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innesota
gricultural
conomist
MINNESOTA EXTENSION SERVICE
UN JVERSJTY OF MINNESOTA
No. 670 Summer 1992
Economic Reform and Agricultural Trade
in Central and Eastern Europe
Harald von Witzke and Ben Senauer
The last few years have witnessed
the most significant political and
economic changes in Europe since
the end of World War II. As Central
and Eastern European nations shed
the remnants of Communist governance, they struggle with the process
of adjusting to Western-style democracies with market-oriented economic systems. For many of these
countries, restructuring agriculture is
one of the crucial problems they face.
For American and Minnesota
agriculture, which are both exportoriented, the political, economic, and
agricultural changes in Central and
Eastern Europe could have major
consequences. This paper addresses
some of the central implications of
the changes in Central and Eastern
Europe for international agricultural
trade and agricultural producers in
this country.
First, we discuss in general the
factors that determine rapid economic recovery after a process of
economic and political restructuring.
Second, we analyze the current
economic situation in Central and
Eastern Europe and the state of
economic and political reforms.
Third, we discuss the prospects for
agricultural production, consumption,
and trade. We end with some conclusions which have implications for
farmers in the United States and
Minnesota.
(See Refonn page 2)
Economic Growth and
Environmental Degradation:
Win-Win or Lose-Lose?
Terry Roe
In recent decades, more people
have been lifted out of poverty than
at any period in history. Yet, approximately one-fifth of the world's
population live in acute poverty with
life expectancy for those born in
1990 in the range of 42 to 50 years.
During this period the demand placed
on the world's natural and environmental resources has grown immensely, giving new impetus to
(See Growth page 6)
Harald von Witzke is an associate professor and
Director of tlte Celller for International Food and
Agricultural Policy. Ben Senauer is a professor in
tile Department of Agricultural and Applied
Economics.
Tern• Roe is a professor in tile Departmelll of Agricullliral and Applied Economics.
(Refonn continued from page 1)
The countries in Central and
Eastern Europe differ significantly
from one another with regard to their
level of economic development, their
cultural, economic, and political
history, the speed and success of
political and economic reform, and
their internal political stability.
Moreover, the future direction and
success of reforms remain uncertain.
The heterogeneity of this region
makes generalizing about developments in this area extremely difficult.
Determinants of
Rapid Economic
Recovery
Having ousted the Communist
governments and abolished the
Socialist command and control
economy, the next crucial step of
reform in Central and Eastern Europe
is to put pivotal institutions in place,
such as banking and legal systems.
These institutions would secure the
continued development towards
Western-style democracies and
economies. What has evolved so far
is promising, though there are
exceptions such as the tragic ethnic
disputes in the former Yugoslavia.
The transformation to functioning
market economies continues, despite
the possibility of major frictions and
setbacks.
It is now generally accepted that a
market economic system is superior
to central planning. The people in
these countries desire economic
recovery and sustained growth and
development. However, there are
strong forces in the region for which
a market economic system does not
have much appeal. A popular argument is that Socialism had some
features that are worth salvaging.
Sometimes a "third way" between a
market economy and central planning
has been advocated.
Knowledge and skill represent the
ultimate engines of economic growth
and development. They can be
unleashed by a functioning market
economic system. However, markets
do not exist and do not function
appropriately in a social vacuum. For
markets to perform as suggested by
simple models of perfect competition, they need to be embedded in an
appropriate institutional framework
that allows the market participants to
exchange goods efficiently. This
institutional framework must assure
market participants that they will
actually receive what they contracted
for. It must also contain assurances
that governments will abstain from
direct market intervention for reasons
other than removing market failures.
Simply ridding markets of the
regulations imposed under a system
of central planning will not automatically lead to a functioning market
economic system and is likely to
result in a growing inequality of
income and wealth which could
destabilize these young and still
rather vulnerable democracies in
Central and Eastern Europe.
Therefore, for economic reforms
to be successful there needs to be a
credible political commitment to put
in place a market economic system.
Deregulation of prices and markets
needs to be paralleled by suitable
institutional arrangements including
a legal system. Reforming the legal
system in and of itself is an enormous task, given that there are few
lawyers trained in the principles of a
legal system consistent with a market
economy. Another problem is the
definition of property rights consistent with a market economy. This, of
course, is crucial for the reprivatization of capital goods and land.
One of the major sources of
economic growth in the post World
War II period has been international
trade. The countries which experienced the fastest rates of economic
growth have been export oriented.
Japan and Germany are examples.
More recent examples include the
East Asian tigers, such as Hong
Kong, Singapore, South Korea, and
2
Taiwan which have open, marketoriented economies.
The commitment to pursue market
economic reforms must include the
opening of their economies and a full
participation in international trade.
However, at early stages of economic
reform and of opening the economies, the current account balance
which reflects a country's exports
and imports of goods and services
tends to worsen dramatically. Many
industries in Central and Eastern
Europe have lost their traditional
markets, but are not yet efficient
enough to compete successfully in
the world markets. At the same time,
imports of goods from the industrialized market economies have increased.
Obviously, economic reforms
which result in the opening of the
economy have to include the move
towards full convertibility of the
domestic currency. Also required is a
central bank that is allowed to
function independently of the government. In today's industrialized
countries, monetary policies tend to
be successful to the degree that the
central bank is allowed to operate
independent! y.
