A publication of the Agricultural & Applied The magazine of food, farm, and resource issues Economics Association 3rd Quarter 2015 • 30(3) Contract Farming: What’s In It for Smallholder Farmers in Developing Countries? Marc F. Bellemare JEL Classification Codes: L23, L24, O13, O14, Q12

As every self-respecting economics major knows by the their agricultural sector, it will be necessary for smallholder time he graduates, whether a country benefits from inter- farmers to actually want to participate in contract farming. national trade depends in theory on whether that coun- So what are the reasons why those smallholders might want try specializes in its comparative advantage—for example, to participate in contract farming? And in light of recent whether it can specialize in the production of goods or ser- evidence, do those reasons actually drive participation in vices for which it has a lower opportunity cost. The produc- contract farming? tion of agricultural goods being the comparative advantage of most developing countries, it follows—again, in theo- “What’s In It for Me?” ry—that those countries should specialize in agriculture. Grosh (1994) was the first to lay out the reasons why, in But what does it mean to specialize in agriculture? principle, smallholder farmers in developing countries For many developing countries, whose agricultural sec- might want to give up the apparent freedom of producing tors are characterized by relatively primitive production crops for themselves and their families or for selling at mar- technologies, specializing in agriculture necessarily means ket in favor of producing crops—often different ones—for modernizing their agricultural sector, a move away from a others within the context of highly regimented contracts. situation wherein many smallholder farmers each produce several crops, primarily for their subsistence and using a Potential Advantages to Contracting relatively primitive technology, toward a situation where 1. Risk and Uncertainty: Producing crops outside of a few larger producers each produce one or two crops for contract farming arrangement and for sale at market often the market using modern technology. It also means moving means that a farmer is unsure of the price he will receive from a situation where the many transactions required to once he gets to market. This is especially so in developing bring agricultural commodities from producers to consum- countries, where such price risk and uncertainty is often ers take place on spot markets to a situation where those more important than in developed countries, which can same transactions take place within more vertically inte- cause serious welfare losses (Bellemare, Barrett, and Just, grated value chains. In other words, modernization implies 2013). In contract farming arrangements, however, it is that fewer transactions are necessary to bring a commodity often the case that the agreement between the grower and from the same producer to the same consumer. the processor specifies a price at which the crop produced Consequently, policy makers in developing countries under contract will be purchased by the processor from the and in international organizations have come to see con- grower, which eliminates price risk. In Bellemare (2012), tract farming and agricultural value chains as key areas of for example, contracts almost always specified a fixed price policy intervention. But in order for developing countries to be paid by the processor to the grower. to tap into their comparative advantage by modernizing

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1 CHOICES 3rd Quarter 2015 • 30(3) AAEA-0815-063 2. Imperfect Factor Markets: Eco- farmers in the context of a contract opportunistic behavior on the part nomic underdevelopment is often the farming agreement is a crop for which of the processor, side selling—what result of fragmented or missing mar- there is little to no local demand. In Fafchamps (2004) refers to as “leak- kets. For example, because of credit West Africa, for example, cotton is of- age”—is opportunistic behavior on rationing due to imperfect informa- ten produced within agricultural val- the part of the growers. Minten, tion (Stiglitz and Weiss, 1981), a ue chains that are entirely owned by Randrianarison, and Swinnen (2009) smallholder farmer may not be able to the state, who is the sole cotton buyer relate an anecdote wherein rampant secure a loan which would allow him in the country (Elabed et al., 2013). inflation in Madagascar led to mass to make the required investments to In such relationships, where there is leakage among the growers they adopt a new production technology. practically no market for the contract studied. In contract farming