Rural labor and credit markets

This paper studies changes over time in the incidence of labor tying. The existing literature is successful in explaining the emergence of this institution, but contains the counterfactual implication that there should be an increasing trend in labor tying. However, previous contributions have so far implicitly assumed that there are no consumption-credit markets available to workers. I show that taking account of borrowing opportunities leads to new predictions about the evolution of permanent labor. In particular, declines in borrowing costs associated to efficiency gains in the financial sector lead to a fall in the fraction of rural workers who are tied. In addition, if consumption-credit markets are operating, a fall in the size of the rural population will cause, under certain conditions, a decline in the percentage of permanent workers. These predictions are consistent with the observed trends in developing countries. Hence, this paper complements previous theoretical work on labor tying: with its addition, the theory now explains the emergence, persistence and final demise of this institution. (C) 1997 Elsevier Science B.V.