The “Efficient but Poor” Hypothesis *

Theodore W. Schultz was an enormously influential economist; the second person in a distinguished department at the University of Chicago to be awarded the Nobel Prize in economics (in 1979, three years after Milton Friedman); the first development economist, along with W. Arthur Lewis of Princeton, to win the Nobel; and the first winner of the Nobel Prize who had devoted much of his early career to studying problems of agriculture. Schultz transformed how the economics profession looked at problems confronting developing countries.

During the 1950s and early 1960s, it was widely accepted among economists and policymakers that the marginal product of labor in agriculture in developing countries was zero, so that labor could be withdrawn from agriculture for industrialization at no cost to agricultural production. It was also widely argued that farmers in developing countries were guided by tradition or culture and did not respond to economic incentives. In Transforming Traditional Agriculture, Schultz demolished these arguments. A central thesis of Schultz's work was that farmers in developing countries are “efficient but poor” (or, as many put it, “poor but efficient”), meaning that they make efficient use of their few resources. For economists trained since Transforming Traditional Agriculture was published and subsequently incorporated into the mainstream of the profession, it is difficult to appreciate how revolutionary Schultz's views on development economics were within the intellectual milieu of the 1960s.

Recently, some development economists have questioned the efficient but poor hypothesis, arguing that aspects of agricultural household decisions and land tenancy arrangements in developing countries seemingly defy efficient economic behavior. The objective of this article is to take a critical look at these claims, bearing in mind Schultz's admonition in his 1979 Nobel lecture that “People who are rich find it hard to understand the behavior of poor people. Economists are no exception, for they too, find it difficult to comprehend the preferences and scarcity constraints that determine the choices that poor people make” (p. 639).

We believe that some of the current work by development economists are missing insights that Schultz offered over four decades ago. We examine some of the initial criticisms of Transforming Traditional Agriculture that appeared in the 1960s and then find echoes of those criticisms in the work of some of today's scholars.

Efficient but Poor in Transforming Traditional Agriculture

The economic approach to understanding problems of developing countries that Schultz espoused was pragmatic and grew from his own life experiences. Schultz was long known as a careful and astute observer of the world, and in his travel to Latin America, India, and Russia in the years immediately after the Second World War, he must have filed away in his memory much of what he had seen. He traveled to India in 1951 as a member of a United Nations expert group charged with formulating plans for economic progress in India. Schultz also read and drew upon the work of other social scientists, including scholars in anthropology, sociology, and political science (Nerlove).

Schultz's view on traditional agriculture is disarmingly simple, but with profound implications for productivity growth—traditional agriculture is a state of low level equilibrium where farmers do the best they can in the institutional framework in which they operate with whatever resources and knowledge they have at their disposal. By experimentation over time, where the state of the arts has not changed and where the environment is inherently risky, farmers learn how to allocate the resources at their disposal in a manner that is consistent with their own interests, that is, in an “efficient” manner.

What follows is that disparities in economic behavior between farmers in poor and high-income countries arise not from any differences in economic motivation but rather from constraints faced by farmers, both resource constraints and constraints arising from existing institutions. Schultz (1965) draws the following policy implications for traditional agriculture: “It is producing precisely the right products in the right amounts and it is using the agricultural factors of production in the right proportion and amounts, and therefore it is contributing a maximum to the national product. More than that it cannot do” (p. 14). Hence, to raise the productivity of traditional agriculture, farmers must have access to new information and high-payoff inputs.

In the work following the publication of Transforming Traditional Agriculture, Schultz (1975) and his student Welch elaborated on the concept of efficiency, dividing it into two components, technical efficiency and allocative efficiency. As Schultz (1975) demonstrated, the efficiency of traditional agriculture stands in stark contrast to the inefficiencies and disequilibria that are pervasive in modern economies. These inefficiencies and disequilibria arise because producers and consumers must adjust to continually and often rapidly changing economic conditions. Investments in human capital are critical in helping producers and consumers make the proper adjustments.

