Contracting, Competition, and Rent Distribution Theory and Empirical Evidence from Developing and Transition Countries

Commodity value chains have undergone tremendous changes in the past decades. Private traders, retailers and food processing companies increasingly contract with farms and rural households to whom they provide inputs and services in return for guaranteed and quality supplies. However, due to a variety of market imperfections and poor public institutions, farmers in developing and transition countries face major constraints in realizing high-quality, consistent supplies. These include financial constraints as well as difficulties in input markets, lack of technical and managerial capacity etc, especially for high-standards products. To secure their supplies, traders and processors engage in contracting to overcome farmers' constraints. Emerging empirical evidence suggests that these new forms of private vertical coordination can be an engine of economic growth, rural development and poverty reduction. However, at the same time there is a concern that the nature of these contracts may act as an important barrier to entry for other agents and may give the dominant partner in a transaction some additional leverage. Competition could potentially play an important role in reducing inefficiencies and enhancing the bargaining power of local suppliers and thereby improving contract terms, in particular where contract conditions are imposed by monopolistic organizations. However, at the same time competition may undermine contract enforcement in these vertical coordination systems, as opportunistic behavior may emerge or as reputation costs of contract breach are lower. The objective of this paper is to analyze the effects of competition on contracting in high-value supply chains in an environment of widespread factor market imperfections and weak contract enforcement. We present a conceptual model and present evidence from various case-studies.