Download A framework for Linking Small Farmers to Markets

A framework for Linking Small Farmers to
Markets
Maximo Torero
Session 4
Breakout Session 5
A framework for Linking Small Farmers to Markets1
Maximo Torero2
Paper presented at the IFAD Conference on New Directions for Smallholder Agriculture
24-25 January, 2011
International Fund for Agricultural Development
Via Paolo Di Dono, 44, Rome 00142, Italy
1
Copyright of the paper is reserved by IFAD. The paper may not be reproduced in part or in full and in any
form without written permission of the Conference Organisers at IFAD (e-mail: [email protected])
2
The author is Division Director, Markets, Trade and Institutions Division at the International Food Policy
Research Institute.
Index
1. Introduction .................................................................................................................... 3 2. What we understand by Infrastructure, Institutions, Market Failure and Access Gap 5 2.1. Defining Infrastructure........................................................................................ 5 2.2. Defining Institutions ........................................................................................... 6 2.3. Defining the Market Failure or Access Gap ....................................................... 9 2.4. Integrating Definitions ........................................................................................ 9 3. How Do Institutions and Infrastructure work for development ................................ 12 3.1. Role of Institutions............................................................................................ 12 3.2. Role of Infrastructure ........................................................................................ 13 3.3. Role of Supply chain management as a way of markets to link different types of
smallholders .................................................................................................................. 17 4. From Theory to Applied Policy Research: A research strategy ............................... 18 4.1. Needed steps ..................................................................................................... 19 4.1.1. Building a typology of microregion using an stochastic profit frontier
approach 19 4.1.2. Identifying best practices in the provision of infrastructure and institutions
for rural development. ............................................................................................... 22 4.1.3. Market Analysis: Identification of the main bottlenecks within the market
chain generated by market and government failures ................................................ 24 4.1.4. Design alternative solutions for these different types of microregions and
develop proposals for pilot projects to implement these suggested solutions. ......... 27 4.1.5. Local capacity building in prioritizing strategies and developing local
support for the replication of successful pilot programs. and in monitoring and
evaluation of alternative solutions ............................................................................ 27 4.1.6. Monitoring and Impact Evaluation Framework ........................................ 28 5. Rural Producer Organizations (RPOs) and Contract Farming as an option to resolve
missing markers and market failures to link small holders to makets .............................. 29 5.1. Rural producer Organizations – Horizontal Coordination ................................ 29 5.2. Contract Farming– Vertical Coordination ........................................................ 31 6. Final comments ......................................................................................................... 34 7. References ................................................................................................................. 35 2
Institutions and Infrastructure for Linking Small Farmers to Markets
Maximo Torero
1. Introduction
Smallholder cultivation is the hallmark of agriculture in much of sub-Saharan Africa,
Latin America and South Asia, where intensity and density of poverty still remains high.
In South Asia, for example, out of 125 million farm holdings, more than 80 per cent have
an average size of 0.6 hectare and farmers with less than 2 hectares account for 40% of
total food grain production. In sub-Saharan Africa, more than two-thirds of the holdings
have an average size of less than one hectare and account for over 90% of agricultural
output. In Latin America there is also a huge inequality in the distribution of land. FAO
estimated that the largest 7% of land holdings in the region (those above 100 hectares)
accounted for 77% of the land, while the smallest 60% had only 4% of the land (Morley,
2001). Most of these smallholders practice either subsistence farming or operate largely
in local markets due to lack of connectivity to more lucrative markets at provincial,
national or global levels. As a result, incentives remain weak, investments remain low,
and so does the level of technology adoption and productivity, resulting into a low level
equilibrium poverty trap.
How can these small holders come out of this poverty trap? Two instruments appear
critical to break this deadlock for the small holders: one is physical infrastructure such as
information technology, roads, ports, etc. that connects smallholders to markets; and the
other is the role of accompanying institutions that can reduce the marketing risk and
transaction costs in the process of exchange between producers and consumers.
Smallholders, due to their small surpluses in production, generally are exposed to higher
degree of risk and transaction costs. So any innovative institutions that link ‘farms to
markets’, reduce their transaction costs and minimize risk will help them to participate in
markets.
However, the exact nature of infrastructure and institutions that can enable the small
holders transcend from subsistence farming of a village economy to actively participate
in provincial, national and international markets, would vary from country to country and
even from region to region within a country. This paper tries to develop a framework that
can capture this heterogeneity and therefore identify and prioritize the types of
institutions and infrastructure that each different type of small holder requires to better
link to the markets.
For simplicity lets assume we can capture the heterogeneity of small holders in three
groups: a small group of farmers, which is competitive in world markets; another major
group, which is engaged in primarily provincial and national markets; and finally those
who are marginalized even from their provincial economy and operate locally at the
village level. The key constraints that need to be addressed to enhance domestic, or
international, market participation differ among these three groups. Agricultural policies
3
with respect to institutions and infrastructure must therefore take into account this
distinction. The fundamental forces for change driving the global and national markets
and their linkages differ within each of these types of farmers.
But capturing the heterogeneity is not all what is needed. Appropriate policies of
investment in infrastructure need to go together with well-functioning market institutions,
to take advantage of market opportunities to sustain increased agricultural output and
raise rural incomes. This is a critically important for small holders in countries recently
experiencing market liberalization. When market information and markets themselves are
not accessible to the small holders, no matter if hard infrastructure exists, farmers capture
little of the value that they create. The demand and supply remain highly unstable, and so
are the distribution costs for goods produced in rural areas. Simply put, markets often do
not work for the small holders.
This paper will provide strategic inputs to strengthen the institutional and infrastructure
base that is necessary to respond to the heterogeneity among the smallholders and to
support enhancement of the competitiveness of smallholders in rural areas in the
production and marketing of their products. It also aims at improving the knowledge
about the impact that complementary investment in rural institutions and infrastructure,
both capital intensive infrastructure (roads, electricity, potable water and drainage, water
for irrigation and telecommunications) and post harvest technologies (storage services,
processing infrastructure, etc) may have in market development and in reducing poverty.
The paper proceeds in the next section by detail definitions of what is meant by
infrastructure, what we mean by institutions, and what is meant by market efficiency gap
and real access gap. This is an attempt to clarify the use of these terms. The next section
mover to the role of institutions and infrastructure for development is analyzed. Finally,
the paper focus on a discussion of how to move from theory to applied policy taking into
consideration scalability and heterogeneity of small farmers.
4
2. What we understand by Infrastructure, Institutions, Market Failure
and Access Gap
2.1. Defining Infrastructure
The world development report elaborated by the World Bank (1994) defines
infrastructure in a concise manner, making reference to long-life engineering structures,
equipment and facilities, and also the services that are derived from and utilized in
production and in final household consumption. Other authors, like Ahmed and Donovan
(1992), refute this type of infrastructure definition, indicating that the concept has
evolved since the early work of Arthur Lewis and Albert Hirschman towards a more
comprehensive definition that includes a wider range of public services that facilitate
production and trade. In the case of agricultural infrastructure, Ahmed and Donovan
(1992) recognize the growing importance of its role in economic development: the related
literature includes agricultural research, extension services, financial institutions and
irrigation as part of a wider concept of infrastructure.
Authors such as Fosu et al. (1995), reflecting this broader definition, distinguish up to 11
components of agricultural infrastructure: irrigation and public access to water; means of
transportation; storage services; commercial infrastructure; processing infrastructure;
public services; agricultural research and extension services; communication and
information services; land conservation services; credit and financial institutions; and,
finally, health and education services. This listing makes reference to “rural
infrastructure” before “agricultural infrastructure,” thus, as Fosu et al. state, the
conjunction of infrastructure services includes items that not only facilitate the
development of agricultural activities, but also rural activities and sometimes even urban
activities.
A similar classification of agricultural infrastructure developed earlier by Wharton
(1967), identifies three categories: one that is capital intensive (like roads, bridges and
dyers); one that is capital extensive (principally extension services or vegetable and
animal sanitation services); and the institutional infrastructure (that consists of formal and
informal institutions).2
In this research program we will try to concentrate on Wharton’s capital intensive
infrastructure and on post harvest infrastructure which include some of the components of
agricultural infrastructure identified by Fosu et.al. With respect to capital intensive
infrastructure we will look into the following types of infrastructure: a) transport
infrastructure (i.e. rural roads or unpaved roads), b) potable water, c) drainage, d) water
for irrigation, e) electricity (interconnected and isolated), and f) telecommunications
2
Wharton was one of the first to emphasize the importance of infrastructure in the generation of positive externalities
at the microeconomic level. This author recognized that agricultural development is not exclusively determined by the
“economic behavior of the producers,” but also depends on the environment, which according to Wharton includes
physical-climatic, socio-cultural and institutional components that form what he calls “the agricultural infrastructure.”
