Rural Organization and Land Reform in Brazil: The Role of nonagricultural Benefits of Landholding

Rural Organization and Land Reform in Brazil: The Role of Nonagricultural Benefits ofLandholdingAuthor(s): JulianoJ.AssunoSource: Economic Development and Cultural Change, Vol. 56, No. 4 (July 2008), pp. 851-870Published by: The University of Chicago PressStable URL: http://www.jstor.org/stable/10.1086/588167 .Accessed: 25/02/2014 15:30

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Rural Organization and Land Reform in Brazil: The Roleof Nonagricultural Benets of Landholding

juliano j. assuncaoPontifcia Universidade Catolica do Rio de Janeiro (PUC-Rio)

I. IntroductionLand reform is a pervasive and controversial issue in Latin America. Economistsand policy makers usually associate the highly unequal pattern of land own-ership with many aspects of economic development, such as poverty, inequality,efficiency, political power, racial conflicts, and environmental strain. However,after many years of attempts, access to land remains an unsolved problem inmost of these countries (De Janvry and Sadoulet 2002).

Despite some differences in implementation, Latin American land reformprograms share the common feature of being embedded in an economic en-vironment where (i) market imperfections and policy distortions tend to seta wedge between the price of land and the capitalized value of the incomestream generated from agriculture and (ii) the land rental market is relativelythin. Land is used not only as an agricultural input but also as a source ofother benefits. Especially in countries characterized by high macroeconomicinstability, as in Latin America, people demand land as a mechanism of pro-tection against aggregate uncertainty, as a tax shelter, or as a means of laun-dering illicit funds (Berry and Cline 1979; Brandao and Feder 1996; De Janvry,Key, and Sadoulet 1997; Carter and Zegarra 2000). Furthermore, the func-tioning of the land rental market is commonly limited in Latin America bylegal restrictions and transaction costs (Macours, De Janvry, and Sadoulet 2001;De Janvry and Sadoulet 2002).

This article investigates the consequences of a nonagricultural demand forland in an occupational choice model with heterogeneity in farming skills andmissing credit and land rental markets. The model shows that unskilled

I would like to thank the editor and the two anonymous referees for valuable comments. I am alsograteful to Ricardo Paes de Barros, Flavio Cunha, Maitreesh Ghatak, Humberto Moreira, BernardoMueller, Walter Novaes, Pedro Olinto, Jacques Potin, Jose Guilherme Resende, Marcelo Rezende,and Hugo Sonnenschein for helpful suggestions on a first version of this article. Financial supportof the CAPES Foundation and CNPq (Conselho Nacional de Desenvolvimento Cientfico e Tec-nologico) is thankfully acknowledged. Any remaining errors are my own.


852 economic development and cultural change

peasants, even being unable to manage agricultural production, become land-owners in order to obtain nonagricultural benefits from landholding. Theabsence of a credit market contributes to this allocation by preventing skilledpeasants from buying the land from unskilled farmers. In addition, if the landrental market does not work properly, those unskilled farmers keep their landunimproved, resulting in a decrease of aggregate agricultural production. Theresulting allocation is inefficient in the sense that potentially there exists acompensation scheme (which is not necessarily first-best implementable) inwhich the economy is better off.

However, in an economy with a perfect land rental market, unskilled farmerswho accumulate land for nonagricultural purposes can lease out their land tobe cultivated by skilled peasants, which increases overall agricultural output.Thus, the land rental market can establish an efficient resource allocation evenif people demand land for nonagricultural purposes.

This model has two main implications for the design of public policiesaimed at improving agricultural production in Latin American countries. First,the model suggests a change in the design of land reform programs. Accordingto the model, contrary to what has been recently implemented in many coun-tries (Deininger and Feder 2000), land reform should be aimed at small farmersinstead of at landless peasants in order to improve efficiency. On the one hand,occupational choice is endogenous. Agricultural workers may decide to keepor not keep their previous job, selling the land provided by the program forconsumption. On the other hand, farm size is endogenously related to thefarmers ability and land use in the model. Occupational choice determinesthat landless people and the wealthiest landholders are, on average, less skilledthan small farmers.

Second, the model highlights the importance of credit and land rentalmarkets in an environment characterized by nonagricultural benefits of land-holding. De Janvry and Sadoulet (2002, 1), for example, suggest that accessto land through assistance to rental offers possibilities that have not beenpursued and deserve urgent attention. Credit markets are another issue thathas been incorporated into market-assisted land reform programs implementedin such countries as Brazil, Colombia, and South Africa (Deininger 1999).

