Udviklingsøkonomi - grundfag Lecture 10 Markets in agriculture. A brief survey of rural microeconomics Ray chapter 11 Binswanger and Rosenzweig, JDS 1986 (long, difficult and full of good insights) 1

2 Overview  We consider the markets for Land Labour Credit Insurance Animal rental  Behavioral factors common to (all) people  Material factors specific to agriculture  Behavioural and material factors can explain market failures. Missing and imperfect markets interact and help explain common institutions found in agriculture.  Why worry about failure of agricultural markets? 1.Efficiency 2.Distribution 3.Informal institutions exist as compensation 4.To under stand development problems 5.Policy relevance

3 Foundations 1.Risk from market, production or health 2.Information is costly 3.People are self interested 4.People value consumption 5.People dislike effort 6.People are risk averse Consequences 1.Asymmetric information 2.Incentive problems (moral hazard) 3.Imperfect enforcement of property rights 4.Broad spectrum of insurance substitutes (where insurance markets are lacking) 5.Collateral shifts risk from lender to borrower 6.Credit markets only exist for those that own assets suitable for colalteral 7.A suitable collateral  can be appropriated by lender  Absence of collaterial specific risk  Earns a return to borrower 8.Collateral substitutes are developed (tied loans, loss of future loans) 9.Assets prices depend on their collateral and insurance value

4 Characteristics of agriculture  Spatial dispersion – land is immobile  High transport costs  Seasonality and climate dependence  Synchronic timing of operations  High risk due to  Climate, weather  Market prices of inputs and outputs  Timing uncertainties  Production factor ”breakdown” (machines fail, people and animals get sick)  Risk is covariate (correlated within the village)  Absence of crop insurance by nonlocals: 1.Information problems 2.Incentive problems  Absence of crop insurance by locals: 1.Covariate risk  Problems of nonlocal financial intermediation  Problems of local financial intermediation  Advantages of the rural moneylender

5 An example – begin with land and labour  Land is unequally distributed To match labour to land, we either need Land rental markets or labour markets land => workers Workers => land  Does this give the same outcome? Yes, if there is constant returns to scale, perfect information and perfect markets No, if risk and market imperfectiosn are important

6 Land/labour example continued solutions: 1.The landowner can hire labour Time rate Piece rate Long term 2.The workers can rent land from the lanlord Fixed land rental Sharecropping (”deleleje”)  Marshallian inefficiency – this works as a high marginal tax. But has an insurance element. Compromise between insurance and incentives. 3.Land sales markets  Credit problems  Market price of land larger than discounted future profits  In good years all want to buy; in bad years all want to sell

7 Can the theory explain differences in land tenure across countries? Very equal land distribution 1.Little need for land or labour markets Somewhat unequal distribution of land We see either 1.Land rental markets 2.Labour markets Depending on where the transaction costs are the largest… Very uneven land distribution 1.Fixed costs of supervision perhaps easie rto carry for a large landlord, who may employ supervisors 2.Political risk for land reform larger in very unequal societies; they therefore avoid land tenancy.

8 Expanded example  Add to the previous example bullocks as draught animal So now three important assets – land, labour and bullocks Will bullocks affect the optimal farm size and contract type? If there are bullock rental markets, they won’t. Are bullock rental markets possible? 1.Moral hazard (renter does not care, does not feed them, drive them hard) 2.Synchronic timing (all need them at the same time)  Operated land follows the ownership distribution of bullocks  Consider credit. Some farmers are credit constrained (they lack collateral) Cannot buy bullocks Cannot buy other inputs (it is often said that ”the poor cannot afford modern inputs…” => implies that land and labour tends to go to farmers with capital and/or access to credit

9 An application: farm size and productivity  Superiority of the family farm (almost universal)  What is the optimal farm size? OP operated land holding OW owned land holding FS size of family labour force

10 Case: plantations  Economies of scale in processing  Coordination problems in harvesting, transport and marketing Solutions either:  Contract farming (small independent farmers deliver on contract to the processing plant), [labour cost advantage]  Plantations [credit cost advantage]

11 Conclusions  The failure of intertemporal markets for credit and insurance imply that agriculture, in general, is not Pareto efficient. We are in a 2nd or 3rd best situation.  Multiple market failures for Land Labour Credit Insurance Bullocks  And factors such as Risk and risk covariance Imperfect enforcement of property rights Initial distribution of assets  Play together to determine transaction costs and thereby Choice of contract Distribution of income and land Income and production Informal institutions