TOPIC 4: PRICE FORMATION FOR

LAND
IMPORTANCE OF LAND MARKET FOR AGRICULTURAL SECTOR
Brief Recap
• Cobb-Douglas Production Function: Y=A(Land)α(OtherResources)β
• 𝑌 = 𝐴 ∙ 𝐿𝛼 𝐵𝛽
• What is 𝛼 and 𝛽?
• 𝛼 and 𝛽 are the corresponding output shares of Land and Other
Resources
• Why?
Brief Recap
• Ψ = 𝑝𝑓 𝐿, 𝐵 − 𝑟𝐿 − 𝑘𝐵,
• f.o.c.
• 𝑝𝑓𝐿 − 𝑟 = 0
• 𝑝𝑓𝐵 − 𝑘 = 0
• For 𝑌 = 𝐴 ∙ 𝐿𝛼 𝐵𝛽 :=> 𝑓𝐿 = 𝐴 ∙ 𝛼𝐿𝛼−1 𝐵𝛽 ; 𝑓𝐵 = 𝐴 ∙ 𝛽𝐿𝛼 𝐵𝛽−1
• 𝑝𝐴 ∙ 𝛼𝐿𝛼−1 𝐵𝛽 = 𝑟 and 𝑝𝐴 ∙ 𝛽𝐿𝛼 𝐵𝛽−1 = 𝑘
𝑟𝐿 𝑘𝐵
•𝛼= and 𝛽 = : Income shares generated by resources
𝑝𝑌 𝑝𝑌
Farm land market Taxonomy in Ukraine
Farmland stock in Ukraine
Total area is 42.7 mln ha or 71% of the total country area
Agricultural producers and FARMLAND
• Agricultural commercial producers - 21 mln ha, incl:
• Small individual farmers:
• 4.4 mln ha; avg size is 105 ha
• Produce about 7% of total ag output
• Agriholdings (large mega farms):
• about 6 mln ha; size: 30-700 thd ha
• Produce about 23% of total ag output
• Independent commercial agricultural companies:
• ≈ 9.5 mln ha; size: 1500 га on avg;
• produce ≈ 22% of total ag output
• Households or unincorporated individual farms (not legally registered)
• ≈ 16 mln ha, avg size 2-3 ha
• Produce ≈ 44% of total ag output
Agricultural producers in Ukraine operate
mainly on leased land

Share of owned land in the total amount of used farmland, 2014

Source: Nivievskyi et al (2016)
Farmland sales market
• Current size of the farmland market is about 4.2 mln ha
• Rest of the farmland (38.5 млн га) – cannot be traded!!! -
64% Ukraine’s territory!
• Private farmland of natural persons – 27.7 mln ha
• Avg size – 3.6 га;
• Owned by 7 mln people
• Private land of legal entities – about 1-2 mln ha
• State farmland – 7.1 mln ha ???
• 5 mln ha are reported to be gone!!!!
• Communal land of communities – 2.2 mln ha
Purchase/sales price of farm land
𝑃𝑟
• 𝑃𝑝 = σ∞
𝑡=1 , Pp - farm land sales price; Pr – rental price; q – capitalization
1+𝑞 𝑡
rate
• Simplifies to:
𝑃𝑟
• 𝑃𝑝 = ;
𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑟𝑎𝑡𝑒 𝑖 −𝑔𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒 (𝑟)
• Pr: gross margins typical proxy for rental price (= upper limit for bidding price)
• Discount rate (i) – opportunity cost of invested funds; usually – rate of return on
risk-free securities plus adjustment for the risk associated with the farmland
investments; return on government securities (e.g. bonds) usually proxies the
rate of return on risk-free securities
• Growth rate (r) – expected income growth (associated with farmland); e.g. TFP
growth rate
More efficient farms can pay more for land
P; OUTPUT
PRICE, UAH/T
MORE EFFICIENT MORE EFFICIENT
NORMAL FARMER (1) FARMER (2)
FARMER

