AAMP Training MaterialsModule 2.1: Factors Affecting Smallholder

CommercializationT.S. Jayne & William Burke, (MSU)

jayne@msu.edu, burkewi2@msu.edu

Contents

• Agricultural commercialization• Definition• Indicators – Labor productivity• Pros and cons

• Agricultural commercialization and the Structural Transformation framework

• Constraints and challenges facing the promotion of agricultural commercialization

• Market participation modeling: strengths, weaknesses, and an example of an applied model

Agricultural Commercialization (Definition)

• The degree to which agricultural production and marketing is based on market exchange and specialization vs. internalized within the household

Agricultural Commercialization (Indicators)

• Household Commercialization Index (HCI)– HCI = value of farm sales / value of farm production– Ranges from 0 – 1.0– The higher the number, the more commercialized the household

• Existence of / degree of reliance on:– Factor markets (fertilizer, labor, etc)– Financial markets (loans)– Output markets (crop sales)

• Rising labor productivity in agriculture…

Labor Productivity

Y = Y * AL A L

Where:

Y = Net outputL = LaborA = Area

Y/L = Labor productivityA/L = Land to Labor RatioY/A = Yield

Commercialization: Some Pros and Cons

• Pros:‒ Can achieve growth in net output per unit area (Y/A) with shifts

in cropping patterns toward higher value crops‒ Can be the result of input intensification, as long as the value of

output exceeds the costs of the additional inputs.

• Cons:‒ Dependence on markets, both for the commercialized crops as

well as the food market. ‒ Competition from large-scale farming

• Important: Commercialization only works if the food market is functioning well!

Agricultural commercialization and the Structural Transformation framework

• Structural transformation / Demographic Transition– Based on economic history of Asia and Europe (B. Johnston, J.

Mellor, Binswanger, Lipton)– In early stages of development, 80% of population is primarily

engaged in staple food production– Broad-based rural productivity growth triggers demographic

transition

Ag Commercialization & Structural Transformation

• There is a symbiotic relationship between rural farms and towns

– Urban areas provide a market for surplus farm output

– Farmers with cash generate demand for urban employment

– As demand for off-farm jobs rises people migrate to towns

– Increased urbanization “pulls” rural labor to urban areas

– birth rates decline and levels of education rise

FUNDAMENTALLY A SMALLHOLDER-LED MODEL!

Ag Commercialization & Structural Transformation

1 2

3 4

Key elements of structural transformation

• Growth processes that effectively reach a large proportion of the population

• Especially the poor – equitable growth

• That being said, broad based equitable growth is difficult to achieve.

Extreme concentration of marketed maize output – Malawi, 2008/09

Source: Agricultural Inputs Support Survey (n=1904 farm households), sample frame from National Statistical Office, Government of Malawi

Challenges to commercialization

• The major challenge to the success of smallholder-led commercialization strategies is to address the asset constraints that prevent such a large % of the rural population from being able to respond to growth opportunities and incentives.

Most smallholders lack the land and other resources to produce a surplus

hectares

Relationship between landholding size and farm household income

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Ha0 .25 .5 .75 1

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N o te : T h e v e r tica l lin e s a re d raw n a t 2 5 th , 5 0 th , an d 7 5 th p e rc en tile s o f p e r c a p ita lan d o w n e d fo r ea chc o u n try . T h e to p 5 p e rc en t o f o b se rv a tio n s a re e x c lu d e d fro m th e g ra p h s b e c au se lin es a re se n sitiv e to afe w ex trem e c ases.

Labor Productivity

Y = Y * AL A L

Where:

Y = OutputL = LaborA = Area

Y/L = Labor productivityA/L = Land to Labor RatioY/A = Yield

Evidence shows that broad-based ag commercialization is associated with:• Relatively equitable initial distribution of productive

assets and resources within society• Agricultural growth in agrarian-based economies• Public support for investments that most of the

population can take advantage of: infrastructure, seed research, extension programs

Evidence shows that inequitable commercialization is associates with:• Highly concentrated initial distribution of productive

assets and resources within society– e.g., latifundia-type landholding systems

• Elite capture of political process• Use of public funds to invest in ways that are primarily

appropriated by elites– Marketing board operations that raise prices with regressive

income distributional effects– Input subsidy programs that are disproportionately targeted to

better-off farmers (not in all cases though)

Now let’s move to methods for assessing the factors associated with smallholders’

ability to participate in markets (commercialization)

Econometric Modeling Example

Example of a basic econometric model

•Assumes the “dependent” variable y, is continuous (e.g. every mobile phone owner uses at least some talktime.

2211 xxy

contactsyearsTalktime 21

Market participation models

• Modeling market participation (e.g. how much maize is bought/sold per household in Zambia), can be a bit tricky because not all households sell their crops.

• Often, “Two-stage” or “Double Hurdle” models are used to address this issue.

• These models include two steps reflecting the dual decision making process:

Decision 1: Whether to participate

Decision 2: How much to buy or sell

2-Tiered Market Participation Model (Ex 1)

Producing Household

Do not Buy or Sell

Market Participant

Decision 1

Participate in the Market?