The market mechanism can result
in a distribution of income and
wealth that is considered socially or
politically undesirable. For market
economic reform to be successful it
is important to develop and implement a redistributive social welfare
system, and a tax system that makes
it possible to finance a social welfare
system without distorting market
incentives.
Perhaps the biggest challenge for
governments in Central and Eastern
Europe is to constrain the political
power of special-interest groups.
These groups try to influence government decisions in favor of their
clientele but to the detriment of
overall economic prosperity and
development. Right from the beginning, special interest groups formed,
and they have begun to influence the
course of economic and political
reforms. One example is Poland,
where farmers' interest groups have
become increasingly successful in
demanding protection from international competition.
In our view, the undue influence
of special interest groups can best be
avoided if the government pursues a
strategy which includes two elements. The first element is to develop and to have approved by the
parliament an "Economic Constitution." The constitution must spell
out the principles of a market
economy with social, distributive,
and fiscal policies consistent with
this economic system. The second
element is to move rapidly in implementing the economic constitution.
Rapid implementation will make it
difficult for interest groups to
develop an effective organization for
lobbying and these groups will tend
to remain less influential.
The Current
Economic Situation
The economic and political
reforms in the countries of Central
and Eastern Europe have progressed
to different degrees and at different
speeds. With very few exceptions the
pace of reform has slowed down
considerably. The old economic and
political systems are disintegrating
and the new market economic
institutions are not yet in place to
sustain rapid economic recovery. The
economies are deteriorating and the
economic situation in many Central
and Eastern European countries has
become worrisome.
As shown in Figure I, economic
activity continues to decline. The
decline in output in 1991 averaged
more than 10 percent for Central
Europe. However, the official
economic statistics may undercount
the level of activity occurring in the
emerging private sectors in some of
these countries. In addition, inflation
is a serious problem. The inflation
rate varied from a low of 36 percent
in Hungary to 550 percent in
Figure 1.
Growth of Gross Domestic Production in Central
Europe, 1990-91 (percent change from previous year)
Bulgaria
Czechoslovakia
Hungary
Poland
Romania
Yugoslavia
-30
-20
.1990
Bulgaria. Under-employment is
widespread, and unemployment
is climbing as inefficient state
enterprises are restructured or
become bankrupt and close.
The current economic problems
have been exacerbated by the collapse of the COMECON (Council
of Mutual Economic Assistance)
trade among former Soviet-bloc
countries. This trade was conducted
in "transferable rubles," which
served as an accounting device.
3
-10
llllJ
0
10
1991, estimated
The COMECON trade provided these
countries a steady market for their
goods, a market which tolerated poor
product quality. They also depended
on the Soviet Union for cheap oil
imports. This has changed dramatically. The Russians now want hard
currency for their oil at world market
prices, and the COMECON market
for Central European exports has
vanished.
The transformation from a centrally
planned to a market economy is
Figure 2.
Per Capita Food Consumption in Central and Eastern Europe in Percent of EC-12
Consumption, 1984-87
140
120
EC = 100
100
80
60
40
20
0
Staple
Foods
Sugar
Vegtable Oils
& Seeds
II
Fruits &
Vegtables
Tropical
Beverages
D
Central Europe
Meat
Dairy
Products
Calories
USSR
Source: United Nations. Food and Agriculture Organization, Trade Yearbook, (various issues).
proving to be much more difficult
than originally anticipated. The
challenge is to carry out economic
reform simultaneously with democratic reform of the political system.
The first stage of the economic
transition typically includes price
liberalization with the removal of
price controls and subsidies, allows
market supply and demand to determine prices, establishes a freely
convertible currency at a market
determined exchange rate, and opens
foreign trade from strict state control.
This first stage has usually been
successful.
The second stage, however,
appears far more difficult. It involves
restructuring and privatizing large
state-owned enterprises. Some 80
percent of industry is still in public
hands in Poland, for example. Many
of the industrial enterprises are so
inefficient and produce goods of such
poor quality that they actually are
"value subtracting," rather than value
adding. This simply means that if the
inputs are priced at world market
levels, they are worth more than the
output can be sold for. Furthermore,
people's attitudes are slow to change.
For example, many still view nonlabor income as immoral. A backlash
has set in as a reaction to the economic distress and inequities that the
transformation process has brought.
The November 199 I Polish elections
can be seen as a vote against rapid
economic reform.
Agricultural
Production,
Consumption, and
Trade
Many people in the West remember pictures of long lines and empty
shelves in food stores in Central and
Eastern Europe under central plan4
ning. This created the impression of
a food shortage and led to the
conclusion that the region as a whole
will be a net food importer for many
years to come. This is supported by
the fact that most of these countries
were significant food importers
under the Communist regime.
However, the long lines and empty
shelves camouflaged the relative
abundance of food. In fact, overall
per capita caloric intake in this
region was not much different from
that in Western Europe.
As seen in Figure 2, the per capita
consumption of staple foods, such as
grain and potatoes, was even higher
than in Western Europe (the 12
countries of the European Community), while consumption of vegetable oils, fruit, and tropical beverages were significantly lower. Meat
and dairy consumption were only
slightly below Western European
standards, although the quality was
Table 1.
