22754 AGRICULTURE & NATURAL RESOURCES DEPARTMENT DISSEMINATION NOTES TOWARD SUSTAINABLE PRODUCTION SYSTEMS AND RURAL POVERTY REDUCTION Number 5 August 1995 Market-Assisted Land Reform: Helping Solve a Debt Crisis Many developing countries have unfairly Why Generalized Debt Relief is Wrong promoted the interests of the politically In tackling a farm debt crisis, a distinction powerful in rural areas with tax breaks, should be made between three sorts of subsidies and other privileges. These have farms: made large, mechanized farms artificially profitable at the expense of small family- * Prudent, well-managed farms, which operated farms, which are fundamentally are not overburdened with debt and will be more efficient. The huge fiscal cost of main- able to ride out the crisis. taining these farm privileges has proved * Farms that are in trouble but fundamen- unsustainable in many countries. They are tally sound, and can be saved provided now undergoing painful but unavoidable they restructure by shedding some land and structural adjustment, which typically other assets. means abolishing farm privileges, raising interest rates, cutting government spending, * Unviable farms, run by inefficient own- and reducing inflation. ers and maintained solely through subsidy Such adjustment may precipitate afarm programs. Such farmers need to cease oper- debt cnsis. The abolition of subsidies and ating altogether, selling all their land and privileges tend to reduce the profitability of other assets to meet their debts. farming sharply. The impact is most severe When a debt crisis occurs, all three cate- on farmers who have borrowed large sums gories of farmers tend to band together to from banks , especially since real interest demand write-offs. But this is unwarranted. rates tend to be high during adjustment. In The first category of well-managed farms such circumstances, farmers and banks of- needs no bail-out, and generalized debt re- ten band together to demand a government lief will simply confer an unwarranted bail-out through generalized debt relief, windfall on such farms. and governments have often given in- Farms belonging to the middle category Brazil, Colombia, Mexico. This is economi- need restructuring. They need to negotiate cally inefficient, and imposes an enormous some debt write-off by banks while paying fiscal burden on the government, slowing the balance of their debt by selling some down the adjustment process. land and assets. Governments can help by Where land ownership is very un- subsidizing a modest part of the write-off in equally distributed, an alternative approach such cases. to tackling a farm debt crisis is through the The third category of farms are unvia- > _ use of market-assisted land reform. The ble, often because they are badly managed World Bank is currently exploring this by large owners lacking motivation and strategy, which can greatly reduce the fiscal skills. These include people who bought g a cost of tackling the debt crisis, and instead land as a speculative investment rather than convert it into an opportunity for promot- for serious farming. Such people should sell ing equity, raising productivity, and increas- all their land and other assets to meet bank ing employment and overall growth in dues. They should then cease operating, farming. with their place being taken by small- AGR Dissemination Notes are an output of the Agriculture and Natural Resources Department of the World Bank. Further information and additional copies may be obtained by contacting Dean Housden, ext. 36637. holders, who are inherently more efficient. How Market-Assisted Land Reform The government can smoothen the process Can Help though exit bonuses, retraining schemes and loans to farmers leaving the sector to Conventional land reform takes the shape help them start new businesses outside of of the government or itS agencies expropri- farming. ang land, with or without compensation, Generalized debt relief is poor policy and then distributing it to smallholders. since it means the worst farmers keep going This process is typically plagued by dis- instead of exiting, land speculators get a putes and delays running into decades windfall instead of being penalized, and (Mexico s land reforms took 50 years to efficient smallholders are denied a chance complete). This disproportionately penal- to buy more land. This is inequitable and izes the poor, who have high discount rates- inefficient. --that is, they greatly prize immediate bene- Why, then, do so many governments fits but attach virtually zero value to bene- announchen, debt rel? manded elites arnmens wfits that arrive after seven or eight years. announce debt relief? Landed elites are well Market-assisted land reform aims to facili- organized and continue to have a lot of po- tatet-ass of aims triki- litical influence, even after structural ad- tate the process of willing buyers striking justment, so they are able to lobby effec- deals with willing sellers, thus eliminating tively for such