The results of the current study contribute to the literature of agrarianorganization and land reform. Notwithstanding the recognition of the im-portance of a nonagricultural demand for land in Latin America by manyscholars, a systematic analysis of its consequences has not been well examinedin the existing literature. For comprehensive surveys of the literature, seeBinswanger and Deininger (1997), Carter and Zegarra (2000), and Deiningerand Feder (2000). Although some authors, such as Conning (2001), Conning


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and Robinson (2001), and Baland and Robinson (2008), have constructedmodels that exhibit features often observed in Latin America to analyze agrarianorganization and land reform, most of the literature considers general aspectsor else are case studies from Asia.1

The remainder of this article is organized as follows. Section II depicts keyaspects of the land markets in Latin America that are analyzed in the model.Section III presents the theoretical arguments regarding how the nonagricul-tural purpose of landholding is likely to affect efficiency in economies withand without a land rental market. Section IV discusses the policy implicationsof the model, and Section V concludes.

II. Context

A. Nonagricultural Payoffs of Landholding

Land is not only an agricultural input but also an important economic assetwith distinguishing features. According to De Janvry et al. (1997, 19): Inmany countries, land values have been inflated by policies that encourageinvestment in land for nonagricultural reasons. The price of land may exceedthe capitalized value of future agriculture profits if the land is being used asa hedge against inflation, as an asset that can be liquidated to smooth con-sumption in the face of risk, as collateral for access to loans, as a tax shelter,or as a means of laundering illicit funds.

In order to illustrate the store-of-value motivation for landholding, I presentsome evidence about the effect of macroeconomic instability on land prices inBrazil. The results show that land prices are much more sensitive to the launchof drastic economic measures than are rental rates.

Brazil has experienced a long period of high inflation. For instance, con-sidering the period from 1980 to 1994, the (simple) average monthly inflationmeasured by the CPI (consumer price index) was 15.9%. The government,facing this challenge, adopted a sequence of policies to contain the inflationaryprocess during the 1980s and 1990s. Those heterodox policies resulted inunexpected (and exogenous, from the point of view of agricultural producers)increases in uncertainty for the economy. The implementation of the economicplans aimed specifically to contain inflation through a set of measures, in-cluding deindexation of the economy, temporary price freezes, and a freeze onfinancial assets to reduce the economys liquidity and generate resources for

1 See Grossman (1994) and Horowitz (1993) for the political economy aspects of land reform orthe studies of land reform in India by Besley and Burgess (2000) and Banerjee, Gertler, and Ghatak(2002).



TABLE 1EFFECTS OF ECONOMIC PLANS ON LAND PRICES IN BRAZIL

Estimates

Pastures Cropland

Sale Rental Sale Rental

(A) Constant 1,520.1(.0000)

118.2(.0000)

2,643.8(.0000)

196.4(.0000)

(B) Dummy variable: new economic plan in t 591.1(.0120)

24.0(.0046)

877.8(.0183)

11.1(.2983)

(B)/(A) (%) 38.9 20.3 33.2 5.7(C) Dummy variable: new economic plan in t1 733.1

(.0021)19.2

(.0219)1,095.1

(.0036)2.85(.7877)

(C)/(A) (%) 48.2 16.2 41.4 1.5

R2.17 .14 .15 .02

Chi-Square Statistics for the Test of Equalityacross Equations

Dummy variable: new economic plan in t 6.860(.0088)

6.231(.0126)

Dummy variable: new economic plan in t1 10.836(.0010)

9.867(.0016)

Note. All series were detrended and centered on the original mean. Since the original time series werenonstationary, I use the Hodrick-Prescott filter to detrend them in order to compute meaningful statistics.The p-values are in parentheses.

the budget. The uncertainty introduced into the economy by those drasticmeasures generated a large shift in the demand for safe assets, including land.

I compare the effects of the implementation of such policies on land pricesfor sales and for rentals. The data consist of semiannual observations of landprices for sales and rentals covering the period 19662000. They were collectedby the Getulio Vargas Foundation, which gathers information from more than3,600 local agencies scattered among many Brazilian districts. Observationsrefer to actual transactions and are collected within the districts at the end ofeach semester. There is data on prices of pastures and cropland. All priceswere deflated to a 2000 level using the IGP-DI (general price index, calculatedby the Getulio Vargas Foundation). In addition, prices are detrended by usingthe Hodrick-Prescott filter and are centered around the original mean. Twodummy variables were builtone indicating the introduction of a new eco-nomic plan in the current semester and another related to the institution ofan economic plan in the previous semester. The following plans are considered:Cruzado (February 1986), Bresser ( June 1987), Summer Plan ( January 1989),Collor (April 1990), and Real ( June 1994).

