FOOD SECURITYConcepts, Basic

Facts,and Measurement

Issues

June 26 to July 7, 2006Dhaka, Bangladesh

Rao 3d:Market Institutions

and Their Functioning

Learning: The learning outcome will be a thorough understanding of market institutions in bringing about poor and good market functioning with a strong focus on factor market institutions, together with prevalent types of institutional reforms and the risks entailed to FS.

Brief Contents• market as an institution; institutions

for proper market functioning• product market and factor market

institutions• land: ownership distribution, tenancy,

land titling, communal resources• labour market institutions and the

meaning of labour market flexibilization

• credit market institutions• approaches to institutional reforms

and risks thereof to FS

Factor Market Institutions

Land Control Institutions

• Agrarian relations define the institutions that regulate access to land, the key resource in AG

Agrarian Relations Unit of Control

Communal Individual

Access

Restricted Corporate property e.g., in SSA Private individual property

Open Some forests, arable land, water bodies Open access resources

COMMON PROPERTY• Common property resources belong to a group

that makes rules & imposes sanctions in the use of the resource.

• The rules & sanctions aim to govern interactions between members and nature, and among members themselves.

• Common property is NOT no property (i.e., open access).

• It is not generally true that mainly the poor benefit from CPR. True, CPR of food-fodder-fuel-forest may be more critical for survival and food security of the poor.

• But rich also benefit immensely from CPR (especially control over the STATE which is itself the "mother of all CPRs“)

• In Africa, communal land regimes prevail and this has helped prevent landlessness and impoverishment

Implications of Corporate Forms

• Corporate forms, unlike open access, do control access to land

• So they are capable of regulated use (and so restrict inefficiency) while, at the same time, preventing undesirable concentration (and so promote equity)

• Examples include Russian mir, Mexican ejido, communal property in the New World, in pre-colonial Indonesia and in much of SSA

Private Land Concentration

• Private land concentration arises historically via conquests, subjugation of original holders or through a process of enclosures (Europe)

• Membership in an aristocracy, bureaucracy, army, clan, caste or ethnic group can perpetuate it

• Private land concentration can also arise from breakdown in communal forms and exposure to markets (commercialization)

The Inverse Size-Yield Relationship

• “Output”: For a year, say, the total farm-gate value of all products produced

• “Land”: gross area operated without adjusting for land quality,

multiple cropping or irrigation• Widely documented across the world

FARM SIZE (area)

YIELD ($ per area)

1 40

1

10

Causes of the Inverse Relationship• Proximate: intensive AG based on

irrigation, multi-cropping, labor-intensive and higher-value crops– With identical technology, must mean

higher L/H– Also means positive size-labor-

productivity relation• Basic: [given size linked to mode of

production]– Land and labor-supervision diseconomies

of scale– Non-marketed/Non-marketable family

labor– Self-supervising family labor– Unemployment: MPL,ff = U(ew) < e*w

< w = MPL,cf

– Monopoly power: MPL,ff = w < mw = MPL,cf

– Idle land holdings for power, prestige, speculation

Fragmented Labor & Land Markets• Spatial spread of AG production limits

labor mobility• Low infrastructure raises costs of labor

mobility• Localization is fundamental reason for

villages• Village economies are, in a way, self-

contained • Labor suppliers will work for lower wages

within• Familiarity allows employers to prefer

suppliers within• Hence, labor markets will be fragmented

over villages• So too lower transaction costs fragment

credit markets• Inter-village wage + interest rates will be

differentiated• Overall unemployment and overall credit

rationing reinforce labor and credit market fragmentation

Power in Fragmented Markets

• Localized/Fragmented labor & credit markets can make for local labor monopsony & credit monopoly

• The inverse relation supports the former, high “usurious” interest rates support the latter

• The former requires concentrated ownership and/or local-employers’ collusion (one-company town)

• The latter requires concentrated wealth and/or informational barriers that are endogenous

• But localized monopolies must forestall retaliatory actions – so often thrive on the basis of clan, caste or or ethnic identity-based discrimination

Choice of Tenancy vs Hired Labor

• 4 options: hired labor (WL), share-rent tenancy (SR), fixed-rent tenancy (FR) and labor rents (LR)

• Supervision: FR > SR > LR > WL• Land Utilization: WL > LR > SR > FR• Allocation Efficiency: FR > LR > WL >