5
(telephone and rural cabins). Post harvest infrastructure will on the other hand include
technologies that will allow small farmers to preserve their harvest as well as to add value
to their crops. Examples of post-harvest infrastructure will include storage devices,
commercial infrastructure, processing infrastructure, etc. However, it is important to
maintain a wider definition and, whenever possible, evaluate the possible
complementarities between this basic infrastructure and the remaining elements that
constitute a more ample definition of rural infrastructure and other assets as human
capital assets and social networks.
2.2.Defining Institutions
The academic literature has not yet agreed on a specific definition of institutions (see
Table 1 on a review of definitions). We adopt a definition that includes the Williamson
(1985) and Northian (1990) transaction cost approach, which focuses on institutions as
efficient solutions to organizational problems in a competitive framework. Rather than
following the distinction of North (1990) between institutions and organizations we adopt
an inclusive view in which institutions are defined as the structure of relations between
individuals within the system of market interactions in which the players include
producers, consumers and the state. As well as the players, this definition includes the
rules of the game (relations between the players) that are organizations in North’s
definition.
Under the broad definition, institutions play five potential roles in strengthening markets
for commodities produced, bought, and sold by smallholders: reducing transaction costs;
managing risk; building social capital; enabling collective action; and redressing missing
markets (figure 1). Empirical research on market institutions seeks to illuminate these
five roles.
It is increasingly clear that the institutional infrastructure to facilitate market exchange is
a critically important area to countries recently experiencing the shortfalls of market
liberalization, specifically for smallholder agriculture. When market information and
markets themselves are not accessible to the rural poor, farmers capture little of the value
that they create, demand and supply are highly unstable, and distribution costs for rurally
produced goods are very high. Simply put, markets do not work for the very poor.
6
Figure 1. Institutions as Links in the Chain of Market Interactions
Transaction costs
Social interaction
PRODUCER
FIRM
CONSUMER
Norms
Trust
Rules
Laws
Codes of conduct
STATE
Source: Gabre-Madhin (2003).
The high risks of production and cycles of over-supply and price depression create
financial risks throughout the distribution chain that inhibit investment and access to
capital. Monopolistic practices, corruption, and excessive regulations also add to the
burden of the rural marketplace. The high costs, risks, and “friction” in rural agricultural
markets prevents markets from achieving sufficient scale for efficiency and similarly
prevent the low-cost and reliable supply of production inputs such as seed, fertilizer, and
other goods to farmers. The very poor farmers also lack the political empowerment,
market knowledge, and business knowledge to address these market roadblocks Thus,
poor rural farmers lack the capacity to improve and influence the markets upon which
their lives depend. But some of these assets can be developed through effective
organization, technical training, and means for assembly and communication.
7
Table 1
Summary of Definitions of Institutions
Authors
Institutions as the
players of the Game
Nelson (1994),
Institutions as the
Rules of the Game
(exogenously driven)
North (1990)
Definition
Institutions refer to specific “players” or organizations such as
industry associations, technical societies, courts, and government
agencies
“Institutions are “ the rules of the game in a society or, more formally,
the humanly devised constraints that shape human interaction”. These
constraints can be informal (sanctions, taboos, customs, traditions,
and codes of conduct) or formal (constitutions, laws, property
rights). North makes a critical distinction between institutions and
organizations. He defines organizations as either political bodies
(political parties, Senate, city council, regulatory agencies);
economic bodies (firms, trade unions, cooperatives); social bodies
(church, clubs, sport associations); and educational bodies
(schools, universities), all as groups of individuals bound by some
common purpose. Thus, in his view, the analysis of the strategies
of individual players must be separated from the analysis of the
underlying rules of the game.
Institutions
as In contrast to North, whose definition of the rules of the game can
Equilibrium Strategies be considered as exogenously-driven (both in the sense of origin
of
Players as well as change through conscious third party design), a third
view, defined as the “equilibrium of the game” notion of
(Endogenouslyinstitutions. Schotter (1981) considers that institutions are
determined rules)
Schotter (1981),
properties of equilibria of games and not properties of the
Sugden (1986), and
descriptions of the games. Similarly, Uphoff (1986) states that
more recently by Aoki institutions are complexes of norms of behavior that persist over
(1995, 2000)
time, by serving collectively valued purposes.
Institutions as Self- This approach views an institution as a “self-sustaining system of
Sustaining Systems of shared beliefs” (p.21). In contrast to the rules-of-the-game
theorists, who view the rules as exogenously given, this approach
Shared Beliefs
Aoki (2001)
views the rules of the game as determined endogenously through
the strategic interaction of agents, held in the minds of agents, and
thus self-sustaining. Shared beliefs are a summary representation,
or compressed information, of an equilibrium, out of the many
possible. As such, an institution is the product of long-term
experiences of a society of boundedly rational and retrospective
agents (Kreps, 1990). Agents making strategic choices on the basis
of shared beliefs jointly reproduce the equilibrium state and thus
the institution becomes self-sustaining and the information
compressed in it becomes taken for granted. In this way, although
endogenously created, the institution becomes objectified (Aoki,
2001)
Source: Gabre-Madhin (2003).
8
2.3.Defining the Market Failure or Access Gap
A helpful concept in relation to access to infrastructure and institutions which
incorporates the diversity between small holders is the distinction between the market
efficiency gap from the true access gap (missing markets)3.
The market efficiency gap is the difference between what markets are actually achieving
under current conditions and what they could achieve if markets where working
correctly. This gap can be bridged through more private provision of services, facilitated
by effective competition, and by market-oriented policies and regulations that create a
level playing field for new entrants. The only questions relate to how far the market can
reach commercially, and how best to implement and sequence more competitive
conditions. Here is where institutions could play a crucial role given that there is potential
for markets to develop.
The true access gap, on the other hand, recognizes that public intervention on
infrastructure is still required to reach some areas and population groups that will not be
served even with the most optimal, efficient and liberalized market conditions. There are
people and places that remain beyond the limits of the market unless additional
investments are mobilized. These investments could be interventions in the form of
subsidies or other special incentives to encourage service providers to operate in these
areas.
The essential difference that exists between the market efficiency gap and the true access
gap points to the conclusion that the two gaps must be addressed in different ways
consistent with the heterogeneity of smallholders. Moreover if this is combined with the
diversity among small holders, it is clear that different specific policy measures must be
implemented to address the market efficiency gap for the rural market before the
subsidies or other policy instruments to provide public goods (such as roads as well as
key institutions) addressed to the real access gap can be effective in the long run.
2.4.Integrating Definitions
Smallholder farmers within countries differ significantly between those competitive in
world markets (rural world 1), those engaged in primarily local and national markets
(rural world 2), and those who are marginalized even from their local economy (rural
world 3). The basic issue is to increasingly integrate smallholder farmers into these
markets. The conceptual challenge is shown in Figure 2 where the three rural worlds are
identified according to their relation to different markets4.
3
4
The conceptual framework of the two gaps is developed in Navas, et.al (2002).
This figure is a modified version from Orden, Torero, and Gulati (2004)
9
LOW COST AREAS
Figure 2
Small farmers Heterogeneity
INTERNATIONAL MARKETS
Globally competitive
and market oriented
farmers
Local market
oriented farmers
HIGH COST AREAS
PROVINTIAL AND NATIONAL MARKE TS
Subsistance farmers
LOCAL MARKETS AND SELF CONSUMPTION
HIGH INCOME SMALL FARMERS
LOW INCOME SMALL FARMERS
Figure 3 moves one step forwards and shows the interrelation between the different types
of smallholders and how this relates to the market efficiency gap (green color) and the
true access gap (yellow color). The subsistence farmers are the ones where the true access
gap is much more relevant. On the contrary, the local market oriented farmers will fall
more on what it was defined as a market efficiency gap, although some of them (i.e. the
less developed with low income households and located in high cost areas), will also fall
on a true access gap.
Additionally and specifically related to the globally competitive and market oriented
small holders, remain the issue of international policies on agriculture support and
protection and the existence of technical regulations and standards. The technical
regulations and standards pose challenges to smallholders to participate in markets just as
high-value demands are creating potential new income streams. This can also be a type of
market efficiency gap, as far as it reduces the participation of these smallholders in the
domestic and global economy. The latter can be because of the lack of clear rules of the
game and lack of good institutions to assess the costs associated with meeting domestic
and international standards, and in assessing how benefits derived from international
guidelines for regulation can be enhanced5.
