Elsevier

World Development

Volume 40, Issue 4, April 2012, Pages 715-730
World Development

Smallholder Participation in Contract Farming: Comparative Evidence from Five Countries

https://doi.org/10.1016/j.worlddev.2011.09.006Get rights and content

Summary

Supermarkets, specialized wholesalers, processors, and agro-exporters are transforming the marketing channels into which smallholder farmers sell produce in low-income economies. We develop a conceptual framework with which to study contracting between smallholders and a commodity-processing firm. We then synthesize results from empirical studies of contract farming arrangements in five countries (Ghana, India, Madagascar, Mozambique, and Nicaragua). The resulting meta-narrative documents patterns of participation, the welfare gains associated with participation, reasons for nonparticipation, the significant extent of contract noncompliance, and the considerable dynamism of these value chains as farmers and firms enter and exit frequently.

Introduction

The modernization of agricultural value chains—the systems of agreements, arrangements, and contracts that link farmers to consumers of food, typically through one or more intermediaries—is both a consequence and cause of economic development. Commercial demand increases due to income and population growth, urbanization, and trade liberalization. Marketed supply rises simultaneously as a result of productivity improvements in production, post-harvest processing, and distribution systems. The two processes reinforce each other (Johnston and Mellor, 1961, Timmer, 1988). The combination of increased commercial demand and supply has led to the emergence of modern marketing channels employing sophisticated management methods, such as costly grades and standards or vertical coordination or integration of activities that profitably add value to raw commodities through transport, storage and/or processing. Participant farmers—whose comparative advantage allows them to tap the latent demand of better-off or more distant markets made accessible by emergent agricultural value chains—typically improve their productivity and profitability, thereby further stimulating commercial demand and supply. The emergence and modernization of agricultural value chains (AVCs) thus result from and contribute to economic development.1

Our study of smallholder participation in agricultural value chains focuses on contract farming arrangements (CFAs). We chose this analytical framework rather than a global value chains approach for both methodological and policy reasons. The insights and methods of contract theory have a special relevance to the empirical analysis of the smallholder–firm relationship in developing countries. Moreover, contract farming can be an attractive option to policy makers keen on integrating the poor in developing countries into a more industrialized sector of the economy and helping them access the gains from trade that characterize successful CFAs.

To what extent and under what terms do smallholder farmers participate in AVCs via contract farming?2 This paper makes two primary contributions to the study of smallholders and agricultural value chains. First, we develop a simple conceptual framework that illustrates the contracting process between smallholders and a modern agribusiness firm engaged in post-harvest processing, storage, or distribution. Our framework emphasizes several key features that emerge consistently in empirical studies of smallholder participation in contract farming arrangements, such as the prominence of geographic supply chain placement and farmer selection effects, the heterogeneity of contractual arrangements and contract terms, the prospective roles of farmer groups and cooperatives as contracting agents, and the highly variable (albeit typically positive) average returns to farmers from value chain participation.

The framework draws on transaction costs, rational actor, and principal–agent theories to explore why particular regions are selected into agricultural value chains and, within those regions, particular farmers are selected for contract participation. The key insight is that the transaction costs associated with contracting and the likelihood of contract compliance vary with geography, by farmer type, and by contracted commodity. We use the framework to structure a comparative analysis of empirical findings relating to smallholder participation in modern value chains in five countries on three continents: India in Asia; Ghana, Madagascar, and Mozambique in Africa; and Nicaragua in Central America. The case-specific findings of the five cases are available elsewhere (Bachke, 2010, Bellemare, 2010a, Harou and Walker, 2010, Michelson, 2010a, Michelson, 2010b, Michelson et al., in press, Narayanan, 2010b, Walker, 2009). Our objective in this paper is to draw these findings together into a meta-narrative to document patterns of participation, the gains associated with participation, and the reasons for nonparticipation across continents and AVC type. A comparative approach enables us to tease out general patterns that transcend the important specific contextual details of any particular country setting, commodity, or contracting firm.

