Agriculture's decline in Indonesia : supply or demand determined

Abstract

Agriculture's share in an economy invariably declines as per capita income rises and as the economy develops. The literature on its causes has focused on the relative price effects arising from demand factors--especially Engel's Law (that the proportion of income spent on food declines as incomes rise)--rather than on such supply-side influences as changes in relative factor endowments and different rates of technical change. Engel's Law is convincing at the global level but it does not explain why agriculture's share should decline sharply in small open economies that experience rapid economic growth. A simple structural model of the transformation of the Indonesian economy, applying the Error Correction Mechanism to capture the dynamics resulting from disequilibria and costs of adjustment is developed. The authors develop an econometric model of the economy's supply side so they can explain agriculture's decline by the three theoretical factors: relative price changes, technical change, and factor accumulation. Based on the model's results, the authors conclude that the decline in the relative price of agricultural output contributed relatively little to the decline in agriculture's share. Technical change actually had a positive effect on agriculture's share, retarding the pressures for a decline in its share over time. By far the most important influence appears to have been the rapid accumulation of capital relative to labor over the period studied (1960-87).Economic Theory&Research,Environmental Economics&Policies,Agricultural Knowledge&Information Systems,Economic Growth,Inequality