5
For further details see Orden, Gulati, Torero (2004).
10
LOW COST AREAS
Figure 3
Small Farmers and Access and Market Efficiency Gap
Globally competitive
and market oriented
farmers
Market
Efficiency Gap
Real Access
Gap
HIGH COST AREAS
Local market
oriented farmers
Subsistance farmers
HIGH INCOME SMALL FARMERS
LOW INCOME SMALL FARMERS
No access gap
Market Efficiency Gap
Real Access Gap
Finally, Figure 4 integrates the heterogeneity of smallholders, their current relation to
different markets, and their relation to the market efficiency gap and the true access gap.
In addition the roles for the public and private sectors in creating the infrastructure and
market institutions needed to lower transaction costs and enhance income-generating
opportunities for the different types rural households is emphasized.
Finally, supply chain management and specifically the rise of supermarkets are changing
the institutional arrangements in the domestic markets of developing countries as a way
to link different types of smallholders. This new dimension developed by the market is
what we try to represent with the circular arrows linking the three types of farmers in
Figure 4. Supply chain management, is playing a role in linking small holders to markets
but at the same time market opportunities are also increasingly affected as in the case of
international trade by technical regulations and standards, which pose challenges to
smallholders.
11
LOW COST AREAS
Figure 4
Integrating Heterogeneity, Market Access problems and the Role of Institutions and
Infrastructure
INTERNATIONAL MARKETS
Globally competitive
and market oriented
farmers
Market
Efficiency Gap
Real Access
Gap
Local market
oriented farmers
HIGH COST AREAS
PROVINTIAL AND NATIONAL MARKE TS
PHYSICAL INFRASTRUCTURE
INSTITUTIONS
Subsistance farmers
LOCAL MARKETS AND SELF CONSUMPTION
HIGH INCOME SMALL FARMERS
LOW INCOME SMALL FARMERS
No access gap
Market Efficiency Gap
Real Access Gap
3. How Do Institutions and Infrastructure work for development
3.1.Role of Institutions
Initially, it was thought that institutions would improve as a consequence of individuals
self interest and therefore take care of transaction costs and information asymmetries.
Although reality had shown that the presence of coordination failure, innovation failure
and authority failure are behind the failure of institutions to emerge efficiently. The high
risks of production and cycles of over-supply and price depression create financial risks
throughout the distribution chain that inhibit investment and access to capital.
Monopolistic practices, corruption, and excessive regulations also add to the burden of
the rural marketplace. The high costs, risks, and “friction” in rural agricultural markets
prevents markets from achieving sufficient scale for efficiency and similarly prevent the
low-cost and reliable supply of production inputs such as seed, fertilizer, and other goods
to farmers. The very poor farmers also lack the political empowerment, market
knowledge, and business knowledge to address these market roadblocks Thus, poor rural
farmers lack the capacity to improve and influence the markets upon which their lives
depend. But some of these assets can be developed through effective organization,
technical training, and means for assembly and communication.
Institutions, as previously mention, play five potential roles in strengthening markets for
commodities produced, bought, and sold by smallholders: reducing transaction costs;
12
managing risk; building social capital; enabling collective action; and redressing missing
markets. It is increasingly clear that the institutional infrastructure to facilitate market
exchange is a critically important area to countries recently experiencing the shortfalls of
market liberalization, specifically for smallholder agriculture. When market information
and markets themselves are not accessible to the rural poor, farmers capture little of the
value that they create, demand and supply are highly unstable, and distribution costs for
rurally produced goods are very high. Simply put, markets do not work very well for the
very poor.
The high risks of production and cycles of over-supply and price depression create
financial risks throughout the distribution chain that inhibit investment and access to
capital. Monopolistic practices, corruption, and excessive regulations also add to the
burden of the rural marketplace. The high costs, risks, and “friction” in rural agricultural
markets prevents markets from achieving sufficient scale for efficiency and similarly
prevent the low-cost and reliable supply of production inputs such as seed, fertilizer, and
other goods to farmers. The very poor farmers also lack the political empowerment,
market knowledge, and business knowledge to address these market roadblocks Thus,
poor rural farmers lack the capacity to improve and influence the markets upon which
their lives depend. But some of these assets can be developed through effective
organization, technical training, and means for assembly and communication.
3.2. Role of Infrastructure
The majority of studies recognize that infrastructure investment has a strong impact on
rural incomes and especially on smallholders. However, this literature has not been
completely successful in assessing the benefits and costs of alternative infrastructure
investment options or the causality of relations that generate higher rural incomes due to
a better endowment of infrastructure services (see Table 2 for a summary of studies).
The work carried out by Fan and Hazell (1999), Zhang and Fan (2000), Fan et.al (2000a),
Fan et.al (2000b) and Fan et. al (2002) in India and China are some of the few studies that
look into the relationships between investment in infrastructure, rural grow, poverty
alleviation and the role of complementarity of investments. The problem with the lack of
causal relationship knowledge between the investment in infrastructure services and the
increase of income generating opportunities and welfare benefits of rural populations is
that the possibility of developing specific policy recommendations is very limited. This
problem normally results in policy recommendations that are directed towards a general
increase in public infrastructure investment but lacks opinions about appropriate
intervention strategies for each specific context.
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Table 2
Summary of Studies that Measure the Impact of Access to Infrastructure
1. Impacts at the Global Level
Authors
Main findings
Binswanger et.al
Identified that the lack of roads is a significant barrier to the ability
(1983)
to respond to agricultural supply
Queiroz and
Working with the case of investment in the infrastructure of rural
Gautam (1992)
roads show that there are various indicators that confirm that
investment in roads precedes economic growth. Moreover they
show for India some complementarities with other assets. Literacy,
agricultural rate of return and health indicator increases are
associated with a rise in road network density
Creightney (1993) Evaluate the impact of public investment upon aggregate demand
and product growth.
Binswanger et.al.
(1993)
Identified various links between infrastructure investment and
growth that could occur simultaneously. For example, they
mention how regions with better infrastructure assets could
pressure for larger budget allocations that would guarantee them
additional public infrastructure, generating an endogenous
investment pattern
Datt and Ravallion Using time series they contributed to the improved understanding
(1996)
of the causal relationship between infrastructure and growth,
showing that the initial conditions in infrastructure development
terms are very important for the Indian states during the period
that the authors studied.
Jalan and
Analyze the existence of poverty traps where the less endowed
Ravallion (1997)
areas were not allotted the new public infrastructure.
Blejer and Kan
These authors also look in to the existence and nonexistence of
(1984), Creightney “crowding-out” of private investment by public investment. They
(1993) or Jalan and show that this effect is very improbable in rural areas, where the
Ravallion (1997)
relationship between public and private investment has to be very
strong and complementary.
Aschauer (1997)
Demonstrated that changes in productivity (i.e., rate of return per
unit of private capital and worker) are positively related to
government infrastructure spending.
Fan and Hazell
Their studies in India and China are among the few works that
(1999), Zhang and attempt to link infrastructure, rural growth and poverty alleviation,
Fan (2000), Fan et. by highlighting the role of investment complementarities. Their
al. (2000a), Fan et. research efforts show that infrastructure investments, particularly
al. (2000b), and
in irrigation, roads, electricity and telecommunications not only
Fan et. al. (2002)
contribute to growth in agricultural production, but also a
reduction in rural poverty and regional inequality in these
countries.
14
Table 2 (Cont.)
Summary of Studies that Measure the Impact of Access to Infrastructure
2. Impacts at the Market or household level
Authors
Main findings
Wharton (1967)
His work was one of the first to emphasize the importance of
infrastructure in the generation of positive externalities at the
microeconomic level. This author recognized that agricultural
development is not exclusively determined by the “economic
behavior of the producers”, but also depends on the environment,
which according to him, includes physical-climatic, socio-cultural
and institutional components that form what he calls “the
agricultural infrastructure”.
Fosu et.al. (1995)
Identified the importance of identifying direct and indirect effects
in order to analyze the effects of public infrastructure on rural
development and rural poverty.
Escobal and
These authors found this in the Peruvian case that a sufficient
Torero (2000)
endowment of public and private assets enables the potential
negative effects of difficult geography to be overcome.
van de Walle
Asks whether or not infrastructure investment returns are lower for
(2000)
the poorest sectors
Escobal, Saavedra Estimate the profitability of some key household assets from
and Torero (2000) different income quintiles of the income distribution and find, for
example, that the additional profitability of having an education
along with having access to public goods like electricity or
sanitation is somewhat higher for the richest than for the poorest
income brackets.
