Technical progress, prices, and resource allocation

Asymmetric technical progress and the regional income distribution are the primary issues addressed in a partial equilibrium analytical model developed by Binswanger and Quizon (1980).5 They examine technical change in a model in which a single agricultural good is produced in two regions, with region-specific land and mobile labour. The price of the single output is assumed endogenous; since all factors are employed solely in the production of that output, the primary determinant of changes in nominal and real factor returns is the price elasticity of its demand.

The Binswanger and Quizon model (hereafter the BQ model) builds on a paper by Evenson (1975) in its analysis of the consequences of technical change in one agricultural region for the distribution of factor incomes when technology in other regions is static, or changing more slowly. It is important for two contributions: its use of the duality between cost and profit functions in distinguishing technical change effects from those due to price changes, and its rigorous modeling of biases in technical change. In analysing relative income changes between regions, between groups of factor owners, and between

ri'he duality between production and profit functions is explored more fully in Chapter 5. 5Most references below will be to a condensed version of their paper, published as Quizon and Binswanger (1983).

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producers and consumers of agricultural goods the Binswanger and Quizon paper

provides - as its title claims - a unified approach to the distributional questions associated with technical progress in agriculture.

In describing a simple economy with asymmetric technical change, the analytical structure developed below draws heavily on the contribution made by Binswanger and Quizon. It differs from their model, however, in two important respects. It explicitly includes production and factor demand in a non-agricultural sector or sectors, and it incorporates a more complete modelling of consumer demand. These are the features which provide the model’s general equilibrium character.

In addition to two sectors producing the agricultural good, the model below incorporates a sector producing a composite non-agricultural good. The price of this good is endogenous (it is assumed to be non-traded). In contrast to the assumption of the BQ model, the price of the agricultural good is here assumed to be determined in world markets, the familiar characterisation of a small, open economy. The demand for agricultural produce is thus considered to be infinitely elastic at a fixed nominal price. Since in a real model only relative prices matter, an increase in the supply of the agricultural good (for example, from technical change), still has the potential to reduce agricultural prices relative to prices of other goods, through a rise in the price of the non- traded good. It is shown, however, that the explicit modeling of a non-agricultural sector introduces additional commodity and factor market responses to technical progress not captured by the BQ model.

The demand for consumption goods in the model developed below is derived from the maximisation of utility by households, which are the sole domestic consumers of output produced in the economy. The Binswanger and Quizon model represents

consumer demand (for the agricultural good only) as a function only of its own price and an exogenous shifter:6

Y' = a P ' + D* , (4.1)

where Y' is growth in the demand for Y, P' is the rate of change in its price, D* is an exogenous demand shifter (representing, for example, population growth) and a is the own-price elasticity of demand for Y. This expression says that changes in income play no role in determining the demand for Y. Booming sector economics shows, however, that the income effects of a change like technical progress induce potentially important

throughout this thesis, a prime (') after a variable denotes a proportional change in that variable. Thus for any variable X, X ' = dX/X.

adjustments in factor and commodity markets - and thereby in relative incomes - through changes in consumer demand for endogenously priced commodities. Consider diagram

Figure 4-3: Goods Market Equilibrium

4-3, which shows (in partial equilibrium) the market for the non-traded commodity. In the BQ model, in which it is the agricultural good which is not traded, consumer demand for the non-traded good is a function only of its price and an exogenous shifter (equation (4.1)). A technical change increasing the supply of the good thus causes a fall in the equilibrium price of P l - P°, and a rise in the quantity demanded of Yl - Y°. In general equilibrium, however, as long as the propensity to consume Y out of income is positive, the effect of the technical change and consequent fall in P will be offset (if Y is a normal good) by a rightward shift in the demand curve - for example from D° to D 1 - yielding a new equilibrium price P2 and quantity Y2. This is the commodity market side of the spending effect in the booming sector model, not captured by equation (4.1).

In the model developed below it is the non-agricultural good which is assumed non- traded. In such a case the changes shown in Figure 4-1 operate in reverse. The resource movement effect of the boom in the agricultural sector initially reduces output of the non- traded good (imagine shifting from S1 to S°), and with no change in demand the price of the non-traded good rises, from Pl to P°. This is equivalent to the shift just discussed for the BQ case, in which it is the agricultural good which is non-traded. The spending effect of the agricultural boom, however, shifts the non-traded good’s demand curve to the right: final equilibrium at the intersection of S° and D1 is attained at an unambiguously higher

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relative price of non-agricultural to agricultural goods. P3. Incorporation of a spending effect thus increases the amount by which real agricultural prices are predicted to fall.

Construction of a general equilibrium model incorporating the two extensions to the BQ model just described - the explicit modelling of a non-agricultural sector and the incorporation of income effects on equilibrium prices - offers the potential for a rich analysis of technical change and income distribution in general equilibrium. Of course, if the non-agricultural sector is very small in relation to agriculture, and its product is not an important part of household expenditures, the distributional effects of a change in one agricultural subsector will be dominated by the movement of resources within agriculture. In such a case the BQ model provides an adequate analytical framework. The evidence on the structure of the Philippine economy presented in chapters 2 and 3 suggests however that agriculture, while certainly a major employer and contributor to national income, has strong linkages to other sectors and thus that the effects of changes in other sectors will exert a significant influence on the distribution of agricultural incomes.

The distribution of real income between households has three major determinants: the pattem of factor ownership, the functional income distribution, and consumer preferences. The functional distribution is in turn influenced by prices and technology. The comparative static model developed in this chapter takes preferences and the pattern of asset ownership as given, and studies changes in the functional distribution caused by

shifts in prices and technology. If asset ownership and consumption patterns are known, then the functional distribution can be mapped onto the household distribution. The development of a model for analysing changes in the functional distribution - and particularly those resulting from technical progress - is the objective of the following section.