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Kenya, agricultural policyoptions and the poor:A computable generalequilibrium analysisOludele Akinloye Akinboade aa Department of Economics , University ofBotswana ,Published online: 27 Feb 2008.

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Development Southern Africa Vol 13, No 5, October 1996

Kenya, agricultural policy optionsand the poor: A computablegeneral equilibrium analysis

Oludele Akinloye Akinboade1

A computable general equilibrium model is used to analyse the allocative anddistributional impact of some agricultural policy options for Kenya. A Kenyan socialaccounting matrix is employed as a database, and it has been aggregated anddisaggregated to accommodate additional data sources and arranged to follow thetransaction value approach. Increasing wages to attract more labour into estateagriculture under conditions of monopsony is the preferred policy to increase labouremployment and to improve households' income and consumption, especially that ofthe poorer segment of society. The economy is either non-responsive to the impact ofindirect tax changes or the changes are quite small. Terms of trade improvementssuch as increasing world prices of agricultural exports result, in a significant boost ofincome and GDP, are effective in increasing returns to labour and are an importantstep in reducing poverty.

1. INTRODUCTIONThe Kenyan population of about 8,3 million people in 1960 rose to about24 million in 1990, with the rural areas accounting for about 76 per centof this total. Kenya is a primary commodity-producing country with agri-culture being the provider of most of the foreign exchange and almost allof Kenya's food and raw materials for the growing industrial sector.Agriculture is particularly important to the economy as it employs about81 per cent of the labour force compared to 7 per cent in industry and12 per cent in services. The agricultural sector contributed an average of25,1 per cent and manufacturing an average of 11 per cent to the grossdomestic product (GDP) in 1984-88, most of which originated from theprocessing of agricultural products.

The economy is open, with the commodity trade ratio averaging about 43per cent in 1984-88. Coffee, tea and sisal are the dominant exports,though tourism and the processing for export of imported petroleumproducts also generate foreign exchange for the country. Because of theopenness of the economy and the strong reliance on primary products,the country is vulnerable to external shocks that influence its earnings inthe international markets. The country's membership of internationalcommodity agreements, such as the International Coffee Agreement, isseen as a means of achieving favourable agricultural terms of trade.

1. Department of Economics, University of Botswana.

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In the first decade after independence (1964-73), Kenya performed verywell, with the real GDP growth rate averaging 6,5 per cent, agriculturalsector growth averaging 4,2 per cent and growth in the manufacturingsector averaging 8,2 per cent. Since 1974, Kenya has experienced a seri-ous decline, with the terms of trade index falling from 114 in 1974-78 to76 in 1989-90. This has led to severe import compression.

The International Monetary Fund (IMF) programmes adopted in the early1970s were abandoned following improved balance of payments thatresulted from a large increase in the prices of coffee and tea in 1975-77.The resulting expansion in aggregate demand created a balance of pay-ment problem in 1978. This led to the acceptance of the InternationalFinance Institution's assistance with its associated conditions. Anotherround of structural adjustment policy was implemented in the early1980s. The agricultural adjustment programme involved raising producerprices to induce farmers to increase output.

The average per capita GDP in Kenya was about US$370 between 1988and 1990, much below the average of US$710 for developing countries.Among the poorest 40 per cent of the population, the per capita incomehas stagnated around US$70. Overall, from 1980 to 1988, about 55 percent of the Kenyan rural population or 44 per cent of the total populationlived below the poverty line.

Scarcity of arable land (which accounts for 11 per cent of available land),low savings and the debt burden largely explain the incidence of poverty.Smallholders make up a large proportion of the rural poor, whereas land-less labourers are found predominantly among the rural very poor.

The United Nations Development Programme (1991) estimates that of theGDP of US$7,4 billion in 1988, investment and gross domestic savingsrepresent 26 per cent and 22 per cent respectively, which indicates a sav-ings deficit in Kenya. Total national debt amounted to 51 per cent of theGDP in 1988 and debt servicing accounted for 19,4 per cent of exportearnings.

The Kenyan factor market has been observed to lack contractual com-plexity associated with transactions. There is no share-cropping or a link-age of labour and credit transactions in a single contract. Among small-holders, hired labour is an insignificant part of total labour input. Thereis evidence of geographical segmentation of the labour market, as most ofthe hired labour is procured from the immediate locality. In addition, inan otherwise labour-abundant economy, labour shortage in plantation(estate) agriculture is common.

