W19? 2 0/ World Bank Discussion Papers tJrbanization, Agricultural D evelopnment, and Land Allocation Dipasis Bhadra Anto6nio Salazar P. Brandao Recent World Bank Discussion Papers No. 141 China's Foreiqn, Trade atid Comparative AdvantaVt~: Prospecis, Problems, and Policy Implications. Alcxandcr J. Ycats No. 1 42 Restrnntmrintg Socialist Industry: Poland;s Experience in 1990. Homini J. Kharas No. 143 China: industrial Policiesfiri an Economy itn Transition. Indcerjit Sirigh No. 144 RPefitnitp Prices: The Experence olaChina, Hluntgary, atid Poland. AnaUid lUjararn No. 145 Dev'elopin Mon go/ia. Shahid Ytsufaiia Shiaidjaved Burki No. 146 Sino-Japanese Economic Relationships: Trade, Direct Inv'estnen t ctand Fuiire Strateyy. Shuichli On o No. J 47 The Effiects ofELonomic Policies on, Afncan .Anriulture: From Past Harn to Future Hope. William K. Jaeger No. 148 T7ec Sectoral Foundations of China's Development. 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The complete backlist of publications from the World Bank is shown in the annual Inde-x of Publications, which contains an alphabetical title list (with fuill ordering information) and indexes of subjects, authors, and countries and regions. The latest edition is available free of charge from the Distribution Unit, Office of the Publisher, Department F, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from Publications, The World Bank, 66, avenue d'1ena, 75116 Paris, France. ISSN: 0259-21OX Dipasis Bhadra is an economist at the Regional Studies Program, University of Baltimore, Baltimore, Maryland. Antonio Salazar P. Brandao is an economist in the Agricultural Policy Division of the World Bank's Agricultural and Natural Resources Department. He is on leave from the Getulio Vargas Foundation in Rio de Janeiro, Brazil. library of Congress Cataloging-in-Publication Data Bhadra, Dipasis, 1960- Urbanization, agricultural development, and land allocation / Dipasis Bhadra, Antonio Salazar P. Brandao. p. cm. - (World Bank discussion papers ; 201) Includes bibliographical references. ISBN 0-8213-2456-X 1. Land use-Government policy-Developing countries. 2. Agriculture-Economic aspects-Developing countries. 3. Urbanization-Developing countries. I. Brandio, Antonio Salazar P. (Antonio Salazar Pess6a) II. Title. III. Series. HD1131.B47 1993 333.33'5'091724-dc2O 93-17320 CIP -iii- FOREWORD The transfer of resources from the rural sector to the urban sector is a characteristic of economic development. Capital and labor leave agriculture seeking higher remunerations in other activities that are located in the urban sector. Spatially this leads to the growth of cities and the accompanying reallocation of land from rural to urban uses. Governments of a number of countries have been demonstrating, in recent years, concern with the fast pace at which agricultural land is being converted to urban uses and, through zoning laws and other interventions, are attempting to reduce the rate of conversion. For economists and policy makers one question that arises in this context is whether these interventions are justified on welfare grounds. Not only that, but also whether the social adjustment costs associated with land conversion (for example the costs associated with dislocation of rural populations left over by the migration process and obuolescence of infrastructure created for agricultural uses) justify interventions. This paper is part of the research program of the Agriculture and Natural Resources Department to analyze the role of the government in the land markets in peri-urban areas. The authors of this study review the literature on urbanization and agricultural development looking for answers to the questions raised by existing policies in developing countries. They point out that this large body of work is mostly organized around sectoral issues and that, despite the many significant contributions made for the understanding of the development process, the literature does not yet provide a comprehensive and unified framework for the evaluation of the welfare consequences of government policies that attempt to slow down land conversion to urban uses. k'e&t Pe~~ Michel Petit Director Agriculture and Natural Resources Department - iv- We would like to thank Gershon Feder, Gregory K. Ingram and Hans Binuwanger for comments to earlier drafts of this paper. Table of Contents I. Introduction 1 II. Economic Development, Urbanization, Economics of City Size and Growth 2 III. Effects of Urbanization on Agriculture 14 IV. Government Interventions in Land Markets: Types, Rationale and Effects 35 V. Summary and Conclusions 49 VI. Bibliography 51 I. Introduction This century has experienced the greatest urban expansion in human history. Most of this population shift has taken place in the second half of the century. Between 1950-1985, the number of people living in cities almost tripled, increasing by 1.25 billion. In the developed regions, urban population nearly doubled (from 450 million to 840 million) while in the developing world, it quadrupled (from 285 million to 1.5 billion). In the past 60 years the developing world's urban population increased 15-fold, from around 100 million in 1920 to close to 1.5 billion in 1990. Meanwhile, rural population has only doubled (UN (1991)]. Moreover, a significant proportion of the urban population is concentrated in metropolitan centers of enormous size. In 1980, nearly one person in three was an urban dweller, and one in ten lived in a city with a million inhabitants or more. The tendency of concentration in large metropolises is predominant in the developing countries. There were 20 urban agglomerations (UAs) in 1970 in the world with a population size of 5 million or more, of which more than one half (11) were in LDCsj in 1990, the number of UAs rose to 34, of which 23 were from the LDCs; and in 2000, UAc are expected to rise to 45, 34 of which will be in LDCs [Table 9, UN (1991)]. The geographical distribution of urban populations in the world has been changing as well. At the beginning of this century the largest share of the world's population living in cities over 100,000 was found in Europe. By 1950 Europe was already behind Asia and America, and by 2000 Asia will dominate the world urban picture, with about 45 percent of the world's population (UNDP (1990)]. The main factors behind this transformation are the general population boom in the 20h century and the rapid economic growth, which is typically associated with a decline in the share of agriculture in economic activities, and 1 an increased share of the industrial and service sectors. The latter sectors are mostly concentrated in urban centers. The literature analyzing urban development is large. Over the last four decades, researchers have dealt with numerous related issues, such as explanations for the existence and growth of cities, the relationship between city growth and industrial growth, allocation and efficient use of urban sector- specific resources, availability and proper management of those resources and policies concerning balanced urban development. The rapid growth of cities, especially in the developing countries, has prompted government interventions. A large body of literature, primarily aimed towards understanding the roles and effectiveness of public policies in the context of urban development and urban land markets, has emerged over the last two decades or so. Urban growth manifests itself not only in a population shift, a subject of numerous studies focusing on rural-urban migration, but also in spatial shifts. Surprisingly, the literature has given much less attention to the implications of urban development for the determination of the process of land allocation between rural and urban uses, or, equivalently, between agriculture and non agriculture. Moreover, most of the existing studies focus on the developed countries and in particular, on the United States. This paper reviews the literature on urban development and the allocation of land between rural and urban uses and discusses the role of the government in in this process. It is organized as follows: Section II deals with the relationship between economic development and urbanization. Section III is on the effects of urban development on agriculture. Section IV examines the rationale and impact of government interventions. Section V summarizes and concludes the paper. II. Economic DeveloDment. Urbanization. Economics of City Size and Growth It is convenient to define two general approaches for analyzing urban development: i) the macroeconomic approach and ii) the microeconomic approach. 2 Macroeconomic studies analyze urbanization in terms of economy-wide aggregate variables, such as GNP, population, productivity, and aggregate migration. The process of economic development entails many structural changes in the economy. As development proceeds, a transfer of resources from agriculture to the non- agricultural sector, and particularly to the industrial sector, takes place. Migration of labor from rural areas is an important dimension of this process, but by no means the only one. Capital and land are also being transferred. The structural and spatial aspects related to this process may be explained in terms of demand and supply forces that underlie the initial changes'. From the demand side, the incentive for resource transfer arises, in part, from larger income shares spent on industrial products and services relative to that on agricultural goods [Engel's Law]. The supply side effects come from faster technical progress in industry than in agriculture (in part because industrial technology is more easily transferable than agricultural technology) and from signifcant scale economies in urban production processes. High employment and population densities, characteristic of urban areas, can be explained in terms of site-specificity of economies of scale and scope. The site-specificity of agglomerative economies (e.g., those associated with the location of ports and other types of area-specific infrastructure) leads to high urban land values which, in turn, induce substitution of land by non-land inputs such as labor and capital. High employment and population densities result from this process. Scale economies in the urban sector reduce unit costs of production. Economies of scope make it possible for the urban activities (e.g., hospitals, law firms, etc.) to produce a variety of related commodities or services at lower cost than can several units each producing only one or a few of the commodities or services [Mills (1991)]. Economies of scale and scope together with transportation costs define the limit of the urban areas. The diminishing ' Useful references dealing with this process are: Mills and Becker (1983), Kelley, Williamson, Cheetham (1972), and Tolley (1987a).The economic development literature on the topic is very large and well known. We focus the review on works which are directly related to the central theme of this paper. 3 returns from agglomerative economies (Henderson (1986)] and the rising transportation costs associated with city expansion force urban economic activities to locate in proximity to each other. Proximity permits production at economical scales without squandering the benefits on expensive transportation. It follows from this literature that economic development leads to urbanization. However, the relationship has been questioned repeatedly in the literature, particularly in the context of developing countries. Hoselitz (1957) argues that, "...urbanization in Asia has probably run ahead of industrialization and the development of administrative and other service occupations which are characteristically concentrated in cities" [p. 44]. He also notes the disproportion between the costs of urban growth and the maintenance of proper facilities for urban dwellers and the earning capacity of the people congregated in cities. Finally, he argues that, "it is evident that migration to the city is due less to the "pull", i.e., the attractiveness which the city exerts, and more to the "push' experienced in the country" [p. 44]. Thus, "...efforts should be made in Asia to encourage rural industrialization, since urbanization has reached for the time being a more than oDtimum level" [p. 50]. Citing the growth of informal sector and open and disguised unemployment in the urban sector, Urqudi (1975] and the Economic Commission for Latin America have also voiced similar concerns. However, many researchers have been reluctant to accept the existence of an informal sector as indirect evidence of the over-urbanization thesis. Many authors argue that the informal sector operates in an orderly and efficient manner and benefits the urban sector of the developing countries. There is a large body of literature on these issues. [See, for example, Mazumdar (1976, 1989), Fields (1975), ILO (1972), and Hemmer and Mennel (1989)]. Empirical studies by Pandey (1977), Mills and Becker (1983), and Tolley and Thomas (1987a) give some support for the rejection of the over urbanization hypothesis. However, the debate is still not entirely conclusive because some statistical results [Tolley (1987a)] appear to be consistent with the over urbanization hypothesis. 