Barriers to Contracting in Village Economics: A Test for Enforcement Constraints

• Development Workshop

Date and Location

Monday, May 8, 2017, 4:10 PM - 5:30 PM
ARE Library Conference Room, 4101 Social Sciences and Humanities

Abstract

In developing countries, informal contracting between individuals underlies activity in many markets, such as credit, savings, insurance, land, labor, and irrigation. This paper tests for a potential barrier to such contracting: enforcement problems. We offer to subsidize the cost of irrigation between potential water buyer and seller pairs, with the subsidy payment to be delivered three months in the future. We vary the seller’s ability to enforce collection of payment by randomizing whether the subsidy payment would be delivered into the hands of the water buyer, or directly into the hands of the water seller. Under the Coasian benchmark, the amount of trade should not be affected by which party will receive the subsidy. However, consistent with enforcement constraints, the amount of irrigation is 58% higher under the Seller-subsidy relative to the Buyer-subsidy. Sellers use ex ante transfers—price discounts and trade credit—to induce trade under the Seller-subsidy, but not under the Buyer-subsidy. In contrast, there is little ex post sharing of the subsidy. The magnitude of the enforcement failure is economically meaningful: buyers experience a 0.274 standard deviation increase in crop yields when the subsidy is delivered directly to the seller rather than to themselves. There is little evidence that potential correlates of relational contracting—such as previous trading history or being in the same caste—equalize trade under the two treatments. The findings suggest that within the context of our experiment, contract enforceability is a first-order impediment to realizing the gains from trade.