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THE POVERTY TRAP: BRIDGING DISECONOMIES IN TRADITIONAL ECONOMIES Herman Geyer Centre for Regional and Urban Innovation Stellenbosch University PROBLEM STATEMENT • Agrarian reform, consisting of the diversification of land ownership, agricultural production and agricultural incomes is a national political priority • It is widely acknowledged that land reform programmes have achieved limited results – spatial, income and racial inequalities persist • It is essential to maintain agricultural economic growth and high production rates - public spillovers: environmental amenities, job creation, food security (food costs), low-cost manufacturing inputs, agriculture exports, small town value chains (Harris-Todaro model), diversified economy (Jacobean spillovers) AGRARIAN REFORM DILEMMA • Inequalities: Gini 0.88%, with commercial farmers (6.1%) earning 97.2% of agricultural income and subsistence farmers (93.9%) earning 2.8% of agricultural income • Marketing/distribution difficulties in a Monopsonic (many producers, few sellers) retail market – small quantities of non-standard goods from periphery difficult to sell • Monopoly rents achieved by retailers at the loss of both commercial and subsistence farmers • Todaro paradox – rural poverty is transferred to urban areas where the poor have even less resources ( less land, less social capital higher living costs) QUESTION: FIX THE INFORMAL OR THE FORMAL SECTOR? • • • • • • Many of the proposals in the Carnegie conference dealt with ways of fixing the informal sector to participate in the formal sector A further question is whether land reform programmes should be continued given the lack of sustainable results Western assumption that the informal sector is not highly efficient and economically rational – they should be restructured to fit the Western capitalist model The paper’s proposition is that the informal sector is a direct consequence of this structure of the formal economy – fix the formal economy, fix the informal economy The paper also argues that land reform programme’s have additional economic benefits other than participation in the commercial sector which validates land reform However land reform initiatives can and be successful if subsidisation mechanisms and pooled marketing is implemented QUESTION: FIX THE INFORMAL OR THE FORMAL SECTOR? • The paper analyses the existence of poverty traps in a neoclassical model - utility maximisation of the representative agent resulting in a long-run equilibrium • If theorises that the failure and land reform is not because land reform itself is flawed but rather structural inefficiencies in a neoliberal agricultural system • Furthermore the paper argues that agrarian reform resulting in subsistence agriculture in a traditional economy has further public economic benefits which exceeds the costs of land reform • Agrarian reform fulfils the Kaldor-hicks criterion as an efficient distribution of public resources DUAL SECTOR MODEL - 1958 • Dual sector model the start of the informal/second/shadow economy – essential reading • Development with unlimited supplies of Labour –first black economist to win the Nobel Prize • Capitalist economy has unlimited labour supply, but only limited labour absorption until marginal productivity of labour = legal wage • Subsistence (informal) economy has marginal productivity below the legal wage, yet subsists because households pool incomes, share costs and substitute basic necessities W. Arthur Lewis • • • Informal economy is the product of the structural inability of the formal economy to absorb labour Neoliberal/neo-classical solution: cut wages and initiate structural adjustment programmes Keynesian solution: cut input costs through public goods and redistribution goods POVERTY TRAP IN A NEOLIBERAL ECONOMY • • Theoretically, in a neo-classical/neoliberal economy the economic growth of all enterprises in the economy will stabilise at a point where the savings produced by factor productivity(profit) equals factor depreciation and labour force changes (costs) yE = kE / sAf(k) = (n+d)k / capital widening = capital deepening POVERTY TRAP IN A NEOLIBERAL ECONOMY • • • • The poverty trap is the situation where the informal producer struggles to produce income beyond the cost of production because input costs rise faster than agricultural production output (costs are larger than profits in small-scale agriculture) Accordingly informal economy declines to the steady-state of lower production Below yT/kT, sAf(k) < (n+d)k / capital widening < capital deepening Yet above a certain capitalisation rate (yT/kT), producers are able to participate in the formal economy because profits are larger than costs WHY THE POVERTY TRAP? • • • • • • • • • The poverty trap is a situation in which agriculture is practised because incomes are insufficient to purchase food, yet the high costs of inputs preclude regular income through commercial agriculture Commercial