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Economics for Beginners

This brief paper is intended to highlight the key economic concepts and issues on which Milking it is based. 1. Demand (a) Demand for any product is affected by a range of variables. Two of the key variables are the price of the product, and the income of consumers. Economic theory predicts that normally there will be an inverse relationship between the price of a product and the quantity demanded of that product; i.e. as price falls, the quantity demanded increases. Economic theory predicts that normally there is a direct relationship between the consumer s income and the quantity demanded of a product at any given price; i.e. as a consumer s income increases, demand will increase. The demand for some products is highly responsive to a change in price or consumer s income, i.e. a given percentage change in price or income will lead to a greater percentage change in quantity demanded. Economists describe such products as having elastic demand. The demand for some other products is much less responsive to changes in price /income. Economists describe such products as having inelastic demand. Many different factors may affect a product s elasticity of demand, but generally it is true to say that essential goods have inelastic demand, while luxury goods have elastic demand.

(b)

(c)

(d)

(e)

2. The agricultural problem (a) Over time economic growth takes place, both within individual economies, and globally. We do not need to concern ourselves here with the causes of growth, but it is important to recognise that growth means an increased level of output of goods and services and an increase in the incomes of consumers. Remember that increases in income lead to increases in demand. However, demand for essential goods is not likely to increase by very much that is because if they areessential consumers are already buying them, whatever their level of income. Additional income will be spent on luxuries. Food, or agricultural products, is regarded as an essential good. Human beings need food in order to live. Once we

(b)

Milking it: Small farmers and international trade. A global citizenship resource Teachers notes

-2have enough food to satisfy our needs, we do not generally buy more food.1 Consumers demand for food is income-inelastic. (c) Therefore farmers tend to get left behind by the process of economic growth. As consumers incomes increase, they spend their money on luxuries (such as manufactured goods, holidays etc.). The producers of these products in their turn receive higher incomes (one person s spending is another person s income). But farmers incomes remain static (or at best they grow less quickly than the incomes of the rest of the economy), leading to the relative impoverishment of farmers.2 Over time, agricultural production has become more efficient. A given area of land can produce a higher agricultural yield, with fewer workers. This is because of more sophisticated technology, machinery, pesticides, fertilisers, growth hormones, seed improvements, etc. Agricultural output has increased. Economic theory suggests that as the output, or supply, of a product increases, its price will fall. As the price of a product falls, normally consumers will demand more of it. But the demand for food is priceinelastic. No matter how far price falls, if we already have enough food, we are unlikely to buy more. In fact any fall in the price of food effectively increases consumers disposable income, and they are likely to spend that money on more luxuries. The paradoxical situation is that as farmers become more efficient, and produce more, their income falls. One might wonder then why they bother. The problem here is that agriculture is a competitive business. If one farmer does not invest in new technology, and another farmer does, then the second farmer s prices will be lower than those of the first farmer. Consumers will buy from the second farmer because it is cheaper to do so, and the first farmer will be forced either to invest, or to go out of business. So, because of the price inelasticity and the income inelasticity of demand for agricultural products, over the long term farmers incomes fall both absolutely, and in relation to other members of society. This is known as the agricultural problem. N.B. This analysis is appropriate both for the situation of individual farmers within any economy, and also for those countries that are primarily dependent on agriculture for their income within the global economy. In the context of the case study examples that Milking it uses, therefore, there are

(d)

(e)

(f)

(g)

Note that we might buy better quality food, or different varieties of food that we could not previously afford. We might also eat out more, or buy prepared foods. None of this, however, increases our total food consumption, or expressed in another way, the total demand for agricultural products. 2 This is one of the reasons why small farmers are going out of business in the UK, and most of our domestic food production is in the hands of big agri-business . Small farms become unviable; only large-scale production is profitable.
Milking it: Small farmers and international trade. A global citizenship resource Teachers notes

-3close similarities between the problems facing both Welsh and Jamaican dairy farmers. 3. Subsidies to farmers (a) Many countries have offered some form of subsidy to agricultural producers at some time to keep them in business. Certainly all the industrialised nations have subsidised agriculture since the 1920s/1930s. There are a variety of justifications for agricultural subsidies. Strategic. Most countries would prefer not to be dependent on others for their food supplies, and would aim for something close to self-sufficiency in basic foodstuffs. This is a precaution against the possibility of food supplies from abroad being cut off, perhaps because of war. Moreover, if there were a crop failure in the supplying country, they would be likely to keep food to feed their own population, rather than sell it to foreigners. Political. Farmers have been effective political lobbyists, and have been successful at enlisting public support (even though, in most industrialised countries, agriculture employs only about 3 per cent of the population. The fuel protests of autumn 2000 in the UK, and various demonstrations by French farmers in recent years are evidence of this. Politicians seem reluctant to challenge farmers. Social /ecological. Many people feel that it is important for social reasons to keep the countryside populated, and also that it is important to maintain the farming industry for ecological reasons. In Europe, including the UK, farmers are assisted through the Common Agricultural Policy (CAP). This consists of a common external tariff against imported foodstuffs that compete with European produce, and cash payments to farmers to encourage them to grow certain crops /produce certain products. There are also other forms of support. In the case of milk, the EU gives indirect support by setting limits on the amounts of milk farmers are allowed to produce. This reduces the supply of milk, which helps stop the price from falling. The EU also buys surplus milk in spring, when more milk is produced. In general, in spite of limits on production, the subsidy system encourages farmers to produce more than they otherwise would, and more than the European market wishes to consume. However, farmers in developing countries receive far fewer subsidies. Their governments cannot usually afford to subsidise them, and are often required to remove any existing subsidies by the IMF and the World Bank. Subsidy regimes tend therefore to lead to overproduction, and the generation of a surplus, which is paid for through taxes. Governments

