Changes in Terms of Trade between Agriculture and Industry

In this article we will discuss about the changes in the terms of trade between agriculture and industry during the course of economic development.

The growth process is generally initiated in the agricultural sector. In the initial stages, labour and capital are transferred from the agricultural sector to the industrial sector. Under these circumstances, most of the economists believe that there is a strong possibility of the terms of trade turning in favour of agriculture as development proceeds.

There are many reasons for it. Per capita output and income will be increasing at a much more rapid pace in the industrial sector than in the agricultural sector. This will bring about relatively greater increase in the demand for’ agricultural products than that for the industrial products.

Relatively more rapid rate of technical progress in the industrial sector will bring about a larger increase in the supply of industrial products than in that of agricultural products. Both these developments will make agricultural products cost more in terms of the industrial products. With this change, capital flow from the agricultural sector to the industrial sector will slow down. Rate of growth of the industrial sector will then begin to fall.

There is a further possibility that capital may move from the industrial sector to the agricultural sector as marginal productivity of capital becomes higher in the agricultural sector. This is what was experienced at one time in Southern United States.

And there are various models which try to show that terms of trade will change in favour of agriculture as development proceeds. The model given by W.A. Lewis only mildly concludes as such.

This is because the model does not intensively analyse the changes taking place in the agricultural sector. Model given by Fei and Ranis and that by Jorgenson strongly bring out the fact that the terms of trade will change in favour of agriculture as the industrialisation goes ahead.

Jorgenson’s model is similar to that of Fei and Ranis in contents with the only difference that whereas Fei and Ranis feel that terms of trade change only after the surplus labour in the agricultural sector has been exhausted, Jorgenson is of the view that terms of trade start changing in favour of agriculture as soon as the industrialisation starts through transfer of labour and capital from the agricultural sector to the industrial sector.

When terms of trade turn against industry (i.e., in favour of agriculture), industrial development is likely to suffer. And, if there is no interference by the state, there is every likelihood that the terms of trade will turn against the industrial sectors as the development proceeds.

Many economists have therefore suggested that steps should be taken to keep the terms of trade against agriculture in the initial stages, through artificial means like price control etc. or through heavy taxes on the agricultural sector.

It may be noted, in this connection that some economists like Nasir Ahmed Khan and Okhawa are of the view that resources from agricultural sector (saving etc.) cannot be mobilised easily through taxation, borrowing or small savings. And even if these measures are successful, the yield will be quite small.

So, they emphasise that direct manipulation of agricultural and industrial prices is necessary for changing the terms of trade against agriculture. Only through such a measure, resources, from the agricultural sector will be available for industrial development.

According to Khan, a change in the terms of trade against agriculture, will not only transfer savings to the industrial sector where these will be used for productive purposes, but will also result in more marketed surplus.

Raj Krishan a however, gives only a qualified support to this suggestion. His view is that there is a critical minimum rate of growth of agricultural output which must be ensured if industrial development is to continue smoothly. Terms of trade against agriculture should be so manipulated that this critical minimum is not hit.

Mellor, however, does not agree with the above conclusions about the trend in the terms of trade between agriculture and industry vis-a-vis the development of the economy does not believe that the terms of trade will automatically change in favour of agriculture after the process of industrialisation proceeds to some extent. He feels that two important points have been ignored while arriving at the above conclusions.

Firstly, the price elasticity of demand for agricultural products is near unity in under developed countries. This will dampen the effect on prices of agricultural products when demand for agricultural products rises but, the supply of such products does not increase to the same extent.

Secondly, in the initial stages of development, the rise in income which is the major source for rise in demand for agricultural products is itself mainly the result of increase, in production in the agricultural sector. So, increase in demand for agricultural products and increase in the supply of agricultural products will go hand in hand. Agricultural prices, thus, will not rise or these will rise only marginally. Terms of trade, according to Mellor, therefore, are not likely to change in favour of agriculture, as the development proceeds.

At the theorem level, economists may, thus, differ about how the terms of trade between agriculture and industry change as the economic development gets underway. However, there has been near unanimity among planners that terms of trade have to be deliberately (if so needed), kept against agriculture in the initial stages of development. Various examples from developing economies can be cited to prove this point.

In the United Kingdom, the free trade movement culminating in the repeal of corn laws in the 19th century had the aim of reducing the relative prices of food and raw materials in relation to the prices of manufactured goods. In the U.S.S.R. collectivities of agriculture was carried out to extract from the peasantry their whole surplus output at a low price for the rapid expansion of the industrial sector.

The terms of trade were kept against agriculture, firstly, by fixing high delivery quotas which left a limited volume of products in kind for home consumption secondly, by fixing low prices for the agricultural products and thirdly, by fixing higher prices for manufactured goods. The government had to appropriate surplus in the agricultural sector at low prices to make it available to the industrial sector.

