Increasing the benefits to smallholders from contract farming: Problems for farmers' organizations and policy makers

0305-750x/87

World Development, Vol. 15, No. 4, pp. 441-448,1987. Printed in Great Britain.

$3.00 + 0.00

0 1987 Pergamon Journals Ltd.

Increasing the Benefits to Smallholders from Contract Farming: Problems for Farmers’ Organizations and Policy Makers DAVID

International

J. GLOVER*

Development

Research Centre, Ottawa

Summary. -

Contract farming (CF) is potentially beneficial to small farmers, providing services not readily available by other means. In reality, growers frequently face serious problems in dealing with firms, indicating the need for intervention by government or by farmers’ organizations. However, the hybrid structure and multip!e objectives of CF schemes make it difficult to organize farmers or to design effective policy interventions. This article describes some of the most frequent problems, points out trade-offs among competing welfare goals and cautions against the use of CF as a simple model for agricultural development.

1. INTRODUCTION’

steady level close to plant capacity. Relying on open market purchases is unlikely to achieve this. Contracts, on the other hand, can specify planting dates (and thus, indirectly, delivery dates) as well as total quantities to be delivered. The contract reduces much of the uncertainty that would exist if the company simply bought crops on the open market and provides some control over the production process (for example, over the variety grown). On the other hand, the company does not have to invest in land, hire labor or manage large-scale farming operations which may tax the managerial capacity and technical expertise of a primarily industrial firm. There is no reason, of course, that the firm cannot use more than one method of obtaining supplies and some firms rely on company farms, contract growers and open market purchases as well. The contract also provides certain advantages for the grower. He or she has an assured market for the crop, access to the company’s services, and easier access to credit. Even in cases in which the firm itself does not provide loans to its growers, banks will generally accept a contract as collateral. In fact, the credit-facilitating aspect of the contract is often the farmer’s principal motive for signing up.2

Current efforts to improve agricultural performance in LDCs tend to emphasize two instruments: technological innovation and alteration of the macro policy framework. While both are usually necessary conditions, neither is sufficient. A third instrument, institutional innovation, also has an important role to play (Ruttan, 1978; World Bank, 1981). The organization of agricultural production and marketing (the latter including both inputs and outputs) will influence the extent to which new technologies are delivered and adopted, and the extent to which producers respond to price incentives. One institutional innovation being promoted in many LDCs is contract farming (CF). In this system, a central processing or exporting unit purchases the harvests of independent farmers. These purchases can supplement or substitute for company production. The terms of the purchase are arranged in advance through contracts, the exact nature of which varies considerably from case to case. Contracts are generally signed at planting time and specify how much produce the company will buy and at what price. Often the firm provides credit, inputs, farm machinery rentals and technical advice, and it always retains the right to reject substandard produce. Contracting is most commonly practiced by food processing firms. Since their processing plants have high fixed costs, these firms have an interest in keeping raw material inflows at a

*The views expressed are those of the author necessarily those of IDRC. 441

and not

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Goldsmith’s (1985) review of 12 case studies of CF found a significant positive impact on rural incomes in almost every case. These changes resulted from a combination of increased productivity and increased cash sales. Precise quantitative measures of income changes were lacking, however, and most studies indicated uneven impact among scheme participants. Contract farming combines some of the advantages of the plantation system (strict quality control, close coordination of interdependent stages of production and marketing) with those of smallholder production (superior incentives, equity considerations) (Williams and Karen, 1985). This apparent combination of efficiency and equity has made CF highly attractive to some LDC governments and many donor agencies. There is now a proliferation of CF schemes throughout the developing world, some run entirely by private enterprises, many involving government and aid agencies (Dinham and Hines, 1983; Minot, 1986). All these characteristics make it difficult to fit CF into simple typologies. Paige (1975), for example. has tried to link specific forms of political behavior to particular commodities, with technologically determined production systems as the intervening variable. In Paige’s analysis, certain characteristics of sugar cane, for example, normally lead to plantation production and trade unions and thence to reformist labor movements. CF does not fit any of the categories in Paige’s typology, however. It has characteristics of both plantation and smallholder production. Furthermore, in many cases, it must fulfill the multiple and often conflicting objectives of its various dominant partners (Rama, 1985). The aid component of many schemes requires them to meet certain equity and development goals as well as to maximize profits. The form taken by CF also varies widely from case to case, most frequently in accordance with the technological imperatives of the crop in question. Contracts vary in intensity. depending in part on the perishability and quality requirements of the product. Finally, there is often considerable variation in the socioeconomic characteristics of the farmers involved in any given scheme and corresponding variation in their participation in the scheme’s benefits. Empirical evidence indicates, not surprisingly, that the conflicting objectives are not always met. In some cases, development objectives have superseded profitability criteria and the projects have not been economically viable. In other cases, market imperfections (most frequently monopsony) combined with an overriding goal of short term profit maximization on the part of the