4 The macroeconomic empirical studies contribute to the understanding of the process of urbanization and its relationship with economic development. However, these studies do not consider the effects of urbanization on agriculture. Moreover, the effects of various microeconomic forces (i.e., demand and supply factors) are not readily apparent in the aggregate analysis. As a result, even though the need for government intervention (if any at all) may be detected with the aggregate analysis, it can not determine what kinds of intervention are likely to be most appropriate to improve the resource allocation in the economy. To understand and analyze the factors determining city size and urban expansion, from a microeconomics standpoint, one needs to ask the following question: Why do cities exist and what causes them to grow? These are the initial questions which gave rise to urban economics as a subject. Drawing on the works of Isard (1956), Alonso (1964) and Muth (1961), Mills (1967) argued that heterogeneity of land and agglomerative economies in manufacturing production justify the existence of cities. Mills (1967) shows that there are benefits associated with the concentration of production on the land of relatively higher quality (that requires less expenses in terms of construction costs) and with higher agglomerative economies. Mills' analytical model, later extended by Beckman (1968), Dixit (1973), Henderson (1977) and others, can be described in very simple terms. "For the same kind of reason for which increasing returns lead to monopoly in terms of microeconomics, industrial development tends to get polarized in certain 'growth points' or in 'success areas', which become areas of vast immigration from surrounding centers or more distant areas" [Kaldor (1975), p. 356]. Due to productivity gains in city areas, physical and human capital can earn a higher return, the higher the density of capital [Dixit (1973), and Henderson (1977)] already present in an urban area, and this sets off a movement of capital and population to the high density core regions or cities in a self-reinforcing cycle (Clark (1964), Mills (1967), Dixit (1973), and Henderson (1977)]. Agglomerative economies in these models are a critical factor to determine city size. Three types of agglomerative economies have been discussed in the 5 literature [Carlino (1978)]. Urbanization economies, which are external to the firms as well as to the industries, arise in response to exogenous factors, such as city size (population or area), and physical infrastructure (ports and railways). Localization economies, which are internal to the industry but external to the firm, are due to agglomeration of specialized inputs used in particular industries, e.g., improved telecommunication and information networks and specialized input markets. Internal scale economies, take place due to firm- specific input indivisibilities; they are internal to the firms and to the industry (Carlino (1978), Mills (1967) and Henderson (1988)]. Other than technical externalities, there are externalities due to "pecuniary" reasons. Pecuniary economies have received relatively less attention in the literature perhaps because for such externalities to be classified as agglomerative economies pertaining to the urban sector, there must be an important spatial element to the interactions of firms and suppliers [Goldstein and Gronberg (1984)]. However, the standard spatial models can adequately incorporate the pecuniary effects by making costs of exchanging goods and services between firms and suppliers varying with the distance. There is a large body of literature [for a review, see Montgomery (1988)) explaining and measuring different types of agglomerative economies. Most of the empirical findings (Segal (1976), Carlino (1978), and Shukla (1984) to name a few) suggest that the agglomerative economies are of the urbanization type and thus depend on the size of the urban area, defined in terms of population. A dissenting view can be found in Henderson [1986]. The diminishing trend in agglomerative economies itself would give rise to a finite and varying equilibrium size for any urban area [Henderson (1977)]. Other than this built-in growth containment, another important factor to limit the growth of cities is transportation cost. Since unit transportation costs increase with distance, they can overwhelm benefits from agglomerative economies. Economic, social, and financial costs which accompany urban growth have also received comparable attention in the literature [Linn (1982), (1983)]. Demand for public goods and services has made municipal financing a major issue in recent 6 times [Bahl and Linn (1987); and Meerman (1979)]. The high rate of urbanization, together with the scarcity of finance capital2 and increasing costs of local public goods in urban areas of the less developed countries, have brought out the importance of the cost aspects of urbanization. Besides this, there is an equity concern over the urbanization costs as well. The agricultural sector is said to bear a substantial portion of the public costs of urbanization due to policies which result in the extraction of a surplus from rural income for the financing of the urban sector (Richardson (1977), Lipton (1977), Kruegger, Schiff and Valdes (1991) and also Linn (1982) for a discussion]. There have been only few attempts to incorporate the benefits and costs of agglomeration in urban areas in a complete way. Linn (1982) points out that "Unfortunately, a comprehensive measurement of costs and benefits associated with urbanization is a difficult task. Nobody appears to have tried to sum individual costs and benefits, including negative externalities arising from congestion and pollution, and positive externalities associated with increased market size, improved communication, and so on. Problems of definition and measurement are serious enough to preclude this approach." [p. 645]. However, there have been some efforts, if not in a complete way, to incorporate both the costs and benefits of agglomeration. Yezer and Goldfarb (1978), in an attempt to determine the efficient city size, have shown that in presence of disamenities, the social optimum will not be the same as the competitive equilibrium. However, without information on production function, scale economies and the city wage, one can not be sure whether the market solution is in general too large or too small. One of the factors which seems to play the most important role in determining the size of cities in presence of disamenities, besides scale economies and the technological change, is the nominal wage in cities. Henderson (1977) and Dixit (1973) have shown that the nominal wage in the city is positively related with the city size. Since urban 2The role of finance capital in building urban infrastructure has been given special attention in Dowall (1990). He points out that a severe shortage of finance capital can hinder the urban infrastructure in many cities in LDCs. This, in turn, hampers the development of urban land markets. 7 disamenities (congestion in particular) increase with city size a higher nominal wage is required to compensate workers. This increase in costs, together with the diminishing returns from agglomerative economies (and, of course, increasing transportation costs) contributes to limit the size of the urban economy. The literature seeking to analyze urban systems and urbanization, incorporating costs and benefits from urban agglomeration, while extensive has left a few issues not fully resolved. The determinants of agglomerative economies and different costs (primarily those due to congestion, pollution, etc.) and their role in determining city size are not so clear. As Rosen (1979) noted, neither the compensating-differentials perspective nor the agglomerative economies argument can provide a completely convincing explanation for the association of wages with city size. In treating city size as exogenous, the differentials literature ignores the effect of labor demand on wages; in taking wages as exogenous, the agglomerative economies literature ignores the long-run labor supply. The urban economics literature, either in an open or in closed city model, considers the role of the rural sector as residual. The utility level of the marginal urban residential households adjusts with that of utility of outsiders (and presumably to that of marginal rural households') or the population of the urban economy is being adjusted (perhaps drawing from the reservoir of rural sector). Furthermore, most of the analyses employ partial equilibrium framework to study the inter-sectoral problems; for example, problems related to housing, transportation systems, pollution control and so on are studied in isolation. A relatively more complete treatment has been provided by Henderson (1977), but he too does not consider agriculture. Dual Economy Models The realization that the study of urban system and/or urbanization can not be completed without clear reference to the rural sector leads to the use of dual economy models . Dual economy models have been used to study rural-urban migration, and the process of urbanization for quite some time [for earlier 8 models, see Harris and Todaro (1970), Kelley, Williamson and Cheetham (1972); and for some recent works, see Kubo (1986), Panagariya and Succar (1986)].3 These models are essentially non-spatial and therefore, have no bearing on the location of economic activities. Later models [such as Kubo's (1986) and Panagariya and Succar (1986)] incorporate some of the recent arguments from the urban economics literature [e.g., urban production is assumed to enjoy Marshallian externalities, however at a constant rate, at all levels of economic activities] but fail to model the behavior of residential households. Apart from their concern with productive activities only, these models do not give any consideration to input fixity, e.g., fixed land supply in sectoral activities. As Kelley and Williamson (1986) noted, " ... while inelastic agricultural land supply insures an eventual constraint on urbanization through rising food costs and real wage increases, nowhere is the impact of inelastic urban land supply or city rents - another key wage good - and urban cost of living considered" (p. 597]. Furthermore, most of these models are partial in nature. Thus a great deal of their analysis suffer from the same problems as the urban economics literature. The need for a general equilibrium framework in the analysis of urbanization has been summarized most strongly by Rogers and Williamson (1982), "... if economic factors play a critical role in determining rural-urban migration, then urbanization and city growth are closely determined by those same factors. It follows that urbanization and city growth can not be analyzed without giving explicit attention to the interaction between rural and urban labor markets. Furthermore, those labor markets can not be fully understood without explicit modeling of labor supply and demand forces in both the sending and receiving regions. In short, urbanization 3In the text we concentrate on models that address the urban expansion and rural contraction. Other issues commonly treated with this type of model are: marketable surplus in a dual economy; terms of trade between sectors; internal labor markets in the urban economy; and more recently, contractual arrangements in the ural economy and their impacts on rural-urban migration and urbanization; [for an overview of the issues discussed within this class of model, see Basu (1984); see also Lewis (1954), Jorgenson (1967), Fields (1975), Mazumdar (1976, 1988), and Lahiri (1989)]. Some of these aspects may have direct and or indirect effects on urbanization. 9 and city growth can be understood only by embedding the process in a complete general equilibrium model" [p. 475]. In order to overcome some of these shortcomings additional efforts have been made by Kelley and Williamson (1984) Becker, Mille and Williamson (1986) Bhadra and Heffley (1991) and Bhadra (1991). Kelley and Williamson [K and W] offer a model of a stylized LDC economy with eight different sectors, including both tradeable and non tradeable goods. The model is savings-driven and the aggregate savings pool is generated endogenously from different sources, such as after-tax corporate and enterprise profits, government savings, and household savings. In addition to the savings constraint (which will eventually bridle the growth of capital-intensive cities), two other constraints have been explicitly incorporated in the analysis: land use in different sectoral activities; and the supply of intermediate inputs, such as imported raw materials, and fuel. Contrary to earlier work [see Tolley (1987) for example], they find that the rapid rates of population growth are not the central influence driving urban growth in developing countries. Capital transfers were not important and rural land scarcity has had only a modest role. The imbalance of sectoral productivity advances (technological events which have historically favored the urban modern sector) and prices appear to have the most potent impact on third-world urbanization. They conclude that trade policy in the industrial countries and price policy in developing countries are likely to have the most important impacts on city growth in the next two decades. Using a similar framework, Becker, Mills, and Williamson (BMW) (1986] study Indian urbanization. The computable solution of the model allows them to separate different hypotheses and perform tests to see their importance in explaining Indian urbanization. Like K and W, they also find that the most potent factor behind urbanization comes from the differential productivity advance favoring the modern urban sector; the central engine of growth is not the demand side through Engel's effects but rather the supply side. The slower productivity growth in agriculture and the availability of arable land in agricultural production, two push factors considered important in earlier studies in prompting urbanization, 10 have been found to have only modest impact. on Indian urbanization. Finally, the study finds some support for Lewis' (1977) assertion that city employment slows down with the decline in net capital inflows. Finally, in the same neoclassical tradition of computable general equilibrium framework, Bhadra and Heffley (1991) and Bhadra (1991) offer a dual economy framework to study urbanization and related issues. The frameworks they used are less complex in terms of sectoral activities than K and W and BMW. However, they offer insights into aspects neglected in other studies. In particular, the agglomerative economies in urban production, zoned lands for urban residential, urban firms, and rural sectors, endogenous agents (i.e., number of firms, numbers of urban residential households and rural households), and endogenous prices for almost all the goods and services and inputs have been explicitly modeled. In this closed economy setting and using computable general equilibrium framework for Calcutta (India) Metropolitan District, Bhadra and Heffley (1991) find that higher degrees of agglomerative economies (localization type) would lead, contrary to conventional wisdom, to lower urbanization. This is so because as the agglomerative economies increase, firms within a particular industry become more productive and the number of firms may actually decline. Consequently, the aggregate demands for inputs might even decline (if the fall in the number of firms is greater than the effect associated with the rise in the firm's demands for inputs) and so does urbanization. A similar argument can be found in Tolley and Thomas (1987a). However in a small open economy an increase in agglomerative economies might lead to higher urbanization. Using the same analytical framework, Bhadra (1991) examines the role of land in this dual economy. Compared with the observed or benchmark situation, the optimal distribution of land, given particular values for parameters and exogenous variables, requires conversion of rural lands into urban uses. The presence of agglomerative economies together with the situation under which agricultural production takes place, Bhadra's (1991) study shows that the conversion of rural lands into urban uses may lead to improvement of aggregate welfare for the regional economy of the Calcutta Metropolitan District. 