Quality Upgrading in Global Supply Chains: Evidence from Colombian Coffee

Do the returns to quality upgrading pass through supply chains to primary producers? We explore this question in the context of Colombia's coffee sector, in which market outcomes depend on interactions between farmers, exporters (which operate mills), and international buyers, and contracts are for the most part not legally enforceable. We formalize the hypothesis that quality upgrading is subject to a key hold-up problem: producing high-quality beans requires long-term investments by farmers, but there is no guarantee that an exporter will pay a quality premium when the beans arrive at its mills. An international buyer with sufficient demand for high-quality coffee can solve this problem by imposing a vertical restraint on the exporter, requiring the exporter to pay a quality premium to farmers. Combining internal records from two exporters, comprehensive administrative data, and the staggered rollout of a buyer-driven quality-upgrading program, we find empirical support for the key theoretical predictions, both the lack of pass-through of quality premia under normal circumstances and the possibility of a buyer-driven solution through a vertical restraint. Calibration of the model suggests that one-third to two-thirds of the (substantial) gains from the program accrue to farmers, with the vertical restraint playing a critical role. The results are consistent with the hypotheses that quality upgrading can provide a path to higher incomes for farmers, but also that it is unlikely to be viable under standard market conditions in the sector.