Political Economy of Economic Policy

Lecture 3

Contracting and ownership in land reform

Chenggang Xu

copyright@Chenggang Xu

Introduction• Essence of land reform:

– Redistribute ownership of land– Fundamental impacts on the contractual relationship between

landowners (landlords) and laborers (tenants)• Why need land reform (redistribution of land)

– High monitoring cost: severe moral hazard problem with over-concentrated land ownership

• Two types of land reforms– Redistribute land from large private landlords – Redistribute land from the state

• Political economy of land reform– Political conflicts between losers and winners of land reform

• Resistance from large private landlords and bureaucrats for losses – Political conflicts between ideologies

• State ownership (socialism) vs. private ownership (capitalism) – Political power derived from interest groups and ideology

Political economy of China’s land reform• Chinese 30 years’ reforms started from land reform

– One of the most successful reforms

• China’s land ownership before land reform– Constitution: de jury state ownership of land– Commune system: de facto collective ownership of land

• Peasants’ compensations were almost fixed (restricted solution set)• No right to move freely (participation condition affected)• Bad solution for moral hazard problems (share cropping model)

• Political obstacles of land reform in China – Strong political & ideological resistance

• Land reform was banned by the Third Plenum of the 11th Central Committee of the CCP (the 1st milestone of the reform)

• Strong political accusations against land reform attempts

• To minimize the uncertainty of the reform experiment is vital– Regional experiment based reform strategy (Anhui and Sichuan)– Regional experiments reduce political/technical uncertainties– Successful experiments were used for gaining political supports

Political economy of reform experiment• Land reform was banned by the Third Plenum of the 11th Central

Committee of the CCP– Land reform attempts were stopped with political threats

• Provincial leaders Zhao Ziyang (Sichuan) and Wan Li (Anhui) experimented land contracting schemes in a few counties in 1979– Dangtu county (Anhui) carried experiment: 17% of households participated– All the land reform experiments were coordinated by local governments

• Substantiated with the successful experiment results, in late 1980 the central government decided to allow for nationwide land reform experiments.

• Zhao and Wan were promoted as the Premier and Vice-Premier of the State Council, respectively, to carry out the nationwide reform experiments

• in 1981 about 45% of households participated in the reform; increased to 80% in 1982; reached 99% in 1984

Land reform: Contracting and Property Rights

• Two major parts of the Chinese agriculture reform– Land reform: Household responsibility system (HRS) replaced

collective farming• Land is leased to rural households for fixed terms

– Price reform: market prices for above quota replaced planning prices

• Increased prices for agriculture products

• HRS as contracting institution & property rights institution– Contractual relationship between government and peasants

• The solution set of the share cropping model is enlarged– Allocate/protect partial property rights of land to peasants

• Rural households enjoy partial control rights over the land that they leased – How about performance when there were substantial improvement

in contracting and property rights?

Chinese Agricultural Reform and Growth(Lin, 1992)

Chinese Agriculture Price Reform(Lin, 1992)

Chinese Rural Institutional Reform:Household Responsibility System

(Lin, 1992)

Input/Output Index of Chinese Agriculture(1978 = 100)

(Lin, 1992)

Reform of Institution and Technical Efficiency of Production

• In standard producer theory (or firm theory) production is a technology relationship between inputs and outputs– All variations in outputs are caused by changes of input factors

• However, the observed production function is an economic relationship– Efforts and decisions of players affect observed outputs– They are responses to institutional arrangements (contracts, ownership, etc.)

• Solow growth model: y = F(K, L, E)– K, L: observable input factors– E: residual – Total Factor Productivity (TFP) or technical efficiency

• Interpretation of residual or TFP has been under debates• Observed ‘technical efficiency’ of production can be altered by

institutional changes, such as economic reforms

Growth AccountingSolow approach

L

dL

Y

LF

K

dK

Y

KF

Y

dY

dLFdKFdY

thentEif

tEtLtKFtY

LK

LK

,0)(

))(),(),(()(

In perfect competition

income share of

income K’s contribution L’sgrowth rate

wF

rF

L

K

L

K

Y

wLY

rK

L

K

00 tLK EifL

dL

K

dK

Y

dY

If

Total Factor Productivity

TFP growth rate > 0

TFP = residual explanations

of TFP

0

t

LK

EL

dL

K

dK

Y

dY

Growth Accounting: US Example

• Solow Residual (TFP) is subject to interpretation– Innovations; new markets; new organizations, …

Evaluate Impacts of the Two Reforms:Price Reform vs. HRS

• Increased prices encourages peasants (Arrow-Debreu theory)

• HRS rewards peasants if they work harder (contract theory)

• Which reform matters more?

