Conservation Payments, Liquidity Constraints and Off-Farm Labor: Impact of the Grain for Green Program on Rural Households in China

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production of agricultural commodities, compensation from the set-aside program and liquid asset minus
any fixed transaction costs that are made when participating in off-farm labor and/or credit markets.

In this stylized model, the Grain for Green program can affect labor allocation in three ways.
First, the program can relax the liquidity constraint through its compensation, δA^gfg . When the liquidity
constraint is relaxed, the shadow value of liquidity, λ^B , decreases. The household will allocate less
labor to farm production and more to off-farm activities, ceteris paribus (through the substitution effect).
Moreover, without a well-functioning land rental market, allocating land to a conservation set-aside
program will reduce the land allocated to farm production. By assumption, labor and land are
complements, so decreasing the amount of land allocated to farm production also decreases on-farm
labor. As a consequence, households have freed-up time to allocate to either productive labor uses or
leisure (also the substitution effect). Finally, if compensation from the set-aside program can relax the
liquidity constraint, the household may be able to either afford the transaction costs associated with
obtaining credit and/or earn additional income through off-farm labor and on-farm activities, potentially
garnering a higher income because of participation in the program. If so, the household can allocate time
to leisure, which would reduce the time devoted to on-farm and/or off-farm labor (income effect).
Whether the net impact is positive is an empirical question. In the following section, we will explain the
identification strategy to test these hypotheses.

Assuming that the income effect is small in the poor regions where the program is implemented,
we derive the following hypotheses:

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