firm, have resulted in serious problems for small contract farmers. The next section of this article provides examples of the kinds of problems frequently encountered by contract farmers. The list is indicative rather than exhaustive and serves to demonstrate the frequent need for intervention, either by government or by organizations of growers themselves. The article’s central argument is that the hybrid structure and multiple objectives of contract farming schemes frequently make it difficult either to effectively organize farmers or to design effective public policy interventions. The article concludes on a cautionary note about the widespread applicability of CF as a development tool.

2. PROBLEMS

FOR GROWERS

Contract farming can present a variety of problems for growers. Many of these arise from the difficulty of coordinating the production and deliveries of many farmers in such a way as to ensure an optimal flow of raw material. These coordination problems result from three sources: (a) failure of growers to comply with company instructions; (b) the company’s lack of physical or manageral capacity; (c) exogenous variables, principally weather. An example of a coordination problem is the competition for company-owned machinery at harvest time; growers must often wait until the firm has completed its own harvest before obtaining access to the equipment. Coordination problems are not the only ones faced by growers in dealing with agro-industries, however; companies may also attempt to manipulate or take advantage of their suppliers. This type of problem is probably the more interesting, but it is often difficult to tell whether manipulation or lack of coordination is occurring. An example from the author’s fieldwork in Panama may clarify this point. Farmers delivering tomatoes to a processing plant often found themselves waiting at the gate for up to a day and a half. During the delay, the tomatoes would lose weight due to evaporation and the company would then receive a more concentrated product for the same price per pound. Longer delays resulted in spoilage and a higher reject rate. The company insisted fairly persuasively that this was a coordination problem which occurred because of weather and because growers had not followed their assigned planting dates. A government investigation of the point was inconclusive and

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many growers continued to suspect that the delays were staged in order to manipulate the effective product price. In cases where growers are in a weak bargaining position when signing a contract or do not fully understand the contract’s implications, the company may be able to draw up an agreement which, strictly enforced, will allow it to manipulate its suppliers. More commonly, however, the contract is superficially equitable, but is circumvented by the company. Sometimes this involves breaking one of the provisions of the contract, though not always. Few contracts are “perfectly contingent” and a number of variables are usually left open. For example, some processors reserve the right to “call up” deliveries from growers at dates chosen by the processor. While companies usually describe their orders to deliver as simple coordination decisions, it is also possible to use the best delivery dates as rewards for favored growers. Some contracts and contracting situations allow more scope for favoritism than others, but this element is almost always present to some degree. Finally, one must distinguish between manipulation by the firm itself and manipulation in the self-interest of individual employees. Inspectors are notorious for demanding bribes, for example, even though this creates quality control problems for the company. Company fieldmen have also been known to take kickbacks on input sales and to recommend excessive applications in order to maximize those kickbacks (Kusterer, 1981). Other examples of problems encountered by growers include the following: Manipulation of inspection standards to control deliveries. (If production exceeds the firm’s requirements, it may surreptitiously raise its quality standards in order to reject excess production: Glover, 1984; Scott, 1984.) -

Poor technical assistance. (Most contracts require growers to follow the company’s advice, but absolve the firm of responsibility for the results: Glover, 1984; Laramee, 1975.)

