Contract Farming
in Developing Countries:

Theoretical aspects and analysis of some Mexican Cases

Report prepared for the United Nations Economic Commission for Latin America and the Caribbean, Santiago, Chile.

David Runsten and Nigel Key

Introduction

Research Report No. 3, August 1996 | issued in Spanish, September 1996

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Contract farming has been used in the more developed countries for a long time. Perishable crops destined for processing, such as sugar beets or cling peaches, were contracted in the United States in the 19th Century. Problems of monopsony or oligopsony by food processors and marketers were also apparent by the late 19th century, and efforts were begun to organize farmers to provide a united bargaining front (Bunje 1980). The Capper-Volstead Act of 1922 exempted agricultural cooperatives from anti-trust laws, which led to a great increase in cooperative bargaining associations in the 1920s. The sugar act of 1934 established farmer bargaining associations for sugar beet growers. The Agricultural Marketing Act of 1937, the Agricultural Fair Practices Act of 1967, the Uniform Business Code, the Perishable Agricultural Commodities Control Act, all provide a legal framework in which to resolve disputes over contracts, to bargain over prices and contract terms, or for the farmers themselves cooperatively to process the agricultural products.⁽¹⁾

As multinational food processors set up operations in Latin America behind Import Substitution Industrialization (ISI) regimes after World War II, they often adopted contract farming as the best raw product supply mechanism, particularly where there were controls on land ownership. In Mexico, for example, the strawberry freezers and fruit and vegetable canners in the BajRo had already adopted such practices in the 1940s and 1950s (Rama and Vigorito 1979; Morrissy 1974). And some of the firms that had maintained plantations, such as the banana producers, adopted contracting as a means of defusing nationalistic criticism of their operations (Glover 1983).

In the 1970s, in line with a general concern with the growing influence of multinational firms in developing countries, a number of studies of agricultural contracting were carried out in a variety of countries of Latin America ⁽²⁾ . In Mexico, studies such as Feder's (1977) of the strawberry industry or Rama and Vigorito's (1978) of fruit and vegetable processing in general were so suspicious of foreign capital and tried so hard to show ill effects that they lost sight of the real effects on incomes and investments in rural areas, and they neglected the economic motivations that determine the behavior of the firms, particularly the issue of institutional and market failure that drives much contract farming.

One strand of concern about contract farming has been the question of whether it was a means to transfer technology to smallholders and raise their incomes, or was a sophisticated form of the "putting out" system that would tie them through a form of indentured servitude and extract all surplus from their work: "workers for capital working at home."⁽³⁾ Unfortunately, the first strand has been associated with a pro-business group who appear to assume that contract farming must benefit the growers (Goldberg 1974; Austin 1981; Morrissy 1974; Williams and Karen 1985), and the second with critics who assume that it cannot. The truth lies somewhere in between, and the growing number of experiences suggest that there are crops and situations appropriate to smallholder participation, and that there are crops and situations that are almost certainly doomed to fail. The success of very small vegetable producers in the Guatemalan highlands (Von Braun, et al. 1989; Glover and Kusterer 1990) has to be weighed against the many failures that can be found in every country.

This paper explores the economic motivations of the agroindustrial firm to contract with smallholders, the economic motivations of smallholders to participate, and some of the problems which arise in the course of the venture. One thing that is very clear is that there are many reasons why a firm might not want to contract with small-scale producers. Despite the rhetoric that the peasantry was being subordinated to large producers, the reality was often that the peasantry was largely marginal to such lucractive enterprises as export fruit and vegetable production, and often shut out of or discriminated against in domestic supply systems as well (so-called mercados controlados). It was not so much that they were being exploited, but that they were excluded from the most profitable activities--not so much that they were victims of capital, but that capital had studiously avoided dealing with them. Here we attempt to develop some theoretical explanations for this reality -- and for such observed phenomena as price discrimination when peasants do participate -- and to show how they have worked in some concrete situations in Mexico.

Contracting is of course not confined to agriculture. There is an increasing tendency to subcontract out specific production tasks in an array of industries, such as garments, electronics, construction, or janitorial services, and many of these involve contractual relations between larger marketing organizations and smaller producing firms. Contract farming therefore must be viewed in a broader theoretical context that includes "make or buy" decisions, transaction costs, market failures, and risk considerations dealt with by all economic actors. It is in this sense that we attempt in the following sections to organize some of the economic factors that influence the choice to contract, the type of contract, and the type of contractee.

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