Central European Production and Trade Balance (exports-imports) for Major Agricultural
Commodities in 1991 *
(In 1,000 tons)
Wheat
Coarse Grains
Oilseeds
Beef & Veal
Sugar
Pork
Bulgaria
5,300
0
3,757
-100
465
-105
126
6
400
5
120
-340
Czechoslovakia
6,500
150
5,480
50
499
-65
391
46
894
40
700
0
Hungary
5,900
2,000
8,553
500
846
72
Ill
34
893
200
500
10
Poland
9,170
50
18,395
-50
I ,128
260
726
6
1,910
50
1,900
32
Romania
5,300
-500
11,520
-890
671
-400
230
-60
600
-20
560
-265
Yugoslavia
6,530
950
13,090
349
577
-282
301
-22
785
-22
900
20
TOTAL
38,700
2,650
60,795
-132
4,186
-520
1,885
10
5,482
253
4,680
-543
*T/iejirstjigure is production and tile second is tile trade balance (exports-imports).
Source: U.S. Departmellt of Agriculture, Economic Research Service. Central and l::ast Europe Agriculture and Trade Report, April 1992.
low. This consumption pattern was
consistent with lines in front of food
stores, because consumer food prices
were highly subsidized and hence
very low. Moreover, under the
system of central planning, there
were not many goods other than food
which consumers could buy, and the
opportunity cost of waiting in line
was low.
With economic reforms, consumer behavior has changed. Real
household incomes have significantly declined, consumer food
subsidies have been removed and
food prices have risen sharply. Given
the still relatively high response of
food demand to income and price
changes in these countries, this led to
declining food consumption for nonstaples.
Table 1 gives 1991 agricultural
production and trade balance figures
(exports-imports) for major crops.
Growing conditions were favorable
last year and consequently harvests
were good. In general, the production and trade levels in 1991 were
quite typical of patterns for the last
four or five years. Hungary is the
largest agricultural exporter, measured in value terms.
In 1989, Hungary's agricultural
exports were valued at $2.15 billion
and imports at $857 million, for a
trade balance of $1.29 billion. As
shown in Table 1, pork products are a
major contributor to Hungary's
agricultural exports. Czechoslovakia
exported agricultural products worth
$718 million and with imports at
$2.23 billion, the trade deficit was
$1.52 billion. Besides oil crops and
feed, some of Czechoslovakia's
major imports are not shown in Table
1 and included cotton, wool, tobacco,
coffee, and fruits and vegetables.
Poland exported $1.29 billion and
imported $1.78 billion, for a trade
deficit of $492 million. 1 Unlike 1991,
Poland had large wheat imports in
1989 and also imported oil crops and
feed, cotton, wool, coffee, and tea.
The agricultural input and output
(processing and distribution) industries remain a major problem. These
industries continue to be largely in
the hands of large, inefficient stateowned enterprises. If they are to be
competitive in the agricultural/food
1 U.S. Department of Agriculture, Economic
Research Service, World Agriculture: Trends and
Indicators, 1971-89, Statistical Bulletin No. 815.
September /990.
5
product trade, these countries will
have to have efficient farm input and
agricultural/food processing and
distribution systems. Not only will
foreign trade suffer because of the
inefficiencies of the output and input
industries, but they will be hurt in
their own domestic markets. As their
markets are opened to Western
goods, there is increased competition
from imported food products which
offer higher quality standards, more
variety, more attractive and effective
packaging, as well as persuasive
advertising.
Conclusions
Agriculture in many Central and
Eastern European countries has the
potential to be rather productive. It
will probably require an extended
period of time, however, before
many of these countries will emerge
as major exporters of agricultural
commodities. The infrastructure
needed for efficient agricultural
production, processing, storage, and
transportation is currently in poor
shape. The entrepreneurial and
managerial skills necessary for
efficient agriculture and agribusiness
industries are scarce. Agriculture
will become more competitive
internationally only when the investments in managerial skill, agricultural
research, infrastructure, and food
processing industries begin to pay off.
In the short run, export opportunities for agriculture in the United
States and Minnesota will remain
limited. Consumer income has
declined and food prices have increased. Both have contributed to a
considerable reduction in food
consumption. Certainly, if some of
these countries begin to experience
sustained economic growth, there will
be windows of export opportunity for
agricultural producers nationwide, as
well as for Minnesota farmers. Lowincome countries with rapidly growing economies are frequently characterized by a growing demand for
agricultural imports.
The next few years will be critical
in the economic and political evolution of Central and Eastern Europe. A
continuing economic decline could
lead to increased political instability
and should be of great concern to
the United States and Western
Europe. One of the most beneficial
actions which could be taken to
assist these countries concerns trade
policy. The "Europe Agreements,"
signed in December 1991, will
strengthen trade relations between
Czechoslovakia, Hungary, Poland,
and the European Community.
However, the European Community gave minimal ground on agricultural products in these agreements,
as well as on other goods such as
textiles and steel, because Central
and Eastern Europe are likely to
become competitive in these areas.
This is another example of the
negative consequences of the protectionist agricultural policies of the
European Community under the
Common Agricultural Policy.