Table 1 shows the regressions of land prices (col. 1) and rental rates (col.2) on the dummy variables representing the launch of the economic plans.Thus, the intercept of each regression can be interpreted as the averaged landprice in the absence of new economic plans in the current and in previoussemesters. The coefficients of the dummy variables represent the average


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changes in prices at the time of the implementation of the economic plansand in the subsequent semester.

The results suggest that the economic plans promoted significant increasesin land prices for sales of both pastures and cropland in the current and inthe next semester, accounting for more than 15% of the total variability ofthese variables from 1966 to 2000. The effects on rental rates are much smallerand are statistically insignificant for cropland. This suggests that the responseof land prices for sale to an exogenous increase in macroeconomic instabilityis larger as compared with rental rates. The uncertainty introduced by theunusual economic plans has increased the demand for land, more substantiallyaffecting land prices than land rental rates. The demand for land leasing seemsless sensitive to macroeconomic shocks.

For pastures, the economic plans have determined an increase of almost40% in land prices of sales in the current semester and up to 50% in thenext one. The rental rates have experienced a much lower increase, around20%. For cropland, table 1 shows significant increments only for land prices,both in the current semester and the subsequent one. The difference betweenpastures and cropland might be a result of the demand for livestock as anothersource of hedge against macroeconomic risks. Indeed, the tests for equality ofcoefficients across equations show that the effects of the economic plans onland prices and rental rates are statistically different at the standard levels ofsignificance.

In the next section, the theoretical model sheds light on the interpretationof these results, showing that the difference in the responses of land pricesand rental rates to macroeconomic shocks is due to a nonagricultural com-ponent of the demand for land. Under certain conditions, the model predictsan increase in the gap between land prices and rental rates in periods of higheconomic instability.

Although this article focuses on one specific mechanism behind the non-agricultural motive for landholding, other possibilities have been suggestedin the literature. As pointed out by Brandao and Feder (1996, 191), insofaras land is a factor of production and a store of wealth, it is also a source ofpolitical power, especially in societies where access to other assets is limited.Baland and Robinson (2008, 5, 18) also argue in terms of the political powerof the elites in Latin America: Nowhere is the evidence about landlord controlof elections so conclusive as in Latin America. . . . Landlords (in Chile)systematically controlled rural voting until the late 1950s. There is a consensusamongst historians, political scientists and sociologists about how this systemfunctioned. . . . Large landlords usually registered all their employees, byteaching them how to sign their names (as literacy was a condition for vote



TABLE 2INTERNATIONAL INDICATORS

Indicators Latin America Asia Europe United States

Number of holdings 10,281,607 143,934,358 7,625,520 1,911,859Total area (hectares) 705,586,803 268,741,639 125,394,061 377,088,222Average farm size 68.6 1.9 16.4 197.2Land gini coefficient .83 .52 .64 .75Agricultural land (%) 65.7 91.8 70.6 88.9

Cropland (%) 20.4 99.5 65.6 52.1Meadows and pastures (%) 79.6 .5 34.4 47.9

Land tenure (area; %):Owner and owner-like 85.5 88.7 61.4 33.9Rented from other 3.6 2.8 23.3 11.6Mixed and others 10.7 8.5 15.3 54.5

Below 10 hectares:Farms 58.7 97.4 74.5 29.5Area 2.5 72.6 11.4 1.2

Source. World Census of Agriculture (1990, 2000).Note. Latin America p Argentina, Brazil, Colombia, Chile, Honduras, Panama, Paraguay, Peru, PuertoRico, Uruguay, and Venezuela. Asiap Bangladesh, Cyprus, India, Iran, Japan, Nepal, Pakistan,Philippines,Thailand, and Turkey. EuropepAustria, Belgium, France, Italy, Luxembourg, Portugal, Spain,Switzerland,and the United Kingdom.

registration). The day of the election, the employer would go vote with alltheir employees.

B. The Land Rental Market and Land UseThis section presents some evidence on the organization of the agriculturesector of Latin American countries. Although there are no data available tosubstantiate this issue directly, the following data provide a general overviewthat supports different aspects of the subsequent analysis.

Table 2 compares several indicators for Latin America with those of Asia,Europe, and the United States. Overall, Latin American countries present ahighly skewed distribution of land, and agricultural land is mostly representedby meadows and pastures that remain underused. Also, there is a thin rentalmarket in Latin America, which is reflected in the fact that 85% of theagricultural land is operated by owners. This combination of characteristicssuggests that land distribution in Latin America is characterized by largelandowners who operate underused farms (pastures) and who do not lease outor sell their holdings. Even with a potentially high demand for land foragricultural purposes, 58.7% of the farms have fewer than 10 hectares. Thiscombination makes Latin American agriculture unique, and the fact that onlyone-fifth of the agricultural land is not covered by pastures and meadows mayindicate that agricultural production in Latin America is below its potential.

