Endowments, Technology, and Factor Markets: A Natural Experiment of Induced Institutional Innovation from China's Rural Reform

Abstract The induced institutional innovation hypothesis postulates that new institutions are innovated to exploit profitable opportunities arising from institutional disequilibrium. The removal of legal restrictions on factor market exchanges after recent reforms in China resulted in institutional disequilibrium. This paper utilizes data from a household survey in China to explore ( i ) the relationship between the emergence of land, labor, and rental markets in a region and the distribution of factor endowments across rural households in that region, and ( ii ) the impact of hybrid rice on the emergence of factor markets in that region. The results are consistent with the induced institutional innovation hypothesis.