Coffee and tea are the main crops grown on plantations and these requirea substantial labour involvement in such activities as picking, soil prepa-ration, planting and weeding. The wage rates on plantations are 20 to 30per cent higher than those prevailing in the smallholder sector, and arenot subject to the minimum wage of the urban formal labour market. Inspite of these higher wages, plantations in Kenya still suffer from labourshortages. This suggests that the wage rate on offer is usually below the

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marginal product of labour - an indication of the monopsony power ofestates.

Experts and lending institutions have therefore been encouraging policyredirection to address the various issues with the focus on the alleviationof poverty. Collier and Lal (1986: 142) argue for government interventionto raise wages in the plantations. They suggest that any minimum wagebetween the current wage rate and the current marginal product oflabour would increase employment and improve allocative efficiency aswell as raise the earnings of existing employees. The provision of appro-priate market incentives through fair prices is one area that the govern-ment of Kenya deems important to make farming profitable and toencourage farmers to put more resources into productive use. This couldbe achieved by a reduction in indirect taxes on domestic as well asexported agricultural products.

A computable general equilibrium (CGE) model is used to assess the pos-sible impact of some agricultural policy options on the employment,income and consumption of the poorer segment of the population inKenya. The policy options examined include those of increasing wages ofthe unskilled in estate agriculture, removing indirect taxes on agricultur-al commodities, and increasing world market prices of agriculturalexports. A benchmark equilibrium data set is generated and comparedwith equilibria generated in the policy experiments. In the process, thesignificance of adopting alternative hypotheses is also assessed. A CGEmodel is preferred to a partial equilibrium approach for its ability to cap-ture the various linkages that the agricultural sector has with the rest ofthe economy at the macrolevel.

The application of CGE models to the Kenyan economy is fairly recent.Dick et al (1983), Blomqvist and McMahon (1986), McMahon (1987),Simons (1988), Lewis and Thorbecke (1992), Tyler and Akinboade (1992a,1992b), and Akinboade (1994), among others, have used CGE models intheir studies of the Kenyan economy. The present study employs thesame data set as that used in Tyler and Akinboade's (1992a) model: thatis, the 1976 social accounting matrix of Kenya updated to the 1980s. Italso examines the allocative and distributional impact of some agricultur-al policy options in Kenya, focusing in particular on the poorer segmentof the population.

The article is divided into three sections. Section 2 discusses the modelthat has been adopted and the sources of data used. Section 3 presentsresults of the simulation of a number of agricultural policy options. Thelast section remarks on the relevance of the article and the study.

2. THE MODEL AND DATAThe study is an attempt to analyse a number of agricultural policyoptions for Kenya by means of an economy-wide policy model whichincorporates the interrelationships between productive activities, factorsof production, households, government and the rest of the world in a gen-eral equilibrium framework. A computable general equilibrium (CGE)model is based on the updated 1976 social accounting matrix (SAM)

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050505

Figure 1: The structure of the Kenyan social accounting matrix used in the model (K£ m)

Activities

Commo-dities

Facc

proti

Instic

Labourtorsf Capitaliuc-on Operating

surplus

House-holds

itu- Compan-ns ies

Govern-ment

Capitalaccount

Rest ofthe world

Total

Activities

Interme-diate input

932,1

Incomegenera-

tion

1 296,1

Totalcosts

2 228,2

Commodi-ties

Domesticsupply1 756,5

Indirecttaxes/tariffs181,9

Imports358,4

Totalabsorp-

tion2 296,8

- Factors of production -Operating

Labour Capital surplus

- Income distribution -1 228,0

- Factor payments abroad -82,4

- Total factor payment -1 310,4

- Institutions -House- Compan- Govern-holds ies ment

Capitalaccount

- Consumption -1 070,5

- Income transfers -276,5

- Direct taxes -196,7

- Domestic savings -242,3

- Transfers abroad -120,5

- Institution expenditure -1 906,5

Invest-ment294,2

Factorpayments

abroad14,3

Trans-fersfrom

abroad23,4

Invest-ment294,2

Rest ofthe world

Exports471,7

Bop deficit51,9

Foreignexchange

inflow561,3

Total

Grossoutput2 228,2

Finaldemand2 296,8

Totalfactor

earnings1 310,4

Institu-tional

income1 906,5

Savings294,2

Foreignexchangeoutflow561,3D

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for the Kenyan economy. The latter has been rearranged, aggregatedand disaggregated to accommodate additional data sources and isadjusted to follow the transaction value approach of model presenta-tion along the lines of Drud et al (1983, 1986). The data set wasextended for the agricultural sector to capture relevant sector situa-tions in the 1980s. These include the magnitude of urban-rural remit-tances, agricultural export taxes, domestic availability of agriculturalcommodities and agricultural imports. Other data sources are theKenya Data Compendium, Bigsten (1987), the Income and EarningSurvey for 1976-87, and the Integrated Rural Survey for 1974-75.Remittance estimates were taken from other studies. The data sourceswere calibrated with the original SAM to attain internal consistency. Afull description of the equations underlying the model and the method-ology used to arrive at solutions of policy experiments is contained inAkinboade (1994). The structure of the Kenyan social accountingmatrix used in the model is shown in Figure 1.