SR • Risk distribution: WL > SR > LR >

FR• “Authority”: WL > LR > SR > FR • Cheung’s Equivalence argument• Choice not fully rationalized in

competitive models• But with local monopoly, choice can be

rationalized

Implication (1): Efficiency• When there is more than one factor of

production, Efficiency is not the same as Productivity

• So inverse relation is not proof of efficiency of small farms not of efficiency of large farms

• But it is proof of systemic misallocation or inefficiency

• Since land inequality is necessary for such inefficiency, we have a link between inequality and inefficiency

• This link arises from unequal access to land and capital (credit) and unequal utilization of labor

• In poor countries, cultivation scale is a negative factor

• But scale can be “advantage” in credit and marketing

Implication (2): Underemployment and

Unemployment• The obverse of inverse relation is

underemployment• Underutilization of land and

underemployment of labor serve to raise inequality

• Since land inequality is necessary for inverse relation, we have self-reinforcing inequality

• Asset inequality accentuates income inequality just as gravity of a massive object curves space towards itself

Surplus Labor vs Labor Constraints

• Surplus or underemployed labor can coexist with seasonal labor constraints. This is typical of most less developed rural economies

• In a land-abundant economy, labor constraints may be year-round also. This seems to be the case in some SSA economies in particular

• But the land-labor ratio is not “exogenous” since the effective availability of land can be augmented through technological change

The New Institutional Economics

The Capacity Wage• Effort capacity will generally depend on

consumption• The Optimal w* maximizes e per unit of

wage-cost w. Profit-max. farms will set w=w* if they know w-e link

• With given land, the total effort demand E may be met

met with L<L0 workers i.e.,

unemployment results!• But is this model socio- politically sustainable?• Leibenstein himself believed social institutions would arise to assure subsistence!

Consumption=w

Effort

m w*

e*

Asymmetric Information:

The Market for “Lemons”• Lemon owners will be eager to sell at a low P but not owners of quality cars. The high proportion of lemons at low P may drive buyers out of the market

• At higher P, the proportion of lemons will be lower but the high P itself will deter many buyers

• It is possible that there is no P* at which demand=supply, so the market fails completely

• In general, when quality depends on price, info re: quality is asymmetric and exploited opportunistically then, markets may be inefficient or completely fail [George Akerlof]

The “Efficiency” Wage Argument

• In capacity wage model, unemployment is due to quality (e) depending on price (w) but there is no asymmetric info nor opportunism.

• In efficiency wage model, the e-w relation is due to shirking, with both asymmetric info and opportunism

• Full supervision has limits. So profit-maximizing farms will offer a market-non-clearing wage (w*>wfe) – so carrot of “job rent” gives power to stick of the sack

• The resulting unemployment is good for profits & for the lucky workers but not for the unemployed or for the economy. “Efficiency” Wage is, in fact, inefficient!

Institutional VS Efficiency Wage

• The issue: what causes unemployment?• EW explains it by assuming workers have a

fallback (unemp. insurance in AEs). This is taken to be superior to “institutional” wage arguments (minimum wage, unions, living or fair wage norms).

• But both EW and IW are “institutional” since wage is directly or indirectly set by an “exogenous” wage

1. In DEs without unemployment insurance, a purely institutional wage argument makes good sense.

2. How realistic can shirking be for poor workers at the margin of subsistence?

3. Since capacity wage is likely to bind, there must be labor market institutions that avert dismal outcomes.

The Credit Rationing Argument

• Asymmetric info here is quality of project financed: borrower knows more than lender

• Lenders restrict default both by loan supervision and by a market-non-clearing interest rate (i* < is=d). The borrower tries to keep this carrot by defaulting less.

• Some potential borrowers will not be able to borrow

• As with efficiency wage, this credit rationing (CR) outcome is inefficient though lenders and lucky borrowers gain

Collateralization VS Rationing

• The issue: why can’t all get money from lenders?

• There is a simpler explanation than CR: lenders lend against collateral. Even with asymmetric information and opportunism, borrowers forfeit collateral if they default. The lender does not have to offer a low interest rate, and the market clears.

• Collateralization nevertheless produces“rationing”-like outcome: only those with collateral can borrow!

