Trade Integration and Rural Economies in Less Developed Countries:
Lessons from Micro Economy-wide Models with Particular Attention to
Mexico and Central America
Report to the
Latin America and Caribbean Regional Office (LCR)
of
The World Bank*
J. Edward Taylor
Agricultural and Resource Economics and
Center on Rural Economies of the Americas and Pacific Rim
University of California, Davis
May 2002
Trade Integration and Rural Economies in Less Developed Countries:
Lessons from Micro Economy-wide Models with Particular Attention to
Mexico and Central America
Summary
The impacts of WTO or regional trade integration on rural production, incomes
and poverty depend critically on three questions: First, to what extent are the influences
of trade integration transmitted through domestic markets to economic agents in rural
areas? Second, to what extent are rural producers diversified or able to diversify their
economic activities in response to trade reform in order to (a) buffer themselves from
negative market shocks and (b) respond to new market opportunities? And third, how do
government policies facilitate or retard internal adjustments to freer trade? Answering
these questions requires an in-depth understanding of the structures of rural markets and
incomes, the ways in which these structures influence production and incomes in rural
areas, and the policies that accompany trade integration. Impacts of trade reforms are
likely to be different in diverse market and policy settings.
This paper presents an analytical and empirical approach towards understanding
how trade liberalization is likely to play out in rural economies, with special
consideration for production, incomes, migration, and farm-nonfarm linkages. It
explores the ramifications of alternative market structures, levels of activity
diversification, technologies, and policy regimes in shaping outcomes of trade reforms on
a local level. A simple yet flexible micro economy-wide model that includes a variety of
activities, technologies, and household types of policy interest is designed and calibrated
using micro survey data from Mexico and Central America. This model is then used to
evaluate household and rural economy-wide impacts of policy changes in diverse rural
settings. Simulations using the model are used to derive policy lessons explore the
extent to which lessons from NAFTA reported in Taylor, Yúnez and Dyer (1999) and
elsewhere may be relevant in alternative production, technology, and market
environments characteristic of rural Mexico and Central America.
Findings highlight the critical role of imperfect markets and transaction costs in
shaping local economy-wide outcomes of trade policy reforms. High transaction costs
and lack of access to capital and new product markets exclude poor rural households
from many benefits of trade liberalization and may exacerbate poverty in the wake of
trade reforms. Lacking access to rural capital and product markets, the major alternative
in poor rural households is to transfer their labor to sectors of the economy with better
access to credit and product markets. This is likely to entail increased wage work,
including migration. Overcoming market barriers is a key to promoting more broadbased participation in the benefits of liberalization.
1
Introduction
Interactions between trade liberalization and rural economies in less developed
countries (LDCs) are among the least researched and understood topics in economics.
This is surprising, given LDCs’ reliance on primary exports, the increasing importance of
poverty alleviation and broad-based growth on development agendas, and the fact that the
majority of the world’s population and poverty is concentrated in rural areas. Almost all
economics research on trade policy impacts focuses on nations or groups of nations,
offering little insight into how trade reforms play out within nations. It is through the
actions of economic actors within nations that communities, regions, and countries
become integrated with global markets, directly or indirectly (Taylor, 2001). Linkages
among economic actors, together with the market structures and policies that influence
these linkages, transmit the influences of trade reforms from directly affected actors to
others inside and outside of the rural economy. Through these linkages, ever-widening
circles of individuals, households, and firms become affected, directly or indirectly, by
trade reforms. The consequences for rural production, incomes and migration depend
upon the extent to which influences of trade integration are transmitted to different rural
household populations, as well as the ability of households to adjust to changing market
conditions, both positive and negative, by altering their income activities in rural areas or
through migration.
This paper offers an intra-national perspective on the impacts of trade reforms on
rural economies. Its focus is on economic actors within nations and the linkages that
transmit influences of trade reforms inside and outside the rural economy. The principal
tool of this analysis is “micro economywide modeling,” based on villagewide models
pioneered by Taylor and Adelman (1996). This approach combines the advantages of
micro models, which focus on individuals, households, and firms, with economywide
models, which highlight economic linkages among economic actors but traditionally have
been implemented at an aggregate (national or multi-national) level. Micro
economywide models explicitly take into account the market structures that govern
economic interactions and that promote or retard the spread of globalization within
countries.
Part 1 provides an intuitive explanation of the avenues through which trade
liberalization may influence rural economies, highlighting the need for a micro
economywide analytical approach to understand local impacts of policy reforms. Part 2
describes the micro economywide approach and its implementation. A stylized micro
economywide model is estimated using household survey data from rural Mexico and El
Salvador. It is used to explore rural economywide impacts of trade reforms and
accompanying policies that directly affect distinct sectors of rural economies, including
labor and capital intensive staples, cash crops, households, and migration. The
Conclusion, Part 3, summarizes findings and ramifications for trade reform and rural
income policies.
2
1
Micro Economywide Impacts of Policy Reforms: An Overview
A major limitation of trade integration studies is their lack of an intra-nation focus.
At the other extreme, there are many micro-economic studies of impacts of policy and
market changes in rural areas, but they generally focus only on the households and
activities that are directly affected by these changes. Research that focuses on the
directly affected households and activities miss myriad ways in which trade policy
changes influence rural economies and particular groups of actors within them.
Impacts of trade integration within nations are complex, involving three sets of
interdependent actors. First, some economic actors are affected directly, by participating in
world markets either as buyers or sellers. These “global” actors include migrants who supply
labor abroad while remitting income back to their home countries, firms supplying output
and/or purchasing inputs from abroad, and households whose members cross national borders
to purchase goods directly from foreign firms.
A second group of actors are affected indirectly, through policy. Policy is one of the
most important avenues through which globalization may influence economic actors. For
example, opening up to world markets stimulates income growth and urbanization, which in
turn create new demands for rural production and rural-to-urban migration. In Mexico,
where staples have been protected by government policies, changes mandated by NAFTA
lower the economic returns from staple production and encourage farmers to shift resources
into other activities, possibly including internal or international migration (Yunez, 2002).
The migrant-source household or the farmer who changes production in response to trade
reforms is thus affected by market and policy changes that might not have occurred without
trade integration.
Many others potentially are affected through their market interactions with global
actors or with others who interact with global actors. Farmers convert croplands into pasture
to supply a growing local and urban demand for meat—possibly using remittances from
children who have migrated to finance this investment. A family hires a local bricklayer to
build a new house and pays him with remittances from a migrant working abroad. Both the
rancher and the bricklayer are affected by trade reforms, in the sense that their activities
depend upon others who are integrated, directly or indirectly, with global markets. The
activities of still others may be influenced by the rancher’s or bricklayer’s newfound income,
and so on—like ripples in a pond.
Any factors influencing interactions among economic actors shape the ways in which
trade reforms play out within countries, regions, and communities. These include local
market structures that promote or retard demand linkages among firms and households.
3
Trade Integration and Rural Incomes: Two Extremes
A well known tenet of international economics is that there are both winners and
losers from trade liberalization. The impacts of trade liberalization on rural incomes are
bracketed by two extremes, which we might call the “optimistic” and “pessimistic”
scenarios. The optimistic scenario is that trade reforms open up new markets for goods
or factors (labor) supplied by rural households, either directly or indirectly, through the
market linkages described previously. The pessimistic view is that rural households,
especially the poor, suffer from negative impacts of liberalization on previously protected
markets, and high transaction costs exclude many rural households from new market
opportunities and/or prevent them from exploiting these opportunities where they exist.
Direct Market Transmission to Rural Households
In order to influence rural households directly, rural markets must transmit the
influences of trade reforms. High transaction costs in product and factor markets may
isolate households from outside markets, limiting or blocking the transmission of policy
influences. This is the motivation for recent studies of “autarkic” agricultural household
economies with endogenous “shadow prices” for household nontradeables (e.g., de
Janvry, Fafchamps and Sadoulet, 1991; Strauss, 1986).
It is unlikely that a household will be isolated from all markets. It is more likely
that markets are selectively missing for individual households (de Janvry, et al., 1991;
Strauss, 1986) or for local economies of which these households are part (Taylor and
Adelman, 1996). That is, household and local economies confront a mixture of tradables
(goods for which there is access to outside markets) and nontradables (good for which
markets are effectively missing).1 Impacts on rural incomes and poverty thus depend, in
the first instance, on how trade reforms selectively affect markets for tradables and
nontradables produced by different groups of rural households.
The most positive scenario for rural incomes and poverty is one in which reforms
enhance market opportunities for tradables supplied by rural households (e.g., raising
horticultural prices for Central American farmers or wages for internal migrants). The
most negative scenario is one in which households supply tradables that were protected
prior to trade reforms. An example of negative impacts is the case where small
commercial maize farmers in Mexico, under NAFTA, or Guatemala, under an expanded
NAFTA, are adversely affected by competition from Iowa corn farmers. A less direct
example is one in which rural households supplied labor to previously protected activities
(e.g., to large commercial farms or, through migration, to protected urban industries). In
this case, rural labor was protected indirectly, through industry protections, prior to trade
reform. Competition from foreign producers depresses prices, wages and employment in
previously protected activities.