Mamatzakis
Similarly to Escobal, Saavedra and Torero showed for Greece that
(2003)
public infrastructure serves as a complementary for private assets
and inputs but it tends to replace agricultural employment.
Esfahani and
Point out, that although access to infrastructure affects
Ramirez (2003)
productivity, income, and economic growth; it also affects the
supply and demand of infrastructure. By neglecting this
simultaneity, there is a possibility of biasing estimated impacts.
Ravallion (2003)
Using information on China demonstrates the existence of
“geographic externalities” that were derived from the interactions
between the level and composition of local economic activity and
private returns from the tenure of physical infrastructure and
human capital. For the author, this interaction makes it evident that
the lack of development in the rural sector is a result of inadequate
investment in infrastructure and human capital, promoting these
externalities
Source: Escobal and Torero (2004).
15
Even though many authors recognize that the externalities resulting from infrastructure
investment play a central role in rural development, there is little existing empirical
evidence that substantiates the argument at the microeconomic level. Future empirical
work to analyze rural households with different levels of access to public goods and
services should allow for the study of the presence and importance of these externalities.
Therefore, in order to completely understand the causal mechanisms that exist between
rural infrastructure investments and changes in rural household behavior we will explore
two mechanisms at the microeconomic level. The first mechanism that will be explored is
how the infrastructure in an isolated and complementary manner, modifies the structure
of income sources that are available to rural households. Also, subjected to these
opportunity changes, we will analyze how this investment raises productivity and income
levels within the framework of the chosen strategy. It is important to highlight that these
analyzed mechanisms attempt to contribute to the understanding of only some of the
causal mechanisms that operate when infrastructure endowments are augmented. We will
focus on the impact that these investments have upon the arrival of new income
generating opportunities that complement the incomes of independent agricultural
workers.
On the other hand, and in light of the scarce public fiscal resources available and on the
role the government has to play in closing the real access gap in developing countries,
knowing the relative profitability of each type of public infrastructure is critical. Even
though, an important fact that has been found is that not all recipes are suitable for all
countries and within countries. The potential best practice to reduce the real access gap in
a large extent depends on the institutional framework existing in each country. Countries
with sound regulatory institutions and legal frameworks can adopt some solutions that
will be out of reach for countries with weak institutions. However there could be
institutional designs that could be adequate to reduce the access gap while simultaneously
developing the legal, institutional and regulatory framework needed to advance different
strategies.
With respect to the areas where the access gap to infrastructure is present forging privatepublic partnerships (PPP) seem to be the most efficient way of closing the access gap in
all services covered. Public intervention alone is usually not cost effective and isolated
private initiatives also fail to deliver all services. Despite the rise in private sector
involvement in infrastructure provision, the overall investment levels particularly where
subsistence small farmers fall are far from adequate. The need for the public sector to
play a facilitating role has not been achieved. Since there is little evidence that rural
infrastructure is commercially viable on a stand-alone basis, the role of the public sector
needs to be reinvented.
In addition, there are two other issues that need to be taken in consideration. The first one
is the lack of coordination in public investments at the country, regional and donor level,
where the linkages and complementarities of infrastructure investment have not been
realized. As a result, it is common to find fragmented approaches, lacking sufficient
attention for substantive policies and development issues. In fact, in many cases, access
16
to infrastructure has not been linked to poverty alleviation strategies or to the general
development goals of countries. Therefore, it is necessary to take an integrated approach,
even if the actual design may vary from country to country since ‘one size’ may not fit
all.
Secondly, investment in infrastructure in these areas is done from top to bottom rather
than demand driven. At present, the estimation of rural infrastructure investment is
generally based on the needs assessed for each sector at the national level, with little or
no assessment of demand and coordination at local level where the service will ultimately
be provided. More often than not, such investment assessments do not reflect the
preferences of users of services and the contingencies of services. For instance, demand
for secondary schooling may be contingent on access roads, and failing to coordinate
these two in given circumstances may result in a mismatch between availability of a
service and its actual use. On the other hand is important for communities to choose the
technology they want to use, the service level they require and to especially have a clear
understanding of long-term costs and maintenance implications so that communities can
choose what is most appropriate for them under their budget constraints. In this respect
there is evidence that if provided with appropriate information and technical support,
communities can make informed choices about service options as well as clearly identify
their willingness to pay, thereby assuming ownership and responsibility for the
infrastructure.
3.3. Role of Supply chain management as a way of markets to link different types of
smallholders
Christopher (1998) defines supply chain management as: “The management of upstream
and downstream relationships with suppliers and customers to deliver superior customer
value at less cost to the supply chain as a whole.” Transaction cost economics also gives
a theoretical framework for understanding the governance structure of the supply chain.
Many authors point out that there is a continuum of vertical coordination, at one end is
the spot market and on the other end is vertical integration as the case of Supermarkets.
Between the two extremes are hybrid forms, which can be divided into specification
contracts, relation-based alliances and equity-based alliances with different coordination
characteristics of direction and control with regard to interdependence, information
sharing, duration of relationship (Peterson et al., 2001).
Although relationships in supply chains can range from arm's length relationship based
on vertical restriction to vertical integration, as identified by Kaufman (2000) there are
four major goals pursued by retailers through the use of supply change management: (1)
lowered operating costs, (2) decreased procurement costs, (3) reducing marketing costs,
and (4) lower distribution costs. All of the above will help to link smallholders to markets
and therefore move upward from local to provincial, national and in the extreme to
international markets (see Figure 4).
17
For poor farmers, the benefits of new supply chain management are that it can provide
information on new products, input, credit and extension services, and marketing
services. These can ease the resource constraint that farmers face otherwise, and reduce
production and marketing risks for farmers. Some services such as information and
extension services that private supermarket supply chains may provide to farmers can
also save scarce public resources. Because of supermarkets, agents such as traditional
vendors based in villages and sub-districts, and wholesalers based in districts and big
cities, are usually bypassed in the modern procurement system, reducing the transaction
costs smallholders will normally bear.6
Changes in procurement systems toward integrated supply chains can have important
implications for the product quality demanded from rural producers and on their
bargaining power. In Latin America, the shift from reliance on traditional wholesalers to
centralized procurement and specialized wholesalers gave supermarkets “the incentive
and capacity to impose standards”. Similarly in Indonesia, supermarket chain such as
Hero and hypermarket chain such as Giant rely on specialized vendors. This paves the
way for imposing standards and product safety measures in farm production. Such output
control affects production costs and requires new management ability. And while control
on output quality can deliver products according to the preference of the end consumers,
control on value chain can also act as entry barriers for potential competitors and pave the
way for monopolistic rents affecting the returns earned by smallholders with limited
bargaining power.
Finally, for consumers, the new supply chain arrangements of supermarkets are important
since they are the closest to urban consumers and in a demand driven diversification,
supermarket/retail chains are the first agent to know the consumers’ preferences and act
accordingly. Supermarkets have emerged as one of the most important buyers in some
developing countries, particularly for the high-value products meeting specific consumer
demands related to production process and quality. In Latin America, supermarkets buy
2.5 times more produce from local farmers than the region exports to the rest of the world
(Reardon and Berdegue, 2002). Supermarkets are now a strong growth retail sector in
Asia and Africa, where smallholder agriculture is concentrated. However, supermarkets
can also influence consumer preferences by introducing new products and packaging.
Therefore, there is a two-way interaction between consumers and supermarkets.
4. From Theory to Applied Policy Research: A research strategy
This paper tries to lay out a framework for developing a strategy based on which specific
country projects will be implemented. Because of the heterogeneity of the smallholders
and the complementarities between institutions and infrastructure, the activities to be
implemented will differ across different types of small holders (subsistence farmers, local
market oriented farmers, and globally competitive and market oriented farmers) which
we assume will be clustered in small geographic spaces or micro regions within the
country and between countries. Thus the objective is to design a framework for policy
interventions that overcome current bottlenecks faced by each of the different types of
6
See Chowdhury, Gulati and Ramachander (2004) for more details.
18
small holders (micro regions) and which incorporates both dimensions previously
mentioned: heterogeneity and complementarities between institutions and infrastructure.
The research program aims also not only to develop the framework but also to validate it
through empirical research and pilot projects in specific areas which, once validated, can
be transferred to other regions.