• As the old adage goes, if you want to borrow from a bank, you first have to prove that you don’t need the loan! If you do really need it, the bank will not be interested in lending to you!

An Institutional View of Labor and Credit Market

Failures• The most crucial markets in any economy

(labor and credit) fail routinely causing inefficiency & inequity. Failure means inability of “Supply=Demand” to set P*

• Their actual operation involves institutional adaptation (social norms, exercise of power, public regulation, etc)

• It is only by invoking a crucial “exogenous” element that any explanation these markets is even possible

• So the study of labor and capital market institutions is critical to understanding modern economies

• The distinction between “old” and “new” institutional economics is not really tenable

Factor MarketReforms

Agrarian Reforms• In all, land inequality favors neither

resource use efficiency (means) nor income equity (ends closely related to poverty and food insecurity reduction)

• Also, inequality tends to impart a bias for labor-saving technical change even with land scarcity

• With fragmented markets and local monopoly, there may even be negative incentive for augmenting land

• All these are prima facie arguments for egalitarian land reforms (coupled with credit and market access reforms)

Types of Land Reform• Rules of property in land or other means of

production, rules of access to local public lands, forestry and fishing and the like directly affect people’s asset base– e.g., land reform, tenancy reform,

nationalization of forests, etc.• “Old-fashioned” land reform• “Market-friendly” land reform• “Land-titling” where land rights are not

fully defined

Tenancy and Tenure• Tenancy divides the controller (may

or may not be the owner) from the holder of land

• Tenancy reforms are predicated on grounds of:– efficiency– equity & poverty alleviation

• One issue is fixed rent (FR) vs. share rent (SR)– Being associated with histories of

exploitative and feudal agrarian relations, SR is frequently the target of regulation and/or abolition

– Besides, poor landless peasants usually cannot take on the risk involved in fixed rent tenancy

TENANCY REFORMS

• Major thrust has been to restrict or prohibit sharecropping. In West Bengal, SC tenants are “registered” (with occupancy right and ceiling on rental share)

• But regulation can also reduce land given to tenancy and increase incidence of pure landlessness

• Tenancy reform in China, Laos, Viet Nam suggests significant gains from individual vs collective responsibility/reward provided egalitarian land access is maintained

LAND TITLING• Involves giving cultivating-possessors legal title

of ownership to land they occupy by squatting on it or by custom/communal practice

• Q: What is the case for land-titling? In general, that it is good for growth and efficiency. But titling may be neither necessary nor sufficient – tenurial security prevents overuse & gives incentive to

invest• But is the land in open access or in communal access?• But who gets the title? and by what means?

– use as collateral increases access to credit• But why should individual property be more bankable than

communal?– titles allow land markets essential for commercial

development• But is commercial development the end of development?• Also, commercial development has often fostered "open

access" e.g., in SSA• Recent African evidence shows no relation

between titling and long-term investment, and no effect on credit access.

• Note also titling can lead to a "land grab" by the strong at expense of weak.

LABOUR MARKET INSTITUTIONS

• Labour-institutional changes often caused by trade liberalization, privatization, public expenditure reduction, transition to democracy (e.g., South Korea), change of government (Reagan, Thatcher)

• Fiscal Austerity has been a key driving force

• Labour Liberalization Lite– dismantling job security laws, allowing private

& public firms to exit freely, or safety net provision to the displaced

• Labour Liberalization Heavy – eliminating unions, wage indexation, minimum

wages, etc.

Some Consequences of “Flexibilization” of Labour

Markets • reductions in both employment &

wages, especially in public sector• wages moving in favour of private

sector• reduced basis for "rent-sharing"

between employers & employees• greater "informalization" of the

workforce and production• rural HH may be less affected than

urban, middle-income HH more than poor

CREDIT MARKET INSTITUTIONS

• Divided into formal and informal. A third option in recent decades is micro-credit e.g., Grameen Bank.

• The poor are mostly excluded from the formal for lack of collateral and/or high unit costs of loans.

• If informal is more isolated, rates and access to credit for poor will be worse.

• Development banking & targeted credit (with or without subsidy) is a solution.– Good examples are India & Indonesia: before VS after

the Green revolution• So is micro-credit. But introduction of micro-

credit has become an excuse for state to cut back not only on public credit but other services for the poor also.– e.g., Andhra Pradesh experience from 1996-2005.