Both the European Community
and the United States would do well
to refrain from disposing of their
surplus agricultural commodities in
Central and Easter Europe unless an
actual food shortage occurs. It is
clearly in our self-interest to have
stable, prosperous, democratic
countries develop in Central and
Eastern Europe.
Economic Growth and
Environmental Degradation:
Win-Win or Lose-Lose?
(Continued from page 1)
concerns about water pollution and
water scarcity, air pollution, solid
and hazardous wastes, soil degradation, deforestation, loss of
biodiversity, and depletion of other
natural resources. An emerging view
is that poverty alleviation is not
inimical to environmental degradation. Rather, the alleviation of
poverty in developing countries will
help to lessen many kinds of environmental degradation.
Causes of
Environmental
Degradation
Population Growth
Between 1990 and 2030 the
world's population will grow by 3.7
billion, according to estimates from
the World Bank. Food production
will need to double. Industrial output
and energy use will probably triple
world wide and increase fivefold in
6
developing countries. 1 If this population increase and the associated
consumption of resources yields
environmental degradation at rates
associated with historical levels,
millions will die prematurely while
others will suffer ill health. Natural
resources will become relatively
more scarce, threatening the
sustainability of production levels
and real incomes for a growing
proportion of the world's population.
Market Limitations
Failure of the market to price
resources according to their true
scarcity is a major factor contributing
to environmental degradation.
Evidence strongly suggests that
resources tend to be poorly managed
and permitted to degradate when
the market undervalues their true
scarcity value. In this situation,
incentives for the adoption of new
technological practices, technical
substitution, and investments to
sustain productivity (which, in effect,
save on the relatively more scarce
environmental resources) are not
sufficient to prevent degradation
from occurring at a pace that is
unnecessarily harmful. This failure
of market prices to reflect the scarcity of natural resources can occur
due to lack of property rights, when
resources are subject to open access,
and because of economic policies
that, through subsidies and taxes,
provide disincentives for their
husbandry.
When resource property rights are
ill defined, individuals have incentives to extract marginal returns from
resources to the point that is below
their true scarcity value. Little or no
incentive is provided to husband
them or to reinvest in sustaining their
productivity for the future since, to
do so, would be to give up any
remaining productivity to others
without being compensated, or
without the assurance of preserving
productivity for the individual's own
1
World Development Report, 1992, p. 2.
use. In countries where property
rights are ill defined, soil erosion,
salinization, and deforestation tends
to be more severe than in other
countries.2 The effects of gross soil
loss on agricultural productivity are
estimated to range from about 0.5 to
1.5 percent of the Gross Domestic
Product (GDP) annually for regions
in Costa Rica, Malawi, and Mexico
where property rights are ill defined.
With open access, individuals
have unrestricted access to resources, such as fish, or unrestricted
claims to tribal lands or lands set
aside for an ethnic groups, as in the
case of grazing lands in Morocco.
Open access has given rise to
overgrazing in many African countries, deforestation of tropical and
dry forests and encroachment on
land set aside for wild animals in
Tanzania and Kenya. When species
become extinct, an irreversible loss
occurs with great uncertainties as to
their impact on the balance of the
ecosystem. The loss of forest
ecosystems also means a decline in
the capacity of forests to act as a
carbon sink to absorb the high levels
of carbon dioxide generated by the
industrial-market economies. Even
the earth's atmosphere is threatened.
This resource, comprised of gases
that provide protection from radiation and prevent global warming,
unhealthy suspension of particulate
matter, acid rain, etc., is subject to
the same excessive use problems as
those mentioned for land and other
resources. Open access to the
atmosphere has allowed the introduction of particulate matter and
various gases believed to contribute
to global warming and ozone
depletion.
A major source of greenhouse gas
emissions is from fossil fuels.
Flavin (1990), 3 estimates that four
countries, the U.S., Japan, West
Germany, and the United Kingdom
account for more than 32.5 percent
of the world's total carbon emissions
from fossil fuels in 1987. The
former Soviet Union and China
alone accounted for another 29.2
percent of the world's total from this
source. Since markets are unable to
price atmospheric resources, regulations are required to restrict and
control access. Without such
regulation, individual firms and
industries have little incentive to
control the byproducts of production
processes that degrade this resource.
Consequences of
Environmental
Degradation
Environmental degradation can be
viewed in terms of its possible
effects on current and future generations. While there is general agreement that natural resources such as
unspoiled lakes, rivers, and forests
contribute to human welfare, not all
consequences of a depleted environment are obvious. Two possible
effects of environmental degradation
are especially noteworthy: (1)
declining health and higher health
costs and (2) lower productivity.
Declining Health and Higher
Health Costs
Health care tends to be a "luxury"
good in the sense that as income
increases, individuals spend an
increasing proportion of total disposable income on health. Based on
data from 25 countries, a recent
study4 estimated that health-care
expenditures would rise by about
1.32 percent for every 1 percent
increase in a country's GNP. Thus,
as real economic growth occurs and
individual disposable incomes grow,
individuals are willing to spend a
greater proportion of their rising
incomes to offset those environmental factors that cause ill health.
Though depletion of natural
resources and environmental quality
is known to have deleterious effects
on human health, the "directness"
with which this occurs is important
to understanding key aspects of the
poverty alleviation-environmental
quality linkages. To clarify these
linkages, Mohtadi and Roe (1992) 5
distinguish between embodied and
disembodied effects.
