Costs and Benefits of Agricultural Trade Standards and the Role of Contracts

Clearly, standards are a risk management tool, particularly for buyers that want to ensure the quality and safety of their supply. The demand for standards is being pushed increasingly upstream in value chains toward producers as a result both of government initiatives and private sector demands. When producers or processors can meet the required standards, they naturally improve their market access. In some cases producers may also enjoy other direct benefits and costs.

Benefits:

• Improvement in operational and managerial efficiency;
• Greater participation in global supply chain and high-value products;
• Environmental benefits of erosion reduction and soil improvement;
• Health benefits;
• Food security, including that of the rural poor (small farmers);
• Economic benefit: price premiums.

• Transition difficulties potentially affecting yields;
• Investments in time and learning;
• Financial investment for infrastructure and technology;
• Higher operating costs for more complex processes.

Benefits: Direct and Indirect

In some cases, implementing standards can improve operational and managerial efficiency. For example, the requirement to keep good records of farm inputs and their application can facilitate internal costs and benefits analysis and improve future planning. Giovannucci in Asia (2005) and Damiani in Latin America (2003) found that when small-scale traditional producers shifted to organic standards, they incurred additional costs but generally enjoyed long-term yield improvements and profitability due primarily to better farm management practices and price premiums. The results among intensive producers were mixed, with some resulting in net economic benefits and others resulting in few, if any, economic benefits (Giovannucci, 2005; Giovannucci, 2006).

Some standards—particularly those that require independent certification—intrinsically fulfill many of the broader requirements for producers to participate in global supply chains or compete in high-value products. For example, detailed recordkeeping of production inputs, traceability, and third-party monitoring that are part of organics are also useful to improve chain competitiveness and more effectively participate in lucrative markets.

Sustainability-oriented standards appear to have some additional benefits for farmers. For example, several recommend diversification away from dependence on a single cash crop, thereby reducing a producer’s risk of crop failure. Pretty et al. (2005) reviewed 286 agricultural project interventions in 57 poor countries and noted that the application of improved environmental standards (IPM, organics, LEISA,¹⁸ etc.) not only generally improved the supply of critical environmental services for the communities but also increased productivity on most of the 12.6 million farms covered. Several standards including GAP offer environmental benefits; studies have shown that these can reduce erosion and improve soil quality (FAO, 2002; Mader et al., 2002).

Food security is of particular concern in areas of rural poverty. By fostering agricultural methods that improve not only the soil’s natural fertility but also its ability to withstand natural calamities such as drought (Altieri, 1999; Drinkwater, Wagoner, and Sarrantonio, 1998) and more efficiently use nutrients (Mäder et al., 2002), the likelihood of food shortages can be reduced. Setboonsarng (2006) notes several studies showing farmers that meet organic standards enjoy a number of advantages. For example, lower production costs can improve farm viability while diversification reduces the likelihood of catastrophic crop failure, and ecological management of local resources further contributes to local food security.

Increasingly, sustainability concerns are emerging in many private standards such as Global-GAP and ISO. These may have some reference to the considerations of Organic, Fair Trade, or eco-friendly approaches while remaining simpler and less demanding. In most cases, meeting standards such as Organics means producers are able to meet the environmental requirements of many, though not necessarily all, other standards.. Bartram and Perkins (2003) reviewed 33 published studies and concluded that substantial biodiversity advantages existed when organic standards were applied. The field-to-table traceability, animal management requirements, and restrictions on the use of agrochemicals provide reasonable assurances of increased farmer safety, food safety, and animal health. The importance of farm-level diversification and a price premium for the required processes and certification further help to ensure a measure of economic benefit.

Besides the clear economic value of market access, the evidence for direct economic returns resulting from the application of standards is less clear. In many cases, meeting a standard is not associated with a higher or premium price; it is simply a requirement for doing business in any high-value product. In commodities and lower-value products, the failure to meet standards is likely to result in a lower price. This is the case for most GAP or GMP standards and all food safety standards. The research on the actual costs and benefits incurred in the adoption of standards is rather limited, although some attempts are currently being undertaken, the foremost being the Committee on Sustainability Assessment (COSA) measuring both direct and indirect costs and benefits of the major sustainability standards at not only the economic level, but the social and environmental levels as well.¹⁹

It is hard to tell the extent to which a price premium is paid for achieving a standard or for meeting a quality level since many products also have some physical or organoleptic quality requirements and the reasons for payment are often not distinguished. In some cases a price premium is clearly associated with the achievement and maintenance of a particular certification; this happens most often with the more complex and demanding process standards related to sustainability such as Organic and Fair Trade.

