Balancing Market Power in Agrarian Contracts: Consequences for Social Efficiency, Cooperation, and Distribution

Abstract

I study the inclusion of a Bargaining Group (BG) formed by sellers in the context of relational contracts in a market where buyers traditionally hold significant market power. The formation of a BG transfers market power to sellers. Existing theories of relational contracts predict that such a transfer will have no impact on market efficiency. In developing contexts, however, a standard assumption from existing theories of relational contracts - the existence of an enforceable base payment - may not hold. In contract settings prevalent in developing contexts, no payments from buyer to seller may be enforceable. In this case, I show that a transfer of bargaining power can erode market efficiency in a dynamic relational contracting environment, which contradicts findings from existing models of relational contracting. When buyers hold significant market power, they forgo short-term opportunistic behavior by honoring promised performance bonuses in order to keep sellers engaged in trade over time and to accumulate surplus over many periods. With a market power eroded by the BG, buyers' long-run gains to trade shirk. When this is coupled with the absence of an enforceable base payment, short-term opportunistic behavior becomes more appealing and trade is more likely to break down. The results here provide policy-makers insight into the economic consequences of enacting policies attempting to balance market power within a framework of fully informal contract enforcement.

Keywords: contracts, incomplete enforcement, bargaining group, distribution, development, institutions

JEL Classification: D86, K12, L14, O12, Q13