Private Sector Investment in Lao PDR: theCase of Contract Farming in Northern RuralInfrastructure Development Sector Project1

Policy Discussion Paper No. 1

[The paper endeavors to document the practices, policy principles andother support systems that make a contract farming an attractiveoption for smallholder farmers. And such concerns are analyzed in thecontext of improving and defining the boundaries where the NorthernRural Infrastructure Development Sector Project (NRI) could usefullyintervene in the promotion of contract farming. The paper concludesthat NRI should focus its efforts on contract farming (smallholderfarmers) for crops destined for niche market based on economic andtechnical realities adopting beneficial contract farming practicesand policy principles supportive of market-oriented agriculture. NRIneed not intervene on existing contract farming arrangements whichare believed to be profitable and concluded on economicconsiderations. However, NRI has a role to promote globally goodagriculture practices on these existing contract farming arrangementsfollowing the principle of agro-ecology.]

Mr. Phaythoune Phomvixay

1 This Paper is expressed as supporting policy to smallholder farmers on the contract farmingdevelopment approach of agro-ecology to Northern Rural Infrastructure Development Sector Projectin Lao PDR.

National Project Manager, National Project Management Office2

Department of Planning and Cooperation, Ministry of Agriculture andForestry

Vientiane Capital, Lao PDR. Contact E-mail: npmo.nri@gmail.com

2 Mr. Kazuyuki Shimazaki, Team leader; Mr. Virgilio E. Cabezon, Policy Development Specialist,and on behalf of the Grant Implementation Consultant (GIC), Nippon Koei in association with NIAConsult and LCG for the Northern Rural Infrastructure Development Sector Project (NRI), ADB GrantNo. 0235-Lao (SF). May 2012.

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ACRONYMS

ADB Asian Development BankAFTA ASEAN Free Trade AreaANR Agriculture and Natural ResourcesASEAN Association of South East Asian NationCFSVA Comprehensive Food Security and Vulnerability AnalysisDAFO District Agriculture and Forestry OfficeFAO Food and Agriculture OrganizationFDI Foreign Direct InvestmentFGD Focus Group DiscussionFPG Farmer Production GroupGAP Good Agriculture PracticeGMS Greater Mekong Sub-RegionGOL Government of LaoHVC High Value CropsIPM Integrated Pest ManagementKII Key Informant InterviewLDC Least Developed CountryMAF Ministry of Agriculture and ForestryMDG Millennium Development GoalNAFES National Agriculture Forestry Extension ServiceNAFRI National Agriculture and Forestry InstituteNGPES National Growth and Poverty Eradication StrategyNRI Northern Rural Infrastructure Development Sector ProjectNSEDP National Social Economic Development PlanPAFO Provincial Agriculture and Forestry OfficePRA Participatory Rapid AppraisalSAD Strategy for Agricultural DevelopmentSRI System Rice IntensificationWB World BankWTO World Trade Organization

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CONTENTS

PageI Introduction 1

1.1 Rationale 11.2 Contract Farming 1

II Basic Premise, Objectives and Methodology22.1 Basic Premise 22.2 Objectives 22.3 Methodology 2

III Context of Lao PDR 23.1 Private Sector Investment

23.2 Agriculture 43.3 Poverty 53.4 Challenges and Opportunities5

IV Contract Farming Practices 64.1 Contract Farming as a Poverty Alleviation Strategy

64.2 Contract Farming Models in Lao PDR94.3 Contract Farming Models in NRI Project Sites

104.3.1 Contract Farming Investors 104.3.2 Salient Features of Contract Farming Investors114.3.3 Perceived Observations by Smallholder Farmers13

V Policies 14

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5.1 National 145.1.1 Private Investment 145.1.2 Agriculture Sector 165.1.3 Food Security 16

5.2 Local Government (Province and District and Villages)175.2.1 Regulatory 175.2.2 Agriculture 18

VI Conclusions and Policy Recommendations 206.1 Overall Findings and Recommendations20

6.1.1 On Contract Farming Practices20

6.1.2 On Contract Farming Model 216.1.3 On Policy Principles 21

6.2 Recommendations 226.2.1 On Contract Farming Practices

226.2.2 On Contract Farming Model 226.2.3 On Policy Principles 226.2.4 In the Overall Context of NRI Implementation23

PageList of Tables

Table 1 Extent of Private Investment (Foreign) in Lao PDR3

Table 2 Potential Benefits of Contract Farming7

Table 3 Indicative Extent of Contract Farming in NRIProject 10

Table 4 Salient Features of Contract Farming Investors inNRI Project 11

Table 5 Doing Business, Ranking of Countries15

Table 6 Activities in Complying with Business Permits,Contract Farming 17

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Table 7 Likely Impacts of Local Government AgriculturePolicies on