1
Effectively missing implies that, although the market may exist outside the household or local economy,
high costs of transacting on that market preclude market participation.
4
The direct effects of trade reforms are likely to be minimal for households or local
economies facing missing markets, due to high transaction costs. An example is the case
of the maize farmer who produces a surplus but does not market it outside the village
because of high costs of transportation, marketing, storage, and/or information. Although
trade reforms reduce maize prices in commercial centers (e.g., by eliminating government
price subsidies or import quotas or tariffs), many rural households and their economies do
not have access to these prices. In effect, local prices are endogenous, and the
transmission of price changes to local markets is, at best, imperfect. In these cases, the
direct impact of trade reform may be minimal.
Indirect Transmission Through Market Linkages
The influences of policy changes cited above all concern households that are affected
directly by the policy change, in isolation of the larger economies of which they are part.
Economic interactions within the rural economy transmit the impacts of policy reforms to
others inside and outside of the rural economy, like ripples in a pond. Consider the following
examples.
Example 1: Labor Market Linkages. A policy reform, by creating new market
opportunities, increases income directly in a (e.g., non-poor rural) household, enabling it to
hire labor from another (e.g., poor rural) household. This expenditure transmits benefits of
the policy change beyond the directly affected household. To understand the impact on
poverty (and other variables of interest), it is necessary to follow expenditure linkages to, and
from, the labor-supplying household. Note that, even if the transfer is spent on consumption,
it nevertheless stimulates income growth in households that sell consumption goods or
services to the household benefiting from the policy. If the latter include poor households,
poverty may decrease even if poor households are not influenced directly by the policy
change. The reverse would occur if the policy reduced income in the directly-affected
household, e.g., by liberalizing previously protected markets.
Example 2: Capital Market Linkages. The household benefiting from the policy
change loans money to a second household in the village, and the second household invests
the funds in a new production activity—perhaps in response to new market opportunities. If
the first household did not benefit from the policy, the second household, lacking access to
formal credit, would not have access to funds to invest. If the borrowing/investing household
is poor, then capital market linkages, combined with new market opportunities, may reduce
poverty. The reverse would occur if the policy change reduced the liquidity of the directly
affected household.
Example 3: Missing Staple Market. Imagine a village isolated from regional staple
markets by poor infrastructure; high transaction costs make villagers rely on local production
to satisfy their staple consumption demands, and producers, finding it too costly to market
their staples outside, seek markets for their surplus staple production within the village.
These conditions create a local market for the staple; the staple price is determined by local
supply and demand, not by outside markets or government policy. A household within this
5
village benefits from a policy change—say, by producing a cash crop whose price increases
as a result of the policy reform. Its income increases, raising the household’s demand for
staples (directly or indirectly, e.g., through demand for livestock products). The local staple
price increases. The higher staple price transmits benefits from the cash crop producer to
local surplus staple producers. If staple producers are poor, poverty may decrease, even
though the policy change did not affect staple production directly. A decrease in the cashcrop price would have the opposite effect on staple-producers’ incomes in this example. If
staple and cash-crop producers compete for scarce resources (land or labor), the missing
staple market could limit the cash-crop supply response to the policy change (a local
economywide analogue to the household with missing markets explored by de Janvry, et al.,
1991).
In all three of these examples, market structures are critical in shaping local economywide impacts of the policy change. In Example 1, without a local labor market, benefits from
the policy change cannot be transmitted to the poor worker household. Example 2 depends
on the existence of a local credit market to channel savings. In the third example, the local
staple price is the link between the household directly affected by the policy change and the
staple producer. Market imperfections are like stones that block or distort the ripples in a
pond, with potentially large repercussions on rural production, incomes, migration, farmnonfarm linkages, and poverty.
Many households potentially are influenced by trade reforms indirectly, through their
economic relations with households directly affected by trade policies. Many or possibly
most impacts may, in fact, lie outside the households directly affected by the policy reforms.
This may be particularly true for impacts of trade reforms on the rural poor, who are not as
likely as wealthier households to have access to commercial markets or to the capital and
other resources needed to respond to new market opportunities. Poor households
nevertheless may be influenced by policies through demand linkages in markets for factors or
goods, which create income multipliers and transmit impacts of migration and policy
changes. Ultimately, multiplier effects of policy changes are transmitted through trade to
regional commercial centers with which rural economies interact—possibly creating migrant
labor opportunities there.
Policy changes may unleash a variety of other general-equilibrium effects on rural
economies. For example, if increased demand for labor in activities stimulated by the policy
change drives up local wages, rural economies may restructure themselves around labor
scarcity, shifting to less labor-intensive (and more capital-intensive) activities and production
technologies. An ever-widening circle of economic actors then becomes influenced by trade
reforms, even if they do not supply to markets directly affected by these reforms.
Paths of influence may be even less direct than this. For example, trade liberalization
leads to new construction in a regional urban center, for which migrants from rural
households supply labor. Rising incomes linked directly or indirectly to trade increase the
demand for meat produced on pastures where corn once grew. The migrant-sending or
livestock-producing village household is affected by trade liberalization, in the sense that its
activities have been reshaped by the country’s integration with world markets. In this
6
scenario, the rural poor may benefit by participating in migration (and receiving remittances)
and/or by entering into livestock production (financed, perhaps, by migrant remittances; see
Taylor 1992).
Table 1 summarizes likely influences of trade liberalization on rural households under
alternative scenarios. The most positive scenario for rural incomes and poverty is given in
the northwest cell of the table, depicting the case in which reforms enhance market
opportunities for tradables supplied by rural households (e.g., raising coffee prices at the
farm gate or wages for internal migrants). The most negative scenario is given by the
southwest corner of the table, in which households supply tradables that were protected prior
to trade reforms. An example of negative impacts is the case where small commercial maize
farmers in Mexico, under NAFTA, are adversely affected by competition from Iowa corn
farmers. A less direct example is one in which rural households supplied labor to previously
protected activities (e.g., to large commercial farms or, through migration, to protected urban
industries). In this case, in effect, rural labor was protected, through industry protections,
prior to trade reform. Competition from foreign producers depresses prices, wages and
employment in previously protected activities.
The other two cells depict influences of trade reforms through markets for
nontradables, i.e., goods for which markets are effectively missing for poor households or
their local economies. Local nontradables may include consumer goods, intermediate
goods, or factors. For example, if trade integration stimulates the demand for livestock,
this may increase ranchers’ demand for grain, both for human consumption and feed. If
the local economy is not well integrated with outside grain markets, the increased
demand by ranchers may exert upward pressure on local grain prices. This, in turn, might
stimulate local grain production, while reducing real incomes of grain consumers and
dampening the supply response of livestock.
Influences through local factor markets depend critically on the factor intensities
of goods stimulated by trade reform. For example, if the activity stimulated by trade
reforms is land rather than labor intensive (the case of livestock), its expansion will tend
to put upward pressure on land prices while dampening local wages. If the activity
stimulated by trade reforms is labor intensive, however, local wages may increase as
labor demand rises. If trade reforms decrease, rather than increasing, demand for laborintensive agricultural goods (e.g., coffee or sugar cane in Central America), the negative
effect on local wages will be amplified by the labor intensity of these activities. Wage
and employment effects transfer impacts of the trade reform to worker and landholder
households—and possibly to urban labor markets, through migration. These impacts
may be positive or negative, as indicated in the table.
Understanding the structure of local and regional markets is critical for tracing out the
likely impacts of trade reforms on rural economies and on poverty. Recently, a nascent body
of research has begun to explore local impacts of policy changes using “micro” economywide modeling techniques (Taylor, Yúnez-Naude, and Dyer, 1998; Taylor and Adelman,
1996). These studies take into account the ways in which agricultural households and firms
interact in local markets, even when high transaction costs isolate them from larger, regional
7
and global markets. Micro economy-wide modeling, the basis for this paper, goes beyond
both the aggregate country and micro household focus, elucidating market structures and the
complex linkages that connect economic actors in the regional economies of which they are
part. Part 2 presents a micro economy-wide modeling approach designed for this purpose.
2
Micro Economy-wide Models: A Graphical and Conceptual Presentation
When local economies are closely integrated with outside markets, their prices are
given, assuming that local actors are not influential within those markets. Local production
and consumption decisions are then guided by exogenous prices. Changes in local demand
affect marketed surplus available to outside markets, but they do not affect local
production—with all prices given, the conditions for profit maximization do not change
when local demand changes. However, when transaction costs insulate local economies from
outside markets, local demand and supply are linked by endogenous, local prices. In this
case, exogenous changes in local demands affect prices, and thus, production decisions. The
result is a web of local economic linkages that transmit influences of policy changes among
households and firms and unleash general-equilibrium effects in the local economy.
Microeconomic models focusing on households, firms, or household-firms (Singh, Squire
and Strauss, 1986), including those in imperfect market environments (de Janvry, et al.,
1991), miss these general-equilibrium effects. Economy wide models, including computable
general equilibrium (CGE) models, are designed to capture the second and higher-round
feedbacks of policy changes. However, national CGE models abstract from local economies,
and they do not provide the detail needed to reliably uncover the full impact of policy
changes on small economies, particularly when households are simultaneously engaged in a
“portfolio” of diverse activities.
Our small or “micro” economy-wide modeling uses an adaptation of village-wide
modeling techniques presented in Taylor and Adelman (1996). It blends microeconomic
analysis with economy-wide modeling, offering an alternative to both micro (household,
firm, and household-farm) and aggregate CGE models.
Consider the effect of a change in an exogenous variable Z (e.g., a trade policy
reform) on an endogenous variable (or vector) Y (e.g., production, income of a particular
household group, or migration). Let P denote a vector of local input and output prices. The
full impact of the change in Z on Y is given by:
dY/dZ = ∂Y/∂Z + ∂Y/∂P dP/dZ
(1)
The first term represents direct income effects, an economy-wide analogue to the
partial effects in a microeconomic model in which all prices are held constant. The second
term represents the indirect, general-equilibrium effects of the exogenous shock through
endogenous local prices. If all goods and factors are tradable (that is, all prices are given to
the local economy by outside markets), or if supplies of all goods and services are perfectly
elastic (as in a Social Accounting Matrix multiplier model), the second term vanishes. In this
8
case, a series of microeconomic models of households and firms (or, in the case of perfectly
elastic supplies, a SAM multiplier model) may be sufficient to estimate local production,
marketed-surplus, and income effects of the policy change. However, if some goods (e.g.,
labor, output) are non-tradable and supplies are not perfectly elastic, the second term in
Equation (1) may be nonzero. Market linkages resulting from endogenous prices alter the
effects of policy reforms in small economies.
Figure 1 illustrates linkages among economic actors in local economies. Some agents
are affected by trade or policy shock directly (A). Through their interactions in local
economies (e.g., production, consumption, or investment expenditures), these directly
affected actors transmit influences of the shock to others inside the rural economy. The
indirectly affected actors, in turn, interact with others, transmitting impacts further into the
rural economy. Any one of these indirectly affected actors may have linkages back to the
directly affected actor. In this way, influences of the trade or policy shock swirl through the
rural economy, reaching an ever widening circle of economic actors. At each round of this
transmission process, part of the impact of the shock exits the rural economy, through various
kinds of leakages. The most important leakages are through rural household (and householdfarm) demand for manufactured inputs and especially consumption goods. These are the
basis for farm-nonfarm linkages in developing country economies (e.g., Mellor, 1976).
Micro economywide models are flexible and may include a large variety of economic
actors. Production activity mixes, factors, and household groups reflect both the structure of
the local economy and the researcher’s interest. The production side of micro economywide
models includes a focus on diverse activities in which rural households may be engaged,
including (depending upon the context) staples, cash crops, livestock, and nonagricultural
activities, including commerce and other services.
Production activities purchase factor inputs explicitly or, in the case of family inputs,
implicitly, from inside or outside the local economy and generate value-added. The
technological relationship between factor inputs and output in each sector is nonlinear,
increasing with quantity of factor inputs but at a decreasing rate, as described by sectorspecific production functions. Typically, factors include labor, capital, and land—or any
disaggregation of these. Prices of factors for which there are markets (e.g., hired labor) can
be observed. However, by definition, markets do not exist for family factors—or, more
accurately, markets for family factors exist only within households—so prices for these
factors cannot be observed directly. Family-factor prices and value-added are estimated
econometrically from time use information and the difference between gross value of
production and the cost of all purchased inputs.
The factor accounts in the model channel value-added into households, in proportion
to households’ shares of factor supplies. Models typically include multiple household
groups, classified according to some criterion (principal income source or income level at the
time of the survey, land tenure, migration experience, etc.).
In addition to the endogenous accounts summarized above, micro economywide
models may contain two groups of exogenous accounts, government and the rest of the
9
world, and a savings-investment account that is either exogenous or endogenous, depending
upon the structure of local capital markets. The government accounts may include local,
state, and federal governments. These public institutions tax rural residents and channel
revenue into local public-sector activities (including some services) or else into public
expenditures outside the local economy. The rest of the world typically includes the rest of
the country and the world abroad. With few exceptions, the relevant rest of the world abroad
for rural residents of Mexico and Central America is the United States, with which migration
connections typically are strong.
Savings accounts gather savings from activities and households, channeling them into
investments in physical or other (e.g., human) capital (schooling) activities. Three rural
capital market scenarios or “closures” are possible. First, in the unlikely case that rural
households have perfect access to outside capital markets, the capital account is exogenous;
local savings and investment demand can be decoupled from each other. Second, at the other
extreme, rural credit markets may be missing altogether. In this case, each household’s
savings limit its investments—households must self-finance all projects. A third possibility
is that local (e.g., informal) capital markets exist but are not integrated with outside (regional
or national) capital markets. In this case, savings may flow among households in the local
economy, but total savings limit total investments. In each of the latter two cases, the capital
account is endogenous, because savings from outside the local economy are not available.
For either a household or an entire local economy, when the supply of a particular
factor exceeds demand, summed across all production activities, one of two things can
happen, depending upon access to markets for the factor. The first possibility is that excess
supply of the factor is marketed outside the household or local economy, at existing factor
prices (e.g., fixed wages). The second possibility is that the market for the factor is
imperfect, limited by high transaction costs (e.g., of monitoring workers) or by policies (e.g.,
limitations in land use, as under Mexico’s land-reform-sector, or ejido, laws prior to recent
reforms). Under this second possibility, two scenarios are possible. The first is that
individual households do not have access to factor markets and thus are constrained to be
self-sufficient in the factor. This case corresponds to missing markets at the household level
elucidated by Strauss (1986) and de Janvry, et al. (1991). The second scenario is that
households have access to local factor markets that are isolated from regional or national
markets by high transaction costs. With micro economy wide models, either or both of these
two scenarios can be modeled.
In addition to markets for factors, markets for goods must also clear, either through
interactions of supply and demand at the household or local level, or else by using outside
markets to sell excess supply or satisfy excess demand for goods. The market-clearing
conditions determine equilibrium quantities and prices (for each nontradable) or marketed
surplus (for each tradable). A trade equation constrains the value of local “imports” or
purchases of goods and services from the outside world to equal total “exports” or sales to
outside markets minus net borrowing. The trade equation represents the redundant equation
in these models.
10
A Stylized Rural Economy-wide (STREC) Model
The economy-wide model used in the trade policy experiments below consists of
separate micro agricultural household models for diverse household groups integrated into a
local general-equilibrium framework. That is, the building blocks of our rural micro
economy-wide model are micro models of firms and households engaged in a variety of
economic activities that are of intrinsic policy interest and that may be influenced directly or
indirectly by policy changes.
The STREC model was designed to explore micro economywide impacts of specific
market and policy changes in a diversity of rural economic contexts characteristic of Mexico
and Central America. It is essentially a hybrid, selectively drawing elements from several
small-economy models that have been estimated for rural Mexico and Central America over
the past decade.2 Although this is a stylized model, all parameters were derived from past
models and estimated using original survey data.
The elements of the model include six production sectors, chosen to reflect
commodities and technologies that exist in rural Mexico and Central America and are likely
to be affected differentially by trade policy and market reforms. The six sectors include:
• Two staple production activities. The first is labor intensive, modeled on traditional
ox-and-plow maize and beans cultivation in Michoacán and Oaxaca, Mexico, and El
Salvador. The second reflects more capital intensive production found in some commercial
agricultural regions of Mexico and Central America. It is characterized by greater use of
machinery, chemical inputs, and modern seed varieties. The production function for this
activity was parameterized from surveys in Coahuila and Jalisco, Mexico.
• Two cash crop activities. One is a highly labor intensive activity, modeled on chile
production in the Sierra Norte region of the Mexican state of Puebla. The other is a
somewhat less labor intensive activity, with production parameters estimated from coffee and
sugar production in Puebla and Jalisco, respectively. This activity is capital intensive only in
a relative sense; it nevertheless employs a considerable amount of labor.
• Livestock production. This activity is intensive in land and capital (animal stocks).
Parameters for livestock production functions were obtained from village household surveys
in El Salvador, Michoacán, and Puebla. Labor shares in value-added are very low in this
activity in all survey sites.
•Nonagricultural production. This is a highly heterogeneous sector comprised mostly
of local services (retail, construction, etc.) together with some small-scale manufacturing.
