MODELLING THE IMPACTS OF MACROECONOMIC AND TRADE POLICIES ON THE SOUTH AFRICAN AGRICULTURAL SECTOR. Anthony Letsoalo and Johann Kirsten

Transcription

1 MODELLING THE IMPACTS OF MACROECONOMIC AND TRADE POLICIES ON THE SOUTH AFRICAN AGRICULTURAL SECTOR by Antony Letsoalo and Joann Kirsten Contributed Paper Presented at te 41 st Annual Conference of te Agricultural Econoic Association of Sout Africa (AEASA), October 2-3, 2003, Pretoria, Sout Africa

2 MODELLING THE IMPACTS OF MACROECONOMIC AND TRADE POLICIES ON THE SOUTH AFRICAN AGRICULTURAL SECTOR Antony Letsoalo 1 and Joann Kirsten 2 ABSTRACT Te purpose of tis paper is to investigate te iportance of acroeconoic and trade polices on te agricultural sector in Sout Africa. Macroeconoic and trade policies are deterined outside te agricultural sector and since te 1990s Sout Africa as been oving towards deregulation and trade liberalization. Structural econoetric odel was applied to deterine te ipacts of canges in acroeconoic and trade policies on te agricultural sector. Two Stage Least Squares (TSLS) was te tecnique used because of te siultaneous nature of te equations in te odel. Te results of te study sows tat 10 percent reduction in iport tariffs will lead to percent increase in te degree of openness of te Sout African econoy. Furterore, te appreciation of te Rand will raise te doestic prices received by farers. Keywords: governent ependiture, real ecange rate, degree of openness, relative prices of agriculture, ters of trade 1. Introduction Te Sout African econoy as been undergoing deregulation and trade liberalization since te 1990s. Te agricultural sector was previously protected and supported by tariffs and subsidies by te governent. After te 1994 election, te Sout African governent as oved towards deregulation and liberalization of te agricultural sector, evidenced by te reoval of subsidies and tariffs and te abolisent of arketing boards in te Furterore, Sout Africa as becoe ajor proponent of free trade under te auspices of World Trade Organization (WTO), tereby ensuring tat Sout African econoy including te agricultural sector is integrated wit te world arkets. However, acroeconoic and trade policies are eogenous to te agricultural sector and te agricultural sector as to adapt to canges in te acroeconoic and trade policies. According to Jonson (1975), wen policies are inappropriate, farers find teselves at an enorous disadvantage in aking affective use of teir natural and uan resources. Moreover, Jaejer and Hupreys stated tat "appropriate econoic policies can provide substantial latitude for iproving agricultural price incentives," and Rausser et al. (1986) entioned tat, " if acroeconoic policies were appropriately designed, tere would be no need for 1 Postgraduate Student at te University of Pretoria, Dept of Agricultural econoics, etension and rural developent 2 Professor and Head of te Dept of Agricultural econoics, etension and rural developent, University of Pretoria 1