4.1.Needed steps
The research strategy proposed involves the following five steps (see Figure 4):
o Identification of different types of rural small holders (typology of microregions)
in terms of their characteristics and development constraints and options.
o Identifying best practices in the provision of infrastructure and institutions for
rural development
o Market Analysis: Identification of the main bottlenecks within the market chain
generated by market and government failures
o Design alternative solutions for these different types of small holders based on
national and international best practices and when not existent we will develop
proposals for pilot projects for suggested solutions where necessary.
o Local capacity building in prioritizing strategies and developing local support for
the replication of successful pilot programs.
o Monitoring and evaluation of alternative solutions
4.1.1. Building a typology of microregion using an stochastic profit frontier approach
The comparative advantages of rural microregions and households are determined by
many factors, among the most important of which include the biophysical factors
determining agricultural potential (e.g., climate, topography, soils, presence of pests and
diseases)7, access to markets and infrastructure, access to services and organizations, and
population density (Pender, et al. 1999; Pender, et al. 2001a, 2001b; Pender, et al. 2004).
A major caveat encountered when designing a comprehensive typology of the
microregions is therefore dealing with the difference between the economic potential of
an area and its current observed status. For instance, a detailed diagnosis describing the
present situation of local economies will help to identify the most deprived areas (i.e.
poverty maps), but some of these areas might have already reached their maximum
economic potential given current conditions, and short run investments will have little or
no impact on the welfare of the local small farmers. Hence, for policy making, a useful
typology of local communities needs to differentiate and combine the notions of current
7
See Escobal and Torero; (2000) for effects of geography on heterogeneity.
19
status and optimal potential of famers. In other words, it has to take into account the idea
that agents’ attempt to optimize, but do not always succeed.
The stochastic frontier approach provides an ideal framework to build the typology.
Conceptually, it is developed from a theory of producer behavior in which the motivation
is the standard optimization criteria (minimize costs or maximize profits), but in which
success is not guaranteed. The associated estimation procedures allow for failures in
efforts to optimize and different degrees of success between producers. This opens up the
possibility of analyzing the determinants of variation in the efficiency with which
producers pursue their objectives.
Taking the farm as an example, the stochastic frontier approach accounts for the fact that,
conditional on geographic location, elements such as prices, biophysical conditions, and
(in the short run) fixed inputs are exogenous to the farmer’s decision process. Hence,
holding this factors fixed there exists an optimal production technology and production
plan that generates the maximum profit the farmer can obtain. With this approach it is
possible to identify where the profit frontier lies, and how much of the difference
between it and observed profits (i.e. profit loss) can be explained by the farmer’s choices
resulting in profit inefficiencies. Adding the stochastic component allows for a better fit
to the farm production process, which is very sensitive to unpredictable changes in
exogenous conditions, like weather or international prices. In this context, profit
inefficiency is defined as the monetary loss which results from not operating at the
frontier given the prices and levels of fixed production factors faced by the farm.
Let x denote a (1 ×m) vector of variable and quasi-fixed inputs and y denote a (1 × q)
vector of multiple outputs involved in the farm production process. Let z denote a (1 × r)
vector of environmental variables that, though not directly determining the farmer’s
profits, could affect the farm’s performance8.
We will discuss later in this section our criteria to place specific variables as elements of
x or z.9
Let ⊂
be the set of feasible production plans of the farm. We define a measure of
,
∈
output technical inefficiency δ (Farrell 1957) for some production plan
such that:
δ0 = δ(x0,y0 |P) ≡ sup{δ | (x0,y0) ∈P,δ > 0}
For (x0,y0) ∈ P,δ(x0,y0 |P) ≥ 1.
(1)
8
In some cases, prices for certain inputs may not exist (or are not available to the analyst), particularly when studying
rural poor populations in developing countries. Active markets and monetary transactions for land or weather-based
insurance, for instance, are rare in these settings, so it is extremely difficult to find a reliable price for land (of varying
qualities) and weather (and climate-risk) preferences. Under these conditions, we believe elements like land size,
climatic and biophysical conditions should be included in x in order to capture their direct impact on production as
fixed or quasi-fixed inputs, even though the argument can be made that these variables capture failures in the land and
risk-coping markets to justify their inclusion in z.
9
Deprins and Simar (1989) and Kumbhakar and Lovell (2000) discuss the rationale for placing certain variables as
elements of x or z, admitting this issue is frequently a judgment call. In many cases, it is not obvious whether an
exogenous variable is a characteristic of production technology or a determinant of productive efficiency.
20
We now define the restricted profit function π(p, z, δ) as the maximum profit attainable
by a farm with characteristics z, facing output prices p ∈ P (z) and input prices w ∈ W
(z):
Π , , ≡ sup , :
,
(2)
Let πi be the observed profits for farmer i. The analyst is confronted with a set of
observations (πi,pi,wi,zi) for i =1,...,n, which are realizations of identically,
independently distributed random variables with probability density function f(π, p, w, z).
This function has support over
.
We assume z is not independent from (π, p, w), i.e. f(π, p, w | z) f(π, p, w). This means
that the constraints on farmers’ choices of prices p and w, and on observed profits π, due
to the environmental variables z the farms face operate through the dependence of (π, p,
w) on z in f(π, p, w, z). There exist several ways to formulate the model such that the
production set is dependent on z (Coelli, Rao, and Battese 1998), however, we consider it
is more appropriate given the empirical setup we are analyzing to assume the
environmental variables z influence the mean and variance of the inefficiency process,
but not the boundary of its support. Hence, in our formulation the conditioning in f(δi | zi)
operates through the following mechanism:
δi = exp(ziβ + εi)
(3)
where β is a vector of parameters, and εi is a continuous i.i.d. random variable,
independent of zi.10 We assume the term εi is distributed N(0, ) with left truncation at
−ziβ for each i.
Because the effect of covariates z operates through the dependence between π and z
induced by 3, these assumptions provide a rationale for second-stage regressions.
Kumbhakar and Lovell (2000) and Kumbhakar (1996) provide the typical setup in these
cases, defining the stochastic profit frontier function as:
πi = g(pi,wi) exp(νi − ξi)
(4)
where νi is the stochastic noise error and xii is a non-negative random variable associated
with inefficiencies in production. Then the profit efficiency of farm i can be defined as:
exp
|
|
exp ∑
|
(5)
where Xdi are exogenous (to the production process) variables characterizing the
environment in which production occurs and that can be associated with inefficiencies of
the farm.
As noted by Simar and Wilson (2007), regressing efficiency estimates obtained from
maximum likelihood estimation of a parametric model for Π(p, w, δ) will very likely
10
See Simar and Wilson (2007) for estimation in a semi-parametric setup.
21
result in problems for statistical consistency because the covariates in the second-stage
regression (z) are correlated with the one-sided error terms from the first stage (in order
for there to be a motivation for a second stage).11 Consequently, the likelihood that is
maximized is not the correct one, unless one takes account of the correlation structure. In
order to do so we estimate (4) in the first stage modeling heteroskedasticity in the onesided error term ξ as a linear function of a set of covariates. The variance of the technical
inefficiency component is then modeled as
exp (6)
We use maximum likelihood estimation and a translogarithmic profit function correcting
for heteroskedasticity as shown in (6), and then proceed to the second stage estimation of
the technical efficiency term ξ on the environmental variables z.
4.1.2. Identifying best practices in the provision of infrastructure and institutions for
rural development.
There is no universal remedy to the existing problems in access to infrastructure and
institutions and the best practice depends on the degree of institutional development in
each country. Some strategies that could be appropriate in one country may not work in
countries that lack the required legal framework and institutions because the advantages
and potential of each strategy are heavily dependent on the country’s institutional
environment.
Although countries that have advanced the most in market-oriented reforms have made
progress in closing both the urban and rural access gap, reforms alone are not enough to
provide complete access in remote poor rural areas. Some sort of public intervention is
needed to close this gap.
Moreover forging private-public partnerships (PPPs) seems to be the most efficient way
of closing the access gap. Public intervention alone is usually not cost effective, and
isolated private initiatives also fail to deliver all services. Despite the rise in privatesector involvement in infrastructure provision and institutions, the overall investment
levels, particularly in rural areas in sub-Saharan Africa, are far from adequate and much
lower in comparison to Asia and Latin America. The goal for the public sector to play a
facilitating role has not been achieved. Because there is little evidence that rural
infrastructure and institutions are commercially viable on a stand-alone basis, the role of
the public sector must be reinvented.
However a detail review of the existing best practices will allow us to identify
institutional designs that could be adequate to reduce the access gap while simultaneously
developing the legal, institutional and regulatory framework needed to advance different
strategies.
11
The errors and the covariates in the first stage will not be independent if the covariates in the second stage are
correlated with the covariates in the first stage, which occurs in most empirical applications.
