Testing for Market Imperfections: Participation in Land & Labor Contracts in Turkish Agriculture

A remarkable degree of self-sufficiency is a distinguishing feature of the typical Third World family farm. However, many family farms deviate from this pattern and engage in transactions involving land and labor. The question is why some households use land and labor markets while others do not. We posit that markets may function imperfectly and discourage households from participation. We model imperfections in terms of transaction costs which drive a household-specific wedge between sales and purchase prices of factors. When the shadow price of a factor falls inside this range, the household has no incentive to adjust that particular margin. The frictionless model emerges as a limiting case in which sales, purchase and shadow prices are equal. The empirical work is based on data from a 1973 nationwide survey in Turkey. The subsample of owner-cultivators is sorted into a 3x3 table according to the adjustments that took place on the land margin (lease out, do not participate, lease in), and the labor margin (hire out, do not participate, hire in), and the determinants of the observed pattern of adjustments are investigated. The estimating equations are obtained from the theoretical model by treating the shadow, sales, and purchase prices as latent variables and expressing them as linear functions of observables. We use an unrestricted bivariate ordered probit specification and estimate the parameters using maximum likelihood methods. This procedure uncovers the links between observables and the transaction costs faced by each household, making it possible to confront transactions cost theory with real world data.