### Christian Böber - 978-3-653-01676-5 Downloaded from PubFactory at 01/11/2019 11:18:31AM via free access

# Hohenheimer Volkswirtschaftliche Schriften

Herausgegeben von

Prof. Dr. Michael Ahlheim, Prof. Dr. Thomas Beißinger, Prof. Dr. Ansgar Belke, Prof. Dr. Rolf Caesar, Prof. Dr. Harald Hagemann, Prof. Dr. Klaus Herdzina, Prof. Dr. Walter Piesch, Prof. Dr. Andreas Pyka, Prof. Dr. Nadine Riedel, Prof. Dr. Ingo Schmidt, Prof. Dr. Ulrich Schwalbe, Prof. Dr. Peter Spahn, Prof. Dr. Jochen Streb, Prof. Dr. Gerhard Wagenhals

Band 68

# Christian Böber

# China in Transition

Poverty, Income Decomposition and Labor Allocation of Agricultural Households in Hebei Province

Christian Böber - 978-3-653-01676-5 Downloaded from PubFactory at 01/11/2019 11:18:31AM via free access

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To Anne and Simone

Christian Böber - 978-3-653-01676-5 Downloaded from PubFactory at 01/11/2019 11:18:31AM via free access

### **Acknowledgements**

The present work was approved by the Faculty of Business, Economics and Social Sciences at the University of Hohenheim as a dissertation in June 2011.

I am especially grateful to my supervisors and referees Professor Dr. Michael Ahlheim and Professor Dr. Manfred Zeller for their advice and support, their encouragement and for the freedom I was granted during my time as doctoral student and the experiences I could make while working with them. Furthermore, I want to thank Professor Dr. Harald Hagemann for his interest and participation in the oral doctoral examination.

I am thankful to Professor Dr. Reiner Doluschitz for his support in the International Research Training Group (IRTG) "Sustainable Resource Use in the North China Plain". The administrative support of Miss Bayer is highly appreciated. I am also thankful to Dr. Diana Ebersberger for helping me organizing the research stays in China and making my participation at international Ph.D. courses and conferences possible. I am grateful to my Chinese friends, colleagues, interviewers and translators who enabled me to conduct my data collection and provided me with many positive insights into the Chinese culture.

During my research within the IRTG and at the Department of Rural Development Policy and Theory I benefited from fruitful discussions with my friends and colleagues during seminars, excursions and coffee breaks. They have also cheered me up in times of difficulties and trouble. Therefore, I say thanks to Stephan, Xiangping, Martin, Gabriela, Mercedes, Abera, Alwin, Steffen, Tina Heike, Til, Thilo, Yannick, Alexander, Christian, Camille, Nazaire, Tim, Florence, and Yoshiko. I am especially thankful to Miss Contag and Katharina Mayer for helping me with organizing office life and traveling and to Coni Schumacher for providing me accommodation during my last months in Stuttgart.

Without the love and support of my parents my studies would never have been successful. I am greatly indebted to them.

I am most grateful to my wife Simone for her patience and mental support. Anne, you make me happy and our life more joyful.

Neuss, January 2012 Christian Böber

# **Table of contents**

# **List of tables**

# **List of figures**

# **List of abbreviations and acronyms**

# **List of Chinese terms and expressions**

# **Zusammenfassung**

Die vorliegende Arbeit betrachtet die Hebei Provinz in der Nordchinesischen Tiefebene (NCT). Sie wurde im Rahmen des internationalen Graduiertenkollegs "Sustainable Ressource in North China" erstellt.

Die institutionellen Rahmenbedingungen im ländlichen China haben sich seit dem Beginn der Reformen im Jahre 1978 stark verändert.  Diesen Haushalten wurden auf Basis der Anzahl der Haushaltsmitglieder Landnutzungsrechte zugewiesen.  Als ein Hauptanbaugebiet für Getreide in der Volksrepublik China kommt der Hebei Provinz eine zentrale Rolle bei der politisch sehr relevanten Frage der Sicherung der Versorgung Chinas mit Grundnahrungsmitteln zu. Um die Erträge zu steigern, wurden in den letzten 20 Jahren vor allem mehr chemischer Dünger und Pestizide eingesetzt. Eine Mechanisierung landwirtschaftlicher Arbeitsschritte fand hingegen kaum statt.  Durch das "System der staatlichen Haushaltsregistrierung" (hukou) sind die Migrationsmöglichkeiten der ländlichen Bevölkerung, insbesondere der Arbeitskräfte, stark eingeschränkt. Aus dieser und anderen administrativen Beschränkungen ergibt sich ein Überangebot an landwirtschaftlicher Arbeitskraft. Andererseits sorgt die wachsende Bedeutung der industriellen Produktion und des Servicesektors im Zuge der dynamischen Entwicklung der chinesischen Volkswirtschaft seit Beginn der 1980er Jahre dafür, dass mehr Möglichkeiten für Arbeitskräfte aus ländlichen Gebieten geschaffen wurden, um Einkommen außerhalb der Landwirtschaft zu generieren.

 Gerade mit Blick auf zunehmende soziale Spannungen und Ungleichgewichte zwischen dem ländlichen und urbanen China und des immer noch relativ hohen ländlichen Bevölkerungsanteils ist es wichtig, die Hintergründe der Entwicklung des (materiellen) Wohlstandes in den ländlichen Landesteilen seit Beginn des wirtschaftlichen Öffnungs- und Transformationsprozesses zu verstehen. Als eine Provinz mit hoher Bevölkerungsdichte und der unmittelbaren Nähe zu den städtischen Ballungsräumen Beijing und Tianjin ist Hebei ein geeignetes Untersuchungsgebiet, um Entscheidungen ländlicher Haushalte bezüglich der Partizipation im nicht landwirtschaftlichen Arbeitsmarkt zu analysieren.

Es ist wichtig, die in Hebei existierenden landwirtschaftlichen Betriebsformen in Vollzeit- und Teilzeitbetriebe zu unterscheiden, um den Zusammenhang zwischen Betriebsform und Entscheidungsprozessen auf Haushaltsebene zu verstehen, und um Veränderungen in der Faktorallokation und Effizienzverbesserungen in Hebeis Landwirtschaft analysieren zu können.  Für diese Arbeit steht ausländischen Forschern erstmals ein repräsentativer Paneldatensatz für die Jahre 1986 bis 2006 des Research Center for Rural Economy (RCRE) zur Verfügung, welcher zur Analyse der Armutsentwicklung in Hebei verwendet wurde. Darüber hinaus wurden diese Daten genutzt, um Armut in chronische und transitorische Armut zu zerlegen, außerdem um Einkommen nach Quellen zu zerlegen, bei gleichzeitiger Wertung des Beitrags jeder Quelle zur Einkommensungleichheit.  Ebenfalls basierend auf diesem Datensatz erfolgte die Untersuchung der Beständigkeit agrarischer Betriebsstrukturen. Die Beschränkungen der Analysen auf den Zeitraum 1986 bis 2002 ist notwendig, da die Inhalte der Umfragen für 2003 bis 2006 nicht vergleichbar sind mit den von 1986 bis 2002 erhobenen Informationen.  In der Zeit von 1990 bis 1993 wurden umfangreiche Reformen durchgeführt, welche eine stärkere Öffnung des ländlichen Arbeitsmarktes zum Ziel hatten.

Landwirtschaftliche Institutionen und Produktionsstrukturen verändern sich schrittweise.

Die vorliegende Arbeit informiert politische Entscheidungsträger über den rückläufigen Anteil der landwirtschaftlichen Produktion am (materiellen) Wohlstand der ländlichen Bevölkerung. Unter Anwendung der Methoden "Variationskoeffizient"- und "Shorrocks"-Zerlegung wird das Haushaltseinkommen nach Einkommensquellen zerlegt. Der Anteil des landwirtschaftlichen Einkommens am gesamten Haushaltseinkommen ging von 47% im Jahre 1986 auf 24% in 2002 zurück. Es zeigte sich, dass nicht-landwirtschaftliches Lohneinkommen besonders stark zur Ungleichverteilung von Einkommen innerhalb eines Dorfes beiträgt. Schlussfolgernd aus dem rückläufigen Anteil des Agrareinkommens ergibt sich für aktuelle Programme zur Angleichung von ländlichen und städtischen Lebensverhältnissen, dass eine Steigerung des landwirtschaftlichen Einkommens allein zum Erreichen des von den Entscheidungsträgern gewünschten Angleichungsziels nicht geeignet ist.

Hinsichtlich der Armutsentwicklung in der Hebei Provinz wurde die Hypothese formuliert, dass das absolute Armutsniveau im Zeitraum von 1986 bis 2002 gesunken ist. Verschiedene Armutsindizes wurden nach Foster, Greer und Thorbecke (1984) für die untersuchten ländlichen Regionen der Hebei Provinz berechnet. Diese Indizes zeigen, dass im Untersuchungszeitraum ein Rückgang der absoluten Armut zu verzeichnen ist. Um die Armutsentwicklung detailliert zu untersuchen, erfolgte eine Zerlegung von Armutselastizitäten anhand von ortsspezifischen und individuellen Charakteristiken der untersuchten Haushalte.   Es wurden zwei Ansätze zur Armutsmessung miteinander verglichen. Der erste misst Armut basierend auf dem durchschnittlichen Wohlstand der Bevölkerung. Der zweite Ansatz dagegen untersucht die Anzahl an Situationen in denen der Haushalt sich in einem Zustand des Mangels befindet.  Die Unterscheidung beider Armutskomponenten ist für sozialpolitische Entscheidungen sehr relevant. Chronische Armut lässt sich eher durch Investitionen in Humankapital reudzieren, wogegen Maßnahmen zur Stabilisierung von Einkommensströmen eher geeignet sind, transitorische Armut zu reduzieren. Es kann aus der Zerlegung der Armutselastizität festgehalten werden, dass die Faktoren Bildung, Fachwissen im Rahmen spezifischer Berufsausbildung und weniger regulative Eingriffe in den Arbeitsmarkt bessere Ansätze zur nachhaltigen Verbesserung des Wohlstandes in den ländlichen Regionen in Hebei darstellen als Transfers oder andere Zahlungen, die nicht im Zusammenhang mit erbrachter Arbeitsleistung getätigt werden.

 Eine Separabilität dieser Entscheidungen kann sowohl für die gesamte Stichprobe als auch für Teilstichproben der Vollzeit- und Teilzeitlandwirtschaftsbetriebe verworfen werden.   Diese Schlussfolgerung lässt sich aber im Rahmen dieser Arbeit nicht weiter quantitativ überprüfen, da keine genauen Charakteristika von Arbeitsmigranten in den zugänglichen Erhebungen erfasst wurden. Die Ergebnisse anderer Untersuchungen sowie qualitative Befragungen bestätigen jedoch diesen Zusammenhang.

Im Anschluss an eine Diskussion der Entwicklung von individuellen und Haushalts-arbeitsangebots- und Allokationsmodellen kam ein statisches Agrarhaushaltsmodell zur Anwendung, um die Bestimmungsfaktoren der Haushaltsarbeitsangebotsentscheidungen zu identifizieren. Es zeigt sich, dass Haushalte mit mehr Familienmitgliedern, relativ mehr Arbeit in der eigenen landwirtschaftlichen Produktion einsetzen als kleinere Haushalte. Das kann ein Hinweis auf Einschränkungen der Möglichkeiten zum Angebot von Arbeit außerhalb des landwirtschaftlichen Sektors sein und sollte in zukünftigen quantitativen und qualitativen Untersuchungen genauer untersucht werden.

 Obwohl Wechsel zwischen den Betriebsformen beobachtet wurden, zeigt sich, dass ein einmal vom Haushalt eingenommener Zustand, Vollzeit- oder Teilzeitbetrieb, mit geringer Wahrscheinlichkeit wieder verlassen wird.  Aktuelle Programme zur Verbesserung der Lebensverhältnisse im ländlichen China folgen kaum dieser Erkenntnis.

