Agricultural price protection and productivity in high and low income countries

It is argued that agricultural pricing policies can have an effect on agricultural productivity through the effects that price expectations can have on the choice of technique by producers, on the incentives for discovering new knowledge and on investment in agriculture. It is hypothesized that there is a positive (negative) relationship between subsidy (tax), but this relationship depends on the degree of the subsidy or tax. The Nominal Protection Coefficient (NPC) is used as a proxy for agricultural policy, and is included as an explanatory variable in production function. Policy is also hypothesized to be an endogenous variable in the process of economic growth, so a simultaneous equations model is estimated consisting of an aggregate production function and a policy equation. Agricultural policy is found to have a positive and significant impact on agricultural productivity and this productivity effect is not the same for all countries. In particular, in the countries that subsidize or tax agriculture moderately, the response of productivity to the NPC is large with an elasticity greater than 2. The results imply that if the price interventions were to be eliminated, agricultural productivity would increase on average by more than 68% in developing countries and would on average by about 30% in developed countries. The results also suggest that it would be possible to reduce the adverse environmental impacts of agriculture caused by subsidies without significantly lowering agricultural productivity in developed countries.