Introduction

As globalization and market liberalization profoundly change global agricultural production, small farms in developing countries are at risk of being excluded from the opportunities for higher-value production arising from the opening of regional and international markets. Small farms typically lack the resources, knowledge, and information to compete in increasingly integrated markets. They are hampered by imperfect market information, poor infrastructure, and have few links with buyers in the marketing chain. These disadvantages contribute significantly to the low incomes and poverty found in developing countries where small farms dominate the agricultural sector.

In the Lao PDR, agriculture accounts for nearly half of the country's gross domestic product (GDP) and employs 77% of the national workforce according to the United Nations Development Programme/National Statistics Centre (UNDP/NSC, 2006). Rice cultivation is the single most important economic activity, accounting for half of all agricultural output and one-fifth of total GDP. Almost all of the country's agricultural output is produced on small family farms. Despite the importance of agriculture to the national economy, poverty in the Lao PDR is most prevalent among small farming households. An estimated 87% of the country's poor live in households headed by farmers (NSC, 1999).

Although the enactment of the New Economic Mechanism (NEM) in 1986 opened the country to international markets, low market integration remains the prevailing condition. The vast majority of farmers practice subsistence rice farming and lack access to the supports necessary to improve their productivity and income. Market access is limited due to poor infrastructure, insufficient market information, and a regionally confined marketing system dominated by a limited number of traders (MPDF, 2004).

To facilitate the transition from subsistence to a market-oriented economy, the government has encouraged foreign direct investment (FDI) by the private sector in rural areas. In areas where transport infrastructure has been put in place, FDI has flowed in to take advantage of the country's relatively abundant, fertile land and low cost of labor.

One example of private sector investment that has proliferated in recent years is contract farming, an institutional arrangement that links farmers to consumers in foreign or domestic markets and links farmers to vital inputs. Under a typical contract agreement, the contracting firm (usually an agro-processing or marketing firm) agrees to purchase a specific commodity at an agreed-upon price and time, while the farmer agrees to supply the contracted quantities at the specified quality standards. The contracting firm also agrees to provide the farmer with production inputs and in-kind credit, to be reimbursed by the farmer at the time of sale.

While contract farming appears to facilitate market linkages and provide opportunities for farmers to increase their income, the rapid and widespread expansion of contract farming has prompted us to take a closer look at its benefits and costs to smallholders.

Using the case of Lao Arrowny Corporation, a Lao-Japanese joint venture that has contracted more than 2,000 farmers since 2002 to produce Japanese rice for export, this study provides a comprehensive comparison of contract rice farming households and noncontract rice farming households under similar agro-ecological and social conditions. It employs propensity score matching comparison and endogenous switching regression models to determine if contract farms are more profitable than non-contract farms, and whether contract farming is biased towards more competitive farms.

The first section of the paper examines the agricultural production and marketing system and provides an overview of contract farming in the Lao PDR. The second section describes the survey data and summarizes the household characteristics of the sampled farms. The third section briefly discusses the methodology used in this study and presents the results of the profitability comparisons. A concluding section summarizes the main findings.

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