Income distribution and the allocation of public agricultural investment in developing countries∗†

We compare the effects, on rural wages and farmer income, of public investments in either a traditional or a modern agricultural sector. The traditional sector has constant or decreasing returns to scale. Economies of scale that are external to farms in the modern sector create a possible engine for growth. We show that if there are moderate returns to scale in the modern sector, and labor has a moderate share of the wage bill in that sector, there is a “critical size” of the modern sector. If the modern sector is close to this critical level at the time of the public investment, then investment in the traditional sector can derail growth and worsen poverty, whereas investment in the modern sector is likely to promote growth and reduce poverty. As the magnitude of the increasing returns to scale parameter or the labor-share parameter increase, this “critical size” of the modern sector falls, increasing the likelihood that investment in the traditional sector is inimical to both growth and poverty reduction, while investment in the modern sector promotes both of these goals.