The Impact of Contract Farming on Agricultural Product Supply in Developing Economies

Motivated by “company+farmer” farming operations of Wens, New Hope Liuhe, and Huiren, this study formalizes the impact of production‐management and resource‐providing types of contract farming, in which the buying firm commits to an ex ante procurement price and promises to buy the high‐value agricultural product (HVA) from contract farmers. We analyze the buyer's cost reduction effort and its impact on farmer participation to characterize the effect of contract farming on the agricultural product supply and all stakeholders. Additionally, we explore the impact of the HVA's production cost. We analytically show that all contract and non‐contract farmers are better off after an introduction of contract farming for HVA. Hence, contract farming can improve the farmers’ income and alleviate poverty. However, if HVA is costly to produce, there will be an inequality‐widening type of contract farming in which contract farmers are more efficient than non‐contract farmers, and the income disparity among farmers will widen. Otherwise, there will be an inequality‐reducing type in which contract farmers are less efficient than non‐contract farmers such that the income disparity among farmers will decrease. More importantly, the buyer benefits from a lower HVA's production cost, but this can hurt all contract and non‐contract farmers for a given equilibrium type. Moreover, reducing the HVA's production cost can increase the supply of a substitutable traditional product along with the switch of equilibrium from the inequality‐widening type to the inequality‐reducing one.