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The ownership of agricultural land by foreign nationals is currently an extremely sensitive political issue in many of the Central and Eastern European (CEE) countries as they move towards European Union accession. During the past decade economic reforms in CEE have resulted in substantial welfare declines within agricultural sectors across the region. Generally, all agents within the agri-food chain have faced similar problems of decreasing terms of trade, increased competition, lack of financial resources and thin markets for both the sale of their output as well as for the sale of their underlying assets if so inclined (Swinnen and Macours, 2000). As a result, farmers have found themselves in severe financial distress and forced to operate at subsistence levels that are well below the optimal productive capacity levels that would be expected under normal equilibrium market conditions without these constraints (Swinnen and Gow, 1999).
Consequently, most farmers have been unable to purchase agricultural land at its long-term economic equilibrium value. Instead they have either leased land short-term or have offered their own land holdings at substantially undervalued prices. Recognizing that all farmers are similarly distressed, lack suitable repayment capacity, and land provides minimal security due to being under-valued, banks have been unwilling to provide farmers with mortgage loans. Consequently, very little land is being sold as absentee landowners have also recognized the market is undervaluing their assets, instead preferring to hold on them until land prices correct themselves. However, a reasonably fluid land leasing market has developed in a number of countries. In Hungary, for example, the land leasing market along EU border countries is being driven by foreigners who have found potential loopholes in the laws and been able to develop innovative organizational and contractual structures to control these land assets, which have been coined pocket contracts.
Shleifer and Vishney, 1992, developed a general equilibrium model analyzing the impact of asset illiquidity under idiosyncratic shocks. The model shows that if individuals are not financially distressed and the economy is in equilibrium then the value of an asset (i.e. land) should equal the present value of future earnings that accrue to that asset when operated in its best use. However, if the economy is hit by an idiosyncratic shock and all agents are financial distressed, assets will be substantially undervalued, unless outsiders are allowed to participate in the market. As a result, the subject of allowing outsiders (i.e. foreigners) to participate in agricultural land markets has become increasingly relevant as many CEE countries exclude foreigners from purchasing agricultural land. Additionally, EU treaty amendments directly address the prohibition of Member States to 'limit land acquisition by nationals of other Member States' (Hodgson, 1999). The policy and welfare implications and sensitivities are substantial, however they have only received passing attention in academic and policy literature.
The objective of this paper is to extend the Shleifer and Vishney (1992) model to help explain and understand the economic impact and implications that the exclusion of foreign ownership is having on 1) the economic value of agricultural land and 2) economic welfare of current and potential landowners and users in the CEE countries. The case of Hungarian land reform will provide empirical evidence to highlight the consequences of the exclusion of foreigners in land markets. Policy implications will be provided for a series of different land reform scenarios.
