Interlinking and Collusion

In this paper, we suggest a new rationale for the existence of interlinked contracts in the agrarian economies of developing countries. Using the framework of an infinitely repeated game with discounting, we show that interlinked contracts can help the dominant parties to collude, in cases where collusion is not possible with noninterlinked contracts. This occurs because either interlinkage pools incentive constraints across markets, or it affects the incentives of agents to accept deviating contracts. We illustrate these mechanisms by considering the case of interlinkage between markets for credit and share tenancy. The model that is used to formalize the second mechanism is characterized by frictions in the tenancy market, which we model using the standard framework of search and matching.