arrangements, crop outside of the contract, the pro- however, it is often the case that the cessor often abuses its monopsony As You Sow, So Shall You Reap? processor advances inputs which power by reneging on the terms of the The advantages and disadvantages of would otherwise be difficult or im- contract, by underpaying growers, by contract farming just discussed are possible for the grower to obtain, and delaying payment, and so on. In an true in principle. How does contract the contracted crop is used as collater- edited volume with the evocative title farming play out in practice? A col- al. In Bellemare (2012), for example, of Living under Contract, Little and lection of empirical country studies seeds, pesticides, and fertilizer were Watts (1994) present several cases and reviews of this literature (Bijman, often provided by the processor to the where contract farming failed to ful- 2008, and Oya, 2012) offer some grower, and the contracted crop was fill its promises. insights. used as collateral. 2. Contract Rigidity: Because of Does contract farming make 3. Extension Services: The pub- the specific quality requirements of smallholder farmers better off? The lic provision of extension services is consumers and the sanitary require- question is not new, at least not when often lacking in developing coun- ments of regulators in export mar- one looks outside of agricultural and tries and, as part of contract farming kets, contract farming arrangements applied economics to consider the agreements, processors often provide in developing countries are often social sciences as a whole. Goldsmith their own private extension services. much more rigid than production (1985) reviews a number of case Those private extension services are outside for one’s own consumption or studies of contract farming in Africa, often more trusted by farmers than for sale at market. Inputs have to be Asia, and Latin America, and finds are public extension services. Bel- applied in specific quantities and pro- that in the majority of cases, the in- lemare (2010) found that yields are portions, specific tasks have to be per- come of growers is greater than that positively and significantly related to formed at specific times, and specific of non-growers. Moreover, he finds the number of such private extensions techniques or implements have to be that participation in contract farm- visits to the grower by a technical as- used. This often comes at great cost to ing is associated with the adoption sistant working for the processor. smallholder farmers who are used to of better production technologies. being their own bosses and produc- Singh (2002) also compares contract Potential Disadvantages to ing according to their own schedules. farming arrangements in the Indian More commonly, the opportunity Contracting state of Punjab, and he also finds that cost of following a rigid production those smallholder farmers who partic- Yet, contrary to what many econo- contract is the production of staples ipate in contract farming have higher mists and policy makers often seem for one’s subsistence. to believe, contract farming arrange- incomes. 3. Leakage, or Side Selling: This is ments are not a panacea. For one, The issue with both studies by the flipside of monopsony power. In contract farming is not easy to set Goldsmith (1985) and Singh (2002), cases where there is a local market for in motion in places where it did not however, is that they ignore the fact the crop produced under contract, it emerge organically. Moreover, con- that it is entirely possible that those is not uncommon for the contracted tract farming is difficult to “make smallholders who elect to participate price to be lower than the local mar- work,” as it often brings its share of in contract farming may have already ket price come harvest time. In such problems and is thus unsustainable been better off than those smallhold- cases, it might be tempting for grow- because one or both parties end up ers who elect not to participating in ers to sell some of the contracted dissatisfied. Contract farming can contract farming prior to their partic- crop on the local market at a higher give rise to the following issues: ipation. This is known as the selection price, claiming this as a loss. Whereas problem, and not only does it threat- 1. Monopsony: It is often the case the exercise of monopsony power is that the crop grown by smallholder en the internal validity of empirical

