The agricultural roots of industrial development: 'forward linkages' in reform era China

TLDR: In this paper, the authors show that in reform-era China there were substantial forward linkages between agricultural productivity and non-agricultural output, and use the predictions of a simple two-sector model to provide evidence that the linkages identified were primarily due to higher agricultural surpluses increasing the supply of capital to local firms.

Abstract: A classic literature argues that improvements in agricultural productivity result in higher non-agricultural output, particularly at low levels of development. The proposed mechanisms for these ‘forward linkages’ vary, but centre on either increases in the supply of factors, especially labour and capital, or demand externalities in product markets. Regardless of the mechanism, the empirical evidence for substantial forward linkages from agriculture is limited. In this paper, I show that in reform-era China there were substantial forward linkages. I exploit the fact that China’s 1978-84 agricultural reforms were more beneficial to farmers with land suited to cash crops to provide plausibly exogenous variation in agricultural productivity. Then, using a newly digitised panel of economic data for 561 counties, I trace the growth of agricultural and non-agricultural output over forty years. Higher agricultural output was associated with significantly faster subsequent growth in non-agricultural output. I estimate 15 and 25 year elasticities of 1.2 and 0.8. I am able to identify these linkages because China is subject to substantial geographic capital and labour market frictions. These frictions limit the equalisation of prices across space and keep local shocks local. I use the predictions of a simple two sector model, which nests the possibility of linkages through demand externalities and the supply of capital or labour, to provide evidence that the linkages identified were primarily due to higher agricultural surpluses increasing the supply of capital to local firms.