Informal contracts with its multifunctionality for food security, rural household development, and global poverty reduction has implication for economic growth.
In a couple of decades, contracts in farming and food sectors are amongst the pathways for sustainable rural growth. Currently, there are opportunities for new agriculture and even with smallholders’ inability to compete the large-scale producers; informal contracts provide to rural households serves as pathways for poverty alleviation. Farmers form cooperatives to access public credits in developing countries. Small companies and farmers of the informal sector have seasonal informal production contracts for fresh vegetables, tropical fruits and cash crops (Eaton & Shepherd, 2001 pp 52).
In the absence of institutional credits, informal contracts allow farmers and retailers to overcome the investment difficulty of starting a farm or food business. Informal contract as a widespread concept in agriculture leads to a strong linkage of sponsors to the supplier function ().
Typically, the farmer agrees to provide quantities of a specific agricultural product that meet the quality standards and delivery schedule set by the purchaser. In turn, the purchaser commits to buy the product, often at a predetermined price. The buyer also supports production through land preparation, the supplying inputs, providing technical advice and arranging transport of produce to the buyer’s premises. In this case, farmers are linked with a large farm or processing plant which supports production planning, input supply, extension advice, and transport. The informal contracts in farming are used for a wide variety of agricultural products (FAO, 2008).
Bolton & Dewatripont 2005, however, explain that informal contracts (also known as parole) are neither signed under seal nor under record and the problem of asymmetric information abound (hidden actions or moral hazards seen through sponsors and farmers default). Olomola, 2007, is in agreement that informal contracts in agricultural production are ordinary agreements between buyers and farmers, which establish the conditions for the production and marketing of farm products. Such an agreement may be oral or written.
Though, very discrete, despite the untenable asymmetric information challenge, it is not a new phenomenon in the informal sector where rural households enter into informal contracts. Even as farmers and food processors decide to acquire informal credit, low- input production occurs. As Governments and regulatory bodies seem lost in their role, farmers and the stakeholders of the food sector seemingly push their voluntary plan to stay in production. These matters in contracts are indicative of the compelling need for relevant institutions and standards in the credit market.
For sponsors, the seasonal contracts represent collateral. Whereas the likelihood of the tendency of contract sponsor to purchase all products within quality and volume parameters is higher, sponsors offer cheap credits and supply inputs to farmers seasonally on credits due to free-riding problem (Gibbon, 2001 pp 352)
Moreover, different contracts potentially have relatively distinctive issues which come with farming inefficiencies. Farming problems are extremely unfavorable for rural livelihoods and market share. Attending to these inefficiencies to ensure appropriateness requires contemporary assessment of informal contracts in agriculture as it inextricably links food security (&pp).
Understanding development implications of informal contracts in farming are therefore crucial, as it is a fundamental component of developing countries’ growth and entails high potential to increase rural incomes.
This paper distinctively examines the role of informal contracts in farming and food sectors. Notwithstanding a lot of literature on informal contracts in farming and businesses, this paper uses existing literature to critically highlight informal contracts and its implication on farming and food sectors. To this demonstration, this paper shows an insightful empirical analysis/scenario to estimate the impacts of informal contracts on farmers.
Drawing upon rural development reports and analyzing contracts in farming models, this paper sets out:
· To investigate to what extent informal contracts becomes a prerequisite condition for effective rural economic growth.
· To investigate to what extent informal contracts might reduce vulnerability.
· To assess the general factors influencing farmers’ participation in informal contract scheme.
· To investigate how institutions regulate informal contract schemes in the informal sector.
· To generally, examine the role of informal contracts in farming and food sectors.
Besides this background information on the topic, the paper is organized into five further chapters. In chapter two is the brief literature review; addresses contract farming and informal contract models. Chapter three is the theoretical framework of this paper; espousing the need for this study. Chapter four is the empirical model used. Chapters five and chapter six are the discussions and conclusions of this study respectively.
2.0 LITERATURE REVIEW
2.1 Meaning of Contract Theory in Farming
Contracts in agricultural production is an agreement between the farmer and processing or marketing firms for the production and frequent supply of agricultural products under forwarding agreements and at predetermined prices (Strohm and Hoeffler, 2006). Roy, 1972 emphasizes that such an agreement may be written or oral. Discussions of contract farming are often lengthy as there are different types of contracts. Notwithstanding this, there are basically five models accepted globally (FAO, 2008). These include centralized model, nucleus estate model, multipartite model, and the informal models. For the purpose of this research, I discuss only the informal model.
2.1.1 Meaning of Informal Contract Model in Farming
This model is basically run by individual entrepreneurs or small companies who make simple, informal production contracts with farmers on a seasonal basis. The crops usually require only a minimal amount of processing or packaging for resale to the retail trade or local markets. This is perhaps the most speculative of all contract-farming models, with a high risk of default by both promoter and farmer.
2.1.2 Effects of Contracts to Farmers and Sponsors
The key benefits of contract in farming for farmers include; improved access to local markets, Assured markets and prices (lower risks) especially for non-traditional crops, Assured and often higher returns, Farmer access to production inputs, mechanization, transport services, and extension advice are enhanced and improved local infrastructures, such as roads and irrigation facilities. Moreover, sponsors have assured quality and timeliness of delivery of farmers’ products, production is more reliable than open market purchases and the sponsor faces less risk not being responsible for production (Agila, Monohara and Asokha, 2008).
2.1.5 Constraints of Farmers in Contract Farming
Despite the aforementioned merits of contract farming, there are also a lot of limitations including; Farmers may become indebted at times in diverting inputs supplied on credit to other uses and this cause production problem, The staff of sponsoring organization may be corrupt, especially in the allocation of quotas, Sponsoring companies may be unreliable or exploit a monopoly position, There are land constraints due to lack of security of tenure and this endanger sustainable operation and There are at times no effective “buyback” arrangements between farmers and organization.
3.0 THEORETICAL FRAMEWORK
Poverty, unemployment, and migration in the informal sector remain the bane of the economic development of rural households. As a result, stakeholders continue to find ways of improving incomes of the rural people. Farmers in developing countries complain of lack of funds to invest into farming and also the difficulty in contacting potential buyers for their produce. However, to help ease the problem of farmers, the informal contract is one possibility identified with a potential of improving livelihoods of farmers.
It is therefore imperative and a common approach to scrutinize the role of informal contracts in farming or the food sector to explain why and strengthen logic by burrowing perspectives from other literature which encourages an alternative explanation how the informal contract impact farming and food sector.
For a firmness to understand the role of informal contracts in farming globally, this study uses two models to provide an explanation of the main issues in this paper.
First, a formal model analyzing and unveiling the rationale for . We use a descriptive table in this analysis.
The second model, which is more quantitative, uses brief descriptive coefficients in a summarized data set to test the actual relationship between To do this, empirical evidence using secondary data obtained from research document allowing a descriptive statistic approach base on the data collection including;