Two main types of general equilibrium models have been applied to theKenyan economy: numerical and computable. Our model falls within thecategory of computable general equilibrium models and utilises the socialaccounting matrix as the principal data set. A CGE model consists of alarge set of structural equations linking producing sectors, factor mar-kets, households, government and the rest of the world, with marketprices as well as production, employment, consumption, savings andtrade being endogenously determined. As it is based on a SAM, theaccounting framework ensures internal consistency and the usualnational accounting identities hold. In addition,- the supply of particular commodities equals their demand (taking into

account imports and exports)- the revenue generated by a productive sector is exactly exhausted by

payments to factors- the incomes of particular household groups are entirely used up in

consumption of goods and services, payment of taxes, transfers toother households or in savings

- government revenue from direct and indirect taxes is equal to govern-ment consumption expenditure, transfers to households plus govern-ment savings

- total savings (including foreign savings) equals total investment- the total current receipts of foreign exchange (including borrowing)

equals total earnings.

A detailed description of the various 'accounts' in the model is given inAkinboade (1994); only a summary is provided here. There are three pro-duction activities representing agriculture, industry and services. Eachactivity is assumed to combine some of the fourteen labour specifications,capital stock and 'operating surplus' in a constant return-to-scale Cobb-Douglas production function for primary inputs to produce value addedat the upper level. Value added then combines, in a Leontief fashion, withthree intermediate inputs at the lower level to produce gross output atproducer prices. The labour specifications comprise four skill categoriesin each of the agricultural and non-agricultural sectors. There are two ofunskilled, one of skilled, three of professionals and one of the

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self-employed in each of rural and urban areas. There are three cate-gories of capital and of operating surplus (or returns to management).Whereas capital contains interest and dividend payments, operating sur-plus accounts are those of retained profits. Factors are combined opti-mally, such that their marginal value products are equated to factorprices. Varying degrees of mobility are specified for labour types by loca-tion and skill; and factor incomes from each category are distributed toinstitutions (households, companies, the government and the rest of theworld) in fixed proportion according to ownership.

Institutional consumption expenditure is allocated to composite com-modities in fixed proportions in quantity terms. This implies unitaryincome elasticity and zero price elasticity of demand.

The model contains four commodities: domestic, imported, exported andcomposite. The imported goods are imperfect substitutes of the domesti-cally produced commodities. Both are combined at a constant elasticity ofsubstitution aggregate to produce composite commodities at minimumcost. The elasticities of substitution of 1,0 for agriculture and 0,5 for theother two sectors are specified. The composite commodities are thenavailable to meet total demand by eight household groups (four in each ofurban and rural areas), government consumption, intermediate use andinvestment. Some of the domestic commodities are consumed at homeand the remainder is exported to the rest of the world.

The rest of the world pays for Kenyan exports and receives payments forimports in foreign currency. Imports are assumed to be available toKenya in perfectly elastic supply at fixed world prices, whereas thedemand for Kenyan exports depends on prices relative to world marketprices of comparable goods, with elasticities of demand of 3,0, 1,5 and1,0 for agricultural, industrial and service exports respectively.

In closing the model, the product and factor market prices are generallyendogenously determined; the world prices of imports and exports areexogenous. There are no restrictions on the balance of trade. To reflectthe monopsonistlc situation in estate agriculture, unskilled labour earn-ings are assumed to be fixed. This implies a positively sloped labour-supply curve and permits us to model more effectively the actual condi-tions prevailing in this market such that the monopsonist can hope toincrease labour supply to plantations only by increasing wages. The otherunskilled labour types are available in unlimited supply at fixed wages,reflecting the competitive nature of such markets. The supply of profes-sionals and of the other skilled labour types is assumed to be fixed.

Total savings in the economy and foreign savings are distributed, in fixedvalue shares, to investment in the three production sectors to purchasecomposite commodities in the same manner (fixed value shares).Investment is, in general, endogenously determined, adjusting to the levelof savings in the economy. However, in order to simulate increasedagricultural export prices, the world price of agricultural exports isassumed to be fixed, causing a disequilibrium in the model. To restorethe model to its equilibrium level and thus achieve a balance of equations

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and variables, agricultural investment is assumed to be exogenouslydetermined. Wages (as opposed to earnings) of unskilled labour in estateagriculture are hence assumed to be fixed. The exchange rate has beenfixed as a numeraire.