Embodied effects of environmental degradation are directly linked to
individual consumption~ they
include the unhealthy residues and
contaminants on food, contaminated
drinking water, unsanitary disposal
of household wastes, and indoor air
pollution caused by the use of wood,
straw, or dung that is commonly used
in cooking fires of the many lowincome households in developing
countries.
Disembodied effects on health
come about from the total consumption and/or production of goods and
services that are harmful to health.
Examples are ozone depletion from
the consumption and production of
goods and services (air conditioning,
refrigeration) that use chlorofluorocarbons (CFCs), sulfur dioxide and
particulate matter6 from the burning
of fossil fuels, toxic effects of
effluent discharges from industrial
processes that utilize heavy metals,
and other hazardous wastes.
Households can at least indirectly
and partially compensate for embodied effects. Individuals may decrease their consumption of residueladen foods, substitute more expensive, possibly organically grown,
foods and, through market forces,
induce competition among firms to
Molltadi, Hamid and Terry Roe (1992) "Endogenous Growth, Health and Environment: A General
Equilibrium Approach," Working Paper, Economic
5
2
Developmelll Cemer, U11iversiry of Minnesota.
World Development Report, 1992, pp: 55-60.
'Falvin, C. ( 1990) "Slowing Global Warming," In
State of the World, L. Browned., N.Y.: W. W.
Norton.
Gertler, Paul and Facques van der Gaag ( 1990).
Tile Willingness to Pay for Medical Care, John
Hopkins University Press, Tables 2-3, p. I I.
4
7
Sulfur dioxide levels have beenli11ked to death
rates from bro11chitis while suspended particulate
matter has been traced to eye and lung damage.
6
supply goods and services that are
healthier. Subject to such market
forces, firms are likely to be more
willing to invest in water purification
equipment and better household
technology for food preparation,
heating and waste disposal. Still, the
market is not likely to totally solve
the problem. After households adjust
their consumption patterns to account
for ill-health effects, welfare could
be further increased by engaging in
collective action. Collective action
may take the form of a neighborhood
or national association whose main
purpose is to influence political
choice on environmental matters.
An association of this type can
attempt to resolve unsanitary waste
disposal, influence state and national
government to establish grades and
standards for residue and contaminant sensitive foods, impose taxes on
the use of pesticides, construct
municipal waste disposal systems,
etc.
In the case of disembodied
effects, the consumption level of a
single individual, and in many cases
of a single firm, will have only a
negligible effect on the environment
and therefore on health. Thus, the
individual will have no incentive to
decrease consumption or place
pressure on domestic firms to, for
example, install pollution-abating
equipment. Since the individual's
own level of consumption has no
effect on health, collective action is
needed to pressure local, state,
federal, and perhaps international
agencies (particularly if the source of
degradation is from activity in
another country) to impose conditions that will mitigate the ill effects
on health. But what incentives are
there for individuals to incur the
costs of forming coalitions to get this
process started? If individual costs.
are high, then deep personal commitment exercised through political
leadership or environmental organizations will likely be required to
induce governmental action in lieu of
an environmental crisis.
Lower Productivity
The environmental problems
which cause resource productivity
problems in developing countries
differ from those in the wealthier
countries. Low-income countries
rely on agriculture and fisheries,
which accounted for about 30 percent
of their GDP in 1990 (World Bank
Tables). Given their level of economic and institutional development,
as a group, land and fishery degradation tends to be their most immediate
and threatening source of real income
decline from environmental factors.
Loss in human productivity from the
environmental effects on health are
also large. Developing countries also
face potential declines in agricultural
productivity from greenhouse gases
and acid rain in some regions. One
of the major resource degradation
problems faced by wealthier countries is that of degradation of primary
resources (minerals, fossil fuels,
timber) in developing countries,
because these resources comprise
important industrial-country imports.
Developing-country investments in
maintaining ecological diversity and
forests, both as a resource and carbon
sink, do yield benefits for the developing countries, but yield proportionally larger benefits for the developed
countries.
Further, policies to arrest natural
resource and environmental degradation typically increase production
costs. Rising costs imply that
incomes of some individuals may
fall. If incomes fall, some individuals may be made worse off, but this
is not the case from a global perspective. Instead, well-designed policies
that alleviate the effects of degradation on health and the decline in
resource productivity are likely to
increase the affordability for individuals and countries to invest in
mitigating further degradation. Since
the benefits and costs of policies
designed to redress environmental
degradation may fall on individuals,
firms, regions, countries or perhaps
generations in disproportionate ways,
8
compensatory schemes that compensate the losers at the expense of the
gainers may need to be implemented.
Environmental degradation should
not be simply viewed as increasing
the costs of producing goods and
services and, therefore, decreasing a
country's competitive advantage in
world markets. Instead, health and
environmental amenities should be
viewed as consumption goods that
the market, by itself, fails to provide
at socially optimal levels. Addressing environmental degradation can
increase the supply of these "goods,"
with the net result that society
benefits.
