Analysing the interplay between comparative advantage, trade policies and trade costs helps in trying to solve the “puzzle” of missing food and agricultural trade. Why is trade intensity higher in manufactures than in agriculture? Why do low-income countries not engage in food and agricultural trade as much as high-income economies? Addressing these questions can help explain why some regions trade more than others and explain how they choose their trade partners. This can also shed additional light on issues related to agricultural development and the structural transformation of the economy.
The assessment of how comparative advantage overcomes the barriers posed by trade policies and costs and shapes trade flows is complex. An econometric modelling study carried out for this report helps explain how food and agricultural trade is determined in a market with many countries, uncovering the influence of comparative advantage, estimating trade costs and laying out the geography of trade.t, 112
More specifically, the modelling study provides estimates for the key drivers of food and agricultural trade, namely: (i) the competitiveness of a country that is reflected by its absolute advantage in agricultural productivity per worker adjusted for input costs; (ii) the influence of comparative advantage, which is captured by the heterogeneity of technology and agricultural productivity per worker across countries and regions; and (iii) bilateral trade costs that, for each country-pair, comprise direct and indirect costs such as tariffs, NTMs, transport and documentation costs, and other factors such as common language, sharing a common border or being party to a regional trade agreement (see Box 2.4 for a discussion on the econometric model).
BOX 2.4Structural gravity models and the fundamental drivers of trade
Econometric models are based on economic theory and rely on statistical inference applied to available data. The gravity model has been a workhorse of empirical trade analysis since the beginning of the 1960s.140 In its basic form, it is based on the notion that bilateral trade flows are proportional to the economic mass of countries (population and GDP) and is inversely related to distance (which is a proxy for trade barriers), very much like Newton’s law of universal gravitation from which it derives its name. Modern structural gravity models quantify the effects of the fundamental drivers of trade. The intuition of structural gravity models relies on how relatively more productive countries with lower input costs can overcome trade costs and export their products. The model portrays the relationship between bilateral trade flows, relative prices and trade cost proxies for each pair of trading partners and estimates a range of indicators that help uncover the fundamental drivers of trade. These are:
Competitiveness and absolute advantage: For each country, competitiveness in the global market reflects its productivity per worker – that is its absolute advantage – adjusted for input costs. A more competitive country is a cheaper source of food and agricultural products and can better overcome trade costs.
Comparative advantage: In the modelling framework, the influence of comparative advantage is reflected by the estimated heterogeneity or variation in relative agricultural productivities per worker across countries. When productivities per worker are similar between countries, price differences are negligible and the possibility of gaining from trade is limited, as the opportunity cost of production domestically may not be different from elsewhere. Therefore, there is no incentive to trade. In other words, for a country, trade can enlarge the set of productivities, and thus prices, that are available from other countries and if prices are not different across countries, trade flows will not be significant. Thus, the greater the variation in relative productivity per worker and prices across countries, the stronger the influence of comparative advantage and the more the trade. In the modelling framework, the influence of comparative advantage can be measured at the global and regional levels.
Trade costs and openness: For each country, trade costs can erode its competitiveness in the global market. Trade costs can also partly offset the influence of comparative advantage. In the model, trade costs are estimated for each pair of trading partners using price levels. The higher the trade costs, the stronger the influence of comparative advantage (the larger the price differences) that would be necessary to make trade possible. An indicator for openness to trade can also be estimated for each country based on its location and average price level.
The econometric analysis, based on 2017–2018 data on bilateral trade flows among 112 countries in the world and 321 food and agricultural products, supports the above intuition. For example, Figure 2.5 illustrates the relationship between bilateral imports and relative prices between trade partners. Relative prices between trade partners measure their relative competitiveness but as countries are located across the geographical space, they also reflect trade costs due to distance and other factors. The higher the relative price between exporter and importer, the lower the bilateral trade flow, as either the exporter is not competitive or faces higher trade costs.
FIGURE 2.5Bilateral trade flows and relative prices
SOURCE: Kozłowska, M.K., Rapsomanikis, G. & Zimmermann, A. 2022. Comparative advantage and trade costs in a Ricardian model of global food and agricultural trade. Background paper for The State of Agricultural Commodity Markets 2022. Rome, FAO.
Competitiveness and absolute advantage
A country with better technology and abundant natural resource endowments, such as land and water, can be more productive and can enjoy absolute advantage. This, together with input costs, determines competitiveness. High productivity per worker and lower input costs mean that a country can be more competitive in the global food and agricultural market (see Figure 2.6).
