Positive Rainfall Shocks, Overoptimism, and Agricultural Inefficiency in China

This study identifies overoptimism of farmers as an important cause of factor misallocation and inefficiency in agriculture. Annual deviation of rainfall from the local normal is exogenous, unanticipated, and transitory, but we find that farmers substantially adjust labor and land allocation in response to a lagged positive rainfall shock. By examining the response of more than 10, 000 farmers in China over 11 years, we show that a lagged positive rainfall shock significantly reallocates labor from high-income off-farm work to low-income farm work, reallocates farmland from high-productivity farmers to low-productivity farmers, and reduces the average rural income by 8.1%. We also found that these effects are primarily driven by the irrational responses of low-productivity farmers and that farms with good irrigation conditions are generally not damaged.