Thursday, October 30, 2008

Why emerging market economies should re-invest in agriculture

In the last two to three decades, much of the emerging market economies veered away from an agriculture-led economy to a manufacturing-led economy. In recent years, some even started moving quickly into a service-led economy. In both cases, whether to a manufacturing-led or services-led, the impetus has been the growing globalization of business, where significant processes from the developed world were offshored to lower-cost sources.

What has been the result to agriculture in these areas?

Agriculture, as a percentage of these economies, slowly declined and garnered less and less importance to government decision makers. As higher-earning and higher value-added industries were born in the emerging economies, the relatively staid and low input agriculture sector lost both people and land dedicated to it.

Why agriculture lost people is evident, since higher-earning and higher value-added manufacturing-led or services-led industries tend to pay more for labor.

Why land dedicated to agriculture was lost was due to increasing productivity gains in the developed world, where technological advances and capital investments made in agriculture led to large surpluses in these countries, thereby taking out the competitive advantage of many underdeveloped countries due to cheaper labor. As food became cheaper because of the large surpluses being achieved by the developed economies, maintaining large tracts if land chiefly for agricultural purposes became less and less tenable for many poor economies. Thus, much of previously agricultural land were developed into industrial, commercial and residential areas.

As the emerging markets increased their respective GDPs, the industry and services sectors increased their share of GDP, while agriculture’s share dwindled. Everybody thought, all was well and good, for it was David Ricardo’s law of comparative advantage at work. Each country need only dedicate its people and resources to whatever economic pursuits best created value in the world economy relative to its neighbors, and they could now enjoy both a growing economy, and continued improvements in standards of living.

Who cared about agriculture? As long as the remaining agricultural areas of the world were still planting and reaping enough food for everybody, everyone can focus on doing more of what the world demanded. And what the world demanded were ever more and more mass-manufactured consumer items, and the increased business services that grew along with their explosive growth. Some previously agricultural exporters in the developing world were becoming net importers of food, as a result of the shift.

Now the world is expected to have a coordinated slowdown next year. The slowdown will not be in just one part of the world, but everywhere. As I have noted in previous posts, this presents the world with a problem. In environments of decelerating or contracting economies, everybody cuts down on consumption. Everybody wants to save. Everybody wants to earn cash inflow, but do not want cash outflow.

Everybody’s individual behavior, taken into the aggregate, results in further decelaration or contraction of economies. Businesses run out of clients. Businesses without clients lay off their workers. Laid off workers cut down on their spending further.

The first cutdowns are always in the most frivolous items. This will comprise much of the consumer items now being manufactured by the developing world. For businesses, the revenue cutdowns will result on supplier cutdowns. That means some outsourced processes that are now being done in bulk in the emerging world will be cut.

The most indispensable items for everybody are food, clothing and shelter. And of these, only food is a recurring expense item. Hence, in times of belt-tightening, only food items are really left for consumption. Countries that now have less emphasis in food production will continue to import their food at the same time that their revenues from exporting manufactured goods is slowing down.

Six months ago, economies the world over were reeling from commodity price inflation resulting from fast-growing demand the world over. But the resulting steep rise in food prices has caused demand destruction both in the developed and developing world. The bursting assets bubble and credit crisis has contributed to the slowing economies of the developed world, and the results of their slowing economies is creeping in as slowed growth, even contraction, in the developing markets.

There is an even greater threat to emerging markets in the medium-term. The threat is coming from the inevitable effects of the coordinated global monetary and fiscal actions being taken to address the credit crisis, which is rapidly spreading globally.

The monetary policy moves are creating an unprecedented increase in money supply. This will result in vastly increased inflation once economic activity starts growing again. The fiscal policy actions, meanwhile, are effectively transferring the world-wide purchasing power solely to citizens of the developed world, where much of the fiscal actions are taking place. Developing economies do not have similar capacities to stimulate local demand, especially as their slowing economic growth dampens government revenues. In the case of heavily-borrowed economies in the developing world, the credit crisis threatens to develop into national crises of their own.

What do you think will the likely effects be of increased money supply, and the sustained demand in the developed world, on global food prices? Yes, that’s right. Inflation will be back sometime soon in the food markets. And the worst lot will be suffered by the poorer economies, who will be lacking in foreign currency earnings, and hence, will have local currencies with poorer purchasing power.

So what can the emerging markets do at this point to keep from experiencing mass starvation in the very possible inflation ahead? Re-invest in agriculture.

The Japanese had it right. Even when the biggest contributor to growth had long been other sectors of the economy, the government still supported (subsidized, if you like) high-cost local food production. They rightly concluded that maintaining local food production is a matter of national security.

Re-invest in agriculture. Do it now before the cost of doing so goes up in two to three years.

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