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c e p A L i ^ ^ ^ ^ )I N T 7 7 9 i

POLICIES AND PROGRAMMES TO PROMOTEAGRO-INDUSTRIALIZATION IN LATIN AMERICA

Mart ine DirvenAgr icu l tu ra l Deve lopment Un i t ,

UN-Econom ic Com miss ion for Lat in Am er ica and the Car ibbean,Sant iago, Chi le

andA lexander Sche j tman

Agr icu l tu ra l Po l icy Adv ice BranchFAO Regional Of f ice for Lat in Amer ica and the Car ibbean,

Sant iago, Chi le

Paper presented at the Internat ional Food Pol icy Research Inst i tute ( IFPRI) Workshop onSt ra teg ies for s t imu la t ing gro w th o f the rura l non- farm econo my in deve lop ing coun t r ies ,Wa shingto n D.C. , May 17-2 0 1 99 8. The v iew s expressed in th is paper are those o f th eauthors and do not necessar i ly ref lec t the v iews of the Organizat ions.

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I . INTRODUCTION: The macro contextI t must be s tated f rom the outset that th is paper deals wi th only a spec i f ic k ind ofpo l ic ies to promote agro- indus t r ia l deve lopment in Lat in Amer ica , namely thosewh ose a im is to con t r ibu te to a change in the p roduc t ion p at terns o f smal l - sca leagr icu l tu re w i th underut i l i zed produc t ive potent ia l . ^As is we l l known, mos t count r ies in Lat in Amer ica have been implement ing majoreconomic re forms : where po l ic ies o f s tab i l i za t ion , deregu la t ion , pr iva t iza t ion o fpubl ic enterpr ises , t rade l iberal izat ion, etc . have impl ied a drast ic re du ct ion of thepub l ic sec tor 's fo rme r heavy invo lvem ent in agr icu l tu ra l com m od i ty and serv icemarkets .Given the product ive potent ia l of smal l -scale farmers, there is a need to look forpol ic ies to increase their levels of product ion and product iv i ty in order to enablethem to compete under the new rules, ins tead of being forced out as producers orinto a precar ious level of subs is tence.In fac t , macro-econom ic and s t ruc tura l ad jus tm ent po l ic ies have m os t ly bene f i tedonly some producers (mainly large-scale and capi ta l ized) ; some regions with in eachcount ry ( i r r iga ted and wel l endowed wi th in f ras t ruc ture) ; and some produc ts (main lyexpor t or iented or of h igher value and/or income elast ic i ty ) increas ing the alreadyhigh degree of polar izat ion in the ag r icul tural sec tor .There is , there fore , the need to redress these t rends w i th a se t o f d i f fe rent ia tedpo l ic ies fo r the d i f fe rent types o f agr icu l tu ra l p roducers , among them, those fam i lyuni ts that , because of the s ize or the qual i ty of their resources, have developmentpotent ia l i t ies that can be real ized through l inkages with spec i f ic types of agro-industr ies .The aim of the research project on which th is paper is based, was prec isely toexamine the poten t ia l role tha t agro- indus t r ia l deve lopm ent co u ld p lay in chang in gprod uct io n pat tern s of a s izable numb er of smal l -scale produ cers and to der ive s om egeneral pol icy guidel ines to achieve th is .To exp lore the fac tors determ in ing success fu l and unsuccess fu l exper iences o fcont rac t agr icu l tu re w i th smal l - sca le producers , 62 case s tud ies were car r ied out in13 countr ies ^ to assess their imp act on the dem and for labour and on im pro v ingaccess to bet ter techno logy , produc ts and markets .

The scope of this paper is limited to only one of the linkages that needs to take place if small-scaleproducers, with underutilized productive resources are to benefit from modernization. Other actions, forthose living in the countryside who have no land or very little, include developing employment options innon-agricultural rural occupations, based on the dissemination of flexible specialization technologies;developing local infrastructure; etc.^ The case studies were carried out by ECLAC and FAO and financed by project grants from th eDutch and German Governments.

