Contract-farming a Step Forward, But Long Road Ahead

Dec 2 , 2023
By Mekonnen Solomon

In July this year, the federal government took a significant step towards modernising the agricultural sector. Parliament enacted a law governing parties in agricultural production contracts, a landmark legislation addressing a critical gap in the country’s legal framework and offering a structured pathway for smallholder farmers to access emerging market opportunities.

The passing of this bill is particularly poignant in a country where agriculture is not just an economic activity but a way of life for over 80pc of the population. Agriculture is dominated mainly by smallholder farmers, who, until now, have been on the peripheries of the globalised market. The disconnect not only limited their economic potential but also kept them vulnerable to the fluctuations of domestic markets and constraints from traditional farming.

The law addresses a fundamental issue of interest alignment between smallholder farmers and contractors. It specifically governs agreements in supplying agricultural produce, establishing a legal framework where previously there was none. One of its key features is its provision for renegotiation of prices under certain circumstances, considering market escalations and the need for equitable, long-term relationships.

However, the law’s passing cannot automatically translate into success. One of the perennial challenges in contract farming is the phenomenon of ‘side-selling’ — where smallholder farmers breach their contracts by selling their produce to third parties, often at higher prices. This practice, though economically rational from a farmer’s perspective, especially in a context of limited resources and high risk, undermines the trust of the contracting parties.

Side-selling has several faces. It is an economic decision where farmers respond to market dynamics and immediate financial gains. It also reflects deeper issues such as the lack of trust between farmers and contractors, inadequate understanding of contract terms due to low literacy or technical expertise, and the constraints of a weak judicial system that offers little recourse for contract breaches.

Additional factors compound this.

A study on the malt barley value-chain development reveals how contract providers, who invest in quality production through training and input provision, face additional costs. These costs impact pricing, and with local assemblers and traders often manipulating market information, farmers are tempted to engage in side-selling. Contractors' preference to work with medium-size farmers over smallholders due to reduced monitoring costs and perceived reliability highlights another dimension of the challenge. The inclination comes from smallholders’ lack of sophistication in contract terms, stemming from factors such as low experience with formal contracts and technical expertise.

The prevalence of side-selling has profound implications. It not only breaches the trust between the two parties but also increases the buyer’s transaction costs and can lead to the termination of the agreement. It is a behaviour that, while economically understandable, undermines the potential benefits of contract farming.

Addressing side-selling requires a multi-fronted approach.

Building trust between producers and buyers is crucial. This can be achieved through improved information flow and integrating farmers into decision-making processes, particularly concerning pricing and quality standards. Frequent monitoring and emphasising relationship building can help align interests and reduce the inclination towards side-selling.

However, the problems extend beyond the individual farmer-contractor relationship. The broader agro-industry landscape faces the issue of free rider problems and inefficient contract enforcement, exacerbated by incomplete institutional arrangements and legal frameworks. The inadequacy of legal institutions and high transaction costs limit the effectiveness of judicial recourse in contract breaches.

The Ethiopian experience is not isolated. Similar challenges are observed across Africa. In Ghana, for instance, poor relations between buyers and sellers led to a significant dropout rate from contract farming arrangements. There has been a shift from smallholders to larger farms and production estates in Kenya and Senegal, reflecting the challenges in managing smallholder-based contracting schemes.

These developments have fueled scepticism about the long-term benefits of contract farming for smallholders, especially considering the need for investments in new technology and the potential to exploit unpaid family labour. Critics also point out the risks associated with monocropping, often necessitated by contract farming arrangements.

Thus, while the federal government’s initiative in establishing a legal framework for agricultural production contracts is commendable, it is merely the first step in a much longer journey. The success of contract farming depends on a multitude of factors, including market structure, capabilities of implementing institutions, the skill level of smallholder farmers, and the logistical realities of agricultural settings.

PUBLISHED ON Dec 02,2023 [ VOL 24 , NO 1231]

Mekonnen Solomon works at the Ministry of Agriculture (MoA).

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