2 CHOICES 3rd Quarter 2015 • 30(3) findings, it is also challenging to ad- field-experimental methods are not internal and external validity—then dress in practice. Warning and Key immune from criticism, and they do one should logically argue for poli- (2002) were the first to attempt to not guarantee the identification of cies that facilitate the emergence of or deal with the self-selection of grow- causal effects from contracting farm- support contract farming. Concrete- ers into contract farming in a study ing. There are many other studies of ly, this could be as simple as a policy of peanut contract farming in Sen- the welfare impacts of contract farm- wherein a government subsidizes the egal, and they find that participants ing, including Glover and Kusterer expansion of a processing firm’s con- in contract farming did, indeed, have (1990), Porter and Phillips-Howard tracting activities to areas where (or significantly higher incomes than (1997), Ashraf, Giné, and Kar- groups with whom) it does not al- nonparticipants. lan (2009), Bolwig, Gibbons, and ready contract, or it could be as com- Another common issue in the Jones (2009), Maertens and Swin- plex as a legal reform that provides literature on contract farming is the nen (2009), Rao and Qaim (2011), better legal recourse for both parties lack of external validity. That is, re- Michelson, Reardon, and Perez to a contract farming agreement in searchers tend to focus on a single (2012), Dedehouanou, Swinnen, and order to make contract farming agree- crop or on a single region, with little Maertens (2013), Michelson (2013), ments more likely to be sustained or to no implications for other crops Narayanan (2014), and Briones to emerge at all. or regions. Simmons, Winters, and (2015). If, given the issues discussed Patrick (2005) were the first to aim The bulk of the evidence suggests above—limited internal validity, for more external validity by look- that participating in contract farming external validity, or potential publi- ing at three contracted commodi- improves the welfare of those who cation bias—one is more skeptical ties—maize, poultry, and rice—in choose to participate (Wang, Wang, about the findings of the empirical three different locations in Indonesia, and Delgado, 2014). Yet because the studies discussed above, then there and they find that those households identification problem—correlation are few if any policy implications. who participated in contract farming is not causation—remains as thorny This is especially the case considering as poultry breeders and maize grow- as ever, one has to keep in mind the that the literature has so far had little ers had better returns to capital than distinct possibility that publication to say about the potential benefits of nonparticipants. Likewise, Miyata, bias has molded what we know of the contract farming for those who did Minot, and Hu (2007) looked at welfare impacts of contract farming. not choose to participate. As a con- apple and onion contract farming ar- Null findings—in this case, findings sequence, it might be unwise to en- rangements in China, and found that that show no association between courage the participation in contract participation in contract farming was participation in contract farming and farming of households who do not al- associated with higher incomes. welfare—tend not to get published. ready do so. In that case, it is perhaps Minten, Randrianarison, and Findings that tend to go against the best to leave growers and processors Swinnen (2009) looked at contract dominant view—in this case, find- alone, without trying to nudge one farming over green vegetables in the ings that would show a negative as- party or the other in any specific di- capital region of Madagascar. The sociation between participation in rection, and to invest instead in bet- advantage of their study is that, al- contract farming and welfare—are ter evidence and replication studies to though they looked at income, they perhaps even more difficult to pub- better inform future policy options. also considered other indicators of lish than findings of no association. welfare, namely income variability Hence, the publication process might For More Information lead to a surfeit of findings showing and the duration of the hungry sea- Ashraf, N., X. Giné, and D. Karlan. a positive association between par- son, finding that households who 2009. “Finding Missing Markets ticipation in contract farming and participated in contract farming were (and a Disturbing Epilogue): welfare. better off along all those indicators. Evidence from an Export Crop Aiming for external validity, Bel- Policy Implications—or Lack Adoption and Marketing In- lemare (2012) studied contract farm- tervention in Kenya,” American ing over more than 10 contracted Thereof Journal of Agricultural Economics crops across six regions of Madagas- Whether policy implications can be 91(4): 973-990. car. Using field-experimental meth- derived from the foregoing depends ods to deal with the selection prob- on one’s willingness to believe the lem, he found that contract farming findings in the literature. If one takes appeared to lead to a 10-percent the positive findings discussed above increase in income. Yet even those at face value—that is, as having both

