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					     Land markets

Development and Transition II
       Tbilisi, 2008
                      Introduction
• Proper functioning of the land market is very important
  for the overall development of the economy.
• If land is held unequally and many individuals fail to
  obtain access to it, they are likely to leave agriculture
  and concentrate in cities (massive rural-urban migration),
  which might have serious political and environmental
  consequences.
• Also from the economic point of view it is very important
  to have a well functioning land market. Focusing on
  economic efficiency, we ,are going to analyze:
   – how the land rental markets deal with substantial inequalities;
   – Efficiency of land rentals;
   – Efficiency of inequality of ownership (link between size and
     efficiency);
   – The role of land reforms.
       Ownership and tenancy
• As one might expect, owner-cultivated farms are
  preponderant in countries with a relatively low level of
  inequality.
• Tenancy, exists all over the world, even though
  measuring correctly its extent may be problematic,
  especially if legislation favors tenants working the land
  for some pre-specified numbers of years in acquiring
  ownership or use rights (incentive to “disguise” tenancy).
• However there are variations (table 12.2 - Ray) in the
  form of the tenancy arrangements. The two most
  common arrangement types are:
   – fixed-rent tenancy (Latin America);
   – sharecropping (Asia).

   [While in Latin America sharecropping=16.1%, in Asia
     sharecropping=84.5%].
        Land rental contracts
• Fixed-rent contracts
  – Fixed amount to be paid to landlord;
  – Landlord relieved of all the risk;
  – Requires tenant to be willing and able to bear the
    risks of agricultural production;
  – More common in presence of highly mechanized and
    capitalistic farms using wage labor;
• Sharecropping
  – Landlord receives a share of the production and might
    pay a share of the costs;
  – Landlord and tenant share the risks of agricultural
    production;
  – More common in presence of smaller and risk-averse
    tenants.
   Land rental contracts,cont.
• It is possible to build a general class of
  rental contracts containing fixed-rent and
  sharecropping as well as pure wage
  contracts:
•      R=αY+F
  – With α =0 we have pure fixed-rent contract;
  – With F=0 we have pure sharecropping;
  – With α =0 and F<0 we have pure wage
    contract where the wage w=-F
      Contracts and incentives
• Traditionally, sharecropping has been seen as an
  inferior system to that of the fixed-rent tenancy.
• The argument dates back to Adam Smith and
  Alfred Marshall and is mainly based on the idea
  of the appropriate provision of incentives.
• The main idea is that, if the effort of the tenant
  cannot be monitored and controlled by the
  landlord, in the case of sharecropping the tenant
  has an incentive to undersupply his effort, as a
  fraction of the output produced is transferred to
  the landlord.
• This is not true in the case of a fixed-rent
  tenancy.
• This can best be seen graphically (Fig.1 and 2)
   Contracts and incentives, cont.
                                                    B
                              Production Function
                                                             A
Output, Costs




                     C

                                                    E



                                 Production Costs
                                                        Figure 1


                          D




                L’   L*                                            Labor
   Contracts and incentives, cont.
                                               B
                         Production Function
                                                         A
Output, Costs