Early Criticisms of Transforming Traditional Agriculture

Transforming Traditional Agriculture turned much of development thought on its head when it appeared and immediately drew a barrage of criticism. One strand of criticism against the Schultz's perspective grew out of a view that the tools of modern economics were inappropriate to understanding the situation of poor people in poor countries. Myrdal, also an economics Nobel Prize recipient, for example, argued that people's behavior in poor countries is not primarily determined by microeconomic calculations of costs and benefits. Chakravorty, an important figure in the Indian economic firmament, argued as late as 1984, two decades after Transforming Traditional Agriculture was published, that the assumptions underlying the neoclassical economic view of resource allocation Indian agriculture were empirically unsound.

A second line of criticism against Schultz was focused on whether surplus labor existed in Indian agriculture. Schultz's view contrasted sharply with the prevailing paradigm, emanating from work by W. Arthur Lewis and others on labor surplus models. The accepted view was that there was unemployment or underemployment in rural areas giving rise to surplus labor that was available for use in industrialization at no cost to agricultural production. The agricultural wage rate was assumed to be “institutionally determined,” with the supply of labor to the industrial sector being perfectly elastic at this institutionally determined wage rate. Bhagwati and Chakravorty, in a frequently cited 1969 survey of the Indian literature on economic policy, stated that “the existence of surplus labor is regarded as almost self-evident by many Indian economists” (p. 55).

The accumulated weight of empirical evidence since the 1960s has undercut the surplus labor hypothesis. Empirical studies of agricultural household labor supply in developing countries have found that labor supply curves are generally inelastic or even backward-bending, in sharp contrast to the perfectly elastic labor supply curve implied by the surplus labor hypothesis (Abler, Tolley, and Kripalani). With a few exceptions, such as Ranis, development economists have abandoned the concept of surplus labor, and it is now part of the history of economic thought rather than contemporary economic thinking.

Modern Criticisms of the Efficient but Poor Hypothesis

Today's critics of the efficient but poor hypothesis echo many of the themes that we have seen above, particularly in regard to attributes of poor people. Numerous scholars argue that the poor in developing countries are special in many attributes and dimensions. For example, Ray argues that a “circle of low (or frustrated) aspirations and endemic poverty may be a self-sustaining outcome” (p. 418). Ray develops the concept of an aspirations window and argues that people's investment behavior is affected by the gap between “the standard of living that's aspired to and the standard of living that one already has” (p. 412). Individual investment effort in Ray's framework is minimal when this aspiration gap is large because it is viewed as too great to overcome, as well as when the gap is small because there is little to aspire toward. Similarly, Duflo argues that “being poor almost certainly affects the way people think and decide” (p. 376), and that a theory is needed of how poverty influences the decision-making process.

Arguments such as these are typically applied to countries—primarily in Sub-Saharan Africa—where significant agricultural and economic growth have yet to occur and where agricultural development schemes have yielded few results. Missing is any sense of perspective about how much of the rest of the developing world was similarly poor three or four decades ago. Many developing countries have had dramatic success in increasing agricultural productivity, raising farm household incomes, and reducing poverty. If poverty is linked to a failure of aspirations in a self-sustaining cycle, how is it that so many previously poor households in these countries have escaped poverty? The experience of these countries bears out Schultz's view that poor people, just like the nonpoor, take advantage of economic opportunities when presented to them.

None of this is to deny that culture can have effects on economic development, such as through fostering or hindering changes in social and political institutions (Ruttan). However, cultural endowments can change, and aspects of culture previously seen as impediments to economic development can be beneficial under different circumstances. Ruttan discusses aversion to impersonal cooperation in Confucian culture. This was viewed in the past as an obstacle to the development of market institutions, but is now seen as serving Chinese firms well in obtaining technical knowledge from relatives abroad and marketing products overseas. Ruttan also discusses Hindu culture, whose caste system and resistance to individualism had previously been viewed as constraining South Asian economies to a low-level state of development referred to by Lal as the “Hindu equilibrium.” As Lal indicates, economic modernization does not require the adoption of Western culture and beliefs, and indeed economic growth in India since 1980 has broken the Hindu equilibrium.

