The effect of land tenure on investment

Yes institutions do matter. The role of land tenure, that is institutions governing land ownership, in investment in productivity-enhancing measures in developing countries has been widely documented.

There are three main theoretical arguments that have been put forward to explain a positive link between tenure security and investment. First, secured property rights are expected to provide a guarantee for farmers to undertake long-term investment in land-improving and conservation measures, since there would be no fear of expropriation. As has been noted, given that the result of land-improving investments is normally realized with a one period lag, if the tenant is evicted with some possibility during this period, he will be enjoying only a fraction of the benefit from the investment in expected terms. This may cause the tenant to supply a lower level of investment in effort for the same crop share, a reason why security of tenure is thought to be good for investment. This is a version of the standard argument for secure property rights. Second, it has been argued that secured land rights make it easier to use land as collateral to obtain loans to finance agricultural investments. The third effect operates through better possibilities for trade. If improved transfer rights enhance factor mobility by making it easier for farmers to sell or rent their land, investment in land-improving measures may be facilitated.

But what of the empirical literature? In a new paper, "Land tenure differences and investment in land improvement measures: Theoretical and empirical analyses" by Awudu Abdulai, Victor Owusu and Renan Goetz, in the Journal of Development Economics (vol. 96 (2011) p. 66–78) argue that the empirical findings on the land rights–investment relationship appear to be inconclusive. This is something they note to help change. Abdulai, Owusu and Goetz explain the contribution of their papers as,

The more recent studies appear to be showing positive impacts of tenure security on investment. Deininger and Ali (2008) show that full land ownership, compared to mere occupancy rights, exerts a statistically significant and economically large effect on investment and productivity of land-use in Uganda. Goldstein and Udry (2008) also find that insecure land tenure in Ghana is associated with greatly reduced investment in land fertility, while Jacoby and Mansuri (2008) find in their study on Pakistan that farmers invest less in their leased plots than they do in their owned plots.

This article contributes to the tenure-security-investment debate by developing a framework that captures the impact of different land tenure arrangements on investment decisions of farmers. The model embodies behavioral assumptions consistent with investment decisions that characterize investment in productivity-enhancing inputs in the agricultural sectors of most sub-Saharan African countries. First, we develop a model to examine the effects of 4 different land tenure arrangements on investment decisions of farmers on theoretical grounds. The investments include planting trees, mulching, and application of organic manure and mineral fertilizers. We then use variations in tenure arrangements between 560 plots obtained from a survey of 246 farmers from 6 villages in the Brong Ahafo region of Ghana to analyze the impact of land tenure arrangements on investment in soil-improving and conservation measures. The empirical part of the article also examines the relationship between land tenure arrangements and farm productivity.

The main contributions of the article reside in the fact that the results from the theoretical analysis hold for a wide range of situations and are as such independent of case specific data. The empirical analysis considers a) endogeneity between land rights and investment decisions and b) interdependence between the different investment decisions. Our empirical evidence shows that land tenure differences significantly influence farmers' decisions to invest in land-improving and conservation measures, and that tenure differences do affect farm productivity, even after accounting for household fixed effects.

The conclusions that Abdulai, Owusu and Goetz reach read,

In this article, we developed a framework to examine the relationship between different land tenure arrangements and households' investment in land-improving and conservation measures in the Brong Ahafo region of Ghana. The land tenure arrangements considered include owner-operated with full property rights, owner operated with restricted rights, fixed-rent and sharecropping contracts. We employed variations in tenure arrangements between different plots to estimate plot-level regressions relating tenure arrangement to investment in tree planting, mulch, manure as well as mineral fertilizer application. We also examined the relationship between land tenure arrangements and farm productivity.

The empirical results are consistent with our theoretical findings and show that secured land rights tend to facilitate investment in soil improving and natural resource management practices. In particular, farmers who owned land with secured tenure were more likely to invest in tree planting, mulch, manure, but not in mineral fertilizer. Farmers on fixed-rent and sharecropping contracts were found to be less likely to attract investments in soil-improving measures such as mulch and organic manure, although fixed-rent farmers were more likely to invest in yield increasing inputs such as mineral fertilizers. The positive impact of better land rights on investment remained unchanged when we introduced household fixed effects into the specification. As pointed out by Jacoby and Mansuri (2008), hold-up problems in the sense of lack of full commitment on the part of landlords could be driving the findings for fixed-rent farmers. The positive association of tenancy duration with investment in trees, mulch and organic manure also suggests that making temporary rights longer would go a long way to enhance investments in soil improving measures.

We also examined the impact of tenure arrangements on farm productivity, using an instrumental variable approach. The results showed a positive and significant effect of tenure security on farm productivity, a finding that reinforces the significance of tenure security in encouraging higher investment in soil-improving measures. Access to credit was also found to be positively related to crop productivity, suggesting that financial constraints may be a hindrance to investments in productivity-enhancing measures. The incorporation of household fixed effects did not change the positive and significant impact of secured land rights on farm productivity. The major policy implication of these findings is that, ensuring tenure arrangements that confer permanent or sufficiently long temporary rights to cultivators would enhance investment in both soil improving
and natural resource management practices. In addition, the results provide productivity-based arguments for enhancing farmers' access to capital.

In short institutions matter and getting them right helps development.