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Before consider ing some general aspects of agroindustr ia l contract ing i t isworthwhi le to make two qual i f icat ions on agro- industr ies ' d i rect impact on thedemand for labour.First ly, i f a minimum density of infrastructure, services and human resources arerequired to attract or make possible the establ ishment of agro-industries of a certainsize, the n mo st probab ly the y wil l sett le at the outsk irts of a to w n near to the p rimaryproduct base. Moreover, a study of the lea Val ley in Peru (Figueroa, 1996) andevidence from Chile show that agro-industries in urban sett ings tend to recruit labourforce fro m the imm ediate urban surrounding s and not rural labour force . Thus thedirect impact of urban agro-industries on rural employment is probably rather weak.Secondly , investment per uni t of labour in modern agro- industr ies tends to be ratherhigh and therefore i ts di rect impact on employment is not as high as manyproponents of i ts development for di rect labor absorpt ion purposes usual ly assume.Medium and large scale agro- industr ies employed 2 366 000 people in 1990 or24.4% of the total employed in manufactur ing industr ies, a share that has beenmaintained over the last 20 years.^ As far as we know, however, there is noinformat ion -except in case studies- of where these agro- industr ies are located.i f Ecuador is any guide on the situat ion in Lat in America, then the average agro-industry is rather smal l and bigger agro- industr ies are concen trated in a fe w regions.Indeed, whi le the average for the country is some 90 employees per agro- industry ,there are only s ix Prov inces -out of 20- wi th an average of more than 50 employeesper agro-industry. ^A rather dar ing conclus ion is that a relat ively smal l proport ion of medium to largesize agro-industries are located in the rural sector and that most of the rural EAPemployed in industries as per the populat ion census (some 3.1 mil l ion people) are infact work ing in smal l to micro enterpr ises.Where agro- industr ies do have a di rect s t rong impact on the rural sector, is on thefarmers that supp ly them w i th raw m ater ial , in the f irs t place as an importa nt buyerof their produce, but often also as an inductor of technological change. I t isprecisely with this kind of l inkages that this paper wi l l be deal ing.

^ As defined by the International Standard Industrial Classification (ISIC): food, beverages, toba cco andwood products; nnedium and large-scale as defined by each country -in most cases, over 50employees-; data pertaining to 14 countries (source: ECLAC's Programme for the Analysis of IndustrialDynamism (PADI).Agro-industries of ten or more employees, not including the wood industry (Source: INEC (1993):Encuesta Nacional de manufactura y minera, Quito, Ecuador). Liudmila Ortega, a consultant to ECLAC and FAO, confirmed that most of th e agro-industries of acertain size she found in her recent investigations in El Salvador and Honduras were located at theoutskirts of towns and not in the rural hinterland; see also Reardon and Stamoulis (1997) on thesubject. Calculated on the basis of a participation of 2 2. 3% of the total rural economically emp loyedpopulation (EAP) in manufacturing industries (Klein, 1992) and a total rural EAP in 1995 of 47.3million (CELADE, 1996).

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I I . AGROINDUSTRIAL CONTRACTING:' Sometheore t ica l considerationsin w ha t fo l lo w s, the term ver t ical co-ord inat ion wi l l be used for al l the s i tua t ionsthat fa l l in between a purchase through the spot market on one extreme, andoperat ions under one and the same owne rship on the other extre me , for w hic hver t ical integ rat ion wi l l be used.