Nor is this to deny that there may be a role for behavioral and psychological research in helping understand the economic choices made by poor farmers in developing countries. Rather it is to argue that if poor farmers are boundedly rational, the boundaries on their rationality are no stricter than anyone else's. They may lack much formal education and know little about the outside world, but they are experts within their own domain. They know their own crops, livestock, soils, climates, water resources, agricultural pests and diseases, and markets, because their livelihoods and even survival depend upon this detailed knowledge.

Ball and Pounder's recent criticism of the efficient but poor hypothesis concerns the degree to which contemporary agriculture in developing countries meets Schultz's definition of traditional agriculture. They note that it would be nearly impossible to find any community today in which the traditional equilibrium has not been upset in some way. However, the essence of Schultz's contribution to economic thought was the dynamic responsiveness of farmers. It is this responsiveness that leads to static efficiency in the stable environment of traditional agriculture. For this reason, Transforming Traditional Agriculture is still highly relevant today even though traditional agriculture has largely disappeared.

Because little agriculture in the world today meets the definition of traditional agriculture, inefficiencies in developing country agriculture are inevitable as a part of the process of adjusting to a changing economic environment. We do not need to turn any further than Schultz (1975), who emphasized that economic change goes hand in hand with inefficiencies and disequilibria. Hindsight is 20/20, and one can always find examples of decision-making errors after the fact: farmers who planted the wrong crops or raised the wrong livestock; used too little of some inputs, used too much of others; failed to adopt new innovations quickly enough; fell short in taking advantage of new financing or marketing opportunities; were too slow in expanding the scale of their operations; or (going in the other direction) should have exited agriculture sooner. Schultz's emphasis on the responsiveness of farmers implies that, when decision-making errors occur, farmers seek to identify and correct the mistakes they made.

Economists attempting to improve the efficiency of the agricultural sector in developing countries cannot rely on the clarity of hindsight. They face the far more challenging problem of identifying correct decisions in advance. For their advice to be useful, they must have information or insights not already available to economic agents in the sector. Ruttan's assessment of the record on economic advice to farmers in developing countries is sobering: “Experience has taught us that when peasants refuse to adopt the practices recommended by agronomists and economists, it may be the experts rather than the peasants who are wrong” (p. 41).

Economists attempting to improve the efficiency of the agricultural sector in developing countries also need to bear in mind Schultz's (1980) advice to carefully understand the scarcity constraints affecting choices made by poor farmers. The poor inhabit a world of pervasive market and institutional imperfections that help to perpetuate poverty, including credit constraints and often insecure property rights. There is also the matter of the risks associated with change. Poor households at the margins of survival may move cautiously in making changes required to increase their productivity, especially if those changes involve substantial cash outlays (relative to their income levels) and there is uncertainty regarding the outcome of those changes. These scarcity constraints, rather than any behavioral differences between the poor and nonpoor, can explain the economic choices made by poor households (Banerjee and Newman).

As Ball and Pounder point out, one area where Schultz may have been remiss in Transforming Traditional Agriculture was in not fully considering the implications of market failures for the efficient but poor hypothesis. Individual efficiency, or bilateral efficiency in contractual arrangements between two parties, is not sufficient to ensure the general equilibrium efficiency of an economy (Stiglitz). However, we do not believe that this limitation detracts from Schultz's insights on the responsiveness of poor farmers to new economic opportunities.

Conclusions

By stressing incentives and the responsiveness of farmers to economic signals, T.W. Schultz generated a new set of possibilities for economic policy toward agriculture. Schultz brought to the fore the role of science and technology in creating new inputs that could help transform traditional agriculture. He demonstrated that output growth in traditional agriculture and the “new” sources of permanent income streams could only come from the fruits of science, not from increased application of inputs already at the disposal of traditional agriculture.

For poor households in developing countries, Schultz's message is ultimately a hopeful one. As Schultz stated in his Nobel lecture, “While there remains much that we do not know about the economics of being poor, our knowledge of the economic dynamics of low-income countries has advanced substantially in recent decades. We have learned that poor people are no less concerned about improving their lot and that of their children than those of us who have incomparably greater advantages. Nor are they any less competent in obtaining the maximum benefit from their limited resources” (p. 649).