Testing Between Competing Theories of Reverse ... Testing Between Competing Theories of Reverse Share

Embed Size (px)

Text of Testing Between Competing Theories of Reverse ... Testing Between Competing Theories of Reverse...

  • Testing Between Competing Theories of Reverse Share Tenancy

    Marc F. Bellemare∗

    July 12, 2007

    Abstract

    Reverse share tenancy, i.e., sharecropping between a poor landlord and a rich tenant, is common throughout the developing world. Yet it can only fit the canonical principal-agent model of sharecropping under specific circumstances. This paper develops and tests between three theoretical explanations for reverse share tenancy based respec- tively on (i) risk-aversion on the part of both the landlord and the tenant; (ii) asset risk, or weak property rights; and (iii) limited liabil- ity. Survey data from Madagascar offer strong support for the asset risk hypothesis, pointing to the need to broaden the canonical share- cropping model to account for reverse share tenancy.

    JEL Classification Codes: D86, O12, Q12, Q15.

    ∗Assistant Professor of Public Policy and Economics, Terry Sanford Institute of Public Policy, Duke University, 201 Science Drive, Box 90239, Durham, NC, 27708-0239, (919) 613-7405, marc.bellemare@duke.edu.

    1

  • 1 Introduction

    Sharecropping, an agrarian contract by which a landlord leases out land to a tenant in exchange for a share of the crop, has been studied by economists ever since Adam Smith’s The Wealth of Nations. Almost two and a half centuries later, the canonical explanation for the existence of sharecropping, following Cheung (1969a), Stiglitz (1974) and Newbery (1977), is that share tenancy matches a relatively richer landlord, whose comparative advantage lies in risk-bearing, with a tenant whose comparative advantage lies in la- bor monitoring. By trading off incentives and risk-sharing, sharecropping can dominate both fixed rent contracts that are considered too risky by the ten- ant and wage contracts that predictably lead to underprovision of effort by the laborer.1

    There nevertheless exists situations of reverse share tenancy,2 in which a poor, presumably risk-averse landlord contracts with a rich, presumably risk- neutral tenant on shares. Such situations do not fit the canonical model of sharecropping because the poorer landlord no longer holds comparative ad- vantage in risk-bearing over the tenant, a situation in which the principal- agent model predicts a fixed rent contract. Indeed, few of the extant models of sharecropping are consistent with the oft-observed phenomenon of reverse share tenancy.3

    In this paper, three theoretical explanations are presented that are consis- tent with both reverse share tenancy and traditional sharecropping contracts. The first model simply the canonical risk-sharing explanation in which both

    1Another strand in the literature on sharecropping is that on transactions cost, which started with Cheung (1968, 1969b) and whose best empirical representations are a pair of papers by Allen and Lueck (1992, 1993) looking at US farm data. The transactions cost approach to modeling sharecropping contracts assumes that the landlord can enforce the optimal level of effort, making sharecropping first-best.

    2A distinction is made between “reverse share tenancy” and “reverse tenancy”, since the latter term could refer to both fixed rent and sharecropping contracts.

    3Worldwide statistics on the prevalence of reverse share tenancy are unavailable, but such statistics are presented below for the empirical application at hand. Reverse tenancy has received some attention due to its prevalence in Lesotho (Lawry, 1993), South Africa (Lyne and Thomson, 1995), Eritrea (Tikabo and Holden, 2003), Ethiopia (Little et al., 2003; Bezabih, 2007), Bangladesh (Pearce, 1983), Malaysia (Pearce, 1983), India (Pearce, 1983; Singh, 1989), and the Philippines (Roumasset, 2002).

    2

  • parties are risk-averse. In this case, sharecropping can emerge as the optimal contract even when the landlord is poorer than the tenant. The second model explains sharecropping as the result of asset risk, or weak property rights: assuming that the strength of the landlord’s claim on her land is an increas- ing function of the share of the crop she receives as rent – a situation that is not unlikely in places where property rights are weak or insecure – she might choose to offer her tenant a sharecropping even though such a contract would predictably lead to moral hazard.4 Finally, the third model, due to Ghatak and Pandey (2000), explains sharecropping as the result of limited liability: if the landlord expects her tenant’s limited liability constraint to bind (i.e., if it is likely that the tenant will default on paying the cash rent), and if the tenant can choose among various techniques that differ in their expected yields and variances, the landlord will choose a sharecropping contract in order to mitigate the tenant’s risk-taking behavior.5

