Farming, Non-Farm Enterprises, and Migration under Incomplete Markets

Abstract:

We study how rural households in developing countries use non-farm entrepreneurship to smooth consumption following shocks to farm income. Using survey panel data from rural India, we show that transitory shocks to agricultural productivity lead farm households to reduce farm labor supply, increase non-farm labor supply, and become more likely to engage in non-farm entrepreneurship and temporary migration. Unlike temporary migration, these shocks have persistent effects on non-farm entrepreneurship, as engaging in non-farm activities enables households to accumulate skills that enhance their non-farm productivity. We then structurally estimate a dynamic model of household labor supply decisions across farming, non-farm activities, and temporary migration. Counterfactual exercises reveal that over 30% of non-farm output in rural India comes from activities that households engage in to protect their consumption following shocks to agricultural productivity. In terms of policy, improving the functioning of insurance markets has substantial positive effects on structural transformation. Specifically, weather insurance contracts and a minimum income guarantee increase non-farm output by about 70% and 40%, respectively. As a potential implication of climate change, we find that a negative shift in the rainfall distribution leads to more than a 30% increase in non-farm output, underscoring the role of climate-driven structural transformation.