Ibrahim Seaga Shaw

Contract Farming: The Cost/Benefit Conundrum for Africa - 15/08/2002

Paris, France

 

The evolution of Agrarian policies in Less Developed Countries ( hereafter LDCs) from a predominantly subsistent level carried out by small-scale peasant farmers to a more diversified production of crops for export has in the recent past seen the increasing participation of Trans-national corporations (hereafter TNCs) by way of `contract farming` (hereafter CF) with LDC farmers, especially in sub-Saharan Africa.

Thus this system of farming represents a monumental link between LDCs and the rest of the global economy dominated by the West. In the current scheme of things, each LDC is perforce integrated into the world economy by of way trade and Foreign Direct Investment (FDI)

Orthodox neo-classical economists see this relationship as mutually beneficial evident in the harmonious interdependence between the First and Third worlds. Many people in the Third world reject that view, however. They see it as a way by which the former asserts its dominance, and confines the latter to a subordinate position in the world economy. In line with this thinking is the Dependency theory which describes it as a `barrier to development`. Radical economists have even gone the extra mile to dismiss TNCs as a modern form of imperialism.

 

CF is an intermediate institutional arrangement that empowers TNCs to participate in, and exert control over, the production process without owing or operating the farms.(Key & Rusten: 1999, p 383). It is an institutional response to imperfections in markets for credit, insurance, price and product information, factors of production, and raw products; and in transaction costs associated with search, screening, transportation of goods and services, price and product bargaining and enforcement.


The shot callers in CF are the TNCs or firms who serve as the middlemen or traders between the LDC farmers and the consumers. The local and foreign firms are more or less part of the `marketing chain` made up of buyers and sellers from farmer to consumer. Local firms buy produce from the farmers, process and sell them first by whole sale, and later by retail, TNCs buy produce, process and export. The chain operates thus:

 

LOCAL FIRMS: Primary procurement--Processing-wholesale-retail
TNCs: Primary procurement-Processing-Export


Some LDC governments have generally blamed traders for exploiting consumers by charging higher prices, far above those received by farmers. Most LDC governments, especially those in Sub-Saharan Africa have tended to use this exploitation as a perfect alibi to justify state-ownership of the marketing system a la state marketing boards. These boards however became less common in most LDCs in recent years.

Neo-classical economists are less keen on the idea of state intervention championed by the left wing or marxist dependency school. They prefer to leave the marketing chain to private traders only intervening to encourage more competition in private markets.

Since most LDCs, especially in Africa, were forced by international financial institutions such as the International Monetary Fund and the World Bank to pursue policies of trade liberalisation to qualify for loans, multilateral and bilateral aid, state marketing boards like most other institutions of state intervention began to give way to the private sector which quickly came to be dominated by TNCs. LDC governments were therefore asked to pursue out-ward oriented policies aimed at using export as 'engine of growth'. They were therefor faced with the choice of following this path of development or continue with their 'inward oriented policies' geared towards national self-reliance.

Desperate to survive the financial crisis that became the order of the day in most LDCs in the 70s and 80s, third world governments found it difficult, if not impossible, to escape the whirlwind of the so-called free trade blowing across the world economy. By kowtowing to the carte blanche of the Britton Woods duo (IMF& World Bank), whose shots are willy-nilly called by TNCs, LDC governments had more or less auctioned their countries' economic sovereignty to the crazy world of globalisation dominated by western powers.

On the other hand, however, free trade-though not necessarily benign-has, in the eyes of the neo-classical economists, often played a crucial role in the evolution of economic development in the world of the second best. This theory is of course based on the theory of comparative advantage, which encourages a country to specialise in producing certain products for export in which it has comparative advantage in relation to its factors of production-land, labour and capital-to pay for imports. Thus international specialisation, value-added agricultural products and labour saving are some of the benefits accruing from free trade.


But it has been argued that while CF promises significant benefits for farmers in many cases, recent studies have revealed circumstances to the contrary.