 Dabei könnte in der Kombination aus parametrischen und nicht-parametrischen Ansätzen eine Chance bestehen, in zukünftigen Untersuchungen Paneldatensätze eingehender zu analysieren, und die Bedeutung individueller Charakteristika einzelner Haushaltsmitglieder auf Arbeitsallokations-entscheidungen zu analysieren. Die aktuellsten Jahrgänge der Befragungen (2007 bis 2009) waren nicht verfügbar. Diese Restriktion war durch eigene quantitative Datenerhebung nicht zu beseitigen, da ausländischen Forschern die Erhebung repräsentativer Daten in den gleichen Dörfern in Hebei, in denen das RCRE Daten erfasst, untersagt ist.

### **Summary**

The Hebei province, as one part of the North China Plain, is an important area of grain production within the People's Republic of China. Over the three decades since the start of the reforms in 1978 rural institutions changed tremendously. The responsibility for agricultural production was reassigned from the collectives to individual households and land use rights were assigned according to the household size. Combined with a strong population growth this led to a rather small average size of farms in Hebei compared to world averages but also compared to other Chinese regions. Migration of the rural population and especially the rural labor force was and is still regulated and restricted by the household registration system. This and other imperfections in (rural) labor markets led to a surplus of agricultural labor. But due to the development of the Chinese economy since the beginning of the 1980s the importance of the industry and service sector increased and more opportunities were created for rural laborers to earn income outside agriculture.

Agricultural production systems change stepwise and the changes are fueled by drivers that are both external and internal to the agricultural sector. The intrasectoral changes, e.g. in land and water institutions not only affect agricultural production but also the well-being of the rural population. Therefore, it is important to understand the characteristics of different farm types and how they affect households' decision making and well-being. It is the first time that an extensive panel data set covering the period from 1986 to 2006 was used to assess the development of poverty in rural Hebei, to decompose poverty, to decompose income and income inequality, and to explain labor allocation decisions of agricultural households and farm type persistence. The interplay with the other sectors, whose institutions changed tremendously as well during the last decades in China, also contributes to changes in rural institutions such as incentive systems and labor allocation behavior.

Present research has emphasized that it is important to assess the development of inequality among the rural population in China, to analyze poverty trends and to decompose poverty in its components, and to assess the interaction between geographical diversity, poverty trends and farm households' labor allocation decisions. To the best knowledge of the author it is the first time that this assessment is done for Hebei province based on a comprehensive longitudinal data set. In addition this work provides an understanding of the determinants of Chinese rural households' labor allocation decisions which helps in the assessment of applied and intended policy measures that focus on rural development.

This study provides valuable information to policy makers about the declining importance of agricultural production for well-being of the rural population. Income was decomposed by sources applying the coefficient of variation method and the Shorrocks decomposition method. The share of agricultural income in total household income declined in the rural areas of Hebei from 47% in 1986 to 24% in 2002. In addition the non-farm wage income contributes strongly to income inequality within villages. The increase in the importance of income that is earned outside the own village is shown by the fact that migratory wage income increased on average by 8% per year, and by this is the income source with the fourth highest growth rate. The per year growth rates of income from fruit production (14%), income from transportation (12%) and income from other family businesses (10%) are higher but fewer households receive income from those sources than from migratory wage income. It is also worth to mention that the share of households earning migratory income is constant and is 36% in 1986 and 2002.

Foster-Greer-Thorbecke-type poverty indicators have been calculated for rural Hebei to assess the hypothesis that absolute poverty declined in Hebei between 1986 and 2002. In general, poverty declined over the assessed period. Poverty elasticities are decomposed according to different location specific and individual characteristics of the assessed households. This was done by using one approach that links poverty to an average in welfare in comparison to an approach that links poverty to ill-fare statuses experienced by households. The amount of land holdings of farmers became less relevant for the explanation of poverty differences between rural households in countries that experienced agrarian change. The results of the decomposition of poverty elasticities indicated that education, the provision of training to the rural population and less restrictions in labor markets are much better measures to increase the chance of long-lasting (sustainable) improvements in rural well-being than transfers or other non-earned income measures. Regarding the results of the decomposition of poverty into transitory and chronic poverty both methods differ strongly. With the approach of Jalan and Ravallion (1998) all of the estimated poverty was explained as transient whereas with the approach of Duclos et al. (2008) two thirds of poverty could be explained as chronic poverty.

Fixed effect regression models have been applied to test the hypothesis that labor demand and supply decisions of rural households are not separable. For the full sample but also for population sub-samples separability was rejected. So it can be concluded that labor time, as one important production factor, was not allocated in the most efficient way.

A static agricultural household model was used here to identify the determinants of farm households' labor supply after reviewing the development of individual and household level models to assess labor supply and allocation decisions. Interestingly, households with more family members used relatively more family labor in agricultural production. This might be an indication for restricted possibilities to provide family labor off the farm. In comparison to common labor supply models this kind of probability model to assess the labor market participation of agricultural households allows to assess the determinants of agricultural households' demand for non-family labor.

A hazard model was applied to reflect dynamics in the farm structure in Hebei. It was found that the chosen states (either full- or part-time farming) were relatively stable over time, beside the fact, that state changes did occur. The longer a household remained in one of the two labor market states the lower was the probability of a change to the alternative state. As a consequence of this duration dependence it can be recommended to provide full-time farm households with support to increase the degree of specialization in agricultural production so that they improve their production efficiency. It would be beneficial for those households allocating some or all labor to non-farming activities if labor migration was less restricted and if more possibilities for job specific trainings outside the agricultural sector were provided. Increased possibilities for the leasing of land would offer the chance to better utilize the agricultural land that is not longer farmed by migrating laborers by increasing the farm size of the full-time farm households.

In this study different methodologies have been discussed and combined to best utilize the information contained in the data set. The approach of combining parametric and non-parametric methods should be the basis for future in-depth assessments of panel data sets covering rural areas in China.

The Research Center for the Rural Economy (RCRE) started the collection of socio-economic and production data on rural households in China in 1986. So, with the comprehensive data set at hand it is possible to assess institutional changes in the agricultural sector and changes in well-being in the rural areas that are closely related to the beginning of the transition period in the end of the 1970s and the beginning 1980s.

Several data quality and variable content problems, e.g. regarding the unique identification of observations, could be solved by carefully cross-checking the data for every year and observation and by restricting the analysis only to those years (1986 to 2002 for the income and poverty analyses and 1995 to 2002 for the other assessments) where variable information is compatible from year to year. Remaining limitations of the work at hand are the application of static approaches, the use of partial models and the restriction of the analysis to the household level. For furthers studies it seems promising to use the most recent panel data for rural Hebei which also include more individual level information than the data set used here to assess the characteristics of individual labor allocation decisions of rural laborers. Also recent shifts in fiscal institutions like the abolishment of agricultural taxes since 2006 might be interesting to be analyzed with respect to their impacts on rural development and intra-sectoral changes in Hebei and other rural provinces in China.

# **1 Introduction**

### **1.1 Background**

*Gai ge kai fang* which means "change the system, [and] open the door" (Dollar, 2007, p.4) [author's addition] is the reform program of China's economic system. Following this goal China opened its economy and got stronger involved in world wide economic exchange. Parallel to these globally oriented reforms the internal policy agenda shifted the attention from a promotion of secondary industries and urban areas to the rural areas, which had received less attention in terms of the development of welfare and infrastructure during the 1960s and 1970s. What happened since the mid 1980s in rural areas of China? Aspects of this question will be answered with the help of a case study on the development of rural areas and respective institutions in times of societal transition and structural changes in agriculture in the Hebei province.

Structural and institutional changes in the agricultural sector are a common pattern found during the development of economic systems from subsistence agriculture to a more diversified economic system (Kirschke et al., 2007). During the structural transformation of an economy the share of the agricultural sector declines and it is expected that the sector provides capital (including land and labor) to other sectors, which allows expanding the activities of the secondary and tertiary sector (Johnston and Mellor, 1961).

Recent research revealed that land renting institutions are differing quite strongly among different regions in the North China Plain and that land rental markets are not completely developed and by this cannot fully fulfill their economic function of allocating land to its most productive uses (Piotrowski, 2009). With respect to credit institutions not only are households found to be constrained in formal credit markets but also substitutability between formal and informal credits appears to be limited in rural China (Jia, 2008).

The term institution in general refers to all measures that are related to organizational processes in all sectors of an economy, to the modes of use rights and resource allocation, social and political norms, but also to other societal and system related mechanisms that could have an impact on individual behavior (Krug, 1990) and the enforcement mechanism behind those measures (North, 1994). In theory, this means that formal and informal institutions are an omnipresent framework that is – purposively or unintentionally – implemented by humans and that determines all human interaction (North, 1990). In the present study more specific institutions such as local measures of land allocation and land renting, implicit or explicit restrictions to migration as well as the role of land for social security (see e.g. Li et al., 2007) and the production of food for subsistence are assessed. As indicated by North (1990), an important role of institutions is to reduce uncertainty and by this the provision of a stable framework that helps individuals or societal agents to organize their interactions. If the efficiency concept of North (1990) is applied then a situation can be called efficient if it leads to economic growth under a set of constraints. Even if institutions should be designed to reduce those constraints, such as transactions costs, it well never be possible to eliminate all constraints. There will be always some constraints like institutions which are constraints in themselves, alongside with economic constraints like technology, budget and time constraints. Or as North (1990) also states, since there is always some degree of uncertainty, e.g. about future development regarding prices or labor demand, it is just not possible to reduce transaction costs to zero and by this to reach the theoretically possible maximization of objectives that might be profits or investments in human capital. When positive transaction costs are included in theoretical models to assess economic transition then the inter-temporal resource allocation is influenced by the role of the state (Buchenrieder, 2001). In such a situation of non-zero transaction costs, the institutions designed by policy to assign property rights do not necessarily follow the argument of Coase (1960). He states that the initial assignment of property rights (e.g. when privatizing former state companies) does not matter in the case of zero transaction costs and freely transferable property rights, since the transactions between market agents will always lead to a distribution of rights that increases the value of production.

Nonetheless, institutions are, beside their stabilizing character, themselves subject to changes during periods of transition (Buchenrieder, 2001). Especially because large societies are facing complex adjustment processes North (1990) favors the adaptive efficiency approach. According to him, adaptive efficiency is linked to the assessment of the kind of regulating structures that have an effect on the pathway of the development of economies over time. As one consequence of adaptive efficiency North (1990) argues for decentralized processes of decision-making which he judges as being appropriate to enable societies to maximize their attempts to find alternative ways of solving problems. In Hebei it can be observed that the organization of formal institutions differs from county to county or even from village to village (Böber, 2008 and 2009). Following the argumentation about decentralized decision making, this could be considered as being efficient to set up institutions that support local economic development by providing growth despite existing constraints. Adger (2000) discusses the necessity of institutions to be resilient and adaptable. To a large extent the resilience of institutions depends on their exclusivity and on the degree of trust that the society has in them. That is important to be kept in mind when evaluating farmers' attitudes towards the formal institutions to which they are liable to. Social resilience is defined by Adger (2000) "…as the ability of communities to withstand external shocks to their social infrastructure." (p. 361). Farmers in Hebei are subject to natural shocks that affect the output of production directly such as floods or droughts but they are also faced with policy or administratively induced shocks such as unscheduled redistributions of land rights.

It is not always possible to identify direct effects of an institutional change. Especially for the micro-economic analyses, based on a data set that is limited to the household level, quite often changes in price systems or policies can hardly be included directly but need to be approximated instead. Also changes in nonmarket institutions such as attitudes or habits that occur rather slowly (Kuiper, 2005) are difficult to cover with the models and available data. However, it is worthy to be aware of potential impacts of institutional changes because they might serve as a key for the interpretation of results that will be presented and discussed later in this document.

