Measuring The Impact of Transaction Costs on Profitability of Farmers: Empirical Evidence from India

Abstract

Measuring The Impact of Transaction Costs on Profitability of Farmers: Empirical Evidence from India Kedar Vishnu , Parmod Kumar & Ruchika Rai 1 Introduction: The modern food retail chains (MFRCs) have recently attracted attention due to the massive increase in the number of stores, expansion of operation from developed countries to developing countries, and increase in the sale of fruits and vegetables (F&Vs) (Reardon et al. 2005). Existing literature has, in essence, captured how the MFRCs benefit the farmers by increasing their income. The studies have incorporated the impact of farmers' characteristics, farm size, irrigation facilities, infrastructure access, credit access from traditional sources on farmers' income, productivity, employment, and welfare (Schipmann & Qaim 2011; Mishra et al., 2018). The Institutional framework is responsible for creating an atmosphere for the emergence of MFRCs in India. The Institutional economics framework provides a way in which MFRCs contracting overcomes particular types of market failures (i.e., Uncertainty, risk sharing, coordination failure) (Grosh,1994). However, the existing studies neglected to capture the variation in contracting practices and their impact on farmers' income (which leads to incurring TCs by farmers). This is unfortunate since the consequence for the farmer for their integration into MFRC is bound to be affected by the nature of the contract, which will influence income, the type and the amount of risk they bear, self-sufficiency, etc. (Grosh, 1994). Very few existing studies reveal that MFRCs tend to behave opportunistically towards farmers (Allen, 2017; Escobal & Cavero, 2012). The new institutional arrangement exposes farmers to contracts when the buyers are either monopsonists or oligopolists (Sivramkrishna and Jyotishi 2008). The risk of an incomplete agreement, lack of enforcement, and asymmetric information create an environment for opportunistic behavior (Hobbs 1997). Lack of enforcement and asymmetric information in the context of quantity, quality, and price may result in high transaction costs (TCs). High TCs may make contracts expensive and infeasible for poor and marginal farmers. This may affect the adoption of contracts under MFRCs and explain the slow adoption rates, particularly for emerging economies. The NIE provides tools that can be useful for reducing the variation in contracting practices by regulating the terms of contracts, defining the rule of agreement, enforcing the terms of the contract, etc. Due to difficulty quantifying the transaction costs, very few attempts are made in the literature to measure the TCs incurred by farmers due to changes in the contract terms. Williamson (2000) has also argued that the theoretical development has not been accompanied by successful measurement of TCs, which are not easy to quantify. We have attempted to see how the reduction in opportunistic behavior and the absence of asymmetric information leads to an increase in farmers' income or a decrease in transaction costs. However, there exists a gap in the literature in this context. This study estimates the TCs incurred by farmers across a different institutional arrangement of MFRCs. We consider farmers' adopting production contracts (PC), marketing contracts (MC), and farmers under the traditional marketing channel (TMC) or independent farmers in this study. These contracts are different from each other. PCs has pre-fixed price and input supply provision, whereas MC provides technical guidance on chemical and fertilizers and higher price than the traditional market. However, TMC provides just a platform for sale. Moreover, it determines the impact of TCs on the adoption of contracts under MFRC. Second, this study offers meant direction in designing arrangements to minimize TCs. Research Question: How to quantify the TCs incurred by the farmers for the different institutional arrangements of contract farming? To what extent has the TCs impacted the farmers' profitability and yield? How can we reduce the transaction cost and increase the small and marginal farmers' participation from developing countries like India? Objective: This study empirically measures the TCs incurred by the farmers for PCs and MCs compared with independent farmers. Further, this study has captured the impact of TCs on the farmers' profitability for PCs and MCs compared with independent farmers. The present study contributes to the existing literature: quantifying the impact of TCs cost on profitability of farmers and analyzing the role of various institutional arrangements in reducing transaction costs. Empirical Framework, Method: We use a utility maximization framework of growers involved in Chili farming. Expected utility depends upon the profits from choosing the two different types of MFRC (PC and MC) and TMC. Hotelling's Lemma is used for deriving transaction costs. Transaction costs are classified as information costs (ICs), Bargaining costs (BCs), and monitoring costs (MCs) incurred by farmers with PC, MC, and TMC. TCS is influenced by many factors such as participation in MFRC, price uncertainty, price discovery costs, product quality uncertainty, rejection rate, frequency of sale, lack of information on the reliability of various forms of contracts, as well as farm and household characteristics. The outcome selection bias variables (ICs, BCs, MCs, TCs, and Net Profits) were estimated using Propensity Score Matching (PCM). PCM compares outcomes variables between two groups of farmers: either PC or MC ("Treated") with TMC ("Control") that are similar in terms of other observable characteristics (i.e., education, age), therefore, reducing the selection bias (Rao et al. 2010). The study applies the NNM matching estimator, a commonly used method. The NNM method picks each treated unit (MFRC farmers) and searches for the control unit (TMC farmers) with the closest propensity matching score. The main attractive feature of NNM is that all the treated teams find a match (Mishra et al., 2016). Data collection: The primary survey was conducted in 2017 from the Kolar Districts of Karnataka. Kolar is known for being the highest producer of chili. We interviewed 300 chili households with 100 each under MFRC with PC, MFRC with MC, and TMC, respectively. Chili farmers were sampled using stratified sampling. The questionnaires were designed to obtain socio-economic variables, input variables, and questions needed to calculate transaction costs, such as opportunistic behavior, asymmetric information, asset specificity, and price and grading standards uncertainty. Preliminary results: We found that MFRC farmers incurred the highest TCs cost by Rs 9,118 per acre than independent farmers (statistically significant), followed by Rs 5,394 for MCs MFRC than independent farmers for chili. In another world, TCs for PCs and MCs farmers constitute 14.50% 9.57%, respectively, share in total production costs. Hence, we argued that proper institutional arrangement could help for increasing the profitability from MFRCs in the range (9.57% to 14.50%) for chili crops. Most of the existing studies have neglected to capture the transaction costs and overestimated the benefits from MFRCs. Further, our findings revealed that monitoring cost constituted the highest share (more than 54% share) followed by bargaining costs (more than 29% share) and IC (less than 17% share) for all the MFRCs farmers. Incurring higher monitoring costs was mainly due to opportunistic behavior by the MFRCs during the grading and sorting of the product. This study is intended to highlight the significance of TCs in the adoption of PC and MC. It wants to guide policymakers to remove the barriers which lead to high information costs, monitoring, and bargaining costs. Eliminating barriers will reduce TCs and enhance marginal and small farmers' incomes.