Contract Farming 20

List of Figure

Figure 1 How Lao PDR Ranks on Doing Business Topics15

List of Annex

Annex 1 Policy Matrix Governing Contract Farming25

References 27

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Private Sector Investment in Lao PDR Agriculture: the Case of Contractfarming in Northern Rural Infrastructure Development Sector Project as

Alternative Strategy to Poverty Reduction

Policy Discussion Paper No. 1

I Introduction

1.1 Rationale

This paper attempts to document and analyze the policy principlesand practices governing private sector investment in agriculturefocused on contract farming with smallholder farmers. In the contextof Lao PDR, private sector investment in agriculture (described insection 3.1) is broadly pursued through land concessions and contractfarming, although in the former there are also variants of contractfarming. Contract farming with small holders/small farmers,especially in the ambit of dynamic markets is the theme of the paperprimarily because of the interest to facilitate and/or up-scale thiskind of arrangement (i.e. commercialization of small holderagriculture) in the northern provinces of Lao PDR (e.g. Phongsaly,Luang Namtha, Bokeo and Oudomxay) where infrastructure andinstitutional components of the ADB-funded Northern RuralInfrastructure Development Sector Project (NRI) are currently beingimplemented.3 The interest is primarily anchored on the overarchinggoal of the NRI project, that is, to increase small farmers’ income.The fundamental question is: can contract farming be an alternativemode to increase small farmers’ income? The paper endeavours to:document empirical findings on the benefits of contract farmingmodels, assess GOL national agriculture and regulatory policies anddetermine the application and implementation of same by the localgovernment (province and district), and offer insights to improve theimplementation of contract farming, especially in NRI sub-projectsites.

3 Details about the NRI project can be found in the website, http://www.nri-lao.org

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1.2 Contract Farming

Contract farming, as investigated in this study, is focused onthose small farmers who have experienced or are still growing cropsunder agreement, whether it is formal (written) or informal (verbal).Large concessions that may have existing contract with small holderswere excluded for reasons that they were outside of the NRI sub-project sites.4 Contract farming is now widespread in Lao PDR. It isbeing encouraged by the government to commercialize smallholders/small farmers’ subsistence agriculture. In a sense, this moveby the government is in line with equity principle which emphasizes onimproving the welfare of the smallholders, who are mostly marginal andhave limited access to capital, technology and markets. Greateraccess to the fundamental factors of production makes contract farmingan attractive option for smallholders to increase their farm incomes,an observation that is shared by researches conducted so far oncontract farming.5

II Basic Premise, Objectives and Methodology

2.1 Basic Premise

The basic premise of the paper is to guide on the implementationof contract farming in the NRI project. There are existing contractfarming activities in the NRI sub-project sites, the progress of whichare shared with mixed observations. It is thus important to documentand assess the best modes of contract farming, policies and othersupport systems that will improve the benefits of contract farming forNRI small farmers.

2.2 Objectives

The objectives of the policy paper are to:

4 Large concession is a form of FDI and the effect of this on the agriculture andforestry could be negative as mentioned in SAD 2011- 2020, page 15. In addition, astudy on” Contract Farming and Plantations” has already been completed available atwww.laofab.org.5 There are equally a number of research studies that negate this observation.

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(a) document the practices, policy principles and other supportsystems that make contract farming an attractive option for smallfarmers; and

(b) provide non-confrontational insights on how to improve thepolicy and administrative environment for contract farming,especially for NRI project.

2.3 Methodology

Desk research was mainly employed to collect the secondary dataon GOL national policies affecting agriculture, trade, investment andother relevant sectors. GOL and development partners’ data weresourced through published documents and the internet.

The literature review, covering international and local wasconducted to document the socio-economic findings of contract farming.This review facilitated the identification of the best practices andpolicy principles and safeguards that mitigate the negative impact ofcontract farming. They were further assessed in the context of the on-going agriculture development in Lao PDR.

Finally, participatory rapid appraisal (PRA) was conducted at thelocal levels (NRI provinces and selected districts) to validate theinformation collected at the national level. Key informants’ interview(KII) was used to collect information on local government’s policies(PAFO/DAFO and village chief) and data to characterize existingcontract farming activities (traders and millers). Focus groupdiscussion (FGD) with farmers was employed to get their perceptions oncontract farming. The PRA was concluded with actual site visitationof the farms to assess the physical, agronomic and topographicfactors.

