Intermediaries, transport costs and interlinked transactions

• Date: 01 May 2018
• Published date: 01 May 2018
• DOI: http://doi.org/10.1111/rode.12375

REGULAR ARTICLE

Intermediaries, transport costs and interlinked

transactions

M

elanie Lef

evre

1

|

Joe Tharakan

1,2

1

HEC-Management School, University of

Liege, Belgium

2

Centre for Operations Research and

Econometrics (CORE), University of

Leuven, Belgium

Correspondence

Joe Tharakan, Place des Orateurs 3,

4000 Li

ege 1, Belgium.

Email: j.tharakan@ulg.ac.be

Abstract

Farmers in developing countries often encounter difficul-

ties selling their products on local markets. Inadequate

transport infrastructure in rural areas and large distances

between areas of production and consumption mean that

farmers find it costly to bring their produce to the market

and this very often results in small net margins and pov-

erty among farmers who are geographically isolated.

Agriculture in developing countries is characterized by

the presence of intermediaries that have a cost advantage

over farmers. Because of their market power, these inter-

mediaries are able to impose interlinked contracts and are

free to choose the spatial pricing policy they use. In this

paper, we develop a model of input–output interlinked

contracts between an intermediary and geographically dis-

persed farmers. We establish when the intermediary uses

either uniform or mill pricing policies, as opposed to spa-

tial discriminatory pricing. For each pricing policy, we

analyze what the welfare implications are in terms of an

increase in farmers’income and a reduction in poverty in

rural areas. We also establish how the choice of a spatial

pricing policy impacts geographically isolated farmers

and how it influences the participation by farmers.

1

|

INTRODUCTION

Smallholder farming constitutes about 80 percent of African agriculture. Five hundred million of

such farms provide income to about two-thirds of the 3 billion rural people in the world (IFAD,

2013). While a large number of individuals in rural areas in developing countries depend on it,

DOI: 10.1111/rode.12375

484

|

©2018 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/rode Rev Dev Econ. 2018;22:484–506.

small-scale agriculture has suffered since the 1980s with globalization and agro-industrialization

causing small farms to go out of business (Reardon & Barrett, 2000). Small farmers’access to land

has been shown to decrease over time (Jayne, Yamano, & Nyoro, 2004). Furthermore, the World

Bank (2007) reports that an estimated 75 percent of poor people in developing countries live in

rural areas. Most of them depend directly or indirectly on agriculture for their livelihoods. In South

Asia and Sub-Saharan Africa, the number of poor people in rural areas is still increasing and is

expected to stay above the number of urban poor, at least until 2040 (World Bank, 2007). The

prevalence of hunger is still greater in rural than in urban areas (Von Braun, Swaminathan, &

Rosegrant, 2004) and rural children are nearly twice as likely to be underweight as urban ones

(World Bank, 2011).

Different reasons explain the decline of small-scale agriculture in developing countries. High

transport costs are one of them. Small-scale farmers face high transport costs to reach local mar-

kets because of inadequate rural transport infrastructures, combined with large distances between

areas of production and areas of consumption. Transport costs also affect farmers negatively

through the cost of access to inputs that reduce both input use and agricultural production (Staal,

Baltenweck, Waithaka, De Wolff, & Njoroge, 2002; Holloway, Nicholson, Delgado, Staal, & Ehui,

2000). Isolated farmers are less productive (Stifel & Minten, 2008; Binswanger, Khandker, &

Rosenzweig, 1993) and have lower incomes (Jacoby, 2000) than farmers who have an easier

access to the market. Small-scale farms are especially affected as they are unable to make the nec-

essary investments to overcome the disadvantage linked to these transport costs.

Evidence suggests that agriculture in developing countries is increasingly characterized by

smallholder farmers producing commodities on contract with agro-industrial firms (International

Fund for Agricultural Development [IFAD], 2003). In Mozambique, 12 percent of the rural popu-

lation is working on a contract basis with local enterprises that are affiliated with international

companies. In Kenya, 85 percent of sugar cane production depends on small-scale farmers who

provide their production to sugar companies. These intermediaries often have some advantage over

farmers. They can, for example, transport goods to the location of consumption at a lower cost

(transporting them in larger quantities with trucks, transforming them to reduce their volume and/

or perishability, etc.), or they can transform the product enabling them to charge a higher price.

Obtaining this advantage often requires incurring an important fixed cost, which farmers cannot

make. Examples of such intermediaries include maize, beans, roots, and tubers in Malawi and

Benin (Fafchamps & Gabre-Madhin, 2006), mandarin in Nepal (Pokhrel & Thapa, 2007), and

cashews in Mozambique (McMillan, Welch, & Rodrik, 2003).

Hence the question is whether contracting with these intermediaries leads to an increase in

farmers’incomes. If this is the case, then helping setting up these intermediaries (through, e.g.,

grants or subsidies) would be another way to reduce poverty in rural areas. However, contracts

between intermediaries and farmers involve interlinked transactions. The intermediary not only

buys the agricultural output from the farmer, but also provides him with the input that is necessary

for his production with the price of both goods being simultaneously fixed. The use of these con-

tracts has been documented for various countries and sectors [see for instance Warning and Key

(2002) for the groundnut sector in Senegal; Jayne et al. (2004) for cash crops production in Kenya ;

Simmons, Winters, and Patricks (2005) for various Indonesian sectors; or Key and Runsten (1999)

for the Mexican frozen vegetable industry]. Existing theoretical work, for example, Gangopadhyay

and Sengupta (1987), suggests that because of the use of interlinked contracts farmers would not

benefit from the intermediaries’lower costs. They show that these contracts lead to a n efficiency

gain, but also that this gain is completely appropriated by the intermediary. This result depends on

the assumption that the intermediary can set a different contract for each farmer. In a spatial

LEF



EVRE AND THARAKAN

|

485