Contract farming and its impact on production efficiency and rural household income in the Vietnamese tea sector
Organization Institute of Agricultural Economics and Social Sciences in the Tropics and Subtropics
Over the last two decades, Vietnam accomplished rapid economic growth under the transitional economy. Significant developments in the agricultural sector brought in by the renovation policy have propelled the country to the rank of the second largest rice exporter in the world. The steady economic growth along with increasing population has led to a rise in demand for agricultural products in the domestic market. Furthermore, Vietnam’s accession to the World Trade Organization (WTO) in 2007 is seen to have boosted the country’s economic reforms resulting in greater integration with the global economy.
Despite these massive political and economic changes, Vietnam is still struggling with high poverty levels, particularly in the remote North West region. The country’s income poverty rate stands at 15.5% while its reaches a 39.4% in the North West Region of the country (GSO 2007). The North West region, with its mountainous topography and temperate climate, is one of the main and historical tea cultivation areas in Vietnam. Its surrounding big cities offer steady demand for high quality tea produced in this region.
In 1999, the Vietnamese government implemented a development plan for tea production for the period of 2005-2010 (Decision 43/1999 QD-TTg) with an aim to increase production, export and create employment. The implementation of this policy was expected to alleviate poverty in the uplands tea producing areas, which are often poor mountainous regions with small scale farming, and limited off-farm income opportunities. Other important public policies measures adopted by Vietnam to stimulate the development of the tea value chain and promote greater access to market for the rural poor farmers include “the law of Private Enterprise” which was promulgated in 1990, and “the Enterprise Law” which was enacted in 1999 and revised in 2005.
In addition to such public policies, vertical coordination in tea supply chain is required to ensure greater small-scale farmers participation to market. Tea being a perishable agricultural commodity which needs early processing after harvesting, vertical coordination can reduce production and marketing risk faced by small-scale farmers. Contract farming is a type of vertical coordination that encourages small-scale farmers’ participation in tea production. It refers to an arrangement between producers and processors to exchange inputs and outputs with pre-agreed price, time, quality and quantity (Singh, 2002). It is also applied widely in the tea sector of North-Western Vietnam.
The role of contract farming as a rural development tool has been discussed in many empirical studies. One major thread of that literature is that contract farming permits to link producers with agricultural markets especially in less developed countries. It is argued that contract farming offers advantages for small-holder farmers in ensuring their access to inputs, credit, insurance, information, technology and markets. In economics theory, particularly in the framework of new institutional economics, contract farming is often explained as an institutional response to market failures such as information asymmetric with respect to price and/or quality and the incompleteness or imperfections in the markets for credit, inputs and agricultural services.
Transaction cost is one of the important elements in the analysis of market institutions. Empirical studies reveal that high transaction costs discourage small-holders to participate in markets. In tea production, sunk costs associated with high initial investments, and commodity’s perishable and time specific processing characteristics, heighten their asset specificity. This high degree of asset specificity in tea production emphasizes the need for contract farming. Furthermore, contracting is one way to divide risks associated with production and marketing between the firm and the producer. In short the method of contract farming provides a foil for the shortcomings in both parties.
The objective of this study is to investigate the importance of income from tea production for the household income of poor small-holder farmers in North West Vietnam. More specifically, given the importance of vertical coordination in agricultural production, the study’s main focus is to investigate the involvement of small-holder farmers in the integrated agro-food channels and evaluate its impact on their livelihood.