III Context of Lao PDR

3.1 Private Sector Investment

Private sector investment in Lao PDR agriculture, especiallyforeign is mainly fuelled by cross border transactions. While thesetransactions may carry foreign direct investment (FDI), the keydriver to promote private sector investment is the mutual consensusencouraged by the host country and external investors as well. In the

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case of the government of Lao (GOL), an explicit policy to promoteforeign investment in agriculture is being espoused in the NationalGrowth and Poverty Eradication Strategy (NGPES) mainly in theinterests of “expanding business opportunities focusing on export-oriented industries with high comparative advantages and increasingmarket linkages and external trade”. External investors notablyChina, Thailand and Vietnam, known to be the major trade alliances ofGOL in the Greater Mekong Sub-Region (GMS), on the other hand, aredriven by proximity and market demand such as increasing demand forquality and better agricultural products due to rising andsophisticated consumer preferences. These countries seek economic andfriendly cooperation with GOL through bilateral routes, among others,in the ambit of the Association of South East Asian Nation (ASEAN),the ASEAN Free Trade Area (AFTA), ASEAN-China Free Trade Area andAyerwaddi-Chao Phraya-Mekong Economic Cooperation Strategy (Baumüllierand Lazarus, 2011).

Agribusiness is the bigger part of private sector investment,carried out through land concessions and contract farming as givenTable 1. Land concessions by foreign investors stemmed from the LandLaw (Articles 64 and 65) where foreigners can lease land from theState for a period of 30 years and maybe renewed on a case basissubject to approval by the GOL. Contract farming is embedded in Goal2 of MAF Strategy for Agricultural Development (SAD) 2020. Goal 2 ofthe SAD states “increased and modernized production of agriculturalcommodities will lead to pro-poor and green value chains targetingdomestic, regional and global markets based on organizations ofsmallholder farmers and partnering investments with the privatesector”. Implicit in this goal is the importance of resourcesprovided by the private sector (which otherwise could not be madeneither by the small farmers nor the government) to link the smallfarmers’ production groups to local and global markets, beginning fromproduction to consumption.

All told, foreign investment in agriculture and forestry in 2009as reported by GOL amounted to about $ 282 million involving 30projects. Domestic investment pale in comparison with this figure,roughly 2.4% of the total investment.

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Table 1 Extent of Private Sector Investment (Foreign) in Lao PDR Agriculture

Crop Extent Location Main Foreign Investors

Rubber 140,000 ha (2008) 268,800 ha (2011)1

54% in the Northern provinces 18% in the Central provinces 28% in the Southern provinces

China (mainly contract farmingin the North)

Vietnam (mainly concessions incl. in Champassak, Saravan and Attapeu Provinces)

Sugarcane 200,000 ha (2005) (further expansion since then, but extent not known

Northern Uplands, Centre

China (mainly contract farming, incl. in Phongsaly, Luang Namtha andOudomxay Provinces)

Thailand (mainlyconcessions and contract farmingin Savannakhet Province)

Maize 66,000 ha (2005) (further expansion since then, but extent not known)

75% in the Northern Uplands

Thailand (mainlycontract farming), also China and Vietnam

Cassava Not known Contract farming, small concessions

China (mainly contract farming, incl. in Luang Namtha and Oudomxay Provinces), alsoThailand and Vietnam

Jatropha 26,000 ha (2009)land allocated, butlimited production

Not known Mainly Asian investors, incl.China, Malaysia and Korea

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Source: H. Baumüller and Lazarus, K. Agribusiness Investments in Laos: Risks andOpportunities in Poverty Alleviation, OXFAM Hong Kong Workshop, Power PointPresentation, December 14, 20111 Vientiane Times, April 10, 2012. The contract is under Ayeyawady-Chao-Praya MekongEconomic Cooperation Strategy

3.2 Agriculture

The value added of agriculture, as per cent share to GDP,averaged at 33% in 2010.6 GDP in current terms stood at $ 7.3 billionin 2010. Currently, more than 60% of the labour force is employed inthe sector, and slightly over 15% of the total exports come fromagriculture. Clearly the 33% value added share to GDP reflects arather slow transformation of the sector into agro-industrialdevelopment.

