Three essays on groundwater and tenancy contracts in rural economies [Elektronische Ressource] / vorgelegt von Anne Margret Steinmetz

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Three Essays on Groundwater and Tenancy Contracts in Rural Economies Inaugural-Dissertation zur Erlangung der Würde eines Doktors der Wirtschaftswissenschaften (Dr. rer. pol.) an der Wirtschafts- und Sozialwissenschaftlichen Fakultät der Ruprecht-Karls-Universität Heidelberg vorgelegt von Anne Margret Steinmetz im Oktober 2003 to my parents 2Table of Contents 1 Introduction........................................................................................................................ 6 2 How Informal Water Markets Function: Empirical Evidence from South India............. 16 2.1 Introduction..............................................................................................................17 2.2 The study area .......................................................................................................... 19 2.3 The sample...............................................................................................................21 2.4 Irrigation and informal groundwater transactions in Nanguneri Taluk.................... 23 2.5 Some qualitative features of informal groundwater transactions............................. 41 2.5.1 The share-buyers' views ................................................................................... 41 2.5.2 The cash-buyers' views .................................................................................... 43 2.5.3 The sellers' views .............

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Three Essays on Groundwater and Tenancy Contracts in
Rural Economies



Inaugural-Dissertation zur Erlangung der Würde eines Doktors der
Wirtschaftswissenschaften (Dr. rer. pol.) an der Wirtschafts- und
Sozialwissenschaftlichen Fakultät der Ruprecht-Karls-Universität Heidelberg





vorgelegt von
Anne Margret Steinmetz
im Oktober 2003






to my parents

2Table of Contents
1 Introduction........................................................................................................................ 6
2 How Informal Water Markets Function: Empirical Evidence from South India............. 16
2.1 Introduction..............................................................................................................17
2.2 The study area .......................................................................................................... 19
2.3 The sample...............................................................................................................21
2.4 Irrigation and informal groundwater transactions in Nanguneri Taluk.................... 23
2.5 Some qualitative features of informal groundwater transactions............................. 41
2.5.1 The share-buyers' views ................................................................................... 41
2.5.2 The cash-buyers' views .................................................................................... 43
2.5.3 The sellers' views ............................................................................................. 45
2.5.4 The non-transacting households' view ............................................................. 48
2.5.5 Interlinking between groundwater transactions and tenancy contracts............ 49
2.6 Conclusion................................................................................................................52
Appendix: Questionnaire...................................................................................................... 56
3 Informal Groundwater Markets: The Role of Share Contracts ........................................ 60
3.1 Introduction..............................................................................................................61
3.2 The structure of informal groundwater transactions ................................................ 65
3.3 The Model................................................................................................................68
3.3.1 The General Model........................................................................................... 68
3.3.2 Exponential utility............................................................................................78
3.3.3 Logarithmic utility............................................................................................84
3.3.4 The case of only two contractual parameters ................................................... 92
3.4 Conclusion................................................................................................................95
Appendix .............................................................................................................................. 97
34 Different input intensities on owned and sharecropped plots: The consequences of
imperfect monitoring, cost sharing, and endogenous crop choice ........................................... 99
4.1 Introduction............................................................................................................100
4.2 Description of the data ........................................................................................... 105
4.3 The cost sharing argument ..................................................................................... 112
4.4 Estimation methods and empirical results.............................................................. 120
4.4.1 Comparison of average input intensities on owned and leased-in plots ........ 120
4.4.2 Explaining the differences in average input and output intensities................ 123
4.4.3 Endogenous crop choice................................................................................. 136
4.5 Conclusion..............................................................................................................150
Appendix ............................................................................................................................ 154
Table 1: Total operational landholdings of households by tenancy status (in acres)......... 156
Table 2: Irrigation of plots by tenancy status..................................................................... 157
Table 2a: Area irrigated under different tenancy contracts (in acres)................................ 158
Table 3: Frequency table of crops by tenancy status (owner/sharecropper) ...................... 159
Table 4: Frequency table of crops by tenancy status (owner/fixed-rent)........................... 160
Table 4a: Proportions of land grown under different crops ............................................... 161
Table 5: Mean input intensities for different crops (all plots in crop production schedule)
............................................................................................................................................ 162
Table 6: Results of the Sidak-test....................................................................................... 163
Table 7: Mean differences in average input and output intensities.................................... 164
Table 8: Differences on owned and sharecropped land of owner-sharecroppers, without
controlling for the cost share (n=43).................................................................................. 165
Table 8a: Differences on owned and sharecropped land of owner-sharecroppers, controlling
for the cost share (n=43)..................................................................................................... 166
4Table 9: Differences on owned and leased-in land of owner-fixed-rent tenants, (n=75)... 167
Table 10: Multinomial logit estimates for the crop choice equations................................ 169
Table 10a: Residence status of landlords ........................................................................... 171
List of variables in the multinomial logit model................................................................ 172
Table 11: Differences on owned and sharecropped land of owner-sharecroppers, actual crop
dummies (n=43) ................................................................................................................. 173
Table 12: Differences on owned and sharecropped land of owner-sharecroppers, predicted
crop dummies (n=43) ......................................................................................................... 174
Table 13: Differences on owned and leased-in land of owner-fixed-rent tenants, actual crop
dummies (n=75) ................................................................................................................. 175
Table 14: Differences on owned and leased-in land of owner-fixed-rent tenants, predicted
crop dummies (n=75) 177
Table 15: Output differences (owner-sharecroppers)......................................................... 179
Table 16: Output differences (owner-fixed-rent tenants)................................................... 180
5 Conclusion...................................................................................................................... 181
References .............................................................................................................................. 185
Acknowledgements ................................................................................................................ 190

