Do Land Market Restrictions Hinder Structural Change in a Rural Economy? Evidence from Sri Lanka

This paper analyzes the effects of land market restrictions on structural change from agriculture to non-agriculture in a rural economy. We develop a theoretical model that focuses on higher migration costs due to restrictions on alienability, and identifies the possibility of a reverse structural change where the share of nonagricultural employment declines. The reverse structural change can occur under the following conditions: if demand for nonagricultural good is income inelastic (assuming non-farm is nontradable), or non-agriculture is less labor intensive relative to agriculture (assuming non-farm is tradable). For identification, we exploit a natural experiment in Sri Lanka where historical malaria played a unique role in land policy. The empirical evidence indicates significant adverse effects of land restrictions on manufacturing and services employment, rural wages, and per capita household consumption. The evidence on the disaggregated occupational choices suggests that land restrictions increase wage employment in agriculture, but reduce it in manufacturing and services, with no perceptible effects on self-employment in non-agriculture. The results are consistent with a migration costs model, but contradict two widely-discussed alternative mechanisms: collateral effect, and property rights insecurity. We also provide direct evidence in favor of the migration costs mechanism.