3 sector-specific policies. Macroeconoic and trade variables suc as: governent ependiture, oney supply, ecange rate and iport tariffs are recognized to ave an effect on te agricultural perforance but te agnitude of te effect are yet to be deterined in Sout Africa. Te objective of tis paper is twofold. Te first objective is to design an appropriate structural fraework tat draws eavily on econoic teory and allows for investigating te linkages between acro econoy and agriculture in Sout Africa. Te second objective is to use te econoetric odel to analyze te iportance of acroeconoic and trade policies on te agricultural sector, wic is iportant for econoic analysts and policy akers. Most of te previous studies analyzing te ipacts on te agricultural sector ave ainly focused on internal factors suc as te size of researc and developent investent, far size and efficiency and land tenure systes. In addition, tere is a consideration lack of epirical evidence investigating te iplications of te acroeconoic environent on agricultural perforance in developing countries were econoic growt and developent depend eavily on agriculture and were agriculture is in need of ore coordinated policies. Tis paper will be organized as follows: te net section will briefly review related literature on te linkages between acro-econoy and te agricultural sector. In section 3, te study will integrate teory to develop te etodology to acieve te above-entioned objectives. In section 4, we will present te structure of te epirical odel, te data used for epirical analysis, estiation and siulation results and teir iplication to te econoy and te agricultural sector in Sout Africa. Suary and conclusion of te study will be presented in section Macroeconoic linkages wit te agricultural sector Te acroeconoics of agriculture involves te relationsip between te general doestic econoy and te agricultural sector, and te world econoy and te doestic agricultural sector (Knutson et al, 2000). Tis definition of acroeconoics of agriculture clearly deonstrates tat te agricultural sector is integrated wit oter sectors in te doestic econoy as uc as it is wit rest of te world. Furterore, Scu (1976) observed tat significant structural cange in econoic environent and te draatic integration wit world arkets indicate tat te agricultural sector sould no longer be treated as a closed sector. To epasize te linkage between world econoy and agriculture, Penson and Gardener (1988) entioned tat tere are two ain cannels linking te international (world) econoy to agriculture. Te first cannel is troug international coodity arkets, were international econoic conditions influence te deand for eports and supply of iports (current account). Te second is troug international capital arkets, were te deand for and supply 2

4 of investent funds observed in te nation's capital account influences interest rate and ecange rates (financial and capital account). Fiscal, onetary and ecange rate policies as well as trade policy affect not only farers' incoe in real and relative ters wit respect to oter sectors of te econoy, but also te ters of trade between agricultural and non-agricultural sectors. Gardner (1981) argued tat, te significance for agriculture of acroeconoic events depends upon wat acroeconoic variables are ost strongly linked to agriculture and ow tese linkages function. According to Penson and Gardener (1988) and Knutson et al (2000), doestic acroeconoic variables tat are ost iportant for agriculture are te rate of inflation, real rate of growt in gross national product, interest rate and ecange rate. However, Knutson et al (2000) entioned tat te iplications of acroconditions are transitted to agriculture troug four variables: incoe growt; inflation rate; interest rate; and value of te currency (ecange rate). However, te ecange rate is te variable coonly used to capture te developents taking place in te international financial arkets. Scu (1976) started wole body of researc on te effects of ecange rates agricultural sector by addressing te effects of ecange rates on te U.S. agricultural sector. In addition, Cabers et al (1988) and Lacaal and Woack (1998) concluded tat te ecange rate of currency is te priary variable linking international econoy to doestic agricultural sector and tat ecange rates are an iportant deterinant of coodity prices and trade flows. According to Fenyes and Meyer (1998), Sout African agriculture as been affected not only by agricultural policy easures but also by consecutive canges to general econoic policy, and by acro-econoic perforance. Moreover, according to Van Scalkwyk et al (1999), te liberation of te Sout African econoy including te agricultural sector will ave no ipact on te international arkets but it as ad ajor ipact regionally in SADC. 3.2 Model developent In developing te conceptual fraework for tis study, assuptions is ade tat acroeconoic and trade policies influence output price, wic in turn affect sectoral productivity and production. Te ground of te fraework is te trade/ nontraded goods odel developed by Dornbusc (1974). Te standard analysis divides te econoy into two sectors: tradable sector and nontradables sector. Te relative price of tradables in ters of nontradables is known as te real ecange rate (RER), and it is troug tis "relative price" tat acro-policies affect sectoral perforance. A rise in te RER eans tat te price ratio iproves in favour of tradable goods, and vice-versa, te decline in RER eans tat te price ratio iproves in favour of nontradable goods. Under te ypotesis tat inter-sectoral resources flows follow relative price canges, oveents in te RER would tend to affect resource allocation 3