3. THE SIMULATION EXERCISESAn increase in the wages of the unskilled in estate agriculture has beensuggested to examine whether this is appropriate in attracting morelabour to labour-deficit plantations and as a policy instrument to alleviatepoverty. The unskilled agricultural labour supply curve is assumed to bepositively sloped with fixed earnings. The wage rate is then exogenouslyincreased by 10 per cent to determine the impact on various variables.The earnings, rather than wages, are fixed in order to capture fully themonopsonistic situation in this sector. Fixing wages would have assumeda competitive market in which, confronted with an increase in the wagebill, the employer simply reacts by reducing the number of workersemployed. Fixing earnings permits the quantity of labour employed tomove along the direction of price (wage) changes. With increased wages,more labour is willing to offer services, thereby increasing labour income(earnings). In simulating an increase in labour wages, our interest hasnot been in the mechanisms for bringing about this change with a view tocomparing them and identifying which mechanism is better.

Eliminating indirect taxes on domestic agricultural commodities and foragricultural exports has been examined for its impact. The model furtherconsiders an augmentation in the world price of Kenyan agriculturalexports which could arise following the action of such bodies as theInternational Coffee Agreement (ICA) of which Kenya is a member. Theworld price is assumed to rise by 10 per cent - a parameter chosen main-ly for its simplicity. It is recognised that it would probably be more realis-tic to examine an increase in world prices as a product of individual inter-national agreements in coffee and tea, for example. Such an approachhas not been followed in this study partly because of difficulty in obtain-ing relevant data to disaggregate the agricultural sector.

In the simulation analyses, we have perturbed the relevant exogenousvariables from base situations choosing a policy parameter of 10 per centin most cases. For indirect taxes, we have considered a total elimination.The impact of the simulations has been compared with their base-runlevels for all endogenous variables. The changes evaluated in the simula-tions, which are selections among alternatives, are chosen as indicative ofdirections of policy change. The simulation results are presented inTables 1-3.

3.1 Results of policy simulations3.1.1 Increasing wages of the agricultural unskilledAn increase in the wages of the unskilled in estate agriculture increasesthe marginal resource cost facing the monopsonist. In order to move to ahigher point on the supply curve, the monopsonist has to pay a higherwage to an extra worker employed and to those already in employment.The simulation is shown to induce a positive response of most variables.In Table 1 it can be seen that a 10 per cent increase in the wages of the

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unskilled in estate agriculture results in little more than an equivalentboost in real GDP. Nominal GDP rises by about 20,4 per cent and realGDP by about 12,1 per cent owing to an 8,3 per cent rise in the priceindex.

Table 1: A 10 per cent increase in wages of unskilled labour in estateagriculture

Percentage change from base solutionBase solution Agricultural export

demand elasticity(K£ m) Low High

GDP at factor cost-constant pricesGDP deflator price indexExports at constant pricesImports at constant pricesNett indirect taxesGovernment expenditureTotal real investmentEstate agriculture unskilled employment

WagesRural unskilled employment

WagesRural self-employment

Wages (implicit)Urban skilled employment

WagesUrban unskilled employment

WagesHousehold real consumption

Urban poorRural very poorRural poor

Agricultural productionAgricultural producer pricesIndustrial productionIndustrial producer pricesService productionService producer pricesAgricultural market pricesIndustrial market pricesServices market prices

1 296,1-

478,1461,6181,9215,2294,224,0

-

57,0-

334,3-

162,2-

65,0-

89,242,262,3

513,9-

599,8-

1 114,5-

-

-

-

12,18,3

-7,842,715,119,476,510,010,027,7

-

16,2-

-

27,527,7

-

23,819,018,510,4

1,7

15,06,1

27,011,0

-

4,1

10,4

16,011,5

-14,163,620,826,9

215,310,010,040,1

-

20,5-

-

39,840,1

-

33,725,424,510,5

1,9

21,48,5

39,115,6

1,6

5,7

14,6

Agricultural export demand elasticities = 3,0 (low) and 10,0 (high).