(b)

(c)

(d)

Milking it: Small farmers and international trade. A global citizenship resource Teachers notes

-4seeking to reduce their liabilities may then seek to sell the surplus often at a price below the cost of production in order to recoup some of their expenditure. (e) This leads to the practice of dumping . Dumping is the exporting of surplus goods to other countries at artificially low prices. The dumped product is usually sold at below the existing market price in the importing country also. This means that domestic producers in the importing country are undercut on prices and may be forced out of business if they are unable to lower their own prices to compete. This is essentially what is happening in Jamaica at the moment in the dairy industry.

4. Theory of free trade (a) The theory of free trade was first developed by the Scottish economist, Adam Smith, in 1776, and later refined by David Ricardo. (Ricardo introduced the theory of comparative advantage.) Essentially the theories argue that if each producing country specialises in the production of the goods that it produces most efficiently, and leaves others to produce goods that they produce most efficiently, then total world output of all products is increased, making the most efficient use of the world s resources. In principle we are all better off . Economic growth has taken place. The argument continues that each country can trade the surplus of its specialised products to obtain from others the products that it is not producing for itself. There is a flaw in this argument, however. As we have already seen, economic growth means rising incomes. However, the demand for agricultural products is income-inelastic. (This is part of the agricultural problem.) Therefore the extra spending generated by growth will be used to buy the products of those countries specialising in other (non-agricultural) goods and they will become richer. There will be little or no increase in the demand for the products of countries producing agricultural goods, and they will become relatively, and perhaps absolutely, poorer. The point here is that while specialisation may increase the size of the global cake, this does not mean that everybody will get a bigger slice. In any event, there is a difference between the rhetoric and reality of the industrialised countries when it comes to free trade. Governments in Europe and USA frequently proclaim their support for the principle, but in practice they continue to subsidise their own farmers, and impose protectionist measures against agricultural imports, thus denying the agricultural economies free access to their markets.

(b)

(c)

(d)

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5. Diversification (a) It may make sense for less developed countries to seek to diversify, i.e. to move out of agricultural production and into manufacturing, if they want to achieve economic growth. In particular they might consider expanding into low-tech, highly labour-intensive manufacture, where they would have a comparative advantage because of the high supply and relatively low cost of labour. However, trading blocs such as the EU continue to operate high protectionist tariffs against imported manufactured goods, which means that it is not easy or profitable for countries to take this route to economic development. For example, in Canada, tariffs on processed food are as much as 13 times higher than those on unprocessed products.

(b)

6. The role of global institutions (WTO, IMF, etc) (a) The World Trade Organisation (WTO) exists essentially to facilitate negotiation between countries to encourage them to remove barriers to trade, or other protectionist measures. This includes the removal of tariff barriers, import quotas and subsidies (which are held to distort competition) from domestic producers. The WTO is a consensus organisation, but the richer and more powerful member countries tend to have more influence. Once an agreement has been made, the WTO can enforce it through its dispute settlement system. The International Monetary Fund (IMF) was set up just after World War II. It exists to provide loans to countries who are facing financial difficulties, particularly those that are experiencing balance-ofpayments problems, to enable them to resolve those difficulties. Note that almost without exception the countries in receipt of IMF loans are economically poor or less developed countries. The IMF invariably attaches conditions to its loans. The IMF argues that the reason why it has to lend money to countries is because those countries have been guilty of economic mismanagement . The IMF insists that they reform . In practice this means that the IMF insists, in exchange for its loan, on an economic management package known as a structural adjustment programme3. Amongst the requirements of SAPS are that countries open their markets to free trade; that they remove import tariffs, import quotas, and subsidies. Also, implicitly, that they agree to free-trade proposals at meetings of the WTO.

(b)

(c)

Now called a Poverty Reduction and Growth Facility.

Milking it: Small farmers and international trade. A global citizenship resource Teachers notes

-6(d) Therefore, the reality of the WTO is that while it claims to be a consensus organisation, some of its members are under pressure to ensure that they vote in a particular way. Poorer countries are effectively forced to open their markets, while the rich countries, free of indebtedness to the IMF, are able to continue to operate their own protectionist policies.

7. Conclusion The rules of the global trading system are unfair to poorer countries, who are effectively forced to open their markets to competition from the industrialised countries, while continuing to have very restricted access to the markets of those countries.

Milking it: Small farmers and international trade. A global citizenship resource Teachers notes