Obstacles to
Economic
Development:
Inward-Oriented
Policies
Many of the world's economies,
including those which formerly were
centrally planned, are moving in the
direction of policy reform. Most,
however, have a great distance left to
go and many still pursue policies
that can be described as "inward
oriented." To better illustrate the
implications of policy reform on
economic growth and the environment, it is useful to briefly discuss
the characteristics of a typical
inward-oriented economy, many of
which can be found in the studies
cited.
Countries pursuing inwardoriented policies typically protect
their import-competing industrial
sector from foreign competition. To
accomplish this they tax the export
sectors and pursue capital market
policies that invariably entail overvalued real currency exchange rates,
low and often negative real interest
rates, and fiscal deficits that are
frequently financed by money
creation. Since agriculture is an
export sector in many developing
countries, rural households tend to
bear the burden of these policies.
Protection of the industrial sector
generally gives rise to concentrated,
often single-firm or state-enterprise
industries, that cannot attain economies of scale nor compete in international markets. Owing to their
marginal profitability, these industries seldom are required to conform
to even modest industrial market
economy standards for effluent and
other byproduct discharges. Further,
they often make inefficient use of
natural resources as measured by
energy per unit value of output,7
timber harvested relative to tree
population per square mile, and so
on.
Since food is a wage good in
many of these economies, political
pressures exist to maintain low
nominal prices for food which induce
lower nominal wages, a benefit to
marginally profitable enterprises, but
higher real wages, a benefit to urban
households. A common result is
lower farm-gate prices which eventually leads to economic stagnation of
the rural sector. The country studies
directed by Krueger et. al 8 found that
in 16 developing countries during the
1980-84 period, farmers received
farm gate prices for export crops that
averaged 40 percent below the price
they would have received had
economic policy not been biased
against them. Since these policies
lead to stagnation of the rural
economy, governments often subsidize farm inputs and take over
agricultural marketing functions.
This is done to increase farm prices
while holding retail prices unchanged, thus absorbing the costs of
marketing services in the federal
budget. In Egypt during the 1980s,
for example, farm-gate prices for
wheat, in bread equivalents, often
exceeded the retail price of bread.
For example, countries ranking highest in carbon
emissions per unit of GNP in 1987 are China,
Egypt, India, Mexico, and Poland, while Japan,
Italy and France rank among those with the lowest
levels of carbon emissions per unit of GNP (Flavin,
1990).
7
Over-valued real currency exchange rates, low and often negative
real interest rates, inflation, and fiscal
deficits that are frequently financed
by money creation, typify the
macroeconomic consequences of
these policies. These consequences
tend to further contribute to declining
competitiveness in international
markets, the pushing of resources
into the non-internationally traded
goods sector of the economy, and
declines in domestic capital formation because asset holders seek to
shelter their liquid assets in other
countries. The majority of the
world's most poverty-stricken
population live in countries pursuing
these inward-oriented policies.
Win-Win Strategies:
Economic
DevelopmentEnvironmental
Preservation
If countries instead choose to
pursue policies that are more strongly
associated with economic growth,
then incomes can be expected to rise.
Rising incomes make it possible for
individuals to at least partially
compensate for the embodied effects
of environmental degradation on
health. Hence, unhealthy residues
and contaminants on food, contaminated drinking water, unsanitary
disposal of household wastes, and
indoor air pollution should be among
the environmental factors that are the
most likely to improve.
Increased affordability should also
induce individuals to place more
political pressure on local and federal
governments to pursue policies and
engage in treaties that seek to mitigate the ill-health effects from the
production and consumption of
ozone-depleting gases, sulfur dioxide
and particulate-matter suspension,
and the toxic effects of effluent
•op. cit., p. 262.
9
discharges from industrial process.
For example, a recent study was done
using time series data for more than
21 cities in 13 countries. The empirical results clearly find that sulfur
dioxide levels tend to decline when
per capita incomes reach somewhere
in the $4,000 to $5,000 range, and
that suspended particles found in a
given volume of air monotonically
decreases as GDP per capita increases.9
In recent years, the studies of
numerous countries and syntheses of
these studies have led to a better
understanding of some of the fundamental factors associated with
economic growth. 10 The findings are
not surprising. Essentially, they
suggest that the keys to economic
growth lie in the amelioration of
market failures, technological
change, and capital accumulation.
These keys must be broadly defined
to include the human capital of men
and women and must include the
efficient allocation of resources to
meet final demand. Foreign trade
policy is also important because it
influences the degree to which
international markets for final goods
and services, information, and
technology interact. This interaction
is needed to yield a growth path
along which patterns of production,
investment, and capacity creation are
determined.
Three lessons are contained in
these findings. One, governments
should pursue stable macroeconomic
9 Grossman, Gene and Alan Krueger, (1991)
Environmental Impacts of a North American Free
Trade Agreement Discussion Papers in
Economics, Woodrow Wilson School, Princeton
University.
10 Refinery prices for various grades offuels in
Egypt during 1985-1990 averaged 36 perce111 of
world market prices. Many state-owned and
operated firms received energy subsidies beyond
these alreadv low prices; Holt, Robert and Terrv
Roe, (1991) ·"The Political Economy of Reform:
Egypt in the 1980s, "forthcoming in The Political
Economy Structural Adjustment, Anne Krueger and
Robert Bates, eds.. Basil Blackwell publishers.
policies. In these policies, trade
balances should be attributable to
structural factors, such as the propensity of households to save. Capital
inflows should be explained by
returns on investment. Two, governments need to establish fiscal policies
in which deficits are financed by
savings and restricted to business
cycles, as opposed to fundamental
deficits of the type experienced by
the U.S. during the last decade.