                              Fixed rent
                C

                                               E



                            Production Costs


                                                   Figure 2

                     D




                L*                                            Labor
 Contracts and incentives, cont.
• Summarizing:
  – Sharecropping leads to a distortion to the tenant’s
    input supply due to a reduction in the marginal rate of
    return to the input (becomes lower than actual value
    of marginal product). This leads to undersupply of the
    tenant’s input;
  – Other types of agreements modifying the marginal
    rate of return to the input will lead to a sub-optimal
    provision of tenant’s input;
  – Rational landowners trying to maximize the earnings
    from land lease will always prefer a suitable fixed-rent
    contract to any share contract (giving same return to
    the tenant).
  Risk, tenancy and sharecropping
• Another important element that we should
  include in our analysis of land rental contracts is
  uncertainty.
• Agricultural production is subject to random
  shocks and this adds an element of uncertainty.
• We can consider a case in which only two levels
  of output are possible: G (good) and B (bad).
• The probability that a good output will be
  produced is given by p.
• We assume that a wealthy landlord is less risk-
  averse (thanks also to diversification of incomes)
  than his tenant.
 Risk, tenancy and sharecropping,
               cont.
• With a fixed-rent contract, the tenant will have to
  pay R regardless of the output generate by the
  plot of land, receiving G-R if things go well and
  B-R if things do not go well.
• If we want the (risk-neutral) landlord to be
  indifferent between sharecropping and the fixed
  rent contract we must have R=psG+(1-p)sB
  (which is the expected return of the
  sharecropping contract).
•  s will have to be R/(pG+(1-p)B)
 Risk, tenancy and sharecropping,
               cont.
• If the expected return to the landlord does not
  change, this will be true also for the expected
  return of the tenant.
• However, we know that the tenant is risk-averse.
  Would he prefer the sharecropping contract or
  the fixed-rent contract?
• It can be shown that the return in the good state
  under sharecropping is lower than with the fixed-
  rent contract. However, it is also true that the
  return in the bad state is higher in
  sharecropping.
 Choice of contract type with risk-
             aversion
• Outcomes of good state for tenant:
  (1-s)G-(G-R)=R-s(G)=R- [ GR/pG+(1-p)B]<0
• Outcomes of bad state for tenant:
  (1-s)B-(B-R)=R-s(B)=R- [ BR/pG+(1-p)B]>0

   If the expected returns are identical and the
   tenant is risk-averse, he will prefer
   sharecropping, as it reduces the variability of
   his outcome.
 Risk, tenancy and sharecropping,
               cont.
• This will allow a risk-neutral landlord to extract
  some additional rent (to increase the expected
  value of his returns) as a compensation for the
  risk he is bearing, while the tenant will still be
  experiencing a gain in terms of utility.
• The most attractive feature of sharecropping is
  that it is not only a way to share the output of the
  productive activity but also the risk associated
  with it.
 Risk, tenancy and sharecropping,
               cont.
• However, we might even move further and
  transfer completely the risk on the landlord if the
  landlord decided to pay a fixed wage to the
  tenant and keep the output. Why isn’t this
  happening then?
   – Landlords are not necessarily risk-neutral;
   – Incentive problems (with imperfect monitoring) 
     trade-off between need to insure and proper
     incentives – lower share to the tenant, lower
     incentives).

Trading off some insurance implies that full
  efficiency is not reached as it is incompatible
  with the landlord’s objectives.
Risk, tenancy and sharecropping, cont.
• Would it be desirable and possible to avoid
  sharecropping by combining a fixed-rent
  contract with a fixed-wage contract?
• Not necessarily, as:
  – Fixed wage contracts have worse incentive problems
    than sharecropping;
  – Mixing different contracts may be difficult in practice
    (working in own plot of land AND as hired laborer);
  – May not be possible to find a “safe asset” such as a
    fixed-wage contract characterized by the absence of
    uncertainty.
          Forms of tenancy, other
              considerations
• Cost sharing of inputs: can limit the inefficiency in the
  provision of observable inputs by reducing the marginal
  cost of the tenant;
• Double-incentive problem: both for tenant and landlord
   fixed-rent not always desirable as landlord has no
  incentive;
• Limited liability and sharecropping: we should expect
  sharecropping to be more common with poor tenants
  (unable to pay fixed rent in bad times) and to shrink
  when tenants’ wealth increase;
• Sharecropping as screening device: e.g. preferred by
  “low productivity” tenants (however, consider also risk-
  aversion and long-term effects). Useful with multiple
  types of incomplete information.
  Land contracts, eviction and use
               rights
• When we move from a static to a dynamic context, we
  have to consider the possibility that a tenancy contract
  may not be renewed.
• In this case, the landlord acquires an additional
  instrument through which provide effort incentives
  (sharecropping + threat of eviction in case of poor
  performance).
• However:
   – Uncertainty for tenants increases  tenants will have to be
     compensated;
   – The value of the contract must exceed the tenant’s next-best
     alternative or the threat will be ineffective.
   – Risk of long-run losses as the tenant will be less inclined to
     engage in activities leading to increases in the long-run earning
     potential of the land.
  Land contracts, eviction and use
            rights, cont.
• Ray indicates two cases in which contracts with
  eviction may be widely employed:

