Commercializing smallholders through interlinked contracts: prospects and challenges in the rift valleys of Ethiopia

This paper investigates the prospects and challenges of commercialising smallholders through interlinked contracts in Ethiopia. It tests the hypothesis that the role of interlinked contracts in accessing
credit and hedging risk thereby enhancing commercialisation is undermined by the presence of
skewed bargaining power and double delegation problems.

The paper finds that smallholders’ contract choice appears to depend on risk and information access but not on marketing costs. Those who are risk averse and have better access to information are likely to choose cooperative contract.

The paper also finds that bargaining power in relational contract and uniform pricing in cooperative ones are challenging farmers’ integration to markets. Thus, it believes that there is a need to re-organise these institutions. Specifically, the paper states that organising cooperative contracts requires designing an incentive structure that enforces higher effort and discriminates free riders. Equally important, in the long-term, the pricing system of the current cooperatives needs to be re-visited.

In addition, the paper reveals that relational contracts have a bigger impact on commercialisation than cooperative contracts do, which implies that the discretionary effect is stronger than the bargaining power effect. Therefore, the paper deems that interlinked contracts have to be systematised in order to capitalise their benefits to smallholders.

Lastly, the paper argues that linking agro-processors and small-scale growers through informal contracts are more effective than organising incentive incompatible formal cooperative.