Production contracts are more appropriate than market contracts for farmers to overcome the many obstacles, thereby increasing their farm incomes
Published Date – 18 January 2024, 11:45 PM
By Dr Kedar Vishnu, Vaishnavi Kodavaluru, Prof Ruchika Rai
It’s been more than three years since the government withdrew the three farm laws that were introduced to bring market-oriented reforms to much-needed agricultural marketing. However, there is still a lot of asymmetric or lopsided information about the now repealed laws.
Considerable attention has been given to capturing the reasons for widespread protest and opposition by farmers against the laws. But, there has been little attempt to study why it could not get implemented from an institutional economic point of view. Here, we have addressed the gap by capturing the implementation failure from the new institutional economics point of view, lacunae in the laws and policy suggestions if a similar reform is introduced. The New Institutional Economics is a rapidly growing interdisciplinary field combining economics, law and governance. While keeping an eye on the firms’ operations, it is helpful to recognise the significance of government intervention in bringing about more efficient economic outcomes.
It was believed that these laws would benefit smallholders by increasing the area under contract farming and also expand the coverage of other crops. The government introduced the provision of contract farming in the Model APMC Act, 2003. Further, the provision was extended to 21 States before introducing the three laws, and eventually it was aimed to cover all the States.
What was Missing?
One of the major gaps in the laws was the need for more precise and comprehensive mechanisms to safeguard the interests and rights of farmers in contract farming arrangements. The government believed that the contract farming provision would allow farmers to receive all the necessary inputs from contracting firms (chemicals, fertilizer, seeds, etc) and fixed procurement prices in advance. However, defining all the terms and conditions of the final product of fruits and vegetables is impossible in an imperfect competitive market. It is important to note that there is hardly any study available in India capturing empirically the volume of transaction costs (TC) or the extent of reduction of farmers’ income due to firms’ opportunistic behaviour for fruits and vegetables. The absence of relevant data obstructs tenable literature in this field. An attempt is made here to quantify the impact of asymmetric information and opportunistic behaviour by the contracting firm on the farmers’ net income.
We have tried to fill this gap by analysing the data of a primary field-level survey of 300 tomato farmers in Kolar district of Karnataka in 2019. The survey was conducted by Dr Kedar Vishnu in 2019 at the Institute for Social and Economic Change, Bengaluru. These supermarkets undertake backward integration by entering into contract farming with farmers to procure fruits and vegetables for their daily supply at retail outlets. We found that more than 30 supermarket players had contract farming with tomato farmers. Our empirical results show that asymmetric information and opportunistic behaviour together reduce farmers’ profit by 13.51%. Further, while looking at the breakup, we found that opportunistic behaviour alone reduces a smallholder’s profit by 8.78% and asymmetric information by 3.07%.
In addition to this, our study result indicates that smallholders associated with contact farming reduce their output by 8% due to uncertainty associated with the promised procurement price and quantity rejection rate. Farmers with contract farming earned Rs 57,299 per acre net profit compared with Rs 18,758 per acre net profit of APMC farmers. Finally, our estimates show that compared with APMC farmers, contract farmers incurred an average of Rs 16,352 per acre transaction costs (72.49% higher than APMC farmers) for tomatoes. Information costs were incurred due to uncertainty of grading standards and procurement prices. Opportunist behaviour was mainly due to the undefined contracts and lack of enforcement due to the lower bargaining power of the smallholders. The findings suggest that promoting contract farming would have likely benefited farmers by increasing their productivity and net profit. Based on our empirical results, we predicted that proper institutional arrangements would have helped farmers raise their profit by 13.51% (without opportunity behaviour) and 8.05% (without uncertainty), respectively. Hence the government’s role is crucial in specifying property rights and enforcing contracts to promote specialisation and reduce transaction costs.
MSP Uncertainty
Further, we felt that the uncertainty associated with the mechanism for deciding the minimum support price (MSP) for 22 crops was a notable omission. The lack of inclusive dialogue and participation led to mistrust and resentment among the farming community. Our empirical findings reveal that, on average, contract farming firms would prefer to offer 10-15% higher procurement prices than the APMC market price. We would like to highlight one interesting fact: contract farming always takes the APMC price as the benchmark for deciding the procurement price. If the APMC market had vanished, the contract farming firm would have offered a low procurement price and increased opportunist behaviour.
There was also ambiguity in the Essential Commodities Act Amendment. The amendment aimed to reduce government intervention in storing and distributing essential goods. However, the ambiguity in the law’s provisions left room for concerns about unchecked hoarding and price manipulation by private entities. Clear guidelines and stricter checks and balances were needed to prevent potential market distortion. The failure to address land reforms was also a missing aspect of the farm laws. The government could not provide any information about the credit support they would give to tenants engaging in contract farming. Also, no mechanisms were proposed to address land-related challenges, including land consolidation, tenancy reforms and access to credit. Lastly, the present government failed to sufficiently increase agricultural infrastructure investments in cold storage, transportation networks and market infrastructure.
Market-oriented Reforms
First, the government should have allowed each State to implement the laws solely and separately. Second, the government should have made some special provisions in laws to make it compulsory to purchase some fruits and vegetables from marginal farmers. The government fails to capture farmers’ trust in contract farming mainly due to asymmetric information. They must make significant attempts to improve the existing market’s information gap with the help of advanced technology.
The government needs to emphasise strengthening the availability of cold storage and warehouses to promote more private investment. We have not been able to attract many international investors in agriculture supply chains mainly due to uncertainty in policy implementation. It has been found that more than 80% of the small and marginal farmers prefer to sell their products in APMC markets. We strongly believe that the government should increase the number of regulated markets by enabling the payment of market fees, reducing commission charges and introducing quality and open auctions based on price discovery.
Moreover, farmers collectively can reduce the asymmetric information problem by improving their knowledge of the markets and price movement. Hence, the government should have attempted to promote collective farming. We need to considerably improve the quality of fruit and vegetables produced by farmers before we can significantly reform the agriculture market. The government ultimately failed to promote and encourage quality standards.
Production contracts would be more appropriate than market contracts for farmers to overcome the obstacles that stand in the way of obtaining credit, inputs and technologies, thereby increasing farm incomes. The government needs to improve the institutional mechanism to be able to implement any law properly and effectively. A well-defined institutional mechanism will help farmers overcome asymmetric information and opportunistic behaviour by the firm.
