Rural market imperfections in India: Revisiting old debates with new evidence

Motivation Ensuring viability of farming and increasing farmers' incomes are key policy concerns in India at present. To realize these aims, markets need to function well: market imperfections can increase production and transaction costs for farmers and thereby reduce incomes. A longstanding and repeated observation in India is that land productivity is inversely related to farm size, an inverse relation (IR) which may well indicate imperfectly functioning land, labour, and credit markets. Purpose The study revisits the inverse relation, to examine whether market imperfections still prevail in India, particularly in output, input, factor, and credit markets. Methods and approach Based on multi‐stage sampling, 1,800 households spread over 45 villages and 21 districts were surveyed across Bihar, Gujarat, Madhya Pradesh, and Punjab. Micro‐econometric methods were applied to the household‐level data to test for relations between farm size and land and labour productivity, and implied evidence of market imperfections. Findings A strong IR between land productivity and farm size on the output side, and farm size and family labour use on the input side can be seen. However, intensive use of family labour on small farms is not the only determinant of farm size‐productivity relations. It is found that smaller farmers are relatively more constrained in obtaining credit. The results suggest that Sen's labour dualism theory, together with imperfections in land and credit markets, offers important insights. Also, drawing from the recent literature, measurement errors in plot size and production and “edge effect” could be some of the contributing factors. Policy implications Our findings point to the prevalence of surplus family labour on small farms, even a decade after the enactment of a major employment guarantee programme (MGNREGS), exacerbated by small farmers having limited access to institutional credit. Thus, particularly for marginal and small farmers, reforming land lease markets to enable easier access to land, providing better access to institutional credit, and improving literacy to enable farmers to deploy abundant household labour in other occupations, are needed to address some of the observed imperfections.