In pr inc ip le, the spot market wi l l be used to organize t ransact ions where a mult i tude ofano nym ous buyers and sellers gather and for wh ich auto nom ous ada ptat ion by each

par ty is the prevai l ing need (Wi l l iamson , 19 94 ) .In turn , ver t ical co-ordinat ion m echanisms w i l l be used for f requen t t ransact io ns, fo rjust- in- t ime del ivery (Belden, 1992) or where co-operat ive adaptat ion between thepart ies is the p revail ing re quirem ent.B i lateral dependency relat ions are created when buyers ask prov iders to make spec i f icdurable investments , in order to comply wi th their requirements. This is so, becausethe suppl iers cannot reor ient their h ighly spec i f ic assets - for which an investment wasmade in v iew of the t ransact ion- wi thout los ing product ive value, and the buyerscannot get the necessary suppl ies eas i ly in case of breach of contract .In the case of agr icul ture, the concept of durable investme nt can be extend ed to thesowing of a spec i f ic crop (even a shor t cyc le one) when i t is produced withcharacter is t ics and in quant i t ies only usable by the agro- industry or for which agro-indu stry pay s a higher pr ice. The same holds for land used for a certa in ty pe o f cro pthat, because of i t looses (or gains) fert i l i ty or becomes less (more) appropriate foral ternat ive uses. In dependency c ircumstances the norm is usual ly a contract for thedurat ion of one or more seasons, inc luding a ser ies of secur i ty c lauses, prov is ionsagainst the revelat ion of informat ion and dispute set t lement mechanisms.Final ly , ver t ica l integrat ion wi l l be the case whe n the produ ct is of h igh spe c i f ic i ty ,when there are economies of scale or of prox imity of the place of product ion with theplace of process ing (Johnson and Ruttan, 1994) and when the costs of product ion,superv is ion and adminis t rat ion are lower than the cost of purchase f rom third par t ies .The agro- industry has therefore three (non exc luding) al ternat ives to determine i tssources of agr icul tural inputs : to buy in the open market ; to establ ish ver t ical co-ordinat ion with agr icul tural producers; or to produce those inputs by i tsel f , dependingon cost and r isk cons iderat ions. There are two k inds of costs to be cons idered: own

^ It was found useful to expand the concept of agro-industry as a processor of agricultural rawmaterial to one encompassing any agent that requires a certain volume of agricultural products, with adefinite degree of specificity as to quality, volume and moment of availability. Thus, this agent can bean agro-industry, a farmers' cooperative, a fresh products packing industry, an exporter, a broker, amarketing board, a chain of supermarkets, and even a tourist resort.The case studies have, for example, reported loss of fertility in the case of tomato plantations by agro-industry on rented land in Peru and also nematode infestation in the case of Panama, on the one hand,and natural repelling of pests attacking melon after rotation with marigold in El Salvador, on the otherhand.

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product ion or purchasing costs of the input as such and transact ion costs which, inturn, wi l l depend on the nature of the inputs.In the case of contra ct ing , transa ct ion costs include : i) search for supp l iers;ii) screening of po tent ial suppl iers; i ii ) negotiat ion of co ntra cts; iv) transfer of goo ds,services, or property rights; v) monitoring behaviour for breech of contract; and vi) theenforcement of the contract term s. High t ransact ion costs associated w i thcontract ing create an incentive for the f irm to ut i l ize markets or internal ize theprod uct ion proc ess (Runsten & Key 199 5, p. 16). In the case of ow n prod uct ionthey include the cost of organizing, training and supervising personne l.A contract w ith a small-scale producer wi l l represent a better alternat ive compa red toow n prod uct ion in the case of agricultural inputs tha t have no econ om ies of scale andare labour and care intensive. This is so because part of the household's labour is anon-tradable, has no opportunity cost and is only able to create value within thehousehold .The resu l t s o f the case s tud ies show th is to be by and large cor rec t .However, they also show that the importance of t ransact ion costs is such that theyof ten become the determining factor for not opt ing for this al ternat ive.One can assume, however, that the more care intens ive the product ion of theagricul tural input is , the smal ler the di f ference of t ransact ion costs between vert icalintegrat ion and contract farming wi th smal l producers wi l l be, so that the sum of thecost di f ferent ials - i . e . produ ct ion plus t ra ns ac t io n- wi l l favou r the lat ter al ternat iveat some point, (see graph)