22
Tipology of Microregions
Rural World 1
Rural World 2
Rural World 3
Replicable solutions within each rural
world
Tool Box of National,
International and new solutions
identified through pilot projects
Design alternative institutional solutions based on local and
international best practices, and developing proposal to implement
and evaluate them, and applying them in each rural worlds
according to the problems identified in the market chain analysis
Identifying strengths and weakenesses within market chains, identifying
market and government efficiency failures, and missing markets in the
provision of infrastructure and institutions for market development.
Figure 5: Framework of Analysis
Heterogeneous Development Strategy for a Heterogeneous Rural Worlds
Networks with
policy makers
and local govt.
CAPACITY
BUILDING
23
4.1.3. Market Analysis: Identification of the main bottlenecks within the market chain
generated by market and government failures
We propose to concentrate on three major aspects: (1) Identifying existing best practices
in the provision of public infrastructure and institutions; (2) identification of the main
bottlenecks within the market chains for priority commodities generated by market and
government failures; and (3) evaluating possible public investment decisions in
infrastructure and institutions proposed as solutions to bottlenecks.
When undertaking market chain analysis, we attempt to break the value creation by
smallholders into a sequence of activities from raw materials to final consumption. From
the perspective of the smallholder and of the sector in which he is producing, a market
chain analysis is a good tool for understanding what the strengths and weaknesses are;
from the economic sector perspective, a market chain analysis supports a better
understanding of the microregion’s competitive position vis-à-vis its key customers and
suppliers. After identifying the various activities performed by the smallholder, we then
attempt to identify the key resources and capabilities he uses in performing those
activities. We can then proceed to an evaluation of those resources and capabilities in
terms of how or if they create a potential comparative advantage and if so what the small
holder needs to realize that comparative advantage.
Assessing the constraints to productivity growth and changes in livelihood activities is
essential to identifying the interventions necessary to raise productivity of any of the key
commodities or non-farm activities within each microregion. We begin by considering
bottlenecks in agriculture. Reviewing and analyzing the set of agronomic and
infrastructure constraints affecting the production of key commodities within each zone
can do this. Naturally, the overriding set of constraints will differ both by and within each
of the different types of microregions. Types of bottlenecks to analyze will potentially
include: market and institutional (market information systems; policies; access to finance
and credit); infrastructure (transportation costs and roads); quality issues (grades and
standards, food safety); production constraints (natural resource degradation, conflicting
rights to resources, land tenure insecurity, farmers’ lack of information about or
confidence in promising technologies, farmers’ resource constraints) and post-harvest
technologies (processing, storage, bulking).
a. Market and Institutional
As previously mentioned institutions play five potential roles in strengthening markets
for commodities produced, bought, and sold by smallholders: reducing transaction costs;
managing risk; building social capital; enabling collective action; and redressing missing
markets. Therefore we will concentrate in identifying which are the main bottlenecks in
the micro regions under study and if these problems are or could be solved through any of
the market institutions outlined in the following table.
24
Table 3: Roles and Types of Market Institutions relevant for Agriculture
Role of Market Institution
Type of Market Institution
i.
Reducing
transaction  Market information/intelligence systems
costs
 Auctions and exchanges
 Grades and standards
 Legal enforcement mechanisms
ii.
Reducing market risk
 Forward and options contracts
 Vertical integration schemes
iii.
Increasing social capital  Producer marketing associations and cooperatives
 Trader networks
iv.
Enabling
collective  Producer marketing associations and cooperatives
action
 Industry groups
 User groups
v.
Redressing
missing  Warehouse receipt systems
markets for credit
 Contract farming
 Credit guarantee systems
 SACCOs and cooperative banks
Source: Were (2003).
In addition it is also important to take into consideration issues related to the link between
property rights and investment decisions. In these sense the theoretical literature
discussed three channels (see Besley, 1995):



The first channel is the risk of expropriation which can be summarized as how the
insecurity is like a random tax on returns of investment. In this sense there is a level
effect, i.e. an overall reduction in investment and a composition effect, i.e. invest in
assets which are less subject to expropriation like investing in more portable assets
(e.g. livestock).
The second channel is gains from trade of land. When incomplete property rights
exist this will impair trade in land, i.e. to sell or to rent. Improving possibilities for
trade in land through titling programs can improve investment incentives when the
gains from trade raider the marginal returns to land. As shown in Besley (1995)
investor faces stochastic trading opportunities and improvements in rights are
modeled as reductions in transaction costs and therefore there is more land trading
after rights are improves.
Finally the third channel is Collateral and Credit Markets. This third channel
assumes two things, first that improvements in land rights encourage lenders to
recognize land as collateral, and borrowers are dependent on access to credit for their
investment in the land. The function of collateral in lending is discussed extensively
by Binswanger et. al. (1985), Barro (1976), and Plout (1985).
25
b. Infrastructure
One of the major bottlenecks or risks faced by smallholders is the lack of an appropriate
infrastructure. It is of crucial importance to analyze the existing bottle necks of
infrastructure and especially the potential roles of the public and private sectors in
creating the infrastructure and market institutions needed to lower transaction costs and
risks and enhance income-generating opportunities for smallholder producers.
o Capital Intensive infrastructure
While the role of rural capital-intensive (roads, electricity, water for irrigation and
telephones) infrastructure in linking smallholders to markets and the effect on poverty
alleviation are well documented, the size of the impact of alternative types of rural
investment depends on local conditions and circumstances. Therefore it is important to
evaluate benefits and costs to rank alternative rural investment options and assess their
complementarities. Econometric analysis of existing community and household survey
data will be carried out to measure the production, productivity, income diversification
and poverty impacts of alternative types of public investment. These can then be
compared with costs, which then can guide public investment decisions. The analysis will
include both direct and indirect effects, which is necessary to fully capture the benefits of
public investments.
Expanding supply without worrying about the limitations of the local market can have a
serious negative effect on local prices. At the same time if there are unemployed local
resources, local government investment programs or rapidly growing non-farm activities
are likely to have a big and favorable impact on local farmers.
o Post-harvest technologies
With the expansion of international food trade and the continued escalation in population
growth, global consumer demand for larger quantities of high quality and low cost
processed foods has created considerable interest and investment in the development of
new or improved post-harvest technologies. This is particularly important for developing
countries where post-harvest losses of cereals are between 10-20% and of fruits and
vegetables as high as 20-100%. In the past, post-harvest research used to focus on smallscale farmers who needed to preserve their harvest to ensure food security for the
household but new, innovative post-harvest systems are allowing farmers to generate
more income by adding value to their crops. These systems also allow the generation of
off-farm employment for people involved in the processing, transportation and marketing
of food products. Efficient post harvest systems are particularly important as competition
for land and water increase and, with migration of rural people to urban centers, there are
likely to be fewer farmers producing food for more consumers. Agricultural trade
opportunities are also increasingly affected by technical regulations and standards,
simultaneously with domestic markets seeing growth of vertically integrated firms. In
each case, the technical regulations and standards pose challenges to market participation
by smallholder’s just as high-value demands are creating potential new income streams
(See Reardon and Berdegue (2002). Assessments are needed of the costs associated with
26
meeting domestic and international standards and how benefits derived from international
guidelines for regulation can be enhanced.
4.1.4. Design alternative solutions for these different types of microregions and develop
proposals for pilot projects to implement these suggested solutions.
Once the major bottlenecks are identified for each of the micro regions the exhaustive
review of existing best practices both local and in other countries will give the necessary
inputs to identify a menu of possible solutions that can be implemented. This effort will
be demand-driven, and will involve close consultation with local policy makers, leaders
of farmer organizations and technical assistance organizations, and other key
stakeholders to identify options that are politically and socially feasible as well as
economically advantageous. Examples of possible pilot projects could include designing
better ways to provide electricity subsidies in areas where access gap is present with price
discrimination schemes based on information provided by pre-pay electric meters,
implementing strategies for diffusion of technology such as fertilizers or improved seeds;
pilots to provide access to infrastructure such as rural telephones and electricity, or to
design mechanisms to maintain rural roads; information centers to reduce market
asymmetries; community banking experiences to mobilize saving and increase credit;
strategies to improve water management; etc. In some cases the solutions may be simple
and therefore easily implemented, but in most of the cases they won’t be simple and
alternative experimental solutions need to be developed. In these cases, proposals for
these pilot studies will be developed and we will search for funding to carry out and
evaluate those pilots. This set of solutions will constitute a menu from which we can
select for each micro region the solution or the combination of solutions that we believe
need to be implemented in order to solve the major bottlenecks inhibiting microregion
development.
