Interlinked Contracts Research Articles

Intermediaries, transport costs and interlinked transactions

AbstractFarmers in developing countries often encounter difficulties selling their products on local markets. Inadequate transport infrastructure in rural areas and large distances between areas of production and consumption mean that farmers find it costly to bring their produce to the market and this very often results in small net margins and poverty among farmers who are geographically isolated. Agriculture in developing countries is characterized by the presence of intermediaries that have a cost advantage over farmers. Because of their market power, these intermediaries are able to impose interlinked contracts and are free to choose the spatial pricing policy they use. In this paper, we develop a model of input–output interlinked contracts between an intermediary and geographically dispersed farmers. We establish when the intermediary uses either uniform or mill pricing policies, as opposed to spatial discriminatory pricing. For each pricing policy, we analyze what the welfare implications are in terms of an increase in farmers' income and a reduction in poverty in rural areas. We also establish how the choice of a spatial pricing policy impacts geographically isolated farmers and how it influences the participation by farmers.

Interlinked Contracts: An Empirical Study

This study investigates contractual relations between farmers and sugar mills in Japanese colonial Taiwan. Our investigation is based on a model of interlinked contracts that is adapted from Gangopadhyay and Sengupta (1998). The validity of our model's predictions is verified by analysing a dataset consisting of contracts between Taiwan's cane farmers and sugar mills. Our data suggest that the contractual relationship is consistent with a scenario in which the interest rates charged by sugar mills on cash loans to farmers are set in order to prevent the diversion of funds to other uses.

A theory of sharecropping: The role of price behavior and imperfect competition

This paper proposes a theory of sharecropping on the basis of price behavior in agriculture and imperfectly competitive nature of rural product markets. First we show the superiority of sharecropping over fixed rental contracts in a benchmark landlord–tenant model with seasonal variation of price, where the tenant receives a low price for his output while the landlord can sell his output at a higher price. Then we consider more general interlinked contracts to show that there are multiple optimal contracts. Finally we incorporate imperfect competition in the product market by assuming that a third agent (called the ɛ-agent) may emerge to compete with the landlord as a buyer of the tenant's output. It is shown that (i) the presence of this competing agent generates a Pareto-improving subset of share contracts out of the multiple contracts and (ii) the unique contract that is robust to the emergence of the ɛ-agent results in sharecropping.

Understanding Economic Development and Institutional Change: East Asian Development Model Reconsidered with Implications for China

This paper presents a coherent framework to characterize the dynamics of economic development and institutional change in the East Asian Development Model. In the early stage of development, due to market incompleteness, a government with high autonomy and capacity can promote economic development through interlinked and relational arrangements (e.g., industrial policy). In later stages, market completion will usually unravel interlinked and relational contracts, and lead to a rule-based society. The paper shows that the appropriate role of government and institutions are functions of the stage of development. In particular, relation-based governance is suited to investment-led development, while rule-based governance is suited to innovation-led development. The paper ends up with some implications for China’s development and institutional change.

Borrowers in a Village Economy: An Analysis of Credit Contracts Across Rural Households

The present study shows the impact of different borrower specific socio-economic, political and demographic characteristics on the probability that a loan will be taken from formal sources as well as on its size. We also study the impact of such factors on interlinked loan contracts. The study is based on a primary survey conducted in 24 Parganas (North), West Bengal, India. We observe that occupational categories, political identification, and economic status are the important determinants of loans taken from formal lending institutions. Another important observation is the existence of credit labour interlinkage in a tied loan market. Mostly poorer people have a higher probability of taking a tied loan.

Interlinking and Collusion

In this paper, we suggest a new rationale for the existence of interlinked contracts in the agrarian economies of developing countries. Using the framework of an infinitely repeated game with discounting, we show that interlinked contracts can help the dominant parties to collude, in cases where collusion is not possible with noninterlinked contracts. This occurs because either interlinkage pools incentive constraints across markets, or it affects the incentives of agents to accept deviating contracts. We illustrate these mechanisms by considering the case of interlinkage between markets for credit and share tenancy. The model that is used to formalize the second mechanism is characterized by frictions in the tenancy market, which we model using the standard framework of search and matching.

Unraveling the Chinese Miracle: A Perspective of Interlinked Relational Contract

This paper is an attempt to provide an explanation for the socioeconomic foundation which underlies China’s economic miracle. As suggested by the theory of interlinked contract, the transition from a planning economy to a market economy is a multifaceted process. In terms of market dynamics interlinking markets replace specialized markets, while in terms of governance dynamics, interlinked contracts give way to formal contracts. A good match between the markets structure and contractual structure is key to the success of transition. In particular, some China-specific institutions, like TVEs, the financial system and the restructuring of SOEs can be better understood within this framework. Broadly, the whole reform package in China also is in good accordance with the spirit of interlinked contract.

