Chapter 52 LABOR: DECISIONS, CONTRACTS AND ORGANIZATION JAMES ROUMASSET and SANG-HYOP LEE Department of Economics, University of Hawaii at Manoa, Honolulu, HI Contents Abstract 2706 Keywords 2706 1. Introduction 2707 2. Theoretical and empirical issues 2708 2.1. The wedge-model farm-household decisions 2708 2.2. Farm size, transaction cost, and efficiency 2710 2.3. Separability and substitutability 2713 2.4. Share, piece-rate and wage contracts 2716 2.5. Efficiency wages 2720 2.6. Casual vs permanent workers 2721 3. Extensions: Toward a co-evolutionary view of agricultural organization 2723 3.1. Interdependency of markets, contracts, and farm-household organization 2723 3.2. The co-evolution of contracts, markets, and specialization 2724 3.3. Unresolved questions and conceptual challenges 2730 4. Policy considerations and directions for further research 2733 References 2734 We are grateful to Julie Anderson Schaffner, Robert Evenson, and Wallace Huffman for extensive sugges- tions and to Kimberly Burnett and Sean D’Evelyn for research assistance. Handbook of Agricultural Economics, Volume 3 Edited by Robert Evenson and Prabhu Pingali © 2007 Elsevier B.V. All rights reserved DOI: 10.1016/S1574-0072(06)03052-0 2706 J. Roumasset and S.-H. Lee Abstract We assess the development economics of on-farm employment with an eye toward pol- icy implications. What do we know and what additional research is needed? The older tradition of labor market dualism and some of the more modern research are seen to share a characteristic of misplaced exogeneity, and calls for asset redistribution and institutional regulation may need to be tempered by more fundamental explanations. Understanding labor contracts as a facilitator of specialization on the farm and in the larger economy is key. Integrating the wedge model of farm behavior with agency-cost explanations of organization will provide a powerful analytical tool. Ultimately, a gen- eral equilibrium view with endogenous institutions will deepen our understanding of why total costs of coordination increase even as turnover costs per worker decline and how public policy can facilitate that cooperation. Keywords labor contracts, transaction costs, farm size, specialization, extent of the market JEL classification: J43, Q12, J41, O13 Ch. 52: Labor: Decisions, Contracts and Organization 2707 1. Introduction The purpose of this chapter is to synthesize economic wisdom about the nature and causes of on-farm employment, labor contracts, and the policy implications thereof. We attempt to do justice to Adam Smith by recognizing that the division of labor is central to the nature of the agricultural firm, the evolution of rural institutions, and agricultural development. Questions addressed include the following. What are the key restrictive assumptions in the conceptual framework that have shaped most theoretical and empir- ical work to date? How might some of these assumptions be relaxed in order to enrich empirical inquiry and deepen our understanding of the farm employment relationship? What are the implications of on-farm labor relations and productivity for regulations of contracting, land reform and other government interventions? On-farm employment issues are important for rural development and poverty allevi- ation strategies. Many rural residents are landless laborers, who tend to be poor, and whose entire way of life – income, the way they spend their day, the uncertainty they face each day about what comes next – is shaped by what happens in rural labor mar- kets. Many other rural residents are small farmers, who also tend to be poor, for whom the ability to work in agricultural labor markets may help them maintain consumption when shocks hit and for whom the ability to hire in agricultural labor markets may be important in making productive use of assets they already own, and in shaping the at- tractiveness of possible investments. We think that development in general involves a reallocation of labor from traditional to commercial agriculture and from agriculture to non-agriculture (whether rural or urban non-agricultural), and labor markets are im- portant in bringing this reallocation about. Economists have taken a particular interest in agricultural labor contracts. The complexity and diversity of labor contracts makes it difficult to assess the level and direction of change in both the cost of labor to employers and the level of living attained by agricultural laborers. Moreover, specific features of labor contracts have led observers to be concerned about both inefficiency and exploita- tion in these markets. In Section 2, we review the conventional wisdom about labor supply and demand in the agricultural household and the nature and consequences of contracts for hired labor. Studies can be roughly classified into two schools of thought. One is Development Microeconomics [e.g., Bardhan and Udry (1999)] which rests on modern theory and recent empirical evidence, but which often employs blackboard economics to discover preconceived allocative inefficiencies. The other is the efficiency school [e.g., Yang (2003)], which aims to provide fundamental explanations of the nature and causes of household decision-making and the organization of production, albeit with models that presume efficiency. This leads naturally to the discussion in Section 3 of promising new directions of research and remaining challenges. Section 4 provides some thoughts on policy and directions for future research. 