In terms of physical resources, FAO estimates the totalagricultural land to be about 2.35 million ha which is about 10% ofthe total land area (23.08 million ha). Arable land, i.e. countingonly the flat land is estimated by ADB at 4% (947,500 ha). Anadditional area involving the moderately sloping topography isestimated to be about 1.5 million ha, but most of this type of land isawarded to concessions, the net effect of which is to put pressure onthe availability of arable land to be cultivated by small farmers.Between 2007 and 2009, the arable land per person stood at 0.22 ha.

Rice is the dominant crop, accounting for 72% of the totalcultivated area. Undoubtedly, the agriculture is rice-based farming,mostly subsistence and addressed to meet the household needs. Therehave been adjustments to change the pattern, from a subsistencestructure to a marketable surplus economy by improving the yield ofrice coupled with the provision of essential support services. Thegovernment invested on irrigation, being a major source of cropproductivity. MAF estimates about 117,500 ha still available forirrigation development. The current irrigated area is roughly 138,901ha, 66% of which is planted with paddy rice and the remaining 34% toother dry season short-term crops such as vegetables and legumes.Through irrigation, MAF reported that the combined crop yields (paddyrice, corn and vegetables) grew by about 4%. However, sustaining the

6 Source: http://data.worldbank.org/country/lao-pdr

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momentum of irrigation investment has been lately hampered by thedeclining public expenditure on agriculture and forestry, from 437billion kip in 2005-2006 to 220 billion kip in 2009-2010, almost 50%reduction.

Lao agriculture is essentially described as rice-based, but inbroader terms, there are two (2) farming systems: notably the lowlandrainfed and/or irrigated farming systems located along the Mekongflood plains and its tributaries and the upland slash and burncultivation system. A smaller system is the cultivation ofhorticultural crops on the Bolovens Plateau in the south. In allsystems, the farming is essentially smallholders with only a fewfarmer organizations. Around 3 million people lives in the lowland(50%), 2 million stays in the upland (30%) and 1 million settles inareas of mixed lowland and upland. A critical problem is likely to befelt on the upland slash and burn cultivation as this method offarming system induces land degradation. Asset reform in the form ofland tenure security coupled with better farming technologies for thepeople living in this area could mitigate the deleterious andirreversible effects of land degradation.

3.3 Poverty

The pressure to exploit Lao PDR’s agriculture and naturalresources (ANR) is being felt intensely because of widespread povertyin rural communities, reported to be inhabited by 80% of the totalpopulation, with total population recorded at 6.2 million as of 2010.7

The 2008 figure on the number of people living below the poverty lineis estimated at 1.7 million people (27.6%); most of them belong to theethnic minorities. GOL efforts to reduce poverty can be consideredsignificant, reducing the poverty headcount ratio from 45% in 1992 to27.6% in 2008. The government is committed to eliminate poverty byreducing this figure to 24% in 2015 (MDG, Lao PDR) through support inagriculture and continued investments in education, health and basicinfrastructure.

3.4 Challenges and Opportunities

7 Source: http://data.worldbank.org/country/lao-pdr

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The main challenge is how to transform the smallholders’subsistence agriculture into a marketable and dynamic agriculture.Clearly the major resource constraint facing the agriculture sector isthe inadequate public funds to support capital and institutionalexpenditures for small farmer development. Partnership with theprivate sector that can equally provide inter-connectivity of supportsuch as credit, technology and markets remains a convincing option inthe medium-term, meanwhile that small farmers have limited access tosuch factors of production. The opportunities for this option,incidentally, are bright because of the following factors:

Reforms undertaken to reduce trade barriers, permitting thedomestic production of crops and livestock with comparativeadvantage;

Significant improvements in transport infrastructure; Reduction of administrative barriers to international trade

with China, Thailand and Vietnam; Favourable prices of agricultural products, allowing farming

as a profitable business; Active involvement of the private sector in linking the

small holders to global market; and Increased domestic demand fuelled by increased population

and incomes

IV Contract Farming Practices

4.1 Contract Farming as a Poverty Alleviation strategy

FAO defines contract farming “as agricultural production carriedout according to an agreement between a buyer and farmers, whichestablishes conditions for the production and marketing of a farmproduct or products. Typically the farmer agrees to provide agreedquantities of a specific agricultural product. The buyer commits topurchase the product, and in some cases to support productionthrough for example, the supply of farm inputs, land preparation andthe provision of technical advice”.8 Glover and Ghee (1992) aptlydescribed contract farming as one of the most promising institutionalframeworks for the delivery of price incentives, technology and otheragricultural inputs. The key element of this definition is the

8 (http://www.fao.org/ag/ags/contract-farming/en/

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“agreement” which establishes the parameters of the contract farming.The agreement can be formal or informal (verbal). Verbal agreement ispronounced, especially in an environment where the legal and socialinfrastructures are still imperfect.

