Measuring transaction costs in China’s rural land rental market: Ex-ante bargaining associated with ex-post contract-violation uncertainty and location specificity

Abstract

I measure the monetary value of ex-ante bargaining costs associated with China’s rural land rental market, confirming the previously unverified existence of transaction costs in this market. I demonstrate that the ex-ante bargaining costs associated with contractual formality represent the main transaction costs that hinder market progress. In a three-step theory, I model the process through which transaction costs are generated. First, uncertainty regarding ex-post contract violations caused by non-agricultural income shocks and location specificity in China’s fragmented farmland results in conflicting partner preferences. Second, the compromise mechanism that facilitates efficient bargaining makes the agent facing lower compromise costs in a transaction more likely to compromise. Third, ex-ante bargaining costs are generated in inefficient bargaining when theoretically predicted agents refuse to compromise. Using a subsample of data introduced in Yang (2020), I find that ex-ante bargaining costs are 126.5 RMB and 35.4 RMB per mu per year, respectively, for renting-out agents and renting-in agents who refuse to compromise in contract negotiations.