Regarding the goals of Chinese policy self sufficiency in food production is one major aim (Fang and Beghin, 2000; Solot, 2006). To achieve this, agricultural production systems are needed that allow for the effective use of scarce natural resources1 and for more participation of the rural population in production decisions and adequate incentives for individual farmers to increase production (Lin, 1997). In the end of the 1970s some production teams started a system where land, other resources and output quotas have been contracted to individual farm households, the household responsibility system (Sachs and Woo, 1997). Since the nation wide introduction of the HRS in 1981, agricultural production in China experienced massive changes in productivity (Davis, 2002; Sanders, 2000) and the rural areas developed rapidly. But Fan (2007) argues that the productivity of labor is still the lowest in agricultural production compared to the industry and the service sector.

Another policy aim is to reduce the rural labor surplus to overcome the problems of rural poverty and low income of farm households (Tuan et al., 2000). Lohmar (1999) mentions that there is an ongoing debate to how far the institutional changes in the rural labor market are considered as being successful. One group of scholars argues that there is a higher increase in opportunities for rural laborers to supply labor off the farm since the end of the 1970s in China than in countries with comparable rural (labor) markets. But Lohmar (1999) also

<sup>1</sup> China is feeding around 1/5 of the world's population but only having access to around 8% of the worldwide available arable land (own calculation based on data for 2008 available at FAOSTAT, FAO, 2010).

lists the arguments of other scientists who consider the relatively large share of human labor in the mix of agricultural production inputs, in comparison to other countries with a similar level of economic development, and the high and increasing inequality between agricultural and non-agricultural household income as facts that indicate imperfections in the labor market. Zhen and Zoebisch (2006, p. 62) emphasize, that the gap in income equality between (rural) households should not be "too great".

The transition of rural China and the agricultural sector was not free of costs. Chinese policy makers are challenged by keeping a balance between industrialization (also of rural areas), urbanization, and self-sufficiency in food production (Zhang et al., 2004). Beside the increase in absolute well-being of the rural population in comparison with the period before the transition from a fully state planned economy the distribution of welfare became more unequal. Not only are the costal areas outperforming the inner provinces of China in terms of income and infrastructure development but especially the gap between the rural and urban population has been widening since the start of the (agricultural) reforms in the end of the 1970's. By the household registration or *hukou* system individuals are categorized in two classes of citizenship, rural and urban. Rural residents are excluded from a wide range of benefits provided to the urban population such as public transport, urban schooling or urban health care and they are not allowed to take up every kind of work in urban areas. Just jobs that are considered as dangerous or dirty and offer low payments are accessible for rural laborers in cities without constraints (Chan and Buckingham, 2008). Ruralurban migration was and is hindered by the household registration system and by this also fueled the emergence of a wide gap in income and welfare between urban and rural areas (Dollar, 2007). But well-functioning labor markets are considered to be a pre-condition for facilitating the successful modernization of the Chinese economy (de Brauw et al., 2002).

Also in Hebei province the rural economy and society and the related institutions underwent structural changes. As can be seen from *Figure 1* the share of the rural labor force working in agricultural production declined relative to the other sectors. But also the absolute number of rural labor employed in agricultural production decreased in Hebei. The information for 1978 is provided to have an overview about the composition of the rural labor force at the start of the reform period. For the years 1992-1994 no data are available for Hebei.

Hebei as one major area of grain production is of great importance to achieve high and constant levels of food production. According to Hu (1997), apart from rice, wheat, maize, sorghum, millet and other miscellaneous grains, in China grains also include potatoes, sweet potatoes, soybeans and beans (Hu, 1997).2 The quota was applied to all of these so-called grain crops. As such Hebei is the agricultural backbone of the urban areas of Beijing and Tianjin. Due to a high population density Hebei itself is faced with pressures on the rural society stemming from land fragmentation and surplus of agricultural labor (Bhattacharyya and Parker, 1999).

Source: Basic statistics for agriculture ACMR (2010).

Moreover, input levels for mineral fertilizer in Hebei province are high and environmentally unsustainable (Zhao et al., 2006). The current migration policy does not allow rural residents to permanently exit agriculture and rural areas. Motives to establish or to stabilize part-time farming like e.g. positive external effects of German small holder farms on the landscape or in Norway and other developed countries to prevent farmers to migrate from the rural areas do not seem to be the first priority on the policy agenda in China.

The research for this thesis was conducted in the framework of Subproject 3.3: "Property Rights and Access to Credit, Inputs and Agricultural Knowledge:

<sup>2</sup> According to Hu (1997) special conversion rates help translating quantities of tuber crops into an equivalent of 1 kg of grain.

Implications for Technical Efficiency, Sectoral Change, and Rural Income Inequality", which is part of the International Research Training Group (IRTG): "Modeling Material Flows and Production Systems for Sustainable Resource Use in Intensified Crop Production in the North China Plain", supported by the German Research Foundation (DFG) and the Ministry of Education (MoE) of the People's Republic of China. In Appendix A, a structural outline of the whole research project is given (*Figure 12*).

### **1.2 Objectives**

Farm sizes in China remained stagnant since the start of the reforms in the agricultural sector, and inequality in income and well-being did not only increase between urban and rural areas but also within rural areas (Benjamin et al., 2007; Lin and Ho, 2003; Wan and Zhou, 2005, Yu et al., 2007). But Rozelle (1994) reviews studies which found falling levels of inequality in rural China after the start of the reforms. Rural non-farm income3 is not only seen as an important contribution to household food security but also might act as an inhibitor of urbanization, because migration is of less importance if households are able to diversify income at their rural location of residence. In addition non-farm income is also one measure to prevent natural resource degradation that could occur from overexploitation because of non-sustainable agricultural production systems when people depend solely on agricultural income (Reardon et al., 1998). A rising share of farms in China is managed by older people (Pang et al., 2004), and many rural laborers work only part time on the farms (Carter et al., 1999).

This increase in off-farm activities affects inequality among the rural population whereby different income sources contribute differently to overall income inequality of rural households (de Janvry et al., 2005). But it is also found that those households that continue farming as full-time farmers and by this specialize in agricultural production have characteristics that make them more productive than those households that leave the sector partly or fully (de Janvry et al., 2005).

Social welfare is a topic of rising interest in socio-economic research in China and different approaches are discussed from different perspectives with respect to either the function of rural social security nets, the development of the rural economy and infrastructure and the role played by family and relationship

<sup>3</sup> Rural non-farm income is defined by Reardon et al. (1998) as all income earned by wage paid activities in agricultural production, industries and services. Farm wages and migratory income are excluded by this definition.

structures (Hebel, 2004). The transition from a state planned to a market economy can be considered as an economic shock that affects the well-being of population subgroups differently (Araar and Duclos, 2006). During the 1970s and 1980s income inequality decreased but welfare inequality increased. Social policy measures with respect to the provision of education and health care and the maintenance of income favored urban over rural areas (Davis, 1989). Also Fan (2007) emphasizes the growing disparity between urban and rural regions. In 2002 the urban per capita income in Northeast and East China was around three times higher than the rural per capita income.

As recent research has emphasized it is important to assess the development of inequality among the rural population in China (Benjamin and Brandt, 1999; Benjamin et al., 2005), poverty (Benjamin et al., 2007; Duclos et al., 2008), the interaction between geographical diversity, poverty trends (Chen and Ravallion, 2004) and farm households' labor allocation decisions (Wang, 2007; Glauben et al., 2008). To the best knowledge of the author it is the first time that this assessment is done for Hebei province based on a comprehensive longitudinal data set. In addition this work provides an understanding of the determinants of Chinese rural households' labor allocation decisions which helps in the assessment of applied and intended policy measures that focus on rural development.

Poor people in rural China are not only affected by inequality in income but also they are less well equipped with the provision of education and health care (Zhu and Jiang, 1995). Also Dollar (2007) shows, there has been increasing inequality regarding education and health care provision in China. Because the data set, as described later, only contains household level data and no regional or census information, the focus of the present assessment of inequality will be on income and on expenditure based poverty measures. Yu et al. (2007) review several studies on inequality in rural China and figure out that the studies differ with respect to the chosen inequality indicators and/or the time span assessed. But in general inequality is found to be more related to regional differences (costal vs. western provinces or urban vs. rural areas) than to differences among households in a specific location.

Benjamin et al. (2005) find in their Shorrocks decomposition of rural households' incomes from nine Chinese provinces that self employment income from non-agricultural occupations and the relatively slow growth of agricultural income after 1995 led to an increase in income inequality in rural areas.

The assessment of the sustainability of agricultural production systems in the North China Plain is one of the overall aims of the IRTG project. Sustainability is often defined as a concept made up of "three pillars", where attention is equally paid to the economic, environmental and social dimensions of decisionmaking (Pope et al., 2004), which are also referred to as the normative dimensions of sustainability (Zhen and Routray, 2003). A sustainable agricultural production system is also based on the time and space-specific dimension of sustainability (Zhen and Routray, 2003). While the net farm income or the crop productivity are examples for economic indicators of sustainability, inequality in poverty and in income are social indicators (Zhen and Routray, 2003). The latter ones are used in this study for the assessment of the social dimension of agricultural sustainability in rural Hebei. They reflect both; the spatial aspect of sustainability, here with respect to different households in one region (province), but also the time dimension of this concept, with inequality indicators containing information about short-term but also about long-term aspects of sustainable development.

The first objective of this study is to assess determinants that influence income generation and the well-being of rural households in Hebei. Research questions related to this aim are:

The agricultural sector in the research area is still dominated by high-input, low-output (per farm and arable land area) part-time smallholder agriculture (Piotrowski, 2009). Following the argumentation of increasing economies of scale, larger, more commercially oriented full-time, farms should be more efficient. On the other side part-time farming in combination with off-farm wage labor activities is seen as a strategy to diversify income based on different perceptions of risk by part-time and full-time farmers (Lien et al., 2006). Wan and Cheng (2001) and Chen et al. (2003) found in their studies on Chinese farms negative economies of scale.

Research in other countries showed that farm exit rates are strongly influenced by family, farm and regional characteristics (e.g. for Germany see Glauben et al., 2006; for Israel see Kimhi, 2000; and Ahituv and Kimhi, 2006). In China there are no studies accessible in English which investigate questions related to the succession of family farms and the changes in farm size structure. The formal reason is that land is not allowed to be passed on to a member of the household if the holder of the land use right dies. But instead the land use right goes back to the village pool of responsibility land and will then be reallocated.

In addition most of the households in rural China are considered agricultural households (Zhu, 1991; and Glauben et al., 2008). By this they represent a production unit that is referred to in this work as farm. Also there is no general decision mechanism about the succession of a farm like in other countries because the household holds only use rights of the agricultural land that was distributed by the village usually based on per capita measures. The village, in other words the state, collectively owns the land (Gale et al., 2005). Differences in the amount of land per household are related to differences in the demographic composition of the farm family but are at the same time also based on administrative land allocation schemes. This is different to the finding of Tschajanow that differences in land holdings can be explained by differences in the reproduction patterns of peasant families (Bernstein and Byres, 2001).

Generally, agricultural income is just one of the various income sources of farm households in developing countries (Schwarze and Zeller, 2005). Due to structural changes in the Chinese economy and the development of the secondary and tertiary sector, a lot of possibilities evolved for the rural population to supply labor also to other activities than to family based agricultural production. So it is worth to analyze the evolution of labor supply decisions of farm households in rural Hebei. The provision of off-farm labor can reduce the surplus of rural labor (Feng and Heerink, 2008) that otherwise cannot be fully employed in agricultural production. The development of job opportunities outside the agricultural sector already reduced the labor surplus in rural areas of China to some extent (de Janvry et al., 2005). Despite the fast growth in China's nonagricultural sectors the reallocation of labor out of agricultural production was rather low during the past decades of transition due to restrictions in labor mobility (WDR, 2008). The assessment of individual, location and institutional factors that have an impact on households' decisions to participate in the agricultural and non-agricultural labor market could help to understand this low rate of labor reallocation.

