Minimum

22.43 23.57 21.29

14.78 17.33 12.38

6.53 7.28 4.22

19.74 24.85 15.55

23.42 37.32 21.55

3.04 7.33 2.84

From 100 to 499.9 ha Maximum Minimum

25.55 27.02 24.07

12.01 14.33 11.99

11.09 18.04 7.84

21.08 36.84 19.13

24.61 35.28 20.89

1.58 2.51 0.87

From 500 to 999.9 ha Maximum Minimum

32.01 39.82 20.18

16.36 18.18 15.06

14.50 16.03 9.08

6.70 17.70 3.49

42.72 61.87 32.10

4.35 6.70 3.49

From 1000 and more ha Maximum Minimum

33.62 42.81 19.49

17.56 25.43 16.15

16.02 27.90 9.91

7.19 19.00 4.88

36.42 50.43 20.35

4.88 7.18 3.37

Source: Mauro Lopes (1977). In the original table by Lopes, he presented the effects of a 10 percent overvaluation, and therefore all estimates had mSnus signs.

( 1 9 9 0 ) are b a s e d on the a s s u m p t i o n that this off-setting effect is large. H o w e v e r , given the existing p o p u l a t i o n g r o w t h and the generally large p o o l of u n e m p l o y e d and u n d e r e m p l o y e d in d e v e l o p i n g countries, it a p p e a r s unlikely that a h i g h e r l a b o r a b s o r p t i o n in the c o m m e r c i a l f a r m s e c t o r w o u l d n o t i c e a b l y r e d u c e p r e s s u r e o n hillsides and the frontier. Also, an i m p r o v e m e n t in the terms o f t r a d e for agriculture can b e e x p e c t e d to (temporarily) i n c r e a s e i n - m i g r a t i o n into the s e c t o r o r r e d u c e o u t - m i g r a t i o n . N e g a t i v e e n v i r o n m e n t a l effects c o u l d also partially b e offset via the

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income effect of higher prices. The hypothesis here is that the slightly higher income of farmers would permit them to use production techniques that are more environmentally benign and, perhaps because of a slightly lower discount rate, make some additional conservation-type investments that increase the long-term productivity. ~ In my view, these potentially positive effects are expected to be small, but empirical work should be undertaken to determine these. Overall, I would conclude that, while higher international prices and less price instability would lead to economic benefits for developing countries, the associated environmental effects are expected to be negative; however, because of positive off-setting effects, this canot be concluded unambiguously without empirical examination. Empirical work should be undertaken to estimate the magnitude of those effects and the parameters involved. Independently, Anderson (1991) has also analyzed the above issues. His conclusions about the results of food trade liberalization are somewhat more positive, and he makes the important point that a removal of distortions on farm prices could and should be accompanied by the introduction of more optimal environmental policy instruments including the removal of any farm input subsidies, where these still exist, or policies to discourage deforestation. That way, possible negative side effects could be reduced.

Concluding Remarks Using essentially a partial equilibrium, two-country framework supplemented by a discussion of possible price-induced migration effects, this paper suggests that a trade liberalization is expected to be associated with generally positive environmental effects (mainly reduced losses) in industrial countries, mainly from lower agricultural production intensity. In developing countries, on the other hand, environmental effects are expected to be negative overall, because of more intensive production and increased pressure for area expansion but this cannot be established unambiguously. At the global level, environmental benefits form an agricultural trade liberalization in industrial countries may outweigh costs in developing countries, but again this cannot be established unambiguously without empirical estimation. Among other things, this depends on the valuation of the various effects, such as pesticide and nitrate pollution, on-farm and off-farm soil erosion, loss of functions of forests and wilderness areas, and biodiversity, just to name a few. Given that the two-country model only deals with two large groups (industrial and developing countries), it is also clear that differentiated country studies are needed to precisely determine the various effects. At the point in time this article is being written, it is not known whether the Uruguay Round will succeed, and if so, whether the degree of protection in agriculture will be reduced, and not only in the industrial countries, but

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also in those developing countries that have erected trade barriers to protect their agricultural sectors or specific commodities.5 In this connection, even if the environmental effects of an agricultural trade liberalization were empirically found to be negative in developing countries, this would not necessarily justify opposing trade reforms. First, at the global level, one can expect positive gains from trade, a well-established result in the literature. Second, while a trade liberalization may lead to negative environmental effects in developing countries on a net basis, the environmental effects in industrial countries can expected to be positive. Therefore, depending on the valuation of those effects, the monetized environmental effects of an agricultural trade liberalization at the global level could be either positive or negative, and should they be negative, there would still be no justification for arguing against trade liberalization, as long as they are not larger than the net economic gains. Third, from the point of view of developing countries, they would, in general, obtain economic gains from an agricultural trade liberalization. Even if it could be confirmed empirically that environmental effects in developing countries are negative on a net basis, one needs to consider them jointly with economic gains. Forth, I agree with Anderson (1991) that negative environmental effects can be reduced or benefits enhanced if appropriate environmental measures are introduced at the time of a possible liberalization. A challenge to the profession remains how to quantify environmental effects, to the extent possible, and there is a great need for empirical work and case studies, particularly in developing countries.6 Given the limits of valuation techniques, multicriteria analysis may be needed to be able to indicate the nature and extent of some of the trade-offs involved.