There is also a greater tendency to establish contracts for perishables than for grains and tubers whichare easily obtainable on the open market at required quality conditionsFor the theoretical basis of this assertion see Schejtman (19 84) pp s.27 4-2 99^ A Me xican agro-industrialist summarized the a dditional costs involved in dealing w ith small-scalefarmers as follows: the Inability to call or fax the producers so that, in order to communicate withthem, they have to be visited; the additional time spent and costs incurred at the factory for unloadingand weighing products from small lorries; the increase in the number of accounting procedures and inthe administrative costs due to the large number of producers working under contract; the need foradditional technical assistance and more field visits; the need to advance operating or investmentcapital; the need to lend or lease special machinery; the greater difficulty of convincing them to useonly authorized pes ticides in the required quantities; etc .

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PRODUCTION AND TRANSACTION COSTS:A stylised representation 12

O S TO l f F i R S I C E S Cp = Cpc-

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whereas the individual farmer has hardly any means at al l to exert pressure especial lythe small- or medium-scale farmer.The existence of imperfect markets -either in land, labour, credit , information,technology, inputs or goods- is a frequent attr ibute of the rural areas in the Region,and helps to explain the presence of many vert ical co-ordinat ion arrangements whereone would have expected a spot market transact ion or vert ical integrat ion.^ ^Furthermore, very often, one f inds interl inked transact ions where the purchasingagreement is complemented with credit , technical assistance, provision of inputs, etc.,as a sub st i tute for m issing or imp erfect m arkets for one or more of these fact ors . Inthese cases, there usual ly is a lack of transparency in cost accounting and risk sharingbetween the part ies. In fact, imperfect or missing markets is one of the reasons whysmall farmers are excluded from part ic ipat ing in the product ion of goods for whichthey seem to have com para t ive advan tages (e.g., labour intensive and sup ervisionintensive crops) because the y are also intensive in the above men tioned facto rs.Were i t not for their l inks with an agro-industry, a government agency, an NGO oranother intervent ion to compensate for such imperfect ions, there would seldom besmall-scale product ion of non-tradit ional export crops.Vert ical co-ordinat ion is also inf luenced by the price paid for a product. Thus, whenprice dif ferences do not compensate for dist inct qual i t ies, then the incentive toproduce better or homogeneous qual i ty products vanishes and so do the reasons toestabl ish vert ical co-ordinat ion agreements.^^In instances of highly volat i le prices, vert ical co-ordinat ion agreements wil l be dif f icultto establ ish or maintain because of the dif f iculty of pre-establ ishing a price andbecause of the temptat ion of both part ies to breach the contract when the agreedprice dif fers signif icant ly from the one that can be obtained on the spot market.^As legal requirements and consumer demands increase as to the use of labels, qual i tyand appearance of the products and their ingredients, there is a tend en cy to wa rd agrowing use of vert ical co-ordinat ion. Trade l iberal izat ion has, of course, acceleratedthis trend. By contrast, the establ ishment of inst i tut ions that classify and control the

Rice and wheat are typical commodities that should be traded on the spot market. Instead, in somecountries they are traded through co-ordination agreements because farmers need credit and a way toobtain it is through interlinked transactions with the future buyer of the cereal. Instead, in Nicaragua, theexistence of imperfect land markets explains why factories buy a higher than usual proportion of sugarthrough vertical co-ordination agreements instead of growing it themselves.Lack of quality discrimination by domestic consumers is probably the reason why in Ecuador andParaguay tomato paste is mainly produced from tomatoes bought in the spot market. The lack of pricedifferentiation on the international market for quality cocoa was the reason given by an Ecuadorian cocoatrader for the declining cocoa quality in Ecuador and the lack of remedial action taken by producers andexporters. The same decline in cocoa quality is observed in Trinidad and Tobago which also has theclimatic conditions and a tradition for producing fine flavour cocoa.For agricultural products it is not unusual to see price fluctuations from 1 to 10 depending on time andplace. Additionally, as evidence from melon producers in El Salvador shows, risk aversion among small-scale producers have them prefer a fixed price above other formulae such as a commission or a (lower)fixed price plus a percentage of profits formula. This, of course, increases the possibility of contract andmarket prices being wide apart at sales time.