FIGURE 2.6Country competitiveness in the global food and agricultural market, 2018
SOURCE: Kozłowska, M.K., Rapsomanikis, G. & Zimmermann, A. 2022. Comparative advantage and trade costs in a Ricardian model of global food and agricultural trade. Background paper for The State of Agricultural Commodity Markets 2022. Rome, FAO. Conforms to Map No. 4170 Rev. 19 United Nations (October 2020).
High-income countries, such as Canada, France, Germany, Spain and the United States of America are estimated to be among the more competitive in the global food and agricultural market. Emerging economies, such as Argentina, Brazil, China, India, Indonesia, Malaysia, the Russian Federation and South Africa are also estimated to be more competitive. The least competitive countries tend to be low- and lower middle-income countries, such as Cabo Verde and the Gambia in sub-Saharan Africa, and Bangladesh and Myanmar in Asia, for example.
These results underline the importance of technology and agricultural productivity per worker in determining competitiveness. Low-income countries, characterized by low agricultural productivity rates and high transaction costs that inhibit technology adoption, are, on average, among the least competitive in the global market.
The role of natural endowments and geography in shaping productivity and competitiveness is also evident. High-income countries, such as Finland and Norway, with large areas north of the Arctic Circle, are found to be less competitive in the global food and agricultural market. Small Island Developing States (SIDS), such as Antigua and Barbuda and Vanuatu, are also less competitive due to scarce natural resource endowments. Land Locked Developing Countries (LLDCs), where the geographical location inhibits integration in the global market, are also among the least competitive countries.
Perhaps, the most striking result that links geography to trade is that in three regions of the world, landlocked countries are among the least competitive traders of food and agricultural products. The Central African Republic appears to be less competitive in Africa; in Asia, less competitive countries include Armenia, Bhutan, Mongolia and Nepal; and, in Europe, it is Bosnia and Herzegovina.
Despite improvements in transport, landlocked countries find themselves behind their maritime neighbours in economic growth and trade. For food and agriculture, this may reflect low rates of knowledge and technology transfers. While this could be attributed to their distance from the coast and the related transport costs, researchers argue that the dependence of landlocked countries on their neighbours’ infrastructure and on their administrative practices are also important factors.113
Comparative advantage
Whereas competitiveness and absolute advantage are determined by agricultural productivity per worker and input costs and reflect the state of technology and the resource endowments in each country, it is the variation of agricultural productivity per worker across countries that uncovers the influence of comparative advantage. The greater the variation in relative productivity across countries, the stronger the influence of comparative advantage, and the more the trade.
The results of the econometric modelling exercise undertaken for this report shed light on the role of comparative advantage in determining trade flows. For the global food and agricultural market, where all countries compete, the variation in relative agricultural productivity per worker, estimated as a relative standard deviation, amounted to 18.3 percent (Table 2.2).u This is higher than a standard deviation of 15 percent, estimated for a large part of the global manufactures trade, suggesting that the influence of comparative advantage in food and agriculture is greater than in the non-agriculture sectors. Nevertheless, despite the stronger influence of comparative advantage in food and agriculture relative to manufactures, trade intensity in food and agriculture is lower.v
TABLE 2.2THE STRENGTH OF COMPARATIVE ADVANTAGE IN FOOD AND AGRICULTURAL MARKETS
SOURCE: Kozłowska, M.K., Rapsomanikis, G. & Zimmermann, A. 2022. Comparative advantage and trade costs in a Ricardian model of global food and agricultural trade. Background paper for The State of Agricultural Commodity Markets 2022. Rome, FAO.
There are marked differences in the influence of comparative advantage across regions. For example, within Europe the estimated standard deviation of agricultural productivities per worker is 22.5 percent. This suggests that comparative advantage exerts a strong influence on intra-regional trade. Within Asia and Latin America and the Caribbean, the strength of comparative advantage is relatively lower. The estimate for sub-Saharan Africa is 15 percent, indicating that the variation of agricultural productivities per worker across countries in the region is relatively low and suggesting that the influence of comparative advantage in shaping intra-regional trade flows between sub-Saharan African countries is weak. It is not only that countries in the region are characterized by low absolute advantage reflecting low productivity per worker (see Figure 2.6), but the variation of these productivities is also small. This gives rise to a reduced role for comparative advantage in shaping trade within the region and, on average, provides little incentives for sub-Saharan African countries to trade with each other.