51 Introduction
From the viewpoint of development economics, missing or imperfect markets represent a
crucial step in the understanding of the economic problems of developing countries. These
missing or imperfect markets also lie at the heart of informal institutions, which are reactions
to the market failures that arise because of legal, informational, or incentive constraints. These
failures are often exacerbated by an unequal distribution of income or wealth. Another
essential property of imperfect markets is that they are contagious: a market failure in some
sector can lead to problems in other markets. For example, an incomplete credit market failing
to provide each household facing a rewarding investment opportunity with a loan may lead to
a failure in the market for whose infrastructure the investment was going to be made. One of
these informal institutions designed to fill the loopholes in imperfect markets are share
contracts. Instead of specifying a fixed payment, share contracts make the payment to a
production factor dependent on the - mostly uncertain - outcome of the production process in
which that production factor is involved. Share contracts in the agricultural sector of
developing economies are best known for their use in combining the markets for land and for
labour, but there is growing evidence that share contracts are also a common contractual form
in the emerging informal markets for groundwater. The dissertation in hand deals with share
contracts in both the market for land and the market for groundwater.
It is a daunting undertaking to conduct research in the realm of share contracts in
agrarian economies given the fact that the inquiry into the merits and drawbacks of share
tenancy contracts compared to fixed-rent leasehold tenancy started as early as in the
eighteenth and nineteenth century with Adam Smith (1776) and John Stuart Mill (1848),
followed by a steady growing literature investigating the efficiency implications of share
contracts and the reasons for their existence. A large part of this literature is summarized in
6Singh (1989), Otsuka et al. (1992), and Hayami and Otsuka (1993). But with that matters
seem to have not been settled because since then a new strand of literature has emerged,
1offering new explanations for the choice of sharecropping tenancy contracts. This literature,
however, the recent one as well as the older one, considers only land-tenancy and labour-
employment contracts which 'are alternative arrangements to combine the two primary factors
of production in agrarian economies', as Hayami and Otsuka (1993) put it. This approach
leaves out of consideration that there is a third 'primary' factor of production, namely water,
which for a long time might have been not especially worth considering in the context of
contract theory, since the inter and intra village allocation of this factor of production was
governed by collective action rather than by contracts between private parties. But this has
changed nowadays, since the use of groundwater for irrigation purposes is steadily replacing
the use of surface water from the notoriously ill-maintained and therefore unreliable canal
systems. Apart from the canal systems being in bad condition, the fact that more and more
farmers are growing more water-intensive crops also leads to an increasing demand for
groundwater, since the canal water supply does not meet this demand. The equipment needed
to gain access to groundwater is available to farmers who have the necessary liquidity or
access to credit. Since the access to groundwater makes those farmers partly independent of
the canal system, they face a smaller incentive to engage in the collective maintenance of it.
That in turn leads to a further decay of the surface irrigation system, making more farmers
dependent on groundwater irrigation. On account of the fact that normally part of the
households in a village cannot invest in the necessary equipment due to lack of liquidity and