The production function for this sector uses factor value-added shares averaged from
nonfarm accounts in the micro economywide models cited earlier. This sector has
considerable backward linkages outside of agriculture (viz., the small store that purchases
2
These include Taylor, Yúnez-Naude and Dyer (1999); Taylor, Zabin and Eckhoff, 1999; Taylor, YúnezNaude and Hampton, 1999; and Becerril, et al., 1996 and 1997.
11
goods from regional commercial centers). It thus represents a major leakage from the rural
economy.
In addition to these production activities, households may supply labor to local labor
markets or to migration. Internal and international migration are included as separate
activities in the model. Both may compete with local activities—especially labor intensive
ones—for labor, and they generate remittance income for migrant-sending households. The
chief distinction between the two migration types is that international migration usually
entails remittances denominated in foreign currency and thus is affected directly by change
rates. This is typically the only activity for which rural households receive direct payment in
foreign currency.
Factors in the model include the key inputs in rural farm and nonfarm production:
labor, land, and capital.
Three major household groups dominate the socioeconomic landscape of rural
Mexico and Central America. They are:
• Landless households, which receive value-added income only from labor activities
but may supplement this by participating in domestic or international migration. These
households usually have low incomes and are vulnerable on the consumption side to changes
in food prices. Trade reforms have potentially conflicting impacts on landless households,
first on the income side, through labor markets, and second by altering prices of consumption
goods.
• Commercial households typically are relatively high-income households exposed to
trade policy reforms primarily on the production side. Food usually represents a small share
of commercial household budgets. This means that agricultural trade reforms are likely to
have a relatively small effect on commercial households through prices of consumption
goods.
• Subsistence households might be viewed as a mixture of the two extremes of
landless and commercial households. They are smallholders for whom production and
consumption are interrelated and potentially simultaneous, as depicted in agricultural
household models (e.g., Singh, Squire and Strauss, 1986). As such, these households
potentially are affected by trade reforms in complex ways involving both production and
consumption. When prices of subsistence households’ output decline, the impact on welfare
is ambiguous. As producers, they lose, but as consumers they benefit. In this way,
subsistence households are more akin to landless than to commercial households.
Production technologies are specified as Cobb-Douglas, and consumption demands
are modeled using a linear expenditure system (LES) approach. Although more complicated
functional forms are possible, our experience with micro economy-wide models suggests that
little is gained from the use of alternative functional forms (and necessary “guestimates” of
accompanying elasticities). We have found the results of our policy experiments using
similar models robust to the specification of functional forms (Taylor, Yunez and Hampton,
12
1999). This is not surprising, inasmuch as the model is always calibrated at the same point
given by the survey data, and most policy experiments involve marginal changes in
exogenous variables. An advantage of Cobb-Douglas production functions is that they are
nonlinear yet relatively simple to implement; under the assumption of profit maximization,
output elasticities are equivalent to factor value-added shares obtained directly from
establishment and household survey data. The base models solve for local equilibrium prices
and quantities of all goods and factors. The trade policy experiments are then run on this
base.
Micro computable general equilibrium models overcome the principal limitations of
fixed-price, including social accounting matrix (SAM) multiplier models, by incorporating
price effects, nonlinearities, and resource constraints. All parameters in the micro CGE
models presented below were estimated using survey data. We view this as an advantage
over aggregate (e.g., national) CGE models, which often rely on assumed parameters and
outmoded data.
In any general equilibrium model, results tend to be sensitive to model closure
assumptions. In our experiments, we explore the sensitivity of findings to various market
closure specifications. Sensitivity analysis of other market specifications can be explored. In
general, the more open local markets are to the outside, the more the indirect economic
impacts of policy changes are transferred outside the local economy.
Parameterizing the STREC Model
The most critical parameters needed for the household component of our model are
value-added shares, which link household incomes to production; expenditure shares, which
shape household demand linkages inside and outside the rural economy; and migrant
remittance elasticities, which relate migration to remittance receipts. In this model, landless
households receive value-added only from labor, and commercial households receive valueadded from capital and land. Subsistence households receive a mix of value-added incomes.
For each production activity, the shares of labor, capital, and land value added accruing to
different household groups were obtained from past models that included the activity.
Budget shares for each commodity-household combination and saving shares were obtained
from past models in which both the commodity and household were included. Remittance
elasticities were obtained from two-stage regressions of remittances on family time (proxied
by number of migrants) allocated to internal and international migration, correcting for
sample selecivity bias that may result from zero observations for some households (Taylor,
1987).
Key model parameters appear in Table 2. The top panel of the Table reports average
factor shares in value-added. Labor value-added shares range from a high of 0.60 (for labor
intensive cash crops) to a low of 0.10 (for livestock). Value-added shares are critical in
translating price and other shocks on particular production sectors into changes in different
value-added concepts. They, together with shares of value-added from each production
activity accruing to each of the three household groups, determine how production shocks
13
translate into changes in income of different household groups. The bottom panel of Table 2
summarizes budget shares for each household group.
Changes in household incomes reverborate through the rural economy like ripples in
a pond. Household expenditure patterns determine the size and direction of these ripples.
Large budget shares for locally produced goods create a potential for household income
changes to stimulate local production activities. For nontradables, local prices transmit
changes in demand to production activities. For tradables, prices are determined in markets
outside the local economy. Thus, local demand does not affect production, but it does
determine the size of the net surplus available to outside markets.
Tradables, Nontradables, and Local Price Transmission
Goods or factors are tradables if outside prices are transmitted perfectly into the
economy that is being modeled—in the present case, the rural economy represented by the
STREC model. Perfect price transmission requires well functioning rural markets with low
transaction costs. The extent to which outside prices are transmitted to rural economies is
empirical, ranging from perfect to nil. Because of this, goods or factors that are tradable in
one region (or for one household within a region; see de Janvry, Fafchamps and Sadoulet,
1991) may be nontradable in another (Taylor and Adelman, 1996). To date, there has been
little effort to empirically test for price transmission in rural economies (exceptions are
Larson, 2002, and Rozelle, 2002). There is evidence, however, that imperfect price
transmission results in isolated markets for factors and goods in some areas (Valdez, 2002).
For example, in Mexico, where the government supported prices for basic grains in the
1990s, high transaction costs prevented most farmers from benefiting by selling harvests to
the government (Taylor, 2002). The extent to which price supports may have influenced
local prices indurectly (e.g., through traders) is not known.
The structure of our model permits us to explore the impacts of a variety of trade and
market shocks on production, incomes, migration and trade in alternative market contexts.
3
Simulations of Impacts of Market and Policy Shocks
The STREC model was used to explore the rural economic impacts of four types of
policy and market shocks under two staple and cash crop production technologies and two
staple-price transmission regimes. The policy and market shocks we explore are:
1.
2.
3.
4.
Changes in prices of staples produced using traditional (labor intensive) and
modern (capital intensive) technologies
Changes in prices of cash crops cultivated under labor intensive and capital
intensive technologies
Government direct income transfers to rural households
Local Currency devaluation
14
Impacts of each of these policy and market shocks are explored under two different
price transmission scenarios. The first assumes perfect transmission of staple prices into the
local economy. In the second scenario, there is an endogenous staple price implying minimal
or no transmission of outside staple prices into the local economy. Only the first scenario
(perfect price transmission) is possible for the first experiment, because the modeler (like the
policy maker) is only able to change prices over which s/he has control in the model (or real
world). This does not include endogenous prices of staples that are nontradable. All
scenarios presented here assume an endogenous rural wage. This means that wages are
determined within the model. The sensitivity of any or all of these assumptions can be
explored by changing closure conditions in the model. (For implications of fixed versus
endogenous wages, see “Policy Shocks and Rural Market Imperfections,” below.) The
results of the seven policy shock/transmission scenarios are presented in Tables 3-6. All
simulations assume increases in prices or positive income transfers. Qualitatively and to a
large extent quantitatively, the results of our simulations are symmetric; that is, the signs of
effects reported in the tables change for price decreases or negative income transfers (taxes).
The impact of trade reforms on commodity prices, of course, may be either positive or
negative, depending upon the degree of protection enjoyed by the commodity prior to
reforms. The findings reported here make it possible to explore the likely directions of
impacts of policy or market shocks once this degree of a-priori protection is known.
Perfect Market Scenarios
Staple Price Shocks
Impacts of North American trade reforms on staple prices are critical because of the
relative efficiency of staple production in the United States and Canada and the importance
of staples in production, incomes, and consumption in Mexico and Central America,
especially of the rural and urban poor. Our staple price experiments explore the impacts of
changes in staple prices on production, incomes, migration and trade under alternative stapleproduction technology assumptions in a diversified rural economy represented by the STREC
model. Table 3 reports simulated results of 10-percent increases in staple prices. If trade
reforms reduced rather than increased staple prices, the magnitudes of impacts would be
similar but of a different sign. Column A reports results of a 10-percent increase in the price
of traditional staples, Column B, the results of a 10-percent increase in the price of modern
staples, and column C, a 10-percent increase in the prices of both kinds of staples.