A large share of farm households in Hebei derives income from nonagricultural sources. The question then is, why they continue farming as parttime farmers and do not specialize into being either full-time farm households or by giving up agricultural production and being households of employed workers or running an own business? Often it is argued by scientists that discuss the assignment of land use rights in China, that rural households keep their land use rights as a means of social security even if they would not really need to farm the land anymore since the household income is earned outside the agricultural sector or is send home as remittances by migrant workers (e.g. Zhao and Wen, 1999). But Phimister and Roberts (2006) show, that part-time farm household are less efficient in their use of inputs, if one discusses efficiency as the "surplus" after deducting input costs from the output (Sen, 1962). Those part-time farm household apply relatively more chemical fertilizer than larger commercially oriented farms. One explanation could be that part-time farm households have lower capital costs for investments in farm production, since they use cash from income earning activities outside the agricultural sector. As another explanation those part-time households might have lower labor costs, at least for those household members (e.g. teenagers or elderly) that don't have sufficient skills which would allow them to participate in off-farm occupations. The results of Barning (2007), Jia (2008) and Piotrowski (2009) seem to indicate, that economies of scale, scope and risk are not fully exploited in the intensive agricultural production systems of Hebei. But other authors provide evidence that farms in China not necessarily have to be large to be considered as being efficient (Wan and Cheng, 2001; Chen et al., 2003). In the section that focuses on the separation of household labor supply and demand (chapter 1.3) an explanation of Sen (1962) is discussed that indicates the potential pitfalls if one uses market based wage rates to include the costs of family labor into the assessment of farm efficiency.

The distinction between part- and full-time households has important implications not only for the income generation of the assessed households but also for the levels of chemical inputs applied, and by this also for the assessment of the environmental pillar of the sustainability of the agricultural production systems in Hebei. An assessment of the impact of intensive input use in agricultural production and farmers' awareness about the relationships between agricultural production and the degradation of environmental resources for Hebei province is provided in Böber and Zeller (2009). So, the second objective of this thesis is to analyze the determinants of change in the number and types of farm households over time. Related questions to this part of the work are:

In the next part of this work hypotheses which relate to the two research objectives are presented.

# **1.3 Hypotheses**

Based on the review of theoretical literature and of empirical studies the following hypotheses are formulated and assessed in the empirical part of this work.

#### *Poverty*

Chen and Ravallion (2004) state, that between different geographic regions China's WTO accession had diverse effects on poverty development. They simulate the gains and losses associated with the WTO accession for rural and urban areas in three Chinese Provinces. Even if the WTO accession is found to have only a slight positive impact on poverty, Chen and Ravallion (2004) indicate that rural households mainly involved in agricultural production might loose most from integrating China into world trade. This is especially true for assessments that focus at the short-run effects of the WTO accession, since rural wages are expected to fall while the prices for consumption goods are expected to increase. The well-being of farm households in China can be affected by different price and income effects. If wholesale prices for agricultural products drop, the income of farm households is reduced, but farm households might also cash in on a drop of consumer prices and higher wages for off-farm labor (Chen and Ravallion, 2004). However, the study by Chen and Ravallion (2004) did not take into account possible specialization of Chinese farms into high-value, labor-intensive crops. In contrast, Hertel et al. (2004) assess possible welfare effects of the WTO accession in the long-run and argue that also poor and specialized agricultural households might gain from increasing labor mobility between the different economic sectors.

The structural changes in rural China contributed largely to the alleviation of poverty (Swinnen and Rozelle, 2006). The growth of the agricultural GDP is considered to be mainly responsible for China's success in poverty reduction because it is estimated that it contributed around 3.5 times more to poverty alleviation than the growth of industry and services (WDR, 2008). This is mainly because China comes from being a country dominated by rural population, which also makes up the largest share of the total poor population. But it is shown in previous studies that absolute poverty in China did not decrease in every year. Especially in the years 1987 to 1990, where some reforms have been stopped or reversed, poverty increased (Dollar, 2007). Since the beginning of the reforms in the 1970s the reduction of absolute poverty was the main aim of policy makers (Hussain, 2004).

In addition to the distinction between absolute and relative poverty, poverty can also be decomposed into a transient component, which indicates the intertemporal variability in peoples' consumption, welfare or ill-fare status, and into the component that represents the proportion of poverty that persist over time; chronic poverty (Jalan and Ravallion, 1998). The distinction between these poverty components is of relevance for applying respective policy measure for poverty alleviation. As Jalan and Ravallion (1998) explain, chronic poverty might be reduced by investments in human capital or physical assets whereas a reduction of transient poverty could be reached for instance by stabilizing incomestreams of rural households. An example for such a stabilization are cropping insurances that partly cover losses incurred due to bad harvests.

It is hypothesized that absolute poverty in rural Hebei declined during the period 1986 to 2002, even if there might have been years in which absolute poverty increased and that the larger share of absolute poverty in 2002 can be classified as chronic poverty. This hypothesis will be assessed in chapter 6.1. In addition, location and household related characteristics (e.g. the educational level attained by the household head) are used in this part of the work to assess determinants of poverty elasticity and inequality in the poverty elasticity among different population groups. The elasticity of poverty with respect to growth is used as one tool to measure to how far economic growth reduces poverty (Son and Kakwani, 2004).

#### *Separation of household labor demand and supply*

The assumptions regarding existing and functioning markets are critical to the formulation of an agricultural household model (Benjamin, 1992). Benjamin (1992) focuses in his discussion of agricultural household decisions on the separation between labor demand and supply. Tschajanow (1923) finds evidence that large households employ relatively more labor per given amount of land than households which have less members and hence a lower endowment with family labor. This is seen as an indicator of labor market constraints that hinder the household to supply labor outside the own family farm. Sen (1962) discusses the appropriateness of applying wage rates to value the amount of family labor input when assessing the productivity of small scale farms. He describes the inverse relationship between farm size and human labor used as input in agricultural production. While the amount of employed labor is decreasing the smaller the farm size gets, the amount of family labor used as production input is increasing, to an extend that in total more human labor is employed per unit of land. In addition, Sen (1962) describes that in many cases small farms are found to achieve a higher output per given area of land. This would seem intuitive, if one assumes farming at the small scale as being more productive. Sen (1962) does not see the size of the farm as the determining factor of the efficiency of the agricultural production but he argues that the production system itself is more relevant for the explanation of farm productivity. If most of the human labor input in smallscale farms consists of non-wage family labor and one uses a market wage to value this labor in terms of production costs, it is often found that the production costs are higher than the (monetary value of the) output of small farms. The conclusion of Sen (1962) is that one has to be careful with using a market wage rate as an indicator for the production costs of family labor, since this wage rate does not necessarily represent the marginal social opportunity costs of labor, especially in situations where no alternative uses for family labor outside the own agricultural production exist.

Benjamin (1992) considers the separation property as ideal to recognize that farmers can be characterized as being workers and capitalists at the same time. He assumes that the optimum (profit maximizing) allocation of farm labor does not depend on household preferences or the amount of land farmed, but only on the available production technology and on the wage rate for labor. Every combination of family and hired labor is possible if separation holds. As indicated by Benjamin (1992), in the context of separability of consumption and production decisions of farm households the supply of household labor is considered in the household utility maximization problem as a consumption decision, based on e.g. consumption preferences of household members and the demographic composition of the household(s' labor force). And the demand for labor is considered as production decision that involves the decision about the desired level of production, the choice between different activities and the input use decision (de Janvry and Sadoulet, 2003). In general, microeconomic household models reflect the trade-off between time and consumption of goods, where leisure is one, by a time constraint. This constraint states that time can be converted into goods if less of it is used for enjoying leisure but more time is devoted to work (see e.g. Becker, 1965).

If separability holds for an agricultural household model, then the amount of family labor that is employed in own agricultural production of the household should not be determined by the amount of laborers or the composition of the household's labor force, e.g. whether there are male or female laborers available in the household (Benjamin, 1992). Or as Arcand and d'Hombres (2006) explain, if separability holds than only plot characteristics, the applied production technology and prices are the determinants of the marginal productivity of all farm inputs. Therefore in chapter 7.1.1 structural variables will be explained that are suited for the assessment of separability between households' labor demand and supply decisions.

In the case of separability of rural households' decision about labor demand and labor supply, the household would act as profit maximizer and would allocate production factors separately from its own factor endowment (Kuiper, 2005) as well as consumption and leisure preferences (de Janvry and Sadoulet, 2003). Thus, the household would choose an allocation of family labor time that maximizes the households' overall utility (Hanf, 1996). In its' decisions about allocation of family labor time, the household would consider the marginal utilities of all possible uses of family labor time.

A well functioning labor market could help in determining the marginal utility of household labor supplied to off-farm occupations and in identifying the marginal costs if non-family labor has to be employed at the family farm (Hanf, 1996). Despite the existence of labor markets still difficulties could arise for the household if it wants to make long term labor allocation decisions: there is instability in off-farm labor demand and uncertainty about the future development of off-farm income for unskilled and skilled laborers (Coutu, 1957).

Coutu (1957) argues in his assessment of part-time farm decisions in the U.S. in the 1950s that some part-time farm households seem to value leisure higher than the marginal product of family labor time allocated to agriculture. He considers the limited knowledge of part-time farm households about agricultural production possibilities as the reason for this finding. The shadow wage of family labor could be distorted downwards due to the social security function of family labor (young laborers taking care of retired household members) in intergenerational contexts (Rosenzweig and Wolpin, 1985). In the context of the present study, labor surplus in rural areas in Hebei could lead to distortions in the valuation of leisure and farm labor time.

As Benjamin (1992) argues, assumptions about separability are made quite often but models that test for specific reasons of the existence of nonseparability, e.g. constraints in rural farm and non-farm labor markets are not often applied.

Bowlus and Sicular (2003) explicitly assess separability in the context of farm household labor allocation decisions based on panel-data for the years 1990 to 1993 for Shandong province. They reject separability between households' labor demand and supply and conclude that even more than one decade after the reforms of the agricultural sector started, the labor market is strongly constrained and does not allow for an efficient allocation of rural labor.

Based on the theoretical discussions of Benjamin (1992) and the results of Carter and Yao (2002), Bowlus and Sicular (2003) and Kuiper (2005), it is hypothesized that labor demand and supply decisions of farm households in Hebei are non-separable.

It is necessary to test this hypothesis because non-separability would not allow solving agricultural household models recursively. The labor demand would depend on the composition of household labor and the labor supply would be dependend on the household endowment with the fixed production factors land and capital (Yotopoulus and Lau, 1974). If non-separability is found, then profits cannot be maximized independently of the utility function during utility maximization (Benjamin, 1992). Lopez (1984) also assesses the interdependence of profit and utility maximization of agricultural households and emphasizes that the agricultural household models have to account for the differences in cases of interdependence or non-interdependence of utility and profit maximization. In addition, the recursivity between agricultural households' labor demand and supply decisions is one major aspect where the respective agricultural household models differ from the assumptions and considerations that led to the development of household models that are applied to assess the labor allocation of workers' households in developed or industrialized countries. In chapter 4.2.2 the model to test for the hypothesis of non-separability is presented and in chapter 7.1 the hypothesis will be assessed.

#### *Labor market participation*

Education is a main explanatory variable with respect to individuals' and households' labor market participation decisions. It increases the productivity of farm and off-farm labor and leads to reductions in transaction costs (Glauben et al., 2008). Ahituv and Kimhi (2006) consider human capital as being more productive in off-farm employment. Higher levels of education achieved are associated with higher earnings (de Janvry and Sadoulet, 2001). Tuan et al. (2000) indicate in their study on Chinese census data that skills necessary for non-farm activities are mainly developed at the secondary or high school level. A decrease in the probability to participate in agricultural production with increasing education is also found by Babatunde and Qaim (2009) for farm households in Nigeria. They argue that households which have access to sectors with higher wages than in agriculture follow a pattern of demand-pull diversification of labor supply.

It is hypothesized that better education of the household head and specific training provided to individual household members have a positive effect on the participation of the household in the non-farm labor market.

Whether this hypothesis holds is assessed in chapter 7.2.

#### *Farm structure persistence*

The literature about labor allocation decisions of individual farmers or farm households discusses two main aspects with respect to labor market states. Some authors provide evidence for structural state or inter temporal dependence of labor supply decisions (Weiss, 1997; see also the discussion in Brosig et al., 2009). True structural state dependence is found if the previous state, in which the observation unit (here household) was, changes the constraints and parameters the household faces in the recent state or if the attitudes of household members are changed by the previous state the household belonged to (Corsi and Findeis, 2000). If there is structural state dependence then policies that affect farmers' labor market participation decisions at one point in time would have an impact on the outcome of future decisions of farmers to participate in the labor market (Ahituv and Kimhi, 2001). Other authors argue that it is also important to discuss impacts of the amount of time that a person remained in a specific labor market state on the probability that he or she might leave the state at a specific point in time (Chan and Stevens, 2001; Knight and Yueh, 2004).

Following Brosig et al. (2009) it is of interest to assess the choice of farm households of either exclusively engaging in own farm production or of supplying labor off-farm as well. By this an insight in the persistence of part- and fulltime farms in rural Hebei is gained.

It is hypothesized that the time that a household operated as either part- or full-time farm household decreases the probability that the household will change the state.

For this hypothesis the assessment is presented in chapter 7.3.

#### **1.4 Outline of the thesis**

Chapter 2 shortly introduces the Hebei province and the socio-economic and environmental conditions framing the development of agricultural production and the involvement of the rural population in agricultural and non-agricultural labor supply. This also builds the basis for understanding why the size of a farm in Hebei is rather small compared to other Chinese provinces. In addition the decision of farm households about the types of crops to be planted, and by this the decision between staples or cash crops, depends on soil, climate and other location related characteristics.

In part 3 of this work time periods that are important for understanding and discussing the recent institutional framework in rural China and Hebei are reviewed. The transformation of the Chinese economy from a planned to a market oriented one went different than in other former planned economies. Some reasons for this different development can be found in China's past institutional system.

In chapter 4 theoretical agricultural household models are discussed that provide the basis for empirically analyzing household behavior regarding the allocation of family labor and for the assessment of the determinants of parttime and full-time farm persistence.

The data set used for the empirical analysis is described in chapter 5. Results for the analyses of poverty and income are presented and discussed in chapter 6. The respective variable sets used and results from the different parametric analyses of the separability test of households' labor demand and supply decisions, households' labor time allocation and the persistence of farm structures are presented and discussed in part 7 of this work. Chapter 8 provides conclusions and suggestions for policy and further research.

# **2 Hebei province**

In this part the Hebei province is described regarding the conditions that are decisive for the dominating role of agricultural production and with respect to socio-economic developments in rural areas of Hebei and regional institutional patterns.

### **2.1 Location, population and natural conditions**

The Hebei province is located in the North-East of China. Together with the provinces Henan and Shandong and to some part Beijing, Tianjin, Anhui and Jiangsu province most of the area of Hebei belongs to the North China Plain (*huabei pingyuan*) (NCP)4. It has a size of 187,700 km² (NBS, 2008) with fertile alluvial soils found in those counties that belong to the NCP (Rumbaur, 2008). The sediment soils are mainly chromic or calcaric cambisols (Rumbaur, 2008). The yellow river and its tributaries flooded the plain areas over centuries. The population of Hebei reached almost 70 million people in 2008 (ACMR, 2010) which results in a population density of around 372 people per km².

The average temperature ranges between -20 to -14 degrees Celsius in January and 20 to 27 degrees Celsius in July (CBW, 2010). The average annual rainfall for Hebei varies between 400 mm and 800 mm (CBW, 2010) but it is very seasonal with low or no precipitation in winter and some periods of heavy rainfalls in spring and July and August. There is high variation between years with droughts experienced in some years and floods occurring in other years (Rumbaur, 2008).

Due to these environmental conditions the NCP is considered to be the major area of grain production of China. Hebei as well has intensive agriculture with mainly grain production in the plains. The Western and North-Western regions of Hebei province do not belong to the fertile plain areas and are mainly mountainous with altitudes up to above 1,000 meters above sea level. In this region less grain and therefore more horticulture production can be found. Typical crops cultivated are for example apples and chestnuts.

See the respective maps for China and Hebei in appendix A.

### **2.2 The rural areas of Hebei province**

Still around 60% of the population in Hebei province are classified as rural (NBS, 2008). In 2008 an area of 6.3 million ha was under cultivation (ACMR, 2010) which represents 5.2% of the total area of arable land in China (NBS, 2008).5 The total area cultivated declined since the 1950s (*Table 1*). Most of the farm land is irrigated and cultivated within the traditional double cropping system that is practiced in most of the plain parts of Hebei.

*Table 1: Population, rural labor force, agricultural land, and irrigation area in the Hebei province (various years compared)*

Note: n.a.: not available.

Source: ACMR (2010) and NBS (various years).

The classical crop rotation includes winter wheat and summer maize or cotton double cropping, for which irrigation is necessary especially for winter wheat because it requires up to 3 times more water during its cropping period than is available from rainfalls during this time (Zhen and Routray, 2002). The precipitation is rather high on average but there is a quite uneven distribution with most of the rainfalls occurring in summer. Some portion of the decrease in

 5 As Lin (2009) states one has to be cautious with Chinese official statistics especially regarding the amounts of arable land available. There was a tendency of underreporting of cultivated land area by official administration at various levels. This tendency was uncovered by the first national land census that was undertaken between 1984 and 1996.

the sown area of grain crops is due to increases in the sown areas for e.g. vegetables, cotton and peanuts. Also the expanding production of cotton is based on intensive underground water irrigation.

Besides its importance for whole China in the production of grain, Hebei is also the province with most of orchard area (in 2007 around 1 million hectares). Orchard areas are dominating in the western and northern parts of Hebei.

The demand for infrastructure leads to land conversion for new settlement areas or roads and railway systems. As can be seen from *Table 2* below, the trend in the change of land use or the reclassification of land from crop production area to other purposes such as garden land (mainly vegetable production) or for state infrastructure projects continued. Together with the still growing population this results in a very small available per capita area of arable land (0.084 ha/person in 2008) in comparison to the world average of 0.236 ha (Lin and Ho, 2003) or even the average for China of 0.092 ha (own calculation based on ACMR, 2010).

*Table 2: Changes in cultivated land in the Hebei province, 2000-2008*

Note: n.a.: not available.

Source: Hebei Statistical Yearbook 2009 available at ACMR (2010).

This low amount of arable land per captia leads to small scale production and the average farm size is small. In terms of output, grains (mainly wheat and maize) are still the main agricultural production occupation for farm households in Hebei province. A large proportion of the agricultural production in the assessed region is subsistence agriculture, with e.g. large shares of the output for grain or eggs used for household consumption.

Over the period from 1986 to 2002 the total amount of arable land per household declined in the study region as did the amount of land per capita, although to a lesser extent showing the relative egalitarian per capita distribution of land (*Figure 2*).

Source: Own computations based on RCRE data for Hebei, 1986-2002. *Figure 2: Arable land per household and per capita by year*

The land is farmed by a high number of small agricultural households. This led to a high fragmentation of the land. In most areas the plot size is small and the households operate on plots that are scattered around the farm yard or house in the village.

Despite the policy aim of grain self sufficieny, the high amount of available rural labor and the scarcity of arable land per capita are a comparative advantage for the production of labor intensive crops; fruits and vegetables (Sandrey and Edinger, 2009). In reverse, China does not have favorable conditions for the production of land intensive crops as cereals or oilseeds.

The assessed villages differ in the per capita amount of land provided to the household (*Figure 3*). This is mainly due to different amounts of arable land available for distribution among villagers.

Source: Own computations based on RCRE data for Hebei, 1986-2002. *Figure 3: Arable land per capita by village*

Also the disparity between the rural population and the population classified as urban, based on the household registration system *hukou*, widened as can be seen by the rising gap between urban household's disposable income and the net income of rural households since 1978 (*Figure 4*). The terms disposable and net income refer to the distinctions made in the Chinese statistical yearbook between urban and rural income available for the coverage of living costs. However, the costs of living are lower in the rural areas, as also shown in *Figure 4*.

Source: Basic statistics for people's livelihood, Hebei province, ACMR (2010). *Figure 4: The urban rural gap in income and living expenditures*

### **2.3 Summary**

Most of the population in Hebei province is classified as rural. The agricultural production system is still dominated by small scale farms. Grain crops dominate in terms of cultivated area, especially in winter wheat summer maize double cropping system, but shifts to cash crops such as cotton and vegetables can be observed. Since the start of the reforms the disparities in income and living expenditures increased. But also the villages within Hebei differ in terms of development and well-being. The reasons for those differences are partly related to differences in the population density and partly to the institutional developments that occurred since 1978, which will be discussed in the next chapter.

## **3 Development and state of rural institutions in China**

This chapter provides an overview of the various stages in the development of rural institutions in China in general and some of which are also specified for Hebei. It is devoted to the historical development of institutions that supports the understanding of the micro-economic assessments in Chapter 7. As a starting point the term transition is explained.

### **3.1 Transition in rural China**

Transition can either be defined or discussed focusing on sectoral transition (Spiertz and Oenema, 2004; Swinnen and Rozelle, 2006) or as an overall transition of the economy and society in the light of normative and positive economic theory. Also agrarian change can be analyzed from different perspectives (Rigg, 2006). One aspect is the deagrarianization which is driven by structural changes within the assessed economy. But also the assessment of poverty trends is included in studies on agrarian change as well as the analysis of changes in the culture and livelihoods of the rural population (Rigg, 2006), which can be seen as more societal changes then as structural changes.

Here the sectoral and the overall transitional view will be combined because from the early 1980s onwards the rural areas in China experienced at the same time a restructuring of production processes within the agricultural sector and an opening and system change occurring for the whole society and economy. Skinner et al. (2001) explicitly argue that the development in rural China has to be assessed with respect to the interaction between agriculture and the secondary sector but also in the context of changing environmental conditions (e.g. increases in environmental costs due to land use changes) and the impacts on local decision makers that arose from the orientation of the Chinese political economy towards markets.

McMillan and Naughton (1992) state that with the transition of a planned economy the whole set of fiscal, monetary, legal system, ownership and price institutions must be changed. Also Swinnen and Rozelle (2006) emphasize that the transition of a communist or socialist economy involves necessary changes in property rights regimes, an adaptation of incentive systems to improve labor and capital productivity and the creation of exchange institutions or markets that are more efficient than the ones under central planning of exchange. The most important effects of well functioning exchange institutions are that they facilitate transactions between different economic agents and by this promote specialization and trade. Those institutions involve a price mechanism by which information about the degree of scarcity of specific factors is provided to consumers and producers (Swinnen and Rozelle, 2006).

The transition of former socialist or communist societies with centrally planned economic systems is discussed in the economic theory mainly from two different perspectives (McMillan and Naugthon, 1992). The first way of transition discussed in theory and also observable with respect to some East-European societies is the "big bang"-approach. Theorists favoring this approach argue that private property rights and a market oriented system of allocation and distribution should replace the former system as soon as possible (Tsang, 1996). The school of thought promoting the second approach, "gradualism", argues that a fast transformation of all spheres of society and the economic system at the same time is not appropriate especially for large and relative homogenous centrally planned communist societies (Gregory and Stuart, 2001). Because a fast and complete transition of a whole state system is accompanied by many stakeholders that loose influence, power or their economic basis a stepwise change of the structures provides a feasible way to prevent resistance from those interest groups. So the compensations necessary for people to agree to changes are lower if the gradualist approach is followed (Dewatripont and Roland, 1992). As Schüller (2002) explains the homo oeconomicus would favor the "big bang" to achieve efficiency in allocation and production and competition based actions and decisions as soon as possible. But if one thinks of the socio-economic actor as homo sociologicus (Schüller, 2002) this would not be the prime interest because the benefits of a fast transition could be outweighed by the risk that the transition becomes a failure due to high pecuniary and non-pecuniary transition costs. China was in a comfortable position as the institutional reforms in the agricultural sector started in the end of the 1970s. The society had recovered from the chaotic years of the Cultural Revolution and the economic system was relatively stable (Bajpai and Jian, 1996). As a consequence there was no need to transform the rural institutions too fast, as it might have been the case in East-European countries, where societies had to cope with a sudden break down of the economic and political structures at the same time.