For products that are Fair Trade certified, typically a minimum price agreement exists that is considered a fair living wage for the producer. Organic product certifications can require considerable transition costs, recordkeeping, and traceability that elicit a price premium. Similarly, eco-friendly standards such as Rainforest Alliance’s are seen as an opportunity cost for producers electing to maintain biodiversity and environmental integrity; these too usually command a price premium. UTZ Certified currently commands a very modest premium though it is too early to tell if that will change for this fast-growing standard as it covers new crops beyond coffee. Ethical trade standards employed in several countries have resulted in improved market access but no clear indication of consistent market premiums. Conversely, when products fail to meet basic standards, they are likely to face a price penalty.

Costs: Direct and Indirect

Several types of costs typically are involved in the adoption of standards. First, a learning curve can require a large and prolonged time investment. This can also require sometimes costly institutional support from a producer organization, community, government agent, or NGO. Confusion about the types of standards and their specific requirements is an intangible cost. Little research has been conducted on these costs. Second, investment is sometimes required in equipment or infrastructure to meet standards. Third, the need for independent verification or certification for compliance and traceability also involves an expense. Traceability through the chain is increasingly relevant and challenging particularly in critical situations, e.g., positive residue tests, false or fraudulent declarations, or discrepancies in quantities traded. While direct certification costs are relatively simple to measure, it is difficult to categorize other typical costs of adopting standards since they depend heavily on two broad-ranging variables: the requirements of a specific standard and the producer’s or processor’s current ability to meet that standard.

Adopting some standards involves a relatively modest change. In other cases, the transition can take years and a prolonged investment before costs are recouped. Without reliable market access, the often-higher operating costs of a new standard can be onerous.

Standards are not necessarily exclusionary for small producers. Some that are oriented toward sustainability can sometimes provide an advantage for smaller producers. The typically more localized and labor-intensive aspect of organic standards mostly lend themselves better to smallholders. Fair Trade standards are designed specifically for small producers and laborers.

Standards can have unintended consequences—and considerable costs—for producers as well as entire agricultural subsectors. For example, the lack of credible public food safety standards in Bangladesh caused the poultry products market to drop by 75% for nearly a year after bird flu was found in Southeast Asia even though not a single case was reported in Bangladesh.

Standards can impose unexpected and unremunerated costs at the local level. In Southeast Asian banana plantations, Dardaine (2003) notes that buyers insist that workers wear gloves and masks while spraying at the packing station where temperatures can reach 40°C yet will not increase the price paid for a box of bananas to cover such costs. Some emerging coffee standards piloted by some of the world’s largest coffee companies to improve sustainable field practices present an interesting case study. The International Coffee Organization 2004) noted that such standards risk becoming a barrier to entry since they impose requirements that producers themselves have to finance in order to participate. The embedded environmental and social practices may be useful and improve farm management, but when imposed on smaller farms without the capital or skills to affect the changes, they can negatively impact the very sustainability that they propose to support.

A number of nations have guidelines and laws for the growing or importation of genetically modified organisms (GMOs), and these present a unique challenge. Unlike a standard that can be met gradually or eventually, GMO contamination of non-GMO crops may be more permanent and is not something that producers can readily alter. The potential for genetic drift is causing trade problems for some producers and countries such as the US and Canada when after industry assurances of containment capability, a number of food crops and storage facilities were discovered to contain GMOs. The EU has already imposed systematic order inspections in August 2006 as an emergency measure after the discovery of illegal, genetically modified rice from the PRC.

Standards can provide opportunities for increasing sustainable production and improving quality and overall competitiveness. The application of standards, however, is a difficult adjustment for many farmers faced with reduced extension services, inadequate information, and outdated capacities. The application of private grades and standards could inadvertently lead to the consolidation of producers, largely eliminating smallholders and the poor from the value chain. A number of countries are now supporting initiatives to develop largely privatesector- based tools such as contract farming to better deal with this challenge.

The Role of Contracts in Agricultural Trade Standards

Contract farming is a way to enable small and medium producers to access the benefits of standards. Using contractual arrangements, agro-industry can assist some farm families to shift from traditional agriculture to production of higher-value products (Patrick, 2003). This may potentially increase incomes of contracting smallholders, reduce risks, and have multiplier effects in the rural economy.