11 These models made considerable improvements over existing dual economy models. They Incorporate locational aspects even though spatial arrangements of the economic activities are purely arbitrary. Distance, unlike in standard urban economics models, does not play any role. Nonetheless, they include both the "push" and "pull" factors that characterize the process of urbanization. Push from agricultural activities, due to land scarcity or lack of improvements in agricultural technologies have been found to have very modest impacts in some of the studies discussed above. However, none of these studies can address the issues fully since the spatial distribution of sectoral activities are arbitrarily fixed. Consequently, the land scarcity in the rural sector due to physical expansion of the urban sector as urbanization proceeds can not be addressed within these analytical models. Furthermore, due to the absence of spatial details, the agricultural land values do not reflect the urban expansion. The improvement in aggregate welfare through conversion of rural land into urban uses, that has been noted in Bhadra (1991), depends on the characterization of the urban economy. The role of government, in most of these models, is implicit [as in Bhadra (1991), Shukla and Stark (1991)]. Direct and explicit treatment is given in K and W and BMW, but they do not consider the issue of market failures. Most analytical models incorporate only one government level for the economy as a whole. This simplifies the analysis, but very often, abstracts from a central feature of reality: policies implemented by different sectoral governments can be conflicting and may have some impacts on migration, city growth and its effects on the rural sector. Even though, as argued above, the dual economy models have not considered properly the spatial structure of the economy, the work of von Thunen stands in sharp contrast with this. While it has greatly influenced the literature studying the implications of urbanization on land use, the empirical applications (discussed in section III) are based on partial equilibrium versions of the model. Samuelson (1983), however, argued that von Thunen elaborated one of the earliest general equilibrium models of modern economics. The model is presented by Samuelson in very elegant terms and contains a complete discussion of the 12 spatial structure of the economy. Nerlove (1989) takes up Samuelson's version of the von Thunen model and studies specifically the role of transportation costs in determing commodity prices, real wages and the spatial distribution of the labor force. In Nerlove's view "[von Thunen is] the author of the first, and in some ways the best, model of the dual economy; a model which with a little effort can be turned into a model of dual economy development having considerable relevance to the developing economies of the world today in which high costs of transport are pervasive and are significant determinants of relative commodity prices". In Nerlove's exposition, there are two sectors in the economy: agriculture (corn) and manufacture (cloth). The latter is produced in the town and the former is produced at various rings at increasing distances from the town. The manufacturing good is produced with the use of labor only and the agricultural good uses land and labor (both production functions are homogeneous of degree one). Preferences are homothetic and transport costs are assumed to increase exponentially with distance. The solution of the model is discussed, but it turns out that the complexity of the model precludes the author from presenting a general set of comparative static results. Some of the comparative static results are discussed in a non mathematical form. It is shown, for example, that a fall in transportation costs (of either corn or cloth) will cause the relative price of corn to rise at every distance from the town relative to its price in the town. Moreover, the production of both corn and cloth increases and this leads to increased use of labor in manufacturing (whose only input is labor), reducing the use of labor in agriculture. In consequence the labor/land ratio falls everywhere, the rents will fall more for lands closer to town and the margin of cultivation moves outwards. The model in its present form can not be used to study the conversion of land from rural to urban uses (since land is only used in agricuture). But, since it is a dual economy model that deals quite effectively with the spatial structure of the economy, it certainly provides a good starting point. However, as more complexity is added, it becomes even less likely that its comparative 13 static properties could be derived analytically. A computable general equilibrium version of the model will be necessary before we can fully understand how the allocation of land will change in response to exogenous and policy variables. III. Effects of Urbanization on Agriculture In this section we first provide an overview of the theoretical literature that deals with rural-urban land conversion issues (which mostly consists of applied partial equilibrium versions of the von Thunen model); then we review the empirical studies analyzing the physical expansion of the urban sector and in the third part, we review the literature on the indirect effects of urbanization on the rural sector. Models in the Tradition of von Thunen's Much of the urban economics literature that grew over the last three decades draws its basic elements from the work of von Thunen (1966). Based on the fact that from 1924 to 1954 between 0.17 and 0.26 acres of rural land were converted to urban land for each additional member of the urban population [Bogue (1956), as reported by Muth], Muth (1961) uses an extended von-Thunen-like model to explain this phenomenon. He postulates a market for commodities at some fixed point in space, around which land of homogeneous characteristics extends to an infinite distance. Firms of two competitive industries, one producing non-farm housing services and the other producing an agricultural good, are located on this land. Muth's problem is to determine the areas in which the firms of the two industries locate and how their areas of location change with changes in the underlying conditions of demand and supply for the two commodities. The model suggests that land use patterns and the market price of land are established by relative rental gradients for urban and agricultural uses. Conversion of land into urban uses proceeds in concentric circles around the market town; at the equilibrium boundary between urban and agricultural uses, the relative rents of 14 competing uses are equal. Muth assumes that firms in a given industry have identical production functions (logarithmically linear); that the price received at the point of production declines exponentially with distance; that total land area available at distance k from the market is proportional to k2 and that the market demand functions are logarithmically linear. An exogenous change in demand for goods of one industry expands the output of that industry. In this partial framework, the supply of the commodity of the other industry diminishes and the market price increases. The land rental increases too. In other words, any change in the demand for one good, is capitalized in the land value via a higher rent for all industries. Unlike changes in demand, effects of change in input prices are not so clear. An increase in the price of an input reduces the supply of both products and the market price of both commodities tend to increase. While the latter tends to make rents higher, the rent function itself changes. The sign and the magnitude of the change in the rental value of land depends on the extent to which the prices of the two commodities increase with the initial shifts in supply; that is, it depends on the elasticities of demand for the two commodities. Similarly, a neutral change in the production technology leads to higher supplies and lower prices. Once again, the change in the land rental depend critically on the demand elasticities. Finally, the increase in the price gradient of one commodity leads to an outward shift of that commodity's supply function. The land rent paid by the industry increases. The rent gradient for the industry whose price gradient has increased rises. However, the rent falls off more rapidly with distance. The steepness of the rent gradient would move the boundary inward. One central feature of the von Thunen plane in the above theoretical framework is that any change in the exogenous conditions is translated into changes in land rents. While in the Ricardian theory, fertility or soil quality plays a role in the determination of land rents, in models on the tradition of von Thunen, situational factors, such as location, accessibility of the site, and the extent of urbanization, are used as determinants of rents, location of 15 production of agricultural commodities and technique and intensity of cultivation. Another attempt to link urban development and agriculture is Schultz' Urban-Industrial (UI) hypothesis. The UI hypothesis, which also has its intellectual roots in von Thunen [see Katzman 1974], relates agricultural to industrial development through the efficiency of markets. The difference of the UI hypothesis from the von Thunen tradition is its focus. The UI attempts to explain regional disparities in agricultural income which von Thunen assumes away. The hypothesis can be summarized in three statements by Schultz (1953): (1) "Economic development occurs in a specific locational matrix; there may be one or more such matrices in a particular economy. This means that the process of economic development does not occur in the same way, at the same time, or at the same rate in different locations." (2) "These locational matrices are primarily industrial-urban in composition; as centers in which economic development occurs, they are not mainly out in rural or farming areas although some farming areas are situated more favorably than are others in relation to such centers;" and, (3) "The existing economic organization works best at or near the center of the particular matrix of economic development and it also works best in those parts of agriculture which are situated favorably in relation to such a center; and it works less satisfactorily in those parts of agriculture which are situated at the periphery of such a matrix." (p. 147). Schultz analyzes the regional disparity in income in the following way: "The sectoral shift in employment from rural to urban areas causes the demand for labor to grow faster than the supply in urban areas relative to rural areas, an effect magnified by the more rapid rural natural increase. This disproportionality between supply and demand raises urban relative to rural wages, in the short run." [p. 687; Katzman (1974)). "Potential migrants from rural areas will weigh the lifetime gain in earnings from rural-to- urban migration against its economic and psychic costs. The farther a rural area is from the urban opportunities, the higher the costs of migrating and acquiring information about these opportunities. Consequently, at equilibrium the disparity 16 between urban and rural incomes will increase with distance from urban centers' (p.687; op. cit.].4 In a pioneering attempt to synthesize von Thunen and the UI hypothesis, Katzman (1974) contends that, "To the extent that spatial differences in prices, wages, and interest rates reflect transfer costs related to distance, the UI hypothesiB is not only compatible with the von Thunen paradigm, but clearly within its tradition. Costs of migrating and commuting and regional interest rate differentials are obviously of this type" lp.687; op. cit]. However, the UI hypothesis differs from von Thunen in its emphasis on market imperfections associated with developments of small towns in rural areas which the simple von Thunen formulation ignores. But as Katzman argues, "... one of the theoretical offsprings of the von Thunen paradigm, central place theory, reaches rather explicit conclusions about market structure which are perfectly consistent with the UI hypothesis: the number of enterprises engaged in the marketing of any good is proportional to the size of the market center; and the scale of enterprise will increase with an improvement in transportation or in the per capita income of the area served, [p. 688; op. cit.]. Thus, "... while the UI and von Thunen paradigms are concerned with somewhat different aspects of reality, both have something to say about spatial variations in factor proportions, labor productivity, and yields. For example, while von Thunen would explain the use of fertilizer in the more accessible areas by higher location rents, the UI might explain this by access to more perfect current input markets or perhaps by greater exposure to centers of innovational diffusion and modern ideas" (p. 688; op. cit.). Katzman's analytical formulation of von Thunen is somewhat similar to that developed by Muth. It incorporates the UI hypothesis and performs a test to distinguish between the two. He first formulates the von Thunen paradigm in a non-spatial neoclassical framework. Assuming profit maximization and specific functional forms for the production functions, optimal output, optimal input use, 4International evidences [Williamson (1965)] suggest that such a disparity in aggregate and per capita income growth across regions may very well exist. 17 input intensity and yields are obtained. The spatial feature is added to this framework by assuming a transportation cost function, increasing with distance at a decreasing rate. Comparative static results are obtained for: (1) increase in demand; (2) improvements in transportation technology and (3) changes in factor productivity. An increase in demand increases the price at the market center, and thus, extends the frontier. At every point within the frontier, rents, intensity of land use, and yields increase. However, if the supply of labor is not assumed to be perfectly elastic, the results would be somewhat different. "An increased price raises the marginal revenue product of labor at every point within the original circle of cultivation. The availability of empty land within the expanded frontier, moreover, offers a high marginal physical product to labor, which induces some migration into this empty ring from the inner circle. At equilibrium, the labor-land ratio, yield, and rent within this circle will be lower than before and the marginal physical product of labor higher, raising wages even further."[Katzman, op. cit., p. 686]. Improvements in transportation technology reduce per unit transportation cost which is reflected in a flatter price gradient from the center. The frontier expands and at every point beyond the market center, rents, land intensities, and yields rise, as does total supply. Wages will increase (decrease) if the elasticity of demand is greater than (less than) unity. On the other hand, the rent gradient would be flatter if the demand elasticity is unity. Neutral technical progress raises the rental gradient, the intensity of land use, yields, total supply and extends the frontier if the price elasticity of demand is infinite. Hicks-neutral technical progress has zero impact on all relevant variables if the demand elasticity is unitary [for details, see Katzman (1974)]. Katzman provides evidence that the von Thunen and UI yield identical results; the incorporation of the UI hypothesis strengthens von Thunen arguments. In his final remarks, Katzman concludes that, "To the extent that spatial variations in commodity and factor prices reflect transfer costs, the UI model 18 logically reduces to a von Thunen model. The UI paradigm genuinely differs from the von Thunen in its emphasis on market imperfections associated with monopoly and monopsony in rural areas dominated by small towns" [p. 694; op. cit.]. Muth's analysis, a classic presentation of von Thunen world, has shown the importance of rural land conversion into urban uses and some of the critical factors behind such process. On the other hand, Katzman presents a combined von Thunen/UI hypothesis that brings out the links between agricultural and urban development. Their major concerns have been the spatial structure of agriculture and market organization. One can deduce some results about the effects of urban expansion on rural sector output and employment, but these are somewhat restricted by the partial equilibrium nature of the models and by the use of Cobb-Douglas technologies that unduly constrain the elasticity of subsitution among the inputs to be unitary (in particular, the elasticity of subsitution between land and other inputs). In more general terms, expansion of urban sectoral activitieLs leads to an intensive use of agricultural lands. The extent of land-use intensity declines as the distance from the market town or urban center increases. Whether the total agricultural output declines, increases, or remains constant depends on the degree of increase in land-use intensity and the extent of expansion of urban sector activities (or, conversely, by the loss of agricultural land). It hinges on whether the loss of production of agricultural commodities due to loss of land exceeds or not the gain due to increase in land-use intensity. However, the more relevant question is whether these changes benefit society at large. The answer to this requires evaluation within the framework of welfare economics,. with the quantification of social gains and losses from both urban and rural activities. It should also be noted that these studies do not consider the issue of land quality, and its interrelations with the intensity of land use and land yield. These kinds of questions will be important in the empirical studies which try to quantify the magnitude of the physical expansion of the urban sector and the associated effects. 19 While the previous discussion of land conversion focuses on the physical aspects (physical conversion as well as intensification) as a result of urban pressure and to overall population growth, indirect effects, however, have not been considered. Indirect effects, which result from mixing residential, manufacturing-urban related activities, and agricultural uses of land, can be categorized as: regulatory, technical, speculative, and market effects (see Andrews and Chetrick (1986), Gardner (1977) and Lopez et. al. (1988)]. i) Regulatory effects appear as a consequence of urbanization. The increased pressures on agricultural land that follows urbanization often lead to regulations designed to force farmers to internalize some of the negative externalities generated by the use of chemical fertilizers and pesticides. ii) Technical effects relate to increased costs in agricultural production due to proximity of urban areas. A common form of this, as reported by Lisansky (1986) and referred by Lopez et. al., is vandalism at the suburban fringe, which affects farmer's costs through destruction of farm equipment and machineries [Lopez et. al. (1988)]. Also, farmers may lose a substantial amount of managerial resources in order to acquire inputs when agricultural production is organized sparsely, as iB the case in fringe areas of some cities. It is interesting to note the contrast with Schultz' UI hypothesis, who argue that proximity to urban centers will favor agricultural activities exactly because, in some sense, it facilitates management. Both effects of course may be observed and the net impact is an empirical question. iii) So called speculative effects induced by proximity of urban centers (i.e. urbanization) distort agricultural production decisions. Farmers may be reluctant to invest in capital intensive new technology or other fixed farm-related improvements because the opportunity cost of land increases as a result of high demand for land by urban developers. Land assumes the role of a financial asset, rather than a productive asset. This is called "impermanence syndrome" which makes farmers reluctant to maintain and replace farm machinery, drainage systems, and other farm infrastructure (see Lopez et.al (1988)]. These speculative effects may become very important in countries with relatively high 20 land scarcity, irrespective of their stages of development. As the UN (1987b) reports on Dhaka (Bangladesh) City observes: "In recent years, in spite of concern over protecting agricultural land, the conversion of land around Dhaka city has been occurring at a rapid rate, mainly because it is more profitable for small farmers in the area to sell off their land and move to the city. That is chiefly because rent for housing has risen much faster than the price of food, whereas wages in agriculture are less than one quarter of wages in other sectors. To compound the problem, there has been intensive speculation in land in recent years by individuals, housing companies and co-operatives, and especially by Bangladeshis working abroad. Because of the lack of alternative opportunities for investment and the fact that land is regarded as a secure hedge against inflation, roughly one third of the remittances of expatriate workers have been used to purchase land" [p. 20]. iv) Finally, market effects occur because suburbanization brings markets closer to the farm activities and thus reduces the transportation costs. The locational advantages make farmers more competitive and even allow them to directly market their products to consumers. This may result in higher farmgate prices (Katzman (1974)]. In addition, urbanization may affect the user cost of land mainly through property taxes and capital gains from increased land value. Lopez, Adelja, and Andrews (1988) evaluate the indirect effects of urbanization on the profitability of farming in the state of New Jersey, United States. They specify a normalized variable profit function, where farmers are assumed to produce multiple outputs using variable inputs and are affected by non price exogenous variables. Variable inputs are labor, capital, land, and intermediate inputs. Non price exogenous variables are: (a) weather; (b) technological change; (c) index of suburbanization [measured by population]; and (d) index of speculative pressure on land [measured by the ratio of the average value of land in New Jersey to the U.S. average]. The model was applied to aggregate time-series farm sector data for the state of New Jersey for the years 1949 to 1982. Four groups of commodities were considered: vegetables, fruits, grain crops, and livestock. The results suggest that there were both positive and 21 negative effects of suburbanization. The effect of land conversion was confirmed by a negative and highly significant coefficient of the variable measuring suburbanization on the (derived) demand for land. The existence of speculative effects was shown to reduce the use of capital. Results of market effects suggest that urbanization increases the farmgate prices for all commodities (except livestock) and reduces the procurement price of variable inputs. Technical, regulatory, and speculative effects, all found to affect output supply and input demands negatively, except for labor. Among the commodities, vegetable production is the only subsector to benefit from urbanization, while livestock production is the most adversely affected. Studies of Land Conversion in the United States Two early attempts to quantify loss of agricultural output and employment are due to Robin Best (1968) and John F. Hart (1976) for the Uhited Kingdom and the United States, respectively. Both show that the total amount of rural land lost due to urbanization in these countries has been very small. Concerns over this issue have been echoed in writings of other authors (see Raup (1975), for example]. However, as Vining, Plaut and Bieri (1977) have argued the focus on the loss of total rural land due to urban expansion is misplaced. Instead of considering total rural land, which includes all lands that are not under urban uses (i.e., arable, non-arable, lands under forestry, etc.), one should consider the loss of "prime" agricultural lands [Class I and II soil quality] to expansion of urban activities. Approximately 384 million acres of land in the United States fall in this category (one fifth of its land surface, excluding Hawaii and Alaska), of which around 250 million acres of land are regularly cropped. As Vining et. al. argue, any study concerning rural land conversion should focus on the loss of prime agricultural lands, rather than total rural land, since that is what possibly has the most significant implications for the national economy. Very often, one observes that urban activities develop in prime agricultural land. Mumford's (1956) observation on the United Kingdom is 22 instructive, " ... though the amount of land occupied by cities, 'built-over land,' is low (2.2 percent) in proportion to the entire land area of the British isles, this is more than half the area of 'first class' land available for agriculture and is a tenth of the 'good land' available." (p. 3941. Similar trend is also observed in the United States [see Vining et. al. (1977)]. This observed correlation between the locations of prime agricultural lands and urban activities is not implausible. There are good economic reasons to explain it. The history of old cities (mostly, those in Europe) suggests that marketing of agricultural commodities was the reason behind their emergence. Population densities in present-day Europe were largely dominated by the pre- existing agricultural density in the 18th century (Losch (1954), and Clark (1975)]. European ex-colonies (mainly those from Latin America and Asia) fit this pattern as well since their role was to supply raw inputs (e.g. cotton, spices, etc.) to facilitate the European Industrial Revolution. Dillman and Cousins (1982) point out that, "Economic growth theory, historical experience, and casual observation of present land use economics lead us to believe that a high degree of correlation exists between the location of prime lands and human settlement. The first inhabitants of newly settled areas select sites based on several optimizing factors. Because there is always some degree of isolation from the rest of the world, settlers often depend upon their own production of food and fiber for subsistence. Thus many of the initial location factors are based upon ideal agricultural production and distribution." [pp. 285-2861. The existing transportation as well as construction technology, in addition to agricultural density, and therefore, costs involved in transportation, communications and other city infrastructure, might have played an important role in determining the location of those early cities. "It is cheapest to construct transportation networks along such courses (flat plateau), airports require large acreage of flat land, and water impoundments and water and sewage treatment plants are located on streams. Shopping centers, industrial sites, schools, trailer parks and other large consumers of land tend to locate along these corridors, (i.e., corridors of flat land) because construction costs usually necessitate 23 construction on sites with minimal slopes. Sites which have already been cleared and are relatively level are preferred" [Dillman and Cousins (1982), p. 286). This hypothesis was tested empirically, by Vining et.al. (1977) in their pioneering research on the United States. Using data for the years 1958-67 and 1967-75,5 they seek to answer the following questions: "(1) Is prime farmland of the United States predominantly located in the vicinity of its urban areas, as it appears to be in the longer settled nations of Europe; (2) are the areas of high population growth predominantly the areas with high concentrations of the good soils; and (3) what is the best available estimate of the rate of loss of prime farmland to urbanization in the United States, and how reliable is this estimate?" (pp. 145 - 146]. In order to answer (1) and (2), they suggest to take counties that fall within a 50-mile radius of the largest 100 urbanized areas of the continental United States. In order to avoid overlapping between counties, they suggest to shade in the counties that fall within these circles. Since a circle of 50 miles radius covers an area of 5 million acres, they select the counties that overlap each circle in such a way that the total shaded area is approximately 5 million acres. The shaded areas contain 20 percent of the land area and 50 percent of the built-over land. Using this method, they find, "a disproportionate share (28.4 percent) of land in Soil Capability Classes I and II. While 18.1 percent of the nation's rural land is in Soil Capability Classes I and II, 27 percent of the rural land within 50 miles of the 100 largest urbanized areas is in these classes. Furthermore, this bias appears to be invariant across the different size classes of urbanized areas" [p. 147; Vining, et. al.]