Following Spiertz and Oenema (2004) transition in agriculture is seen as a process of sectoral change in response to internal or external drivers that results in a change of the incentives for the sectoral actors. The term transition itself implies that this process is anti-systemic (Ness and Raichur, 1989) by changing know institutions. Some examples for drivers of change are: population growth, market and price changes, policy changes, adoption of new technology, changes in the level of education of the rural population, and climatic changes or flooding (Spiertz and Oenema, 2004). The actors respond by adapting their (production) decisions to the perceived changes.

*Figure 5* provides a graphical illustration of these processes. Transition as a process entails the movement from state determination of productive endowment and income values to market determination of those values (Benjamin et al., 2005). The change from a socialist to a market-oriented economy goes along with changes in factor prices. For example, returns to education or special skills are expected to be higher (Benjamin et al., 2005) than under the commune system that hardly rewarded differences in labor productivity or human capital.

Following Happe (2004) 'structure' is used here as a term that refers to an entity which consists of several components that are inter-related to each other. With respect to the agricultural sector those components are the farm firm or household itself and the available production factors land, labor and capital (Happe, 2004). The OECD (1995) defines structural changes in agriculture as the movement or exchange of production factors within the sector (e.g. among farm households), and between the agricultural, the industrial and the service sector of an economy.

Source: Adapted from Spiertz and Oenema (2004). *Figure 5: Drivers of change in agricultural production structures*

As suggested by the feedback loop it is not always possible to clearly distinguish between the cause and effect of externally induced changes due to the simultaneity of change in the sector but also society wide. Based on the interactions of rural actors, especially agricultural households, with other sectors and administrative levels of the state societal and policy changes during the opening process of China also influenced the structure of the agricultural sector. Farm households are the core production decision unit in the agricultural sector of Hebei. Their decisions about the provision of off-farm labor had an impact on the development of non-agricultural industries. Institutional changes regarding land use rights, the abolishment of the commune system, and the stronger focus on agricultural subsidies influenced on the other side the decision processes of the farm households. In general, the agricultural sector is of great importance for the development of an economy at its early stages (von Urff, 1982) because it provides food and non-food commodities and labor force that could be used in other sectors (Swinnen and Rozelle, 2006).

With respect to the development of the agricultural sector in Hebei one can identify some inhibitors of change:

This list does not claim to be complete. What is clear is that the assessment of the changes in rural institutions has to involve the discussion of societal and political factors influencing the transition. Therefore time related variables are included in the microeconomic assessment later in this work that might unveil impacts of policy or macroeconomic changes on rural households' decisions.

### **3.2 Rural China prior the period of communism**

Over a long period of time (from the first dynasties until the appearance of the People's Republic) land was privately owned in China. Almost 50% of the cultivated land before the socialist revolution was owned by landlords. The landlords rented land to peasant households so that a system of independent but fragmented agricultural production and decision units, private farms, existed in rural China (Lin, 1997).

Land was the most important component in a system that Zhao and Wen (1999) describe as a "combination of intergenerational and inter-temporal transfer of wealth, with emphasis on intergenerational transfers" (p. 3). Land protected its owners in two ways from old age poverty. First, land was traditionally inherited to the sons of the family after the death of the father. Being aware of the heritage to receive the young generation behaved well with respect to their parents and provided their income to the intergenerational household (intergenerational transfer). In the case of a loss or non-existence of children aged land owners could, as a second way to ensure old age security, sell the land or rent it out (inter-temporal transfer) and by this make a living either from the revenues generated by the land sale or from the land rent flows (Zhao and Wen, 1999).

Before the foundation of the People's Republic of China in 1949 income inequality was relatively high in China (Rozelle, 1994). Roll (1980) calculates a Gini coefficient for income of 0.443 for overall rural China in the 1930s. Brandt and Sands (1990) estimated Gini coefficients with respect to income for three villages in northeastern Hebei in the 1930s of 0.346, 0.349 and 0.391 respectively and 0.46 for the province as a whole. In the 1930s rural households in China derived a significant share of their income from sideline agricultural income such as weaving and spinning (Roll, 1980). Income earned by those sideline activities and a higher share of household laborers being involved in nonagricultural activities contributed positively to income inequality reduction. The marginal contribution of these variables to inequality reduction was lower than the negative impacts on income equality stemming from the amount of owned farm land or the amount of hired agricultural laborers (Roll, 1980). The land reform contributed to a decrease in local income inequality but did not address reasons and did not change inter-regional inequality (Roll, 1980). In addition, the rural population received a dividend from the abolition of land rents (at the expense of the former landlords) and changes in the tax system (Roll, 1980).

Before the revolution in 1949 most agricultural taxes were related to the amount of land owned or farmed and tax collection was in the responsibility of provincial governments. The tax system was regressive; the higher the amount of taxed items the lower the tax rate. In 1951/52 a progressive tax system based on per capita crop income was introduced which helped in reducing inequality in overall household incomes (Roll, 1980).

## **3.3 Collectivization**

This section reviews the main features of the period of a collectively organized agricultural production system in China to build the basis for discussing institutional changes that occurred during the reform of the sector (see chapter 3.4).

Hartford (1985) provides an overview of seven principles that have been the basic characteristics of the collectivized agricultural production system in rural China from the beginning of the collectivization in the 1950s up to the structural reforms of the agricultural production from 1978 onwards:

Looking at these principles describing how the agricultural production was organized and was intended to be working, it is obvious that the system was lacking mechanisms that allowed for incentives for both, individual workers but also local decision makers to improve production and to use scarce resources as efficiently as possible. Lin (1988) explains that close supervision in agricultural production goes along with high supervision costs and therefore reduces the incentives to work as part of an agricultural production team. In addition, rural labor productivity was very low due to relative low amounts of arable land per capita (de Janvry et al., 2005).

From the point of view of politics, the agricultural sector was not of first priority. It was considered to support the development of other industries and to provide support for urban development (Gale et al., 2005) and industrialization (Karplus and Deng, 2008). This was reflected in the socialist price system which set high prices for industrial products and low prices for agricultural outputs and via this mode of price setting lowered the real income of farmers (de Janvry et al., 2005).

But the socialist ideology was oriented to diminish inequality especially among the rural population (Rozelle, 1994). As Roll (1980) shows in his seminal assessment of income inequality development in China in the early1930s and 1950s, rural Gini coefficients, with respect to income, declined from the 1930s to the 1950s. Putterman (1990) indicates that in the 1960s and 1970s there was hardly a change in intra-rural income inequality.

Because most social and health care services were also provided by the collective they were by this likely to contribute to equalization in well-being among the rural population. Therefore, Benjamin et al. (2005) argue that household's well-being was less sensitive to household's productivity during communism than it might have been from the start of the transition of rural China until now.

### **3.4 Policy changes during the transition and the development of market institutions**

Over the last two to three decades the completely centrally planned and organized economic system has been replaced by an institutional framework in which a Party-state decides about the parameters that condition market forces (Lin, 2009). This process started between 1976 and 1978 as Chinese policy makers formulated higher levels of efficiency in production and (resource) allocation as important topics in economic policy (Krug, 1990).

1978 is often referred to as the starting point of opening reforms or structural change in rural China (Lin, 1988; Swinnen and Rozelle, 2006) due to the fact that in this year institutional changes, like the provision of incentives to individual households to increase production and some relaxations in the quota system started in Anhui province and later resulted in the HRS, that was gradually implemented in the other regions of China and formally accepted in 1981 (see an overview in Jia and Fock, 2007).

Due to the focus of the present work, the institutional frameworks regarding the use of land and the generation of income by rural households will be reviewed in this part. Beside national laws and provincial regulations the local institutional setup varies strongly. This is a major challenge especially for foreign researchers. Therefore the institutional framework is outlined based on how it should be according to national regulations, but if possible references are made to actual patterns and differences between different locations in Hebei based on own qualitative information.

One has to have in mind, that policies that have been formulated to explicitly address a specific, e.g. macroeconomic, topic implicitly also affect the development and distribution of welfare and income (Roll, 1980). For rural China examples for such implicit impacts could be adjustments in the foreign exchange rate system that occurred often in the 1980s and 1990s (Wang, 2004). Also China's WTO accession influenced its terms of trade and changed relative prices between agricultural and industrial products. Carter and Zhu (2009) find evidence that the opening of China to world trade had a positive impact on those relative prices and therefore agricultural producers could be expected to economically profit from relative to industrial products higher rewards for their outputs.6 But also the decentralization of fiscal revenue raising and public spending (Zhang and Zou, 1998) can have an impact on rural (economic) development, for example with respect to public spending for health care and education. Between 1986 and 1995, public spending for education decreased from a share of 63.4% in Chinese overall public spending to a share of 45.6% (Zhang and Fan, 2004).7

Even if it is argued that decentralization in general is enhancing the efficiency in revenue collection and spending, Zhang and Zou (1998) find for the period 1987 to 1993 a negative relation between fiscal decentralization and economic growth on provincial level. This might be due to the general political turbulenc-

<sup>6</sup> As can be seen from Mundell's (1961) discussion about optimal currency areas, flexible exchange rates based on national currencies work well for countries with high internal but low international factor mobility. Wang (2004) considers a Mundell-Fleming model as being applicable for the assessment of China's real exchange rate between 1980 and 2002. He considers the opening of China's trade, the elimination of price controls, the increased orientation towards markets and other institutional changes during the reform process as leading to a higher relevance of applying macroeconomic models developed to assess open economies (see Krugman and Obstfeld, 2004, for a theoretical discussion of related macroeconomic models).

<sup>7</sup> According to Zhang and Fan (2004) public spending in China comprises expenditures for research and development, for education, and for the construction and maintenances of irrigation schemes, roads, electric power plants and grids and communication facilities.

es during this time. Zhang and Zou (1998) argue that a central level fiscal system can better support investments in public goods that have nation-wide positive externalities in societies that are at early stages of economic development.

In China land, as the core input factor for agricultural production, serves two main goals of policy makers. It is the basis for the country's food subsistence and fulfills traditionally a social security function (Zhao and Wen, 1999). According to Lin (2009) land is perceived society wide as so important for food production and provision of at least some part of old age security, especially to the rural population, that this perception even outweighs positions such as the need of exclusive property rights, the principle of utility maximization and the request for fully functioning (land) markets.

The first sentence of Article 2 of the Chinese Land Administration Law (in force since 1 of January 1999) states, that:

"The People's Republic of China practices socialist public ownership of land, namely, ownership by the whole people and collective ownership by the working people." (National Development Reform Commission, 2010)

As a consequence of this, the agricultural land in rural areas belongs to the rural collective as mentioned in the 2nd sentence of Article 8 of the Land Administration Law.

"Land in rural and suburban areas shall be owned by peasant collectives, except for those portions which belong to the State as provided for by law; house sites and private plots of cropland and hilly land shall also be owned by peasant collectives." (National Development Reform Commission, 2010)

Or as Chin (2005) points out, the farmers' collective *nongmin jiti* holds the ownership of the land but it is not clearly defined who the farmers' collective is. According to the first two sentences of Article 14 of this law, there is the possibility to issue user rights for agricultural land. Land contracts should be concluded for a period of 30 years. But quite often land is found to be reallocated before the end of the official allocation period for example because of changes in the village population (Lohmar et al., 2001).