3 CHOICES 3rd Quarter 2015 • 30(3) Bellemare, M.F. 2010. “Agricultural Goldsmith, A. 1985. “The Private Oya, C. 2012. “Contract Farming in Extension and Imperfect Su- Sector and Rural Development: Sub-Saharan Africa: A Survey of pervision in Contract Farming: Can Agribusiness Help the Small Approaches, Debates, and Issues,” Evidence from Madagascar,” Ag- Farmer?” World Development Journal of Agrarian Change 12(1): ricultural Economics 41(2010): 13(10/11): 1125-1138. 1-33. 507-517. Grosh, B. 1994. “Contract Farming Porter, G., and K. Phillips-Howard. Bellemare, M.F. 2012. “As You Sow, in Africa: An Application of the 1997. “Comparing Contracts: An So Shall You Reap: The Wel- New Institutional Economics,” Evaluation of Contract Farming fare Impacts of Contract Farm- Journal of African Economies 3(2): Schemes in Africa,” World Devel- ing,” World Development 40(7): 231-261. opment 25(2): 227-238. 1418-1434. Little, P.D., and M. Watts. 1994. Rao, E.J. O., and M. Qaim. 2011. Bellemare, M.F., C.B. Barrett, and Living Under Contract, Madi- “Supermarkets, Farm Household, D.R. Just. 2013. “The Welfare son, WI: University of Wisconsin Income, and Poverty: Insights Impacts of Commodity Price Vol- Press. from Kenya,” World Development atility: Evidence from Rural Ethi- Michelson, H.C. 2013. “Small 39(5): 784--796. opia,” American Journal of Agricul- Farmers, NGOs, and a Walmart Simmons, P., P. Winters, and I. Pat- tural Economics 95(4): 877-899. World: Welfare Effects of Super- rick. 2005. “An analysis of con- Bijman, J. 2008. “Contract Farming markets Operating in Nicaragua,” tract farming in East Java, Bali, in Developing Countries,” Work- American Journal of Agricultural and Lombok, Indonesia,” Agricul- ing Paper, Wageningen University. Economics 95(3): 628-649. tural Economics 33(s3): 513-525. Bolwig, S., P. Gibbon, and S. Jones. Michelson, H.C., T. Reardon, and F. Singh, S. 2002. “Contracting Out 2009. “The Economics of Small- Perez 2012. “Small Farmers and Solutions: Political Economy holder Organic Contract Farming Big Retail: Trade-Offs of Sup- of Contract Farming in the In- in Sub-Saharan Africa,” World De- plying Supermarkets in Nicara- dian Punjab,” World Development velopment 37(6): 1094-1104. gua,” World Development 40(2): 30(9): 1621-1638. Briones, R.M. 2015. “Small Farmers 342-354. Stiglitz, J.E., and A. Weiss. 1981. in High-Value Chains: Binding or Maertens, M., and J.F.M. Swin- “Credit Rationing in Markets Relaxing Constraints to Inclusive nen. 2009. “Trade, Standards, with Imperfect Information,” Growth?,” World Development 72: and Poverty: Evidence from Sen- American Economic Review 71(3): 43-52. egal,” World Development 37(1): 393-410. Dedehouanou, S.F.A., J.F.M. Swin- 161--178. Wang, H.H., Y. Wang, and M.S. nen, and M. Maertens. 2013. Minten, B., L. Randrianarison, and Delgado. 2014. “The Transition “Does Contracting Make Farm- J.F.M. Swinnen. 2009. “Global to Modern Agriculture: Con- ers Happy? Evidence from Sen- Retail Chains and Poor Farm- tract Farming in Developing egal,” Review of Income and Wealth ers: Evidence from Madagas- Economies,” American Journal 59(S1): S138-S160. car,” World Development 37(11): of Agricultural Economics 96(5): Elabed, G., M.F. Bellemare, M.R. 1728-1741. 1257-1271. Carter, and C. Guirkinger. 2012. Miyata, S., N. Minot, and D. Hu. Warning, M., and N. Key 2002. “The “Managing Basis Risk with Mul- 2007. “Impact of Contract Farm- Social Performance and Distribu- tiscale Index Insurance,” Agricul- ing on Income: Linking Small tional Consequences of Contract tural Economics 44(4-5): 419-431. Farmers, Packers, and Supermar- Farming: An Equilibrium Analy- Fafchamps, M. 2004. Market Insti- kets in China,” World Develop- sis of the Arachide de Bouche Pro- tutions in Sub-Saharan Africa, ment 37(11): 1781-1790. gram in Senegal,” World Develop- Cambridge, MA: MIT Press. Narayanan, S. 2014. “Profits from ment 30(2): 255-263. Participation in High Value Ag- Glover, D.J., and K. Kusterer. 1990. Marc F. Bellemare (mbellema@umn. Small Farmers, Big Business: riculture: Evidence of Heteroge- neous Benefits in Contract Farm- edu) is Associate Professor and Direc- Contract Farming and Rural tor, Center for International Food and Development, St. Martin’s Press, ing Schemes in Southern India,” Food Policy 44: 142-157. Agricultural Policy, Department of Ap- New York. plied Economics, University of Minne- sota, Saint Paul, MN.

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