5 between different sectors of te econoy. More specifically, an increase in RER would sift resources out of nontradable sector into tradables and reduce incentives to produce nontradable goods and vice-versa is true. In order for te odel to easure te ipacts of policies on eports and iports separately, te econoy is furter decoposed into tree arkets: eportables (), iportables (), and oe goods (). Te odel's trade coponents for two traded goods allow doestic supply and deand for tese goods to be different. However, tis is not true for oe goods for wic te arket needs to clear doestically to eet te equilibriu conditions, wic are fulfilled troug adjustents in relative prices of traded goods in ters of oe goods (Hau, 2000). In tis study te supply of oe goods is defined, denoted by S, as a function of te relative prices of eportables and iportables in ters of oe goods and by resource endowent and tecnology: P P S = (,, K, L, τ ) P P (1) Were P, P, P are doestic prices of eportable, iportable, and oe goods, respectively, K and L represent capital and labour and? denotes tecnology. S is negatively related to relative prices of bot traded goods. Higer prices for eportables and iportables would sift resources out of te nontraded sector to te traded sectors and consequently reduce te production of oe goods. Likewise, we specify te deand for oe goods, P, as a function of te relative prices of two traded goods easured in ters of oe goods and incoe (denoted by Y). In sybols, P P D = D(,, Y) P P (2) Te increase in te prices of eportables and iportables will reduce teir deand and tereby increasing te deand for oe goods. Te increase in doestic incoe will cause doestic consuers deand ore of eportables and iportables and less of oe goods (Abel and Bernake, 2001). In order to easure te incidence of coercial policy on traded goods, coparative static is needed for analysis of price effects. For tis end, we assue K, L,?, and Y to be constant. Hence, te differentiation of equation (to evaluate te incidence of trade policy logaritically) (1) yields: S S ds = d( P / P ) + d( P / P ) (3) ( P / P ) ( P / P ) 4

6 Fro (3) te results are: Sˆ = η ( Pˆ Pˆ ) + η ( Pˆ Pˆ ) (4) Were? and? are supply elasticities of oe goods wit respect to te relative prices of eportables and iportables, respectively, te at (^) denotes a proportionate cange in a variable. Siilarly, fro te deand function tis is obtained: Dˆ = ε ( Pˆ Pˆ ) + ε ( Pˆ Pˆ ) (5) Were e and e are te deand elasticities of oe goods wit respect to te relative prices of eportables and iportables, respectively. By equating (4) and (5), to eaine te coparative static properties of te odel, tis is found: ˆ ˆ ) ( ˆ ˆ ( P P + P P ) = 0 (6) Were? j = (e j -? j ), j =,. defining te incidence paraeter w = (? /? +? ), equation (6) can be rearranged as: Pˆ ˆ ( ˆ ˆ P = ω P P ) (7) Or, Pˆ = (1 ω ) Pˆ + ωpˆ (8) By assuing w to be constant and integrating equation (8), te real ecange rate for eports is derived as : P P ln = a + ω ln (9) P P Equation (9) provides a fraework for investigating te ipacts of trade and ecange rate policies on te eport sector. However, tis fraework does not allow for te effects of quantitative restriction on trade. For eaple, consider te case of an effective iport quota. A binding iport quota results in iger prices of iportable goods in te doestic arket, and ence, tis sector will attract ore resources. Te increased deand for resources by te iporting sector will alter teir prices, causing a cange in te price of oe goods. Tese oveents in prices will in turn affect te RER and resource allocation. For tis reason, te degree of coercial openness (DCO) of te econoy is introduced in te odel, as bot an eplanatory variable and as well as endogenous variable. Te net coponent of te odel defines te ecanis cannels troug wic te ipacts of trade and acroeconoic policies are transitted to agriculture. Mecanically, first acro-policies are linked to agricultural prices and ten production function for te agricultural sector is specified. It is troug tis production function tat te relative prices and, terefore, acroeconoic and 5