Article 3 of the Rural Land Contract Law of the People's Republic of China (RLCL) explains that a contract system should be applied for entitling user rights of land in rural areas (MoA, 2010). But also in this law no clear definition of the composition of the collective economic organizations in the countryside is provided. This leads to difficulties in applying the law in practice. Who should decide how to allocate the land and to whom? According to Skinner et al. (2001) the responsibility for land use decisions lays mainly in the hands of province, county and town(-ship) decision makers. Chin (2005) states that at the basic administrative level, the village, de facto the village leaders control the distribution of the land. This is partly confirmed by results of own surveys (Böber, 2008 and 2009) where farmers stated that there have been reallocations in villages beside official reallocations and without the need to reallocate land use rights due to correct for changes in the composition of the population in the villages. Such "out of turn" reallocations at village level, accepted or even arranged by town or province administration, quite often occur to change the legal status of land from "agricultural land" into "non-agricultural land" that is allowed to be used for e.g. infrastructure construction (Lin, 2009). Lin (2009) hints towards another conflict that arises with respect to land use rights, their allocation and the conversion of land between different purposes. Due to the hierarchical relationships in the Chinese political system there is hardly a possibility for rural (farmers') collectives to claim their rights. So the state or urban administration can convert rural to urban land without the need to involve rural stakeholders in the decision process. The ordo-liberal principle of freedom of decision about private property (see Eucken, 2004) does not hold for the current conditions in the Chinese economy. Farmers, besides their re-granted responsibilities for agricultural production, still do not possess land titles or are not allowed to rent-out or rent-in land in some regions. But the transition from "a planned economy under the law of exchange value" to a "socialist market economy with Chinese characteristics" (Sachs and Woo, 1997) provided the rural population with more direct decision power over their agricultural production, off-farm labor allocation and by this ultimately also over their income and overall well-being.

Decentralization also took place with respect to the monitoring of environmental resources resulting in sometimes overlapping and not well structured responsibilities and funding sources (Rozelle et al., 1997). The degradation of natural resources directly affects human health but also increases human insecurity due to the uncertainness of the links between pollution and the future development of the living base (UNDP, 2008).

The introduction of the household responsibility system shifted the decision about household's labor allocation from the collective to individual households. At the same time, the emergence of township and village enterprises offered employment opportunities especially in industrial production (Qian, 2000). So households that where endowed with more labor than needed for agricultural production practically got a chance to supply this surplus labor to off-farm jobs. Fan (1990) cites Lin (1987) who finds that the introduction of the household responsibility system as one major institutional change in rural China was responsible for 60% of the growth of agricultural production in China between 1980 and 1984, and for around 51 percent of the poverty reduction during the same time (Fan et al., 2004). Even with improved possibilities for rural households to decide about labor allocation rural labor markets as such did not function perfectly in the 1990s (Benjamin and Brandt, 1997).

Since the opening policy started in China's rural areas in 1978 the institutions and regulations for the agricultural markets and the price system were changed several times. Heerink et al. (2007) list at least three main periods or stages in the development of market structures in the rural areas. They see the first period lasting from the end of the 1970s till 1984. This period is characterized by the responsibility of the farm households to produce state mandated fixed amounts of agricultural products and by a state buying-up system with state fixed prices. From Šik (1968) one learns that such a centrally planned and controlled system seeking for equality gives more or less no incentive for individual engagement and productivity improvement. But Sen (1966) argues that Chinese leaders have been aware of lacking incentives and encouraged local political leaders to increase outputs by offering non-monetary incentives. He shows in his assessment of labor allocation in cooperative systems that even a system of centralized labor allocation decisions can lead to a Pareto optimal allocation of labor and a maximization of social welfare. Putterman and DiGiorgio (1985) discuss several combinations of centralized and community level decision making and voting procedures about individually or collectively organized agricultural production. They find that democratic local choices about the degree of collectivity might be more efficient than centralized decisions and could increase social welfare of the local communities. If local communities are provided with the choice between individual household farming or agricultural production organized in a collective their decisions would be mainly influenced by the following motives: level of community control over land allocation, the equality in access to land and to how far the institutional parameters of the allocation decisions are defined in a democratic manner (Putterman and DiGorgio, 1985). Transactions costs, which are in general the costs of finding a contract partner, setting up a contract and enforcing agreements (North, 1990), are higher in a collective decision system (Berggren and Karlson, 2003) but this is not discussed by Putterman and DiGorgio (1985).

Heerink et al. (2007) state, that the Chinese government readjusted the price system to encourage developments in the rural areas by rising prices for output. So it can be argued that the political decision makers were partly aware of the discouraging nature of plans, the negative impact of distorted rural-urban price systems and the low labor productivity (in rural areas) in a centrally planned economy. The policies applied in the second period between 1985 and 1993 seem to confirm this argument. According to Heerink et al. (2007) a dual price system was installed. This system focused on state mandated fixed prices for a state planned fixed quota that had to be delivered of every agricultural product to the state on the one side. On the other side farmers were allowed to sell above quota amounts for market prices. To raise the agricultural production the prices for products in the contract farming system were quite often increased. Qian (2003) also mentions the dual-track concept regarding prices that allowed farmers to sell (grain) production above the quota requirements to market prices.

Heerink et al. (2007) see 1994 as starting point of the third period. In the end of 1994 the former procurement system was again put in force for grain (Buschena et al., 2005). The motivation behind this re-installment was the promotion of grain production instead of producing cash crops as rapeseed or cotton. The reason for this behavior was to produce enough grain to reach selfsufficiency in grain supply in China (Chen, 2006). Because of this, state intervention into market processes remained persistent especially for grain.

With opening the market for food and also for housing in urban areas the policy makers lowered the barriers for the rural population to migrate to cities even beside the fact that they continued the *hukou* system (de Janvry et al, 2005).

At the beginning of the reforms possibilities for provincial and local governments to tax and collect fees for investment have been linked to locally generated revenues. At the same time the ability of the central government to redistribute funds between provinces was limited by putting a cap on the taxation of state owned industrial companies (Rozelle, 1994). Some local leaders responded to those changes by increasing the taxation of local industries to subsidize agricultural production (Rozelle, 1994). But in reality the tax burden on the agricultural population was not relieved. In 2002 the tax-for-fee reform started with the aim to sum up all local fees rural residents were confronted with in a single agricultural tax (Kennedy, 2007). But still this agricultural tax was a burden for the rural population. In addition the tax revenues to local administrations were lower than the revenues from the fees collected before. Empirical studies indicate that the lower revenues might have resulted in a less efficient provision of services, especially due to deficiencies in local transfer systems, and this might have negatively affected rural areas especially in the poorest regions (Kennedy, 2007).

To finally counterweigh discrimination against agricultural production by heavily taxing farm outputs directly or rural labor indirectly, e.g. by forcing households to provide it as an input to infrastructure construction, China started the abolishment of all central state and local agricultural taxes and fees in 2004 (Gale et al., 2005). By 2006 the agricultural tax was abolished (Yu and Jensen, 2009). In addition subsidy programs have been initialized to provide income support to rural households. Currently different measures of direct and indirect income support for farmers are applied at province and county levels (Gale et al., 2005). Some examples are fertilizer subsidies that lower purchase prices, area related subsidies if households plant grain crops but also direct support if farm households invest in mechanization (13 billion Yuan in 2009 for agricultural machinery purchases; peopledaily, 2010). It is planned to reform this fragmented subsidy system so that farmers are only supported ones per year to stabilize subsidy flows (Chang and Zhang, 2010). With all these policy measures the Chinese government aims to solve the 'San-Nong' problem, which consists in the relatively declining income from farming in comparison to non-farm income and by this the widening of the gap between rural and urban income (Yu and Jensen, 2009). However, the average amount of subsidies received by every farm household was rather low (Gale et al., 2005). As Huang et al. (2011) state, in 2002 the central government provided subsidies to agriculture that where equal to only 0.007 per cent of the agricultural output. So it was questionable if these measures significantly increase agricultural and total income. Also the goal of stabilizing and securing grain production hardly seemed to be achievable with average payments of 10 Yuan per mu if grain crops are planted (Gale et al., 2005). The policies to support farmers changed radically since 2002. In 2008, 95 billion Yuan have been provided as subsidies for the agricultural sector (Huang et al., 2011). Around 82 per cent of this amount were made up by grain subsidies (*liangshi butie*) and input subsidies (*nongzi zonghe butie*). Huang et al. (2011) conclude that the subsidies do not lead to any distortions in farmers' decisions regarding the amount of area of land sown with grain or in the decisions about the use of fertilizer. So, subsidies can rather be seen as income transfers to rural households than as influencing the grain production area and consequently the grain output. But such a type of income transfer (unearned income) might have distorting effects on the labor time allocation decisions of the households regarding different agricultural or non-agricultural occupations, as will be assessed in part 7 of this work.

The second most important (non-labor) production factor for agriculture, besides land, is water. Because production in Hebei province heavily depends on irrigation and almost 80% of irrigation water originate from groundwater (Zhang et al., 2008), the distribution and management of water is crucial for agricultural producers and the society as a whole. The importance of a reasonable management of the production of water is increased in face of declining groundwater resources all over North China. Water provision and distribution is regionally organized in several ways. In the period of de-collectivization private ownership of tube wells significantly increased (Zhang et al., 2008). Major characteristics especially of the markets for groundwater in North China are that they are informal, localized, unregulated and impersonal (Zhang et al., 2008). Water is provided to farmers sometimes from the village, sometimes from a farmers' association but also from private entrepreneurs. Usually, the latter ones are local residents that privately invested in digging wells and building tube infrastructure (Böber, 2009). So even though de jure water is the property of the people (Zhang et al., 2008) de facto water management institutions are not transparently organized and lack efficiency (Varis and Vakkilainen, 2001) and it is quite likely to observe that no one in the different administrative bodies that are involved in ground water management seems to assume him- or herself being responsible for the implementation of existing laws and rules (Zhen and Zoebisch, 2006). In addition Zhen and Zoebisch (2006) explain that there are no monitoring and reporting methods included in the existing regulations for ground water management. Although the price of water seems to be reflecting the actual costs for ground water pumping (Zhang et al., 2008), price distortions might arise in the water market as soon as state interventions bias the prices for energy.

### **3.5 Farm households in China and Hebei**

#### **3.5.1 General overview**

In China more than 200 million farms exist (Swinnen and Rozelle, 2006). However, one has to bear in mind that the concept of a farm in China differs from the concepts of farms in Europe, the U.S. but also in other parts of Asia. For example McConnell and Dillon (1997) distinguish six basic farm types for Asia (excluding China):

During the transition, most of agricultural land was transferred via the use right system to farm households, so that the majority of arable land in China still is cultivated by family farms on a small scale (Swinnen, 2009).

At present the actual size of an average Chinese (family) farm is rather small in comparison to the size of production units during commune time. There are also new developments regarding the participation of agricultural households in businesses other than agricultural production. In 2008, around 14.8 million households in Hebei are classified as rural household, which equates to around 70% of all households in Hebei (Hebei Statistical Yearbook 2009 available at ACMR, 2010).

Sandrey and Edinger (2009) summarize, that it is not easy to define what is meant by a small farm or a small-holder farm household in China. Elements of the former communal system can still be found in the institutional setting in rural China. So, Sandrey and Edinger (2009) refrain from the concept of clearly defined individual farm households but assume that it is more appropriate to use the concept of farming cooperatives to describe the linkages between rural households. In the present study, the farm households are considered to be individual decision units, even if they sometimes depend on community level cooperation like regarding the exchange harvesting machinery.