Under each technology scenario, the immediate impact of the staple price change is to
increase the profitability of staple production. Producers respond by raising output. In each
case, there is an increase (of 5 to 7 percent) in production of the staple whose price rises.
Increasing staple output requires intermediate inputs and factors. The demand for factors
used most intensively by staple producers increases disproportionately (labor, in the
traditional staples case, and capital, for modern staples). This puts upward pressure on factor
prices. In the three experiments depicted in Table 3, wages increase by around 0.1 to 0.4
percent in response to the 10-percent staple price increase. Higher rural wages, in turn,
15
discourage migration (by just under 0.3 to 1.1 percent) and associated remittances (by 0.2 to
0.7 percent).
Factor supply constraints transmit (generally negative) impacts to other production
sectors that compete with staples for factor inputs. In all staple price experiments, production
of other tradables (including the other staple, cash crops, and livestock) decreases. Hardest
hit are the sectors making the most intensive use of inputs demanded by the sector whose
price goes up. In all three experiments, it is evident that staple production competes with
labor-intensive cash crops. In Experiments A and B, output of labor-intensive cash crops
falls by 0.14 to 0.56 percent. Livestock production, the least labor-intensive sector, is least
adversely affected by the staple price change.
Nominal incomes in households supplying factors to staple production, in turn, go up.
However, higher staple prices also increase consumption costs, with negative effects on real
incomes. By far the largest beneficiaries of higher staple prices are commercial households,
where incomes increase in both nominal and real terms. For landless and subsistence
households, nominal incomes increase, but because of the importance of staples for
consumption, real incomes fall. There is a second round of demand linkages, as commercial
households spend their new-found income on goods and services inside and outside the rural
economy while landless and subsistence households attempt to reorient their consumption
away from staples. Higher demand for tradables is transmitted outside the rural economy
through various types of external market linkages. Marketed surplus increases sharply for
traditional staples in Experiment 1 (given a negative base surplus) and for modern staples in
Experiment 2. Higher rural production and especially consumption demand for manufactures
increases external trade (by 0.09 to 0.50 percentage points).
Overall, the findings in Table 3 suggest that impacts of the staple price change on
production, incomes, migration, and trade are sensitive to technologies used in staple
production. They also reveal income effects that are much smaller in percentage terms than
the original 10 percent increases in staple prices. Relatively small impacts of price changes
on rural incomes reflect the high level of diversification in the economy; all in all, with many
different production (and migration) activities, a given change in staple prices has a
disproportionately small impact on household incomes. Income effects are also mitigated by
cross-effects of the price change on other activities, including nonstaple production and
migration. Studies in the 1990s of the likely impacts of NAFTA in rural Mexico tended to
focus on maize production in isolation of other rural production activities, thereby
exaggerating estimated effects of NAFTA on the rural economy and on migration (see
Taylor, Yúnez-Naude and Dyer, 1999).
If trade integration reduces staple prices in Mexico and Central America, impacts on
rural incomes will be relatively small. In fact, in real terms, many (particularly landless)
households could benefit from staple price declines, as their food prices decrease.
Nevertheless, these households will have to make up for lost income from staple production
by shifting to new production activities and/or to migration.
16
Changes in Cash Crop Prices
Impacts of trade integration on farmgate cash crop prices depend upon the extent to
which cash crops are protected from outside prices prior to trade reforms as well as the extent
to which prices are transmitted through rural markets. North American integration opens up
new potential external markets for cash crops, as evidenced by Mexico’s rising agricultural
exports to the United States post-NAFTA. However, it also creates potential competitors for
local cash crop producers—e.g., Central American sugar producers facing competition from
Mexico under an extended NAFTA. Our cash crop price experiments explore the impacts of
changes in cash crop prices under alternative market scenarios.
Table 4 reports simulated impacts of 10-percent increases in cash crop prices on the
rural economy represented by the model, assuming perfect price transmission in markets for
cash crops, staples, and livestock. The findings in this table mirror those in Table 3. For the
cash crop benefiting from the price increase, output increases, driving up local wages and
pulling resources away from the production of other tradables (the other cash crop, livestock,
and staples). The increase in price of the labor-intensive cash crop has a relatively large
effect on wages (0.96 percent), negative impact on migration (-2.75 percent), and income
benefit to landless households (just under 1 percent). The capital-intensive cash crop price
increase, on the other hand, nudges wages upward only slightly (by 0.21 percent), has a small
positive effect on landless household incomes (0.l6 percent), and decreases migration by less
than in the labor-intensive case (0.62 percent). Predictably, labor-intensive cash crops
compete most with traditional staples, whose output falls by more than 2 percent. In each of
the cash-crop price experiments, the trade balance in staples, or marketed surplus,
deteriorates, as the demand for staples increases (a result of rising incomes) while staple
production falls.
These findings illustrate the importance of technology, particularly labor intensity of
cash-crop production, in shaping local economywide impacts of trade reforms. If market
integration primarily affects labor-intensive cash crop production, its impacts on the incomes
of landless households, local wages, and migration—whether positive or negative—are likely
to be relatively large. On the other hand, if trade reforms primarily affect capital-intensive
cash crop or livestock activities, the impacts on rural incomes, poverty, and migration—
whether positive or negative—will tend to be muted. Policies that encourage capital and land
intensive activities at the expense of labor intensive ones could even decrease rural labor
demands, depressing wages and stimulating migration.
Rural Income Subsidies
The negotiation of a North American Free Trade Agreement (NAFTA) in the early
1990s presented an opportunity to integrate the liberalization of Mexico’s maize sector with
that taking place in the rest of the economy and to harness peasant resources more efficiently
in other sectors of the economy (Tellez, 1993; Bartra, 2000; Nadal, 2001). The cornerstone
of the maize sector’s liberalization consisted of the disappearance of support prices (then
paid through the state trading agency, CONASUPO) and the simultaneous removal of trade
17
barriers, allowing imported US corn to fill the gap between domestic supply and demand.
The government addressed the anticipated adverse income effects of lower staple prices (see
staple price experiment, above) through its PROCAMPO program. Under PROCAMPO,
rural maize-producing households receive cash transfers designed to compensate them for
lower grain prices without violating the rules of current international trade agreements (i.e.,
NAFTA and GATT). PROCAMPO was designed to be a decoupling policy; that is, income
subsidies were not expected to affect current production.
We used the STREC model to explore the likely impacts of government income
subsidies to rural households in a micro economywide framework. Table 5 reports the
results of simulated income transfers to each of the three household groups. Under
PROCAMPO, payments are made on a per-hectare basis. In our experiments, for
transparency, we set income transfers equal to 10% of household base incomes. This permits
us to test the extent to which direct income payments to rural households are truly
“decoupled,” while providing a benchmark for understanding the full impact of transfers on
rural incomes, including indirect effects. Column A in Table 5 presents simulated impacts of
a 10-percent income transfer to landless households; Columns B and C present impacts of
transfers to the other two household groups.
The results in Table 5 cast doubt on whether decoupling schemes really are decoupled
in rural areas. Income transfers, other things being equal, stimulate demand and exert
upward pressure on wages and prices of nontradable commodities in local economies.
Wages represent a crucial factor-market link between households and production. Higher
wages adversely affect production in all sectors, especially in the most labor-intensive
activities. Demand linkages transmit benefits from the transfer-receiving households to
others in the rural economy. For example, the transfer to landless households increases
subsistence-household income by .4 percent and commercial-household incomes by nearly .5
percent. Transfers to subsistence households contribute 2.6 percent to commercial-household
incomes. Because of their access to value-added from local production activities, subsistence
and especially commercial households are the largest beneficiaries of indirect linkages
resulting from the income transfers. The diagonal elements in the “Household Incomes”
rows of Table 5 reveal that, in each case, the 10-percent income transfer results in a greaterthan-10-percent increase in the recipient households’ income. Income growth stimulated by
the transfer reduces marketed surplus (by 1.6 to 12 percent) and increases rural-urban trade
linkages (by 2.2 to 4.1 percent).
These income experiments offer insight into the indirect influences of income
changes in rural economies, through the linkages discussed earlier. The direct effects of the
income transfers are limited, in each case, to the 10-percent increase in income for the single
household group targeted by the transfer. All other impacts in Table 5 represent indirect, or
“ripple,” effects. Because local economies adjust both to changes in output prices and
compensating income transfers, it is difficult to design an income-transfer scheme that is
truly income-neutral. In the case of PROCAMPO, it is clear that subsidy payments
overcompensated farmers for income lost as a result of the removal of staple price supports
(e.g., see Taylor, Yúnez-Naude and Dyer, 1999).
18
Currency Devaluation
In addition to altering the external market environment for participating countries,
regional trade integration also has potentially far-reaching ramifications for macroeconomic
policy, as illustrated by U.S. efforts to stabilize the Mexican peso in the 1990s. Most
research on impacts of currency devaluation, like most trade studies, have a national rather
than intra-national focus. Micro economywide models make it possible to explore the ways
in which currency devaluations, like policy changes, play out within rural economies.
