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Ownership and Tenancy “The metayer [sharecropper] has less motive to exertion than the peasant proprietor, since only half the fruits of his industry, instead of a whole, are his own." John Stuart Mill (1848) Fall 2010 Huw Lloyd-Ellis () Econ 239 Fall 2010 1 / 23 Overview Distribution and ownership of land is central to rural development ,! ,! ,! ,! functioning of the land market — ownership vs. tenancy linkage to credit markets linkage to labor markets rural-urban migration Nature of tenancy — …xed rent vs. sharecropping ,! ,! ,! ,! sharecropping: historically widespread “non-market institution” currently still common in Asia consequences for productivity example of debate over role of institutions Huw Lloyd-Ellis () Econ 239 Fall 2010 2 / 23 Example: Tenancy in the ICRISAT Villages Discussed in Ray pp. 420-423 Sharecropping is dominant as a form of tenancy Wide variety of tenancy arrangements ,! 50–50 output shares, plus input cost sharing ,! 75% shares, plus tenant pays for all inputs “Reverse tenancy” is common ,! 32% of leasings are from small to large farmers ,! 47% between farmers that own similar sized plots Huw Lloyd-Ellis () Econ 239 Fall 2010 3 / 23 Is sharecropping associated with lower yields? Discussed in Ray pp. 430-431 Village surveys from ICRISAT ,! can compare owned and sharecropped land for same farmer Results: ,! sharecropped land 16% less productive (controlling for other factors) ,! no systematic di¤erences between …xed rental and owned land Why do we observe sharecropping if it so unproductive? Policy question: should the government ban sharecropping ? ,! Alfred Marshall (1881) on England vs. France Huw Lloyd-Ellis () Econ 239 Fall 2010 4 / 23 A Simple Analytical Framework Value of output: Y = g (L) ,! L = labour e¤ort ,! decreasing marginal product, MP Cost of e¤ort to Tenant: C (L) ,! increasing marginal cost, MC Huw Lloyd-Ellis () Econ 239 Fall 2010 5 / 23 Output, Cos t Production Function, g(L) Labour MP Labour Figure: Production Huw Lloyd-Ellis () Econ 239 Fall 2010 6 / 23 Output, Cos t Produc tion Func tion, g(L) Cos t Function, C(L) Labour MC MP Labour Figure: Production, Cost Huw Lloyd-Ellis () Econ 239 Fall 2010 7 / 23 Output, Cos t Production Function, g(L) L** Labour MC MP L** Labour Figure: Production, Cost and Economic Surplus Huw Lloyd-Ellis () Econ 239 Fall 2010 8 / 23 Linear compensation schemes: I = (1 Tenant’s income : α )Y F C (L) R = αY + F Landlord’s income : ,! pure wage contract : F < 0 and α = 1 ,! pure rental contract : F > 0 and α = 0 ,! sharecropping contract : F 0 and 0 < α < 1 Huw Lloyd-Ellis () Econ 239 Fall 2010 9 / 23 The Negative Incentive E¤ects of Sharecropping Development Planning View Assume both parties are risk neutral Under sharecropping Tenant exerts e¤ort until: (1 α)MP = MC ) undersupply of e¤ort and low output relative to …xed rental Policy implication: remove sharecropping and replace with …xed rents Huw Lloyd-Ellis () Econ 239 Fall 2010 10 / 23 Output, Cos t g(L) (1-α)g(L) C(L) Labour L** L MC Efficiency Loss MP (1-α)MP L L** Labour Figure: Ine¢ ciency of Sharecropping Huw Lloyd-Ellis () Econ 239 Fall 2010 11 / 23 Output, Cos t g(L) g(L) - F C(L) L** Labour MC MP L** Labour Figure: E¢ ciency of Fixed Rental Contract Huw Lloyd-Ellis () Econ 239 Fall 2010 12 / 23 Sharecropping as an E¢ cient Response to Risk Chicago School View If sharecropping is so ine¢ cient, why is it so common? Risky production: Y = g (L) + x g (L) x with probability with probability 1 2 1 2 ,! average output: Ȳ = g (L). Tenant and Landlord are risk–averse ,! cost of risk is a transactions cost that varies with α Huw Lloyd-Ellis () Econ 239 Fall 2010 13 / 23 T otal Cost of Ris k Expos ure MCR Expos ure Figure: Marginal Cost of Risk Huw Lloyd-Ellis () Econ 239 Fall 2010 14 / 23 Landlord and Tenant can agree on e¢ cent level of e¤ort, L ,! if Tenant does not provide this e¤ort, Landlord does not pay him Then choose value of α to minimize the total cost of risk to the two parties ,! since 0 < α < 1, sharecropping results as an e¢ cient response to risk Policy implication: no need for government intervention Huw Lloyd-Ellis () Econ 239 Fall 2010 15 / 23 Cos t of Ris k T enant Landlord α Cos t of Ris k T otal Cost 0 α∗∗ 1 α Figure: Cost-Minimizing Sharecropping Contract Huw Lloyd-Ellis () Econ 239 Fall 2010 16 / 23 Problems Assumes away (1) negative incentives of sharing (2) cost of monitoring e¤ort Does not explain 50–50 splits when Landlord is wealthy (risk–neutral) Huw Lloyd-Ellis () Econ 239 Fall 2010 17 / 23 Sharecropping as an Incentive Scheme New Institutional View Assume for simplicity ,! Landlord is risk–neutral, but Tenant is risk–averse ) wage contract is optimal according to Chicago school ,! costly monitoring ,! cannot infer e¤ort due to risk ) trade–o¤ between risk and incentives Huw Lloyd-Ellis () Econ 239 Fall 2010 18 / 23 MC E MP Labour MCR 1−α Figure: Fixed Rent Case Huw Lloyd-Ellis () Econ 239 Fall 2010 19 / 23 MC E MP (1 −α1)MP L1 Labour MCR 1 −α 1 −α1 Figure: Too Little E¤ort Huw Lloyd-Ellis () Econ 239 Fall 2010 20 / 23 MC E (1 −α2)MP MP Labour L2 MCR 1 −α2 1 −α Figure: Too Much Risk Huw Lloyd-Ellis () Econ 239 Fall 2010 21 / 23 MC A E B (1 −α∗)MP MP Labour L* MCR C D 1 −α 1 −α∗ Figure: Constrained-e¢ cient Sharecropping Contract Huw Lloyd-Ellis () Econ 239 Fall 2010 22 / 23 The incentive–constrained or second–best e¢ cient value of α is ,! decreasing in MP ,! increasing in MC ,! increasing in cost of risk Sharecropping is a rational response to risk and incentive problems BUT outcome not same as predicted by neoclassical theory (i.e. not e¢ cient) Provides explanation of why sharecropping disappears as economies develop ,! cost of risk may decline with development — why? Policy implication: should not ban sharecropping, but should encourage institutional changes that reduce risk. How ? Huw Lloyd-Ellis () Econ 239 Fall 2010 23 / 23