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“You Quit??” – Small Farmer Contracting and the Importance of Dropout

Over the past 20 years, international trade liberalization and various reforms have dismantled many government controls on agricultural markets in the developing world, opening new commercial spheres for farm products and new marketing choices for farmers in the Global South[1]. One class of these opportunities is linked to the modernization and expansion of agricultural value chains to move agricultural production from the farm gate to consumers. Modernized agricultural value chains generally supply exporters or modern retail chains, using a system of private grades and standards, contracts, and other agreements with farmers to eliminate intermediaries and bypass the traditional marketing system. The traditional spot-market system, in contrast, is characterized by networks of transactions and multiple intermediaries: typically, rural brokers purchase all of a farmer’s production and sort and transport products from countryside spot markets to wholesale buyers operating in regional and national market centers.

Purchasing agricultural production directly from farmers is attractive to retailers, exporters, processors, and large wholesalers as a way of improving product traceability and reducing sourcing costs. Nonetheless, contracting with numerous small farmers can be an expensive proposition, and researchers have wondered whether small-volume farmers would be included in these new marketing opportunities. Moreover, these new large-scale buyers generally demand conformity with product quality or process standards, a minimum scale of transaction, or some combination of the two, also potentially disadvantaging the small producer.

Economists concerned with agriculture and development have been interested in how the expansion and modernization of agricultural value chains in the developing world will impact rural poverty and inequality. One key issue is whether new markets will represent paths of inclusive growth, or serve only to widen extant inequalities in rural areas. With these concerns in mind, researchers have investigated the degree to which small farmers are being included in modern agricultural value chains, and have assessed the dimensions and magnitude of benefits to that inclusion.

A body of work now suggests that small farmers can indeed be included, provided that they can meet transaction schedules (weekly, semi-weekly, year-round or seasonal) and minimum transaction scales required by the buyer. Participation, therefore, is often associated with access to irrigation, membership in a farmer group or both. Irrigation allows farmers to stabilize their production flows and potentially produce year round while farmer groups allow farmers to meet supply quantities through coordination and aggregation. My own work has established that reliable access to water (permitting year-round production) and proximity to major roads were critical for participation in supermarket supply chains in Nicaragua. The importance of this finding: if geographic factors shape where and how buyers site supply chains, then the placement itself may reinforce existing inequalities based on geographic advantages and disadvantages.

Conditional on inclusion, the accumulating evidence is that farmers benefit financially from participation in modern supply chains—exhibiting (depending on the study) higher incomes or assets than small farmers who do not participate, though recent work has established that benefits can be highly variable across farmers, firms, and crops. Empirically identifying the benefits of participation in modern markets is methodologically challenging because of the selection problem—firms strategically select farmers to work with, and farmers decide whether to join a proffered relationship. Because the contract offer and the decision to participate likely correlate with unobservable characteristics (for example, risk aversion or managerial skills) that also affect farmers’ behavior, revenues, and welfare, , it is difficult to isolate the effect of participation in a new value chain.. Even so, to establish welfare impacts, researchers have used a number of analytic strategies, including difference-in-differences, instrumental variables, and propensity score matching.

However, a critical issue that very few researchers have studied thus far is the observed high rates of dropout from new or recent supply chains. Participation in these modern supply chains exhibits considerable churning: high rates of both entry and exit. For example, between 2000 and 2008, more than half of the farmers supplying supermarkets in Nicaragua eventually dropped out; the mean tenure of a supermarket supplier was only 2.4 years. In most cases and in the majority of studies, however, the size of a population that has dropped out is unknown, because few studies have either tracked suppliers over time or worked to track down former suppliers who had already quit by the time a given analysis began.

It is critical that we know the circumstances of these exiting suppliers in order to understand both the effects of participation,[2] and to better design policies to facilitate participation and countenance the effects of exclusion. How and why do farmers decide about entering into a supply chain? How do they decide how and when to exit? How do they include information about their neighbors’ experiences in their decision to join, stay, or exit a new market?

In a new working paper, I use data[3] on the timing of farmers’ entry into and exit from Nicaraguan supply chains between 2000 and 2008, to focus on farmer supply chain participation dynamics. The data we needed was hard to collect; we spent months tracking down former suppliers in Nicaragua’s countryside and interviewing them about their experiences with Walmart and La Colonia, the domestic supermarket. I use the data to test the hypothesis that farmers acquire information about the profitability of a new marketing channel relative to the traditional market—not just from their own experience in the modern market, but also from their neighbors’ accumulating experience and from their neighbors’ decisions to exit.

Results suggest the following: First, neighbors’ exits from the supermarket supply act as significant negative influences on a farmer’s own decision to participate in the new market; Second, observation of neighbors’ accumulating experience in the supply chain is a significant positive determinant of a farmer’s continued participation; Finally, I find evidence that farmers often “free-ride” on their neighbors’ experience, reducing their own experimentation to benefit from the information they glean from their neighbors’ entry and exit.

Evidence suggests that early entrants into a supply chain (who often enter alone rather than in farmer groups or within village clusters) experience less favorable contractual terms than those who join later in terms of the likelihood of supermarket payment default, product rejections, and number of annual transactions. This finding explains observed strategic decisions by some farmers to delay entry. Specifically, I find that the likelihood of supermarket payment default is inversely related to the number of suppliers in a village. For tomato growers (the largest product represented in the sample), I find that the share of production rejected by the buyer decreases as more farmers join the supply chain in the village; and I identify an inverse U relationship between the number of village suppliers and the number of annual deliveries made by the tomato farmer to the supermarket – so the number of deliveries initially increases in the number of suppliers in the community and then decreases.

The policy implications of these findings notably differ from work establishing social dynamics in technology adoption. Because high-yielding crop varieties, such as new hybrids, allow all farmers to benefit without concern for market externalities, the major policy question has generally been how to most efficiently promote universal adoption. The same is not necessarily true, however, for market participation; the dynamics of modern markets are more ambiguous. How do farmers incorporate their neighbors’ market outcomes into their own decisions? What are the optimal village-level adoption dynamics? Can a farmer’s exit from or entry into a modern market have a net positive externality for the village? So far, such questions are largely unasked and unanswered in the literature.

[1] Thomas Reardon at Michigan State University has documented and analyzed how population growth, increased urbanization and the rise of foreign direct investment have been associated with a dramatic increase in the number of supermarkets in regions of the world including Latin America, Asia, and Africa. See;jsessionid=6FBEA961161442062A3C0278880F841D.f01t02,, and

[2] Assessing the effects of participation in modern supply chains without attention to farmers who have quit may provide an overly sunny picture of the effects if the only farmers who remain suppliers are those who find that they benefit. Or, in contrast, if the best farmers exit supply chains in favor of new marketing opportunities we may be underestimating the effects.

[3]The research is in collaboration with Managua’s Nitlapan Institute and was made possible by support provided in part by the USAgency for International Development (USAID)Agreement No. EDH-A-00-06-0003-00 awarded to the Assets and Market Access Collaborative Research Support Program (AMA CRSP). Additional funding for this research was provided by: AAEA McCorkle, Cornell Latin American Studies Program, Social Science Research Council IDRF.

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