In the STREC model, as in most Mexican and Central American villages, labor is the
only export for which rural households receive payment denominated in foreign currency
(typically, U.S. dollars). Devaluations increase the value of migrant remittances in local
currency. This has two impacts in the model. First, it creates an immediate income transfer
to remittance-receiving households. Second, it has a migration effect, increasing the
attractiveness (the marginal effect of migration on remittances) of international (but not
internal) migration by an amount equal to the percentage exchange-rate devaluation. This
stimulates international migration, by making both local wage work and internal migration
relatively unattractive. The simulation results reported in Table 6 represent the sum of
transfer and migration impacts, once they have been shaped by local economywide effects.
The 10-percent exchange rate devaluation stimulates international migration by 8.3
percent and remittances from abroad by 4.7 percent. This exerts upward pressure on local
wages. Internal migration and output of all tradables production fall sharply. The
household-income effects of remittances are significant, ranging from 1.5 percent for
commercial households to 6 percent in landless households. Marketed surplus of staples
decreases. The devaluation stimulates trade linkages with outside markets (by just under 2
percent).
As a migration as well as an exchange-rate experiment, this simulation provides
insight into how rural economies reshape themselves around migration, shifting resources out
of labor-intensive tradables production and increasing their commercial ties with outside
product markets. It reveals potential “Dutch disease” effects of migration on local
economies, at least in the short run.
In the long run, migrant remittances may have positive effects on local economies by
stimulating investments in local production activities (Stark, 1991; Taylor and Martin, 2000).
In rural Mexico, increased participation in migration has been accompanied by expansion of
livestock over time, an activity that is both profitable (because of rising meat demands
stimulated by income growth and market development) and complementary with migration
(because of its minimal demands for labor; see Taylor, 1992 and Fletcher, 1999).
Policy Shocks and Rural Market Imperfections
Transmission of the impacts of trade policies through the rural economy depends
critically upon the structure of rural markets for cash crops as well as for other goods and
19
factors of production. High transaction costs endemic to many rural economies isolate local
economies from outside markets for some goods and/or factors. When this happens, the
affected goods or factors become nontradable, in the sense that their prices are determined
through the interaction of local supply and demand instead of being transmitted exogenously
from outside (e.g., world) markets. Policy or market shocks that stimulate production (e.g.,
of cash crops) or increase demand (e.g., government or migrant income transfers) alter the
prices of local nontradables. This transmits the influence of the policy or market shock to
new production activities, and through factor markets, to new household groups. That is,
nontradables create income linkages within the rural economy. Ironically, this can result in
larger rural income multipliers than are evident in open rural economies, because changes in
demand affect local production of nontradables directly, rather than leaking out of local
economies through rural-urban trade. However, the increased local linkages come at a cost,
in two forms. First, by trapping land, capital and labor in local nontradables production, high
transaction costs reduce production efficiency. That is, they inhibit local economies from
concentrating resources in the activities in which they enjoy a comparative advantage and
thus maximizing their gains from trade. Second, external shocks that stimulate the demand
for local nontradables often lead to inflation, which reduces household real incomes.
The experiments presented below explore the ways in which selected rural market
imperfections may alter the impacts of trade policy and market shocks on local economies in
the STREC model. For each experiment conducted earlier (except for the staple-price
experiment), we compare the rural economywide impacts of the policy or market change (a)
when all rural prices, including wages, are exogenously transmitted from external markets,
and (b) when prices of staples and labor are endogenously determined by the interplay of
local supply and demand, as would be the case for economies facing high costs of transacting
with outside markets. As we shall see, market imperfections have far-reaching implications
for how trade reforms play out in rural economies.
Table 9 compares the results of the previous experiments under these two marketstructure (or in modeling jargon, closure) scenarios. Panel I compares the results of the cashcrop price simulations under the assumptions of (a) perfect and (b) missing external markets
for staples and labor. Panels II and III present comparisons for the household income
transfer and exchange rate experiments. The implications of market imperfections are clear
by comparing columns (a) and (b) under each experiment.
If capital is fixed and all inputs and outputs are perfectly tradable, with exogenous
prices set by external markets, there is no mechanism to transmit the impacts of market or
policy shocks from the directly affected agent (sector or household) to other production
sectors in the economy. Production decisions in each activity are determined by profit
maximizing behavior, based on given technologies and input and output prices. Nothing in
the profit-maximization calculus changes when all prices are transmitted to local producers
from external markets. This explains the zero effects of policy and market shocks on
production in sectors not directly affected by the shocks in Columns (a) of Table 7. The
difference between these results and the (generally negative) cross-sector results reported in
20
previous tables is due to the fact that local wages were assumed to be endogenous in the
earlier experiments but set by external labor markets here.3
In the cash crop experiment, with access to perfect markets for all goods, firms and
households can freely shift resources out of staple and livestock production in response to
new market opportunities in cash crops. Shortages created by increased demand and/or
decreased supply of staples or other goods are alleviated by trade with outside markets at
given prices. This creates a high supply response in cash crops. Household incomes increase
as households benefit from higher factor incomes from cash crops. The distribution of
impacts across households in column (a) reflects the distribution of factor incomes across
household groups. The higher cash-crop prices simulate external trade linkages, as marketed
surplus of staples decreases sharply and as nonagricultural trade rises.
Lacking access to external markets for labor and other goods, the local economy faces
self-sufficiency constraints that create tradeoffs and competition between nontradables and
cash crop production. In the absence of perfect access to outside labor, wages increase, and
in the absence of access to outside staple markets, higher incomes bid up staple prices. In
combination, higher wages and other prices induce households to keep resources in other
production activities, dampening the cash-crop supply response. The presence of
nontradables reduces production efficiency in the economy. The impact of the cash-crop
price increase on household incomes is now lower, especially in real terms, constrained by
the lack of access to outside markets. In one case (landless households, which have a large
staple budget share), real income actually falls.
Local market imperfections also shape the impacts of government (Panel II) and
migrant (Panel III) income transfers in rural economies. With perfect access to outside
markets (II(a)), transfers that stimulate household demand increase purchases from outside
markets, without affecting local production. In contrast, when high transaction costs make
some local goods and factors nontradable (II(b)), increases in demand put upward pressure
on local prices and influence production. The impacts on production may be negative, if
prices of key inputs (e.g., labor) rise, or else positive, if higher demand raises output prices.
Endogenous local prices create local income multipliers, as well as price inflation, which
tend to magnify impacts on rural economies. Comparing columns (a) and (b) in Experiment
II, it is clear that direct income payments to households are “decoupled” from production
only if the economy is a price taker in all markets—that is, perfectly integrated with external
markets from which all prices are transmitted. When local market imperfections exist, one
can no longer say that “decoupling” schemes truly are decoupled.
Migration, like government income transfers, has different impacts on rural
economies under alternative market structures. Under all market scenarios, the exchange rate
devaluation (Panel III) creates a de-facto income transfer to migrant-sending households and
stimulates new migration. When the local economy has perfect access to all markets,
including labor, households can increase migration without reducing production, by hiring
labor to take the place of those who migrate. In scenario (a) under Panel III, although
3
Alternatively, this assumption could reflect surplus labor and an institutionally set rural wage, as in a
Lewis world.
21
migration increases, there is no adverse effect on production. If households do not have
perfect access to external labor markets, they must shift labor out of other activities in order
to increase migration. Households can reduce production to increase migration provided that
they have access to external markets to satisfy food demands. Otherwise, the need to satisfy
local food demands will exacerbate the tradeoff between migration and production. In
scenario (b), all production activities are affected by the currency devaluation, even though
the only direct impact of devaluation is on migration. Part of the impact of migration is on
food and factor price inflation, a pattern well known to students of migration and
development in LDCs.
These experiments explore the implications of only a few rural market imperfections.
In real life, rural economic actors are likely to face imperfections in multiple markets,
including labor and some commodities as well as capital, land, insurance, and information.
The results in Table 7 offer a glimpse into the variety of implications that these rural market
imperfections may have for production efficiency, incomes, and the potential for broad-based
growth.
4
Conclusions
The results of the policy experiments under alternative market scenarios, presented
above, reveal difficult policy tradeoffs. Cash crop production is critical for market
integration of rural economies in Mexico and Central America, because this is where most
agricultural trade opportunities are likely to be found, in contrast to staples, given the relative
efficiency of US and Canadian staples production which places the comparative advantage in
staple production squarely to the north. Table 8 summarizes the volume and growth of
Central America’s agricultural exports to the United States between 2000 and 2001. It
illustrates the increasing importance of horticultural exports for Central American
economies: they increased 13 percent between FY 2000 and FY 2001 and constituted 30
percent of all agricultural exports from Central America to the United States in 2001. Only
forest products and livestock exports grew more rapidly during this period (16 percent each).
