Industrial output fluctuations in developing countries: General equilibrium consequences of agricultural productivity shocks

This paper shows how agricultural productivity shocks can generate large industrial output fluctuations in poor countries, using a static general-equilibrium model with Stone-Geary preferences. A negative shock to agricultural productivity increases food prices, which affects manufacturing output through two channels: (1) meeting subsistence requirements in the face of rising food prices causes poor households to shift consumption away from manufactures; (2) capital and labor move away from manufacturing and into agriculture in response to the food price increase. As a result, manufacturing output decreases in response to the decline in agricultural productivity. This effect is larger the closer is income to the subsistence level. Calibration exercises show that the growth rate of industrial output fluctuates significantly more in poor countries in response to changes in crop yields, a proxy for agricultural productivity. In addition, I test the predictions empirically. I utilize annual manufacturing data and instrument for crop yields using year-to-year changes in rainfall. The results show that a 1% decrease in crop yields induced by shortages in rainfall decreases manufacturing output by 0.38%, capital investment by 1.56%, and employment by 0.20% across 44 developing countries. Overall, crop yield variation (instrumented by rainfall shocks) can explain about 28% of industrial output growth fluctuations in developing countries. JEL codes: O12, O14, D58, E32