Agricultural production and food system have been subject to structural changes including informal contracts with its multifunctionality for food security, rural household development, and global poverty reduction.
In absence of institutional credits, informal contracts allow farmers and retailers to overcome the investment difficulty in starting farming or food business. Informal contracts as a widespread concept in agriculture lead to a strong linkage of sponsors to the supplier function (Rehber, 38-50).
For decades, contracts in farming and food business are amongst pathways of sustainable rural growth. Despite smallholders’ inability to compete the large-scale producers; informal contracts provide to rural households serves as conduits for poverty alleviation. Largely, in informal sectors, companies and farmers have seasonal informal production contracts for fresh vegetables, tropical fruits and cash crops (Eaton & Shepherd, 2001 pp. 52).
Typically, in informal contracts, the farmer agrees with the purchaser to provide quantities of specific volumes of quality standard agricultural products at a delivery schedule and often, at predetermined prices. The purchaser commits to production with land preparation, the supplying inputs, and providing technical advice. In this case, farmers are linked with a large farm or processing plant which supports production planning, input supply, extension advice, and transport. Certainly, the informal contracts in farming lead to a production of wide variety of agricultural products (FAO, 2008).
For sponsors, the seasonal contracts represent collateral. Whereas the tendency of contract sponsor to purchase all products within quality and volume parameters is higher, sponsors offer cheap credits and inputs to farmers seasonally on credits due to the free-riding problem (Gibbon, 2001 pp. 352). In a recent study in developing countries, Fisher & Qaim, (2012b) showed that farmers form cooperatives. This collective action can reduce transaction cost and facilitate access to high-value output markets
Bolton & Dewatripont 2005, however, explain that as informal contracts (also called parole) are neither signed under seal nor recorded and the problem of asymmetric information abound (hidden actions or moral hazards occur as sponsors or farmers default). Olomola, 2007, agrees that informal contracts in agricultural production are ordinary agreements between buyers and farmers, which establish the production and marketing conditions for farm products. Such an agreement may be oral or written.
Though very discrete, the untenable asymmetric information challenge is an old phenomenon in the informal sector, rural households enter into informal contracts. Despite farmers and food processors decision to acquire informal credits, low- input production occurs. As governments and regulatory bodies seem lost in their role, farmers seemingly push voluntary plans to stay in production. These matters in contracts are indicative of the compelling need for relevant institutions and standards in the credit market(,,,,).
Moreover, different contracts potentially have relatively distinct issues which come about from farming inefficiencies. Farming inefficiencies are undeniably unfavorable for rural livelihood. Smallholder farmers constitute a large proportion of the undernourished people worldwide. Analyzing these inefficiencies for appropriateness in agriculture is possible as farmers’ entrepreneurial skills jointly affect supermarkets participation and household nutrition (Qaim, Chege & Anderson, 2015 pp. 394-397).
In understanding these crucial development implications of informal contracts in farming and food sectors requires contemporary assessment for sustainable growth as it inextricably links food security and entails high potential to increase rural peoples’ incomes in developing countries.
Notwithstanding several studies on informal contracts in farming, the study uses existing literature to critically highlight informal contracts and its distinctive implication on farming and food sectors. To this demonstration, the study insightfully shows empirical analysis/scenarios to assess the impact of informal contracts on farmers.
Drawing upon development reports and analyzing contracts in farming models, the study sets out:
· To investigate the extent to which informal contracts become a prerequisite condition for effective economic growth.
· To investigate the extent to which informal contracts reduce vulnerability.
· To analyze the general factors influencing farmers’ participation in informal contracts.
· To examine the effectiveness of informal contract in farming and food sectors.
Besides this background information on the study, the paper is organized into five further chapters. Chapter two is the brief literature review; addresses contract farming and informal contract models. Chapter three is a theoretical framework of the study; espousing the need for this study. Chapter four is an empirical model used. Chapters five and chapter six are discussions and conclusions of the study respectively.
2.0 LITERATURE REVIEW
2.1 Meaning of Contract Theory in Farming and Food Systems
A contract in agricultural production is forward purchase agreement between farmers and processing or marketing firms for frequent supply of agricultural products at predetermined prices. Knowingly, the agreement may be written or oral. Written contracts are standardized with identical inputs, credit condition and price by product. For farmers are required to follow rigid instructions of the firm (Minten, Randarianarison, & Swinnen, 2005 pp. 11 ) Contracts in farming are thought of as a way of commercialization and industrialization in agriculture especially for the developing countries. Contracts in farming help small family farms and farm laborers who need capital and managerial assistance (Moore, 1994 pp. 28-32). The majority of these farms are small. It is commonly recognized that small family farms are potentially an important source of growth in agricultural production. though small-scale agriculture has some socio-economic advantages, there are some serious constraints as well regarding the problems of access to production inputs, services, and information (Rehber, 2007 pp. 38-50). Different contracts in farming make its discussion more demanding. Notwithstanding this, there are basically five models accepted globally. These include the centralized, nucleus estate, multipartite, and informal models (FAO, 2008). For the purpose of this research, the focus is only on the informal model.
2.1.1 Meaning of Informal Contract Model in Farming and Food Systems
Basically, this model is run by individual entrepreneurs that make simple, informal production contracts with farmers on a seasonal basis. Usually, the produce from these contracts requires only a minimal amount of processing and packaging for the retail outlet or local markets. Perhaps, the most speculative of all contracts in farming models, with a high risk of promoter or farmer default (FAO, 2008). This imperfect contract performance allows firms to drop smallholders who fully do not honour contracts if, for example, firm learns that other regions or other smallholders within the same region offer profitable and reliable sources. Conversely, smallholder may exit the contract agreement if they find that the contract delivers less than anticipated, if new opportunities emerge (Barrett et al., 2012 pp. 720).
2.1.2 Effects of Contracts to farmers and Sponsors
The benefits of contract in farming for farmers include; improved access to local markets, assured markets and prices (lower risks) especially for non-traditional crops, thus, assured higher returns. Farmer access to production inputs, mechanization, transport services, and extension advice are enhanced. Local infrastructures (roads and irrigation facilities) are improved. Moreover, sponsors have assured quality and timeliness of delivery of farmers’ products, production is more reliable than open market purchases and the sponsor faces low risk not being responsible for production (Agila, Monohara , 2008).
2.1.3 Constraints of Farmers in Contract Farming
Despite the aforementioned merits of contract farming, there are several limitations including; Farmers become indebted in diverting inputs supplies on credit to other uses and this cause production problem. The staff of sponsoring organization may be corrupt, especially in the allocation of quotas, thus, sponsoring companies are many at times unreliable or exploit from a monopoly position. There are land constraints due to lack of security of tenure and this endanger sustainable operations. There are at times no effective “buyback” arrangements between farmers and organization (Rehber, 2006 pp 143).
3.0 CONCEPTUAL FRAMEWORK
Poverty, unemployment, and migration in informal sectors remain the bane of economic development. As a result, stakeholders continue to find alternate paths of improving incomes of the rural people in developing countries. Notably, developing countries farmers lack funds to invest in farming and have difficulty in contacting potential buyers for their produce. However, in dealing with this problem of farmers, the informal contract is one possibility identified to improve farmers’ livelihoods.
To explain why and strengthen logic of informal contracts in farming or the food sector will allow burrowing perspectives from literature which encourage an alternative explanation on how informal contracts impact farming and food sector.
For firmness to espouse the role of informal contracts in farming globally, the study uses empirical models to provide explanations to main issues of the study. Thus, a formal model analyzing and unveiling the role of informal contracts is utilized allowing the use of descriptive tables in the analysis.