J. Agric. Sci.
Technol. (2006) Vol. 8: 93-106
Agricultural Land
Productivity Improvement and Trade Liberalization in Iran: A CGE Analysis
H. Salami1
ABSTRACT
This paper examines
the effects of agricultural land productivity improvement on the economy of
Iran assuming that the domestic and international trade liberalizations will open
up the opportunities to expand market access. A 25-sector computable general
equilibrium model was developed to simulate the effects of this policy. The
simulation results indicate that enhancing agricultural land productivity while
implementing trade policy reform results in an expansion of agricultural sector
which, in turn, leads to the expansion of food manufacturing and service
sectors and mitigating the problem of unemployment. Furthermore, improving land
productivity results in a decrease in the price of food products and an
increase in real GDP. Consequently, food security enhances and Iranian
welfareimproves. As a result, this is an appropriate domestic policy for Iran.
This policy resultsin an expansion of agricultural sector which in turn leads
to expansion of food manufacturing and service sectors, mitigates the
unemployment problem, improves the Iranian welfare as the real GDP increases,
and improves the food security in Iran, as the price offood products
decreases.Keywords: CGE, Land productivity, Trade liberalization, Iran.
Global agricultural
trade liberalization has accelerated since the Uruguay Round Agreements (URA)
on agriculture have been implemented. The agreements required WTO members to
gradually reduce domestic government support, remove export subsidies, and ease
barriers to the market access relative to the respective levels of Aggregate
Measures of Support (AMS) estimated for the base period of 1986-1988. While the
reduced trade distortions in the major supplying nations have opened up
opportunities for developing countries to reap the benefits embodied in
international trade, it has raised concerns that the implementation of the
agreements will adversely affect these countries. These concerns are more
serious among the net-importing countries and those that have not succeeded in
revising their domestic trade regulations and policies in accordance with WTO
requirements. As Amjadi and Yeats (1995) asserted, some URA effects on
agriculture could be adverse, unless appropriate domestic policies are adopted.
They argued that reforms to ensure that prices paid to domestic producers
increase in line with international prices and that the removal of domestic
constraints that prevent local producers from taking full advantage of new
export opportunities are among the essential trade policies to mitigate the
perceived adverse effects of the UR agreements. Furthermore, one of the basic
tenets of economics is that a liberal international trade regime leads to a
more efficient allocation of resources and a higher level of economic well
being as compared with a regime that involves artificial trade distortions.
Thomas and Nash (1991) summarize a number of studies that indicate the
efficiency gains from trade reform ranging from 1 to 2 percent of GDP per year
up to as much as 10 percent of GDP if production is
characterized by
increasing returns to scale. Also, Rutherford and Tarr (1998) cited studies
that reported even larger direct gains from trade liberalization. In addition,
the advancement of factor productivities is considered to be an effective
factor in export promotion and to further the benefits of national and
international trade liberalization. The main purpose of this paper is to
examine effects of agricultural land productivity improvement on the economy of
Iran when domestic and international trade liberalization open up opportunities
to expand access to the international markets. The interest to consider this
policy arises from the fact that this option is legitimate under the WTO
regulation. Thus, it can be taken as a good alternative for the current direct
subsidy payment, which is prohibited under the same regulations. To evaluate the
effects of this policy, the impact of continuing the current trade regime which
is characterized by high level of protection and distortion and nonmembership
of WTO, was investigated, while it is assumed that the increased world
agricultural prices are received by domestic producers. Also, an attempt is
made to analyse the consequences of some export promotion measures in selected
agricultural and the related manufacturing commodities. The improvement of land
productivity and promotion of exports of agricultural commodities may have
implications for other sectors of the economy of Iran. Accordingly, a
computable general equilibrium (CGE) model is used as the analytical framework
for this study. This approach is chosen as CGE models have the ability to incorporate
inter-sectoral linkages and account for both the direct and indirect impacts of
policy shocks on the economy of Iran.
METHODOLOGY
Trade Distortions
in Iran
The process of economic adjustment in Iran,
aiming to accelerate economic growth, was initiated with the beginning of the
First Five-Year Development Plan (FFYDP) in 1988. Liberalizing the trade regime
and exchange system has been at the heart of the adjustment processes. The
process of trade liberalization in Iran began with lowering the level of
tariffs and reducing non-tariff barriers. Table 1 reports change in the levels
of tariff, as a measure of trade liberalization, for major groups of
commodities over the years 1986-88, 1996, and 1999. As indicated, the simple
average rate of tariff for most of the commodities including agricultural raw
materials, fish and shellfish, beverages, textiles, wood products, chemicals,
iron and steel, has fallen by more than 50 percent from 1988 to 1999. Except
for dairy products, the other commodities in the table have also experienced a
reduction in the level of tariffs. Moreover, a substantial reduction in the
maximum tariff rate of the commodity groups, as indicated in the dispersion
ranges, can be noticed from the table. The Non-Tariff Barriers Frequency Ratio
(NTBFR), as another measure of trade liberalization, is reported in Table 1.