Livestock production, however, employs little labor and thus has limited potential to
stimulate employment and benefit landless laborer households in rural areas.
Rural economies’ ability to respond to new market opportunities depends critically on
their access to markets not only for cash crops, but also for other goods and factors. Lack of
access to outside markets for staples and other goods limits rural economies’ response to new
cash-crop opportunities. Because of this, lowering transaction costs or raising productivity in
other production activities may be critical to facilitate adjustment to trade and market reforms
and ensure gains from trade for those engaged in cash crop production.
Nevertheless, high transaction costs, by protecting some local production from
outside market competition, also benefit some rural households, possibly including the rural
poor if an important share of their income comes from these market and policy-protected
activities. Individuals engaged in activities protected either by policies (e.g., staple price
22
supports) or by market imperfections (high transaction costs) stand to lose from trade reform
and market development. This creates a rationale to implement compensatory schemes, such
as Mexico’s PROCAMPO income transfers to rural households.
Impacts of income transfers on rural economies, like trade and market reforms,
depend critically on the structure of local markets. Although local market imperfections may
magnify the impacts of government transfers on local production and incomes, they also
increase consumption costs and deny rural households many of the consumption-side gains
from trade with new markets.
Taking advantage of lower prices for consumer goods requires having access to cash
income. If trade and market reforms adversely affect labor-intensive production without
significantly expanding labor demand in other rural activities, securing access to cash income
may require migration. The results of all of the simulations presented above reveal
potentially important migration effects of trade policy changes.
Exchange rates are among the most important variables directly affecting
international migration. The migration response to currency devaluations is positive and
large. This makes the impacts of trade and market reforms on migration potentially complex.
On one hand, reforms inherently imply structural adjustments in rural economies that may
displace labor and stimulate migration, at least in the short run (Martin, 1993). On the other
hand, if regional market integration stabilizes exchange rates, it may reduce incentives for
international (though not necessarily internal) migration. NAFTA’s positive impact on
macroeconomic stability in Mexico in this way may have discouraged Mexico-to-U.S.
migration.
Rural economywide modeling methods highlight linkages within rural economies and
the ways in which these linkages, together with rural market structures, shape policy and
market outcomes. Directly affected agents transmit the influences of migration to others in
the rural economy. Understanding these linkages is critical to exploring how trade policies
and market reforms play out within nations.
23
REFERENCES
Becerril García, J., G. Dyer Leal, J. E. Taylor, and A Yúnez-Naude. 1996. “Elaboración de
Matrices de Contabilidad Social para poblaciones agropecuarias: El caso de El Chante,
Jalisco.” Mexico City: El Colegio de Mexico, Documento de Trabajo (September).
Becerril García, J., V. Evangelista and R. Martínez Villagrán. 1997. “Elaboracion De Una
Matriz De Contabilidad Social Y Analisis De Multiplicadores Para La Comunidad De
Naupan, Puebla.” Mexico City: El Colegio de Mexico, Documento de Trabajo
(September).
de Janvry, A., M. Fafchamps and E. Sadoulet. 1991. "Peasant Household Behavior with
Missing Markets: Some Paradoxes Explained." The Economic Journal 101:1400-1417.
Cornelius, W.A. and P.L. Martin. 1993. The Uncertain Connection: Free Trade and Mexico-toU.S. Migration. San Diego: Center for U.S.-Mexican Studies, University of California,
San Diego.
Fletcher, Peri L. 1999. La Casa de mis Sueños: Dreams of Home in a Transnational Migrant
Community. Boulder: Westview Press.
Hinojosa-Ojeda, R. and S. Robinson. 1992. “Labor Issues in a North American Free Trade
Area.” In N. Lustig, B. Bosworth, and R. Lawrence, eds., North American Free Trade:
Assessing the Impact. Washington, DC: Brookings Institution.
International Monetary Fund (IMF). 1999. Statistical Yearbook. Washington DC: IMF.
Larson, Don. 2002. “Exchange rate pass-through and domestic price transmission:
Methodology and application.” OECD Global Forum On Agriculture:
Agricultural Trade Reform, Adjustment And Poverty, Paris, 23-24 (May),
CCNM/GF/AGR(2002)9
Levy, S. and S. Wijnberger (1992). Mexican Agriculture in the Free Trade Agreement:
Transition Problems in Economic Reform. OECD/Gd(92) 77 Technical Paper No. 63.
Paris: Organization for Economic Cooperation and Development.
Lucas, Robert E.B., 1987, Emigration to South Africa's Mines, American Economic Review
77:313-30.
Martin, P.L. 1993. Trade and Migration: NAFTA and Agriculture. Washington, D.C.:
Institute for International Economics.
Massey, D.S., Joaquin Arango, Graeme Hugo, Ali Kouaouci, Adela Pellegrino, and J. Edward
Taylor. 1998. Worlds in Motion: Understanding International Migration at the End of
the Millennium. Oxford: Clarendon Press.
24
Mellor, J. The New Economics of Growth. Ithaca: Cornell University Press, 1976.
Rozelle, S. 2002. "The Nature of Distortions to Agricultural Incentives in China and
Implications of WTO Accession.” UC Davis, Department of Agricultural and
Resource Economics, Working Paper.
Rozelle, S., J.E. Taylor, and A. de Brauw, 1999, Migration, remittances, and productivity in
China, American Economic Review 89(2), 287-91.
SAGAR (Mexican Ministry of Agriculture). 1994-1997. On-line Data Bases.
Singh, I., L. Squire and J. Strauss, eds. 1986. Agricultural Household Models, Extensions,
Applications and Policy. The World Bank and The Johns Hopkins University Press.
Stark, O. 1991. The Migration of Labor. Cambridge: Basil Blackwell.
_________. "Economic Organization, Information and Development," in Chenery, H. and
Srinivasan, T.N., eds., Handbook of Development Economics, Volume I. Elsevier
Science Publishers, 1988.
Strauss, J. “Appendix: The Theory and Comparative Statics of Agricultural Household
Models: A General Approach,” in Singh, Squire and Strauss (eds.), Agricultural
Household Models, Extensions, Applications and Policy. World Bank and The Johns
Hopkins University Press, 1986.
Taylor, J.E. 1999. “The New Economics of Labour Migration and the Role of Remittances in
the Development Process.” International Migration 37(1):63-88.
_________. 1995. Micro Economywide Models for Migration and Policy Analysis. An
Application to Rural Mexico. Paris: Organisation for Economic Co-operation and
Development (OECD).
_________. 1992. Remittances and Inequality Reconsidered: Direct, Indirect and Intertemporal
Effects, Journal of Policy Modeling 14:187-208.
Taylor, J.E. and I. Adelman. 1996. Village Economies: The Design, Estimation, and Use of
Villagewide Economic Models. Cambridge: Cambridge University Press.
Taylor, J.E., Antonio Yúnez-Naude and Steve Hampton. 1999. "Agricultural Policy Reforms
and Village Economies: A CGE Analysis from Mexico." Journal of Policy Modeling
21(4):453-480.
Taylor, J.E., Antonio Yúnez-Naude and George Dyer. 1999. “Agricultural Price Policy,
Employment, and Migration in a Diversified Rural Economy: A Village-Town CGE
25
Analysis from Mexico.” American Journal of Agricultural Economics 81:653-662,
August 1999.
Valdés, Alberto. 2002. “Agricultural price distortions and price transmission in
developing and transition countries.” OECD Global Forum On Agriculture:
Agricultural Trade Reform, Adjustment And Poverty, Paris, 23-24 (May),
CCNM/GF/AGR(2002)7.
Yúnez-Naude, A. 2001. “The Dismantling of CONASUPO, a Mexican State Trader in
Agriculture.” El Colegio de Mexico, Centro de Estudios Económicos (unpublished
paper, May).
26
Table 1. Direct and Indirect Influences of Trade Reforms on Rural Incomes
Affect of Trade Reforms Through Markets for…
Protection for Local
Production Prior to Trade
Reform
Tradables
Nontradables
Negative
+
+/Positive
+/-
27
Table 2. Factor Shares in Value-Added and Household Expenditure Shares, By Activity
Production Activity
Basic Grains
Cash Crops
Nonagricultural
NonLabor
Capital
Livestock
tradables
Traditional Modern Intensive Intensive
Factor Shares in Value-Added
Labor
Animal
Capital
Physical
Capital
Land
Total
0.40
0.35
0.60
0.32
0.10
0.20
0.04
0.05
0.05
0.03
0.27
0.00
0.41
0.15
1.00
0.30
0.30
1.00
0.21
0.14
1.00
0.23
0.42
1.00
0.04
0.59
1.00
0.80
0.00
1.00
Household Expenditure Shares
Good
Household Group
Landless Subsistence Commercial
Basic Grains
BGLI
BGKI
LVV
NONAGV
Non-local
0.14
0.08
0.06
0.33
0.31
0.05
0.05
0.07
0.37
0.36
0.02
0.02
0.04
0.49
0.33
Savings
CAPITAL
HKSAV
Total Savings
0.07
0.01
0.08
0.08
0.02
0.10
0.07
0.03
0.10
Total
1.00
1.00
1.00
28
Table 3. Simulated Impacts of Changes in Staple Prices on Rural Production, Incomes,
Migration, and Trade, Under Perfect Price Transmission
Percentage Effects of 10% Increase in Price of...
Sector or Household Group
A
Traditional
Staple
B
Modern Staple
C
All Staples
6.65
(10.0)
-0.05
-0.25
5.05
(10.0)
6.38
(10.0)
5.00
(10.0)
-0.14
-0.56
-0.69
-0.05
-0.18
-0.22
-0.03
-0.02
-0.09
-0.09
-0.11
-0.12
0.09
-0.27
-0.18
0.37
-1.09
-0.72
0.47
-1.35
-0.89
0.07(-0.53)
0.08(-0.87)
0.58(-0.24)
0.29(-0.31)
0.44(-0.51)
0.81(0.44)
0.36(-0.83)
0.52(-1.37)
0.94(0.19)
-15.05*
-0.34
0.09*
0.79*
35.04
0.51*
-14.31*
34.71
0.59*
Village Production (Prices)
Staples
Traditional
Modern
Cash Crops
Labor-Intensive
Capital-intensive
Livestock Production
Nonagricultural Production
Wages and Migration
Wages
Migration
Remittances
Household Incomes
Landless
Subsistence
Commercial
Market Linkages
Marketed Surplus of Staples
Traditional
Modern
Rural-Urban Linkages
(nonagricultural trade volume)
* Denotes that marketed surplus is negative in the base model. A large percentage change in
marketed surplus reflects a small marketed surplus in the base.
29
Table 4. Simulated Impacts of Changes in Cash Crop Prices on Rural Production, Incomes,
Migration, and Trade, Under Perfect Price Transmission
Percentage Effects of 10% Increase in Price of...
Sector or Household Group
A
B
C
Labor-Intensive Capital-Intensive All Cash Crops
Cash Crops
Cash Crops
Village Production (Prices)
Staples
Traditional
-2.26
-0.45
-1.00
Modern
-0.76
-0.92
-1.62
15.59
(10.0)
-0.63
-1.31
-0.15
-0.02
4.59
(10.0)
-1.58
-0.05
15.37
(10.0)
4.59
(10.0)
-2.10
-0.07
0.96
-2.75
-1.82
0.21
-0.62
-0.41
0.76
-2.19
-1.45
0.76
0.11
0.55
0.16
0.16
0.37
0.59
0.34
0.82
1.19*
-3.87
0.51*
0.32*
-2.92
0.86*
0.86*
-5.66
1.23*
Cash Crops
Labor-Intensive
Capital-intensive
Livestock Production
Nonagricultural Production
Wages and Migration
Wages
Migration
Remittances
Household Incomes
Landless
Subsistence
Commercial
Market Linkages
Marketed Surplus of Staples
Traditional
Modern
Rural-Urban Linkages
(nonagricultural trade volume)
* Denotes that marketed surplus is negative in the base model. A large percentage change in
marketed surplus reflects a small marketed surplus in the base.
30
Table 5. Simulated Impacts of Income Transfers on Rural Production, Incomes, Migration,
and Trade, Under Perfect Price Transmission
Percentage Effects of Direct Subsidy Equal to 10% of
Base Income to...
A
Landless
Households
B
Subsistence
Households
C
Commercial
Households
Traditional
-0.24
-1.38
-1.47
Modern
-0.08
-0.46
-0.49
-0.42
-2.43
-2.59
-0.07
-0.38
-0.41
-0.02
0.25
(0.90)
-0.09
1.44
(5.23)
-0.10
1.53
(5.57)
0.10
-0.29
-0.19
0.58
-1.68
-1.11
0.62
-1.79
-1.18
10.08
0.37
0.45
0.46
12.20
2.64
0.49
2.34
12.81
1.63*
-3.58
2.16*
12.16*
-26.40
4.08*
6.50*
-14.56
4.41*
Sector or Household Group
Village Production (Prices)
Staples
Cash Crops
Labor-Intensive
Capital-intensive
Livestock Production
Nonagricultural Production
Wages and Migration
Wages
Migration
Remittances
Household Incomes
Landless
Subsistence
Commercial
Market Linkages
Marketed Surplus of Staples
Traditional
Modern
Rural-Urban Linkages
(nonagricultural trade volume)
* Denotes that marketed surplus is negative in the base model. A large percentage change in
marketed surplus reflects a small marketed surplus in the base.
31
Table 6. Simulated Impacts of an Exchange Rate Devaluation on Rural Production, Incomes,
Migration, and Trade
Sector
Percentage Effects of a 10% Currency Devaluation
Village Production (Prices)
Staples
Traditional
-4.13
Modern
-3.28
Cash Crops
Labor-Intensive
-8.87
Capital-intensive
Livestock Production
-2.87
-0.70
Nonagricultural Production
-1.54
Wages and Migration
6.39
8.27
-13.71
4.72
-8.20
Wages
Migration
International
Internal
Remittances International
Internal
Household Incomes
6.09
3.78
1.52
Landless
Subsistence
Commercial
Market Linkages
Marketed Surplus of Staples
6.42*
-18.09
1.88*
Traditional
Modern
Rural-Urban Linkages
(nonagricultural trade volume)
* Denotes a negative value in the base model. A large percentage change in marketed
surplus reflects a small marketed surplus in the base.
32
Landless
Subsistence
Commercial
Household Incomes
Wages
Migration
Remittances
Wages and Migration
0.33(-1.10)
0.19(0.13)
0.51(0.48)
0.55
0.76
-0.81
0
0.93
-1.23
-0.18
-0.07
0
-0.05
0
0.42
4.38
4.59
N/A
14.64
(0.34)
-0.05
(0.30)
-0.09
Imperfect
15.37
0
Modern
Cash Crops
Labor-Intensive
Capital-intensive
Livestock Production
Nonagricultural Production
0
Perfect
Staples
Traditional
Village Production (Prices)
33
Cash Crop Price Increase
0
0
10
0
0
N/A
0
0
0
0
0
0
Perfect
0.05(0.00)
0.03(-0.09)
10.02(9.94)
-0.05
-0.07
0.02
-0.01
-0.01
-0.01
-0.04
(0.48)
0.25
(0.75)
0.49
Imperfect
Landless
0
10
0
0
0
N/A
0
0
0
0
0
0
Perfect
0.37(0.02)
10.21(9.21)
0.15(-0.42)
-0.36
-0.55
0.19
-0.05
-0.05
-0.09
-0.28
(3.74)
1.89
(5.78)
3.77
Imperfect
Subsistence
10
0
0
0
0
N/A
0
0
0
0
0
0
Perfect
10.12(9.99)
0.07(-0.24)
0.05(-0.14)
-0.12
-0.18
0.06
-0.02
-0.02
-0.03
-0.09
(1.25)
0.64
(1.93)
1.27
Imperfect
Commercial
Experiment and Price Transmission Regime*
Household Income Transfers
Table 7. Implications of Imperfect Price Transmission in Staples Markets for Cash Crop, Income Transfer and Exchange Rate
Experiments
4.34
7.60
6.67
-1.60
-0.76
-2.99
-9.23
(5.05)
-0.82
(4.23)
-1.56
13.79 6.26(5.68
)
8.65 4.02(3.10
)
5.19 1.96(1.61
)
14.07
25.47
N/A
0
0
0
0
0
0
Perfect Imperfect
Currency
Devaluation
Rural-Urban Linkages
(nonagricultural trade volume)
*Endogenous staples prices and wages
Traditional
Modern
Marketed Surplus of Staples
Market Linkages
0.41
N/A
-1.27
0.71
N/A
0.84
34
1.89
-1.78
1.18
1.92
N/A
N/A
2.45
-13.91
9.21
2.69
N/A
N/A
2.64
-4.62
3.06
2.72
N/A
N/A
6.10
-16.89
11.18
2.16
N/A
N/A
Table 8. Exports of Agricultural Products to the United States by Members of Proposed
U.S./Central America Free Trade Agreement, 2000-2001
Products
Rank 2001
2001
% Change 2000-2001
Horticultural Products
1
$596,645
Fishery Products
2
$487,261
Tobacco & Products
3
$89,435
Forest Products
4
$66,791
Livestock and Meats
5
$57,247
All Agricultural Export
$1,914,553
Source: U.S. Department of Commerce, Bureau of the Census
35
13%
6%
2%
16%
16%
-10%
Trade or
Policy
Change
Directly
Affected
Agent
(A)
36
Actor iN
Actor i2
Actor i1
(B)
Indirectly Affected Agents
Figure 1. Local Economy-wide Influences of Policy Reforms
Actor jM
Actor j4
Actor j3
Actor j2
Actor j1
(C)