These results on the influence of comparative advantage within regions are in line with the findings on regional trade clusters discussed in Part 1, which pointed to relatively increased trade between countries in the same region except for Africa (see also Figure 1.10).
Trade costs and openness
Together with competitiveness and comparative advantage, estimates of food and agricultural trade costs add to the analysis of the fundamental drivers of trade. The results of the econometric exercise suggest that distance matters: with other factors that give rise to trade costs being the same, trade between countries that are more than 6 000 miles apart face a trade barrier that is 100 percent higher than that between countries that share borders or are in close proximity of each other (separated by up to 375 miles).
The role of geographical distance in increasing food and agricultural trade costs remains significant, despite improvements in transport technology and the adoption of digital technology that allows traders everywhere in the world to access enhanced information on products. Digitalization has not brought about the “death of distance”; however, there is some evidence on its impact on merchandise trade. Based on information available both online and offline, a study suggests that while trade flows decrease with distance, distance may matter less online.114, 115
Bilateral trade costs in food and agriculture are significant (Figure 2.7). For example, the ad valorem trade cost of importing food from the United States of America to Australia – two high-income countries located in different regions – amounts to 115 percent. Imports by Uganda from Ethiopia – two low-income countries near each other – are subject to a 383 percent trade cost in ad valorem terms. These estimates reflect all trade costs, including tariffs, costs arising due to NTMs and other costs, such as transport or time delays at the border. They also consider distance, differences in institutions that regulate trade, the efficiency of export and import procedures between borders, or whether the trade partners are signatories to the same trade agreement.
FIGURE 2.7Bilateral trade costs according to country income level classification, selected trade partners and average costs per country income classification (ad valorem equivalent), 2017
SOURCE: Kozłowska, M.K., Rapsomanikis, G. & Zimmermann, A. 2022. Comparative advantage and trade costs in a Ricardian model of global food and agricultural trade. Background paper for The State of Agricultural Commodity Markets 2022. Rome, FAO.
Despite the multitude of factors that give rise to trade costs, the estimates reveal that trade costs are decreasing with the level of development as measured by income per capita. For example, food and agricultural trade between all high-income countries across the world is subject, on average, to a 175 percent ad valorem trade cost equivalent. Average trade costs between all low-income countries are approximately 1.4 times higher, amounting to a 244 percent ad valorem equivalent. Differences in transport infrastructure and in the efficiency of the regulatory institutions between high- and low-income countries, among other factors, account for the large differences in average trade costs.
In terms of intra-regional trade, food and agricultural trade costs in sub-Saharan Africa are estimated to amount to 237 percent ad valorem equivalent on average, compared to 152 percent for Europe (Figure 2.8). Indeed, sub-Saharan African countries face the highest costs when they trade between themselves and within the region. Intra-regional trade in Asia and Oceania – a region with many countries spread over wide geographical area – is subject to an average of 202 percent of ad valorem trade costs equivalent.
FIGURE 2.8Bilateral trade costs and intraregional averages (ad valorem equivalent), 2017
SOURCE: Kozłowska, M.K., Rapsomanikis, G. & Zimmermann, A. 2022. Comparative advantage and trade costs in a Ricardian model of global food and agricultural trade. Background paper for The State of Agricultural Commodity Markets 2022. Rome, FAO.
Openness to trade is important for economic growth. Trade facilitates technology and knowledge spillovers across countries, improving productivity and promoting growth (see Box 2.5). Openness to trade depends on the country’s location and the geographic barriers it faces, as well as its average price level relative to that of its trade partners that also reflects trade policies.
BOX 2.5Trade openness impacts: Growth, productivity and inequality
Most economists would agree that openness to international trade promotes economic growth.141 Trade results in efficiency gains as resources are allocated in line with comparative advantage. In agriculture, where differences in land and water endowments and climate are significant across countries, gains from openness and market integration can be large.142 These gains can add to the rate of growth of the economy but are difficult to estimate.