Although Asian countries exhibit the same tenure structure, they have amuch more egalitarian distribution of land and a substantially smaller average


Assuncao 857

farm size. The rental market in Asian countries is also limited. A predominanceof cropland indicates a high intensity of land use. The situation in Europeancountries is similar but less radical. The rental market is active, and only 61%of the area is operated by landowners. The United States, in contrast, exhibitsa highly concentrated land distribution as in Latin America, with a highaverage plot size. However, only one-third of the area in the United States isoperated by landowners, and less than 30% of U.S. farms have fewer than 10hectares. As a result, 52.1% of U.S. agricultural land is cropland.

III. ModelThe key feature to be addressed in the model is that land provides nonagri-cultural payoffs to its owners. As pointed out by Berry and Cline (1979, 11),in countries with poorly developed capital markets, especially those withchronic inflation, landowners may find it attractive to hold land for speculativegainor merely to accomplish the store of value objective. I focus on thisspecific mechanism of nonagricultural landholding, and I assume that thereis a monetary loss in savings between the periods of life. Therefore, this requiresa dynamic structure even though the main argument developed below isessentially staticdynamic issues are not considered in the model for the sakeof simplicity and tractability. I start with an intertemporal setup that isconverted into a simple static environment in which the main implicationsare derived.

A. SetupConsider an economy with an infinite number of periods and overlappinggenerations of two-period-lived peasants. In each period, a large populationwith mass normalized to one is born, and it has wealth distribution .G (a)tInitial wealth is received by each individual in the form of a bequest fromthe individuals parents. All individuals are sorted and named according totheir initial wealththe peasant labeled 0 is the poorest, and the peasantlabeled 1 is the richest. Peasants devote their first period of life to productionand their second period of life to consumption.

There is a monetary loss in savings between the young and old ages thatoccurs with probability . This loss can be prevented only by thep [0, 1]holding of land titles. The parameter p can be interpreted in different waysit can represent the probability of loss to theft, the probability of an economiccrisis, or expected inflation eroding the value of financial assets.

Individuals have an endowment of one unit of labor, which is suppliedinelastically, either on the individuals own farm or when the individual worksfor someone else as an agricultural laborer. Although the population is com-



pletely homogeneous with respect to its ability to work, there is heterogeneityin farming skills. The distribution of skills is assumed to be independent ofthe distribution of wealth. At each level of wealth, a fraction a of individualsis skilled and the remaining fraction of is unskilled.1 a

The agricultural good, taken as the numeraire, is produced by skilled farmersand consumed by everyone. Skilled farmers can expect to produce q units ofoutput per hectare using a fixed-coefficients production function that requiresone worker for every unit of land. Agricultural production is a random variablewith an expected value equal to q and a finite variance. Production takes oneperiod to be done, and the inputs, land and labor, can be hired in competitivemarkets at prices p and w, respectively. Unskilled farmers, in contrast, arerestricted to the exploitation of natural resources (like hunter-gatherers), anactivity that requires no extra labor and that produces expected unitse ! qper unit of land. The exploitation of natural resources is also a random variablewith a finite variance. Whether a peasant is skilled or unskilled has no effecton his productivity as a worker, and so the wage rate is uniform; to simplify,the wage is paid in the second period.

The dynamics of the economy are as follows. Each generation produces orworks when young and consumes when old. In a period t, young farmersspend their wealth buying land from the old-aged farmers of previous gen-erations and contracting young workers to be paid in the second period. Inthe second period, peasants receive their incomes (wages or agricultural profits),sell their land to youths of the next generation, and allocate their final wealthbetween consumption and bequests.

Agents are risk neutral, and the preferences of an individual born in periodt are given by , where is the consumption of the second periodg 1gc a ct1 t1 t1and is the bequest for the next generation. Thus, the indirect utilityat1function of an individual with initial wealth and final wealth , wherea yt t1

is determined by the occupational choice and the realization of the randomyt1variables, is represented by

g 1gU(a , y )p max c at t1 t1 t1c ,at1 t1

subject to c a p y (1)t1 t1 t1

g 1gp g (1 g) y .t1

Here and . The preferences are such that con-c p gy a p (1 g)yt1 t1 t1 t1sumption and bequests are proportional to the final wealth .c a yt1 t1 t1


Assuncao 859

Initially, it is assumed there is no land rental market.2 Section III.D examinesthe consequences of opening a land rental market for this economy.3 Unskilledfarmers cannot use their land titles to prevent monetary loss, and they alsocannot lease out their land to skilled peasants for agricultural production. Theonly option open to them is to exploit natural resources.

