Behavioral and Material Determinants of
Production Relations in Agriculture
Hans P. Binswanger and Mark R Rosenzweig
Journal of Development Studies, 1986
Objectives
 Analyze the institutions governing production and exchange
of output and primary factors of production in rural areas
 Incorporate risk and information constraints, together with
the material attributes of agricultural production and
production factors
 Analyze barriers to markets for credit and insurance, and
land sales markets
 Analyze the causes of diseconomies of scale in agriculture,
and the reasons for the existence of plantation agriculture
Two simultaneous problems of
agricultural households
 Achieve high levels of incomes, consumption and leisure (one
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period problem)
To even out consumption in the face of risk, and to avoid disasters
(over time problem)
In economics we separate these problems by assuming that we
have inter-temporal markets for risk and credit (Arrow and
Debrew)
But these are generally non-existent in agriculture or highly
imperfect
Therefore the inter-temporal functions have to be solved in output
and factor markets, by building reserves, or via social relations
Initial Assumptions
 Individuals face many risks
 Information is costly
 Individuals are self interested, they value consumption and
dislike effort
 Individuals are risk averse
Initial consequences
 Asymmetric information in labor, credit or insurance
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markets
Incentives problems: moral hazard or adverse selection –
leads to share cropping in rental markets
Imperfect enforcement of property rights – eg theft
Desirability of broad spectrum of insurance
Collateral requirement for larger loans
Consequences for credit market
 Credit rationing for borrowers without collateral (even at
higher interest rates)
 If there are no insurance markets, credit becomes and
insurance substitute
 Collateral assets must
 be appropriable,
 not carry asset-specific risks,
 returns must accrue to the borrower
Collateral conditions for different assets
Basic agricultural assumptions
 Heterogeneity of land and people
 Spatial dispersion and high transport and travel costs
 High cost of acquiring information
 Leads to aggravation of asymmetric information
 Seasonality of production, and synchronic timing of
operations
 Many sources of risk: from weather and yield, price, timing
uncertainties, life cycle risks
 Covariance of risks in small agricultural areas!
Absence of crop insurance
1.
High travel costs makes sales and cost of damage assessment
expensive, and increase moral hazard
Potential solutions:
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2.
Insure only catastrophic events such as hail or floods which are easy to observe:
specific risk insurance widely available
Index-based insurance that insures a weather event, not the yield risk (has many
problems)
High covariance of risk
All farmers experience loss in the same year
Leading to bankruptcy of the insurer
 Potential solutions:
 Combine farmers from different regions or different countries
 but this solution aggravates problems 1
 The combination of problems 1, and 2 has proven insurmountable for market-
based crop insurance
Problems of financial Intermediation
Because he is locally based, the rural moneylender has superior
information about clinets, little moral hazard
However, rural moneylenders do not take deposits but lend only out
of equity – Why
Seasonality: At harvest time all farmers would want to deposit money,
and withdraw it at sowing time
If moneylender lends the deposits out, he cannot return the money to the depositors
at sowing time, or give additional loans
Covariant risk: If moneylender lends out deposits, and the crops fail,
all depositors will want to withdraw funds at the same time, and
more people will want to borrow.
Reserve banking in villages is therefore not possible
This explains why banks have historically moved into rural areas only very late,
and why they often primarily mobilize savings
Possible solution: Insure the credit or
deposits
Has been tried in many countries to make agricultural credit more
widely available
Has mostly failed for the following reason:
Crop insurance and credit suffer from the same problems of high sales
and monitoring costs
They also suffer from the same co-variance problem
You cannot shift the problems from one institution to another one
that faces the identical underlying material conditions and
problems.
Characteristics of labor arrangements
Consequences
 Seasonal underemployment
 The need for supervision of labor
 Rising labor costs with size of operational holding
 Incentives issues are a necessary and sufficient condition for this
feature. (Neither friction in the labor market or uncertainty of supply
are needed)
 Relationship between the size of the family labor force and the size
of the operational holding
 These are joint consequences of the behavioral and technological
characteristics of labor arrangements in agriculture
Lower bounds on operational size of
farms: animals and machines
 Animals and machines are lumpy inputs
 They are fragile and require high maintenance costs
 Combined with incentives issues this makes long term rental very
difficult
 Given the labor cost advantage of family labor, seasonality and
synchronic timing of operations, it is more profitable to use
animals on machines on your own farm rather than hire them out
separately.