Interlinked contracts and social power: Patronage and exploitation in India's waste recovery market

Interlinked contracts have been examined almost exclusively in the context of the rural sphere. This article describes the nature of exchange regimes between two sets of primary collectors of recyclable waste, that is, waste pickers and itinerant buyers, and their dealers, in the city of Delhi. Far from the casualised labour transaction commonly described for the unorganised urban sector, the findings portray a picture of personalised and surprisingly long-term exchange between the parties. While a new institutional economics approach might explain the underlying motivation and consequent general form of the implicit contracts, it cannot explain the differential nature of each. It is suggested that in order to do that a political economy approach must be taken. This would understand interlinked transactions as being embedded within and consequently influenced by the particular social context, in this case of an inequitable and impermeable caste hierarchy amongst those that engage in waste work.

Employment with connections: Negative network effects

In less developed countries, it is widely observed that employers hire workers through employee referrals. In this paper, we show an extension of this kind of networks that may decrease applicants' payoffs while a diversification of the networks can raise referred applicants' payoffs. We also discuss the effect of the extension of interlinked contracts on farmers' wages.

Credit-Product Interlinkage and Captive Markets in Backward Agriculture: A Theoretical Analysis

This paper builds a model of fragmented duopsony in backward agriculture following Basu and Bell (1991) in which the purchasers (traders) have captive markets each but compete in a contested market. We focus on the formation of captive markets through trader-farmer interlinkage in the form of interlinked credit-product contracts (ICPCs). ICPC (or the formation of captive markets) is not an entry-preventive strategy in the model. Its motive is to push the farmers to their reservation income level. However, the captive and the contested markets are linked by the requirement that the reservation income of a captive farmer has to equal the income of a farmer in the contested market. In general, in our model strategic considerations determine the extent of use of ICPCs rather than explaining their existence. (In a special case, however, they do explain existence.) We also show that a credit subsidy policy will reduce the size of the captive market, improve the welfare of the farmers and raise the agricultural productivity of the economy while the effects of a price subsidy policy will be ambiguous.

Interlinkage, limited liability and strategic interaction

The literature on interlinkage is inconclusive regarding the strict superiority of this arrangement. We analyze a landlord and a moneylender as two players making non-cooperative decisions regarding the terms of their respective contracts with a tenant. In the sequential game where the landlord moves first and the tenant has limited liability, we demonstrate that there exist circumstances in which interlinkage is superior, even with nonlinear loan contracts, a result that carries over when there is moral hazard. The incorporation of risk aversion yields strict superiority in general. The main result is unaffected by changes in the seniority of claims, but is sensitive to changes in the order of moves: limited liability ceases to ensure the strict superiority of interlinked contracts if the principal who provides the variable factor of production moves first, even if he has junior claims to the output.

Policy instruments for sustainable land management: the case of highland smallholders in Ethiopia

AbstractDegradation of land continues to pose a threat to future food production potential in many developing economies. Various approaches, mainly based on command‐and‐control policies, have been tried (with limited success) in the past to encourage adoption of erosion‐control practices by farm households. High transactions costs and negative distributional impacts on the welfare of the poor limit the usefulness of standards and taxes for soil and water conservation. One innovative approach is the use of interlinked contracts which create positive incentives for land conservation. This study analyses the social efficiency of such policies for erosion‐control in the Ethiopian highlands using a non‐separable farm household model. Incentive contracts linked with conservation seem to be promising approaches for sustainable resource use in poor rural economies. This may suggest that conservation programs should give greater consideration to better fine‐tuning and mix of policies that help achieve both economic and environmental objectives.

Interlinkage, investment and adverse selection

The paper explores the nature of interlinked contract under adverse selection where agents intertemporal preferences are private information. Our principal findings are: 1. (a) More patient agents (with low rates of time preferences) are offered credit contracts and others are offered share and credit contracts (i.e. interlinked contracts). 2. (b) Interlinkage of contracts reduces investment 3. (c) and is second-best and the non interlinked contracts is first-best.

