Agribusiness and Smallholder Farmers in the Philippines: A Free Hand, Increasing Bargaining Power, or Contract Regulation? Virgilio R. De Los Reyes et al Department of Agrarian Reform – Philippines 2015 WB Conference on Land and Poverty Washington DC, March 2015

Smallholder farming in the Philippines Philippines: 30 M ha Alienable & Disposable: 14.2 M ha Agrarian land: 7.9 M ha But smallholder farmers’ & fisherfolks’ contribution to GDP is lowest SectorContribution to 2013 GDP (in PhP)% Agri, hunting, forestry & fishing1.3 Trillion11% Industry3.6 Trillion31% Services6.6 Trillion58% TOTAL Ph GDP for Trillion100% More than half of total farms in the Philippines are below 3 hectares due to land reform. Agrarian land titles: between 0.5 to 3 hectares Total number of beneficiaries: 5.28 smallholder farmers Source: NSCB, National Accounts 2014

Needs of Smallholder Farmers: Land, Credit, & Support Services ACCESS TO LAND TROUGH SECURE PROPERTY RIGHTS Expands the ability of Smallholders to make investments on their land; hence, financial institutions become willing to give them loans ACCESS TO CREDIT Spurs land investments that improve smallholder farmers’ productivity ACCESS TO OTHER SUPPORT SERVICES Agri extension, farm management & rural infrastructure that improve productivity INCREASE FARM- BASED INCOME OF SMALLHOLDER FARMERS

Needs of Smallholder Farmers: Land, Credit, & Support Services (cont.) But there remains work to be done: –The Comprehensive Agrarian Reform Program or CARP is yet to be finished –Formal credit & other support services are not readily accessible to smallholder farmers

Entering into contracts to “improve income” Smallholder farmers enter into agribusiness arrangements with the private sector to make their land productive and increase their income. Types of contracts entered into by smallholder farmers: Contract farmingA contract where usually, the investor specifies the required crop, quality, and price and the smallholder farmers sell their yield at the agreed-upon price at a future date Joint venture agreement A contract where the investor and smallholder farmers form a JVC and the farmers contribute the use of their land and their labor. The investor gives capital and technology for production, processing, marketing or infrastructure construction Lease agreement A scheme where smallholder farmers give general control to the investor over the use and management of their land for a certain amount of lease rental for a definite period of time Leaseback agreement A scheme where smallholders give general control to the investor - who used to own the land - over the use and management of the awarded land for a certain amount of lease rental for a definite period of time Source: DAR data

But farmers have issues: Summary of contracting concerns Contract period (for all arrangements) Smallholders - Long contract period, lack of timeframe for renegotiation & lack of provision for price review Investors - Longer contract period is better for recouping investments Production / Yield (contract farming) Smallholders - It is sometimes hard to meet the target because of external factors. Investors - Low and varying quality of produce. Pricing (contract farming) Smallholders - Low buying price despite high costs of inputs and labor. Other buyers are willing to pay for higher price. Investors - Prices are market-dictated Land rental (lease & leaseback arrangements) Smallholders – Rental should be based on the production potential of the land Investors – Cash advances are deducted from the rental without interest Wages of farm workers (lease & leaseback arrangements) Smallholders – Wages are usually below the minimum wage Issues on the juridical entity (JE) of farmers & the JVC between farmers & investors Smallholders – Some lament that they were not consulted in building the JE and/or the JVC. Joining the JE and/or JVC became part of the land transfer scheme Investors – JE leaders lack skills in running their org., some show evidence of corruption Source: DAR data

Issues are more severe in contracts involving smallholders who received private farmland Smallholder farmers who received expropriated land from private owners need to pay for land amortization, hence, increasing their costs. Problem is heightened when investors provide low lease rental and below minimum wages Landowners who received compensation and continued to engage in agriculture (e.g. leaseback) are given ready fund source Nature of landownership and benefits of smallholder farmers Public or govt. land Govt.-owned & controlled corp. Private No need to pay for amortizationYNN Receives wages & benefitsYYY Receives lease/rent paymentsYYY Receives incremental income the juridical entity (e.g. for trucking or security services) The ability to have incremental income depends on the management skills of the leaders of the farmers’ juridical entity Source: Writer/presenter’s analysis

Roles of government Dilemmas and tensions arise when there are no clear policy handles for the ideal “degree of involvement” of government Two aspects of contract formation where government assumes important roles: Institutional environment of contractsInstitutional arrangement of contracts Refers to the political, social & legal ground rules that establish the basis for production, exchange & distribution. Includes the rules governing property rights & formation of contracts. Agrarian reform is an important component of property rights regime in the Philippines. The govt. plays a role in the crafting of rules and implementation. Land reform gaps remain: a) succession, b) transfers & assignments, c) collective titles & rights in the JE. Refers to the specific structures & processes through which the units or parties can cooperate or compete. It provides a mechanism that could change the institutional environment. The gov’t. has many roles in contract arrangements but degree of involvement varies. The govt. plays ex-ante and ex-post roles in contract arrangements. Source: Writer/presenter’s analysis

Gov’t roles in ex-ante & ex-post contract arrangements: Hands-off? Pro-active? RolesLimited roleHeavy role Contract drafting-No involvement -Provides information to parties -Organizes farmers to form JEs & to partner w/ investors -Ensures farmers’ FPIC -Drafts contract stipulations & terms Contract negotiations -No role -Serves as witness to the negotiation -Insists on contract stipulations & terms -Serves as witness, gives support Safeguarding agreements - No role-Monitors compliance of parties -Issues restraints on actions of parties Dispute resolution-Investigates the issues -Allows private arbitration -Investigates the issues -Mediates the parties -Addresses the concerns Contract renegotiation & revocation -No role -Sends parties to third- party arbitration -Conducts investigation -Provides venues for stakeholders to understand issues -Recommends terms & conditions for contract renegotiation -Revokes contracts Source: Writer/presenter’s analysis

