Grain into gold? The impact of agricultural income shocks on rural Chinese households∗

This paper analyzes whether there is evidence of a poverty trap driven by credit constraints and non-linearities in the return to capital in rural China in the 1990s, estimating the effect of positive income shocks experienced by rural households as a result of increases in the price paid for mandatory grain quota sales. Households were required to sell part of their grain output to the state at a below-market price, and increases in the quota price generated income shocks that also varied cross-sectionally in accordance with crop composition. The identification strategy exploits climatically driven variation in crop composition in conjunction with quota price fluctuations to identify quasi-random variation in the size of the positive income shock and estimate its impact on economic outcomes. The results suggest agricultural investment decreases and investment in non-agricultural businesses and migration increase as households gain increased income, consistent with a poverty trap in which households are initially constrained from entering new productive sectors. There is also evidence of large increases in consumption and borrowing.