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Center Discussion Paper No. 991, Economic Growth Center, Yale University, New Haven, CT, Foster, Andrew D., and Mark R. Rosenzweig, 2010

An empirical study of agricultural production in India relates inefficiency to small farm size, finding larger farms to be less credit constrained, better mechanized, less susceptible to income shocks, and requiring less labour per acre cultivated.

Agriculture in India is dominated by smallholder farming, with 80% of farms less than 2 acres as per the 2001 Census of India. Prior studies have found smallholder farming to be more efficient due to the characteristic use of family labour which leads to lower supervision costs. However, these findings are subject to the assumption that gainful non-farm employment does not exist. Recent growth in the rural non-farm sector has made it possible for agricultural labour to earn better wages elsewhere.  Thus there is reason to believe that the efficiency of small farms is lost, which the authors argue emphasizes the inefficiencies of low rates of mechanization and low collateral for obtaining credit.

An empirical model of agricultural production is used to study how farm efficiency varies with landownership, family or hired labour, and economies of scale from mechanized processes. New panel data for a sample of about 5,000 farmers is obtained from a 2008 rural economic development survey covering 17 major states of India. Profits per acre is used as the measure of efficiency, for which both plot-level and farm-level data provide detailed analysis. Since profits are correlated with land and machine acquisition, an empirical technique exploits inherited assets to isolate the effect of land ownership on efficiency.

The findings indicate that profits per acre are greater for large farms. A one-acre increase in landholdings will lead to a 9.2% increase in profits for the average-sized farm, and for farms less than 5 acres in size the rate at which profits are increasing is also rising. Part of this effect can be attributed to mechanization, and indeed larger farms are found to be more likely to use machinery in agricultural production. However, the benefit brought about by machinery is found to decrease as farms get larger, suggesting that the smallest farms have the most to gain and thus are under-mechanized.

Investment in machinery, however, is subject to financing. Landholdings are found to increase with investment, which is consistent with the notion that land holds value as collateral for credit. Further analysis provides evidence that when a shock to income occurs, due to weather variations for example, the effect on future profits will decrease as farms get larger. That small farms are most susceptible to income shocks suggests that they are limited in their access to financing for input purchases, which then reduces the next crop’s productive output and profits.

The results hold the strongest implications for labour markets in rural India. Greater access to credit will allow for more investment and a higher rate of mechanization, which will in turn reduce the labour required per acre of cultivation. Having made a case for the inefficiency of small farms, the authors consider a process of land amalgamation whereby a minimum threshold induces greater efficiency in farm production. A simulation finds that at a threshold of 20 acres, 22.7% of the agricultural labour force could be released without any effect on the wage rate, a result not inconsistent with labour surplus theory.  In contrast, a threshold of two acres would imply a surplus labour rate of 0.4%. Moreover, “a two acre floor would lead to a 37% reduction in the number of farms.”

The authors conclude that agricultural production is inefficient in India due to the great number of small farms, and the significant amount of labour they employ. However, a surplus of labour does not necessarily imply that the rural nonfarm economy could absorb the amount released. Nor is it assumed that a land amalgamation could proceed without barrier. Careful study of the framework for land transfer should be accompanied by the continued development of economic opportunities outside of agriculture.