Academic journal article AEI Paper & Studies

Agricultural Contracts and Competition Policies

Academic journal article AEI Paper & Studies

Agricultural Contracts and Competition Policies

Article excerpt

Executive Summary

The objective of this paper is to provide insights and policy directions on the market-competition ramifications of agricultural contracts, also known as alternative marketing arrangements (AMAs). The value share of agricultural production under contracts stands around 35 percent. The use of contracts in agriculture varies significantly across commodities. Contracting is less common in major field crops and leans more heavily toward specialty crops, hogs, and poultry. There are also significant variations in the types of contracts used. The use of marketing contracts favors crops against livestock, whereas the share of production contracts is almost entirely exhausted by livestock production. The main difference between marketing and production contracts is the ownership and control of production factors. In marketing contracts, all critical farm-level production factors are owned and controlled by the farmer. In production contracts, farm-level production factors are shared between a farmer and a contractor, and the contract specifies production practices that a farmer has to adhere to.

In this study, the spotlight is entirely on livestock contracts, where competition issues are more pronounced. In the livestock industries, both farmers and packers face nontrivial risks in their production and marketing activities. AMAs provide farmers and packers a way to attenuate these risks. The reduction in various risks with the use of AMAs increases farmer welfare significantly Farmers who use AMAs are found to be more risk averse than those who rely on the spot market, and welfare increases for these risk-averse farmers when risks are reduced or eliminated.

AMAs also benefit the packers in the sense that organizing the procurement of livestock through multiple channels mitigates risks and information asymmetry problems. AMAs benefit consumers as well. An important advantage of AMAs is that through contracts packers are able to incentivize producers to produce better-quality livestock or the kind of livestock that consumers prefer. Although AMAs bring many of the benefits, there are also concerns about AMAs. Due to the rising popularity of AMAs, the spot market has become thin. Also, it has been shown that AMAs depress spot market price. Finally, AMAs tend to benefit farmers with large operations more than their smaller counterparts. Because of these concerns, there were a series of legislative attempts to ban the use of AMAs or certain features of various AMAs when various farm bills were negotiated.

In addition, a series of concerns have been raised over the years that are specific to production contracts and in particular to those used by the poultry industry. The most serious attempt of the federal government to regulate livestock production contracts is the Grain Inspection, Packers and Stockyards Administration (GIPSA) 2010 proposal to amend the Packers and Stockyards Act (P&S Act) under the 2008 Farm Bill. Probably the most controversial proposal was to significantly regulate using tournaments in settling poultry contracts. Most of the original proposals were dropped or modified. Those that remained were provisions regarding the suspension of delivery of animals, rules about the additional capital investment criteria, provisions regarding the breach of contract, and provisions regarding arbitration. The proposed regulation to truncate tournament payments such that penalties for below-average performance are no longer allowed was among the provisions not included in document, but future imposition of such a rule is still considered. Regarding the regulation of tournaments, we argue that integrators could significantly mitigate potential welfare losses due to tournament truncation by adjusting the contract parameters.

Overall, the proposed truncation policy would not significantly increase growers' incomes, and some producers could end up worse off than before the regulation. …

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