  – Limited liability: usually this type of contracts provide
    a return that exceeds tenant’s opportunity cost  in
    case of poor tenants this threat may significantly
    increase the incentive effect on effort;
  – Non verifiable information regarding tenant’s effort:
    while this information may not be used in courts (not
    included/enforced through a standardized contract), it
    can still be used to improve incentives through the
    threat of non renewal.
     Land contracts, eviction and use
               rights, cont.
• Welfare effects of eviction:
   – Banning eviction can increase the economic welfare of incumbent
     tenants by increasing their bargaining power;
   – However, banning eviction potentially reduces the welfare of
     potential tenants by making it harder to get “fresh” tenancy contracts;
   – Banning eviction can heighten productivity by transferring the
     bargaining power from the landlord to the tenant, especially in a
     context of trade-off between the provision of incentives and the
     provision of insurance (may not occur spontaneously as it may go
     against the interests of the landlord that is interested in maximizing
     his own return and not productivity).
 In general, removing eviction, we can have increased productivity
  if the positive incentive due to the increase in the tenant’s share is
  higher than the negative incentive associated with the loss of the
  eviction instrument. Which effect dominates is an empirical
  question [see Operation Barga, pp. 444-445 and Banerjee, Gertler,
  Ghatak, 2002; found evidence of increasing productivity]
   Land ownership, land size and
           productivity
• The present (mostly unequal) distribution
  of land ownership represents the result of
  history.
• Where we have an unequal distribution of
  land, we might ask whether this has an
  impact on productive efficiency and what
  type of action would be best to improve
  productive efficiency.
 Land size and productivity: some
            concepts
• Productivity
  – Total factor productivity of small vs. large
    farms (production function “above” or
    “below”?);
  – Production efficiency of small vs. large plots
    (marginal products of inputs equaling
    marginal costs – usually tested comparing
    output per acre, correcting for land quality –
    assumption: whenever the conditions of
    efficiency are violated  under application of
    inputs);
  Land size and productivity: some
          concepts, cont.
• Factors potentially explaining different
  performances:
   – Technology: given other inputs – expanded in
     proportion - we might expect land to exhibit constant
     or increasing returns to scale as size increases 
     small size is not an advantage;
   – Imperfect insurance markets and small-farm
     productivity: in presence of imperfect information,
     limited liability (and imperfect credit markets) and
     uncertainty (and risk-aversion coupled with imperfect
     insurance markets) making impossible to design and
     offer productivity-maximizing contracts  ownership
     of small plots farmed by family labor is associated by
     intrinsic productivity advantages;
        Land size and productivity: some
                concepts, cont.
                  – Imperfect labor markets (unemployment) and
                    small-farm productivity:
                                                  Per-acre production function
Output per acre




                                  Opportunity cost for             Opportunity cost for the family < w
                                  the employer = w                 (because it includes a certain
                                                                   probability p of unemployment)

                                                In presence of unemployment :
                                                1 ) we can assume that w>marginal product of labor
                                                (unemployment);
                                                2) output per acre on small farms will tend to be higher.
                                                 Family farms including in their evaluations the probability of
                                                unemployment seem to be moving closer to the efficient
                                                allocation of resources

