PERFIL PROFESIONAL DEL CERTIFICADO DE PROFESIONALIDAD Unidad de competencia 1

The concept of private sector coordination is specifically highlighted as a key process within the developmental coordination framework. In light of this, the following three sub-sections will examine the type of coordinative mechanisms that develop within the private sector, their capacity to contribute to the process of market development, and the conditions under which they are developed and sustained. It is important to observe that the literature used in this section is not exclusively linked with the work of Dorward, Kydd and Poulton. Instead the model of developmental coordination has been used as a

68 framework for investigation from which other areas of NIE literature have been identified where appropriate.

2.4.1 - Interlocking Investments

Earlier it was observed that the lack of private sector engagement in the markets for farmer inputs, such as pesticides and fertilisers, has been highlighted as one of the major failures resulting from market liberalisation. Cash strapped farmers, with very little access to credit, do not have the resources to purchase inputs within liberalised markets [Poulton, 2006; Hoff et al, 1993; Kherallah et al, 2000; Poulton et al, 2006]. Theoretically, however, buyers may have an incentive to provide such services in order to enhance farmer production levels, compete for market share, and build capacity at the farmer level. Indeed, Poulton et al [1998, p 6] found evidence that ‘where opportunities for profit making exist, private sector actors will innovate to overcome failures in important markets, including those for seasonal credit and inputs’.

The provision of farm inputs on credit is one such investment that a buyer may choose to make in a farmer. In NIE terms this may be viewed as an asset specific investments being made in the farmer. As such, whilst the buyer has the potential to gain from the investment, the buyer also faces a big transaction risk in the form of farmer default [opportunism]. In response buyers may use interlocking arrangements as a form of hybrid contract structure to overcome the risk of opportunism in the developing country environment [Dorward and Kydd, 1994].

Interlocking is defined as the ‘provision of seasonal inputs on credit using the borrower’s expected harvest of the crop in question as a collateral substitute to guarantee loan repayment’ [Poulton et al, 1998, p88]. The farmer is therefore able to afford the input, given that the repayment schedule of the loan is tied to the crop harvest. Poulton et al [1998] promote interlocking arrangements as the best way to overcome the market failures of information asymmetry and insecure property rights, when contracting in the rural environment. Similarly chapters eight and nine of Hoff et al [1993] also support

69 interlocking, finding that it goes a long way to reducing the information asymmetry and enforcement problems between a borrower and a lender. By reducing the risk of default, buyers are able to use interlocked transactions as a mechanism through which to compete for farmer loyalty. Indeed, Dorward et al [1998] find that the incentive to develop interlocked input and output transactions is based on the traders’ desire to increase market share.

However, as witnessed in Ghana [Shepherd and Onumah, 1997], along with many other liberalised African markets [Poulton et al, 1998], interlocking arrangements have often led to opportunistic behaviour from producers. This occurs where producers receive an output guaranteed loan from one buyer and choose to ‘strategically default’ [Poulton et al, 1998]

on the loan by selling the contingent produce to another buyer. By doing so the farmer avoids repayment of the output linked loan.

For a number of reasons the problem of strategic default has been particularly damaging in sub-Saharan Africa [Poulton et al, 1998 pg 91-92]. Firstly, it is found that because many Africa farmers own their land, they face a less immediate need for credit to pay land rent and therefore the threat of losing out on a future credit opportunity is not a major incentive for repayment. Secondly, due to weak infrastructure in rural Africa traders face a significant challenge in monitoring the actions of farmers⁶⁷. Thirdly, it is found that farmers in Africa have developed a cultural attitude that any loan or input given to them is a gift from the government. This attitude has been developed based on years of government handouts. Dorward et al [1998] also highlight this problem, adding that politicians who have done much to create this mindset need to take a lead role in changing farmers’

attitudes towards repayment. These three factors have together created a very negative attitude towards repayment, and as a result inputs are now sold on a cash only basis [Poulton et al, 1998]. However, cash payments for inputs are often beyond the immediate financial resources of the sub-Saharan farmer.

67 Rottger [2000, p 12] describes the problems faced by traders as a result of poor transport infrastructure in growing areas.

70 Nevertheless, Hoff et al [1993] and Poulton et al [1998] find that due to the relationship the trader has with the farmer, traders are recommended as a viable channel through which to distribute inputs to farmers. Coulter et al [1999] suggest that traders can use good communication and monitoring, incentives for repayment, punishment, and lending to groups as ways to reduce the risk of default. Indeed, in terms of communication and monitoring traders are in the optimal position to carry out these functions. As such, despite the risk of default, it might be suggested that traders are in the best position to take over the responsibility from the government in the area of farmer inputs. In light of this, the potential for LBC’s to take on this role in Ghana will be investigated in this study.

2.4.2 - Social Capital

North [1990] finds that informal institutions are particularly important in providing structure to uncertain exchange conditions in the developing world. This may be particularly true in Ghana, where Fafchamps [1996] finds that due to the lack of infrastructure for formal contract enforcement, alternative ‘informal’ mechanisms are required to improve security in the process of exchange [Fafchamps, 1996]. Closely related to this, Lyon [2000] also observes the importance of social capital within the Ghanaian trading environment.

Social capital is defined as the norms and networks that facilitate coordination between trading parties [Putman, 1993; Ostrom, 1999]. Building on this it is possible to consider trust and reputation as aspects of social capital that can build up between trading partners [Lyon, 2000]. Trust can have a positive effect in trading relationships, lowering transaction costs through facilitating cooperation and coordination, and reducing the need to screen and monitor trade partners [Putnam, 1993; Lyon, 2000].