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Tying one contract to another. (In cases where the company purchases more than one crop, growers may be pressured to sign a contract in crop A in order to get one in crop B: Glover, 1983.)

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Cheating or insufficient specification in growers’ accounts. (The company may charge growers for goods and services not actually delivered, or fail to specify quan-

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etc.: Odada, 1984.)

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tities, dates, 1985; Scott,

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Late payments. (Delays of up to two years have been recorded, a problem of particular severity where inflation is high: INA/IICA, 1980; Odada, 1985.)

3. POLITICAL RESPONSES CONTRACT FARMERS

1985; Rama,

BY

In cases where individual growers are dissatisfied with their relationship with the company, a very common response is to attempt to form a growers’ organization. The contracting situation typically contains some elements which undermine those efforts and others which further them. One of the factors which impedes organization is the frequently heterogeneous composition of the contract growers (Development Alternatives Inc., 1975; Rama, 1985; Scott, 1984). In Honduras, for example, firms contract with peasant farmers, large absentee landlords, and modern business farmers (Glover, 1986). The interests of these various types are quite diverse and this seriously impedes efforts to organize politically. Most significant is the presence of absentee landlords who often plant sugar simply to keep the land in production and thus immune to expropriation under the agrarian reform law. In some cases, these absentee landlords are simply “front men” who turn over de facto control of their farms to the company (NACLA, 1976). They are not particularly concerned about the product price and may even settle for a small loss on the contract as an alternative to losing their land. These growers have little in common with the profit-oriented growers and do not want to be bound by any collective agreement a bargaining group might negotiate. Generally, when agro-industrial firms concede higher prices in such agreements it is only in return for higher yields, higher quality standards, regular deliveries and so on. While the progressive farmers might benefit from such an agreement, traditional landowners would be sure to lose. The author has encountered several cases in which the presence of non-profit-maximizing growers among the firm’s suppliers has been a major organizational problem. It is possible that firms deliberately include such growers among their suppliers for this very reason. Another split which has undermined grower solidarity is that between simple producers and producer/shippers. This split was found in New Brunswick, Canada (Glover, 1983) and among

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Ecuadorian banana producers (Clover, 19X3; Larrea et d., 1986). In the potato industry in Eastern Canada and the banana industry of Ecuador, some producers also purchase produce from other growers and sell it to exporters. Exports provide an alternative outlet for growers who do not have contracts and for varieties not purchased under contract. In both countries, producers have attempted to form broad-based organizations involving all producers, regardless of their ultimate market outlet. However. producer/shippers have access to market information that simple producers do not and are therefore in a position to take advantage of the latter. Since they can always sell their own produce, they have no interest in reforms designed to improve the market access of small growers; in fact, they oppose such reforms since they use simple producers as reserve suppliers. Nor do they favor measures that would stabilize the market, since fluctuating prices provide these shippers with the opportunity for speculation. The interests of simple producers and producer/ shippers are quite divergent, yet it is politically very difficult to exclude the latter from growers’ organizations. When they are included, they tend to dominate the association and subvert its goals as perceived by the simple producers. Just as the diversity of interests among farmers has presented difficulties, so have the ambiguous interests of individual farmers. While growers may perceive the long-term benefits of organizing themselves. the contracting relationship also encourages individual interest promotion. As mentioned, no contract is perfectly contingent and each gives the firm room to provide some growers with better conditions than others. This encourages growers to cultivate friendly, even personalistic relations with the company and to refrain from antagonizing it by joining growers’ organizations. In New Brunswick. leaders of the National Farmers Union (NFU) tried to form a broad-based potato growers’ organization of the type described above. NFU leaders said that, initially, contract growers were the easiest to organize. These growers had a visible, concrete adversary to focus on (the firm) and specific complaints against it. Once it came to take concrete action, however, these same growers were the first to back out. The processing firm provided a focus for resentment, but it was also the sole source of income for these growers. If we can generalize from this case, the vulnerable position of many contract growers appears to arouse resentment at the same time as it inhibits risk taking. On the other hand, there are elements in the situation which promote grower organization,

