Agricultural Misallocation, Occupational Choice and Aggregate Productivity - The Role of Insecure Land Rights and Missing Financial Markets

Compared to advanced economies, most of the least developed countries feature extremely low agricultural labour productivity while productivity in non-agriculture is only modestly low. This particular inefficiency in agriculture is a puzzle. We believe that it can partly be explained by misallocation of production factors, in particular of land, across farms - e.g. some farms use too much land and others too little. Besides, comparing incomes of workers in agriculture and non-agriculture, it is puzzling why so many workers remain in agriculture, indicating misallocation across occupations.

The aim of our project is twofold. First, we plan to identify causes of the aforementioned misallocation. Second, we intend to compute how policies that diminish misallocation could change agricultural, non-agricultural and, ultimately, aggregate productivity - i.e. by how much could they potentially increase GDP. Also, we are interested in the welfare effects of such policies on individuals with distinct characteristics (by skill, wealth, gender, age, occupation, etc.) - who stands to gain and who may lose? As such our proposal directly addresses Theme 1 of the present Call and indirectly addresses Theme 2 as well.

We hypothesise two reasons for misallocation. The first one is insecurity of land rights. In many countries in sub-Saharan Africa, farmland formally belongs to the public while individual farmers are granted the right to farm it. Some farmers may lack the skills to use the granted land efficiently, but short of the right to sell or rent it out, they operate it. Meanwhile, skilled farmers are precluded from operating an efficient amount of land, either because they cannot get hold of communal land or because the remaining privately held land is expensive. This also affects the occupational choice of individuals. Inefficient farmers may remain in farming because it grants them free land usage while optimally they would prefer to sell that right and work in other sectors.

Second, misallocation of land results from missing financial markets. Many farmers have no access to insurance against risks and also lack saving mechanisms such as a bank account. In such circumstances farmers may hold land not only for production purposes but also as an asset to be sold in the advent of adverse shocks. Farmers particularly keen on insurance may operate more land than what is efficient, draining resources from farmers who are relatively efficient but unwilling to pay an insurance premium for the land use. Still others may be efficient enough to increase landholdings, but are held back by credits constraints.

We intend to measure the validity of our hypotheses by studying the specific cases of Ethiopia and Uganda, two countries characterised by a high fraction of land subject to insecure tenure and underdeveloped financial markets. For this we will collect the necessary data via a social survey. The choice of these two countries will help us distinguish between issues that are country-specific and those that can be extended to more regions in Sub-Saharan Africa and other developing countries sharing similar institutional and market features. Specifically, we plan to run surveys of individuals to estimate their decisions in the face of existing policies, prices and market arrangements.

We will use structural general equilibrium model economies for our analysis. In such models decisions of distinct individuals and the formation of prices are all interdependent. This is crucial, because our proposed policy changes may alter the decisions of many individuals, which in turn affects relative prices and creates even more economic shifts. Our approach takes into account such feedback effects and is hence an ideal tool to understand what would happen if policies were to change.

The beneficiaries of our research are primarily those interested in policies aimed at alleviating poverty in predominantly agricultural economies.

1. Policymakers: Our research will be of immediate interest to government officials and policy analysts in Ethiopia and Uganda, but also in other countries where land rights are insecure and/or farmers have limited access to financial services. Our research provides answers to two types of questions.

(a) How large is the income loss due to existing policies/institutions governing property rights and financial markets? Our quantification will distinguish between the impacts on agricultural as opposed to non-agricultural productivity. Our quantitative exercise will also allow to measure how much of the income loss stems from misallocation of land across farms, and how much is due to misallocation of workers across different sectors in the economy. These insights will diagnose to what extent such policies/institutions represent obstacles to development.

(b) What is the potential effect of counteracting policies? For instance, we will look into policies such as land certfication, permission of land sales and rentals, and crop insurance. Our aim is also to compute welfare effects of such policies on individuals with distinct characteristics (e.g. by skill, wealth, land ownership, gender, age and occupation). This enables policymakers to identify the likely beneficiaries from policy changes. It also permits the formulation of appropriate transfers to compensate potential losers. Crucially, we will weigh the fiscal costs of such policies against potential GDP gains to identify fiscally sustainable measures. In addition, we will provide two practical pieces of information: first, how will policy changes affect relative prices (of various goods, land and labour), and, second, how are these policy changes to play out over time.

2. Advocacy groups: Our findings are also aimed at advocacy groups on a number of themes.

(a) Nutrition: Raising agricultural productivity ultimately increases the production of food and stimulates a drop in food prices. We will not explicitly look at welfare effects beyond higher food consumption, but our results should be of interest to those arguing that better nutrition produces knock-on benefits in the form of improved health and enhanced cognitive and physical abilities.

(b) Rural land security: Our research should be of concern to groups advocating a more transparent and secure allocation of land rights. Our project will provide them with additional arguments based on efficiency that go beyond pure equity considerations. This is of special interest to groups advocating gender equality as women's land security is often particularly compromised.

(c) Rural development: Our estimation of the optimal matching technology between individual farmers and the quantity and quality of land operation will also be of immediate interest to aid agencies, educational campaigners and other organisations promoting efficient and sustainable farming.

3. Public-private partnerships: Our findings will deliver quantifications that will prove valuable for public-private partnerships seeking investment opportunities. They need to know how social returns compare to private returns. Such projects include e.g. the following:

(a) Micro-credit: To the extent that we find major welfare losses stemming from missing financial markets, the social returns to micro-credit may show up as significantly higher than private returns once aggregate economy effects are taken into account.

(b) Land banking: In the absence of secure land rights that obstruct allocation of land across users, one interesting innovation consists of developing land banks that pool land rights by renting in from owners and in turn rent out land to other users.

(c) Rainfall insurance: This may be an important product to sponsor if the lack of weather insurance entails large social costs.