Finally, governments should select
policy instruments to effect income
transfers among societal groups that
have minimal impact on producers'
resource-allocation decisions.
Otherwise, resources tend not to be
allocated to their most profitable
alternative and the economy suffers a
loss in economic efficiency.
Briefly, there are five additional
routes through which policy reform
to achieve economic growth can also
resolve environmental degradation.
First, inward-oriented policies that
tax the rural sector almost always
give rise to the under-valuation of the
rural sector's sector-specific assets,
such as land, forests, and natural
resources that a country exports.
When resources are undervalued,
individuals tend to excessively
exploit them and to under invest in
their maintenance. Hence, reform
that reflects the true scarcity of these
resources in market prices should
result in their better husbandry.
Second, policy reform that
increases the profitability of previously taxed firms should also increase their willingness to accept and
pursue policies that save on natural
and environmental resources while
the previously protected and marginally profitable firms should either
decrease their scale of economic
activity or shut down. Since many of
the marginally profitable and protected firms typically receive large
subsidies, particularly for energy, 11
forcing them to incur the true cost of
environmental resources should yield
significant environmental savings
while at the same time contribute to
the more efficient use of other
resources.
Third, relative to inward-oriented
policies, policy reform tends to open
up an economy to international
markets for information and technology that, by substituting for the old
technology, can save on the use of
environmental resources. As noted
below for the case of Mexico, reform
often encourages economic activity
that uses a country's most abundant
resources, such as labor. It turns out
that many of these types of economic
activities do not use abundant energy
and other environmental resources,
and hence, opening up the economy
tends to save on these resources.
Further, when international companies enter the economy, they tend to
utilize modern technology that often
employs more modern methods for
saving environmental resources than
would otherwise be available. In
Argentina, an IBM subsidiary
recycles three-quarters of the waste it
generates because it could not find
local disposal facilities. Similarly, in
Nigeria, Chevron uses only waterbased lubricating fluids in its drilling
operations for the same reasons. 12
Further evidence in this regard is
provided by Grossman and Krueger,
op. cit. They find that the
maquiladora plants (firms that are
permitted to locate close to the
American side of the border in
11 These include a 17-coumry study discussed by
Cordell, Max ( 1990 "Macro Economic Policy and
Growth: Some Lessons of Experience," 1n Proceed-
ings of the World Bank Annual Conference on
Development Economics, pp. 59-84, another 21-
country sludy direcJed by La/ and Myint and
discussed by La/, Deepak ( 1990) The Political
Economy of Poverty, Equity and Growth in 21
Developing Countries: A summary of Findings.
Paper prepared for the American Economics
Association Meetings, Washington. D.C., and still
another 18-countrv studv directed and discussed bv
Krueger, Anne, M: Sch;.if and A. Valdes, ( 1988) .
"Agriculturallncemives in Developing Countries,"
The World Bank Economic Review, 2:255-271.
12 Economist,
Vol. 323, May 30-June 5, page 11.
10
Mexico) appear to have located along
the Mexican-American border for
reasons of lower wages and not for
reasons of avoiding U.S. environmental restrictions.
Fourth, policy reform that decreases fiscal deficits, and broadens a
country's tax base by decreasing its
reliance on foreign trade taxes is not
only good for economic development, it is also good for the environment. Conversely, when governments incur large fiscal deficits and
have large and cumbersome bureaucracies that are heavily engaged in
carrying on activities that can be
better performed by the market,
environmental degradation often
results. In such circumstances, the
expenditures to monitor and control
environmental degradation will be
less than is socially profitable in a
benefit-to-cost context. The opportunity cost for governments in inwardoriented economies to incur larger
deficits and to engage in additional
planning and management activities
required for environmental management tends to be too burdensome to
address environmental problems to
the degree they should otherwise be
addressed.
Fifth, policy reform and investments in public goods, particularly in
education for both men and women,
will tend to reduce environmental
degradation associateJ with relatively large numbers of low income
households in rural areas. Removing
the mentioned taxes on the rural
economy and opening the urban
industrial economy to foreign
competition and capital inflows will
in the longer term tend to induce a
migration from the rural to the urban
sector of the economy. Typically,
protection of the domestic industrial
sector from foreign competition does
not permit an economy to efficiently
use what is often its most abundant
resource, cheap labor. While labor
migrates to urban sectors in an
economy pursuing inward-oriented
policies, labor still gets locked into
the rural economy where it often
subsists on small farms using
traditional technologies. This
situation often forces labor to meet
urgent short-term needs by mining
natural resources, e.g., farming land
on hill sides that are easily eroded,
over grazing, and excessive cutting
of trees for firewood. Poverty also
prevents them from reinvesting in
the natural resources they are forced
to mine. 13
Low-income households in which
women are relatively uneducated
typically have larger families than
higher income households where
both parents are educated. Research
suggests that low income households, particularly in rural areas,
have larger families because of the
need for family labor, relatively high
infant mortality, and the need to help
secure an income stream in old
age. 14 As an economy grows and
real wages rise, households choose
to have fewer children and to invest
more in each child in terms of
health, education and so on. Investments in the education of women
tend to make them more aware of
family-planning choices and induce
them to seek employment outside
the home, thus increasing incentives
to reduce family size. Recent
evidence from a cross-section of
countries shows that where no
women are enrolled in secondary
education, the average woman has
seven children, but where 40 percent
of all women have had a secondary
education, the average drops to three
children. Hence, public investment
in education is not only desirable for
economic development and equality
among the sexes, it is also a way to
dampen population growth and
population induced pressures on the
environment.