particularly when a fairly homogeneous group of small growers is involved. In such cases, issuing instructions and inputs to growers and seeing that planting and harvesting dates are observed can be difficult when hundreds of dispersed growers are involved. Some kind of growers’ organization is usually helpful and in some cases the companies involved have actually encouraged the formation of such groups (Development Alternatives Inc, 1975; Dew, 1976). One firm operating in Guatemala stated that it would no longer go into a new production zone unless a cooperative already existed there that it could work through (Kunsterer, 1081). Cooperatives formed by growers, with or without company encouragement, have in some cases restricted themselves to their original function and, in others. taken on new tasks, such as the collective production or marketing of other crops. Any contracting situation contains elements which promote grower organization and others which impede it and the “net effect” is certain to vary from case to case. Furthermore, while firms often find growers’ organizations useful, local governments frequently perceive them as threatening and sometimes attempt to discourage their formation or control their activities. The most likely typical outcome of these conflicting pressures might be the formation of a growers’ organization, but one that is either fragile and beset with internal splits or one that is under the control of the company or the government and which serves mainly to enhance communication with growers. Finally, it should be emphasized that the relationship between firm and growers is a dynamic one. Firms frequently offer favorable terms to growers in the early stages of an operation in order to attract suppliers, but arc unable to sustain those terms in the longer run. This common phenomenon has been referred to as “agribusiness normalization” (Kusterer. 1982; Rama, 1985). If an arrangement that is initially favorable to growers deteriorates, farmers “locked in” by debt, specialization, or the disappearance of other markets will find it difficult to extricate themselves. On the other hand, even an unfavorable situation *can have positive long-term consequences if farmers can learn from the experience and if they have the freedom of maneuver to apply the knowledge gained (Scott, 1984). A will make “trick” clause in a first contract growers look at subsequent contracts very carefully. A year or two with even an exploitative firm may teach farmers enough about cultivating a new crop to enable them to grow it for another market. The common experience of growing for

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a single buyer may also increase the cohesion of farmers to the point that they act as a group on issues unrelated to contract farming.

4. TRADE-OFFS

FOR POLICY

MAKERS

If efforts by contract farmers to defend their interests are ineffective, intervention by government would seem to be indicated. This, of course, assumes a government responsive to the concerns of small farmers. Frequently this assumption does not hold. Agribusiness firms may exert greater political influence than growers and even governments sympathetic to the latter may be forced to deal with problems more pressing than farmers’ welfare. For example, pressure to squeeze the agricultural sector for foreign exchange earnings is overwhelming in debt-laden countries and may lead to a shortterm coincidence of interests between governments and export-oriented firms. Furthermore, it is an oversimplification to speak of “the government”; one must distinguish among the often conflicting objectives of its various agencies. In a Honduran case, a private sugar mill purchased and processed the cane of local farmers (Glover, 1983, p. 197). The National Development Bank provided credit to growers, a second public agency set prices for the firm’s processed output, and the Ministry of Finance taxed its revenue. Each agency had a different objective with respect to producer prices. The Bank could be expected to favor a high producer price, since that would facilitate the recoupment of its loans to growers. If producer prices were high enough to reduce the firm’s profits, however, the Ministry’s tax revenues would be reduced. Furthermore, the price control agency’s interest would be in a low producer price, in order to keep the wholesale price of sugar down to a politically acceptable level. In such situations, simple goals like “maximizing smallholder welfare” are soon subordinated to the more specific objectives of individual agencies. In spite of these caveats, there is evidence that some LDC governments have intervened on behalf of small contract farmers. Rama’s (1985) survey of agribusiness in Latin America found many instances in which governments attempted to obtain better contract conditions for producers. This article assumes that such governments will continue to intervene and would benefit from more complete information about the effects of their interventions. The following paragraphs illustrate some of the difficulties that