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The impact of this simulation has been measured on the agricultural sec-tor as a whole and not separately for the estate sector as would have beenthe case if data had been available to disaggregate the sector, and tospecify a separate supply function for the estate and plantation agricul-ture. The impact of increasing the wages of unskilled labour on the entiresector could therefore be seen, inter alia, in terms of an increased wagebill. This wage bill is passed on to consumers in the form of higher prices;agricultural producer prices therefore rise for the entire sector and not forthe plantation sector alone. In this simulation, the increased wage bill ispassed on to consumers in the form of a 1,7 per cent rise in agriculturalproducer price. There are increases of 6,1 and 11 per cent in the non-agricultural producer prices of industrial and service products respective-ly. Production for the domestic market is encouraged by about 16,1 percent in agriculture, 21,1 per cent in industry, and 31,9 per cent in theservices.

Exports are discouraged in all sectors, hence aggregate exports fall by 7,8per cent and there is a shift in resources from export production todomestic production. Imports are, however, significantly boosted, princi-pally owing to increased imports for investment, which goes up by morethan 75 per cent. The balance-of-payment situation therefore deterio-rates.

As expected, the wages of the unskilled in estate agriculture, and henceemployment, rises by 10 per cent; and by more than 25 per cent for theother labour types, both skilled and unskilled. Self-employment goes upby 16,2 per cent. In all, increased labour employment increases labourearnings and hence household income. The assumption of zero price elas-ticity of demand combines with this, resulting in increased consumptionacross all households - rural and urban. Increased household incomeraises domestic savings and hence investment. Total investment in theeconomy therefore goes up by about 75 per cent, commensurate with theincrease in imports of investment goods. This is allocated by destinationin fixed-value shares to the three sectors. Not surprisingly, the urbanpoor households from whom the unskilled in estate agriculture and theskilled are largely tapped, benefit slightly more than the rural poor. Therural poor derive their benefit largely from improved rural self-employ-ment and increased earnings from the rural unskilled as well as the ruralskilled labour types.

The second part of the simulation considers an increase in the wages ofthe unskilled in estate agriculture when the elasticity of agriculturalexport demand is set high at 10 per cent. There are much greaterresponses in most variables. A much bigger reduction in aggregateexports follows a reduction of about 15, 3,4 and 13 per cent in agricultur-al, industrial and service exports respectively. This occurs despiteincreases of 1,9, 8,5 and 15,6 per cent in agricultural, industrial and ser-vice-producer prices, further highlighting increased preference for domes-tic production. Total investment now doubles from the base value, owingalso to increased imports of investment goods. Gross agricultural outputincreases by the magnitude of the change in the wage rate of theunskilled in estate agriculture. There are greater responses in other

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sectors, implying some resource shift to non-agricultural uses. Increasesin employment are much larger, as are increases in household incomeand real consumption. There is a slight increase in the price index andthe real GDP.

3.1.2 A reduction in tax incidenceThe simulation to eliminate indirect taxes seeks to remove some of thedistortions in the agricultural product market. There is a significantamount of literature on the effect of the underpricing of agricultural out-put in the domestic markets with its implications for income distribution.The argument is that agricultural producers are very often disfavoured bydeliberate government policies. Consequently, ensuring appropriateprices for agricultural producers is central to the adjustment policy forthe agriculture sector, which was recently implemented by the Kenyangovernment.

In addition to removing distortions in the product market, the total elimi-nation of indirect commodity taxes provides a strong incentive for price-responsive farmers to commit more resources to production. This impliesa shift in the supply curve to the right for the commodity benefiting fromthe policy change and is the result of an increase in the producer prices.If the demand curve is assumed to remain unchanged, a fall in the mar-ket price of the product in question stimulates demand by the con-sumers. In short, tax reductions benefit both producers (via a rise in pro-ducer prices) and consumers through increased availability at lower mar-ket prices.

Tax reductions would undoubtedly result in a decrease in governmentrevenue and hence a fall in the amount available to the policy-makers tomeet committed obligations. This is a balanced budget simulation - gov-ernment disbursements change to match the new level of governmentrevenue. No attempt has been made in this simulation to control for pos-sible impact on government revenue. However, if the reduction in govern-ment revenue is weighed against the rise in households' real income thatcould result from a fall in market prices, this policy might seem appealingand appear as a transfer of resources from the authorities to households.Households are expected to be better off; their purchases increase andare available at lower prices. A rise in households' real income would alsoimply a rise in domestic savings and investments. However, since the gov-ernment is also a significant contributor to domestic savings, a decreasein government revenue may affect the size of the increase in domesticsavings and hence investment.

