Plot-level data, that allows controlling for household-specific heterogeneity, is used to analyze this issue and contribute to the literature in three respects. First, we explore the existence of an inverse relationship not only for output or gross revenue but also for profit per hectare with family labor valued at market wages or an imputed household-specific shadow wage rate. Second, to reduce the possibility of the relationship being driven by measurement error and unobserved plot characteristics, we control for a wide range of time-variant and -invariant characteristics including soil quality and unfavorable productivity shocks. Finally, as plot characteristics that prevent mechanization emerged as a key factor in overturning the relationship in India (Foster and Rosenzweig 2011), we conduct analysis both at plot and holding levels.

Descriptive statistics by tercile of the farm size distribution reveal three regularities. First, plot (and farm) size is inversely related to land quality, i.e., smaller farms and plots have higher land quality and are less likely to be affected by crop shocks. Second, differences in output per hectare and input use intensity across farm size classes are pronounced: output value for farms in the bottom tercile is, at US$ 860, almost three times that of those in the top tercile (US$ 298) with differences even more pronounced (from US$ 1,296 to 317) at plot level. But for profit/ha using actual input costs and valuing labor at market wages, the inverse relationship between size and productivity essentially disappears.

Econometric estimates allow us to infer the underlying production technology, control for other factors such as land quality, and compute household-specific shadow wages to obtain profits that more accurately reflect the opportunity cost of labor. Results suggest that (i) technology is characterized by constant returns to scale; (ii) even after controlling for land quality, yields, labor intensity and shadow profits per hectare are all much higher on small farms; and (iii) profit per hectare (with labor valued at market rates) is virtually identical across holding and plot sizes. Results thus point to labor market imperfections as a major reason for the inverse relationship between farm size and productivity, but suggest that, with existing market imperfections, small farms are able to absorb large amounts of labor in a gainful way.

As long as farmers’ labor use responds to price signals, interventions (e.g., restrictions on sub-division or involuntary consolidation programs) may thus yield few benefits and could even be counter-productive. Efforts to reduce labor market imperfections and nonagricultural growth that leads to higher wages and nonagricultural employment opportunities pulling labor out of agriculture may be more effective tools to improve rural welfare than land market interventions.

The paper is organized as follows. Section 2 discusses the conceptual basis for a systematic relationship between farm size and productivity, the empirical evidence in support of this hypothesis, and the way in which it is likely to evolve in light of greater reliance on credit and mechanization. Section 3 presents data and descriptive evidence at the household and plot levels and draws out implications for the estimation 3