. Unable to determine the rate of the conversion over time, due to lack of data, Vining et. al. had to rely completely on SCS reports. According to the SCS estimate (based on 1967 and 1975 survey), prime farmland is converted to urban uses (750,000 acres of Class I and 5 Data were prepared by the Soil Conservation Service (SCS) of the United States Department of Agriculture (USDA). The methodology of data collection, quality of data, and since the release of National Agricultural Land Study report, the interpretation of those data have come under serious attacks, especially that of 1967 and 1975 (see Raup (1975), Fischel (1982), and Simon and Sudman (1982), among others]. 24 II a year, between 1967 and 1975) at twice the rate at which land in general is being converted and three times the rate at which non-prime rural land is being converted (i.e., a rate of .2 percent a year or 1 percent every five years). Since for every additional acre urbanized, another acre is sterilized in some manner, either inundated by water, strip-mined, put into buffer zones, or simply unusable due to housing developments [Dideriksen and Sampson (1975)], the U.S. could lose around 12 percent of its prime farmland in 30 years, an acreage nearly equal to the amount of prime farmland not now in cropland but with medium to high potential for conversion to cropland [see Vining, et. al.]. Note also, the SCS estimates of loss of total rural land (2.1 million acres a year) is 75 percent higher than the average loss (1.2 million acres a year) reported by Hart (1976). In order to explain the modest correlation between loss of prime agricultural lands and the expansion of urban activities, Vining et.al. incorporate migration trends in different regions of the United States. Assuming a stable relationship between density of an area and the fraction of its land built over, Vining et.al find that, " ... it is not the redistribution of population from high density to low density counties that is causing this large increase, but a higher rate of consumption of rural land for urban purposes at all densities" [p.153]. Despite data limitations, the study suggests that a moderate but significant bias in the location of urban population near prime farmland of the United States. Holding all other factors constant, prime farmland is more likely to be urbanized than other land as the population expands geographically. The moderate correlation found in the study is not explained by migration trends, but rather by the general increase in population and overall density. This comes as no surprise, since [Vining and Kontuly (1978)] net migration in the core regions of the United States and in the more developed counties has been declining. A major research effort on this topic was made by the National Agricultural Lands Study Commission (NALS). NALS was established by the Secretary of Agriculture and the Chairman of the Council on Environmental Quality (CEQ) in 25 June, 1979 to study the amount of rural land loss in the United States and its effects on the national economy. The report was submitted in 1981. The NALS study expressed serious concerns over the loss of food and fiber production in the future, given the rate of conversion prevailing at the time. The basic argument favoring prohibition of conversion at the national as well as at the state level is summarized in Fishchel (1982), "In the 1970s two events made urbanization a serious problem. First, the dramatic rise in world grain prices and the accompanying increase in U.S. exports eliminated the excess capacity that characterized U.S. agriculture since World War II. Second, studies by the Soil Conservation Service indicated that there was a quantum leap in the rate at which rural land was being converted to urban and built-up use. Projecting these trends into the next century suggests that unhappy consequences will follow: The U.S. will not have enough farmland to meet world demand, at least not at 1976 real prices" (pp. 237-238]. Data presented in the NALS Final Report indicate that the rate of conversion of rural land to urban, built-up, transportation, and water uses accelerated from 1.8 million acres per year during 1958-67 to 2.92 million acres per year during 1967-75. The effects of this conversion were readily translated as shortages of land for production of food and fiber, given the present trends in domestic and export demands. There are six estimates, assuming constant price and different trends in supply and demand, which report shortages of land. The first projection was made by the Department of Agriculture as required under the Soil and Water Conservation Act (RCA) of 1978. RCA forecasts that given average annual growth in total demand at 1.3 percent rate (0.8 percent in domestic and 2.3 percent in export demand), additional cropland required (compared with its 413 million acres of 1977 base) in the United States would be 26 millions of acres in the year 2000. Resources for the Future estimates these figures under two different scenarios, with prevailing EEC policies and with trade liberalization in the EEC, as 37 and 71 millions of acres, respectively. On the other hand, NALS study reports, with low, mid, and high-range projections, additional land (compared to its 294 million acres of 1980 base) that would be 26 required is, 77, 95 and 113 million acres in the year 2000 [for details on these projections and discussion, see Brown et.al. (1982)]. All these projections may have overstated the actual requirement of land since they assume the prices of food and feed grain will remain constant from 1980 to 2000. Allowing price to vary would relieve some burden that has been placed on the land as the residual equilibrating factor in the food and feed grain market [Brown et. al (1982)].6 Thus, one may expect that land now used for grazing cattle will be shifted into crops and more livestock will have to be fed higher-cost feed grains. This might spill over into other markets as well, for example, higher meat price will lead to a lower demand in the meat market. Furthermore, most of the available measures of land-supply elasticity have severe limitations. As a result, figures on growth of supply in general, and growth in yield,7 in particular, that have been used in these projections might have some serious problems. The Final Report of the NALS study recommended that the President or Congress should adopt farmland preservation as a national goal, to make federal agencies adopt policies to reduce their impact on prime farmland, and to encourage state and local governments to enact comprehensive growth management programs to contain urban development. The loss of production of food and fiber due to the farmland conversion in the United States has been at the center of NALS' argument; surprisingly enough, other reasons, such as creation of negative externalities associated with urban development (e.g., congestion, pollution, etc.) and loss of positive externalities (such as clean air in open space, etc.) with the loss of farmland have not played any significant role in the NALS report [Fischel (1982)]. This has been the case, most likely, given the narrow focus of the NALS study, and furthermore, the lack of a complete framework within which one can take into account both the cost and benefit aspects of urban development 6 However, as Brown et. al. (1982) have noted the actual prices are likely to rise, dampening the increase in demand and reducing the additional cropland required [Brown, et.al. (1982)]. 7NALS study uses projected annual increase in crop yields of 1.5, 1.25, and 0.75 percent for low, mid, and high range projections, respectively. 27 in a more complete way. As Fisher (1982) succinctly puts it, "Because unrestricted development imposes losses on farmers does not mean that restrictions on development (which preserve farmers' wealth at the expense of future home-buyers) represent a gain in efficiency; the externality is reciprocal. Defining the farmland conversion issue as a problem in externalities generated by certain development patterns places certain rights (to farm, to breathe clean air) above other rights (to build homes on cheap development sites, for example)" [p. 254]. Due to inadequate analytical framework, poor data, and methodology adopted, NALS study could not resolve the issues clearly. Consequently, the debate still centers around emotional issues, rather than on economic grounds. Farmers' 'rights to farm' has been given 'emotional emphasis' at the neglect of good economic analysis. Studies for Developing Countries The trend in urbanization has been different for developed and developing countries. A comparison between the trend in developed countries [Vining and Kontuly (1978)] and developing countries (Vining (1986)] suggests that while the large cities in the developed countries are experiencing net out-migration, in most developing countries they are still experiencing high and, in a number of cases, increasing rates of net in-migration. However, both of these trends are believed to reduce the amount of farmlands. Net migration into core areas would lead to urban sprawling, where net out-migration from the cities is associated with the development of secondary cities; both processes causing some sort of encroachment over the previous agricultural or farmlands. A long-standing view in the urban development literature has been that countries experience a kind of lock-step spatial evolution as their economies industrialize - with core regions growing larger at the expense of peripheral regions until a high level of economic development is reached, at which point the exhaustion of this process sets in rather quickly. Evidence to this account has 28 been provided by Williamson (1985), Wheaton and Shishido (1981), among others. Critchfield (1981), on the other hand, has argued that there are countries which do not follow this pattern. Countries such as India, Indonesia, Sri Lanka, Egypt, Pakistan, Bangladesh, and China, which together account for more than 60 percent of the developing world's population, have relatively high rates of population growth and urbanization. However, their low level of industrialization raises the question of whether they would ever attain sufficient scale to lift a significant proportion of populations to income levels high enough to initiate the process of deconcentration8. Biased urban and industrial growth strategies (see Lipton (1977, 1984)], together with the neglect of the agricultural sector characterize most of these countries and have resulted in massive in-migration to the core cities (Vining (1986)]. For example, the rate of net migration to the region containing and surrounding the capital city of Indonesia, Jakarta, is high and increasing. The urban sprawling which results in encroachment on agricultural land has also been reported by Vining (1986), "Jakarta city itself, or DKI Jakarta, experienced a decline in its rate of net immigration, but this appears to be simply due to the spread of Jakarta beyond its administratively defined boundaries. Jakarta plus the surrounding districts of Bogor, Bekasi, Tanggerang, and Serang have experienced a significant increase in their aggregate rate of net migration between the periods 1961-71 and 1971-81" (p. 10]. In addition to this migration, natural growth in urban and rural population has severe consequences on the availability of farmlands. As reported by a World Bank Country Study on Indonesia [World Bank (1990)J, " ... both rural and urban population increases are causing the conversion of prime agricultural land to residential use. Despite Java's slow rate of rural population growth and declining share of national population, its rural population is expanding by about 150,000 new agricultural households per year. " ... this means declining farm sizes and increased landlessness" [p. 45]. The magnitude of this conversion in Java, Indonesia, is 'However, there is conflicting evidence on this account. BMW has shown, as we have discussed earlier, that the Indian urbanization pattern does match with that of conventional wisdom. Vining's (1986) findings, to a large extent, do not confirm Critchfield's thesis. 29 approximated in the Country Study report as well, "... so intense is land pressure in Java that the need for house-lots alone is estimated to require the conversion of some 10,000 ha of agricultural land per year. The Indonesia National Urban Development Strategy Project (INUDS) has calculated that Indonesian cities will also expand by 376,000 ha between 1980 and 1995, of which 222,500 ha would be in Java. Thus, Javanese cities are expected to expand by about 15,000 ha per year. Roads, industries and other uses are expected to increase total land conversion to 40,000 ha per year" (p.45]. However, these calculations may have been seriously understated as most of them do not take into account the effects related to temporary settlements, for example, those related to seasonal and circular migration (UN (1989)]. Concerns over farmland conversion due to urbanization pressure and natural growth of population have been expressed for other countries as well. The Dhaka Metropolitan District in particular, and Bangladesh economy in general, can be classified as another example of land-scarce economies. The city of Dhaka is bounded on the west and south by the flood plain of the Burhi Ganga River and on the east by the flood plain of the Balu River. Both areas are flooded (1.5-4 meters) for up to four months of the year. Most of the land above the flood line and within a reasonable distance of the central core is either already in urban use or is of high agricultural value (see UN (1986)].9 The need to manage conflicting goals of the urban and rural sectors, under these circumstances, very often lead to confusing and ad-hoc policies. "Competing demands for the scarce supply of non-flood-prone land are difficult to resolve. The municipal authorities are concerned with providing land and shelter for a population whose residential location options are severely limited by the inability to pay for 9Note, such topographical constraints can severely limit the urban development and may have severe consequences on the available 'usable' farming land. Another example of urban development under topographical constraint is Kathmandu, Nepal. Types and nature of urban development under topographical constraints, unfortunately, have not given much attention in the literature. For a discussion, see "How Topography, Land Use Regulations and Infrastructure Affect Urban Land Supply: An International Comparison: A Research Proposal," Urban Development Division, Infrastructure and Urban Development Department, The World Bank, May 1991. See also, Rose (1989). 