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Table 2: Impact of total elimination of indirect agriculturalcommodity taxes

Base solution

GDP at factor cost-constant pricesGDP deflator price indexExports at constant pricesImports at constant pricesNett indirect taxesGovernment expenditureTotal real investment

(K£m)

1 296,1-

478,1461,6181,9215,2294,2

Estate agriculture unskilled employment 24,0Wages

Rural unskilled employmentWages

Rural self-employmentWages (implicit)

Urban unskilled employmentWages

Urban skilled employmentWages

Household real consumptionUrban poorRural very poorRural poor

Agricultural productionAgricultural producer pricesIndustrial productionIndustrial producer pricesService productionService producer pricesAgricultural market pricesIndustrial market pricesService market prices

-57,0

-334,3

-65,0

-

162,2-

89,242,262,3

513,9-

599,8-

1 114,5•

-

-

-

Percentage change from base solutionDomestic agriculture Agricultural exports

Agriculture export demand elasticityLow

0,06-

0,10-0,20,07-0,6-0,4

0,2

-

-0,0-

0,14-

-0,04---

0,090,080,09

0,2

-

0,01-0,2-0,1-0,1-0,6-0,1-0,1

High

0,08-

0,13-0,020,09-0,6-0,4

0,3-

-0,0-

0,18-

-0,03---

-0,070,110,12

0,3-

0,00-0,2

-0,11-0,1-0,6-0,1

-

Low

2,2

0,6

3,6

1.0

1,70,3

0,335,4

-1,3

-

4,1-

1,4--

1,4

1.8

3.33.45.40,31,2

0.41.20,60,30,30,6

High

7,52,1

10,23,65,85.51.2

16.8-

5,9-

13,3-

6,1

--

6,1

7,3

11,111,516,8

1,14,41,75,52,51,0

1,12,4

Agricultural export demand elasticities = 3,0 (low) and 10,0 (high).

Table 2 indicates that the effects of tax changes on domestic agriculturalcommodities are minor on GDP and key variables. The economy appearsvirtually non-responsive. The result is no different when the exportdemand elasticity is increased to 10. There are, however, minor increasesin agricultural exports which are almost counterbalanced by decreases inthe exports of other commodities. Minor improvements in gross agricul-tural and industrial productions are offset by a near equivalent reductionin service production, leaving only a small improvement in the economy'sgross output.

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There are two effects at work in changing export taxes: fiscal and substi-tutional or allocative effects. The allocative effects tend to suggestresource reallocation from other sectors to agriculture. The economy ismore responsive to reduction in taxes on agricultural exports. As expect-ed, the effect is small under low agricultural export demand. Owing to thesmall positive change (2,2 per cent) in GDP at factor cost and in nett indi-rect taxes, government revenue rises marginally. Nominal GDP rises by2,8 per cent, a little more than real GDP because of a minor (0,6 per cent)increase in the price index. Exports increase by about 3,6 per cent, whichis more than three times the increase in imports. Increased export earn-ings combined with a smaller increase in import payments improve thebalance of payment. Employment of agricultural workers increases bybetween 4,1 and 5,4 per cent, and so do labour incomes which are subse-quently allocated to households in proportion to labour endowment. Thushousehold income improves. Encouraged by a rise in disposable incomes,all households consume more and those in rural areas appear a littlebetter-off. Increased incomes for households combined with a smallincrease in government revenue result in a marginal increase in total sav-ings and hence investment.

Total agricultural production and exports are boosted by a reduction in orelimination of agricultural export taxes. The impact on other commoditiesis smaller, although still positive. A 12 per cent rise in agriculturalexports combines with reductions in the exports of other commoditiesand results in aggregate exports increasing by 3,6 per cent. The reductionin exports of other sectors combined with smaller increases in other sec-tors' production for the domestic market will suggest a resource shift toagriculture.

When agricultural export demand elasticity is changed to 10, theresponse of the economy is, in most cases, slightly more than three timesthat observed under the low export demand elasticity. This is not surpris-ing, as the results are largely multiplicative of the export demand elastici-ty assumed.

3.1.3 Increasing world market pricesA rise in world prices of agricultural exports is synonymous with the inci-dence of a windfall. It is now more lucrative to commit more resources toproduce agricultural commodities. This may call for increased use of pro-duction input, including labour. At constant wages, more labour isemployed. Where the supply of labour is assumed to be fixed, wages arebound to rise. On the basis of the initial assumption in this model thatthere is no separate supply function for exports, the significant increasein total production will be devoted largely to exports. Increased use of fac-tors implies increased factor receipts by respective households, increas-ing income and real consumption. The rise in household income raisesdomestic savings and hence investment.

