Concerns Surrounding the Promotion of Contract Farming

Although there is a range of benefits in contract farming, it is by no mean a panacea to agricultural commercialization and poverty reduction. Several concerns have been raised regarding the desirability of contract farming from a poverty and equity standpoint, foremost of which involves the opportunistic nature of such arrangements. The major concerns are discussed in this section.

A. Monopsony Control

Contract farming as a development tool has been criticized for the exploitative effects of monopsony control, whereby farmers are tied to one purchaser (Grosh, 1994). The firms generally possess more information, resources, and organizational ability than small farms. Their strong bargaining position enables them to potentially extract significant rents from smallholders, leaving them only marginally better off.

Many examples reveal farmer vulnerabilities whereby their bargaining power is reduced due to coercive contractor practices (Little and Watts, 1994). Once farmers invest in new crops and production to adhere to contractual requirements, financial and time constraints render them unable to easily switch to other types of crops (for example, tree crops take a long time to establish and grow). Lacking alternatives, farmers become dependent upon buyers, and firms are then able to elicit more self-serving contract terms.

In addition, the transition from subsistence farming to cash crop production has the potential to render households vulnerable to food shortages and nutritional loss. Many contract farming arrangements are based on monocropping of a non-traditional crop, causing farmers to become reliant on income from the sole cash crop. If the firm does not live up to its the contractual obligations, farming households may thus be vulnerable, since they no longer grow a variety of edible crops and lack the funds to purchase food (Key and Runsten, 1999).

B. The Burden of Labor Management

Although contract farming may reduce the cost of labor management for the agro-business firm, the burden of labor management is in fact transferred to the poor farm households. The act of purchasing directly from farmers rather than hiring wage workers shifts the burden of labor recruitment and control onto the producer (Baumann, 2000). In this respect, although agro-business firms may benefit from reductions in labor management and land cost, such practices may also lead to exploitation since family labor is inclusive of women and children. White's (1997) study of dairy contract farming ventures in West Java determined that in “family” run dairy farms women and children provided an estimated 60% of all labor inputs (White, 1997). However, contractual agreements are often signed and the proceeds controlled by the male head of the household. The burden of farming practices may be placed on the most vulnerable members of the household.

C. Contract Enforcement

Many developing countries lack the laws and ensuing legal framework to support contractual agreements. Agreements themselves may not be easily enforceable or legally binding. Opportunism on the part of both parties can result. In most developing countries contract farming arrangements are operated in accordance to traditional values and norms rather than legal agreements (Glover and Gee, 1992).

In the absence of legally binding contracts, firms can suffer from the effects of extracontractual sales of outputs (Eaton and Shepherd, 2001). Contract default by farmers often increases with a rise in the number of willing purchasers. When alternative markets develop and competing buyers offer competitive prices, farmers are given the incentive to break their contracts, often failing to repay input credit to the contractor (Coulter et al., 1999). The absence of an effective legal system and the lack of collateral held by small farms can result in considerable risks for agro-business firms. An issue involving input diversion occurs when farmers are tempted to use inputs supplied by the firm for non-intended purposes (Eaton and Shepherd, 2001; TDRI, 1996).

Much can be done to mitigate the opportunistic behaviors of both contractual parties. At the local level, farmer organizations and NGOs can play a pivotal role in protecting farmer assets by establishing their own systems for quality management, input production (fertilizers), traceability, and, if possible, certification (IFAD, 2005). Local government bodies and NGOs can ensure a firm's capacity to offer profitable contracts to farmers prior to the establishment of agreements by checking a contracting firm's financial and managerial capacities.

D. Bias Toward Large Farms

One criticism of private-led contract farming is that agro-business firms favor large-scale farmers (Key and Runsten, 1996). Agro-business firms may be motivated to seek contracts with larger farmers to reduce transaction costs and allow for the procurement of more uniform products (Baumann, 2000). In this respect, the cost of managing a large number of small farms may indeed influence a firm's decision to establish such relations. Nevertheless, in the context of developing countries, contract farming with small farms has proven successful in some instances.

Agro-business firms prefer limited land size to ensure easier maintenance and greater quality control over a given crop as is the case with asparagus and cucumber farming in Thailand. Often smallholders can produce a high-quality, labor-intensive crop if given the appropriate technical supports.

Nevertheless, although contract farming appears to involve small farms, such arrangements may exclude the poorest of the poor. Landless peasants and households possessing only limited marginal lands tend to be overlooked by firms.

E. Requirement for Increased Management Skills

Contract farming requires high-level managerial skills on the part of the agro-business firms. Although the level of supervision is likely to be significantly less than that required for plantation operations, highly skilled management is needed to properly supervise farmers. Poor management and a lack of communication among contractual parties may lead to farmer dissatisfaction and a breakdown in contractual agreements (Eaton and Shepherd, 2001; TDRI, 1996).

By employing local staff or community leaders in managing farmers, contracting firms can improve their conflict resolution management and avoid cultural challenges as seen in one firm's hiring expatriate management in Africa.

F. Increased Risk

Firms are required to bear increased risk in contract farming. Most contracts stipulate that the firm will purchase all the produce, usually at a price higher than the prevailing market price. The firm may bear the price risk as well as the risk of crop failure due to poor management or seasonal factors. To ease potential losses, the firm may maintain tight control over management and offer seasonal or annual contracts so as to exclude unproductive farmers from the future contracts (Patrick, 2004).

Farmers also face greater production risk in the case of newly introduced crops which may take time to adapt to new growing environment and required new growing techniques which are new to farmers. For example, cashew nuts contract farming in Thailand had initial success but failed after a few years due to unanticipated pest outbreak associated with nontraditional crop.

G. Health and Environmental Implications

In countries where contract farming has been practiced over a few decades, experiences indicate that poverty reduction impacts should be assessed in a holistic framework. In situations where contract farming of cash crops (monocropping) were undertaken with a heavy reliance on agro-chemicals, yields generally increased substantially during the initial period. As a result, household incomes were greatly improved during the first decade, but yields tended to stagnate or decline as soil conditions deteriorated due to excessive use of agro-chemicals. The heavy use of these chemicals has also led to serious health conditions for farmers while threatening environmental resources, including water resources and aquatic animals. Many of the pesticides that are banned or strictly controlled in the West have been introduced to farmers in developing countries through contract farming, resulting, for example, in negative health impacts on farmers.

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