Finally, in order to keep the analysis of occupational choices interesting,agents cannot borrow to finance their land purchases. Hence, the access toland is constrained by the initial wealth, as in the literature on occupationalchoices with financial constraints (Banerjee and Newman 1993; Galor andZeira 1993). Denoting the farm size by T, the lack of a credit market impliesthat for a peasant with initial wealth a.pT a

In summary, there are three possible occupations in the economy. In thefirst period of life, each individual faces an occupational choice problem beforethe realization of the random variables regarding the agriculture and theexploitation of natural resources. From (1), the expected utility of the indi-viduals in any case is completely determined by the expected final wealth

since . Given the structure de-g 1gE(y ) E(U(a , y ))p g (1 g) E(y )t1 t t1 t1scribed above, the expected final wealth of an agent born in period t is

(1p)a w if worker,t tE(y )p (1p)a eTpp T ( p p )T if unproductive farmer, (2)t1 t t t t t1 t t{(1p)a (qw )T pp T ( p p )T if productive farmer,t t t t t t1 t t

where is the initial wealth, is the price of land, and is the farm size.a p Tt t tNote that a proportion of wealth that is not used for land purchasing1 pis lost. Young farmers buy land at price and sell it in the next period atptprice . In summary, landholding provides three kinds of potential benefits:pt1agricultural profits, protection against monetary loss, and price appreciation.Notice that if farmers spend all their initial wealth on land, they becomecompletely hedged against monetary loss, while landless workers are fullyexposed to the loss imposed by p.

Recall that we are employing a dynamic structure for our model solely tobuild a meaningful land market where savings decisions are important. Land

2 Many arguments have been used to determine imperfections in land rental markets: risk sharing(Cheung 1969), hidden actions and moral hazard (Stiglitz 1974; Eswaran and Kotwal 1985; Ghatakand Pandey 2000), screening (Hallagan 1978; Allen 1982), and limited liability constraints (Shetty1988; Laffont and Matoussi 1995).3 Notice that there is a clear distinction between land leasing and land sale in the model, evenconsidering that land is used only in one period. Although both types of operation allow agriculturalproduction, only the land titles can provide a safe device for savings. At the end of the agriculturalproduction, landowners can sell their lands and recover the initial wealth invested.



transactions occur between young peasants (buyers) and old-aged peasants(sellers). However, this article is not focusing on such dynamic issues as wealthaccumulation or class formation. To simplify the analysis, we consider a time-invariant distribution of wealth , which can be thought as the long-G p Gtrun and stationary wealth distribution of the economy. In this case, the modelis made up of a simple sequence of static decisions, and only stationary equi-libria are considered. Hereafter, it will be assumed that , and allp p p p pt1 ttime indices will be dropped.4

B. Occupational ChoicesThe analysis of occupational choices involves a comparison between con-sumption profiles, given the price of land and the wage rate. First, the oc-cupational choices are derived. Then, the prices w and p are determined incompetitive markets.

Both extractors and farmers choose their farm size taking p as given. Theabsence of a credit market means that the demand for land belongs to theinterval . Since final consumption is a linear function of T in (2), they[0, (a/p)]decide for either (becoming workers) or the maximum size affordableTp 0

. Equivalently, the demand for labor for farmers is equal to , becauseTp a/p a/pagricultural technology requires one worker for each hectare of land. Substi-tuting the demands for labor and land in (2), final consumption becomes

(1p)aw if worker,E(y)p [(e/p) 1]a if unproductive farmer, (3){{[(qw)/p] 1}a if productive farmer.

The occupational choice follows from the comparison of consumption possi-bilities in (3). Skilled peasants choose among all three possible occupations,and they become productive farmers if and only if

wpq e w and a { a . (4)1q w pp

If , productive farms are (weakly) more profitable than the extractiveq e wactivity and every skilled farmer undertakes agricultural production.5 Unskilled

4 Another simplifying assumption is the linear production technology. As a consequence, differentfrom Carter and Zimmerman (2000), wealth inequality persists over time, producing a stationaryequilibrium in which some individuals are hedged against monetary loss. Again, the model isfocused on the effects of nonagricultural benefits of land on rural organization and the design ofland policies.5 Section III.C shows that, in equilibrium, w cannot be strictly larger than .q e


Assuncao 861

Figure 1. Occupational choices

peasants, however, are limited in their choices: they must become workers orextractors. They establish themselves as unproductive farmers if and only if

wpa { a . (5)2e pp

It is easy to see that if and only if . The occupational choicesa ! a q w 1 e1 2can be completely described by the initial wealth if , as is depictedq w ein figure 1, which represents the population in a box with skills in the verticalaxis and wealth in the horizontal axis. From left to right, individuals areordered from the poorest to the richest. The individuals at the top of the boxare unskilled, and those at the bottom of the box are skilled.

