Capital Formation and Agriculture Development in China Jikun Huang

Capital Formation and Agriculture Development in China Jikun Huang Center for Chinese Agricultural Policy Chinese Academy of Sciences And Hengyun Ma College of Economics and Management Henan Agricultural University A Report Submitted to FAO, Rome August 2010 Capital Formation and Agriculture Development in China 1. Introduction In the post World War II era, modern development economists mostly agree that the role of agriculture and rural development is absolutely an integral part to process of nation building and healthy development (Johnston and Mellor, 1961; Johnston, 1970). Agriculture plays five important roles in the development of an economy: i) supplying high quality labor to factories, constructions sites and the service sector; ii) producing low cost food which will keep wages down for workers in the industrial sector; iii) producing fiber and other crops that can be inputs to production in other parts of the economy; iv) supplying commodities that can be exported and earn foreign exchange which can help finance imports of key technology packages and capital equipment; v) raising rural incomes. The view toward agricultural and rural development in the modern world has changed dramatically in the past several decades. Traditionally, agriculture was thought of an inferior partner in development. Since the size of the sector falls during development, it was logically considered that it could be ignored. Why is that leaders would ever want to invest in a sector that is shrinking? Some academics urged policy makers to treat agriculture like a black box from which resources could be costlessly extracted (Lewis, 1954). All investment was supposed to be targeted at the industry and the cities. As a low productivity sector, it did not deserve investment. Unfortunately, countries that took this path seriously soon found out that while such a strategy may work in the initial years of development, in the longer run it slowed development and often ended up in failure (Timmer, 1998). Neglect of agriculture meant that a large part of the population was left out of the development process. If those in the low productive part of the economy were not invested in, they found it difficult to shift to the developing parts of the economy. Dual economies grew apart. It was found that in many cases, production in agriculture fell and food prices rose. Many households fell into isolated subsistence. When this happened, of course, the stability that is required for growth disappears and development stagnates and can even go into reverse. There are many examples of countries that encountered these difficulties, such as, Argentina, Mexico, Nigeria and even to some extent the Former Soviet Union. In contrast, during the last century nations that grew fast and entered the ranks of developed nations — for example, Japan and Korea—frequently found that heavy investment in agriculture was an integral part of their development strategy. China is actually one of such typical examples. Observers reported widely about the discontent of China’s rural populations, not the least due to the heavy burden of fees and taxes before early 2000s (Esarey et al., 2000). Village leaders were required to finance most local public infrastructure as well as their village’s operating budgets with the fees assessed on villagers (Liu et al., 2009). Local governments in many areas imposed heavy tax burdens on farmers (Tao et al., 2004). In some villages poor households paid more than 30% of their annual earnings in fees and taxes. During this time the government transferred little in the way of fiscal support to the rural economy. Indeed, as late as 2002 2 the total amount of subsidies targeted to the agricultural sector by the Ministry of Finance (MOF) was only 100 million yuan (MOF, 2008). This amount is extremely small given the size of China’s rural population. Subsidies to agriculture from the central government amounted to less than 0.007% of the value of agricultural output, only around 0.1 yuan per capita. Most of the subsidies went to enterprises and local government; even it is unclear if farmers really benefited at all. However, in the nowadays, China’s leaders has dramatically changed their policies towards agriculture since the mid-2000s, moving from taxing agriculture to financing agriculture. After 2003, things appear to have suddenly changed in the direction of agricultural policy. In 2003-2005 the leaders abolished taxes and fees (Luo et al., 2007). In 2004, subsidies to farmers rose to 14.5 billion yuan (MOF, 2005). By 2005 instead of the net flow being from rural households to the government’s fiscal coffers, the flow reversed. Between 2004 and 2008 subsidies from the MOF to the agricultural sector rose by more than 2.5 times and reached 95 billion yuan in 2008.1 In 2009, subsidy further raised by nearly 30% (from an already high base) and reached 123 billion Yuan. The total local tax and fee bill of farmers was zero. Moreover, according to the MOF, most of the subsidy payments went directly to farmers, instead of as before, to agricultural enterprises and government agencies. Beside emerging trends in subsidizing agriculture, public investments in agricultural and rural development have also been growing substantially. What triggered this turnaround in the beginning of this century? Policy documents suggest that leaders in China consider the growth of agriculture, particular grain production, is necessary condition for social stability and ensuring national food security and therefore a foundation for its successful economic development. At the same time, policy makers stated explicitly that they wanted investment in agriculture and rural sector and subsidies to increase farmers’ incomes for reason of rising rural and urban income gap. The primary reason investment contributes to growth and development is that it contributes to domestic capital formation. The nexus between capital formation in and for agriculture and agricultural growth, and agricultural growth and food security and poverty alleviation are very well articulated in the literature. Further, domestic capital formation is fundamental for increasing production and Total Factor Productivity (TFP) and consequently for sustainable development and reduction in poverty. The overall goals of the paper are to investigate the structure, magnitude and trends of capital formation in agriculture in China, to analyze of the determinants of agricultural investment and capital formation, and to provide policy options for promoting appropriate agricultural investment and capital formation for stimulating sustainable food production in China. To achieve these goals, this study will have the following five specific objectives: 1) To provide overview of China’s agricultural development and food security in the past three decades; 2) To examine trends, stocks, and shifting in composition of agricultural 1 According to government sources, there are four types of subsidy payments, including ‘grain subsidy’ (in Chinese—liangshi butie), ‘input subsidy’ (nongzi zonghe butie), ‘quality seed subsidy’ (liangzhong butie), and ‘agricultural machinery subsidy’ (nongjiju butie). The first two subsidy payments accounted for 82% of total subsidies in 2008. 3 investments by both public and private sectors; 3) To examine capital formation and its determinants of major public investments and private investment at aggregate level; 4) To examine capital formation and its determinants at farm level and by major commodity; and 5) To assess the impacts of investment/capital formation and sources of investment on agricultural production and total factor productivity (TFP) for major agricultural commodities. The rest of the paper is organized as follows. The next two sections present economic and agricultural growth, structural changes, and key development strategies and policies that led to the changes in China agricultural development. Then the following two sections provide details on capital investment and capital stock formation in agricultural sector by both public and private sectors, determinants of agricultural capital stock formation, the impacts of agricultural capital stock on agricultural production. In section 6, stochastic production frontier function is constructed and then total factor productivity (TFP) is estimated and decomposed into technical efficiency (TE) and technological change (TC) for each of major agricultural commodities and overall agricultural sector. The last section summarizes the findings with a few major conclusions. 2. Overall Economic Performance and Agricultural Growth in China 2.1 Economic Growth and Structure Change China’s economy has experienced remarkable growth since the reforms were initiated in 1978 and pushed forward by a number of subsequent policy initiatives. Since the mid- 1980s, rural township and village-owned enterprises development, measures to provide a better market environment through domestic market reform, fiscal and financial initiatives, the devaluation of the exchange rate, trade liberalization, the expansion of special economic zones to attract foreign direct investment (FDI), state-owned enterprise (SOE) reform, agricultural trade liberalization and many other policy efforts have contributed to China’s economic growth. In response, the annual growth rate of gross domestic product (GDP) was nearly 10 percent between 1979 and 2008 (NSBC, 2009) Rapid economic growth has been accompanied by significant structural changes in the economy. While the average annual growth

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