2708 J. Roumasset and S.-H. Lee 2. Theoretical and empirical issues 2.1. The wedge-model farm-household decisions The essence of the Coase Theorem is that without transaction costs economic organiza- tion is indeterminate. Large farms could hire labor or workers could equivalently rent land. Moreover, there would be no need to consider the farm-household as a decision- making unit. Farms would maximize profits and the household would (separately) spend household income, be it earned from the farm or elsewhere. This would leave us unable to explain the stylized facts of farmer behavior and agricultural organization, however, and unable to meaningfully assess the consequences of proposed policy reforms. In the presence of transaction costs, farm and household decisions are interdependent and the farm-household model becomes an appropriate centerpiece for decision-making regarding family and hired labor. Consider a single-period farm-household model: max u(a, c, l; z) w.r.t. a,c,l,Lh,Lf subject to budget, time, and production constraints pss + wsLs + y = c + pbb + whLh, ¯ L = Lf + Ls + l, f(Lh,Lf ; A) + b = a + s, where a: food consumption, c: non-food consumption, l:leisure, z: farm characteristics, Lh: labor hired to work on farm at wage wh, Lf : labor supplied by the household to work on farm, Ls: labor supplied by the household to work off farm at wage ws, y: other exogenous income, ps: price of food sold by the household, s: quantity of food sold by the household, pb: price of food bought by the household, b: quantity of food bought by the household, L¯ : total labor endowment of the household, f(Lh,Lf ; A): food production function, A: farm characteristics. To highlight the role of labor, we assume that non-labor inputs are fixed. Rearranging budget and time constraints yields c + wl = wL¯ + π + y, Ch. 52: Labor: Decisions, Contracts and Organization 2709 Figure 1. Segmentation of farm labor demand and household supply. where w is the shadow wage with ws w wh, and π = pf (Lf ,Lh; A) − w(Lf + Lh) is shadow profit with shadow price ps p pb. The utility-maximizing farm- household can be said to be equivalently maximizing shadow profits. This is illustrated below. Figure 1 depicts three possible cases, which shows the household labor supply sched- ule of a representative farm household and three labor-demand schedules, depending on (quality-adjusted) farm size. For D1, the family exports its excess labor (Lh = 0), and the relevant shadow price of labor is ws, the selling wage after deducting journey to work and other neces- sary expenses from the nominal wage. For D3, the farm-household imports hired labor (Ls = 0), and the shadow wage is wh, the hiring wage after including the employer’s agency cost, recruiting and supervision costs and the residual costs of labor shirking (see Section 2.2). In both cases, the costs embodied in low alternative wages force fam- ily to work on other farms or to hire workers beyond the point when marginal product of labor equals nominal wage rate. If labor demand intersects household supply in the intermediate range between wh and ws, the shadow wage rate is given by the house- hold’s marginal opportunity cost of labor. Accordingly, the rational farm household can be said to be maximizing shadow profits based on the shadow-wage schedule: ⎧ ⎨ ws,L<L1, = w ⎩ wh,L>L2, S, L1 <L<L2. 2710 J. Roumasset and S.-H. Lee In this version of the model, both family and hired labor are implicitly in effective labor units, i.e., after deducting any costs of labor shirking. This shadow-profit-maximization form of the model can be used to estimate farm demand for labor and other inputs without having to fully specify household demands and supplies. By assuming that farm-households do not switch categories in response to small changes in price, the “wedge model” can also be used to determine the composi- tion between hired and family labor, as well as labor demand. Using simulations based on African parameters, de Janvry, Fafchamps and Sadoulet (1991) estimate the demand elasticity of leisure with respect to output price to be 0.27 for market-oriented farm households but only 0.06 for self-sufficient farmers. The elasticity of demand for hired labor was 0.61 for market-oriented farm-households and zero (by definition) for the self-sufficient group. In situations where a substantial proportion of farm households are self sufficient, these results help to reconcile observations of non-responsiveness with the assumption of (shadow) profit maximization.