Contract farming has become a popular way to integrate smallholder farmers into modern, high-value markets; however, poorly designed contracts may create additional risks for farmers and even subject them to abuses by larger agricultural players. In July, the FAO, along with UNIDROIT and IFAD, released a Legal Guide on Contract Farming, a comprehensive guide to establishing sound, transparent agricultural contracts between growers and buyers. The document provides advice on sound contract design, risk allocation, and conflict resolution, all presented in layman’s terms to be accessible to a wide audience.
Recent IFPRI research has also addressed the need for alternative dispute resolution (ADR) mechanisms to assist farmers and buyers resolve disputes outside of the court system. In a World Bank Viewpoint note published in 2014, IFPRI researcher Nicholas Minot provides a literature review of several major contract farming studies and finds that conflicts between producers and buyers most frequently occur over quality standards and price. Farmers may be tempted to renege on their contracts if they can make more money selling in the market, while buyers may be tempted to fabricate quality testing as a way to reduce the price they need to pay to farmers.
In many developing countries, settling these disputes within the court system can be impractical because of associated high costs and lengthy delays. ADR mechanisms, which allow parties to resolve their disputes outside of court, often provide a more practical solution. Such mechanisms can take the form of dispute settlement boards that are required to render judgment on a dispute within a specified timeframe. Similarly, in many countries, village leaders or trusted NGOs can be given the responsibility of adjudicating disputes.
Another ADR mechanism that has been gaining in popularity is the use of third-party testing to verify product quality. A study of contract farming of cotton in Mali showed that using a third party to enforce the terms of the contract on both sides resulted in an increase in cotton quality. Such testing can help reassure farmers that buyers are not going to trick them out of fair pay by claiming to have received a low-quality product; this makes farmers less likely to renege on the contract on their end, thereby increasing trust between both parties and making contracts more transparent and stable.
Overall, Minot finds that according to most of the econometric literature, contract farming raises participants’ income by 25-75 percent compared to similar farmers who are not on contract. But in order to ensure that contracts meet their potential to improve smallholders’ wellbeing, it is crucial to design them in a way that protects all parties. By increasing the trust that farmers and buyers have in one another, ADR mechanisms such as third-party quality testing could allow contract farming to expand into new regions and commodities.
Minot concludes, however, that more research is needed to fully understand the impact that ADR mechanisms have on smallholder’s participation in and outcomes from contract farming. In particular, studies focusing on contracting firms’ objectives and constraints would shed light on the conditions and characteristics that firms look for when contracting with farmers, as well as on what constitutes a successful contract in the eyes of the buyer. In addition, multi-year longitudinal studies and randomized control trials would provide more robust information about the dynamics of contract farming and more rigorous impact evaluations.
By: Sara Gustafson, IFPRI