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Table 3: Impact of a 10 per cent increase in the world prices ofagricultural exports

Percentage change from base solutionBase solution Agricultural export

demand elasticity(K£ m) Low High

GDP at factor cost-constant pricesGDP deflator price IndexExports at constant pricesImports at constant pricesNett indirect taxesGovernment expenditureTotal real investmentEstate agriculture unskilled employment

WagesRural unskilled employment

WagesRural self-employment

Wages (implicit)Urban unskilled employment

WagesUrban skilled employment

WagesHousehold real consumption

Urban poorRural very poorRural poor

Agricultural productionAgricultural producer pricesIndustrial productionIndustrial producer prices :Service productionService producer pricesAgricultural market pricesIndustrial market pricesServices market prices

1 296,1-

478,1461,6181,9215,2294,2

24,0-

57,0-

334,3-

65,0-

162,2-

89,242,262,3

513,9-

599,8-

1 114,5

--

-

6,62,18,13,45,27,01,1

14,1-

5,8

-11,5

-5,8

--

6,0

7,19,8

10,114,20,94,81,6

5,52,50,9

1,12,3

21,96,2

27,111,217,223,5

3,4

46,9-

19,8-

38,3-

19,8--

20,4

24,032,833,747,1

2,813,5

5,1

18,78,12,73,57,7

Agricultural export demand elasticities = 3,0 (low) and 10,0 (high).

Table 3 shows that a 10 per cent rise in the world prices of agriculturalexports boosts the Kenyan economy, resulting in 6,6 per cent growth inreal GDP. Total agricultural exports rise by about 30 per cent. Increasedprofitability of agricultural production encourages increased use ofresources in agriculture. The demand for all labour types increases.Agricultural value added grows by as much as 14 per cent. The shift ofresources to agriculture means that this policy brings about a muchsmaller increase in total production in non-agricultural sectors mainly fordomestic supply, thereby discouraging non-agricultural exports.Agricultural exports become relatively more profitable than non-agricul-tural exports, providing justification for committing additional resources

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to agriculture. A marginal rise in producer prices also stimulates produc-tion for the domestic market of about 7 per cent in agriculture.Household income increases by between 6 and 10 per cent for ruralhouseholds and so does real household consumption. Domestic savingsincrease by about 11 per cent. With a substantial increase in export earn-ings much above import bills, the balance of payment deficit reduces byabout 38 per cent.

When the elasticity of agricultural export demand is changed to 10, thereis a much greater response by most variables. The response is also largelymultiplicative - about 3,3 times the response observed in the earlier simu-lation. Agricultural exports are much more significantly boosted and thereduction in the exports of other commodities is much more pronounced.Overall, the effect is a much larger shift of resources to agriculture.

The augmentation in the world prices of Kenyan agricultural exports hasbeen modelled as being exogenously influenced. It might result from bet-ter terms of trade such as increased demand for Kenyan exports, or anegotiated increase in prices as can be occasioned by international agree-ments such as the International Coffee Agreement. This experiment is inmany ways similar to the incidence of the coffee and tea boom in the late1970s. It confirms the findings of Bevan et al (1989) that the boom result-ed in a substantial rise in agricultural production and labour employ-ment. It also confirms significant increases in the incomes of poorerhouseholds.

This study also demonstrates how sensitive results of simulation exercis-es are to parameter specification. Though the direction of response of theKenyan economy is unchanged, the magnitude of response of most vari-ables is multiplicative in line with the size of the export demand parame-ter specified. The small country assumption implies that Kenya cannothope to influence world trade in agricultural commodities significantly,but the elasticity of demand for Kenyan exports has internal allocative aswell as distributional implications. The higher the elasticity, the larger theresources that are allocated to agriculture and the greater the opportuni-ties for earning income for those who depend on the sector for their liveli-hood.

The simulations raise a number of policy questions, including what thepolicy-maker must do when confronted with a massive influx of foreignexchange. Among others, the increased receipt could be- saved by the government. If it is anticipated that the windfall is likely to

be ephemeral, then it might be a sound policy judgement to save whatis earned against the time when world prices might come down. Thispolicy has the advantage of having low political risk and is also easy toimplement.

- spent on the provision of more social services. This is appealing espe-cially if the pre-boom state of social infrastructures has been poor. In acountry where a large proportion of the population is illiterate andwhere basic health facilities are lacking or poor in many areas, theinflux of foreign currency may provide an avenue to implement populistpolicies through the provision of these and other social services.

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- spent on debt servicing or repayment. Even though this may increasethe creditworthiness of the country, this option is likely to be resistedinternally and may have implications for the relevance of the boom toredressing income distribution and poverty alleviation.