"See Uma Le/e and Sleven W. Slone, Populalior.
Pressure, the Environment and Agricultural
Intensification: Variations on the Boserup
Hypothesis, Madia Discussion Paper 4, The World
Bank, 1989 for a discussion oflhese issues.
14 See T. Paul Schullz. "Educalion lnveslmenls and
Relurns," in The Handbook of Development
Economics, Vol. 1, Chenerv and Srinivasan, eds.,
Norlh Holland, 1988, pp: J43-630 for a review of
I his lilera/ure.
We have given little attention to
policy instruments and design of
institutional structures to ameliorate
market failures except to note that as
individuals become more wealthy
they are likely to be more willing to
encourage governments to address
these failures. Still, it is a challenge
to design and implement policies to
resolve the market's limitations,
especially its inability to deter
environmental degradation.
These failures are especially
evident in the areas of disembodied
health effects and open access. This
challenge includes building institutions to establish and clarify property
rights, providing information on the
environmental causes and effects of
economic activity, and channeling of
collective action to focus on the
sources of degradation. A balance is
needed between the institutional
capacity to manage, monitor, and
enforce policy instruments and a
tendency for these instruments to
cause unintentional consequences on
economic incentives. Since this
aspect of economic policy tends to
be more dependent on cultural
characteristics of society, the form of
government, and the stage of economic and institutional development,
the particular approach to resolve
market failures, as is already evident
in many countries, will need to be
tailored to the specific country.
Hence, conditional on the ability
of governments to pursue policy
reform and their ability to resolve
problems of market failures, there
appears to be considerable grounds
for optimism. Win-win development
strategies are very possible, and may
be indispensable. That is, if we do
not pursue win-win strategies we
may well default to lose-lose. Winwin strategies do not imply that the
productivity of all environmental
resources nor all amenities and ill
health effects will be ameliorated.
As Summers states "We can help our
descendants as much by improving
infrastructure as by preserving rain
forests, as much by educating
children as by leaving oil in the
ground, as much by enlarging our
scientific knowledge as by reducing
carbon dioxide in the air." 15 In other
words, the degradation or even
exhaustion of a resource is not
necessarily inconsistent with the
welfare of present and future generations nor with the socially efficient
allocation of resources.
Trade-Offs Between
Wealthy and Poor
Countries
Many health and resource productivity benefits from environmental
policies in developing countries
accrue to the wealthy countries, and
some of the potential ill health and
resource productivity problems
facing developing countries have
their origin in the economies of
wealthy countries. The implication is
clear: wealthy countries should
compensate the poorer countries.
Three points should be kept in
mind:
First, health is a luxury good and
wealthy countries are willing to pay
more for the ill effects of the environmental degradation on health than are
poor countries. An opportunity exists
for both wealthy and poor countries
to gain from trading in goods that
have environmental implications to
health. For example, poor countries
can often export healthy goods, e.g.,
organically grown food, to earn
foreign exchange which can be
allocated to the purchase of new
technology produced in wealthy
countries.
Second, foreign aid to encourage
economic growth in poor countries
has ~esirable environmental consequences for wealthy countries. Since
environmental degradation crosses
national boundaries, the development
of new technologies that conserve
environmental resources serves their
15 Economist,
11
Vol. 323, May 30-June 5, p. 65.
interests as well as the interests of
wealthy nations. Furthermore, since
the economies of poor countries tend
to be adversely affected when the
economies of wealthy countries are
mismanaged, economic growth in
wealthy countries is actually to the
advantage of poor countries.
Finally, the world's wealthy
economies must be the ones to take
the initiative. They have the major
capacity to influence world opinion,
to take initiative in fostering treaties,
and to assure treaty compliance.
Thus, the key responsibility must lie
with the world's wealthier nations to
form new world institutions that are
in the best interest of both the
wealthy and poor nations.
Environmental degradation
affects health, a luxury good, and the
productivity of a variety of resources
in complex, and occasionally,
irreversible ways. As income
growth occurs, individuals tend to be
willing to pay proportionately more
to resolve environmental effects on
health. Hence, one major difference
between low- and high-income
countries is that the embodied health
effects of degradation tend to be
more immediate and harmful to
individuals in poor countries than to
individuals in wealthy countries.
Many of the harmful effects of
disembodied factors are the result of
economic activities associated with
wealthy nations. For example, ozone
depletion can largely be attributed to
sulfur dioxide emissions, particulate
matter suspension, and toxic effects
from effluent discharges. Yet poor
nations, as well as wealthy ones,
accrue many of the ill health effects
of these activities. Because these
effects are difficult to resolve by
individual actions through the
market, governments are required to
address them.
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gric~ltural
onom1st
No. 670 Summer 1992
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