The question of smallholder participation in CFAs is of great importance to policymakers seeking to stimulate rural economic growth and poverty reduction. From the mid-1980s on through the turn of the millennium, the prevailing development policy orthodoxy emphasized macroeconomic (e.g., exchange rate, trade, taxation) and sectoral (e.g., agricultural, industrial, services) policies following the so-called Washington Consensus. But this strategy often bypassed smallholder households because (i) market segmentation impeded price transmission, which in turn distorted incentives and prevented the successful uptake of arbitrage opportunities (Barrett, 2008); (ii) macroeconomic and sectoral approaches ignored the many market failures constraining smallholder supply response (Barrett & Carter, 1999); and (iii) the Washington Consensus largely ignored the institutional preconditions for markets to facilitate exchange and welfare improvements (Fafchamps, 2004, Greif, 1993, North, 1990, Platteau, 1994a, Platteau, 1994b, Platteau, 2000).

Since the turn of the millennium, attention has shifted toward more micro-level and institutional policies. In particular, contractual arrangements with downstream processors, agro-exporters, and retailers, often orchestrated through farmer groups, are increasingly seen as a means of overcoming the market imperfections that led to the failure of macroeconomic and sectoral adjustment policies (Gow, 2000, Grosh, 1994). Yet smallholder access to agricultural value chains—especially to more remunerative markets—is commonly limited. Smallholders’ productivity may be limited by geographic or biophysical constraints such as insufficient water for irrigation or they may lack access to limited productive assets (e.g., land, livestock, labor, tools), constraining their capacity to generate a marketable surplus. The production technologies available to and appropriate for smallholders can be similarly limiting. Finally, institutional constraints—such as limited access to credit and insurance, insecure land rights, and uncertainty regarding new risks—may further reduce the feasibility and attractiveness of CFA participation for smallholders.

The handful of empirical studies on the welfare effects of modern CFA participation have faced methodological difficulties—discussed in greater detail in Section 2(e) below—in establishing the causal impacts of CFAs (i.e., in determining whether observed welfare changes can be ascribed to CFA participation). So the degree to which participating smallholders benefit remains somewhat uncertain. This is especially true in cases where new institutional arrangements leave smallholders exposed to risks of which they were not fully aware ex ante, and in cases where buyers are monopsonistic or oligopsonistic and thus enjoy contractual bargaining power over farmers that may permit firms to extract most of the gains from trade (Sivramkrishna and Jyotishi, 2008, White, 1997).

Consistent with the uncertain welfare results, in places where smallholder participation has actually taken place on a large scale, it has been subject to significant reversals. CFAs regularly shed participants or collapse completely. These patterns of engagement with and disengagement from marketing arrangements closely resemble patterns of smallholder adoption and disadoption of agricultural technologies (Feder et al., 1985, Foster and Rosenzweig, 2010).3

Section snippets

Conceptual framework and empirical issues

In this section we lay out a brief conceptual framework in which an agricultural commodity-processing or distributing firm contracts with smallholders for commodities that it sells either wholesale or retail on urban or foreign markets.4 The framework offers a clear and concise way to understand the procurement decisions of firms and patterns of smallholder participation in and welfare changes

Data

This section briefly describes the context and data for each of the five studies of smallholder contracting discussed in the comparative analysis below. Essential features of the case study and of the data and estimation methods used in the underlying analysis are noted in Table 1. Readers interested in greater detail should consult the source materials cited in the rightmost column of Table 1.

Empirical findings

Given the framework developed in Section 2 and the data briefly described in Section 3, we now discuss the patterns that emerge from the evidence on the determinants, dynamics, and welfare effects of smallholder participation in evolving CFAs in the developing world. We structure the discussion in this section to correspond to the four stages of the framework outlined in Section 2.

Conclusion

The rapid transformation of agricultural value chains and spread of CFAs with the rapid rise of supermarkets, fast-food chains, and other retailers with downstream market power, along with a more prominent role for global agro-exporters, is one of the more important and fascinating agricultural development phenomena of the past few decades. The relatively high upfront investment required to participate in modern markets is a challenge to participation of smallholders, however (Reardon and

Acknowledgments

This paper was initially prepared for the workshop on Institutional Innovations and Policy Interventions in Support of Smallholder Market Participation held at the United Nations Food and Agricultural Organization in Rome, June 3–4, 2010. We thank the organizers for prompting us to synthesize findings from multiple studies into this paper, and thank workshop participants, Brian Dillon, and three anonymous referees for useful comments and suggestions. All remaining errors are ours.

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