agriculture has extremely high risk due to high variability in product prices Capital goods include intangible goods such as human capital and informational goods not supplied by banks Standardisation in monopsonic retail incurs specialised skills costs, resource costs and high risk Credit has interest costs and transaction costs Lumpy physical capital goods – land, vehicles, equipment, utilities, fertiliser, seeds and stocks Labour-intensive production = low productivity rates Subsistence farmers prefer low input cost, low output, low-risk agriculture as rational utility maximisers Therefore land reform initiatives tend to subsistence agriculture – it’s the most rational and economic option EQUILIBRIUM IN THE INFORMAL SECTOR – DUAL TECHNOLOGY MODEL • • • In the informal sector, and informal equilibrium point is achieved in a new-classical economy in which the product of household labour Af(w) = n(w) household consumption of labour product This economy produces at near constant rates of return and has iceberg costs because output is non-pecuniary Surpluses produced is not enough to participate in the formal economy or to constitute as savings and thus is consumed directly. Final equilibrium is based on the carrying capacity of the land ECONOMIC VALUE OF TRADITIONAL ECONOMIES • Equity issues is an important rationale behind the implementation of land reform however land reform also has to conform to the economic rationale of diversified production and agricultural incomes • Traditional economies, being informal subsistence based economies have important economic functions • They provide higher living quality through a diverse location of household income strategies and pooled resources • They provide alternative welfare functions for the poor-elderly and disabled • They develop translocational socio-economic networks operating through circular migration and remittances (NELM) • They enable the development of transitional industries BLACK AND COLOURED LOW INCOME INFORMAL EMPLOYMENT GROWTH FORMAL ECONOMIC EMPLOYMENT NOT ECONOMICALLY ACTIVE POPULATION GROSS VALUE ADDED PRODUCT GROWTH EFFECT OF INPUT SUBSIDISATION ON THE INFORMAL SECTOR • If the level of input subsidisation is higher than the poverty trap depreciation, it will result in increased absorption of subsistence farmers into formal economy (sBf(k)) and increased surpluses amongst farmers who choose to remain in the informal sector (Bf(w)) PROS AND CONS OF FREE MARKET • Free-market economy: lower taxes, lower output (yA), higher food and industrial input prices, lower living quality for poor, higher prices of industrial goods, lower industrial production rates, lower exports, increase urbanisation, lower rural growth, increased urbanisation, decreased rural and industrial employment (kA) PROS AND CONS OF POOLED MARKETING • Pooled marketing: increased taxes (tB), higher output (yB), lower food and industrial input prices, higher living quality for poor, lower prices of industrial goods, increased industrial production, increased exports, increased rural growth, increased rural and industrial employment (kB) AGRICULTURAL MARKETING SCHEMES • • • • • • • • Statutory control boards collectivising the marketing of agricultural goods One channel marketing, only board stores and distributes goods Boards cooperatively and democratically administered by farmers Boards carry admin duties: registration, taxation, research, auditing, information, marketing, distribution, price fixing, administration, professional services, all at nominal cost to the farmer Boards instituted long-term price controls, stabilising and lowering food prices/ production inputs, enabling collective bargaining by farmers, and increasing agricultural output Boards subsidised lumpy inputs, enabling a higher capital-labour ratio and higher productivity Non-price competition based on quality, variety and internal efficiency Distribution costs are shared equally by producers, allowing farmers in peripheral locations to compete with centrally located producers AGRICULTURAL MARKETING SCHEMES • • • • • • • Instead of stimulation packages, pooled marketing of produce and input subsidisation – increase productivity rates throughout the agricultural sector Protects small farmers from price competition and prevents market exploitation by the retail sector Public spillovers: high employment rates, higher production volumes, increased public health, food security, lower food prices for the poor, lower production costs for industries, increased exports Higher production resulted in stronger small-town value chains – economic growth in peripheral areas Practised in varying degrees in US and EU. Was successfully practised in South Africa between 1937-1996 Is still successfully practised in sugarcane farming, the only agricultural sector successfully meeting BEE targets Was destroyed by neoliberal WTO policies, before it could be used to uplift small-scale black farmers after uplifting white farmers for decades