India’s Farm Productivity Puzzle Lies in Distorted Land Markets

It is now well known that agricultural productivity in India is very low. Despite overall economic progress, agricultural productivity in India remains extremely low compared to developed countries, with output per worker only a small fraction of that in the United States. At the same time, there is substantial variation in agricultural productivity across Indian states, comparable to cross-country differences. This variation provides a unique opportunity to study how institutional differences, particularly in land markets, affect resource allocation and productivity in agriculture within a common national framework.

New research examines how distortions in land markets, particularly those arising from institutional differences across Indian states, affect agricultural productivity. Using detailed household-level panel data and a structural model, the researchers provide a comprehensive analysis of how barriers to land rental markets lead to inefficient allocation of land and lower aggregate productivity.

This research concentrates on land-market institutions, especially restrictions on land leasing. These restrictions vary significantly across states due to differences in colonial land systems and post-independence land reforms. Many states implemented tenancy laws aimed at protecting tenants, but these laws often imposed severe restrictions on leasing. 

In some states, leasing is outright prohibited, while in others it is allowed only under restrictive conditions. These policies, combined with weak land records and legal uncertainties, discourage landowners from renting out land and limit participation in rental markets.

To empirically analyse these issues, the research under discussion uses data from the Indian Human Development Survey (IHDS), covering two waves (2004–05 and 2011–12). This dataset provides detailed information on farm output, inputs, and land ownership and leasing. A key advantage is the ability to distinguish between owned, rented-in, and rented-out land, allowing the researchers to directly measure participation in land rental markets. They construct farm-level total factor productivity (TFP) using a production function and panel methods to isolate persistent productivity differences across farms.

Data Patterns
The data reveal several noteworthy patterns.

First, there is substantial dispersion in farm productivity within and across states.

Second, land allocation is weakly correlated with productivity, indicating misallocation: more productive farmers do not necessarily operate more land. 

Third, rental market activity varies widely across states, with some states exhibiting very limited leasing. Importantly, states with less active rental markets tend to have higher misallocation and lower productivity.

To interpret these patterns, the researchers develop a structural model of heterogeneous farms operating under distorted land markets.

The model incorporates two types of distortions: 

(i)           state-level barriers to rental market participation, which create a wedge between the cost of renting in and renting out land.

(ii)          Idiosyncratic farm-level distortions that affect individual farmers’ effective land costs. A key innovation in this research is modelling participation decisions explicitly: because of rental barriers, some farmers optimally choose not to participate in land markets at all, creating an “inaction region” where land remains inefficiently allocated.

The researchers estimate the model parameters using moments from the data, including the share of farms not participating in rental markets and the relationship between productivity and land use. They then conduct counterfactual experiments to quantify the impact of distortions. The results show that land misallocation has large negative effects on agricultural productivity. Eliminating all distortions would increase agricultural TFP in India by about 65% on average, and by more than 100% in some states.  

A salient finding is that state-level rental barriers account for a substantial share of these productivity losses. 

More than half of the potential gains from reallocation are attributable to these barriers rather than to idiosyncratic distortions. In some states, such as Tamil Nadu, rental barriers are particularly severe, effectively acting as very high implicit taxes on land transactions and generating large efficiency losses.

The analysis also emphasises that improving rental market participation would significantly change land allocation patterns. In an efficient scenario, nearly all farmers would participate in rental markets, and the share of land not rented would fall dramatically. This reallocation would allow more productive farmers to expand and less productive ones to contract, increasing overall efficiency.

Broader Contributions
This research contributes to the wider literature on resource misallocation by stressing the role of institutions that affect the extensive margin of market participation. Unlike much of the existing literature, which assumes all producers can access markets, this research shows that barriers preventing participation are crucial in understanding inefficiency in Indian agriculture.

In sum, this research credibly demonstrates that land-market institutions—particularly restrictions on leasing—play a central role in shaping agricultural productivity in India. By limiting the reallocation of land toward more productive farmers, these institutions generate significant misallocation and reduce aggregate output. The findings suggest that policy reforms aimed at improving land records, strengthening property rights, and relaxing leasing restrictions can substantially enhance agricultural productivity. That said, it should be noted that other factors, such as technology adoption and input use, may also interact with land-market distortions in ways that we do not presently understand very well.