of exogenous changes to which land markets need to respond increases disproportionately. The transaction costs associated with renting out land may well affect land owners’ decisions on whether to, e.g., adopt new technology or take up off-farm employment, thus having implications for nonfarm growth.

Given its limited land endowment that is under increasing threat from degradation, making the most productive use of available land resources is important for Ethiopia to escape the threat of starvation and dependence on food aid. Similarly, the population’s continued high level of dependence on agriculture implies that well-functioning land rental markets that would allow those with little comparative advantage in agriculture to take up nonagricultural employment will be critical to lay the basis for overall development and a more diversified rural economy. If the experience of other countries that followed similar strategies is anything to go by, land rental markets will have to assume a major role in allowing movement of labor out of agriculture, and transferring land to more productive producers. However, past studies of the extent efficiency of rental markets in Ethiopia yield contradictory results; while some are unable to reject the hypothesis of frictionless adjustment through rental markets (Pender and Fafchamps 2006), others provide strong evidence for land markets allowing at best partial adjustment (Teklu and Lemi 2004, Ghebru and Holden 2006, Holden and Ghebru 2006).

In this paper, we use a large panel data set from Ethiopia that contains a substantial share of cultivating households owned and sharecropped land simultaneously, in addition to being more detailed and larger than what had been available in other studies. To assess the efficiency of sharecropping as a key contractual arrangement in land markets, we estimate a production function and input demand functions using household fixed effects. To explore the extent to which land markets help farmers capitalize on existing opportunities, we use a friction model (Rosett 1959, Skoufias 1995) to identify whether rental markets allow producers to attain their desired level of land holding irrespectively of their endowment, and also to provide an empirical estimate of the magnitude of friction in land rental markets.

Our results suggest that input and output intensities are indeed statistically significantly lower on sharecropped as compared to owned plots, thus leading us to reject the hypothesis that tenure status does not affect producers’ decisions and that sharecropping contracts are not affected by Marshallian inefficiency, though the level of inefficiency is much lower than that found elsewhere in the literature. At the same time, we find evidence not only for large amounts of friction that prevents land owners to use rental markets to adjust to their optimum size but also to support the hypothesis that such friction reduces productivity by preventing productive producers from gaining access to additional land.

The paper is organized as follows. Section II discusses features of the rural economy in Ethiopia to motivate the study and provide the background for some of the analytical hypothesis. It also introduces the conceptual framework for testing the efficiency of sharecropping and the extent to which rental 3