According to this measure, there is no single commodity group, which can be
imported to Iran without requiring an import licence. Although the percent of
NTBFR has not changed over the period 1988-1999, to ease the process of
imports, the number of licences and permits required for importing the
commodities has been substantially reduced (see Salami, 1998). Despite the
afore mentioned reduction of tariff and non-tariff barriers, Iran’s accession
to the WTO and consequent access to world markets would require the eventual
elimination or further eradication of many distorting policies in trade,
production, and consumption of agricultural commodities, which are inconsistent
with WTO principles. Reducing domestic and trade distortions would realign
production costs to relative world prices, which will result in a reallocation
of resources among the competing production sectors in Iran.
Model Specification
The economy of Iran
is divided into 25 sectors: 10 agricultural, 2 mining, 6 manufacturing, and 7
service sectors. In the agricultural sector, wheat and wheat products, rice,
oil seeds (industrial crops), and sugar (sugar beets), which constitute the major
agricultural imports, are considered as separate production sectors. This
specification provides a basis for simulating the effects of world price
increases of agricultural products, resulting from URA, on the Iranian economy.
In Iran, horticulture and fisheries are regarded as major exporting sectors.
Accordingly, in the present CGE, each of them is formulated as a separate
sector. In addition, animal husbandry which provides import- substituting
products is another important production sector. The mining sector consists of
two main sub-sectors; crude oil and natural gas, and minerals. These two
sectors are mainly responsible for providing the foreign currency required for
operating and developing the other economic sectors in Iran. In the
manufacturing sector, food industries excluding edible oil, textiles and
leather industries, carpet and rug industries, agricultural machinery and
equipment, and chemical industries are separated from all other industries.
This specification can provide clear linkages between the agriculture and the
related forward and backward industries. Furthermore, the “carpet and rug”
industry is a major export-contributing sector, while the edible oil industry
is a heavily imports- based sector. In addition, the food, textile and leather
industries have considerable potential for export promotion given that
implementation of the URA will expand opportunities to access markets.
Therefore, the above specification can easily accommodate various policy
simulations. In the service sector, utilities and water supply, banking and
insurance, trade, transportation, construction, and all public services are
considered as separate sectors. It is assumed that all specified sectors,
except the two public services, and the construction service sectors, are
trading sectors. They import from the rest of the world, and produce and supply
goods and services to both domestic and foreign markets. The last three sectors
are non-trading in the sense that they supply their services completely to the
domestic market. The Armington assumption, which treats domestic and imported
goods as imperfect substitutes, is used for modeling trade in the present CGE
model (Armington, 1969). This assumption is adopted to take into account a
two-way trade and to avoid an unrealistically high degree of specialization. It
is assumed that imported and domestically produced commodities are aggregated
into new composite commodities based on a constant return to scale CES
function. The composite commodities are used as inputs in the production
sectors, and are consumed as final goods by government and one representative
private household. The cost minimization assumption applied to the CES
production function results in the import demand function where the levels of
imports depend on the ratio between domestic and foreign market prices and the
degree of substitutability between domestic and foreign commodities. Exports
are also specified as a function of changes in the relative prices of domestic
and foreign markets. A small country assumption is used in specifying all
sectors’ imports and exports, except for those of the mining, horticulture, and
wheat sectors. Mining and horticulture exports are modeled with an assumption
that Iran has some market power in the international markets. This suggests
that Iranian crude oil and fruit exports face a downward sloping excess demand
curve from rest of the world importers. Furthermore, as Iran is a major wheat
importing country, it is assumed that Iran has some market power in the
international wheat market. The CGE model developed in this study, like most
models of the ORANI type (Dixon et al., 1982; Dixon et al., 1992), assumes
that, at the first level, primary and intermediate inputs are combined in fixed
proportion to produce each unit of output. At the second level, the primary
factor inputs are combined using CES technology to make GDP. At this level,
substitution is made possible only among primary factor inputs. The primary
factor inputs include labor, capital, and land. It is assumed that labor is
used in all sectors and fixed in supply within the country but mobile among
sectors. On the other hand, capital input is assumed to be sector-specific and
fixed in supply. Land input is assumed to be used only in the agricultural
sectors and is fixed in supply. International migration of labor and
adjustments to the capital stock in response to shocks in the economy are not
permitted. These long run adjustments of labor supply and investment may
obscure the short run impacts of shocks in the agricultural sector.