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qual i ty of agr icul tural products , by reduc ing t ransact ion costs , make spot markett ransact ions more feas ible even for spec i f ic goods.For a novel ty or newly int roduced product , at the bot tom of the learning curve,character ized by l i t t le demand and supply , h igh r isk and high returns, the typearrangem ent w i l l probably be gin as a ver t ical ly integrated or co-ordinate d ven ture (or am ix ture o f both) . The t rans i t ion f rom nove l ty to com mo di ty , tha t is to a produc t o fhigh demand and supply , less r isk and less returns per uni t , might change the type ofar rangeme nt (von Hesse, 1994 ) , depend ing on the par t icular s i tua t ion, e i ther tow ard sthe spo t ma rket -because of the increase in the n umbe r of buye rs and sel lers ;^^tow ard co nt rac t ing smal l fa rmers wh o tend to w ork fo r a smal le r compen sat ion than acommerc ial f i rm, or remain ver t ical ly integrated, in order to capture al l the prof i ts nowthat r isks are lower .Smal l farmers ' organizat ions tend to reduce t ransact ion costs s ince negot iat ions canbe done throug h farmers ' representat ives instead of wi th each farm er separately . A tthe same t ime, they can improve their bargaining pos i t ion. I t wi l l therefore be thebalance be twe en the tw o that w i l l lead the agro- industry to al low (even encourage)the organization or act against i t .^In the case o f agro-indus t r ies ow ne d by farmers ' co operat ives an d cont rary toexpec ta t ions , conf l ic ts may ar ise between the indus t r ia l par t and the farmers , inrelat ion to pr ices, s t rategies and other condi t ions.^ Wann and Sexton (1992, p.988) po in t out tha t th is k ind o f cooperat ives do not necessar i ly inc rease compet i t ionbetween agro- industr ies for their inputs supply but ins tead, may diminish i t in as faras the farm ers are obl iged to del iver the m to the coo pera t ive.Diagram 1 t r ies to v isual ly summa r ize the above. I t has been div ided into three areas:the characteristics that ideal ly should lead to a cer tain type of intera ct ion b etw ee n th eagents are s t ipulated in the f i rs t area; some consequences of th is interact ion arement ioned in the second area; and in the th ird, ment ion is made of the displacementfactors tha t move the type o f in terac tion f rom the opt im al one to another one.

in Chile, cling peaches (for canning) are an example of this: they are traded through the spot marketalthough the specificity of the product would have led to expect otherwise.It could be the case of pineapples in the Dominican Republic.8 This was precisely the dilemma faced by ASAGRO in the Santa valley in Peru whose firstadministration opposed the organization of the asparagus producers because of price disagreementswhile its second administration backed its formation with resulting drastic reductions in transactioncosts.CONAPROLE (Milk Producers' National Cooperative) in Uruguay and the Cooperative Citrus Growers'Association in Trinidad and Tobago offer two clear examples of these types of conflicts.

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Diagram 1F A C T O R S T H A T E N H A N C E O R R E S T R I C T V E R T I C A L C O O R D I N A T I O N

M A R K E T V E R T I C A L C O O R D I N A T I O N V E R T I C A L I N T E G R A T I O N- Low product specificity andrequirements- Autonomous adaptation

- Mutua l dependency (product andinvestment specific)- Need to adapt in co-operation- High product specificity- Economies of scale

CONSEQUENCES- Each agent assumes all thecosts, risks, information effortsand profits- Supervision and transaction costs- Risk and profit sharing power play- Possibilities of free-riding- Possibilities of principal-agentrelations and inter-linkedtransactions

- Costs of administration,supervision, capital andland- Tota l absorption of risksand profits- Size and location riaidltiesDISPLACEiVIENT FACTORS- Little price/quality differentiation- Big price fluctua tions (fosterfree-riding from both sides)

- Increase in mutual confidence>