approach forces a distinction between market performance and other factors affecting farmers’ choices, thereby making it possible to explore multiple policy pathways.

Our applied model takes the form of a panel-selection model, which we estimate using rural household survey data from Ethiopia. Our findings are consistent with the prediction of the conceptual model that heterogeneous market performance and heterogeneous household circumstances combine to generate heterogeneous choices about using fertilizer-based technologies. We find that incomplete markets limit technology adoption by limiting choice, especially for resource poor households who are least able to cope with the hurdles raised by poorly performing markets.

# Literature background

The idea that markets do not always work well is a reappearing theme, especially in development economics. It is different from the classic notion of market failure in which phenomena such as externalities can lead to sub-optimal outcomes even when markets are complete and efficient. It is also a broader concept than the idea of non-competitive markets, although a lack of competition can be an element of poorly performing markets. The notion of what constitutes incomplete markets has evolved over time, but it is largely a relative concept. For our purposes, we use the term to imply that locally available goods and services are fewer or more expensive than they would be under optimal public policy, for example, policies that support efficient transportation systems, reliable contract enforcement, or unobstructed information flows.

A number of interrelated terms such as incomplete markets, imperfect markets, weak markets and poor market access are often used to convey market limitations. Early on, the term “incomplete markets” was closely associated with missing contracts, especially contracts for risk. The idea was important in early studies that examined the consequences of using commodity-exchange- contracts to hedge price risks on commodity exchanges for farmers who were ultimately concerned with income risks. See, for example, Dillon and Anderson (1971), Myers (1988), and Moschini and Hennessy’s (2001) review. Later, missing markets for risk, together with liquidity and credit constraints, would become a central feature of finance models developed to explain how risky assets are priced (Mehra and Prescott 1985; Mankiw 1986; Lucas 1993; Heaton and Lucas 1996).

In the development literature, the pervasive presence of uninsurable risk, poorly functioning labor and credit markets, and high transaction costs were used to explain the diverse livelihood strategies of rural households, including choices about production technologies (for example, Norman 1974; Morrison 1980; Lipton and Lipton 1993; Rosenzweig and Binswanger 1993). Market imperfections were also used to explain the prevalence of small scale farming in Africa and Asia (Feder 1980, 1985)<sup>1</sup> ; migration patterns (Masset et al. 1993); seasonal price swings (Saha and Stroud 1994; Stephens and Barrett 2011); and the loss of traditional sources of protection for crop genetic resources (Van Dusen and Taylor 2005). Of course, as many

> 1 See also the references in Lipton (2006) and Larson et al. (2013).

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