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can arise in attempting to design effective policies. Apparent conflicts can arise over different welfare goals. For example, some evidence suggests that small contract farmers are most likely to benefit when they produce high value items, particularly for export to affluent developed country markets (Checchi and Co., 1977, 1978; Voll, 1980). (Specialty crops like off-season fruits and vegetables are an example.) If the firm exercises some market power in the final market, producer price increases can to some extent be passed on to consumers, owing to the relatively price-inelastic demand for seasonal luxury goods; thus there is room for bargaining over the distribution of excess profits. There is little such flexibility in situations where basic products are sold for low and often controlled prices in local markets. The apparent conflict is between two development objectives providing income and employment for farmers and satisfying the basic needs of consumers. Export agriculture has frequently been criticized for diverting resources away from local food production (George, 1976; Lappe and Collins, 1977; Wallace, 1980). Whether the apparent conflict is a real one depends largely on the extent to which international trade can be effective in redistributing production to meet basic needs. Even when government has clearly defined a single objective - increasing the welfare of small contract farmers - trade-offs and Catch 22s are common. For example, one might recommend that growers restrict themselves to crops with short growing cycles. since a long cycle tends to reduce the grower’s flexibility. Sugar requires a considerable amount of labor in the first year, but will produce for the next several years with much less labor; in fact it may take more work to uproot the cane, till the soil and plant a new crop than to harvest the cane. In such a situation, even if a contract deteriorates after the first season, a grower may be tempted to stick with it rather than abandon his investment (Scott, 1984). The corollary to this recommendation is that a short crop cycle or a short-term contract provides shorter term benefits when an arrangement is advantageous to the grower. It might also be the case that small farmers are most likely to benefit from contract farming in crops whose production technology is not undergoing rapid change. This has been cited as a factor in the apparent success of the Commonwealth Development Corporation’s outgrower schemes (CDC, 1984). It is reasonable to assume that small growers will find it more difficult than large ones to adopt innovations, because of

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inferior access to information or inputs, greater risk aversion or lower savings capacity. If so, the natural advantage of smallholders - superior land productivity - may be overwhelmed by the technological advantage of the larger growers (Berry, 1973). Moreover, under conditions of rapid technological change, a country or region’s comparative advantage in production, and with it the viability of a CF scheme, can disappear rapidly. The Catch 22 here is that one of CF’s most promising features is its effectiveness (relative to public extension systems in LDCs) in transferring technology to small farmers. To exclude small farmers from CF involving technologically dynamic crops is to exclude them from one of their few opportunities for exposure to new techniques. Furthermore, CF may be able to overcome some of the impediments to rapid adoption by smallholders (e.g., lack of access to credit, information or inputs). Research on this aspect of CF would be of broad theoretical interest in identifying such impediments by their absence. The availability of alternatives is one of the most important preconditions for a contract farming situation that benefits small farmers. If the policy context is a dynamic one if government has the means to increase alternatives - there is no conflict. If the context is taken as given, however, and the choice is where to introduce CF (in competitive or non-competitive environments), then a serious conflict does arise. Farmers who have many alternatives are generally the more prosperous ones anyway - the ones who need help are peasants who can only grow a couple of basic crops or have only one middleman to sell to. If we say that agroindustries should only be set up in areas where there are already abundant alternatives, we exclude the target group. Another equally tricky precondition for beneficial CF is that the company have no farms of its own. Clearly, a group of farmers who control 100% of a firm’s supplies will be in a strong bargaining position. On the other hand, company production has positive aspects (CDC, 1984; Phillips, 1965). A firm with its own farms will often have specialized machinery which it can rent to growers and better technical assistance than a company that is strictly a buyer. Only large growers could afford to buy specialized machinery and they are likely to be in less need of advice than small farmers. The policy recommendation that would maximize the growers’ bargaining power would also result in the exclusion of the target group. This contradiction appears even on the apparently simple issue of price. A high contract