In the context of agriculture, Sykuta and Parcell (2002) explain that a contract codifies the rules of transactions through three key elements: value, risk, and decision rights. A successful contract allocates value, risk, and decisions in a way that is mutually beneficial, ideally sharing risk and improving quality and production (MMWBP, 2005). As such it can assign roles in meeting standards and other difficult demands of modern agrifood trading systems.

Generally the buyer selects standards and transmits this condition up the value chain. Small producers may be unfamiliar with the requirements of standards and unable to access the necessary technology or equipment. Then a contractor can more readily serve as a conduit for providing such requirements, and producers are relieved of finding the right product or technology and financing its initial purchase. Since producers rarely visit the terminal markets for their products, they may not be fully aware of specific requirements. In several southern African nations, one processing and exporting firm was able to enter a market dominated by European producers when it expanded its extension services to local farmers, using technology to help them understand and achieve the desired color range for peppers that were to be exported as paprika (van Gent, 2005; Giovannucci et al., 2001).

Contract farming can also improve market access especially for smaller producers. As contractors work with farmers to ensure that standards are met, they also aggregate supply and provide the necessary packaging, transportation, and transaction requirements to enable sales and higher-value markets. For example, a large commercial horticultural firm in Zambia helps smallholder farmers sell EUREPGAP certified vegetables to Europe by providing them access to the firm’s own packing plant and airfreight quotas (Purcell and van Gent, 2005).

A certain balance of power between participants in the value-chain is necessary to facilitate sound relationships, and unless farms are quite large or well organized, this requires the presence of viable institutional structures. Poulton et al. (2004) noted in the case of Africa that contracts were more successful where there was neither monopsony buyer power nor perfect competition among buyers (MMWBP, 2005). As an example, in Viet Nam, contract farming of undifferentiated products such as ordinary rice has not succeeded as it has with specialty products such as organic aromatic rice, because side-selling is more difficult for specialty products (MMWBP, 2007).

In Viet Nam, the enactment of Decision 80 in 2002 attempted to increase the use of contracts to improve procurement and efficiency in the rural economy. The government has tried to provide incentives for parties to engage in contracts by providing favorable access to finance, land, and infrastructure. However, contracts under Decision 80 have largely been unsuccessful to date. Nguyen Do Anh Tuan et al. (2004) and Tran Cong Thang et al. (2004) suggest that three main issues have compromised such contracts. First, farmers have been accused of reneging on contracts when higher prices are offered from traders. Second, when buyers are faced with oversupplies of products from contracted producers, quality standards are sometimes tightened so processors can reject unwanted output. Third, knowledge of contractual obligations by parties in the contract is often lacking (MMWBP, 2005).

For contracts to be successfully used in many Asian countries, several areas will need to be improved. First, a “one size fits all” approach toward contracts may hurt, rather than help, producers and buyers. Second, the limited organization of producers and the imbalance in market relationships that are not addressed by institutions lead to failures. Third, greater knowledge is required in both the public and private sector to educate those engaged in contracts on the nature of contractual obligations and to develop enforcement mechanisms (formal or informal) that improve the governance of contracting relationships. Combined, these issues suggest both greater public sector roles and also greater strengthening and tightening of the value-chain through improved private-sector organization. Without such measures, the poor are unlikely to benefit from their participation in contracting relationships to raise quality and improve production practices (MMWBP, 2005).

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Comment(s)

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1. Prof. J. George
   (posted 06 July 2008 / 07:56:18 PM)
   
   The authors, Giovannucci and Pursell needs to be complimented on this publication for putting together a business perspective to the application of standards in the food trade.
   
   The perspective of the book however could have been broadened if the production landscape in the region was brought to play a dominant role. The price discovery advantages are certainly not available to the producers. The cost burden, however, is surely an additionality for the producer in more than one ways. For instance, the AGORA experience in Bangladesh is being experienced in all the member countries in the region. This burden is magnified when the state governments either in collusion or in default setting withdraws due to the fiscal conditionalities.
   
   The publication could have immensely benefitted from a professional copyediting and/or critical peer review. But it is a useful addition to the discipline of food safety regulation.
2. Dr T. Tappani
   (posted 03 June 2008 / 05:47:56 AM)
   
   This ADBI paper: "Standards and Agricultural Trade in Asia" is quite a practical and useful look at the topic of trade and development. The authors, Giovannucci and Pursell, clearly have a sharp eye for the needs of business and the realities of farmers (mostly small in the region) and combine these to offer some practical solutions that the Asian Development Bank and governments would be wise to consider in their work.