Household Composition and Labor Demand: A Test of Rural Labor Market Efficiency

A central issue in agricultural taxation and pricing policy analysis is the degree to which the rural labor market can be characterized by a competitive supply and demand framework, and if so, what is the magnitude of the elasticity of demand for labor. The primary focus of this paper is to determine the degree to which farm household behavior is consistent with a competitive, clearing external labor market. In order to implement this program, the old observation that in the absence of labor markets, household composition is an important determinant of farm labor use, is formalized by incorporating household structure into the general framework of agricultural household models. The conditions under which specific market distortions, such as off-farm employment rationing, will lead to household demographic composition affecting farm labor demand are derived. After completing this theoretical discussion, an empirical model is developed which tests the proposition that household labor demand is independent of family composition. This model is estimated on a detailed household / farm data set from rural Java. Several statistical issues, including measurement error and endogeneity of the market wage are addressed through the use of appropriate instrumental variable techniques. I cannot reject the null hypothesis that farm labor allocation decisions are taken independently of household structure. In addition, farm labor demand has a well determined negative wage elasticity in the range -0.3 to -0.5. The results of the research indicate for the case of Java, farm household behavior is consistent with a clearing, competitive external labor market.