price may not only drive the firm out of business, it will attract inefficient growers who should probably be producing a different crop. If the price is too low, on the other hand, only the most efficient producers will be attracted, and peasants who might be good growers if they got some help and experience will be shut out. Furthermore, the contracting relationship is not a “zero sum game”; the distribution of benefits between the firm and its growers can affect the total magnitude of benefits available. For instance, an increase in the contract price will redistribute income from firm to growers, but it may allow the company to achieve economies of scale and thus greater long-run profits. Investments in technical assistance to growers which result in better quality produce or more reliable deliveries can similarly benefit the firm. The point is fairly obvious but deserves emphasis. The ‘non zero sum” character of the relationship makes it difficult, even in theory, to arrive at a distribution of profits that will maximize the long-run benefits to growers. If the firm is “pushed back” to a profit level just adequate to keep it in business, it will not be able to expand or set up other plants. The benefits from contracting, such as they are, will go to existing growers and not to new entrants. Obviously, devising policies in this area is quite tricky. In addition to the types of conflicts just mentioned, there are serious difficulties involved in policing a contract. Many of the variables, such as with whom to contract, are under the firm’s control. It would be impractical to tell firms they cannot deal with absentee landlords, for example, especially when one of the goals of agricultural policy in many LDCs is to modernize these landlords and get them to produce commercial crops. Another problem is that most contracts involve too many variables to police effectively. Even if one can decide on a suitable price and fix it in the contract, as suggested by Scott (lY84), there are many ways the company can get around it. It can manipulate quality standards, cr raise the prices it charges for inputs, or delay payments and collect the interest in the meantime. If the firm really wants to sabotage the contract, there are a dozen ways to do it. There is probably not a great deal a government can do to police a contract and it should definitely not impose contracting on an unwilling firm or in an inappropriate situation. A more promising approach than attempting to intervene in existing situations is to undertake more careful ex ante appraisals, drawing on lessons from successful and unsuccessful experiences. Research should attempt to define the conditions under which CF can operate profit-

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ably and to the benefit of small farmers without intervention. For example, it is fairly clear that the preferred crops are those which do not require specialized machinery. Growers who have invested in such machinery can be effectively locked in to growing a particular crop, even if prices or relations with the company deteriorate. It is a truism, but one frequently ignored, to say that smallholders are most likely to benefit when producing crops suitable for smallholder production. Many schemes have attempted to involve small farmers in crops better suited to plantation production, with poor results. An extreme case is Honduras, where the government in the mid-1970s required all agro-industries to purchase at least some of their raw materials from outgrowers. In cases where firms could have grown their own crops more cheaply, the

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result was ill will and mistreatment of contract growers. It is entirely possible that these companies were, in fact, trying to sabotage their contract arrangements in the hope that the government would retract the legislation. There is a need to systematically examine successes and failures and from them draw generalizations about the conditions under which CF can operate profitably and to the benefit of small farmers. Our expectations should be realistic about the degree to which policy interventions can alter the outcome of fundamentally unworkable situations and about the appropriateness of CF as a panacea for the improvement of smallholder agriculture. Defining an appropriate niche for smallholder contract farming is an ambitious enough goal and one whose benefits would be substantial.

NOTES 1. This paper further explores some of the issues raised in a previous article in this journal (Clover, 1984); contract farming is defined and described more extensively therein. It is based on the author’s fieldwork (Clover, 1983) and secondary sources as cited. Fieldwork consisted of case studies of contract farming carried out in New Brunswick (Canada), Honduras, Panama and Ecuador. The time devoted to each case study varied between three weeks and three months

and involved interviews with farmers, traders, company managers and technicians, government officials at the site and in the capital, researchers and journalists. Further details on methodology can be found in Clover (1983, pp. 14-21 and its Appendix).

2.

The preceding three paragraphs are excerpts from

a longer discussion farming in Clover

of the economic (1984).

logic of contract

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