• Use growth accounting approach to decompose impacts of the two reforms

Peasant’s production and rewards

Peasant’s Utility Function

From TFP estimation to incentives

Growth Accounting

• The key is to estimate TFP, A, by using Dennison-Solow-type growth-accounting technique

Chinese Agriculture Growth Accounting (McMillan et al., 1989)

Estimate model parameters based on estimated TFP, A

Estimate Major Results

Estimated Chinese Ag Incentives and TFP(McMillan et al., 1989)

Problems with McMillan et al. Results• Lin (1992) investigates impacts of HRS in a different approach. He criticized

McMillan et al as follows• Dennison-Solow growth-accounting technique used by McMillan et al has been

criticized (Zvi Griliches, 1963) – Solow model is not very useful if a production function is not stable, ie. with a major

unknown shift– Attributing growth by an unknown residual is not most helpful for understanding– How to measure it accurately if we do not know what is the residual

• Remark: above critique is not fully correct since – McMillan et al has decomposed ‘residual’ into known components: price and HRS– Lin’s approach shares a similar spirit in this aspect

• Their decomposition of the TFP growth into a price component and an incentive component requires strong assumptions about the utility function form and parameters– their results are sensitive to these assumptions.

• Many factors, which affect TFP, are not considered • The price used in the analysis are state above-quota procurement prices

– They are lower than rural market prices and do not reflect market either

Regional fixed effect model (Lin, 1992)

• MP: the index of market prices relative to manufactured input prices• GP: the index of above-quota prices relative to manufactured input prices • NGCA: the percentage of total sown area in non-grain crops• MCI: the multiple cropping index• D: regional dummy • T: time trend

Regional and Time fixed effect model (Lin, 1992)

Supply-response function (Lin, 1992)• The above model intends to estimate the impacts of reforms in institution and

prices on productivity• However, inputs, the crop pattern (NGCA), and cropping intensity (MCI) may be

endogenous to the HRS reform and to price changes. – The impacts of HRS and price changes on production may be over- or

underestimated• To assess their impacts on agricultural production correctly, the following supply-

response function excluding input factors, NGCA and MCI will be estimated – Estimation results are in column 5 in the following table

Impacts of HRS on Agriculture Outputs (Lin, 1992)

Crop Output Growth Accounting (based on column (4))

Major findings• The dominant reasons for the spectacular growth during 1978-

1984 were HRS reform and the sharp increase in the use of chemical fertilizers.

• The HRS reform was completed in 1983-1984. Therefore, even without any other cause, the rate of output growth would have fallen to about half of the previous level.

• The growth rate of chemical-fertilizer input dropped from 8.9 percent per year during 1978-1984 to 3.7 percent during 1984- 1987.

• If fertilizer use had continued to increase at the previous rate, its contribution to output growth would have been 5.54 percent of the 1984 level, instead of the 2.26 percent that actually occurred.

• The outflow of the labor force from the cropping sector to other sectors alone caused output to fall 2.95 percent compared to the 1984 level.

Crop Output Growth Accounting (based on column (5))

Major findings • Why chemical-fertilizer usage and labor has been

declined– The sharp drop in the state procurement prices relative

to input prices

• The change in state procurement prices resulted in a 5.04% drop in output in 1987 compared to the 1984 level.

• The adverse effect of the drop in state procurement prices on output growth, however, was compensated for by the rise in market prices, which lifted the 1987 output level 5.36 % over that of 1984.

Impacts of HRS• Impacts of the HRS is far beyond crops

• Diversification of agriculture– Much faster growth in animal husbandry, fishing,

• Industrialization in rural area– Township-village enterprises (TVEs) as the major engine

of China’s growth in the first stage of China’s reforms

• Substantially improved labor productivity creates huge labor supply to other sectors of the economy