In Japan, the terms of trade in statistical terms were steady. These did not show any movement in favour of agriculture (or against it) as the industrial development proceeded. This was because unlike the U.S.S.R., Japan experienced simultaneously a rapid increase in agricultural in productivity due to expanded use of chemical fertilizers, selective breeding, distribution of improved seeds for rice, improved method of transplantation of plants and inter-culture.

However, in reality, the trade were turned against agriculture through heavy taxes. Most of the gains in agricultural productivity were siphoned off through land taxes in order to finance industrial expansion. No doubt, landlords also earned a handsome amount due to high rent but income so earned was invested by landlords in small scale industries in rural areas. The land tax provided about 70% of Government revenue during 1878-1907.

In Argentina too, the terms of trade were kept against agriculture to supply capital for rapid expansion of the non-agricultural sector. The negative price policy which was adopted in Argentina, was summed up as follows:

“During the period from 1944 to 1955, prices received by farmers were kept low and part of the foreign exchange received for exports was diverted far the benefit of industry by means of multiple exchange rates. At the same time Argentina industrialists were protected by high import duties on competing products and by a system of import licensing. These had the double effect of lowering agricultural incomes and raising farmer’s cost of production”.

In India too, the Government had followed for sometimes, a negative price policy so far as the agricultural products are concerned. Since the beginning of planning era in India terms of trade remained against agriculture till 1963. The following views expressed by F.A.O. in 1958 regarding price policies in Asian countries confirm the ‘general nature of this trend. According to F.A.O,” ….in the formulation” of food and agricultural price policies in the countries of the region (with the exception of Ceylon and Japan) the interests of agricultural producers have generally been relegated to second place.”

However, terms of trade cannot be kept against agriculture for long after the development process has been initiated. Terms of trade against agriculture will affect its growth adversely. Coale & Hoorer have pointed out, “If one sector limits the growth of the other, it is more likely to be the case of agricultural growth limiting non-agricultural growth than vice- versa”.

This assertion, though of a general nature, is more relevant after the process of economic development through industrialisation has gone under way.

The critical minimum rate of growth in agricultural production as suggested by Raj Krishana and according to Raj Krishana, this critical minimum rate has been quite high in various developing countries due to the following reasons:

(1) Mortality rate in these countries has gone down considerably because of provision of improved medical facilities. This has resulted in a rapid increase in population and has thus necessitated a higher rate of growth in agricultural production.

(2) The growing income of these countries has led to a greater increase in demand for agricultural products. Growing demand for food could, no doubt, be met by imports from outside. However, option of importing grains at low rates is not available in the present situation. Foreign assistance in terms of food grains like P.L. 480, too is on a limited scale, and

(3) The political and social awakening in the peasantry is also persuading it to pitch its production targets at a higher level.

Under these circumstances, a situation favourable to the growth of agricultural sector has to be created. Changing the terms of trade, favourable to agriculture is one of the desired measures to achieve this objective. It is felt that negative price policy for agriculture cannot be followed without risk.

It was because of this reason that F.A.O. in 1965 pointed out that:

“It has been increasingly realised that the relative low level at which, in the interest of consumer, prices had hitherto been held in many of these (developing) countries is incompatible with the incentive needed for a steady increase in production. System of guaranteed prices for basic food crops are increasingly being adopted in developing countries, in addition to the national stabilisation schemes for export products that were already in operation in earlier years.”

This is the reason why attempts were made by various Governments, at a later stage of economic development, to change the terms of trade in favour of agriculture by decontrolling the prices of agricultural products or by deliberately raising their support prices if such a system existed and by arranging the supply of agricultural inputs at subsidized rates. India, for example, decontrolled food prices inl964 and set up the Agricultural Prices Commission in 1965. Subsidy on fertilizers and agricultural machinery was also introduced/raised.

In Soviet Russia, prices of agricultural commodities have been successively increased since 1953. For example, the prices of agricultural commodities were trebled, prices major grains and potatoes were raised by 8 to ten times and of meat animals by 12 to 14 times between 1952 and 1959.

Efforts were made to turn the terms of trade in favour of agriculture by reducing the delivery quotes for the state and by increasing the prices of agricultural commodities during the sixties in many East-European countries. In China, in 1963, food grain prices were 61% higher when compared with those prevailing in 1951.

Of late, minimum floor prices have been guaranteed in a number of countries in Asia, Africa, and Latin America. The above examples show that at a later stage in the development process, the terms of trade have to be changed in favour of agriculture if agriculture is not to act as a limiting factor for the development of the industrial sector.

Now a question crops up. Will not the terms of trade favourable the agriculture ultimately affect the growth of the industrial sector? The answer is in affirmative if the inter-dependence between the agricultural and industrial sector remains as strong as ever.

And, that is why it is said that it is not the agricultural sector alone in whose favour, the terms of trade have to be changed. Rather, the terms of trade, during the process of development, have to be manipulated in favour of one sector or the other from time to time according to circumstances.