from Development Channel

The Role of Government in Agriculture

A farmer harvests tobacco in Harare, Zimbabwe, January 2014 (Courtesy Reuters/Philimon Bulawayo).

July 22, 2014

A farmer harvests tobacco in Harare, Zimbabwe, January 2014 (Courtesy Reuters/Philimon Bulawayo).
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Emerging Voices features contributions from scholars and practitioners highlighting new research, thinking, and approaches to development challenges. This article is by Evan Axelrad, a recent graduate of the Master of Public Policy program at University of California Berkeley and former program specialist with the U.S. Department of Agriculture’s Foreign Agriculture Service. He has also consulted with organizations including the International Fund for Agricultural Development and Kiva Microfunds.

In his 1913 inaugural address, U.S. President Woodrow Wilson vowed to improve “agricultural activities never yet given the efficiency of great business undertakings…or afforded the facilities of credit best suited to their practical needs.” Three years later, he passed the Farm Loan Act, establishing an extensive farm credit system that transformed U.S. agriculture.

Today, developing countries are facing the same credit constraints and productivity problems that the United States and other advanced economies overcame in decades past. New research published by the Initiative for Smallholder Finance draws lessons from the history of agricultural finance systems in Germany, the United States, and South Korea that can inform the evolution of agricultural finance systems in developing markets today.

The research finds that finance systems most effectively meet the agricultural sector’s needs when governments design policies that supplement instead of replace credit provided by private institutions. In the absence of private institutions, informal moneylenders, who can charge untenably high interest rates, typically hold the majority of farm debt. But governments in Germany, the United States, and South Korea have successfully created inroads for viable commercial lenders by passing regulations that prevent usury and waging campaigns to boost agricultural productivity and increase rural populations’ familiarity with formal financial services. Still, disproportionate government involvement can limit commercial lenders’ presence, potentially stunting markets and leading to problematic over-reliance on state support. For example, in South Korea, decades of extensive government credit subsidies led to the near-absence of commercial banks in rural areas, limiting the longer term competitiveness of the country’s agricultural sector.

While government-subsidized credit may be an appropriate tool for supporting early agricultural finance systems, subsidized loans are most effective when they are part of larger policy packages that improve agriculture’s profitability. In Germany, the United States, and South Korea, government agricultural agencies have coupled credit with services that promote farm modernization and increased use of productive inputs such as fertilizer.

The Initiative for Smallholder Finance’s research also reveals a potential positive feedback loop between credit provision and increased farm size: in the three case studies, farm size grew as the agricultural finance system developed. Between 1910 and 1970, the average size of farms in the United States expanded from 138 to 390 acres, and average German farm size rose from roughly 7.5 acres in the 1850s to almost twenty-five acres in 1960. While credit provision is only one of numerous context-specific factors that drive structural change in agriculture, it seems to contribute to an increase in average farm size over time.

Though larger farms benefit from economies of scale in agricultural production, smallholders make important contributions to food security and often play a critical role as environmental and cultural stewards.In addition, more than two billion of the world’s poorest citizens live in households that depend on agriculture for their livelihoods and improving access to finance for the 450 million smallholder farmers worldwide represents an important opportunity to alleviate global poverty.  Therefore, when developing agricultural finance systems, policymakers may need to install social and environmental safeguards to preserve smallholders’ livelihoods and guide the sustainable development of larger agricultural markets. Governments and other actors should appreciate smallholders’ unique social and economic contributions and craft policies to ensure that agricultural finance development benefits rather than marginalizes them.

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