In looking at the benefits and costs of CF on LDC economies in sub-Sahara Africa, like other parts of the third world, one may need to search for answers to important questions such as: Where LDCs better off before the introduction of CF by TNCs? Did or do LDC farmers have better prices for their produce? Did or do they have access to credit and technological assistance …and so on and so forth?

It is in the context of the possible answers to some or all of the above questions that one may possibly arrive at the benefits and costs of CF to LDC farmers in particular, and their economies as a whole.

Development thinking on the cost/benefit analysis of CF is expectedly divided into two ideological blocs-the right wing represented by the Neo-classical economic theory on one hand, and the left wing represented by the Marxist/dependency theory paradigm.

It has often been argued that the left's usual view of the role of the state as the guardian of vested social (class-based) interests runs counter to the rights' hypothesis of the free market economy. The right has constructed it's own political economy of the state from the weaknesses and policy failures of state intervention aimed at promoting national well being.

An important phase in the evolution of development thinking in recent years was the emergence of the mainstream economic theory which of course quickly ballooned into the New Right or Left of Centre depending on the situation.. This position, which agrees or disagrees with either side of the divide in the name of promoting economic development, has however been lampooned for leaning more towards the right.

While the Neo-colonial economists believe that there are more benefits to be accrued from CF, those of the Marxist dependency school think that there are more costs involved in it for LDCs.

 

ECONOMIES OF SCALE OR WEALTH ACCUMULATION

Neo-classical economists have argued that CFs often associated with economies of scale -in marketing, purchase of inputs, technical expertise etc-all to make LDC farmers achieve large-scale production at a little cost in terms of inputs or factors of production such as land and labour.

In his study of the experience of contract farmers in Indonesia's West Java province, for example, Ben White agrees that the 80s and 90s saw the steady growth of `food and commercial crop production…stimulated by various structural adjustment and deregulation measures which accelerated the transition from import substitution to export orientation`. (Hill, 1995).

Sheila Bhalla's 1999 study of the Indian Agricultural state of Haryana is among the most apt examples of economies of scale influenced by CF. It is the only Indian state which has combined high farm output growth rates with an absolute decline in the number of workers engaged in agriculture during the liberalisation era.

But in the eyes of the dependency theorists, the economies of scale only go to increase the profits and wealth of the rich ruling and corporate class at the expense of the rural poor.

Echoeing this line of thinking Bhalla wrote: 'Most important, what the Haryana case demonstrates is that the ultimate enemy of the poor in this context is the tendency of the new economic policy to generate gross inequality-not the straightforward kind where most people get better off, but the benefits of growth accrue more to the rich than the poor, but the real mean kind where the relatively rich get richer and the poor get poorer, not just in relative terms, but absolutely. No economic policy can be called efficient in third world countries if it does this to people whatever else it may achieve in other areas.'

There is also the case of Ivory Coast where large scale agricultural production by CF only succeeded in ushering in what Samir Amin refers to as 'growth without development' benefiting only the ruling class and the large plantation owners at the expence of the rural poor.

It is therefore becoming increasingly clear that while CF promises to deliver a bucketful of benefits for LDC farmers, recent surveys monitored by Key & Runsten in 1999 have only proved that members of the rural population have reached only limited gains or have been directly harmed by CF.

Taking the dependency pool of reservation on CF some notches up the ladder, Ben White, writing in 1997, argueed that the interest of large-scale capital and international agencies in `small peasant` (family-farm) forms of production represents an attempt to subjugate them to capital in a form which allows the surplus profit from agricultural modernisation to be captured not as profits for direct producers but as profits for the `core`, and transforms peasants into a class of virtual `development peons'.

 

ACCESS TO CREDIT, TECHNICAL ASSISTANCE OR ECONOMIC IMPERIALISM AND `MONOPSONY`

Access to credit and technical assistance has often been advanced to justify CF as an ideal agricultural path for LDC farmers to follow. The emphasis laid by CF on the production of crops for export makes it possible for contract farmers to get access to bank credits. In most cases credit contract is, according to Key and Runsten, transacted `at the same time as the farming contract and does not require any trips to a bank-administrative costs are minimised and the borrower can avoid notary and other collateral fees`.

