Central America's free trade flop. Why liberalisation failed to boost agricultural performance

During the 1980s many developing countries adopted trade 'liberalisation' policies such as the lifting of exchange rate controls. They expected a boost to the agricultural sector's export performance to be among the gains, spurring higher levels of production. Liberalisation superseded interventionist trade policies such as import substitution, that were perceived to cause distortions and so work to agriculture's disadvantage. But a University of London (School of Oriental and African Studies) research report shows that in most respects the agricultural economies of Costa Rica, El Salvador, Guatemala, Honduras and Nicaragua did far better during the interventionist 1970s than they have since liberalisation. What caused this reversal?

The SOAS study probed the performance of the agriculture sector in five Central American countries that have adopted liberalisation policies. Various assumptions underpin the notion that liberalisation ought to favour agriculture. If agriculture is a country's comparative strength, then with liberalisation:

• comparative prices ought to move in favour of agriculture
• the exchange rate should depreciate when controls are lifted
• this should increase the price of goods which can be traded, relative to 'non-tradeable' goods
• in chiefly agrarian economies, agricultural prices relative to those of other tradeables should rise.

Yet the research findings flatly contradict these orthodox notions. For all five countries in the study, exports grew most rapidly during the years when import substitution strategies were most rigorously implemented. The results also show that liberalisation had no real impact on growth of exports in general. As for agriculture, the study found that only in Costa Rica did liberalisation coincide with a rise in net agricultural exports. In four out of five cases, agriculture exports declined after liberalisation.

What reasons lay behind this apparently perverse supply response? It was found that, contrary to expectations, in two out of five cases the exchange rate appreciated after liberalisation. Agriculture prices were then compared with those prevailing elsewhere in the economy, such as transport or energy costs. Evidence showed other price trends moving against agriculture trends in four out of five cases. Yet relative prices moved in favour of agriculture in the same four countries during the import substituting 1970s. Further investigation showed prices of both exported and imported agricultural commodities fell after liberalisation. The only product whose levels of production rose was bananas.

These findings suggest that:

• falling world prices largely triggered the fall in relative prices of agricultural export products in Central America and trade liberalisation exaggerated these effects
• rather than depreciating to offset international price trends, exchange rates tended to climb in real terms under liberalisation. This trend may have been due to free capital inflows after removal of exchange controls
• the signs are that liberalisation has shifted incentives away from agriculture in Central America - the very opposite of the effect it is normally expected to achieve
• this effect is not necessarily bad thing. Some argue that if the world price of a given product is falling, then pressure to diversify into other products must become irresistible
• even so, though some diversification seems to have occurred it has not been enough to save the agricultural trade balance from deteriorating in four of the five countries under study.

If fostering agriculture is a policy goal, there are better ways to do it. A judicious combination of export promotion and import substitution targeted on agriculture could be more successful. A country by country approach is needed to test whether such moves will improve agriculture's poor track record.

Source(s):
Unpublished report to FAO by J. Weeks (December 1997)

Funded by: UN Food and Agriculture Organisation, 1997

id21 Research Highlight: 1998-November-23

Further Information:
John Weeks
Centre for Development Studies
School of Oriental and African Studies
University of London
Thornhaugh Street
Russell Square
London WC1H 0XG
UK

Tel: +44 (0) 171 637 2388
Fax: +44 (0) 171 436 3844
Contact the contributor: jw10@soas.ac.uk

Centre for Development Studies, School of Oriental and African Studies