1 To cite a few more recent references: Basu (1992), Sadoulet et. al. (1994), Sengupta (1997),
Ray (1999), Ghatak and Pandey (2000), Ackerberg and Botticini (2001), Ray and Singh
(2001), Dubois (2002).
7credit-constrainedness, water has become a factor of production the access to which is no
longer exclusively determined by rules set by the village collective. It is now rather a factor of
production which is owned privately by some of the households and the allocation of which
therefore requires contracting between private parties. Strictly speaking, there is now a mixed
regime of access to water: For one part of their seasonal irrigation needs, farmers still rely on
surface water, for the other part, they have to rely on their own wells or on other farmer's
wells.
This is where the second and the third chapter of this dissertation set in: The
contractual forms under which groundwater is traded between households turn out to be the
same as those employed to allocate the two other 'primary' factors of production, land and
labour. The two main contractual forms to combine groundwater with land and labour are that
the farmer who needs additional irrigation pays the seller either a fixed rate per unit of water
he receives or a prespecified share of his output on the field irrigated by the seller's well. The
mainly observed contractual forms combining land and labour are, first, a fixed payment in
cash or kind from the tenant to the landlord, second, a share of the output produced on the
tenancy paid by the tenant to the landlord, or, third, a fixed wage rate paid by the landlord to
the hired workers working on his fields. At this place, we will not go into the details under
which circumstances what kind of contractual form is chosen in land and labour transactions,
the interested reader is referred to the literature cited above. But there is one obvious
difference between the principal-agent relationship in land-tenancy and labour-employment
2contracts and the principal-agent relationship in groundwater contracts. Agency theory , on
which the treatment of land and labour contracts is based, considers the choice of an optimum
contract between a principal (the owner of a resource) and an agent (the user of the resource)

2 See, for example, Arrow (1985), Hart and Holmstrom (1987), Levinthal (1988).
8and it is assumed that 'an agency problem arises when the agent's action (e.g. work-effort) is
not directly observable by the principal and the outcome is influenced not only by the agent's
action but also by uncertain factors outside the agent's control' (Hayami and Otsuka, 1993, p.
3). Things are different for groundwater contracts. First, the owner of the resource, the
wellowner, is under none of the contractual forms interested in monitoring the user's (the
water buyer's) actions, since under a fixed rate contract his payment is in any case
independent of the buyer's actions and in the case of a groundwater share contract, as matters
stand, the contract is only negotiated when the buyer has already supplied all other inputs, so
that the wellowner can observe the condition of the crop before entering the contract and
personally applying his resource to the crop. Second, in the case of groundwater transactions
it is the wellowner's (the resource owner's) actions which are observable for the buyer but
which are not enforceable by the buyer. Thus, there is a reversal of roles between the resource
owner and the resource user, the user of the resource having to provide incentives to the
owner of the resource. The role of groundwater is therefore, with some reservations, probably
best compared to the role of labour in tenancy contracts.
More detailed information on the pattern of contract choice in so-called informal
groundwater markets is presented in chapter 2, which contains the results of a field study on
groundwater transactions conducted by myself during January and February 2001 in Tamil
Nadu, India. The main reason which led me to undertake the study was the perception that the
existing empirical literature on informal groundwater transactions, which is cited in the first
section of chapter 2, is mostly based on studies which are on a rather aggregated level and
therefore fail to provide a satisfactory detailed depiction of the pattern of groundwater
transactions and of the associated payment modes at the household level. But since these
empirical details are vital for a theoretical investigation of the determinants of contract choice,
information on such questions as the following was gathered in the study: At which point in
9time during the cultivation period the contractual form is chosen? Is there any connection
between the remaining number of days in the cultivation season for which a farmer needs
water and the contractual form chosen? Is it the wellowner who dictates the contractual form
and the terms of the contract, or do the parties bargain over the terms of the contract? Once
the contract has been chosen, who then decides how much groundwater will be supplied, and
how much of the other inputs such as labour, fertilizer etc. will be employed in the production
process? Does a contract with a wellowner assure a supply of groundwater, or is there no way
of ensuring that the seller will deliver the amount of water agreed upon in advance? The
answers to these question are of particular interest if one wants to shed some light on the fact
that fixed rate payments and sharecropping arrangements coexist in some local water markets,
but not in others. In addition, chapter 2 presents descriptive statistics for some characteristics
of the sample households and for some variables related to their groundwater transactions.
The household characteristics include landholdings in the different categories of land,
wellownership, and the amount of money invested in irrigation equipment. The variables
related to the groundwater transactions are, for example, the number of buyers and sellers
transacted with in the season under consideration, the fixed rate or cropshare paid or received
for groundwater, and the number of days for which water was bought during the season.
Comparisons regarding these characteristics and variables are made between the three
household categories sellers, buyers, and non-transactors, and between the two sub-categories
of buyers, cash-buyers and share-buyers. These descriptive statistics let one gain some insight
into the factors determining whether a household sells water, purchases water, or is inactive in
the informal water market.
In chapter 3, I come back to the empirical facts set out in chapter 2 in order to build up
a model capable of explaining the choice of different contractual forms in informal
groundwater markets. This task is definitely worth undertaking, since on the one hand, the
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