On the other end of the spectrum, the cost LDC farmers have to pay for this credit, however, is the below market prices which they charge the TNCs for their raw agricultural product. `Hence, credit market transaction costs present an incentive for firms to contract rather than use spot markets…Firms can earn the highest returns to their financial services from these growers willing to pay the most for credit ( Key &Runsten: 1999, p384).

But that is not all. Another cost that goes hand in glove with this credit windfall is that most agro-industrial TNCs process or pack crops for which there is little or no local market. The LDC farmer therefore loses out when market distortions force firms to change `contract` crops. Examples of such crops in Mexico include broccoli, basil, special melons and kabota squash.

Neo-classical economists also point at technological and marketing assistance as an advantage for contract farmers. Agro-industrial TNCs have emerged as the most dynamic path to economic growth and social development where technology and marketing strategies are transferred to LDCs.


But in the eyes of the Dependency school, there is equally an inherent cost in this benefit. We often see that the farming systems that agro-industrial firms transfer to developing countries reflect the relative prices of labour and capital prevailing in the countries where the technology was developed. Moreover, a large chunk of the machinery and agro chemicals, including fertilizers, genetically modified seeds, herbicide etc are labour saving and capital intensive largely favouring wealthier farmers.

This situation has the double-bubble problem of putting small-scale peasant agriculture at a competitive disadvantage relative to large-scale production.

Another inherent cost of this much-hyped technological benevolence is the almost forgotten issue of inappropriate technologies and products. TNCs are generally seen as costly and highly imperfect organs for the transfer of technology to LDCs.

Along this line of thinking Stuart Corbridge (1986) agrees with firebrand critic, Vaitsos, who says:…a more acceptable form of transfer may lie with unbundled licensing and patenting agreements which, for all their shortcomings relieve the purchasing government of the necessity to buy an entire technology package (which in any case will remain under TNC control. (Vaitsos: 1973)

Agro-industrial firms have also been accused of introducing the `wrong products into the Third world. Richard Peet talks about cultural imperialism`, peet, 1982, p. 297). Thus the firms `take their product decisions with respect to their own international factor environments…. quite at odds with the factor proportions appropriate to LDCs. Corbridge: 1986,p 165)

Another cost is inevitably buried in the tendency of contracting TNCs to use both promotional activities and naked blackmail in hiring farmers to abandon traditional seeds and switch to company-controlled seeds. Promoted as high yielding and disease resistant, the company seeds appear tempting to the multinationals, which make the buying of this seed variety by the former a condition of the contract.

Transfer pricing, which is one of the ways TNCs transfer excess profits to their home countries, is very much evident here. There is always a large-scale intra-firm trade involved in the transfer of inputs and outputs for CF owned by one TNC parent company.

A TNC can, for instance, according to Diane Elson (1995) transfer funds from a particular country by `raising the prices it charges for inputs (seeds, fertilizers) `to its subsidiary in that country; or by lowering the price it pays for outputs`(value added exports) from that subsidiary.`. Thus here prices are not determined on an open market with independent and competing buyers and sellers at arms-length. While the contract farmer and the LDC get a raw deal, the TNC, which transfers its huge profits emerges as the ultimate winner in the whole transaction.

 

EMPLOYMENT OR UNEMPLOYMENT


There has often been a tug of war between the neo-classical economists and dependency theorists in associating with increasing employment on one hand and unemployment on the other.

On the benefit side, CF may create positive multiplier effects for employment, both in the farm and non-farm sectors in the local economy. Bhalla's study of the Indian agrarian state of Haryana offers a most apt example of this claim. Bhalla (1999, p28) asserts that by 1993-94, although `labour productivity had risen in both sectors, the figure for the non-farm sector had gone up to more than four times that for agriculture in India as a whole.

