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A Financial Contracting Approach to the Role of Supermarkets in Farmers' Credit Access

02/2008; DOI: 10.2139/ssrn.1102579
Source: RePEc

ABSTRACT Replaced with revised version of paper 10/17/08.

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    ABSTRACT: This paper highlights the strategic role that private quality standards play in food supply chains. Considering two symmetric retailers that are exclusively supplied by a finite number of producers and endogenizing the producers' delivery choice, we show that there exist two asymmetric equilibria in the retailers' quality requirements. The asymmetry is driven by both the retailers' incentive to raise their buyer power and the retailers' competition for suppliers. We find that the use of private quality standards is detrimental to social welfare. A public minimum quality standard can remedy this unfavorable welfare outcome.
    04/2011;
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    ABSTRACT: Standards are increasingly important in the global market system. Consumers rely progressively more on public standards (set by governments) as well as private standards (set by firms) to make their consumption decisions. Similarly producers rely heavily on standards to gear their production systems to one another and to increase transparency and traceability throughout the supply chain. Standards address a large variety of issues in consumption and production such as nutritional (e.g. low fat, vitamin-rich), safety (e.g. pesticide residues, small toy parts), quality (e.g. minimum size requirements, life span guarantees), environmental (e.g. low carbon dioxide emissions, waste management), and social concerns (e.g. no child labor, fair trade). While the above examples illustrate some of the potential benefits of standards, their implementation also entails costs and affects prices. The second chapter of this dissertation illustrates that standards may therefore have different positive or negative welfare impacts on different actors in the market. Additionally, standards may increase or decrease social welfare. These potentially different impacts on various groups in society have caused suspicion that standards may be captured by lobby groups to serve their individual interests instead of the public. Despite standards potential benefits, fears have arisen (a) that these public regulations may be used as strategic trade-protectionist tools to shelter domestic producers; (b) that private standards may be introduced by retailers as devices to extract rents from other agents in the supply chain; and (c) that certain (groups of) producers in developing countries may be excluded from these production systems governed by high standards and high quality. Each chapter in this dissertation addresses one of these concerns. To analyze the first concern that standards may serve as protectionist instruments, the third chapter develops a political economy model of public standards in which both consumers and producers try to influence the governments standard-setting behavior through lobbying. The model shows that public standards nearly always affect imports and can be either catalysts or barriers to trade, even if standards are optimal from a social welfare perspective. Hence a public standards impact on trade cannot be directly linked to protectionism since the change in imports may be optimal from a (domestic) social welfare perspective. Additionally, even if public standards deviate from the social optimum, this does not necessarily amount to producer protectionism as producers may be hurt by suboptimal public standards as well. Importantly, the model does not refute the possibility that public standards may serve protectionist intentions, but it nuances the argument that all standards are pure protectionism. Hence an important implication of this chapter is that one should be careful in categorizing standards as protectionist instruments or not, and that standards may be welfare optimal while negatively affectingtrade. Additionally, this model contributes to explaining the observed positive correlation between standards and development, and demonstrates that this relation not necessarily implies that protectionism through standards rises with development as well. The fourth chapter addresses the same concern of standards-as-protectionism but from a strategic and dynamic perspective. The chapter advances a dynamic political economy model of technology regulation in which two countries governments strategically decide which of two technologies to allow by setting a public standard. We show that a temporary difference in consumer preferences between those countries may trigger differences in initial technology regulations, and thus different investments by producers. Due to these technology-specific investments, producer interests in both countries shift in favor of maintaining the regulatory status quo which excludes foreign imports, although producers were initially indifferent towards the technology choice. Consequently, if governments are responsive to domestic producers pressures, regulatory differences may be long-lasting even if consumer preferences are identical between countries in the long run. Hence producer lobbying may create hysteresis in (differences in) technology regulation. These results fit well the differences in biotechnology regulation between the EU and the US, and illustrate that both consumer preferences and protectionist motives play a crucial role in explaining these differences. The main factor that causes producer lobbying and thus regulatory persistence is the cost related to switching between different technologies. If producers could adjust their production technology without losing profits to foreign producers, their incentives to lobby in favor of a regulatory status quo would disappear and hence the hysteresis in technology regulation as well. This holds the important policy implication that to overcome the status quo bias, adjustment costs need to be reduced. This would effectively reduce the capture of public standards and technology regulation by interest groups that aim at protecting their home markets from foreign imports. The fifth chapter tackles the second issue, namely that retailers may employ private standards to extract rents from other agents in the supply chain. The model shows that several factors may cause retailers to set their private standards at more stringent levels than public standards. Retailers are more likely to set relatively more stringent and rent-extracting private standards if (a) the rent transfer from the retailer to producers is smaller such that producers bear a larger share of the standards implementation cost; (b) the producers interest group has a larger political power when producers interests are opposite to those of the retailer; (c) the standard creates a smaller efficiency gain for consumers; and (d) the standard entails larger implementation costs for producers. We also show that retailers market power is crucial in this argument: if retailers have no market power, private standards are never set at higher levels than public standards. Hence when producers use their political power to obtain lower public standards, retailers may apply their market power to set higher private standards. In combination these factors may contribute to explaining why industry-wide private standards may be more stringent than their public counterparts. Importantly, the model also demonstrates that, in general, the optimal private standard differs from the socially optimal one. This sub-optimality generates additional profits for retailers at the expense of consumer and/or producer welfare. Therefore government intervention that regulates the use of private standards could be warranted. However, doubts might be cast on the optimality of government intervention in the domain of private standards because, as demonstrated in the third chapter, also politically optimal public standards may differ from their social optimum due to interest group lobbying. Finally, the sixth chapter addresses the issue that certain (groups of) producers may be excluded from a high-quality economy (HQE) and supply chains governed by high standards. The partial equilibrium model developed in the sixth chapter shows that the initial production structure (in terms of productivity heterogeneity) affects who is able to participate in the HQE and who is not. The most productive producers switch first to the HQE, and in countries with a more heterogeneous production structure this process is more likely to lead to an initial exclusion of producers, although the emergence of the HQE occurs faster in terms of rising incomes. In countries with a more uniform production structure, the emergence of the HQE, although delayed, can be expected to be more inclusive. We also demonstrate that, depending on their nature, transaction costs may or may not reinforce the disadvantaged position of less productive producers. Additionally, our model shows that contracting between producers and processors i.e. processors supplying credit to producers may induce the HQE to be more inclusive towards less efficient producers. The model thus lays out three different mechanisms by which a HQE can be made more inclusive towards different groups of producers, namely (a) by reducing heterogeneity in the initial production structure through raising productivity of the least productive producers; (b) by reducing transaction costs in general and especially those transaction costs that reinforce productivity disadvantages; and (c) by creating an institutional environment that is favorable to contracting between producers and processors or that facilitates producers access to credit.
    01/2011;
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    ABSTRACT: This paper develops a formal theory of the endogenous process of the introduction of high quality production in developing countries. Initial differences in income and capital and transaction costs are shown to affect the emergence of and the size of the high quality economy. Initial differences in the production structure and the nature of transaction costs—as well as the possibility of contracting between producers and processors—are shown to determine which producers are included in the high quality economy, and which not.
    Review of Development Economics 01/2012; · 0.69 Impact Factor

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