Lemma 1. For every pair such that , unproductive farms(w, p) w q eare (weakly) larger than agricultural farms on average.

Lemma 1 is a consequence of heterogeneity in farming skills being coupledwith credit market imperfections (as shown by Assuncao and Ghatak [2003]).This result is especially interesting in the context presented here because itimplies that farm size contains information regarding land use. Figure 1 showsthat all farmers with plots of size demand land only forT [(a /p), (a /p)]1 2agricultural production. A fraction of large landowners, with1 a T 1

, retain their holdings only to collect natural resources, doing so withouta /p2agricultural production. Section IV will examine the implications of this resultfor the design of redistributive policies.



C. EquilibriumAn equilibrium in the land market should equalize the aggregate demand forland to the fixed supply of land . Conditions (4) and (5) determine thatTskilled peasants with wealth greater than and unskilled peasants with wealtha1greater than demand hectares of land each. Therefore, the equilibriuma a/p2condition in the land market can be arranged as

a adG(a) (1 a) adG(a)p pT. (6) a a1 2

Equation (6) determines that the total expenditure on land purchase is equalto the value of land endowment.

There is a subsistence activity that requires one unit of labor to generate apayoff of without land. This is available to any individual. It is assumed thatwagricultural technology strictly dominates the subsistence activity, that is,

q 1 w. (7)

To simplify the notation, individuals in the subsistence sector will be referredto simply as workers, with . As a result, the equilibrium wage ratewp wbelongs to the interval . If , the demand for labor is zero[w, q e] w 1 q ebecause nobody aspires to become a farmer, resulting in a decrease in w until

. However, if , the supply of labor is zero because the subsistencew q e w ! wactivity provides a better alternative.

In the labor market, the equilibrium condition is given by

1a adG(a) aG(a ) (1 a)G(a ), (8) 1 2p a1

with the strict inequality holding only if . The left-hand side of (8) iswp wthe demand for labor, while the right-hand side is the supply of labor.

The equilibrium wage rate and the price of land are determined by theendowments of the economy and the wealth distribution. For example, givenG, if the land endowment is sufficiently low, only the equilibrium withT

can prevail.wp wIn order to evaluate the role of public policies, I adopt the notion of pro-

ductivity enhancing allocations. Since the land policies considered in thisarticle might imply a redistribution of assets and since the economy is alreadyconstrained by missing markets, there are no Pareto-improving policies. Bar-dhan, Bowles, and Gintis (2000, 545) define a policy as productivity en-hancing if the gainers could compensate the losers and still remain better off,except that the implied compensation need not be implementable under the


Assuncao 863

informational conditions and other incentive constraints in the economy. Inthe context of the model, a productivity-enhancing policy is possible wheneverthe aggregate agricultural production is below its maximum value .qT

In the model, agricultural production is undertaken only by skilled peasantswith wealth greater than . Thus, the aggregate agricultural production isa1

a

Qp q# adG(a) .[ ]p a1Using (6), Q can also be expressed in terms of ; in equilibrium, that is,a2

1 a Qp q# T adG(a) ! qT, (9)[ ]p a2

where is the maximum aggregate agricultural production feasible.qTAgricultural production is maximal only if there are no extractive farmers.

The next proposition summarizes the agricultural efficiency of agriculturalproduction in the model discussed above.

Proposition 1. In the absence of a land rental market, agriculturalproduction is depressed; that is, there is a role for productivity-enhancingpolicies.

From (9), agricultural production is not maximized whenever . Ina ! 2this situation, there are alternative allocations of resources that improve theaggregate production. Section IV will elaborate on the design of land reformpolicies as a means of improving aggregate agricultural production. Two lim-iting cases are important for summarizing the driving forces behind theinefficiency.

First, suppose that extractive benefits are arbitrarily low and that(e r 0)therefore This is a situation where unskilled farmers demand landa p w/p.2exclusively to prevent monetary losses. The existence of a nonagricultural useof land, expressed by , determines a reduction in agricultural productionp 1 0because part of the land endowment is barely used. Since there is no landrental market, those farms are kept unimproved. In this case, if , allpp 0land is used for agricultural purposes (since ) and the maximal feasiblea p 2production is achieved.

