Overcoming Concerns Surrounding Contract Farming - Importance of Farmers' Groups

Overcoming the negative aspects of contract farming requires action on several fronts and entails the involvement of various stakeholders, as summarized below:

A. Improving Bargaining Power, Community-Level Enforcement, and Contract

Management—The Role of Farmers' Groups and NGOs

The type and amount of benefits acquired by smallholders depend largely on the strength of their bargaining power. Small farms typically have limited bargaining power, particularly if they possess few assets and scarce alternative income opportunities (Key and Runsten, 1999). Farmers' groups can play an important role in the success of contract farming arrangements through the power of group clout (Glover, 1987). In an effort to reduce transaction costs, firms often prefer to organize farmers into groups or deal with existing farmer organizations. Farmers' groups appear not only to improve the bargaining power of smallholders, but also serve to lessen some of the criticisms of contract farming.

More specifically, farmers' groups can perform the following beneficial functions to facilitate and improve contract farming ventures:

• Facilitate communication between firm and farmer
• Provide technical transfer and farmer training
• Facilitate credit provision and group guarantee
• Achieve economies of scale
• Aid quality control and assurance
• Improve bargaining power and upgrade processes

Aside from the aforementioned beneficial functions of farmers' groups in facilitating participation of the poor in contract farming, effective farmer organizations can form the basis of community empowerment. They can serve to generate social capital and therefore contribute to sustainable poverty reduction.

B. Minimizing Monopsony and Mitigating Opportunistic Behavior—The Role of Government

Contract farming in the first stage of development generally places firms in a monopsony position. The monopsony power of firms would decline with increased number of firms operating in the same area; thus, government-created policies for investment and competition would lead to decline of monopolistic power of firms over farmers. Grosch (1994) asserts that government has substantial latitude to promote contract farming by:

• Making the establishment of estate agriculture difficult or impossible.
• Creating joint ventures with private firms that want to use contracting.
• Providing complementary infrastructure.
• Regulating the terms of the contract.
• Using the police and court systems to help enforce the terms of the contract.

State promotion of contract farming can also serve to ameliorate some of the negative effects associated with opportunistic behavior. Simmons (2002) has identified the role of governments as market regulators to guard against agro-business abusing its market power.

Patrick (2004) asserts that government's role in promoting contract farming may improve conditions at both the macro and micro levels. Macro changes would be directed at reducing costs of contracting for all parties. Micro reforms may include training, arbitrating disputes, undertaking research, and providing extension services relevant to the expansion of contracting. Training programs for smallholders in literacy, accounting, and cash management may reduce miscommunication in contracts. Experience has shown that a government's ability to plan and execute economic policies can have significant effect on agrarian transition.

C. Promoting Sustainable Technologies to Achieve Social and Environmental Objectives—The Role of Corporate Social Responsibility

In recent years, fueled by development of communication technology, an increasing number of consumers are making choices on the basis of social and environmental attributes of the products. In response to this, firms have started adopting more socially and environmentally responsible ways of production, under the broader ambit of corporate social responsibility (CSR). This increasing importance of CSR has played a key role in the growth of investments in pro-poor sustainable technology to mitigate negative health and environmental consequences. These pro-poor and pro-environment technologies include promoting low-external inputs, recycling farm resources, and avoiding premature mechanization or replacement of labor.

D. Ensuring that Contract Farming Benefits Smallholders Instead of Large Farms—The Importance of Exploiting Comparative Advantage

While it cannot be denied that contract farming has benefited large farms instead of smallholders in several cases, there have also been a number of successes in contract farming with smallholders. As discussed in the previous section, firms may choose to contract with smallholders when enforcement costs associated with large farms was high enough to outweigh the various fixed transaction costs.

Apart from the issue of contract enforcement costs, however, firms may also decide to contract with smallholders when the contracted crop is labor- and knowledge-intensive rather than capital-intensive. Contract farming of labor- and knowledge-intensive crops could potentially benefit the poor smallholders since they generally have large families and can provide high-quality labor to meet quality requirements of such crops.

One promising area in this regard would be promoting contract farming for organic agriculture, more so in the case of poorer farmers in marginal areas, since it is organic agriculture rather than conventional methods that can lead to higher yields and better incomes. One ADBI study found that the smaller the farm, the higher the profitability and profit efficiency (Setboonsarng et al., 2005).

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