Furthermore, the model assumes wage rigidity in the labor market. In this
specification, the labor market clears through adjustments in the unemployed
labor force. Since capital is sector specific, its rental rates, which are
endogenous to the model, will adjust to clear the market for capital input. The
same argument holds for land input in the agricultural sector. Cost
minimization yields the demand functions for the primary inputs in each of the
industries. Intermediate demands are determined by fixed coefficients. In the
present model, there is one representative private household that consumes
commodities and supplies the primary factors of production. The household
income is formed by primary factor rewards. The household demands for commodities
are derived from maximization of a Cobb- Douglas utility function subject to
its income corrected for taxes. The same argument holds for deriving government
consumption demand for commodities. The complete algebraic model is presented
in Appendix 1. The definitions of variables used in the model are shown in
Appendix 2 while the parameters of the model are given in Appendix 3. The model
is short-run in nature. In this scenario, the markets for factor inputs respond
to policy shocks through price changes while, in the long run, the adjustments
are mainly through quantity changes. The model is not closed in the sense that
neither the changes in exports equal the change in imports nor the changes in
savings equal the change in investments. Since capital stock is fixed, there
are no changes in investment. Consequently, it is assumed that there are no
savings. The exchange rate is also assumed to be fixed and the balance of
payments adjusts any change in the trade balance. Following Johansen (1960), the
model is specified in the form of proportional rates of change in which
variables are specified in a system of linear equations. In order to account
for linearizing errors associated with Johansen’s approach, a multi-step
solution was obtained using the GEMPACK program. (See Hertel et al. 1992, for
details on errors associated with linearized models.) The main sources of data
are: a) The input-output table for 1991 (Iran Statistical Center, 1994); b) The
National Accounts data for 1991 published by the Central Bank of the Islamic
Republic of Iran; c) The data on factor elasticities of substitution in the
agricultural sectors are taken from Salami (1996); d) The values for other
parameters are adopted from drawing heavily on the literature. (Sadoulet and deJanvry1991,
is the main reference for export demand elasticities.) To investigate the
effects of land productivity enhancing policy, three different policy measures
are simulated. 1) Continuing the present trade regime which is characterized by
a highly protected and distorted regime and a non-membership of WTO, while
opening up the domestic market to price signals in the world market. In this
scenario, the world prices of major agricultural products such as wheat, rice,
sugar beets, industrial crops, fruits, and vegetable oils are assumed to
increase by 4 to 10 percent as predicted by FAO(1995), Goldin and van der
Mensbbrugghe (1995), and Brando and Martin (1993). 2) Allowing local producers
to take full advantage of new exports opportunities and, thus, expand exports
of fruits (including nuts), carpets and rugs, and textiles by 10 percents,
while leaving other policies unchanged. 3) Reducing public expenditure on
production subsidies by 20 percent and increasing the expenditure to raise the
land productivity by 10 percent, while taking advantage of new exports
opportunities .
RSULTS AND
DISCUSSION
The impacts of land
productivity improvement on the agricultural sector on the economy of Iran are
analyzed within three different scenarios. Specifically, the effects on
domestic production, prices, imports, exports, household demand and
expenditure, employment, GDP, and inflation are investigated and analyzed.
Scenario I
Table 2 reports
simulation results of an increase in world prices of the specified commodities
on the economy of Iran. According to this scenario, transmission of increased
world prices for the aforementioned agricultural products to the domestic
market results directly in an increase in prices of substituting products and
indirectly in an increase in the product prices of poultry and husbandry. This
induces the expansion of domestic production in all agricultural sectors,
except for the forestry sector. The output response to the price increases is
not the same in all sectors. Wheat shows the highest degree of responsiveness
(0.9 %) while the industrial crop sector reveals the lowest one (0.02 %). The
rise in agricultural sector outputs and
the decline in
demand for agricultural commodities as a result of price increases, reduce the
need for importing agricultural commodities. The import reduction is 7.61
percent for wheat, 6.7 percent for rice, 6.8 percent for sugar beets, 3.57
percent for industrial crops, 6.95 percent for meat products, and 0.23 percent
for fruits. The increased agricultural output prices will also increase the
cost of production in the sectors using agricultural products as inputs. This
results in a 0.3 percent increase in the prices of food industry products, 0.07
percent in the prices of vegetable oils, 0.16 percent in the prices of
textiles, and 0.17 percent in prices of carpets and rugs. This in turn causes a
reduction in household demand for these commodities. On the other hand,
expansion in the agricultural sectors leads to an increase in demand for the primary
inputs (labor, land, and capital) used in these sectors, the products of
support industries (namely, machinery, equipment, and chemical products), and
the demand for credits and insurance services. Among the macroeconomic
variables, a rise of 0.9 percent in the consumer price index is noticed as a
result of increases in the prices of most agricultural and nonagricultural
products. A small reduction in GDP by 0.03 percent is shown as a contraction in
the service sectors, which has a share of almost 40 percent in Iranian GDP
(Table 5). Furthermore, total imports increase, while total exports decrease.