Within the context of rural Ghana, the most commonly reported reason for trusting someone is the establishment of a long term ‘personal’ trading relation [Lyon 2000].

Closely related to this, Fafchamps [1996] finds that within the Ghanaian trading environment the business relation between two parties is often the best form of collateral.

71 Indeed, Laven [2005] finds that the second most popular reason why a farmer would choose to sell to a particular LBC in Ghana is the social relation which the farmer has with the buyer.

2.4.3 - Collective Action

Poulton et al [2004] find that collective action amongst buyers helps to facilitate private sector engagement in the market. Whilst the provision of public goods is traditionally the role of the government, in the absence of the government this responsibility may be undertaken by the private sector, especially where the private sector has the potential to benefit⁶⁸ [Poulton et al, 2004, p 522]. This is known as a ‘Coasian solution’, where the potential beneficiaries of a public good may pull their resources together in order to collectively reap the benefit of the service provided [Coase, 1960].

Larsen [2002] shows how collective action between private sector actors has been used to enable the private sector to maintain coordination in the Zimbabwean cotton market.

Despite the liberalisation of Zimbabwean cotton in the early 1990’s very few changes have emerged in the market, as the private sector has taken up the traditional functions of the parastatal. In light of this, the capacity of LBC’s in Ghana to work collectively may to some extent determine the appropriate level of government intervention in the market.

In addition to the provision of public goods a group of individuals may choose to work collectively in order to influence institutional change. Indeed, Olson’s [1965] original theory of collective action was developed to show why certain interest groups are more influential over government policy compared with other groups. Group size is considered the main variable affecting the capacity for collective action, with larger groups finding it more difficult to coordinate their actions. Olson also found that the effectiveness of collective action is determined by group heterogeneity and the existence of a common goal.

68 Larsen [2002] shows how buyers working together in the Zimbabwean cotton market have been able to deliver inputs to farmers. This has resulted in increased production and a reliable flow of high quality cotton for buyers.

72 2.4.4 - The Buyers’ Association (collective action)

In relation to African commodity markets, Poulton et al [2004], find that buyers may establish a ‘collective organisation’, such as a buyers’ association to help overcome collective action problems. Hall and Soskice [2001, p 10-11] classify the buyer association as an institution that facilitates collective action, by encouraging the relevant stakeholders to engage in collective discussion and reach a common agreement. Buyers’ associations are referred to as institutions that facilitate ‘deliberation’, reducing the uncertainty actors have about each other and allowing them to make credible commitments to each other [Hall and Soskice, 2001, p 10].

The buyers’ association can also be used to reduce the risk of opportunistic behaviour from farmers [Poulton et al, 1998; Coulter et al, 1999]. Ostrom [2000] observes that the existence of opportunistic players is especially likely where full and accurate information about all the players is not known. However, where the participants of a buyers’

association exchange information about opportunistic actors this can build an awareness of untrustworthy actors and therefore lead to more effective sanction [Hall and Sokice, 2001].

For example, if a particular farmer engages in an opportunistic act such as non-repayment of a loan, then by creating an awareness of that farmer within the network, the mechanism for sanction is more effective because all buyers will then know to avoid that particular farmer⁶⁹. Closely related to this, Poulton et al [2004] find that collective agreements established between buyers in the Zimbabwean cotton market have led to a reduction in opportunistic behaviour throughout the market [Poulton et al, 2004].

Whilst buyer networks may be effective in solving market coordination problems, they may suffer from internal coordination problems [Ostrom, 2000]. In challenging the logic of collective action, Olson [1965] contended that because the benefits of collective action are shared within a group the rational agent has an incentive to free ride on the efforts of others. As such, the free-rider problem can pose a significant barrier to collective action in

69 Grief’s [1993] study of the communication networks used by the Jewish Maghribi traders is a regularly used example of such sanctioning behaviour.

73 both: the provision of public goods, where funding contributions from all members of the private sector are necessary; and lobbying for institutional change where the bargaining power is at its greatest when all members are active. Where the size of the group is large, Olson found that the incentive for free riding increased, thus making collective action more difficult. Olson’s theory is commonly used as the basis for why public goods need to be provided coercively under the government, and why certain groups are more effective at achieving institutional change than others.

2.4.5 - Market Concentration

Building on Olson’s logic of group size, Poulton et al [2004] observe the practice of

‘relational coordination’ between buyers in the highly concentrated Zimbabwean cotton market. This form of coordination is characterised by informal agreements enforced by consensus or private action and it ‘may be the most effective option for many cash crop systems in Africa’ [Poulton et al, 2004, p 523]. Given the small number of buyers in the network, information is easily exchanged and agreements can be credibly enforced.

Network activity between a small number of sophisticated firms reduces the transaction risk of rent seeking, opportunism and free riding from rival buyers. Based on the establishment of competitive agreements and the exchange of information between buyers, the threat of farmer opportunism can be greatly reduced, thus enabling asset-specific investments in farmers.

These findings are supported by Larsen’s [2002] study of the Zimbabwean cotton market, where buyers providing interlocking arrangements with farmers were able to avoid strategic default due to a concentrated market structure. Within this market repayment rates of 98% were achieved based on a strong network of competitive agreements and information sharing between buyers. However, Poulton [2006] finds that in recent years market entry has increased leading to higher levels of strategic default. Resultantly there has been a reduction in the number of inputs made available to farmers. Similar findings are also found for the Zambian cotton market [Poulton, 2006]. In light of these findings it

74 appears that in certain circumstances it may be necessary to sacrifice a certain degree of competition in order to achieve coordination between buyers and farmers at the local level.