Second, assume that there is no monetary loss such that and, con-pp 0sequently, In this case, the distortion in agricultural productiona p wp/e.2comes from failures in the credit and rental markets rather than from the factthat land is used as a hedge against inflation.

In summary, the absent credit and rental markets jointly decrease the ag-



gregate agricultural production because of the heterogeneity in farming skills.This effect is exacerbated by the nonagricultural demand for labor if .p 1 0

D. Opening Up a Land Rental MarketPrevious results are derived in an environment where there is no land rentalmarket. The absence of the rental market can be associated with potentialpolicy targets, including financial constraints or threats against property rights.In the case of financial constraints, for example, such measures as credit forland rental can be used to overcome the problems related to ex ante limitedliability constraints (Laffont and Matoussi 1995). Moreover, when the problemis related to threats of squatting by the tenant, measures to improve securetenure can be used as an important instrument of land policy (Macours et al.2001). Despite many implementation issues that are not taken into account,the following analysis suggests that improving the land rental market shouldbe a goal of public policies. It is shown that a land rental market can establishan efficient allocation of resources even in the presence of a nonagriculturalpurpose for landholding.

In the perfect land rental market case, decisions about farm size T andcultivated area A are disentangled. During their youths, individuals decide onland purchases and land leases. Those peasants whose cultivated areas exceedtheir farm sizes have to pay a rent to cover the difference, . However,A Tyoung peasants with unimproved land receive rents.

Let s denote the rental rate. Then, consumption during old-age in the caseof a perfect land rental market becomes

(1p)aw if worker,E(y)p (1p)[a pT s(AT)] pT eA if unproductive farmer,{(1p)[a pT s(AT)] pT (qw)A if productive farmer.

In each occupation, consumption is linear both in A and in T, which resultsin corner solutions. Analogous to the previous case, the absence of a creditmarket implies that .6pT s(A T) a

The following analysis considers only equilibria in which

q w (1 p)s 1 pp (1 p)s 1 e (1 p)s. (10)

Under (10), skilled peasants choose and Unskilled farmers,Tp 0 Ap a/s.however, choose and Notice that, as long asAp 0 Tp a/( p s). w q, it is not possible to have the opposite, that is, land ownership in the handse

6 Notice that there is a distinction between the price of land and the rental rate even thoughindividuals produce for only one period. While rental rate refers only to land use, price of landalso accounts for sale of the land in the following period.


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of skilled peasants being leased out to unskilled peasants. If (10) does nothold, there are no rental transactions in the market, which is a situation ofless economic interest.

The analysis derived in the case with no land rental market still applies,and the new thresholds (levels of wealth associated with the indifferenceamong occupations) are given by and a p ws/[q w (1 p)s] a p1 2

. Condition (10) implies that . w( p s)/[pp (1 p)s] a 1 a2 1The aggregate demand for land property is , while(1 a) [a/( p s)]dG(a)a2

the aggregate demand for cultivated area is , that is, respectively,a (a/s)dG(a)a1

(1 a) adG(a)p ( p s)T, (11)a2

a adG(a)p sT. (12)a1

Aggregate agricultural production is, therefore, Qp q(a/s) adG(a)p qT.a1Proposition 2. In all equilibria with rental transactions (in which [10]

holds), a perfect land rental market drives the economy toward a situationwhere there is no role for productivity-enhancing policies even if .p 1 0

The existence of a perfect land rental market makes land ownership irrelevantfor agricultural production since there is no investment in the model andpeasants have complete access to land in a competitive rental market.7 Allavailable land is used for agricultural production, resulting in efficiency. As aconsequence of the linearity of the model, unskilled peasants own all availableland, which is rented out to, and cultivated by, skilled farmers.

IV. Policy ImplicationsIn the absence of credit and land rental markets, the previous analysis suggeststhe existence of an inefficient allocation of resources (the aggregate agriculturaloutput is depressed) that is exacerbated by nonagricultural land use. Differentpolicy implications can be derived from the model. This section analyzes theeffects of redistributive land reform policies and improvements in the creditand land rental markets.

7 For an analysis of the effect of land tenure on investments, see Banerjee and Ghatak (2004).



A. Redistributive Land ReformRedistributive land policies have been adopted in many developing countriesto promote agricultural development.8 Redistributive land policies in manycountries have consisted of important land transfers from large landholders tolandless people. To evaluate such policies in the context of the model, it isimportant to define three different classes of peasants, previously introducedin figure 1:

Agricultural workers/landless peasants: poor skilled peasants with wealth belowand unskilled peasants with wealth below . Individuals within thisa a1 2

class do not have enough wealth to acquire an adequately profitablefarm, preferring to employ themselves as workers.