There are three specific research questions included in the study:
1. Does contract farming enhance production efficiency compared to non-contract farming?
2. What are the differences in socio-economic characteristics of contract and non-contract farmers?
3. How strong is the impact of contract participation on household income?
For this study, Moc Chau district, one of the traditional tea producing areas in Vietnam, was selected as the research site. The district has 3,200ha of tea producing area with a total of 6,726 households engaged in tea production. Moc Chau is located 950m above sea level, and has tropical monsoon climate, which is ideal for tea production. Three types of organizational arrangements are found in terms of production and marketing where tea producer were involved:
1. via state-owned enterprise
2. via private company
3. and via direct spot market
The population is stratified into four clusters:
1. tea farmers contracting with state-owned enterprise (SOE)
2. tea farmers contracting with private firms or cooperative
3. tea farmers with no contract
4. and non-tea farmers
A sample of 40 households was randomly drawn from clusters 1 and 2 each. A larger sample was obtained from each of the clusters 3 and 4, since they serve as control groups with higher heterogeneity and variance with respect to socio-economic and farming characteristics. Overall the samples from the four clusters consisted of 245 farm households. The survey questionnaire included modules on household demography, other socio-economic characteristics and tea production. The socio-economic modules of the questionnaire were based on Living Standard Measurement Surveys (LSMS) methodology. These modules aim to measure and understand the living standards of households. The tea production modules aim to obtain information on production, costs and production efficiency, and the market module consisted with the questions on contract participation associated with socio-economic characteristics of households. In addition, quantitative and qualitative surveys at the village level and on a few selected tea firms were conducted to understand institutional changes in the village and to investigate socio-political factors influencing tea production. The entire survey was conducted during the period between June and November 2007.
The first research question was investigated using the Stochastic Production Frontier Function (SPFF) model to estimate the technical efficiency associated with socio-economic characteristics of households, and to assess the difference among the clusters. The results showed high coefficient estimates of partial production elasticity associated with land size and material costs (a sum of costs of fertilizer, manure and pesticide). The SPFF model also identified significantly higher technical efficiency estimate of the group which is in contract with the SOE by applying non-parametric tests. This observation is associated with three different household characteristics: age, education and number of farm income source. Contrary to our initial expectation, living standard of households was not a determining factor for achieving higher technical efficiency. This result threw light on one concern: there might be a selection bias if contract participation is associated with household characteristics. To deal with the problem of homogeneity in the model, a treatment effects model was applied to control selection bias, and estimate and assess the technical efficiency with reduced-bias samples.
The second research question was investigated using the Binary Outcome model to find the probability of participation. Ten variables obtained from household survey were included in the model to determine contract participation in a contract farming scheme. The results revealed that six out of ten variables associated with household characteristics are statistically significant determinants of participation in contract farming. The six variables are average age of adults, squared average age of adults, proportion of adults who finished secondary school, years of experience in tea production, number of years of residence in the village, and number of memberships in organizations of adults.
The results indicated that older farmers participate more in contracts than younger farmers; perhaps to avoid risks associated with marketing and production. Also, those farmers who have more experience in tea production tend to participate more in a contract farming scheme. Access to information also might be one of the important determinants for farmers to decide to participate in a contract. Longer residence in the village negatively affects contract participation because it broadens farmers’ social networks where they can acquire more market information which enables the establishment of their own marketing channels. On the other hand, farmer’s membership in any kind of organizations positively affects contract participation. By being members of an organization, farmers are more exposed to positive information on contracting which might enhance their participation.
To assess the impact of contract farming participation on income, the propensity score matching method was applied to reduce the bias in the estimation of the treatment effect of contract farming participation. The estimation revealed a statistically significant, but very small impact of contract farming participation on daily per-capita income of about 900 Vietnamese Dong (VND). The technical efficiency estimate after matching revealed a statistically significant difference between farmers who contract with SOE and non-contract farmers, but there was no statistically significant difference between farmers who contract with private firms and non-contract farmers. Hence, it can be assumed that the SOE provides more precise and experienced extension service or technical advice than the private firms.
The empirical study shows that production efficiency and income of households could be increased through participation in contract farming. It also highlights that government can play a crucial role in linking resource-poor farmers to market, particularly in developing countries.
Publisher Faculty of Agricultural Sciences, University of Hohenheim
Keywords Contract farming , Vietnam , tea production , technical efficiency , propensity score matching