Acknowledgements The author is Senior Economist in the Environmental Policy and Research Division of the World Bank. He is indebted to Ed Schuh, John English, Andrew Steer, Kym Anderson and John Sutton for valuable comments and suggestions. Also, he has benefitted from comments by the editor and two anonymous referees. The views expressed, however, are those of the author and should not be attributed to any other individual nor to the World Bank.

Notes i Valdez (1987) summarized the results of eleven of such studies. 2 Also, farmers would incur losses in both income and asset values. 3 From the point of view of an agricultural sector in an individual developing country, this change is similar to a currency devaluation. 4 The higher income does not change conservanon atntudes, but it facilitates implementing these where they exist (see Lynne, Shonkweiler, and Rola, 1988). Also note that if the effect

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was found to be significant, it would also be expected to be significant in industrial countries, where it would reduce the expected environmental benefits of an agricultural trade liberalization. 5 In general, however, taxation of the agricultural sector appears to be still more prevalent than protection, see Lutz and Saadat (1988). 6 In this regard, see for example, Lutz and Munasinghe (1991), Munasinghe and Lutz (1991), and Tisdell (1992).

References Anderson, Kym (1991), 'Agricultural Trade Liberalization and the Environment: A Global Perspective", The World Economy 14(4). Binswanger, Hans (1989), 'The Policy Response of Agriculture', Proceedings of the World Bank Annual Conference on Development Economics. Bravermann, Avishay (1989), 'Comment on "The Policy Response of Agriculture" by Binswanger'. op cit. Cavallo, Domingo (1988), "Agriculture and Economic Growth: The Experience of Argentina, 1913--1984', Paper presented to the 20th Conference of the International Association of Agricultural Economasts, Buenos Aires. Heimlich, Ralph (1989), 'Productivity of Highly Erodible Cropland', Journal of Agricultural Economtcs Research 41(3). Jagannathan, N. Vijay (1989), 'Poverty, Public Policies, and the Environment', Environment Working Paper No. 24, World Bank. Johnson, D. Gale (1950), 'The Nature of the Supply Function for Agricultural Products', Journal of Farm Economics 40(4), 539--64. Lopes, Mauro (1977), 'The Mobilization of Resources from Agriculture: A Policy Analysis for Brazil', Ph.D. Thesis, Purdue Umversity. Lutz, Ernst and Yasmin Saadat (1988), 'Issues Relating to Agricultural Pricing Policies and Their Analysis in Developing Countries', Agricultural Economics 2, 19--37. Lutz, Ernst and Mohan Munasinghe (1991), 'Accounting for the Environment', Finance and Development 28(1). Lutz, Ernst and Herman Daly (1991), 'Incentives, Regulations and Sustainable Land Use in Costa Rica', Environmental and Resource Economics 1. 179--194. Lutz, Ernst and Michael Young (1992), 'Integration of Environmental Concerns into Agricultural Policies of Industrial and Developing Countries', Worm Development 20(2). Lynne, G. D., J. S. Shonkweiler, and L. R. Rola (1988). "Attitudes and Farmer Conservation Behavior', American Journal of Agrtcultural Economics 70(1), 12--19. Munasinghe, Mohan and Ernst Lutz (1991), 'Environmental-Economic Evaluation of Projects and Policies for Sustainable Development', Environment Working Paper No. 42, The World Bank. Schuh, G. Edward (1990), "International Economic Policies and Sustainable Development', Background Paper No. 2, Workshop on the Economics of Sustainable Development, Washington, DC, January 23--26, 1990. Sutton, John D. (ed.) (1988), "Agricultural Trade and Natural Resources: Discovering the Critical Linkages', Rienner Publishers, Bouldon & London. Tisdell, Clem (1992), 'Conservation, Protected Areas and the Global Economic System: How Debt. Trade, Exchange Rates, Inflation and Macroeconomic Policy Affect Biological Diversity', paper prepared for the IVth World Congress on National Parks and Protected Areas, Caracas, Venezuela. February 10--21, 1992. Valdez, Alberto (1987), "Agriculture on the Uruguay Round: Interests of Developing Countries'. World Bank Economic Review 1 (4), 571-594.