In addition to the effect of efficiency gains, trade facilitates technology and knowledge spillovers across countries, promoting growth by improving the production process, increasing product quality and resulting in new products. Since 1995, the growth in food and agricultural trade has taken place together with increases in agricultural productivity per capita, particularly in emerging and developing countries.143
Many practioners are questioning this conventional wisdom on the effects of trade openness on growth and productivity. Trade results in winners and losers and its effect on income redistribution may be large. A handful of studies focus on the impact of trade openness on agricultural productivity – the underlying hypothesis being that trade facilitates the diffusion of technology and knowledge spillovers. Focusing on how agricultural productivity in 44 countries – both developed and developing – converges at higher levels, a study finds that openness to trade increases labour productivity growth rates in agriculture within an analytical framework that also accounts for the costs of technology diffusion and adaptation.144
Additional evidence suggests that trade openness can have a short-run negative impact on agriculture’s efficiency.145 However, in the long run, it is found to increase efficiency in agriculture, reflecting the ability of the sector to adapt to global markets and increased competition through technology adoption, but also through the exit of inefficient farms from the sector. In Chile – a country that liberalized trade in the 1990s after a period of import-substitution policies – an analysis of 70 000 farms suggests that trade openness is positively related to farm yields.146
Downstream, a study of more than 20 000 food firms in France and Italy suggests that import penetration in both final food products and intermediate inputs systematically contributes to firm-level productivity growth.147 Participation in agricultural and food global value chains, either through imports of inputs or exports of intermediate products, is also found to promote agricultural labour productivity.148, 149 The main mechanism for this lies on how value chains unbundle the production process, allowing farms and firms to leverage their comparative advantage in global markets and facilitate the transmission of improved technology, leading to better farm practices and improved labour productivity.
These linkages between trade openness and technology are unwrapped by a micro-level data study of the impact of trade in agricultural inputs on the productivity of 1.1 million fields across 65 countries. Since the 1980s, trade openness in agricultural inputs was found to result in significant shifts from traditional farm technologies to modern ones, thus having distributional implications for productivity and welfare across the world.150
Trade openness, either by intensifying competition or by fuelling the structural transformation process, can promote growth and affect income distribution and inequality. A recent analysis of the impacts of eliminating tariffs on agricultural products across low- and middle-income countries pointed to increases in both income and inequality.151 The results suggest that liberalizing agricultural trade would increase household incomes on average.
At the same time, eliminating import tariffs was found to have highly heterogeneous impacts across and within countries and across households. In most countries, the top 20 percent of the richest households would gain more from liberalization than the bottom 20 percent, thus exacerbating relative inequality.
Trade openness may have different impacts across genders. The evidence suggests that trade liberalization had heterogeneous effects on the agricultural sector, negatively affecting female workers in Africa, but benefiting the ones in Latin America.152 In developing countries, women have less access to education than men and openness to trade will affect gender inequality through its impact on the allocation of labour across sectors and through wages. In Ethiopia, for example, women left agriculture faster and entered into the service sector following a reduction in tariffs. However, the low levels of education of female workers meant that women moved to low value-added sectors.153
In the context of agrifood systems, trade openness highlights the trade-offs between promoting economic efficiency and generating positive social outcomes. Integrating smallholder farmers in global markets is challenging. Policies that promote trade openness often tend to underplay market failures and complementary actions are needed to address inequality. Inclusive business models, such as contract farming, can address the constraints farmers in developing countries face when entering markets and global value chains.154 But a range of public policies and investments, such as carefully designed input subsidies targeted at smallholder farmers, skills upgrades and education, gradually removing labour market rigidities, as well as improvements in infrastructure and regulation, can complement the market mechanism and promote a fair structural transformation.
SOURCE: Adapted from Zimmermann, A. & Rapsomanikis, G. 2021. Trade and Sustainable Food Systems. Food Systems Summit Brief prepared by the Research Partners of the Scientific Group for the United Nations Food Systems Summit.
On average, high-income countries tend to be the most open to trade (Figure 2.9). For example, Germany’s location and price level makes it an attractive market for trade partners to export to, especially members of the European Union. New Zealand, although relatively remote, is characterized by price levels that are close to the regional average, making it an open market for exporters to compete in.
FIGURE 2.9Trade openness, 2018
SOURCE: Kozłowska, M.K., Rapsomanikis, G. & Zimmermann, A. 2022. Comparative advantage and trade costs in a Ricardian model of global food and agricultural trade. Background paper for The State of Agricultural Commodity Markets 2022. Rome, FAO. Conforms to Map No. 4170 Rev. 19 United Nations (October 2020).