The activity approach to identifying investments outlined above may highlight some
common bottlenecks that constrain a number of different production activities. For
example, if lack of roads and weak marketing institutions constrain growth of one
promising commodity in a region then them probably also constrain most other
commodities grown in the same region as well as local manufacturing and other non-farm
activities. Investments that release these constraints can therefore have a broader impact
than just for the priority commodities or activities considered, and hence fall in the
category of thematic investments. Some investments also enhance broader development
options, including opportunities in the non-farm economy. These include investments in
roads, education, health and rural finance. Analyzing these kinds of thematic investments
requires a cross section econometric analysis of household surveys including
complementary interaction effects.
4.1.5. Local capacity building in prioritizing strategies and developing local support for
the replication of successful pilot programs. and in monitoring and evaluation of
alternative solutions
27
The approaches outlined above should help inform the selection, by development
domain, of priority activity-oriented and thematic investments in institutions and
infrastructure, and provide some assurance that if appropriately implemented, key
strategic goals will be achieved at the national and regional levels. But implementation
needs to ensure that investments come together in ways that are appropriate to local
conditions and that fit with the development strategies that make sense to local people.
The challenge is to interface the inherent top-down decisions associated with many public
investments with the bottom up interests of local people.
This reconciliation depends fundamentally on involving local governments and
communities in decisions about what to invest in, where and how. But some a priori
guidelines can also be obtained for planning purposes by analyzing the kinds of
development options or livelihood strategies that are available to communities located in
different microregions.
4.1.6. Monitoring and Impact Evaluation Framework
A monitoring and evaluation framework is key to a needed learning process in
development strategy. It serves to assess progress against stated goals, and also to help
identify weaknesses and strengths in past approaches and hence what might be improved
in the future. For these purposes, the selection of indicators has to be linked to the
analytical framework used in the strategizing process. This is particularly critical for
providing a basis for analyzing cause and effect relationships, and for identifying why
goal indicators (such as poverty) changed the way they did, how much of the change was
due to plan interventions, and what could be done better in the future.
The evaluation methodology will allow us to obtain credible and transparent estimates of
the impacts of the proposed solutions to the bottlenecks identified. The objective of
impact assessment for any social program is to estimate the beneficiaries’ state after
program completion relative to their hypothetical state had they not participated in the
program. Given that it is not possible to observe the beneficiaries in the counterfactual
condition of not having participated in the program, it is necessary to use a control group
of non-participants, chosen such that they adequately reflect a hypothetical situation of
beneficiaries under the non-treatment condition. If the control group is not adequately
selected and does not have characteristics similar to those of the beneficiaries, outcomes
that result from pre-existing differences between treatment and control units can be
mistakenly attributed to the program. The resulting selection bias confounds a great
number of quasi-experimental estimates of program effects, particularly in large-scale
interventions.
In some of the interventions, random assignment to treatment and control groups from the
potential population of beneficiaries is envisaged to allow us to construct an appropriate
counterfactual by ensuring that, on average, those who are exposed to the selection
problems that plague quasi-experimental studies, particularly important for looking at
technology adoption since there are likely to be important unobservable differences
28
between users and non-users. The randomization will take place at different levels
according to each of the different interventions.
Of course, the ability to pursue such a randomized design will require the active support
of local policy makers and other key stakeholders for this approach. This will build upon
the involvement of these stakeholders in identifying and implementing the set of options
to be tested, but will also require capacity building to increase the understanding of key
stakeholders of issues affecting program evaluation and why a randomized design is
desirable.
In the case randomization is not possible other methods as matching could be used. In
this method a relevant control is assigned to each beneficiary, an individual who does not
have access to the benefits of the program but who is “very similar” to him. The
similarity should be with regard to the characteristics that are important to determine the
variable or indicator that is being assessed. For example, if we have a household with
access to telephone we will have to find another household in a similar community and
with similar socioeconomic characteristics and household composition, to be his “control
partner”. This is done with the idea that this action may reflect the well being that the
household with access might have had if he had no access. Once the matching is done
among the household with access and controls, the medium impact of the program may
be estimated as the simple or weighted average of the impact for each matching couple.
There are different techniques for the matching method, as well as forms to interpret what
is to be “most similar”. We will use several of them as a sensitivity test to our results.
Once the control groups are identified the parameter to be estimated is the Average
Treatment Effect on the Treated (ATET), or just “treatment on the treated”. This
parameter indicates the average effect of the program on current participations. In terms
of notation it is:
TT  E (i | Di  1)  E (Y1i  Y0i | Di  1)
(3)
where i is the individual, i is the difference in outcomes between a world where that
individual participates and a unit where it does not, Di is a dummy variable for current
participants, so that Di=1 for units that participate in the program and Di=0 otherwise, E
denotes de expectations operator, where the expectations are conditional on the condition
to the right of the vertical bar (“|”).
5. Rural Producer Organizations (RPOs) and Contract Farming as an
option to resolve missing markers and market failures to link small
holders to makets
5.1. Rural producer Organizations – Horizontal Coordination
As shown in the previous sections, it is almost general consensus that, among other
forces, globalization will generate an increase in food prices. There are stark differences
29
across developing countries and their ability to benefit from this market opportunity,
mainly because of the differences in capacity for meeting international food safety
standards (Athudkorala and Jayasuriya 2003). The ability to meet high food safety and
quality standards is lowest in smallholder agriculture because of the scale economies. The
most important reason is the inability of the smallholder dominated production systems to
meet the food safety and quality requirements of the rich country markets (UmaliDeininger and Sur 2006).
Moreover, underdeveloped physical structure, limited supply of power and irrigation,
limited number and narrower spread of pre-coolers, cold storages and refrigerated
transport vehicles and accredited certification agencies. Most importantly, these standards
require a high degree of information on requirements related to inputs, packaging, etc.
that is costly to obtain and process.
The creation of producer organizations is the most common solution to share the fixed
costs necessary for small holders to link to dynamic markets. The RPOs is a form of
collective action that will both improve the farmers’ access to credit, information, and
improved varieties of crops. Economies of scale in production are different from
economies of scale in marketing, which are dominant in high value export markets. A
product may not have economies of scale in the production process, but its marketing
costs may show economies of scale. Conceptually, wherever there are economies of
scale, be it in production or marketing, producers will have incentives for collective
action, generally in the form of producer associations.
Producer associations solve the problem of atomized producers, allowing to exploit
economies of scale in marketing. It is less costly to get international certifications of
quality and hygiene for exports for a centralized producer association, who can also
devote resources to get relevant information on current legal and technical issues in the
targeted markets (for instance, limits of chemicals). The use of better technology will
reduce the post-harvest losses.
In addition, by negotiating in block, farmers get better conditions: higher prices for their
products, lower prices for their inputs. Furthermore, transport costs can be dramatically
reduces by synchronizing demand for transport services. Another consequence is the
creation of on-site packaging and other added-value activities, promoting rural non-farm
economies
As could be expected, the literature has found ample evidence that access to developed
country markets provides higher revenues. The export of horticultural production in
Guatemala generated gross margins per hectare 15 times as large as maize production and
that the gross margins per labor day were twice as large (von Braun and Immink 1994).
Mc Culloch and Ota (2002) horticultural export growers have higher incomes after
controlling for farm size, education, irrigation, and other factors. What is not clear in
every case is whether the increases in revenues are high enough to compensate the higher
costs associated with these activities. Beyond transaction costs (including the
30
administrative costs of the cooperative) there are costs directly related to learning and
adopting the new technologies.
Over the past decade, many governments and donor agencies have shown renewed
interests in RPOs as means to provide services to households in rural communities. This
was recently re-affirmed in the World Development Report (2008) which emphasizes the
important role of these organizations in providing services to farmers in the face of
market and state failure. This interest is in some cases driven by the rapid and
spontaneous expansion of these organizations, such as in several countries of West-Africa
where about half of villages surveyed in 2002 were found to have at least one such RPO.
In some other cases, these organizations (re-) develop as a response to government
policies to promote them. Such is the case in several East-African countries. In Ethiopia
for instance, the federal Government aims to provide cooperative services to 70% of all
farm households by 2010.
Despite a growing number of documented case-studies, there are very limited empirical
assessments of these organizations and the extent to which they can effectively support
smallholders as a way to target poverty.
5.2. Contract Farming– Vertical Coordination
Contract farming is an economic institution that responds to imperfections in the credit,
insurance, information, inputs, and raw product markets; and to transaction costs related
to search, screening, and transfer of goods, bargaining and enforcement (Key and
Runsten 1999). This institution has the potential to incorporate low-income growers
(mostly small landholders) into the modern agricultural sectors because it is a source of
credit, insurance, and information for the contracted farmers.