30 public transport. At the same time, there is an urgent need to ensure an adequate food supply for Dhaka City's rapidly increasing population, which grew at an average annual rate of 8 per cent during the most recent intercensus period (1974-1981). In recent years, in spite of concern over protecting agricultural land, the conversion of land around Dhaka City has been occurring at a rapid rate, mainly because it is more profitable for small farmers in the area to sell off their land and move to the city" (UN (1986), p. 20]. "Because the main bidders in the urban land market in Dhaka City are expatriate workers and the well-to-do, market prices of land have risen about 40-60 per cent faster than the prices of other goods and services and are now completely out of line with per capita income levels" (UN (1987b), p.203.'0 In their comparative analyses on characteristics, problems, and policies in Asian mega cities, Brennan and Richardoson (1989) have corroborated the observation relating to pressure on land, "In some cities, this price increase is partially explained by special circumstances, such as the absolute scarcity of land not subject to flooding (Dhaka), purchases by nationals returning from working in the Middle East (Karachi and Dhaka), or the existence of a large greenbelt (Seoul)" (p. 1221. Furthermore, "The land supply problem is independent of the type of ownership, it is as severe in cities where much of the land is publicly owned, such as Karachi (about 80 percent) and Delhi, as in cities where most land is privately owned such as Bangkok, Manila, or Seoul. In all cases, the price of land has increased much faster than the consumer price index, exacerbating the difficulty of acquiring land for low-income housing" (p. 122]. This trend is also supported by other researchers. Dowall (1989) reports on Bangkok Metropolitan Region (BMR), "The strong growth of the region's population and economy is clearly reflected in the changing patterns of land use. Between 1974 and 1984, approximately 32 square kilometers of land were converted 10For example, as UN (1987b) reports (footnote E 6; p. 36), "As of 1984, prime residential land cost Tk. 12 million per acre within Dhaka City and as much as Tk. 1.8 million per acre on the urban periphery." It may be worthwhile to point out in this context that the GNP per capita for the Bangladesh economy stood as low as $170 per annum ($1 = Tk. 35 approximately) with an average growth of 0.4% per annum [WDR (1991)]. 31 per year from rural, largely agricultural uses to urban activities. By 1984, the urbanized area of the region was 1,304 square kilometers, accounting for 17.1 percent of its total land area. In the Bangkok Metropolitan Area, 855 square kilometers were urbanized in 1984, accounting for 54.5 percent of the total land area. If present trends continue, the urbanized area of metropolitan Bangkok will expand by 512 square kilometers by the year 2000, an increase of over 40 percent" (pp. 3-4]. Due to the initial development at the center of the metropolis, the secondary development is taking place at the outer distance. During the decade 1974-84, most of the conversion took place within 11 to 20 kilometers from the city (45.2% of total land converted into urban uses), it spread further away between 1984-88 (e.g., 45.4% of total land were converted into urban uses) (see Dowall (1989) and Tables 1 and 2 in Dowall (1990)]. This pattern is emerging because, "Increasingly, housing development is shifting to outlying areas as well as infill locations. In the future, there will be little infill development as the area within 20 kilometers becomes developed. Vacant land for development is declining in the core area of the city (only 11 percent of the area is still vacant, and much of this land is not developable) [Dowall (1990), p. 15]. This is expected to increase pressure on land in the fringe, "urbanization will clearly shift to the fringe areas....Housing development in these areas will also tend to consume more land as residential plot sizes on the fringe tend to be larger. This will increase pressures on more urban lands in the future" (Dowall (1990), p. 15]. Indirect evidence of land conversion can also be traced in spatial trends in land prices. Dowall and Leaf (1990) and Dowall (1990) for Asian cities, Mohan and Villamizar (1982) for Colombian cities and Ingram and Carroll (1981) for Latin American cities provide relevant information. For example, all these studies report a pattern of "flattening out" of rents which simply reflects the impact of increasing mobility and the decentralization of urban activities. This "flattening out" phenomena would increase the land rent much faster on the outer edges of the city. In their study on Jakarta, Dowall and Leaf (1990) report that, ... at the center of the city, prices (in real terms) increased by less than 32 5 percent per year, whereas in the area of the city between 15 and 20 kilometers, prices increased three times faster -- nearly 15 percent per year. On the edge of the city, the rate of increase of parcels is four times faster than at the center" [p. 11]. The higher price in the outer edge relfects the market pressure for rural land conversion. Not all the authors, however, agree with the view that urbanization may lead to conversion of farmland. Mills (1980) argues that, " ... urbanization does not necessarily mean a reduction in land available for agriculture. Urban population densities in large cities are much greater than in small towns and villages. Thus, the movement of a family from a village to a large city frees more land in the village than it requires in the large city. The difference between the land freed in the village and that required in the urban area is a net addition to land available on which to grow crops" [p. 10]. There are two observations one may cite against the validity of this argument. First, a large portion of the migrants (to the city) come from landless agricultural economic background [for a review of the literature on this issue, see Yap (1978)]; secondly, quite a large portion of are not accompanied by their families; backward linkages are often observed (Shaw (1988), and Gugler (1991)]. Moreover, in economies with high population densities the land freed by one migrant will certainly be taken by someone else. Under these circumstances, 'freeing up' of land does not arise. Mills agrees, however, with the contention that natural growth of population may lead to conversion: "Of course, growth in total population both increases the demand for food and reduces the land available on which to grow the food" [Mills (1980), p. 10]. Research on the technical, regulatory, market, and speculative effects of suburbanization, as previously discussed, originated within the framework provided by von Thunen/Schultz's UI hypothesis. These studies primarily focus on spatial structure of agriculture; that is, intensity of land use and yields in concentric circles from the market or urban center, the place where urbanization begins. Generally speaking, they have been interested to explore the impact of differential rates of growth of urban-industrial development on productivity of 33 agriculture and income differences among areas [Hyami and Ruttan (1985)]. The impact of urban-industrial growth on agriculture takes place through the interaction between intersectoral factor and product markets. Research have been very limited and, to a large extent, taken place in the context of developed countries. Two important exceptions are Nicholls (1969) and Katzman (1974). The latter tested the von Thuenen/Schultz' UI hypothesis in two regions of Brazil. In broad terms the results support the hypothesis of those theories. One important question related to these studies, both at the theoretical and empirical levels, is that they are cast in a context of a non binding total supply of land. This may have been a good approximation for the frontier type analysis done by Katzman in Brazil, but it certainly is not applicable in other situations. In particular, these frameworks can not be directly implemented in the case of severely land-constrained countries as is often the case in Asia. Unlike the studies on the issues relating to land conversion in the United States, the available studies on the less developed countries, as we have discussed earlier, examine the issues rather indirectly by investigating the effects of an urban center on the structure of agriculture, i. e., intensity of land use, yield from production and other market effects (e.g., effect on product price). Few conclusive statements can be made from these studies about the nature of land conversion and subsequent effects on the national economy as a result of creation and expansion of an urban center. Casual observations and or very preliminary data suggest [as reflected in UN Policy Papers, Indonesia Country Study Paper, and Dowall (1989, 1990)] that it is likely that rapid population growth together with increased urbanization (in particular, countries from Asia and Africa) create high pressure on land in both urban and rural sectors. The growth in urban economic activities generates an increased demand for space, for productive activities as well as for housing and related urban services. observing this trend emerging, investors (whether they be commercial or simple households concerned about a future home site), begin bidding up the price of land beyond the capitalization of rent it currently produces. The expectation of higher future rents, in other words, is capitalized back into purchase values. 34 This phenomenon itself reinforces the rise in prices, and increases the concerns of all potential purchasers that land will be more costly, in real terms, than it is now, so the temptation to enter the market as early as possible increases [Doebele and Hwang (1978)]. For those who can not afford to enter the land market at the center, distance provides the trade-off. Moving away from the center of the city allows these households to afford land and housing within their ability to purchase albeit at a higher transportation cost." IV. Government Interventions in Land Markets: TvDes. Rationale, and Effects Government interventions in land markets are very common, both in DCs and in LDCs. Urban land policies and land-use policies have been pursued over the last two decades quite extensively in order to raise productivity in the cities and to ensure a balanced growth pattern. 12 On the other hand, rural land "Trade-off between transportation cost and land rent would yield a rent- gradient function (Alonso (1964), Muth (1969), Mills (1972a), and Henderson (1977)] which declines with distance. This relationship is found to be valid for less developed countries as well [Millo (1972), Mohan and Villamizar (1982), Ingram and Carroll (1981), Dowall (1989, 1990), Dowall and Leaf (1990), and Dowall and Treffeisen (1990)]. 2Regional income inequality has been, very often, the argument to promote balanced regional growth (see Williamson (1965), Rondinelli and Ruddle (1978), Griffin and Khan (1978) and Friedman (1981)]. Such imbalance has occurred, as many of these authors argue, due to concentration in one or in only few major cities. For example, about 35 percent of the population in the Republic of Korea lived in Seoul and the greater metropolis during the late 1970s and 1980G and nearly half of all factories were concentrated there. The Calcutta Metropolitan District (the city of Calcutta and surrounding districts of the state of West Bengal) with 19 percent of the state's population contains 82 percent of the state's total industrial units, generates some 88 percent of total employment and one quarter of its income. Calcutta city with one sixteenth of the state's total population generates about one sixth of it's income. This disproportionate concentration of population, economic activities and social infrastructure in the core regions is also found in Bangladesh, Burma, India, Indonesia, Pakistan, Philippines, and Thailand [Rondinelli (1990)]. But the regional income inequality argument has been criticized both at the conceptual level [Tolley (1987a)) and at an empirical level [Henderson (1980)]. For example, Tolley (1987a) has argued that the nominal income as a measure of sectoral well-being is inappropriate. In most studies, nominal differential is used as a proxy for difference in well- being. On the other hand, using cross-sectional data, Henderson (1980) has pointed out that there may not be any income inequality at all. His evidences suggest that differences in regional per capita income do not reflect differences in opportunities for any individual, but rather regional differences in labor- 35 policies have also been justified on the grounds of increasing agricultural productivity and improvements in the distributions of income and wealth. However, they have been followed in isolation to guarantee sectoral goals. While some recognition [e.g., Renaud (1978)] has been given to the sectoral linkages, by and large, they remain purely sector-specific. The Role of the Government Land's critical role in society, both from an economic point of view and from a political point of view, is a fundamental motivation for government interventions in land markets. However, the literature does not provide a rigorous theoretical discussion pinpointing possible market failures to justify intervention. Lichfield (1990) and UN (1976) list some reasons for intervention, but the arguments do not have sound economic underpinning. The discussion in UN (1976, p. 61-70) indicates that "Land resource management" is one reason for intervention becauses 'Land is a scarce resource whose management should be subject to public surveillance or control in the interest of the nation." Nonetheless, there may exist market failures that justify the involvement of the government in land markets. In what follows, we present a list of some points that require addtional research, focusing on the operation of market forces in the process of conversion of land from rural to urban uses. a. Food security: Many LDCs, specially the poorer ones, depend on imports for a significant share of their food consumption. Quite often they also face severe foreign exchange constraints because the lack of diversification of their economies and of their small export sector. Domestic food shortages may occur in the event of shocks due to weather calamities or sharp increases in international food prices. It may be possible, taking this risk element into account, that a reduction in the rate of land conversion can improve the overall food security of the country, specially in view of the fact, noted earlier, that force composition and in the cost-of-living. 