Several SIDS are found to outrank many richer nations in terms of openness to trade. Despite their geographic remoteness and low connectivity, small islands, such as Maldives and Saint Kitts and Nevis, leverage trade to meet food security and nutrition objectives. These countries have limited natural resources to produce adequate food and agricultural products, yet they are open to trade and they exploit their comparative advantage in fisheries and tourism to finance food imports. Many sub-Saharan countries are found among the least open countries.w
Putting the pieces of the food and agricultural trade puzzle together
Comparative advantage and trade costs determine trade flows across countries. Although the influence of comparative advantage is stronger in food and agriculture (see Table 2.1), food and agricultural products are not traded as intensively as manufactures. Tariffs are relatively higher for food and agriculture, but they make up for a small part of total trade costs that are significant and combine to weaken the role of comparative advantage in the sector (see Figure 2.4). The analysis suggests that trade costs in agriculture are often twice as high as in manufactures. A low value-to-weight ratio but also the perishability of food and agricultural products result in high trade costs. Costs related to compliance with non-tariff measures, such as standards, are also higher in food and agriculture. The importance of trade costs in hindering food and agricultural trade has significant policy implications and efforts should be made to target measures in reducing them (see the discussion on trade facilitation in Part 4).
Trade costs make up for an important missing piece of the food and agricultural trade puzzle. Although low-income countries are characterized by low agricultural productivity per worker and low competitiveness in the global market relative to high- and middle-income countries (see Figure 2.2 and Figure 2.6), on average, they are less open to trade and a large part of their consumption is met by food that is produced domestically (Figure 2.10). Low-income countries import about 14 percent of their food consumption on average, while high-income economies trade much more intensively and rely on the global food markets to meet about 60 percent of their food needs.
FIGURE 2.10Share of imports and domestic production in total food consumption, 2018
SOURCE: FAO.
Once more, the high trade costs faced by low-income countries can help explain differences in trade intensity across countries. Estimates suggest that low-income country imports from high- and upper middle-income countries are, on average, subject to trade costs of approximately 220 percent and 208 percent in ad valorem equivalent. Such high trade costs partly insulate countries and inhibit trade. As a result, countries that face high trade costs choose to meet a large part of their food consumption requirements with domestic production, even if they were characterized by relatively low agricultural productivity per worker. If trade costs were lower, low productivity countries could gain significantly by importing a larger part of their food needs at lower prices.
The interplay between comparative advantage and trade costs in determining trade and its geography is most evident in sub-Saharan Africa. The modelling exercise suggests that the region is characterized by a low strength of comparative advantage (Table 2.2), and by high intra-regional trade costs (Figure 2.8). Indeed, Africa is characterized by a very low share of intra-regional trade (Figure 1.13). The African Continental Free Trade Area that aims to accelerate intra-African trade should specifically focus on policies and measures that target trade costs to promote trade in food and agriculture (see Part 4).
Trade costs also have important implications for the structural transformation of developing countries. High trade costs in food and agriculture can translate into less trade and expanded agricultural sectors. Food is a necessary good and in low-income countries, low food imports may result in a large proportion of labour and other resources being allocated to food production to meet the country’s food subsistence requirements. For example, in low-income countries in 2019 where they face high trade costs, the share of agriculture in total employment is very high at 59 percent on average.
Lowering trade costs promotes trade, and countries characterized by low agricultural productivity per worker would increase food imports. This would help meet food subsistence requirements and release workers from agriculture to other more productive sectors of the economy. With flexible and well-functioning labour markets, this reallocation of labour would result in increasing agricultural productivity per worker and contributing to economic growth.116 More trade would also help the diffusion of knowledge and technology, adding to productivity gains (see Box 2.5). Nevertheless, with more and cheaper food imports, this process of structural transformation would also entail losses especially by farmers who are unable to increase their efficiency and compete in more open markets.
Empirical evidence at the farm level sheds light on the relationship between trade costs, agricultural productivity and food subsistence requirements. For example, in Peru trade cost reductions, resulting from improvements in road infrastructure, raised agricultural productivity by 5 percent. At the same time, about 20 percent of farmers were found to be worse-off as the reduction in trade costs allowed the entry of other sellers into the market and strengthened competition.117
Another study in Mexico suggests that higher inter-regional costs for fruits as compared with maize, in conjunction with food subsistence constraints, prevents farmers from specializing in cash crops such as fruits. Trade costs account for a large part of the relative employment between maize and fruit and a lower productivity in agriculture. A reduction of inter-regional trade costs in Mexico to a level that is prevalent in the United States of America would increase the cash crops to a staples employment ratio by 15 percent and could generate a 13 percent increase in agricultural productivity per capita.118