7 trade variables influence agricultural perforance. Higer output prices are epected to increase productivity, as te increased profitability would ake firs allocate ore resources to innovation activities and increase teir investents in new tecnologies. Considering agriculture produces at te sae tie eportable, iportable, and oe goods, ten an aggregate price inde for te sector, denoted by P a, would be coputed as an average of P, P, P. utilizing te geoetric aggregation etod we obtain, P (10) α1 α 2 ( 1 α 1 α2 ) a = P P P a 1 and a 2 represent te sares of eportable and iportable agricultural products, respectively, in total agricultural output. Since te Sout African agricultural sector is an eportable sector (agricultural eports eceed iports), it is legitiate to assue iported agricultural products to represent only a negligible proportion of total agricultural output (i.e. a 2 = 0). Hence, agricultural prices can be approiated as follows: Pa P ln = α 1 ln (11) P P Soe acro-variables will be included in equation (11) as te sare of eportable agriculture (a 1 ) depends on econoic variables tat deterine deand and supply and on te degree of coercial openness (DCO) of te econoy. Furter, agricultural prices depend on acroeconoic policies tat affect te deand for oe goods and consequently sectoral output. Te last coponent of te odel is te agricultural sector production function. Te specification adopted te concept of endogenous tecnology introduced by Mundlak (1988), wic postulates tat prices are tecnology-canging variables. Tis approac assues tat prices not only deterine te position of a producer across different curves. Te ypotesis ere is tat econoic agents coose innovations and adopt new innovations in arony wit teir incentives and constraints. Epirically, tis is acieved by defining a variable-paraeter production function. Tese paraeters are specified as functions of soe state variables representing te structure of incentives and constraints facing firs. Tis study uses Cobb-Douglas specification wit tie varying paraeters and n inputs to represent te agricultural production function. Algebraically, tis specification takes te following functional for: n β y( ; β ) = Α i i (12) Were, i= 1 6

8 ln Α = a + a s + u (13) 0 k= 1 k= 1 k k 0 β = b + b s + u (14) i i0 ik k i Y is te aiu level of output tat cane be produced fro any given set or cobination of input = ( 1, 2,, n ). S = (s 1, s 2, s ) is a vector of state variables and u's are error ters. Te above specification is very fleible in tat in tat it allows us to include as any as any state variables as possible Epirical Model Te econoetric odel used to analyze te ipacts of trade and acroeconoic policies on te agricultural sector in Sout Africa consists of a syste of tree equations. Te endogenous variable is te real ecange rate (RER), te degree of openness (DCO), and relative agricultural doestic prices (P a /P ). Te eogenous variables are iport prices (P ), prices of oe goods (P ), eport ta rate (t ), iport tariff rate (t ), te sare of governent ependitures (G) and te sare of oney supply (M) in te total incoe (y). Te epirical odel is described by following set of equation: s RER = F( P / P, DCO, G, M ) (15) s DCO = F(( 1 t /1+ t ), G, M ) (16) s P / P = F( P / P, DCO, G, M ) (17) a 4.2. Te data used Tis study will use secondary data between 1981 and 1999 to estiate te ipacts of trade and acroeconoic policies on Sout African agricultural sector. Te ain sources of te data are be: abstract of agricultural statistics publised by National Departent of Agriculture (NDA, 2001) and istorical econoic and statistical database publised by te Sout African Reserve Bank. Te codes of te data and derivation of te variables ave be eplained in Appendi Estiation Procedure and siulation results Te structural econoetric odel (as in tis study) cannot be estiated using ordinary least square (OLS) because ordinary least square (OLS) yields biased and inconsistent estiators wen estiating siultaneous equations or crossequations. Terefore, tis study will use te Two Stage Least Squares (TSLS) because TSLS yields unbiased and consistent estiators. 7