                       L*   L**                          Labor input per acre
Land size and productivity: some
        concepts, cont.
– Pooling land: if it is possible to pool farms’ activities
  subject to returns to scale, then small farms can
  always “win” over large farms. This however depends
  crucially on the nature of the returns to scale.
   • An example of successful pooling are cooperatives whose
     main activity is to market the products.
   • In other cases (when increasing returns are at the production
     level), the incentive problem returns, as joint production
     creates externalities (undersupply of effort - free riding).
     [Example: TFP decreasing following collectivization and
     increasing with de-collectivization].
 All these counteracting forces lead to the conclusion
 that the question can only be answered empirically
       Land size and productivity:
          empirical evidence
•    Productivity gains arising from incentives (with
     imperfect markets) seem to outweigh the
     technological returns to scale from larger plots,
     in developing countries [differences with
     respect to USA and Canada].
•    From more to less productive:
    1. Owner-occupied and using predominantly family
       labor (except very smallest ones);
    2. Large, mechanized, owner-cultivated farms
       employing wage labor (some efficiency losses from
       hiring labor, at least partially compensated by
       mechanization);
    3. Sharecropped land.
        Land size and productivity:
         empirical evidence, cont.
•   Note: empirical productivity studies must be
    treated with care, as:
    –   There might be differences in the quality of the plots
        of land (smaller, higher quality – inheritance, less
        productive sold, etc.);
    –   Mixed evidence in some studies (very smallest less
        productive – then productivity increases to a
        maximum and finally decreases with size).
•   At any rate, productivity per acre on
    sharecropped land appears to be lower than
    productivity of the same farms under owner
    cultivation and size appears to be negatively
    correlated with productivity.
      Land size and productivity:
       empirical evidence, cont.
•    Suggestion that there is at least some tentative
    support for the hypothesis that regions of greater
    inequality have proportionally more to gain – at least
    under the efficiency viewpoint – from land reform.
•   Another interesting result is that advantages of small
    farms over larger ones are smaller in higher-risk
    environments. This may be due to the existence of
    imperfections in credit and insurance markets. The
    larger these imperfections, the more vulnerable
    smaller farms will be, the smaller the productivity
    differential is likely to be.
•    if land ownership implies also better access to credit
    (land as collateral, for example) productivity per acre
    may be further increased relative to pre-reform.
                  Land sales
• In a “second-best” world in which fixed-rent
  contracts are not optimal and, more generally,
  tenancy contracts do not reap fully the incentive
  gains, the possibility of small landowners to buy
  land from rich landowners could lead to productivity
  gains.
• This, however, requires a properly working land
  market.
• Empirical evidence suggests that land markets in
  most cases do not work well, with sales from
  relatively rich to relatively poor not being very
  common. Most sales instead appear to be distress
  sales from poor to rich.
               Land sales, cont.
•    Possible reason of thin land mkt - dual value
     of land:
    1. Discounted sum of income streams generated
       working/renting the land;
    2. But ALSO possibility to use land as collateral
       (especially valuable in presence of imperfect
       credit markets).
     The value for the buyer that does not have the
       money needed to buy the land will not include
       the possibility to use land as collateral, so the
       value for the buyer may turn out to be lower
       than that of the seller (despite possible
       productivity gains).
                         Land reform
•    If:
    1.     Productivity is higher on smaller plots;
    2.     Productivity gains cannot be realized fully by tenancy;
    3.     Land sales markets cannot adequately substitute for imperfect
           land tenancy markets.
•     we still have the option of organizing land
     transfers from rich to poor with or without adequate
     compensation (paid by the government of by donors
     – anyway, not entirely by the beneficiaries).
•    However, resistance of powerful lobbies is very
     likely to make the implementation of this type of
     reforms very difficult. This is why in the past major
     land reforms have been the product of political
     upheavals in society (Cuba, Japan, Korea and
     Taiwan).
               Land reform, cont.
•   There are, however, intermediate steps between
    government inaction and large-scale redistribution.
    For example, providing tenants with unlimited use
    rights to land or putting land ceilings.
•   Anyway, even if they may go in the right direction
    (Teklu, 2004 - Banerjee, Gertler, Ghatak, 2002),
    also these methods fail to solve completely the
    productivity problem.
    –   Unlimited use rights do not allow using land as a
        collateral;
    –   Land ceilings can be circumvented.
•   Most successful land reforms remain those where
    property was transferred and incentives where set
    right (see Korean example).
                  Conclusions
• For several reasons the operation of land markets
  alone appear to be potentially inadequate to create
  the required balance between land and labor
  endowments.
  – Rental markets for land must balance the conflicting
    demands of providing insurance to the tenants with
    appropriate incentives to maximize production. This
    principal-agent problem leads to a sacrifice of overall
    efficiency.
  – Similar considerations preclude an efficient functioning
    of the land sales market.
• It is important then to understand the market(s) for
  labor, the various forms that such markets assume
  and the implications for the development process.

				
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posted:6/26/2011
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