    After presenting these competing theoretical explanations for reverse share tenancy, this paper tests them empirically using field data from Lac Alao- tra, Madagascar’s most important rice-producing region. In Lac Alaotra, 37 percent of plots are under some form of land tenancy (i.e., fixed rent or sharecropping), and 24 percent of plots are sharecropped. In addition, reverse tenancy (a precise definition of which is given in section 5.3 below) occurs on almost 19 percent of plots, and over 12 of plots are under reverse share tenancy.6 The data strongly support the asset risk hypothesis, indicating the need to broaden the canonical model to account for reverse share tenancy.

    This paper thus offers a threefold contribution to the literature. First, and of most general interest, it sheds light, both theoretical and empirical, on a relatively common phenomenon that has so far been ignored by development economists, as described above. Second, this paper contributes to both the empirical contracting literature and the empirical sharecropping literature by testing whether observed contracts correspond to the predictions of the

    4This special case of the adverse possession (Shavell, 2004; Posner, 2007) rule for land is empirically motivated and discussed at length in section 2.2 below.

    5Although the limited liability constraint is less likely to bind for richer tenants, section 2.3 discusses how even if the average tenant household liquidated all of its assets, it still would not be able to afford the cash rent.

    6All estimates are significant at the 1 percent level. These statistics are probability- weighted means, as described in section 4.

    3

  • theory rather than by testing whether agents respond to incentives (Pren- dergast, 1999).7 As such, it is most closely related to two recent papers: one by Dubois (2002), who develops a dynamic principal-agent model in which landlords choose sharecropping agreements in order to trade off moral haz- ard and incentives to overuse land; and the other by Pandey (2004), who tests whether the principal-agent model accurately predicts how sharecrop- ping contracts change with technology. Finally, by finding that insecure land rights motivate the emergence of sharecropping in Lac Alaotra, this paper can inform land policy in Madagascar and in other places with similar fea- tures. As such, this paper is perhaps closest in spirit to recent works by Macours (2004), who shows how heterogeneity among ethnic groups com- bined with weak enforcement of property rights causes landlords to contract with partners from the same ethnic group; Macours et al. (2004), who show how insecure property rights cause landlords to only lease out to a restricted circle of acquaintances; and Conning and Robinson (2007), who develop and test a general equilibrium model of agrarian organization and property rights.

    The rest of the paper follows is organized as follows. Section 2 presents the three theoretical models of sharecropping described above. In section 3, the empirical framework and identification strategy is discussed. Section 4 presents the survey methodology as well as descriptive statistics for the data used in the empirical application. In section 5, the estimation results are presented and analyzed, along with a number of robustness checks. Section 6 concludes and briefly discusses implications for policy.

    2 Theoretical Framework

    2.1 Standard Model and Risk-Sharing Hypothesis

    Consider the canonical model of sharecropping. A principal whose utility function is V (·), with V ′ > 0 and V ′′ ≤ 0, contracts with an agent whose

    7Following Marshall (1920), the moral hazard problem associated with sharecropping became known as Marshallian inefficiency. For the most part, the empirical literature on sharecropping has aimed at determining whether agents indeed do respond to incentives in sharecropping contracts. Notable contributions include Bell (1977), Shaban (1987), Laffont and Matoussi (1995), Pender and Fafchamps (2006), and Arcand et al. (2007). In most cases, the null hypothesis of no moral hazard is in favor of the alternative hypothesis of Marshallian inefficiency.

    4

  • utility function is U(·), with U ′ > 0 and U ′′ ≤ 0. Assume that the princi- pal and the agent’s utility functions both exhibit decreasing absolute risk aversion (ARA). The principal hires the agent to exploit a plot of land and produce output q ∈ [q, q]. The level of output is stochastic, and its realiza- tion depends on the effort of the agent, e ∈ E. Both output and effort are linked through the probability density function f(q|e), which describes the likelihood of observing output level q given effort level e. The agent’s payoff from accepting the contract offered by the principal is additively separable in the utility derived from the contract and in the cost of effort, which is rep- resented by the twice continuous

Recommended

View more >