9 4.4. Estiation results Te Estiated Results of te Ipact on Degree of Openness InDCO = lnBARS 0.34lngepti 0.34Du (0.32) (3.03)* (-2.31)* (-1.58) R 2 = 0.37 DW = 2.02 Note: te t-statistics are in te parentesis NB: * = 1% Significant, ** = 10% significant Te results above sow tat te ipact of acroeconoic and trade policies on te doestic degree of openness. Te results indicate tat 1 percent increase (an increase in Bars variable iplies tat iport tariff decrease) lead to 2.38 percent increase in te degree of openness in Sout Africa. In contrast, te increase of 1 percent in governent ependiture will lead to decline in degree of openness by 0.34 percent. However, te duy variable indicates tat te degree of openness in Sout Africa between 1994 and 2000 as been decreasing, but tis is not necessarily true. Te degree of openness as increased fro 34 percent in 1990 to 0.53 in 1999 for te agricultural sector and for te wole econoy; te degree of openness as increased fro 39 percent in 1990 to 49 percent in Te Estiated Results of te Ipact on Real Ecange rate of Eports lnrer = lnreler lngepti (33.92)* (-5.5)* (31.00)* R 2 = 0.98 DW = 2.25 Note: te t-statistics are in te parentesis NB: * = 1% Significant Te results presented above indicate tat 1 percent increase in te ters of trade will lead to decrease of 0.61 percent in te real ecange rate in Sout Africa. Tis iplies tat as Sout Africa ters of trade rises, te value of te Rand will depreciate against te U.S. dollar. Furterore, te results indicate tat 1 percent increase in governent ependiture will lead to an increase of 0.79 percent in te real ecange rate. Under te ypotesis tat resource flow follow cange in te price of eportables, iportables and oe goods discussed in section 3, rise in governent ependiture iplies tere will be ore doestic investent, ence ore consuption of oe goods. Total incoe and oney supply variables were dropped fro te equation because tey ave very low t- statistics. 8

10 Te Estiated Results of te Ipact on Relative price of Agricultural sector lnrelat = lnrer lnospti 0.06lngdp lndco (0.93) (1.77) (1.17) (-0.87) (0.004) R 2 = 0.96 DW = 0.93 Note: te t-statistics are in te parentesis NB: * = 5% Significant Te results above indicate tat real ecange rate variable is te only variable tat as significant effect on te relative price of agriculture. But, according to Koutsoyiannis 2 (1977: 249), "ulticolinearity ay affect only a part of te estiates, wile oter estiates ay reain fairly stable and reliable. In tis case, te reliable estiates ay be used for any purpose, forecast or policy forulation (wic requires reliable inforation about structural coefficients)". Money supply, gross doestic product and degree of openness do not ave significant effect on relative prices of agriculture in Sout Africa. Te results sow tat an increase of 1 percent in real ecange rate will lead to an increase of 0.19 percent in relative prices of agriculture BASELINE AND POLICY SCENARIOS It is clear fro te previous section tat canges in acroeconoic and trade policies will ave iplications for bot Sout African econoy and te agricultural sector. Tis section will discuss possible policy scenarios. Te eternal socks will be introduced to te following variables: iport tariff, governent ependiture, oney supply and real ecange rate. Tere are eigt cases of scenarios to be siulated: case 1 being 10 percent increase in governent ependiture; case 2, 10 percent decrease in governent ependiture; case 3, 10 percent increase in iport tariff; case 4, 10 percent decrease in iport tariff; case 5, 10 percent decrease in iport tariffs and 10 percent increase in governent ependiture; case 6, 10 percent increase in oney supply; case 7, 10 decrease in oney supply and case 8, 10 percent increase in real ecange rate Degree of openness scenario Te policy scenario in te degree of openness in te Sout African econoy will be to siulate wat will be te ipact of cange in governent ependiture and trade policy (iport tariff) on te degree of openness in te econoy. Table sows tat trade policy will ave a uge ipact tan governent ependiture on te degree of openness. Te increase in governent ependiture will ave a negative influence on te degree of openness and a decline in iport tariff will lead to an increase in te degree of openness in Sout Africa. Te 2 Koutsoyiannis, A. (1977). Teory of Econoetrics, 2 nd edition, Macillan Press LTD. 9