36 there is a land quality bias associated with urban expansion. This however is only a conjecture at this point. Research both at the theoretical and empirical levels is needed to provide an assessment of the relevance of this conjecture. b. Externalities: Positive and negative externalities generated by urban growth can provide a rationale for interventions in the land markets in the fringe areas. External effects may be defined as unpriced or improperly priced effects emnating from production or consumption activities that impinge on the welfare function of third parties [Mishan (1976)]. For example, production of manufacturing goods in the urban sector may cause negative externalities in the consumption of urban residential households (e.g., pollution and noise). If located in proximity to agricultural activities, they may cause damage to production (pollution and congestion). Farming activities, on the other hand, may also give rise to negative externalities in the consumption of households (nuisances such as odor and use of pesticides). Recently, environmental costs, emnating from production (in both the urban and rural sectors) and consumption activities, have come to occupy an important part of the debate on public regulations and control. There could be positive externalities as well. For example, open-space associated with rural and agricultural activities. Naturally that the types and nature of externalities depend on location, preference structure, interactions and dependency among participating agents' preferences and objectives and types of goods involved. Regulations in different forms, if properly placed, force some external costs back on the producers and consumers. Proper internalization may limit the divergence between social optimality and outcomes that arise from unregulated private decision processes. However, establishing that externalities exist may not automatically imply a departure from Pareto optimality and justify government actions. It depends on the existence of adequate markets for negotiating contracts. Mills (1977) argues that the problem of understating preference (and thus, free-riding) for public goods is genuine, but it is not necessarily solved by the government taking reponsibility for ensuring their optimum production. Frequently the transaction costs of arranging private contracts are very high or markets to deal with 37 externalities do not exist, and thus governement should intervene. The cost of negotiating private contracts for public goods might be insurmountable. Two of the many costs which are often not fully internalized are pollution and congestion. In any event, the existence of unnegotiated and uncompensated external effects are examples of market failures in land allocation and sometimes can justify social actions.13 The rationale for government interventions under these circumstances is that government transaction costs are less than private transaction costs and the fact that governments can use coercion. Mille (1977, p. 10) argues that, "Although coercion is an unpleasant notion, one should not underestimate how much cheaper it is to make public goods decisions using some coercion rather than none." c. Environment degradation in LDCs has been a concern of local governments and of the international community. Expansion of the urban sector over agricultural land (quite often prime agricultural land) can contribute, in land scarce economies, to intensify the process of environment degradation not only through deforestation but also by increasing soil losses (erosion) due to more intensive cultivation. The social valuation of environmental degradation tends to be higher than the private valuation, requiring government actions to assure an "optimal" exploitation of natural resources. To the extent that the rate of land conversion is an important link in the process, government intervention to curb it may lead the economy through a less distorted path of exploitation of its natural resources. d. Asymmetric Information often arises in the land market, specially in the fringe areas of developing countries. A commonly held view is that speculation distorts resource allocation and is detrimental to the functioning of the land market, specially in the fringe areas (for example, because of the 'impermanence syndrome'). However, in situations where information is evenly 131t is very unlikely that markets to handle externalities are mature or even in existence in less developed countries. Whether this is due to excessive government actions nullifying individual incentives or due to enormous transaction costs is a matter of debate and requires clear understanding of the institutions, its goals and consequences of policies. 38 distributed, speculation is a legitimate economic activity, that transfers risks for those most apt to deal with it. In the land market it can possibly affect the pace and timing of conversion. The impermanence syndrome is not a consequence of speculation per se, but of the fact that the expected rental value of land increases due to the expansion of the urban sector. However, speculation when asymmetric information exists favoring urban groups can worsen the income distribution and lead to a more concentrated ownership structure. There are sound equity reasons for government intervention in this case"4. Moreover, in land scarce economies speculation may induce production losses (that is reduced efficiency), specially if restrictions to renting agricultural land exist or if tenure security is a problem (typical second best type arguments)'5. Production losses may take place too if the purchasers of land can not rent it out and do not have adequate knowledge of the agricultural production function, in which case they will select simpler, but often not the most efficient, technologies. e. Irreversibility. The costs of conversion of land's from urban activities back to agricultural activities are often prohibitively high. While promoting new urban areas, LDC governments should keep in mind this aspect of the rural land conversion which has long-run consequences and, so far, has received virtually no attention either in the literature or among the policy makers. This quasi-irreversible nature of city growth over agricultural land gives raise to one possibility for government intervention in a second best context. In a large number of LDCs agriculture is taxed through price policies (see, for example, Krueger, Schiff and Valdes, 1991). These policies will reduce the returns to land and increase the rate of land conversion'4. However, considering that society 14 However, not necessarily by restricting the market process. In this case it may be necessary to improve the dissemination of public information on government projects, which, typically, trigger many speculative actions by urban insiders. '1 Note that tenure security is broadly defined here. It is not a question of whether a 'good' title exists or not. It involves the costs of securing ownership, which may include withdrawing land from lease to avoid a situation where the owner is not the one exploiting it. 16 The reasons for the existence of such distortive policies will not be discussed here. For our purpose it is sufficient to acknowledge their existence. 39 perceives those policies as temporary mechanisms to transfer resources from agriculture to support industry it may be necessary to intervene directly in the process of land conversion. Otherwise, when the time comes for the distorting policies to be lifted, the supply of land for agricultural activities would be lower then optimally desired. It is useful to discuss in more analytical terms the grounds on which some form of government intervention may be justified to reduce or eliminate the process of land conversion. Consider a situation where there are no restrictions on the use of land. In figure 1 the demands for land by the rural and the urban sectors are depicted. The equilibrium in the land market is attained at point A, where the rental is the same in the two sectors (d, = r,). The amount of urban land is OL, and the amount of rural land is LL,, where L is total land availability. Suppose now that a tariff is imposed on the goods imported by the urban sector to increase revenue. This raises the domestic price of urban goods and shifts the demand for land upwards, as shown by the dotted curve in figure 1. Land will be converted to urban uses in response to this policy: the increase in land utilization in the non agriculture sector is L2 - L,. The rental value of land increases to d,. In the new equilibrium, however, the social marginal value of land to the urban sector is higher than the private marginal value. The latter is, of course, d2, while the former is the rent corresponding to point C in the figure, which leads to a deadweight loss, w, measured by area ABC. If the tariff is maintained for, say t years, and then eliminated the present value, at interest i, is given by the expression on the right hand side of equation (*) below: T C =~~ w _ w _ _ _ _ TC = E w = WX (l+i) t_1x (*) 1 (1+1)n i The deadweight loss, however, can be greater if at the time of the removal of the tariff (when the additional revenue is no longer needed) the quantity of 40 IJc~~~~~~~~~~~~~~~~~~ 0 ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ d - Q a Q '~~~~~~~~ _ 3 t, UX ~~~~~~~~ 6 ss I _ S >,';'''M~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ ~~~~ I r . ~~~~~~~~~~~~~~~~~~~/ ,\ s ADD~~~~~ l~~~~~~~~~~~~~~~~~~~~~~~~~~~~ I-~~~~~~~~~ / land in urban uses remains unchanged. For example, suppose that due to extremely high costs, land is never converted back to its best alternative use in agriculture. In that case, the deadweight loss caused by the temporary tariff is (w/i) . However, if this is the case and if the government sees the tariff as a temporary instrument to raise revenue, it Is better, at the time the tariff is introduced, to also adopt policies aiming to restrict or impede land conversion. If for example, the government imposes zoning restrictions not allowing the urban sector to use the additional land, there will be no loss in efficiency in the allocation of land. The urban rent increases to d3 while the agricultural rent is still r,. The difference persists as long as the tariff and the zoning restrictions are effective. This analysis rests on the assumption that the government can enforce the zoning laws at negligible costs. If the costs of enforcement per period are lower than w, a policy such as this will increase efficiency, otherwise not. While this simple representation is useful in laying down the fundamentals of the problem, there are additional complications. For example, at the same time that land is moving from agriculture to industry in response to the tariff, it is likely that labor and capital will go in the same direction. However, these two factors of production might move back to agriculture more easily than land upon the removal of the tariff. This clearly affects the cost calculations in a fundamental way. Exactly how much capital and labor return to agriculture will depend on a number of factors related to the characteristics of the technology in the two sectors, other "push" and "pull" factors operating in agriculture and non agriculture and also other policies that change the relative returns to these factors in each sector. A satisfactory answer thus depends on a careful accounting of all of these elements. 42 TvpoloQv of Land Markets and Some Common Interventions Urban development in LDCu is, very often, characterized by the primacy structure [see Rondinelli (1990)]. This type of urbanization leads to "urban sprawling". Urban sprawling onto the rural sector activities creates pressure on land. This gives rise to fringe area development and the characteristics of the land market in these areas are usually different from those in purely urban or rural sectors. In other words, since land adjacent to the urban areas is more likely to be converted, the market structure in this area assumes special characteristics. The effects of policies may be different than in pure urban and rural land markets. Fringe areas are, generally speaking, immediate beneficiaries of urbanization as Schultz, Katzman and others have indicated. On the other hand, they are also the prime recipients of the negative effects of urbanization, like negative externalities and the disincentive to make production related investments due to expectations about the potential for conversion, as discussed earlier. In most LDCs, the land market in the fringe areas assumes specific characteristics,17 but policies designed for the rural or urban sectors are often adopted in the fringe areas as well.' Despite the apparent differences that might exist between the rural and urban areas, in one hand, and fringe areas on the other, policies in most of the countries do not seek to differentiate them. Legal, political, economic and financial constraints [Durand-Lasserve '7Low-income residential households in many LDCo tend to live in the urban periphery or in the fringe areas (UN (1986-1989)3. Many of these households live in squatter or slum settlements. Land rights and land-use rights are, very often, transacted informally, if not completely illegally (see Doebele (1990) for a discussion]. Improper property rights to land and land-use are a major constraints for raising productivity (see Dowall (1989, 1990) and Jimenex (1982) for a discussion on positive effects of property/titling rights on urban land productivity; see Feder et. al. (1989) for a discussion on positive relationship between property/titling rights and agricultural land productivity]. "As Doebele (1989) points out correctly, "It is difficult to take a strong position on this theme, since national governments and international agencies have given so little attention to the complex and variegated arrangements that low income people have devised to cope in situations in which no conventional land tenure exists. These intricate informal institutions have, in some cases, been abruptly swept aside in the name of formalizing titles, in the same manner as informal housing has sometimes been swept aside by bulldozers" (p. 11). 