Small farmers: individuals operating plots with size AllT [(a /p), (a /p)].1 2landowners within this group are skilled peasants.

Large landholders: farmers with plot size . A fractiona of those farmersT 1 a /p2are skilled, and the remaining fraction of those farms are operated1aby unskilled peasants.

Consider, initially, that the social planner can distinguish between pro-ductive and unproductive farmers. Thus, any transfer from unproductivefarmers to skilled farmers improves aggregate agricultural production. Onceagricultural technology faces constant returns to scale, the choice of thebeneficiaries is driven solely by initial wealthall skilled farmers with

are potential beneficiaries, and farm size does not play any particulara a1role. All peasants with wealth strictly below and unskilled peasants witha1wealth strictly below are choosing to become workers. As a result, marginala2increases of a for those peasants do not affect their occupation choices. There-fore, if the beneficiaries are landless, they are more prone to sell the receivedplots for consumption.

Now, assume that the ability of each farmer is not observed. As a conse-quence, policy instruments are restricted to be conditioned only on farm sizeand transfers from unskilled peasants to skilled farmers are not allowed. Inthis context, there are two selection problems with the implementation ofredistributive policies: the choice of the beneficiaries and the choice of whichland is to be confiscated or bought. The model has a partial solution to thisproblem, indicating that small farmers should be the beneficiaries. Althoughthe type of farmers is not directly observed, it can be identified by farm size.The previous sections showed that all farms with small plots, varying from

8 See Deininger and Feder (2000) for a survey.


Assuncao 867

to , are operated by skilled farmers. Therefore, transfers from largea /p a /p1 2landholders to small farmers increase aggregate agricultural output. The prob-ability of reducing productive farms among large landholders, , is lower1 athan the probability of increasing productive land among small farmers, whichis equal to 1.

B. Market ImprovementsThe absence of credit and rental markets is a key ingredient of the analysis.Section III.D shows that a perfect land rental market can establish an efficientallocation of resources even if a credit market does not work and people demandland for nonagricultural purposes. Similarly, a perfect credit market can elim-inate inefficiency. With free access to credit, all skilled individuals can manageproductive farms and agricultural output is maximized. These two observationssuggest that achieving market improvements should be a policy target.

As pointed out by De Janvry and Sadoulet (2002), the land rental marketis an important instrument of access to land in many countries. In LatinAmerica, while measurement errors and underreporting may overstate suchweakness, the land rental market is unquestionably thin. This is the case fora variety of reasons. De Janvry and Sadoulet (2002, 1) report: Case studiesin a number of countries show that main limiting factors to land rentaltransactions are weakness of property rights and lack of reliable conflict res-olution mechanisms. Consequences are rentals that are few, informal, short-run, and segmented as they occur within narrowly defined circles of confidence(by kinship, proximity, farm sizes, and social class). Rentals are also sometimesforbidden (land reform sector) and rents controlled at excessively low levels.Based on this diagnostic, results from Section III.D suggest that such measuresas strengthening and enforcing property rights and formalizing flexible rentalcontracts can increase agricultural production and enhance land use.

The missing credit market prevents skilled peasants in the model frombuying land from unskilled farmers. A credit market could eliminate therestriction that , which would allow all skilled individuals to participatepT acompetitively in the land market; this would establish an efficient allocationof resources. But credit markets are characterized by informational issues thatimpede their functioning (Ghosh, Mookherjee, and Ray 2000). In this sense,economic policies of public credit for land acquisition can improve land useeven if there is a nonagricultural motive for landholding and no rental market.Currently, public credit for land acquisition is an important part of the com-munity-based approach to land reform being implemented by Brazil, Colom-bia, and South Africa (Deininger 1999).



V. ConclusionThis article analyzes the implications of nonagricultural land use to agrariandevelopment in an economy characterized by limited credit and land rentalmarkets. It shows that a nonagricultural motive of landholding in the presenceof financial constraints generates a potential mismatch between the distributionof land and the distribution of farming skills. It argues that this inefficiencyarises not because land is more than an agricultural input but rather from theway that the land rental market fails to operate.

In terms of policy implications, the model suggests that small farmersinstead of landless people should be the target of redistributive land reformprograms. These small farmers have a greater chance both of having betterfarming skills and of being less willing to sell the obtained land for con-sumption. In addition, improvements in the credit and land rental marketscan have substantial consequences in enhancing land use and in increasingaggregate agricultural production.

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Rural Organization and Land Reform in Brazil: The Role of nonagricultural Benefits of Landholding

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