C2<C
V; PHYSICAL
VOLUME, T/HA
V1>V
Land market roles
• Efficiency enhancing role
• Equity considerations
• Financial markets developments; Land is considered to be the best
collateral
• Land improving investments
Transaction costs and market imperfections
• In perfect market: no difference between land sales and rentals
• In reality credit market imperfections and transaction costs play role:
• Imperfect capital markets: land purchases have to be financed out of own
savings
• Financial markets imperfections: confidence in money=> land as a store of
wealth
• Absence of alternative investment options=> land as a hedge against inflation
• Other than production reasons: prestige, lifestyle, traditions, etc
• Transaction costs (incl. enforcing property rights) imply a premium on the
buyer’s side
Farmer’s decision under imperfect credit
market condition
• Ciaian et al (2009):
• Π = 𝑝𝑓 𝐿, 𝐵 − 𝑟𝐿 − 𝑘𝐵, s. t. kB + 𝑟L ≤ S(W)
• kB + 𝑟L ≤ S(W) is a credit constraint that assumes that the maximum
amount of credit that a farm can borrow (S) depends on farm
characteristics (W), such as reputation, farm profits and assets, including
the land. For example, farmland sales moratorium reduces options for the
farmers to collaterize the loans and this will be reflected in the constraint.
• LaGrangean function
• Ψ = 𝑝𝑓 𝐿, 𝐵 − 𝑟𝐿 − 𝑘𝐵 − 𝜆(kB + 𝑟L − 𝑆), where 𝜆 is the shadow price
of the credit constraint
Farmer’s decision under imperfect credit
market condition
The optimal conditions with binding credit constraints (𝜆 > 0) are then
given by:
• 𝑝𝑓𝐿 − 𝑟 1 + 𝜆 = 0
• 𝑝𝑓𝐵 − 𝑘 1 + 𝜆 = 0
• kB + 𝑟L − 𝑆 = 0
• under credit constraints the marginal value product of land is higher
than the marginal cost of land.
Ukraine: application
• Assume 𝑌 = 𝐴 ∙ 𝐿𝛼 𝐵𝛽 :=> 𝑓𝐿 = 𝐴 ∙ 𝛼𝐿𝛼−1 𝐵𝛽 ; 𝑓𝐵 = 𝐴 ∙ 𝛽𝐿𝛼 𝐵𝛽−1
• 𝑝𝐴 ∙ 𝛼𝐿𝛼−1 𝐵𝛽 = 𝑟 and 𝑝𝐴 ∙ 𝛽𝐿𝛼 𝐵𝛽−1 = 𝑘
𝑟(1+𝜆)𝐿
•𝛼= , or in per ha equivalent
𝑝𝑌
𝑟(1+𝜆)
•𝛼= 𝑝𝑌
𝐿
• From the example above: 𝛼 = 34%; while the rental price on average
is USD 50 per ha; average revenue from the hectare in Ukraine is
about USD 900 per ha
• 𝜆?
Benefits of producers and land owners under
moratorium

Emprical Demand function for leased land

It was built using farm-level gross margins (average 2013-2015)
 Benefits after moratorium

Land sales market Land lease market

S* SL

Producers surplus
Producers losses
Owners benefit
SS
Owners losses

P* P*

PS PRмін=$50/га
мін= $1000/га DL
($1000/га)