Bhalla claims that even though at the all-India level, the gap between farm or non farm labour `grew wider and wider` from the 50s to the 90s,…Haryana managed to move against the stream with the help of CF.

Bhalla adds:The Haryana workforce urbanised at an exceptionally rapid rate. Moreover, Haryana also was one of the very few states where, even in rural areas, non-farm employment grew fast enough during the 1970s to regain all the ground lost during industrial years, and more. (Bhalla: 1999, p29)

On the other extreme, however, CF has been dismissed for creating more unemployment and major disruptions in farm households `especially between Male head-of -households and their wives and children.(Carney & Watts, 1990). Moreover recent experiences in Latin America, Runsten & Key claim that despite the highly labour intensive nature of most processed crops, many firms shun small holders, preferring to farm with larger capitalised growers.

The `capitalist` nature of CF may also be at odds with the interests of women in agricultural development. While peasant farming involves the whole family, farm workers in CF are usually male. As expected, a male-head-of household may have more sway over his wife if he negotiates a contract with a TNC (Taussig: 1992)

In his study, Bhalla (1999, P46) also admits that the `share of the rural workforce` in Haryana, as well as its real wages on one hand, and rural poverty on the other, went up at the same time.

Kaplan & Kaplinsky (1999) take this thesis of jobless output and export growth some steps up in their soul-searching study of South Africa's Decidous Fruit Cannning Industry (hereafter DFCI). They claim that despite South Africa's average growth rate of 3% since its transition from apartheid rule in 1994, this has had no impact in reducing the country's unemployment-South Africa is said to have "one of the worst unemployment problems in the world" (Fallon and Lucas: 1998, P.1). And this despite DFCI exports accounting for 32% of the country's 1990-94 exports.


SPECIALISATION, TRADE LIBERALISATION OR MARKET DISTORTIONS & ENVIRONMENTAL DEGRADATION

As I emphasised earlier in this essay, it is in this domain that the fiercest crossing of swords between the Right and Left in development thinking has taken place. But for the purpose of this survey, I would limit myself to where it directly relates to CF in LDCs

On the benefits front, neo-classical economists argue that with free trade-the elimination of all trade barriers-will make domestic prices equal to world prices. Weeks (1999, p 49) claims that ` this results in an increase in the output of the product whose price has risen, and a decline in the output of the product whose price has fallen (Specialisation). Domestic demand for each product no longer equals the production of each. Supply-demand equilibrium is achieved through international trade, which results in welfare gains… It is this line of argument that yields the generalisation that a policy shift towards free trade will result in a country realising its comparative advantage`

For CF to thrive in LDCs, the above thesis of trade liberalisation must hold sway.

In his study of African governments' intervention in the market, Bates (1995, p156) states that they do so `in an effort to lower prices. They adopt policies, which tend to raise the price of the goods farmers buy. And while they attempt to lower the costs of farm inputs, the benefits of this policy are reaped only by few rich farmers. For this, and other reasons, mainstream economists dismiss state intervention as adverse to the interest of farmers. Before the introduction of contract farming in most LDCs in Africa, state marketing boards were very common. The model below explains better.

Table 1:

MARKETING BOARD CONTRACT FARMING
Farmer Farmer

LDC state marketing board TNC
 
World Market (e.g TNC) DC supermarkets

DC Supermarkets


Bates further admits that in their pursuit of industrial development, LDCs in Africa need revenues and foreign exchange, and African governments therefore had no alternative but to intervene in markets in an effort to set prices in a way that transfers resources from agriculture to the `industrialising sectors of the economy'.

But enter CF, state intervention via marketing boards gave way to capitalist intervention via TNCs in this crazy world of globalisation. This brings me to the most neck-breaking cost of CF where the whole big noise of specialisation and trade liberalisation is merely reduced to one big joke-Market distortions-that for all intents and purposes favours the DCs against the LDCs.

