# **3.1 Testing the efficiency of sharecropping**

In a world of perfect information, complete markets and zero transaction costs, the distribution of land ownership will affect welfare but will not matter for efficiency as market transactions allow everybody to operate at an optimum farm size (Feder 1985). In addition to non-agricultural options which will affect potential tenants‟ reservation utility, labor (which needs to be supervised), credit and insurance market imperfections as well as transaction costs due to search and contract enforcement will, however, affect the outcomes from land rental markets. The efficiency outcome might not always prevail and heavily depends on the choice of contractual arrangements.

By varying the share and the fixed payment to the tenant, land owners who wish to rent out can achieve any combination of contractual forms from a wage labor contract through a share contract to a fixed rental contract. While all contracts will lead to equivalent outcomes if output is certain and tenants‟ effort can be monitored and enforced (Cheung 1969), relaxation of this assumption gives way to a number of scenarios. If effort cannot be monitored and agents are risk neutral, fixed rental contracts are optimal. This is because in a pure sharecropping contract tenants will equalize the marginal disutility of effort to their marginal benefit, and so exerting less than the socially optimal amount of effort and obtain lower levels of production. For risk-averse agents, the optimum outcome will require a trade-off between the riskreducing properties of the fixed-wage contract, under which the tenant's residual risk is zero, and the incentive effects of the fixed rental contract, which would result in optimal effort supply but no insurance against bad events. Second, limited tenant wealth has a similar effect because in case of a negative shock tenants with insufficient wealth are likely to default on rent payments. This implies that landlords will tend to enter into fixed rental contracts only with tenants who are wealthy enough to pay the rent under all possible output realizations, implying that poorer tenants will be offered only a share contract (Shetty 1988). Finally, a dynamic setting opens up a number of additional perspectives besides the scope for using the repeated game context and the threat of eviction to reduce the efficiency losses of sharecropping. On the other hand, a rental contract that provides tenants with adequate incentives to maximize profits in any given time period may lead to overexploitation of the land if (dis)investment is considered, implying that a share contract with lower-powered incentives and possibly compensation may be more appropriate (Ray 2005).

A large literature has focused on testing the extent of inefficiency involved in sharecropping contracts, with often mixed results (Otsuka and Hayami 1988). Within-household data suggest that, in India, share tenancy is associated with an average productivity loss of 16% (Shaban 1987). Part of the losses might have been policy-induced as fixed rental contracts were outlawed in the study area. Recent studies using household fixed effects suggest that, in light the constraints faced agents‟ choice of contractual arrangements is rational 7