L*=2 млн.га L*=14.5 млн.га LR=16.5 млн.га

Welfare Effect after Moratorium: Ownership
Restrictions
Welfare Effect after Moratorium: Analysis
Framework
Land turnover law – scenario analysis - 2
 the scenario whereby financial support of small farmers to access the capital
and increase their productivity is available, produces additional USD 2.2 bn of
agricultural GDP or annual additional 0.4p.p of Ukraine’s GDP growth
 the scenario whereby only financial support of small farmers to access the
capital is available, produces additional USD 0.42 bn of agricultural GDP or annual
additional 0.07 p.p of Ukraine’s GDP growth
 the scenario without financial support of small farmers to access the capital and
increase their productivity, produces additional USD 0.017bnof agricultural GDP or
annual additional 0.003p.p of Ukraine’s GDP growth
Land Tenure Policies
• Land Tenure = property rights of access to land
• Benefits from well defined and secured property rights to land (land
tenure):
1. Greater incentive for long-term resource conservation and increased demand for
investments
2. Improving transferability of land to more efficient cultivators
3. Ability to use land as collateral in formal credit markets
• Costs from individualized property rights
• Expenditures for demarcation and delineation of land plots
• Maintaining the records of land ownership
• Enforcing those rights and resolving disputes
• Insurance function of communal land (social costs)
Benefits: 1. Greater incentive for…
• Tenure security (measured by the extent of rights possessed by the
owner) significantly affects farmers’ investments decisions.
Technically this is a probability of loss of future income due to
conflicting challenges.
Benefits: 2. Improving transferability…
• Importance and ability of being able to transfer use or ownership
rights to land increases with economic development, specialization,
and better development of other markets
• With growth and integration such exchange (transfer) involves
members not from the same community
• more formal tenure system will decrease asymmetric information
and improve transfer rights
Benefits: 3. Ability to use land as a collateral
• Land is an ideal collateral
• Immobility; virtually indestructibility
• + secure, clearly defined and easily transferable ownership rights
• Collateral – necessary condition of participation in the credit market
• But this might not be enough:
• It does not affect transaction costs associated with administering credit to
small farmers
Costs of individualized property rights
• State Land Cadaster – physical records of land plots (identification
and description of land plots). There are costs to demarcate,
delineate, establish and maintain records of land ownership, enforce
the rights and resolve disputes
• State register of property rights on real estate (formalization –
confirmation - of rights to land and real property)
• Social costs: access to the commons as a safety net for the poor; e.g.
access to pastures
 Objectives of Land Tenure Policies

Broad Objectives Operational Objectives

• Economic Efficiency
• Equity and poverty alleviation
• Environment and Institutional
Sustainability
• Equitable access to land
• Secure land rights
• Smoothly functioning land
markets
• Environment and Institutional
Sustainability
Objectives of Land Tenure Policies
• Environment sustainability
• Soil is regarded as fully renewable resource
• But if soils are abused the damage may become irreversible
• EU example: land policy is increasingly becoming environmental policy with
‘multifunctionality’ of agriculture
• Institutional effectiveness and sustainability
• Gradual shift from informal to formal systems of land tenure
• Titling requires a clear legal basis and institutional infrastructure
• Costs are involved (discussed above)
Policies for Land Markets (with focus on
Ukraine)
• Land rights almost always are restricted in the name of the broader
public interest (local community or national government)
• Government frequently restricts transactions
• Questions often posed:
• Are equity and efficiency objectives adequately served by existing land tenure
rules and regulations?
• What restrictions are appropriate for ownership in the interest of greater
equity?
• What are the consequences for efficiency?
Rental market regulations
• Rental/lease land right provides less security than ownership
• But transaction costs are lower
• Rental contracts are registered and transferable in Ukraine
• Rental contracts specify terms of land plot usage
• Restrictions in Ukraine:
• 3% Minimum rental price
• 7 years minimum duration of rental contracts
• Are they justified from equity and efficiency points of view?
Sales market restrictions
• Transferability (tradability) restrictions
• Moratorium on land sales
• Restricted access to foreigners
• Pre-emptive rights
• Taxes on early sales
• Transfer taxes
• Authorization of Land Sales
• Land ownership ceilings
• Max/min landholding and ownership size restrictions
Sales market restrictions: Landholding ceilings
• The research undertaken thus far suggests that laws limiting the
amount of land that an individual, family or entity can hold can be
difficult and complicated to implement and often fall short of their
intended equity goals. Main outcomes:
• adversely affected productivity,
• failure to change agrarian structures,
• neutral or negative effect on poverty,
• negative impact on rental market, costly and difficult administration,
• circumvention and contestation, corruption, litigation, poorly crafted
legislation,
• tenure insecurity, discouragement of land related investments, costs
associated with ceiling outweigh the expected benefits.
Sales market restrictions: Landholding ceilings
• Justification:
• Land ceilings as a potential tool to avert the unregulated concentration of
agricultural land ownership
• Speculation was mentioned as one of possible justifications for land ceilings
• Are there alternatives?:
• Land ceilings because big landholders are more able… why not assist to the
small ones then directly?
• Speculation brings in liquidity to the market. There might be a problem of
asymmetric information (speculative gain). Reason is that information costs
are higher for individuals than for large farmers; why not help individuals with
informational support then? Fix the cause, but not the consequence!!!
Sales land markets: transferable restrictions
• Transferable restrictions destroy the market value of land
• Main consequence of restrictions => decreased demand
• => lower price
• Value of land as a collateral for credit decreases => reduction of
investment and growth