0Net Purchases Net Sales

Decision 2

How much will market

participants buy or sell

2-Tiered Market Participation Model (Ex. 2)

Producing Household

Decision 1

Participate in the market as a buyer, seller or

not at all?Net Buyer Do not Buy

or SellNet Seller

Decision 2

If I participate, how much am I

buying and selling? 00

Net Purchases Net Sales

Market participation models

• The previous models include two steps reflecting the dual decision making process:

Decision 1: Whether to participate

Decision 2: How much to buy or sell

• The weakness of the two-tiered models discussed so far is that it requires all observations to be producers– Can’t extrapolate to entire country– May under-estimate the effects of a given policy on marketing

behaviour (i.e. if policy affects the decision to produce)

• The Triple Hurdle Model (Burke, 2009) can give a more comprehensive perspective

Triple Hurdle Model: Market Participation with Production DecisionNationally Representative Sample

Decision 1

Whether to produce

Decision 2

Participate as buyer, seller or

not at all

Decision 3

Quantity bought or sold among

participants

Non-Producers

Net Buyers Net SellersAutarkic

Quantity Bought

Quantity Sold

Producing Household

Insights from the Triple Hurdle Market Participation Model• The Triple-Hurdle Model provides the probability of:

– Not producing– Producing, but also being a net buyer.– Producing, but not participating in the market– Producing and selling

• Expected value of market participants net purchases or net sales

• Expected value of sales and purchases of any household (per household expected values)

Kenyan dairy example

• About 85% of East Africa’s 3.5 million dairy cattle in are raised in Kenya

• Compared to Maize– Although nearly all households produce maize,– Less than ½ of maize producers sell to generate cash– On the contrary, about 70% of dairy producers are net sellers– Top 10% of households generate ~ 80% of maize revenue,

versus ~ 55% of dairy revenue

Kenyan dairy example (2)

• Since private dairy purchasing enterprises became legal, there are four principle buyers of dairy:– Kenya Creamery Company– Other co-ops– Private processors– Informal dairy “hawkers” tolerated, not legal

• Despite growth, domestic supply is outpaced by domestic demand and export.

• Why?

What explains market participation?

• Transfer cost determinants• Endowments• Access to production inputs• Market Prices• Production shocks

Triple Hurdle Model Simulation (Exercises)

• Open the Excel workbook corresponding to this presentation

• Read the information in the [NOTES] sheet carefully• You will use the output from a triple-hurdle model of

market participation in the Kenyan Dairy sector to evaluate the impacts of various shocks on dairy market participation

• Changes to yellow-highlighted values in [Simulation values] sheet create changes in the probabilities listed in row 3 of the [Simulation results] sheet

Triple Hurdle Model Simulation(Exercise 1: Baseline)

a) At the mean data values provided, what is the probability that the average household does not produce dairy?

b) What is the probability that they are a producer, but net buyer of dairy?  

c) What is the probability that they produce, but neither buy nor sell dairy?

d) What is the probability that they are a producer and net seller of dairy?

e) Finally, what is the unconditional expected value of net sales at the data means?

Triple Hurdle Model SimulationExercise 2: Distance to Electricity

a) Holding all other factors at their data means, what is the expected value of net sales for a given household that is 10 kilometers from the nearest source of electricity? (Change cell 22E to 10 in [Simulation values] sheet)

b) What is the expected value of net sales for a given household that has electricity nearby? (Change cell 22E to 0)

c) Why would a dairy farmer closer to electricity be expected to sell more dairy?

Triple Hurdle Model SimulationExercise 3: Land Holdings

Return cell E22 to it’s data mean value (4.17).

a)What is the likelihood of being a producer when lagged acres owned is 15? (Cell E30 = 15)

b)What is the likelihood of being a producer when lagged acres owned is 0.5? (Cell E30 = 0.5)

c)What does this tell us about dairy farming in Kenya, and what are the policy implications of this result?

Triple Hurdle Model SimulationExercise 3: Land Holdings

Reset lagged acres owned to the mean (Cell E30 = 3.5).•Simulate an observation in which no organized purchasers are present. (Change E25:E28 = 0) What are the unconditional expected net sales?•Is it feasible that this household could be a net seller? How?•The presence of which buying agent is correlated with the highest unconditional expected net sales, and how many litres of milk per year are sold by the average household?•What are the policy implications of this finding?

Resources

• Bellemare, M.F., and C.B. Barrett. 2006. “An Ordered Tobit Model of Market Participation: Evidence from Kenya and Ethiopia.” American Journal of Agricultural Economics 88: 324-337

• Burke, W.J. 2009. "Triple Hurdle Model of Smallholder Production and Particiaption in Kenya's Dairy Sector." MS Thesis. Department of Agriculture Food and Resource Economics. Michigan State University.

• Goetz, S.J. 1992. “A Selectivity Model of Household Food Marketing Behavior in Sub-Saharan Africa.” American Journal of Agricultural Economics 74: 444-452.

• Key, N., E. Sadoulet, and A. DeJanvry. 2000. “Transactions Costs and Agricultural Household Supply Response.” American Journal of Agricultural Economics 82:245-259.