The slowdown in GDP growth leads to a fall in the overall level of employment.
On the basis of the above results, allowing increased world agricultural prices
to be transmitted to the domestic markets while leaving all other policies
unchanged can generate negative effects on the overall economy of Iran, and
thus it is not recommended.
Scenario II
This scenario examines the degree to which the
negative effects of increased world prices of agricultural products on the
economy of Iran can be offset by setting an export promotion policy. Since
fruits (including nuts), carpets and rugs, and textiles are all major Iranian
non-oil exporting items, it is assumed that exports of these products will be
increased by 10 percent as a result of increased market access opportunity
expected following URA implementation. The results of this simulation are
reported in Tables 3 and 5. Table 5 reveals two noticeable points. First,
export expansion of agricultural products improves GDP growth and the level of
employment so that the negative effects of the first scenario from these two
perspectives are mitigated. A 0.01 percent improvement in real GDP and a 0.05
percent increase in the level of employment are the immediate effects of the
expansion in exports. Second, export expansion exacerbates the inflationary
effects of increased world agricultural prices on the economy of Iran in the
short run. This overall price increase, in
turn, causes a
reduction in the real income of Iranian households from (-0.09) to (–0.14)
percent.
Scenario III
This
scenario investigates the consequences of agricultural land productivity
improvement as an alternative policy for the current direct subsidy payment to
the agricultural sectors. The investment required to advance land productivity
is financed by expenditures saved from a partial removal of subsidy on
agricultural inputs. In this scenario, it is specifically assumed that the
expenditure saved from a 20 percent reduction in the agricultural subsidies is
invested in agricultural land to increase productivity by 10 percent. The
encouraging results of this scenario are presented in Tables 4 and 5. According
to Table 5, growth of the real GDP (3.81%), an increase in the level of
employment (2.52%), a rise in exports (2.05%), a decline in imports (-0.4.22%),
and an increase in the real income of the household (2.41%) are all positive
effects of
improvement
as an alternative policy for the current direct subsidy payment to the
agricultural sectors. The investment required to advance land productivity is
financed by expenditures saved from a partial removal of subsidy on
agricultural inputs. In this scenario, it is specifically assumed that the
expenditure saved from a 20 percent reduction in the agricultural subsidies is
invested in agricultural land to increase productivity by 10 percent. The
encouraging results of this scenario are presented in Tables 4 and 5. According
to Table 5, growth of the real GDP (3.81%), an increase in the level of
employment (2.52%), a rise in exports (2.05%), a decline in imports (-0.4.22%),
and an increase in the real income of the household (2.41%) are all positive
effects of implementing the above policy. These results are not surprising,
since the progress in land productivity decreases the unit cost of production
and increases the producers’ profits, and thus encouraging greater production
of goods and services. As indicated, the enhancement in land productivity
offsets the negative effects of the previously described scenarios, and results
in the
aforementioned positive impacts on the economy of Iran. Therefore, one can
conclude that improvement in the land productivity should be considered as an
appropriate domestic policy in order to prevent the adverse effects of trade
liberalization, and to reap the benefits of national and international trade
liberalization.
CONCLUSION
The findings of this study are consistent with
the wisdom that reducing trade distortion and expanding trades results in an
improvement in overall economic efficiency and growth. The types of policies
and the economic environment, however, have important implications for the
other macroeconomic variables. In the context of the Iranian economy a policy
package that consists of increasing land productivity, removing input
subsidies, and expanding exports appears to be an appropriate policy option for
increasing the supply of agricultural and nonagricultural output, improving
real household income, and enhancing labour employment. In other words, the
Iranian economy cannot benefit from joining the WTO unless this is accompanied
by a set of policies which result in an improvement in land productivity in the
agricultural sector.
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