 Operating a farm without owning draft animals therefore is very
difficult
 we obtain a lower bound on farm size.
 When technology shifts to mechanization, the lower bound may
rise
Management skills and lower and
upper bounds
 Management skills: for (1) supervision,
 and (2) for decisions under uncertainty
 Indivisibility of management skills cannot be circumvented by a
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rental market for management so we have another lower bound
But given heterogeneity of land, supervision of workers becomes
less efficient at larger scale, and so are the decisions taken under
uncertainty.
For given family labor force, hired labor costs therefore rise with
farm size
This will normally lead to diminishing returns to scale in farming.
At any given time there is therefore an optimum distribution of
operational farm sizes
Factor Market possibilities
An application to land scarce
environments (e.g. India)
 Property rights in land (or use rights) are well developed
 Land has value and has value as collateral or as a collateral
substitute
 Cost of capital decreases with size of ownership holding (but
not with the size of operational holding)
 No institutional barriers on any markets, including land
rental or sale
 Financial and insurance markets are poorly developed
 Competition among agents
Is there also an optimal ownership
distribution?
 A landless individual with farming skills and draft animal will find it
optimal to rent in land rather than hire his labor and animals out
separately
 Large owners can gain by renting out land to small famers
 because of the lower labor costs of the tenants
 The operational distribution of land will therefore be more equal than
the ownership distribution
 The cost of rental arrangements will rise little with the number of
tenants
 There is therefore no upper bound on ownership
 The ownership distribution is largely indeterminate
The land sales market
 In normal agricultural periods there will be few land sales in
normal periods
 Few small sellers, because it is more profitable to cultivate your
own land
 There will be few demanders of land: because you cannot use land
as collateral to purchase land
 The land has a collateral value, and you need to pay both for that
value as well as for the discounted profits from agriculture
 If you mortgage the purchased land, your profits will be insufficient
to pay for the interest and repayment.
In very good agricultural years
 All farmers have money and would compete for the purchase
for land, while few would want to sell
 Very few transactions in good years
In very bad agricultural years (or a
sequence of bad years)
 The labor market vanishes, as there is no demand
 Farmers would have to sell assets in order to feed themselves
 Once assets are depleted, they will resort to distress sales of land
 Because of covariance of risk, other farmers do not have any
money to buy land
 Only moneylenders would be able to purchase land, using the
value of debts of farmers, as well as extra cash, to pay for it
 Land will accumulate in the hands of moneylenders
Implications
 The land rental market enhances efficiency of agricultural
production,
 because it transfers land from large owners with high labor costs to
tenants with much lower labor costs
 The land sales market, via distress sales, transfers land from the
small farmers to moneylenders,
 who have no comparative advantage in farming
 It is therefore efficiency reducing and inequality increasing
 Over the history, this has led to periodic needs for land reform,
from the Roman Empire to India and China
Why are there plantations
 Sugarcane, tea, bananas for exports
 There are economies of scale in the sugar and tea factories and in
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the huge banana boat.
But there are also economies of scale in grain mills, yet we do not
have any grain plantations
Sugarcane and tea have to be processed within hours from harvest,
and a whole banana boat has to be filled in 24 hours, sealed and
refrigerated to avoid spoiling of the bananas
This creates enormous coordination problems between the farms
and the plant or boat, with planting and harvesting having to be
coordinated tightly
This can be solved by having a large farm with a single
management – a plantation
Or by the use of contract farming
Other topics explored
 Farm size, factor ratios and productivity
 Technical change and the alterations of production relations
 Mechanization
 Yield increasing technology – Green Revolution
 Dry season irrigation
 Production relations in land abundant areas
Next time: Power, Distortions, Revolt and Reform