As Zhu (1991) explains, the term 'peasant household' is usually applied to differentiate between rural households and households of workers and state employees. De facto, almost every rural household can be considered as a unit of agricultural production or farm household. This is mainly due to the fact that at least in the villages assessed here, almost 96% of households possessed use rights for agricultural land and devoted at least some hours of work to the allocated plots. In addition the household head is usually classified as 'rural' according to the *hukou* system. Also Chen et al. (2004) state, that Chinese households are classified as rural as long as they engage to some extent in agricultural production no matter if they devote household labor to non-agricultural occupations.

Wang (2007) provides a slightly changed definition of Nakajima's (1986) definition of the farm household that is applied here. Instead of behaving strictly profit-maximizing the rural farm household is defined as "semicommercialized" rural production unit that uses a mix of purchased input factors and input factors available from the household's endowment, especially family labor and land (Wang, 2007). The output of the farm household's agricultural production is partly consumed by the household itself and partly sold. The distinction between own consumed and marketed outputs is relevant especially for the discussion of income and poverty trends.

#### **3.5.2 Part- and full-time farm households**

The assessment of differences between full-time and part-time farm households is one of the major aims of this study. Poverty indices are calculated separately for the sub samples containing full- and part-time farm households respectively in chapter 6. In chapter 7.1 separability is tested for part- and full-time farm households and in chapter 7.3 an ex-post analysis of intra-sectoral change with respect to trends in farming population and farm size is applied. Therefore it is necessary to distinguish different types of rural households with respect to parttime and full-time farming activities.

Different concepts can be used to define part-time and full-time farming. One group is based on the sources of income and the other on the allocation of working time to on-farm and off-farm activities. According to Ahearn and Lee (1991) there are advantages of both concepts. The income-based concepts are useful in cases of yearly collected data without panel data character and have the advantage that they display which proportion of the household income is derived from farm and off-farm work. Income-based concepts offer a good possibility to analyze the diversification abilities and strategies of rural households. In contrast to these income-concepts the time-based concepts define part-time farming in a different way. Time-based concepts allow detecting the activities to which the household in total or the individual household member devote their available working time. The disadvantage of this concept is the difficulty to draw conclusions on the contribution of a given activity to the livelihood and the well-being of the household based on the amount of hours spent on that activity. This is particularly difficult because of a high variation in the required amount of working time for different types of farm products (Ahearn and Lee, 1991). As Fuller (1991) states there is the potential for an operator bias if only the time allocation or income sources of the main operator (often the household head) are considered. An operator's labor could be substituted by family members so that the operator can work part-time off the farm and the farm as such could still be counted as full-time farm. Following Croll (1994) the household in China is seen as an economic, social and political unit that determines production and consumption and utilizes family labor, land, capital and other resources. Furthermore she describes the most typical form of a Chinese household as one consisting of 4-6 members belonging to two to three generations (Croll, 1981). Although family per economic definition of input factors may not be regarded as an "input factor" it could well be argued that the ties and specialization inside the family and the social functions of a family provide a necessary basis especially for the functioning of a rural economy. Chinese farmers that devote some part of their labor time outside the own agricultural production are officially considered to be part-time workers rather than being classified as part-time farmers as in other countries (Zhu, 1991). So, according to Zhu (1991) the terms 'peasant household' and 'farmers' families' are used interchangeably in China when referring to a rural household that is involved in farming.

The interest to look at part-time farming activities arises from the fact that part-time farming can be seen as one part of many problems discussed in relation to agriculture (Hildreth, 1991). Zhou et al. (2001) state, that part-time farming is likely to evolve in societies or economic systems where land is a scarce resource and distributed equally and the transfer of land or land use rights is restricted. Some of the problems listed by Hildreth (1991) are of importance for discussing part-time farming in China. One of these problems is the distribution of income within the agricultural sector but also between agriculture and the other sectors. As can be seen in Chapter 6.2.1 there is rising importance and an increase in the share of income components derived from non-farming activity in the income composition of rural households in Hebei. Other aspects discussed are the impacts of part-time farming on land use patterns (Hildreth, 1991), landuse intensity (Suh, 1985) and the intensity of fertilizer and pesticide use among part-time farm households (Phimister and Roberts, 2006).

Rawski (1972) mentions, that the holding of multiple jobs was a strategy of peasants in ancient China to achieve a higher standard of living by complementing agricultural production with craft work and retail activities. Croll (1994) sees the development of part-time farming as a phenomenon that was new for rural areas in China as it became obvious in the 1980s. It arose with rising numbers of Chinese farmers working full-time as wage earners outside the farm. In parallel to the argumentation of Chaplin et al. (2003) it could be assumed that households' diversification of production activities in present China is a process of decreasing dependence on agricultural activities and that the strategy to diversify farming activity can contribute to rural development. De Janvry et al. (2005) find positive spillover effects from non-farm activities to the agricultural production. So part-time farming is seen as a way for rural households to compensate for failures in credit or insurance markets that would increase the risk to well-being of the household if agricultural income is fluctuating strongly due to fluctuations in production as well as due to in- and output price fluctuations.

In the classification of part-time and full-time farm households of Brosig et al. (2009) every household that allocates all family labor to on-farm production is considered as full-time farm household. Households that allocate some or all of the family labor to off-farm occupations and still farm any amount of land are classified as part-time farm households. This definition of part- and full-time farm households is applied in chapter 7.3 for the assessment of the persistence of those farm types over the period 1986 to 2002. The choice of this definition allows consistently adapting the model of Brosig et al. (2009) to the recent study. For the income and poverty assessments (chapter 6) farm households are defined as being part- or full-time farm households based on the information provided in the data set about the self classification of farm households as to which activity they devote their labor time.

Both definitions above refer to the distribution of labor time to distinguish between part- and full-time farm households. As already discussed (and further elaborated in chapter 6) a large proportion of farming was and still is subsistence agriculture. If agricultural products are not marketed but consumed by the household itself an income based classification of farmers would likely understate the share of farm income in total income if a large share of the products is not sold in markets but consumed by the household. So, more households might be classified as part-time farm households than in the case where a labor time based classification is chosen.

In chapter 7.2 households are grouped in four different labor market participation regimes that are defined by using the information about the allocation of family labor time combined with the information if non-family labor is employed by the household.

### **3.6 Alternatives to small scale farming?**

This part shortly addresses the question, if there is the possibility to adopt an institutional structure for rural Hebei province that allows the creation of larger and less scattered farms. The small size of the farm "enterprise" can especially be a problem for agricultural households when they want to market their production since their market power is rather low compared to the market power of middlemen or wholesalers.

In North and North-East China (e.g. Heilongjiang province and Inner Mongolia Autonomous Region) farm sizes are larger than in Hebei because the population density is lower so that family based farms cultivate more land. Besides family farms, the state operates large farms which can exploit economies of scale regarding their production and have market power also with respect to the processing and marketing of their products. The World Development Report (WDR) for 2008 presents an example of a marketing cooperative for water melons. This kind of farmer cooperative is seen as a measure to enable small farm households to get linked to the supply chain.

As long as land use rights are distributed based on population size to guarantee equality among the rural population in a specific location and a large share of population remains classified as rural, it is obvious that farm size will remain small in Hebei. Voluntary and market induced (as opposite to mandatory state/policy forced agglomerations) farmer associations with appropriate mechanism to control individual members' behavior could be a feasible way to overcome the disadvantages of small farm entities especially with respect to their low market power compared to agricultural input suppliers or wholesalers. Because no representative data about such institutions are available in the examined data set those possibilities of overcoming potential inefficiencies of family farms in Hebei due to scale inefficiencies will not be further discussed in this work.

In terms of production efficiency farms in Hebei do not have to be explicitly larger as long as rural institutions allow for the application of improved technologies or the efficient use of labor. As Schultz (1964) argues, changes in farm size, either farms getting larger or smaller, may be a consequence of a modernization process in agriculture but are not a pre-condition for modernization. Small farms can be efficient if they are provided with sufficient knowledge about farming technologies and practices and if the household laborers are adequately educated. So it is rather a question of factor proportionality instead of asking for the "right" size of a farm (Schultz, 1964).

#### **3.7 Summary**

This chapter provides the background information about the development and recent state of rural institutions in Hebei province and reviews different approaches to define part- and full-time farming.

After centuries of private land ownership and market based agricultural production systems the aim of policy during the communist period was to reorganize the rural institutions to distribute land more equally and by this also to achieve a lower inequality in income and well-being among the rural population. The organization of farms into collectives and the introduction of non-market price systems lowered the incentives for individual agricultural workers but also for the collective production units to produce sufficient amounts of agricultural outputs (especially grain) as efficiently as possible. Based on the household registration system around 70% of all households in Hebei are currently classified as rural. A farm household is defined in this study as an agricultural production decision unit that may follow the motive of profit-maximization (among others) and acts as a semi-commercial unit that is self-sufficient to some extent. Farm households are classified into part- and full-time farms based on the allocation of household family labor time to farming or to off-farm activities instead of distinguishing farm types based on the shares of income derived from agricultural production and off-farm activities. Different classifications of farm households will be applied in the following chapters.

Exchange institutions that function well should contribute to an efficient allocation of production factors and should also contribute to prices and income values that are determined by the market rather than the state. The transition of an agricultural production system is a stepwise process that is fueled by internal and external drivers and results in the change of incentives of decision units in the agricultural sector. During the stepwise transition of institutions in rural China more rights and responsibilities were assigned to the agricultural households. Many of these households were not limited anymore in their possibilities to earn income and to allocate their family labor to only agricultural production. Instead, the share of part-time farm households rose. Already in ancient China a mixed system of agricultural production and the provision of family labor off the farm was considered as improving the household's well-being.

Another finding of this chapter is that the current system of rural institutions differs strongly within Hebei. In addition to national and provincial laws and rules, village and community level differences with respect to agricultural production systems are observed. Those differences are included in the empirical assessments in chapters 6 and 7 by the use of village dummy variables. Further information to reflect differences in institutions are not available.

## **4 Theory and methodology**

### **4.1 Development economics and measures of poverty and well-being**

Governmental and administrative decisions affect income inequality. For rural China the long lasting system of taxes, subsidies and grain quotas influenced factor prices (Benjamin and Brandt, 1999). The structural and administrative reforms undertaken in the last decades in China are considered to change households' factor endowments, especially regarding land and labor due to regular and irregular reallocations and the development of rural non-agrarian industries. Allowing the development of market institutions has an impact on the distribution of land and affects its social security function (Benjamin and Brandt, 1997). As it is also stated by Benjamin et al. (2005), it is difficult to separate between effects from the transition of rural China and growth or development effects in empirical (income) inequality assessments. Wages for instance can change due to better accessibility of local and migratory labor markets and improved incentive mechanisms in agricultural production but also due to overall economic development.

In welfare economics, the common values of a given society can be represented by a social welfare function (SWF). A social welfare function depends "on the personal conditions of all individuals" (Harsanyi, 1955, p. 315) and expresses the subjective preferences of all members of the society (Harsanyi, 1955). Consequently, social welfare functions are more than just the sum of individual utilities (Harsanyi, 1955). Usually well-behaved welfare functions rank more unequal distributions of welfare lower than more equal distributions even if the mean value of the respective welfare indicator (based on either income or consumption) is the same (Benjamin et al., 2005). Different economic variables can be used as indicators to express welfare of a society (Mueller, 2003). Therefore a SWF can be formulated for example with respect to utility levels, income or poverty. Usually, utility concepts include factors that can be expressed in monetary terms such as income or the value of housing but also non-pecuniary social measures for well-being as trust, reciprocity or fairness.

Following Schumpeter (1909), not only the sum of individual welfare is necessary to be known for utility and welfare assessments but also the distribution of welfare among individuals matters. In theory, inequality within a population or between regions can be assessed with respect to different factors like land and other production factor endowments (e.g. machines), health status, education, infrastructure development or consumption. For example Deutsch and Silber (2004) state, after a review of inequality studies, that inequality in income is usually higher than inequality in consumption. They explain this with the smoothing of consumption8.