11 cobined effect of iport tariff and governent ependiture will be detriental to te integration of te econoy in te world arkets. Table 5.3.1: Ipact on Degree of openness Degree of Openness % Cange Baseline Case % Case % Case % Case % Case % Real Ecange rate scenario Te rise in governent ependiture will ave a negative influence on real ecange, tat is, wen te governent increases its ependiture te value of te rand will depreciate. In contrast, wen governent ependiture decline te value of te rand will appreciate. Table 5.3.2: Ipact on Real Ecange rate of Eports Real ecange rate of eports % Cange Baseline Case % Case % Relative Doestic Price of Agriculture scenario Real ecange rate is te only acroeconoic variable, wic was found to ave ad an influence of te relative prices of agriculture. Hence, 10 percent increase in real ecange rate will lead to 1.46 percent decline in agricultural prices and vise-versa is true. Table 5.3.3: Ipact on Relative Doestic Price of Agriculture Relative price of Agriculture % Cange Baseline Case % Case % Case % 5. Suary and Conclusion Te objective of tis paper was to eaine te iportance of acroeconoic and trade policies for te Sout African agricultural sector. More specifically: governent ependiture, oney supply, iport tariff and real ecange rate on te degree of openness, real ecange rate of eports and relative price of agriculture. Te ajor assuption of te study was tat acroeconoic and trade policies will affect te agricultural sector troug output prices. 10

12 Macroeconoic and trade policies will ave an effect on te degree of openness, real ecange rate and te relative prices of agriculture. More iportantly, an increase in te degree of openness will ave iplication for te doestic agricultural sector, eiter positively or negatively. Furterore, by increasing governent ependiture, governent will reduce Sout African econoy integration into world arkets, Reference Fenyes, T.I and Meyer N.G. (1998). Agricultural policy and acroeconoic issues in Sout Africa in perspective, Agrekon, Vol 37, No 1. Jonson, D.A. (1975). World agriculture, coodity policy, and price variability, Aerican Journal of Agricultural Econoics Knutson R.D., Penn J.B and Barry L. (2000). Agricultural and food policy, 4 t edition, Flincbaug. Prentice Hall. Koutsoyiannis, A. (1977). Teory of Econoetrics, 2 nd edition, Macillan Press LTD. Lacaal, L and Woack, A.W. (1998). Ipacts of trade and acroeconoic linkages on Canadian agriculture, Aerican Journal of Agricultural Econoics, Vol 80. National Departent of Agriculture. (2001). Abstract of agricultural statistics, Pretoria. Penson, J.B. and Gardener, B.L. (1988). Iplication of te acroeconoic outlook for agriculture, Aerican Journal of Agricultural Econoics Rausser, G.C., Calfant, J.A., Love, H.A. and Staoulis, K.G. (1986). Macroeconoic linkage, taes, and subsidies in te U.S. agricultural sector, Aerican Journal of Agricultural Econoics Scu, G.E. (1976). Te new acroeconoic of agriculture, Aerican Journal of Agricultural Econoics Van Scalkwyk, H.D, van Zyl, J. and Jooste, A. (1998). Te effect of te ecange rate and international factors on te copetitive position of Sout African weat producers, Agrekon, Vol 34, No 4. 11

13 Appendi1: Te Codes used in te Estiation Process Variable Abbreviation Calculation Degree of DCOW Total trade / total incoe openness Trade barriers BARS (1-T )/ (1+T ) Were T and T are eport and iport tariffs; and eport tariffs are assued zero. Governent GEXPTI ependiture as a proportion of total incoe (GDP) Money supply as MOSPTI a proportion of total incoe (GDP) Real ecange RER FOREXP / CPI rate for eports Were: Forep foreign price of eport, fob CPI - Consuer price inde (price for nontraded goods) Ters of trade RELEXR Forep / Forip Relative agricultural doestic prices Agricultural rate of return on capital RELAT ARRC AGPROCP Were Forip Price of iports, cif PPIAGR / CPI Were PPIAGR Inde of agricultural product price (PY WL) PK SCAPA*LN (AGCAP/LAB) Were AGCAP - Gross capital foration in Agriculture LAB - Agricultural labour 12