relief. In addition, banks the usual delays and conferring immediate hands with farmers on this issue forming a A key problem caused by a debt crisis is formidable political coalition. A ke lemarket by atically, When a debt crisis occurs, the price of that the land market shrinks dramatcally, land usually falls rapidly. One reason is that since there are very few buyers or sellers. land privillegeals rapidimis sgnecaonty withat Market-assisted land reform will increase farm privileges dimenish significantly with both the demand for and supply of land, structural adjustment, so the factors that and thus help resolve the debt crisis, in ad- earlier drove up the price of land artificially dition to improving equity. have now disappeared. The second reason Increasing Demand. In market-assisted is that land transactions shrink dramatically reform, government grants are essential to in a debt crisis and market liquidity falls. re gornmentherwise cannot to Banks find it is not worthwhile to foreclose target the poor, who otherwise cannot buy Bank mortgad it rmlanot worthce to frecosae land. The grant can be 100 percent for small on mortgaged farmldand since no buyers are glt,adte eln nasiigsaeu available save at give-away prices insuffi- plots, and then decline on a sliding scale up cient to cover loan dues. Interest rates are to a certain maximum size, adjusted for generally very high in a debt crisis, and land quality. Studies show that the landless good farmers will not borrow at high rates have the ability to raise a fair amount of eq- to buy land. Smallholders and landless uity through relatives, friends and their workers would like to buy land, but lack own savings. Such co-financing by benefici- cash and access to credit. So banks often aries means that even a modest fiscal provi- claim that they will collapse if they do not sion will go a long way in increasing the claimethat gover n bil-collae wifthey disous ndemand for land. Besides, the government get a government bail-out, with disastrous will necessarily have to invest substantial consequences for other sectors of the econ- in buily hal investructanhe omy. Governments are afraid of letting a sums in building rural infrastructure in the farmycrisis escalate into a general banking reform zones, and beneficiaries can contrib- facrisism escalae to mal-o an king ute free labor as "sweat equity", further in- crisis, and so may agree to bail-outs. How- creasing their capacity to buy land. Finally, ever, this entails a prohibitive fiscal cost, so the government can give banks modest an alternative strategy is needed. tegvrmn a iebnsmds subsidies that may help cover transactions costs to increase their lending to beneficiar- ies. 2 Increasing Supply. Such a big increase Suggested Reading: in the demand for land would send land prices skyrocketing in normal times, but in Johan van Zyl and Hans Binswanger. 1995. a debt crisis land prices have already "Market-Assisted Rural Land Reform: How crashed and there is huge list of potential Will it Work?" In van Zyl, J., Kirsten, J. and sellers inhibited only by the paralysis of the Binswanger, H. Policies, Markets and Mecha- sellrs nhiitedonl bytheparaysi ofthe nisms for Agricultural Land Reform in South land market. Potential sellers can be con- f g L verted into actual sellers through several Afiica, (Capetown: Oxford University steps, some of which have been outlined Press). earlier in regard to the three categories of This Dissemination Note has been prepared by farmers: Swaaminathan Azyar, Andrew Parker and Johan van Zyl under the supervision of Hans * The government can give a modest sub- Binswanger, Senior Agncultural Policy Ad- sidy to banks to write-off part of the debts viser, Office of the Director. of the middle category of farms, which can be salvaged with restructuring. * The government can subsidize bank foredosure of the mortgages of the third category of unviable farmers, provided this land is sold to individuals and groups who qualify for land reform grants. * Exit bonuses, retraining schemes and loans to start new businesses can be offered to exiting farmers. * The government can subsidize or guar- antee pension schemes that offer exiting farmers an income stream comparable to what they would earn from farming but free from its risks and fluctuations. In this manner, modest conditional sub- sidies can create a large number of buyers as well as sellers, and the moribund land market will become very active. Banks will be able to recover the bulk of their dues, and with the benefit of selective subsidies will ride out the debt crisis. The fiscal cost will be far less than for a generalized bail- out, making more money available for funding beneficiaries and developing infra- structure in the reform zones. In South Africa, calculations show that funding of these actions will achieve a real social rate of return of 28 percent. In addi- tion, fiscal costs associated with market- assisted land reform will be only 78 percent of the of blanket debt relief. 3