Determinants of Factor Misallocation in Agricultural Production and Implications for Agricultural Supply‐side Reform in China

• DOI: http://doi.org/10.1111/cwe.12241
• Published date: 01 May 2018
• Author: Liange Zhao,Hanning Li,Hongyun Han
• Date: 01 May 2018

©2018 Institute of World Economics and Politics, Chinese Academy of Social Sciences

China & World Economy / 22–42, Vol. 26, No. 3, 2018

22

*Hongyun Han (corresponding author), Professor, School of Management, Zhejiang University, China.

Email: hongyunhan@zju.edu.cn; Hanning Li, PhD candidate, Zhejiang University, China. Email: 11320050@

zju.edu.cn; Liange Zhao, Professor, School of Economics, Zhejiang Gongshang University, China. Email:

hhyzlg@163.com. This research was supported by the Major Program of the National Social Science

Foundation of China (No. 14 ZDA070), the Key Project of Natural Science of Zhejiang Province

(No. LZ14G30001) and the Fundamental Research Funds for the Central Universities.

Determinants of Factor Misallocation in Agricultural

Production and Implications for Agricultural

Supply-side Reform in China

Hongyun Han, Hanning Li, Liange Zhao*

Abstract

Allocative inefciency in agriculture is an issue puzzling researchers and policy-makers

in China. Based on household data from the China Family Panel Studies of 2012, the

present paper quantifies the potential distortions in China’s agricultural production

and examines their underlying determinants across regions. The results reveal that

there are different levels of distortions across regions. The Middle region is facing the

greatest distortion. Increases in machinery input, the proportion of non-farm income

and effective labor input will reduce distortions. Household saving, farmland rent and

farmland size are signicantly positively related to distortions. There is a complementary

effect between labor and farmland in alleviating production inefciency, but substitution

effects exist between capital and farmland and also capital and labor. The increase in

farmland size will aggravate the impact of capital on distortions. Given the constraint

of super small-scale farmland, facilitating land transfer is a necessary precondition for

improving allocative efciency.

Key words: allocative efciency, factor misallocation, total factor productivity

JEL codes: D13, D24, Q12

I. Introduction

Under assumptions of constant supply of available production factors and accessible

management know-how, traditional small farmers are believed to be reasonably efcient

at allocating their available resources as a response to price incentives, even when they

are trapped in a low equilibrium in a given institutional framework and have limited

Hongyun Han 0428.indd 22 2018-5-4 15:09:44

©2018 Institute of World Economics and Politics, Chinese Academy of Social Sciences

Determinants of Factor Misallocation in Agricultural Production 23

resources at their disposal (Schultz, 1964). Schultz’s “poor-but-efcient” hypothesis has

been one of the enduring themes in rural development economics over the past three

decades. One strand of criticism against Schultz’s perspective relates to the applicability

of modern economics tools in understanding the situation in poor countries; a second

line of criticism focuses on the existence of surplus labor (Abler and Sukhatme, 2006).

The sources of total factor productivity have emerged as the core issue of development

economics research (Hayami and Ruttan, 1970), and allocative inefficiency arising

from factor misallocation is becoming an issue of much concern among development

economists. A full account of the allocative efficiency of all factors is too ambitious

due to the lack of data in agricultural economic research (Caselli and Feyrer, 2007).

“Many empirical contributions to this discussion treat efciency as a black-box concept

and lack the explicit consideration of the scale of agricultural production” (Sauer and

Mendozaescalante, 2007, p. 114). The sources of distortions have been poorly explained,

and the effects of other institutional factors, industry characteristics and demographic

factors on distortions have been neglected (Aoki, 2008). These issues inevitably hinder

the process of improving allocative efciency in agricultural production.

Although the increase in total factor productivity (TFP) has made a major

contribution to agricultural growth as a result of technical progress and institutional

improvement (Lin, 1992), the misallocation of resources (Zhu et al., 2011) and the

barriers to factor mobility have retarded the economic growth in China (Yuan and Xie,

2011). Factor misallocation is common in agricultural production in China, yet little

attention has been given to the determinants of misallocation in China (Guo and Jia,

2005). How is agricultural allocative efciency impacted by distortions of production

factors? What are the determinants of factor misallocation? All of these questions have

remained unanswered. With specic attention to agriculture in China, the present study

aims to answer the abovementioned questions by evaluating the extent of agricultural

distortions and investigating the determinants of these distortions.

This study has two primary goals. First, it measures the level of distortions in

agricultural production to show how distortions drive wedges between the marginal

products of capital and labor across regions. Following Hsieh and Klenow’s framework

and the extended application for Chinese agriculture by Zhu et al., the allocative

distortions of capital and labor and a factor distortion index are calculated based on

farm-level data (Hsieh and Klenow, 2009; Zhu et al., 2011). Second, the sources

of agricultural distortions, including the effect of capital structure, farm size, labor

migration and the interactive effects of input factors, will be examined. Finally, policy

recommendations are made. The rest of this paper proceeds as follows. Section II

elaborates on the determinants of distortions, and the methodology and data used in

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