43 (1989)] have been the reasons in many LDCs for failing to devise land development strategies with particular attention to segmented land markets. Analytical models likewise, do not differentiate the intricate specific aspects of the land markets in these sectors.19 The urban economics literature, as discussed earlier, ignores the rural sector completely while the dual economy models do not take into account the spatial distribution of activities arising out of location and differentiated transportation costs, location-specific inputs, different market structure and so on. By ignoring differences between urban, rural, and fringe areas, particularly in land markets, analytical discussions are often short of insights. Nerlove (1989), as discussed earlier, provides an interesting analytical model, based on von Thunen, that deals with spatial variables. Urban development through primacy of cities has been a major concern for LDC governments. This led many of them to pursue policies of deconcentration and development of new towns and cities. Development of new towns and cities in the periphery affects the land availability for the rural sector quite significantly. Furthermore, in most cases, constrained by the available financial resources and aimed to sustain the development of those newly created cities, governments chose locations with relatively low costs in building the infrastructure. This often takes place on flat and relatively better agricultural landsm affecting agricultural employment and output quite significantly. Available studies (Lee (1987, 1990) and Rondinelli (1990)] indicate that most of these decentralization policies either have failed or have had very limited success. 19As a matter of fact, most of the analytical models in dual economy literature do not deal with the land market. Urban economics analytical models give no attention to the fringe area and rural land markets [see Bhadra (1991)]. mChoosing agriculturally better-off regions for developing those new cities are almost preconditions for the success of these policies. As Renaud (1979) pointed out, "(Decentralization policies] must be based on favorable policies toward the farm sector because its stagnation would imply a slow growth of provincial rural centers, stagnation of small towns and faster concentration into large cities. The more equal the distribution of income and assets in rural areas the greater will be the benefits of these policies. Decentralization policies must also encourage the growth of intermediate-sized urban centers with a good growth potential because economic goods and services, financial flows and innovations circulate throughout the country via the system of cities (p. iv]." 44 Policies that affect land conversion take various forms: a) those related to government land, b) regulations to guarantee security of tenancy, the rules by which tenure is transferred, ceilings on land holdings and rent control measures and c) measures that affect the land market through shifto in demand and (perhaps) supply but which do not deal directly with land market variables (sos examples are: agricultural price policy that often tax producers, construction of infrastructure by the government and differences in labor legislations between the rural and the urban sectors) and d) differential tax treatment given to urban and rural lands. Spatial strategies are objectives of many governments when they intervene in the land market. Most often they aim to reduce growth of primate cities, to promote small and intermediate sized cities, to create growth poles, to develop small and intermediate sized towns, to develop lagging regions and to promote land colonization schemes (see Rondinelli (1990) for discussion for Asia]. Among these goals, rural development, lagging region development and the promotion of small towns and intermediate sized cities seem to be the most important. Some common general policy measures have been public infrastructure subsidies, concession of grants, loans and tax incentives to new industries or for relocation of established industries, direct state investment, housing and social services, human resources investment and job training. Fisher (1982) and Murchison (1980) discuss other commonly used direct measures through which governments try to influence the rate of agricultural land conversion. The presentation below is based on Fisher (1982): i) Agricultural zonin : these measures restrict or prohibit the construction of nonfarm buildings in agricultural areas. Without other support programs to increase productivity in agriculture and, more generally, to improve the economic opportunities in the rural sector, the effect of such policies in preventing urban expansion are difficult to establish. Nonetheless, zoning laws are common in LDCs (see for example, the Country Study Report on Indonesia (1990), and several UN reports (1986-1989)] and in the DCs. One striking example of this kind of regulation is Japan, where a number of restrictions to conversion 45 exist. One of the most restrictive provisions states that, "Farm landowners must obtain the permission of the governor of the prefecture or of the Ministry of Agriculture, Forestry and Fisheries in order to transfer land to other uses (except in urban areas where the Agricultural Commission has been notified of the change)" (Australian Bureau of Agricultural and Resource Economics, p.75). Another example is the United States where a number of zoning laws and regulations exist. (ii) Agricultural districtina: these policies do not restrict development directly but instead permit farmers to establish districts within which they are protected from certain state or local regulations or from private nuisance suits. These kinds of policies are very common in DCs, especially in the US (Barros and Newman), Canada, and in Western Europe. (iii) Public purchase or private transfers of develoiment rights: These programs seek to alter the pattern of land conversion through public purchase of rights to develop certain land, the farmer or owner retaining the land and other rights associated with ownership (Barros and Newman). These measures would put the fringe land market in a more competitive position against the expansion of the urban sector. (iv) Estate tax relief: this is a form of protection of agriculture and is very common in LDCs. The purpose is to facilitate the transfer of farmland to heirs who should continue farming. Tax reliefs affect the conversion process because they are capitalized in agricultural land values thus creating an artificial obstacle to prospective buyers. This may indeed delay the conversion of land21. In this respect Japan also offers a striking example, with agricultural land receiving almost zero taxation. This becomes even more surprising if one takes into account that cultivated land in the metropolitan areas of Tokyo-Yokohama, Nagoya and Osaka-Kobe accounts for 16 percent of the 21 However, the distortions caused by such a process can be very large, leading to inefficient allocation of resources and to concentration of ownership and income. 46 land in these regions (Australian Bureau of Agricultural and Resource Economics, p. 316). (v) Tax rebates: these will contribute to a reduction of the tax burden on farmers by refunding farm taxes in excess of some percentage of farmer's income. (vi) Comprehensive arowth management: These types of measures seek to control development patterns through a combination of policies, particularly the timing and location of utilities and other public facilities. The importance of public capital in promoting and managing comprehensive growth in LDCs has long been recognized [see UN reports (1980-90); World Bank Reports (1985-1990); Human Development Reports (1990)]. These measures, by definition, are to be pursued in order to achieve an "ideal" or "optimal" development stage. In most cases, pursuing these policies requires elaborate information and a very complex dynamic planning framework which is frequently unavailable. Many of these policies are in effect in the LDCs. A comprehensive evaluation of their effects on land use patterns and on conversion does not exist. It is important to note however that even though policies like zoning or physical growth restrictions may result in temporary slowdown of the urban expansion, political economy factors have a crucial role. In most LDCs land is a major asset and a source of economic power, and pressure groups can influence policy makers to eliminate or ignore restrictions and impediments to urban development. A static analysis of policies and their effects on land use can only provide a simplified story. Furthermore, failures of these policies, even when they are cast in the proper economic framework, are often rooted in legal and institutional elements (Doebele (1989, 1990)J. Not well defined property rights and difficulties of enforcement are other important aspects of this. Whether or not based on sound efficiency or equity considerations, governments in LDCs have been intervening in the land markets. However, large 2 Even more than tax relief, this can lead to much higher concentration of property and income. In a system of progressive taxation of income, the beneficiaries of the rebates will mostly be the higher income groups which will have an incentive to purchase land from lower income landowners. 47 metropolitan areas of LDCs continue to grow and small and medium metropolises continued to enlarge their sizes. The attempts to curb the conversion of agricultural land around the large metropolises as well as around the new and intermediate sized cities, has had very limited success. This has become a serious problem especially for countries with relatively high land scarcity and moderate to high population growth (e.g., see UN reports on Bangladesh (1986) and Indonesia (1989); see also World Bank Indonesia Country Study Report (1990)]. One further reason for the failure of government policies is the contradiction in the policy objectives itself. As Rondinelli (1990) points out, "Metropolitan growth control policies were never very successful, in part, because they were never seriously implemented and because few governments were willing to recognize explicitly that their own macroeconomic policies and investment strategies played major role in creating metropolitan centero and in reinforcing urban population concentration. Examples of such policies which often come into conflict with sectoral balanced growth are import restrictions, minimum-wage laws, capital market regulations, and national government subsidization of investment in some urban infrastructure and/or direct investments in those infrastructure" (p. 35) (see also Henderson (1982)1. Many interventions lead to inefficiency and thus require further interventions later on. This point has been emphasized by Doebele and Hwang (1979) in their pioneering work on the Korean land market. They noted that the dislocation of prices from the levels that have been produced by the market would artificially alter the use of land. Areas which are controlled to produce artificially low prices are likely to be used at lower intensities than a full market price would require. Government interventions also lead to "hoarding" by owners in expectation of higher prices through some legal loopholes. These would certainly increase transaction costs of those policies by making governments pursue higher surveillance of those benefitted by its controls. Government is often faced with the difficult question of how and whom to compensate for the dislocations in expectations (and hence of values) its interventions have produced. Government may also turn out to be a revenue maximizer through its 48 control over the most lucrative market, instead of promoting efficient and equitable distribution of land. Finally, it is also likely that policies of different ministries and departments vested with the power of controlling the land market may nullify each others' or may even work at cross-purpose [see Doebele and Hwang (1979) for a discussion of these issues in the context of Korean land market]. Furthermore, only rarely has there been any concern expressed in terms of costs involved in pursuing government policies. Costs in administering the policies and those borne out of government interventions- related inefficiency are enormous. As a result, governments of LDCs often face serious difficulties in implementing policies. V. Summary and Conclusions In this paper we have surveyed the literature on the interactions between urban development and agricultural development and the implications for the conversion of land from rural to urban uses. Initially the perspective of the urban economist was analyzed. This is a large body of research, which concentrates on urban development per se, with agriculture playing a minor role in the process. Welfare analysis to incorporate costs and benefits of urban expansion, including effects in the agricultural sector, has not been performed in the existing literature. Dual economy models do incorporate the agricultural sector, but often in a highly stylized fashion. They treat the spatial structure of the economy as given (distance and soil quality, for example, do not play any role) and often do not deal explicitly with the reallocation of land. These models can not therefore be used to address the issue of land conversion properly. The effects of urbanization on agriculture have been analyzed in a series of models inspired by von Thuenen's work. They provide insights into the spatial organization of agriculture and interesting hypothesis about the effects of proximity to urban centers on profitability of farming. While the spatial structure of agriculture is considered, these are not general equilibrium models. 49 This can potentially be a serious problem, where intersectoral factor markets (specially for labor and capital) and the economy-wide resource constraints will be critical determinants of the results of the process of urbanization. In most of these models, for example, the land constraint was not considered explicitly (although in some cases rightly so) requiring some further refinements if their results are to be extended to land scarce economies. Governments in many countries intervene heavily in the land market. The types of interventions most common are discussed as well as their consequences. There does not seem to exist in the literature a systematic discussion of market failures (if any) and of the interventions required to deal with them. The survey indicates the need for additional investigation in the area. 50 VI. 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