An analysis of delayed formal and interlinked informal credit in agriculture

A model of interlinked credit-product contracts between small farmers and large farmers when the small farmer faces delay in getting formal credit and the large farmer does not, has been developed. The small farmer remains on the reservation income level, and his reservation income is inversely related to the length of the delay. However, this does not hamper the productivity of the small farmer. The large farmer extracts the surplus through the interlinked contract and this surplus is positively related to the length of the delay. Interlinkage and non-inter-linkage equilibria become identical if the small farmer gets the formal credit at the beginning of the crop cycle. Various subsidy policies worsen the distribution of formal credit.

Price uncertainty and credit-product interlinkage: an extension of the analysis of Gangopadhyay and Sengupta

An extension of the theoretical analysis of the credit-product interlinkage by Gangopadhyay and Sengupta (Oxford Economic Papers 39 (1987) 333–42) is described in this paper, introducing price uncertainty. A distinction is made between the fixed-price interlinked credit-product contract and the fixed-commission interlinked credit-product contract. The results of the model of Gangopadhyay and Sengupta are obtained only in some special cases of this model.

Interlinked contracts and moral hazard in investment

In agricultural tenancy arrangements, the tenant is often required to undertake effort aimed at maintaining and improving the productive stocks. This paper investigate the design of contracts which induce optimal investment of such effort. It is found that a long-term contract which interlinks tenancy with a credit agreement is optimal. In equilibrium the tenant obtains credit from the landlord at a rate of interest below the market, and is perpetually indebted to the landlord.

Credit Markets in Northern Nigeria: Credit as Insurance in a Rural Economy

This article addresses the issues of imcomplete markets and imperfect information in the context of credit markets in rural northern Nigeria. In much recent theoretical literature, the problems of moral hazard and adverse selection are assumed to be decisive for the organization of agrarian institutions. In contrast, it is found that in the four villages surveyed credit transactions take advantage of the free flow of information within rural communities. Information asymmetries between borrower and lender are unimportant, and their institutional consequences - the use of collateral and interlinked contracts - are absent. Credit transactions play a direct role in pooling risk between households through the use of contracts in which the repayment owed by the borrower depends on the realization of random production shocks by both the borrower and the lender.

An inquiry into quasi‐credit contracts: The role of reciprocal credit and interlinked deals in small‐scale fishing communities

In agrarian village societies beset with many hazards and uncertainties, people evolve various means of coping with risk. What is perhaps less known is that credit transactions can sometimes serve the function of reducing risk in such societies. This article is concerned with examining several insurance‐motivated credit arrangements in small‐scale fishing communities. A hunger insurance mechanism of ‘reciprocal credit’ and a system of interlinked contracts aimed at insuring against risks in the spheres of labour and marketing relations will be extensively dealt with. Moreover, the concept of ‘triadic’ relationships will be shown to have special relevance in the case of traditional insurance arrangements aiming at controlling problems of ‘moral hazard’.

INTERLOCKING FACTOR MARKETS AND AGRARIAN DEVELOPMENT: A REVIEW OF ISSUES 1

IT is being increasingly appreciated in the literature on agrarian development that many of the key issues cannot be, analyzed without an understanding of the nature of interlinkage of factor markets (particularly those of land, labor and credit) in the specific institutional context of a poor agrarian economy. To take a simple but important example, land reforms in the form of land redistribution and intervention in the land market alone cannot be effective if the existing links between land and credit contracts are ignored and a viable alternative to landlords as the major source of credit for small tenants and other peasants is not found. Quite often a landlord and his tenant enter into several transactions at the same time: in land renting, in wage labor hiring, in production and consumption credit, in cost sharing of purchased inputs. in marketing of output, etc., all as part of a comprehensive, interlinked contract encompassing several markets. Generalizing from his experience with the hill peasants of Orissa, Bailey (1966) notes: watershed between traditional and modern society is exactly this distinction between single-interest and multiplex relationships. (He goes on to comment that in the cognitive map of the peasant single-interest functionallyspecialized relationships are to be made-with due caution-only with outsiders, those who are outside his moral community.) In the general-equilibrium framework of economic theory or some of the. computable planning models markets, of course, are inter-related by assumption, but they do not usually explore (a) how the interlinkage of markets reinforces the impact of imperfections in each market, (b) how different transactions are sometimes personalized in an inter-locking system of (unequal) exchange among the same participants in order to get around the problem of non-existence of a complete set of markets and (c) how differential adjustment mechanisms operate in different factor markets (like price mechanism in one market and quantity rationing in a related market). Yet without posing and analyzing these issues it is difficult to understand the functioning of allocation and accumulation (and hence income and wealth distribution) processes in agriculture. The literature on these issues is still