On the other hand, it arises as a profitable strategy for large firms that need to ensure a
steady supply of raw materials meeting certain quality standards. Therefore, contract
farming rarely appears in the staple food industry, but is relatively common for industrial
crops, which are destined to high-income consumers who are willing to pay a premium
for quality and safety standards (Minot 1986).12
The case of contract farming, which usually involves a large-scale buyer that needs to
ensure a steady supply of raw materials meeting certain quality standards, has captured
the attention in the last decades. Advocates of this kind of institutional arrangement see
contract farming as a means to incorporate small farmers into growing markets for
processed goods and export commodities. Because the contracts often involve the
provision of seed and fertilizer on credit, technical assistance, and a guaranteed price at
harvest, this form of vertical coordination simultaneously removes a number of
constraints on small-farm productivity, including risk and access to inputs, credit, and
information.
12
Minot, Miyata, and Hu (2007) analyze the case of apple and onion contract farmers in China. They find
that apple growers benefit from higher yields, while onion growers benefit from higher price.
31
Several studies clearly point out significant income gains to farmers participating in
vertical coordination arrangements in high value commodities (Minot et. al. 2006; Roy
and Thorat 2008; and Birthal et al. 2005). Other studies show the important role of
contract farming in reducing risk for small farmers (Ramaswami et al. 2006) as well as
enabling them to meet the stringent food safety standards in high value markets (Okello
et al. 2006; Narrod et al. 2006; Roy and Thorat 2008, Mergenthaler et. al. 2007). Miyata
et al. 2007 shows evidence that in China contract apple growers benefit from higher
yields, presumably due to technical assistance from contractors, while contract green
onion growers receive higher prices. Several studies, however, confirm the disadvantage
of the small farmers with regard to transaction and marketing costs in relation to the
larger farmers (Okello et al. 2006; Rich and Narrod 2006). Thus, the linkage with small
farmers has to be innovative to reduce the transaction and marketing costs of dealing with
a large group of small farmers (Minot and Roy 2006; Gulati et al. 2006). Where there are
scale diseconomies, producer or marketing organizations have been attempted (Roy and
Thorat 2008; and Narrod et al. 2006). Contract farming with a large group of small
farmers has often taken the form of a vendor system to overcome the problem of high
transaction costs (Chowdhury et al. 2005; Birthal et al. 2005). In the absence of laws and
institutions supporting contracts in developing countries, enforcement of contracts and
incidence of mistrust has at times been a problem (Singh 2002; Dev and Chandrasekhar
2004).
Contract farming has therefore shown to be an effective way of integrating farmers into
domestic and international markets; its benefits have gone mainly to medium-sized and
relatively more educated farmers. The reasons why smaller and less educated farmers
have been excluded, however, remain ambiguous. The most commonly cited reasons are
size limitations and fixed costs, as well as limited power of small farmers in contract
enforcement, which may limit small farmers’ ability to invest in such arrangements or
benefit from them. While for small farmers technological barriers to contract farming are
real and important, it is crucial to highlight evidence which shows that incentives-based
problems are partially responsible for the failure of contract farming.
In the case of rural non-farm enterprises the institutional arrangements by which these
firms have moved beyond direct sale to final consumers include subcontracting,
franchising, flexible specialization, and a consortium approach. Subcontracting has been
the most prevalent especially in Asia.
In understanding the potential benefits of institutional arrangements as contract farming,
it would important to consider value chains analysis. Interest in rural supply chains has
expanded rapidly over the past several decades as it helps map the network of related
vertical supply channels linking input suppliers, processors, and distributors together in
systems that take products from raw materials through processing and distribution and on
to final consumption. This facilitates the understanding, diagnostics and intervention
design in complex rural networks and where in the value chain market failures are
binding and institutional arrangements are potentially effective.
32
A potential advantage of this institutional arrangement is that they allow for greater
specialization along the value chain, which often proves to be important in improving
productivity. In particular, in the case of smallholders vertical integration would allow
farmers to specialize in purely agricultural activities, in which most probably lay their
comparative advantage. In this way other decisions and activities leave the small farm.
For example, in the case of contract farming, marketing, financial, and technical, safety
and quality decisions are carried out by the large contractor, who is in a better position to
allocate skilled labor to those activities as well as undertake needed investments. In sum,
it seems institutional arrangements allow for productive complementarities between large
and small units and also between rural and urban based enterprises.
Moreover, it is known that nontraditional crops need a higher level of financial resources,
and agroindustrials are well suited to act as lenders to growers. This is so because of their
superior ability to monitor and enforce credit contracts compared to banks and MFIs, and
lower default rates. In first place, given their normal business activities, monitoring is less
costly for agroindutrials than for banks. In second place, other than legal action
(financially and socially costly, as well as ineffective), they can threat to stop doing
business with the farmers. There is a trade-off between the benefits of lending to small
and large landholders. In first place, those willing to pay the most for credit are
smallholders, because they are generally unable to self-finance and their access to formal
loans is restricted. However, they also have higher risk of default and transaction costs
than large landholders, what makes lending to smallholders less profitable.
In a similar fashion to access to credit, agroindustrials are better suited to provide
insurance to small landholders than insurance companies. Insurance provision is
necessary for the small holder to produce the non-traditional crops that the agroindustrial
demands, because these crops are more risky than traditional crops. They not only imply
higher costs, more variable yields, and more variable prices, but also higher variability of
market supply and thin local markets. In practice, surplus production in one region can
hardly compensate for deficit production in another region, and most non-traditional
crops are perishable so they cannot be stocked to counteract fluctuations. Informal
insurance methods are often costly and inefficient. The contracting firms are better able
to diversify risk by diversifying production sources geographically because they have
access to inexpensive financial resources. In addition, their participation in the production
process allows them to provide insurance with low transaction costs and to avoid some
moral hazard problems. Risk-averse farmers, who generally are smallholders, are willing
to pay more for insurance. Hence, they will sell at a price under the expected market
price, as long as it is secured. However, contracts that protect against production risk face
moral hazard problems. Monitoring costs can be reduced by requiring the farmer to bear
a large share of the production risk. Larger growers are better able to bear risk, so firms
will have an incentive to contract with them.
Small holders face an important advantage against big producers: the cost of labor
supervision. Since most of their labor is family labor, they realize the marginal gains,
whereas hired workers at a large farm do not benefit from extra effort and, by the
contrary, need to be monitored. However, efficient production requires information
33
about optimal cultivation techniques: when and how to apply chemicals, when to water,
weed, and rotate crops. It also requires information about permitted chemicals (types and
amounts) in different export markets, and desired characteristics (size, texture, color,
weight, etc.). Gathering this information implies high fixed costs, therefore economies of
scale arise. The agroindustrial firm can gather the information and split the cost among
all the farmers.
6. Final comments
Smallholder cultivation and high intensity and density of poverty levels are the main
characteristic of rural areas in sub-Saharan Africa, Latin America and South Asia. Most
of these smallholders practice either subsistence farming or operate largely in local
markets due to lack of connectivity to more lucrative markets at provincial, national or
global levels. As a result, incentives remain weak, investments remain low, and so does
the level of technology adoption and productivity, resulting into a low level equilibrium
poverty trap.
Two instruments appear critical to break this deadlock for the small holders: one is
physical infrastructure –such as roads, electricity, potable water and drainage, water for
irrigation and telecommunications - that connects smallholders to markets; and the other
is the role of accompanying institutions - such as land titling on the enforcement of
property rights; credit markets; and contract farming; vertically integrated schemes;
market information systems; commercial rules and laws; commodity exchanges;
warehouse receipt systems; and producer and trader associations on economic
coordination ‐ that can reduce the marketing risk and transaction costs in the process of
exchange between producers and consumers.
The proposed paper provided strategic inputs to strengthen the institutional and
infrastructure base that is necessary to support enhancement of the competitiveness of
smallholders in rural areas in the production and marketing of their products to better link
them to markets to help generate incomes for both smallholder farmers and rural labor.
The paper brings together three dimensions in its analysis in linking smallholders to
markets:



the heterogeneity of small farmers and therefore their specific bottlenecks in
connecting to markets,
the complementarities of investment in rural institutions and infrastructure (capital
intensive and post-harvest technologies) may have in market development and in
reducing poverty, and
the level of market accessibility.
In addition it applies a common multi-pronged approach to developing countries
which aims to the production of an international public good which can be applied in
more than one country or region.
34
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