4. CONCLUDING REMARKSThis article has presented results from a computable general equilibriummodel of the economy of Kenya using the social accounting matrix as abasic data set. The allocative as well as distributional implications havebeen examined for the GDP, employment and income, especially that ofthe poorer segment of the society. Our model is medium term in outlook;future studies could build other models for Kenya with a longer-termfocus. This might necessitate the presentation of a dynamic model thatseeks to examine the short-, medium- and long-run implications of vari-ous policy issues.

The data set used is rather dated though attempts were made to calibratethe agricultural data to reflect as much as possible the conditions prevail-ing in the early 1980s. This has the potential of introducing some biasesinto model results and could have implications for their empirical verifla-bility.

Future research Work should seek to employ a more recent data set andupdate available data for all the sectors of the Kenyan economy. Attemptsshould also be made to further disaggregate the agricultural sector intofood as well as cash crop subsectors.

Furthermore, our -model also relied on other countries" estimates of theexport demand elasticities and those for archetype economies in theabsence of such estimates for Kenya. This has been shown to have impli-cations for the results obtained. The analysis has demonstrated how sen-sitive the economy could be to parameter specification in some cases —the response being multiplicative. Future studies should establish themagnitude of such parameters for Kenya and hence provide an avenuefor improving on the model.

The focus of analysis in this article is on the implications of increasingthe wages of the unskilled in estate agriculture, increasing the worldprice of agricultural exports and removing indirect taxes of agriculturalcommodities on the poorer segment of the population. As a result, it hasbeen deemed fit to disaggregate factors of production - particularly labour- into several relevant categories in view of the importance of the contri-bution made by labour to household income in Kenya. Household cate-gories have similarly been grouped into eight, four each in urban andrural areas, to capture differential social or institutional structure andhence the impact of policy change on respective household categories.However, data constraints have prevented a disaggregated treatment ofthe agricultural sector in this analysis, even though such an exercisecould certainly have been very useful to capture the peculiarities of small-holder and plantation agriculture, for example. It might also have beenuseful to split each category into cash and food crop production and tosimulate the respective implications of subsectoral development on, for

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instance, food security, employment, income generation, and the allevia-tion of poverty. This could have brought out the implications of differen-tial participation in production activities by the various socio-economicgroups and might reveal more relevant results.

Our study has not been focused on how exogenous higher wages could bebrought about in reality with a view to examining which mechanism isbetter. Raising wages in estate agriculture under a monopsonistic situa-tion to attract more labour into agriculture has been shown to be highlybeneficial in that it boosts real GDP, employment and household income.It boosts the earnings of those remaining in employment and the incomesof new labour recruits, resulting in much greater increases in producerprices for non-agricultural commodities, and much greater production inthe non-agricultural sector. This implies some shift of resources awayfrom the agricultural sectors. The non-responsiveness of the Kenyaneconomy to the elimination of indirect taxes on domestic agriculturemight be an indication of the very limited nature of the distortion thatthese taxes have brought on the commodity market. Kenya ranks amongthe countries with high producer prices in sub-Saharan Africa and effortshave been made recently to eliminate remaining minor distortions com-pletely. Thus, the impact of eliminating indirect taxes on agriculturalexports is small, thereby further buttressing the limited nature of the dis-tortion on the agricultural export commodity market. The model hasshown that an improvement in the terms of trade results in increaseddemand for Kenyan exports leading to increased prices and a significantboost to income and GDP. It is also effective in increasing returns tolabour, which is an important step in reducing poverty.

Our simulations at two different levels of agricultural export demandelasticities yield results which are largely multiplicative, demonstratingthe sensitivity of Kenya to the generation of agricultural foreign exchange.It is also a reflection of the simplicity of some of the assumptions of themodel. Assumptions such as zero substitution possibility at the lowerlevel in the production process and zero price elasticity of demand, fixedfunctional forms of revenue generation and income distribution precludewider variability in model responses. This may have affected the results ofthe model.

The article has, however, attempted to show relative changes in house-hold income consequent on a policy change, in preference to an aggregatemeasure of income distribution. The latter would have concealed theimpact on particular socio-economic groups. Our results indicate thatthese policy changes are capable of improving the position of the poor.Increasing the wages of the unskilled in estate agriculture and improvingthe terms of trade for agriculture are preferred, in that order, on the basisof the impact on the employment, income position and real consumptionof the poor. Eliminating indirect taxes on agricultural commoditiesappears inferior on all counts as an instrument to alleviate poverty.

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Submitted July 1994; final version accepted for publication March 1996.

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