Kaplan and Kaplinsky (1999) offer one of the most striking examples of these market distortions in the study of canning industry in South Africa. Thus the desperate bid to adjust to the demands of globalisation rendered most LDCs vulnerable to the whims and caprices of DCs. These demands include the lowering of trade barriers, removal of state subsidies on agriculture, and of course, replacing state marketing boards with agro-industries or firms. Mainstream economists claim that where this specialisation is in resource-abundant sectors, then the gains to welfare and growth will be upped. But Kaplan & Kaplinsky (1999, p1787) claim that the `dangers posed by globalisation are that remaining market imperfections will make it difficult to appropriate these potential benefits…`

Thus the global organisation of production and exchange makes it difficult for South African food canning producers to realise their potential comparative advantage. This, claims Kaplan & Kaplinsky (1999, p1788), `has implications not just for firm specialisation and government economic policy, but also for the general relevance of much of mainstream economics to economies operating in a world of the second best.`

A most apt example of market distortions is evident in Kaplan & Kaplinsky's study where despite South Africa's DFCI being both a low-cost and high-quality producer of canned fruits, its share of global production has significantly dropped in recent years.

Table 2

Buyer ranking on scale of 1-5 (1=lowest, 5=highest) 

 

  S. A. Spain Australia Greece N. Italy S. Italy
Visual 5 4 3 3 4 2
Colour 5 4 3 3 4 2
Taste 3 4 4 4 4 2

 

Source: Interview with Chief Buyers at a large European Importer, May 1999 (Kaplan & Kaplinsky: 1999, p 1789)(Surprisingly, "taste" does not appear to be as important as other quality attributes in this sector)

They further argue that: Given cost and quality advantages, it might be expected, therefore, that the South African DFCI would be expanding at the expense of high cost and lower quality competitors such as Greece, Spain and Italy. Yet the trend of global production has been in favor of the relatively uncompetitive producers. Despite its comparative advantage, South Africa's share of global production has been falling, as has its share of the EU market. The major beneficiary has been Greece, with Spain and Italy also registering substantial improvements in output. (Kaplan & Kaplinsky: 1999, p 1789-1790)

These market distortions in favour of DCs therefore explain the falling international market share of the lowest cost/ highest quality South African producer and of course the tightening of its profit margin. Kaplan & Kaplinsky claim that the primary factors determining changing patterns of global production shares are the European Union's trade and Common Agricultural Policies (CAP). These provide significant gains to European producers, both on the output side (via protection) and on the input side (via subsidies).`

What beggars belief from all this is while the rich DCs in the North impose trade barriers and provide subsidies for their producers, they force LDC governments to liberalise as a pre-condition for foreign aid and investment. This is grossly unfair and it is at the centre of the cost of CF as the basis of an uneven playing ground in favour of DCs against LDCs.

Another cost of this so-alled trade liberalisation aspect of CF is the inherent environmental degradation syndrome.In their study of Thailand, (laherty, Vandergeest and Miller, 1999), they discovered that the conversion of or rice paddies to shrimp ponds`raises serious concerns over the potential for environmental degradation, resulting in increased marginalisation, exclusion, and pauperisation.`


THE WAY FORWARD

As argued by dependency theorists such as Kaplan & Kaplinkky (1999), policy prescriptions which are being followed by LDCs such as South Africa to reduce trade barriers and to deregulate industry governance structures, may make sense when all countries follow similar policies. But when major DC competitors continue to pursue highly protective policies in areas where LDCs have a clear comparative advantage, the consequences of liberalising may be adverse for the latter.

When all is said done, there needs to be level playing ground where the relationship between TNCs and LDC farmers and governments should be one of mutual trust and equal partnership needed to create a striking balance between the maximisation of profits by the former and attainment of sustainable and human face development by the latter.

I think to achieve this balance LDCs need to pursue South-South trade, regional agro-economic integration, international product cartels, co-operatives among farmers, trade barriers and subsidies to protect LDC economic interests as DCs do when necessary. For what is good for the goose should also be good for the gander. I hope these recommendations would be taken in good faith by the Council on Agriculture in the emerging African Union. 

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