Lesson drawing from Philippine experience: Considerations for gov’t roles But first, here are several assumptions: Incomplete information – Even if smallholder farmers and investors are capable of arriving at effective and efficient contracts, both would have limited information. Between the 2 parties, smallholders would have less information Opportunistic behavior – Parties could engage in behavior characterized as “self-interest seeking with guile” (Williamson, 1985). Hence, “hold-up” problems could arise when contracts violate the intent of the contractual understanding High transaction costs – Defined as costs involved in contracting (Mercuro & Medema, 1997), transaction costs deter parties from filling the contract gaps ex-ante. Hence, agreements are incomplete.

Lesson drawing from the Philippines: Gov’t roles in contracting arrangements LIMITED ROLE THIRD WAY Focuses on increasing the bargaining power of smallholder farmers but allowing them to negotiate freely HEAVY ROLE -Improving the negotiating power of smallholder farmers is expected to provide benefits to both the smallholder farmers & private investors. The third way is not expected to crowd out private investors. -- In the third way, the Government has a diminishing role in the relationship, although never absent; and yet it allows market forces to operate freely.

A key to increasing the bargaining power of smallholder farmers is by creating juridical entities which can consolidate resources and transact businesses In the Philippines, the current institutional framework offers a limited choice of JEs: corporations or cooperatives. Preference is on forming cooperatives due to easier registration and tax incentives. But cooperatives are not suited for profit-making Gov’t. needs to a) review the documented compulsory membership in JEs, b) simplify the regulatory requirements on cooperatives, c) improve JE options to include for profit and community-based social enterprises Considerations for Gov’t. roles: A. Capacity dev’t of smallholder farmers’ juridical entities or JEs

Considerations for gov’t. roles: B. Providing human capital & one-off grants to juridical entities INVOLVES THE COMBINED PROVISION OF: Tailor-fit agri- extension & business development knowledge & skills Revenue- Generating assets (farm machines & equipment) Receiving these human capital and physical assets from government addresses the imbalance of power between smallholder farmers and private investors

Considerations for gov’t. roles: C. Providing assistance in accessing credit SMALLHOLDER FARMERS’ CREDIT ACCESS IS CONSTRAINED BY: SUPPLY SIDE: >Formal providers hesitate to provide loans because they don’t know the needs and behavior of smallholder farmers >Smallholders are “high risk” and not “credit ready” DEMAND SIDE >Smallholder farmers lament the “stringent requirements” imposed by formal institutions and the high transaction costs (e.g. in securing TIN and business permits, developing biz plans & fixing financial records Government should help smallholder farmers by reducing transaction costs and by managing some of the risks (through guarantee programs and agri-insurance)

Given the bundle of assistance for smallholder farmers, which utilized public funds, contracts involving them are now more imbued with public interest The government must provide benchmarks and parameters in contract formation. For instance, the government could release guidance in drafting long-term contracts: –Consider changing explicit contractual terms of exchange into stipulations that establish rules governing the relationship. –Instead of putting the actual contract period, amount, or lease rental or the actual contract price, the parties could be advised to focus on putting the rules determining the appropriate length of contract, rules determining the process for adjusting prices, wages and fees and rules regarding termination of relationship Considerations for gov’t. roles: D. Serving as third party in contract formation

The ex-post role of government in resolving intra and inter-organizational disputes is important especially if the conflicts have policy implications. Rule of thumb is for government not to treat contracts involving smallholder farmers as ordinary commercial contracts and thus to exert efforts at addressing contract-related disputes. Considerations for gov’t. roles: E. Dispute resolution F. Contract renegotiation and revocation The role of government in renegotiating and revoking contracts is important particularly if the issues have policy implications. One of the important points that the government could consider is the imposition of minimum wage payment and other mandatory statutory benefits for farmworkers.

The roles of government in this third way are not confined to the institutional arrangement of contracts. The government remains the central figure in improving the rules governing property rights including the stabilization of the land tenure of smallholder farmers. The government could also enhance the effectiveness and efficiency of rules governing juridical entities, taxation of smallholder farmers and provision of agricultural credit. Considerations for gov’t. roles: G. Improving formal rules

The incomplete and often asymmetrical information in agribusiness contracts involving smallholder farmers need to be addressed. The government can fill in the data and thus, equalize the field of information by putting up independent sources of information. Data on prices and market demand will help smallholder farmers in drafting and negotiating contracts with investors. Greater stability of contracts can be enhanced to assure investors of predictability. Considerations for gov’t. roles: H. Addressing the incomplete and asymmetrical information

The discussion provided answers to the question: what roles should the government take in contracts or agreements involving smallholder farmers? It assumed that contracts involving smallholder farmers – in a country like the Philippines which is largely agricultural but where the farmers remain poor – are imbued with public interest The government must package its support services to crowd in private investors. One way to do it is by improving the institutional environment of contracts and by increasing the bargaining power of the JEs of smallholder farmers Conclusions

Further study this area by determining which considerations or sub-set of considerations would yield the highest returns or the biggest bang for the buck Work towards complying with and monitoring adherence to the Voluntary Guidelines on Responsible Governance of Tenure of Land, Fisheries and Forest (VGRGT) and the Principles for Responsible Agricultural Investment (PRAI) UNIDROIT is preparing a LEGAL GUIDE for contract farming. Sent suggestions on the roles of government in addressing contract farming concerns like information asymmetry. Ways forward

Thank you For inquiries, authors could be reached through: