Contract farming as partial insurance

Marc F. Bellemare, Yu Na Lee, Lindsey K Novak

Research output: Contribution to journalArticlepeer-review

Abstract

A core result of contract theory is that contracts can help transfer risk from one party to another, the latter insuring the former. We test this prediction and explore the mechanism behind it in the context of contract farming, the economic institution wherein a processor contracts the production of a commodity to a grower. Specifically, we look at whether participation in contract farming is associated with lower levels of income variability in a sample of 1,200 households in Madagascar. Relying on a framed field experiment aimed at eliciting respondent marginal utility of participation in contract farming for identification in a selection-on-observables design, we find that participation in contract farming is associated with a 0.20-standard deviation decrease in income variability. Using mediation analysis to look at the mechanism behind this finding, we find support for the hypothesis that fixed-price contracts—which transfer all price risk from the grower to the processor—explain the reduction in income variability associated with contract farming. Because the assumption that makes our selection-on-observables design possible also satisfies the conditional independence assumption, we estimate propensity score matching and doubly robust weighted regression estimators, the results of which show that our core results are robust and that participation in contract farming would likely be more beneficial for those households that do not participate than for those who do. Our findings thus support the notion that, in a context where formal insurance markets fail, contracts can serve as partial insurance mechanisms.

Original languageEnglish (US)
Article number105274
JournalWorld Development
Volume140
DOIs
StatePublished - Apr 2021

Bibliographical note

Funding Information:
We thank seminar audiences at the University of Florida, the University of Georgia, the University of G?ttingen, the University of Guelph, Kyoto University, as well as conference participants at the September 2016 FAO Rural Transformation, Agricultural, and Food System Transition conference, the 2017 Centre for the Study of African Economies conference, the 2017 Canadian Agricultural Economics Society annual meetings, and the 2017 Agricultural and Applied Economics Association annual meetings. We also thank two anonymous reviewers for useful comments and suggestions as well as EPAR at the University of Washington for making their Tanzania LSMS code publicly available. Bellemare is grateful to NIFA for funding this work through grant MIN-14-061??Smallholder Participation in Agricultural Value Chains: Evidence from Madagascar.? All remaining error are ours.

Funding Information:
We thank seminar audiences at the University of Florida, the University of Georgia, the University of Göttingen, the University of Guelph, Kyoto University, as well as conference participants at the September 2016 FAO Rural Transformation, Agricultural, and Food System Transition conference, the 2017 Centre for the Study of African Economies conference, the 2017 Canadian Agricultural Economics Society annual meetings, and the 2017 Agricultural and Applied Economics Association annual meetings. We also thank two anonymous reviewers for useful comments and suggestions as well as EPAR at the University of Washington for making their Tanzania LSMS code publicly available. Bellemare is grateful to NIFA for funding this work through grant MIN-14-061—“Smallholder Participation in Agricultural Value Chains: Evidence from Madagascar.” All remaining error are ours.

Publisher Copyright:
© 2020 Elsevier Ltd

Keywords

  • Agricultural value chains
  • Contract farming
  • Contracts
  • Insurance
  • Risk and uncertainty

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