Informal contract farming agreement, are common under a mutualconsensus between the contracting parties, and in some cases do work.9

Singh (2006) concluded that it is not the contract per se which isharmful as a system but how it is practiced in a given context.Carefully designed and implemented contracts can lead to betterment ofall parties involved, especially the small farmers. Manoron, et al(2011) observed that having a written and/or signed contract does notprovide any financial advantage for contract farmers, although it isassociated with higher levels of access to market information,training, and advice to production groups. Elements that determine thesuccess or failure of contract farming are governed by strong markets,macro-institutional policies, sophisticated technology and landownership (Simmons, 2002). Berdegué, Biénabe, and Peppelenbos (2008)described that getting the collaborative arrangements right betweentrained and organized farmers; a receptive business sector; andfavourable public policies and programmes are key to inclusion ofsmall farmers in restructured and dynamic markets, oftentimessynonymous to contract farming. Coulter, Goodland, Tallontire andStringfellow (1999) also found out that contract farming and farmingcooperation approaches often work best together, with stronggrassroots linkage to farmers controlled enterprises (FCEs)contracting with agribusiness companies. Grassroots development inthe form of enterprising small farmer who could establish regularsupply of farm inputs (e.g. organic fertilizer) for farmers’ usewithin the village is a classic example of expanding the supply chainthat could foster a conducive environment for contract farming.Clearly, these studies suggest a number of generic factors, amongothers, as policy dictates, forms of agreement, level of materialsupport, extent of flexibility, and strength of relationship, all ofwhich can affect the outcome of contract farming.

Contract farming as a poverty alleviation strategy essentially

stems from its beneficial effect on increasing farmers’ income. Theeconomic arguments supporting this claim may be gleaned over thepotential benefits given in Table 2.

9 Feedback received from FGDs with farmers in Phongsaly (Bountai District).

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Table 2 Potential Benefits of Contract farming

Parameter Potential BenefitsFarmersAccess to markets Contract farming arrangements serve to

link farmers to distant markets wheredemand and price of crops are morefavourable

Access to credits Purchasers extend credit to farmers eitherin cash or in kind by providing inputssuch as seeds. In cases where purchasersdo not extend loans to farmers, banks mayaccept the contracts as collateral.

Access to technology and skillsdevelopment

Contract farming arrangements mayfacilitate the introduction of newproduction techniques and further measuresthat upgrade agricultural commodities.These include training and assistance incrop production, soil and water managementand bookkeeping of inputs and outputs.

Access to inputs Purchasers may undertake measures toensure that contracted producers havetimely access to inputs including seedsand fertilizers, in addition to trainingsupport and monitoring proper crophusbandry practices.

Increased income Contract farming can lead to improvedincome, especially in cases where contractfarming is adopted for non-traditionalcrops that are sold at a premium.

Reduced price risks In contract farming a pre-determined pricefor the crop is generally establishedduring contract negotiations at the onsetof the growing season. This may protectfarmers from incurring losses in sale dueto downward price fluctuations.

Reduced production risk Contract farming arrangements facilitaterisk sharing from production failures dueto uncontrollable circumstances includingweather or disease. Purchasers may absorblosses associated with reduced or non-existent throughput for the processingfacility. Where production problems arewidespread as a result of uncontrollableevents, purchasers may defer the repayment

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of production advances until the followingseasons.

PurchasersControl over volume and consistency Contract farming assures suppliers that

the required crops can be producedconsistently. Contract farming may resultin increased yields and improved qualitywith regards to certain types of crops

Improved cost efficiency Contract farming allows firms to minimizecost by not purchasing land or directlyhiring labour. Contract farming can helpfirms minimize supervision costs, usuallyincurred due to classic principal-agentproblems.

Source: Setboonsarng, S., P. Leung and J. Cai, (2006) Contract Farming and PovertyReduction: the Case of Organic Rice Contract Farming in Thailand,’ ADB InstituteDiscussion Paper No. 49

There have been rigorous empirical studies to support the claimof contract farming being an effective approach for povertyreduction.10 In Lao PDR, for instance, Manorom, et al (2011), in astudy conducted under the Phnom Penh Plan for Development Management,found out that contract farming practiced by small holders growingcabbage, maize, and sugar cane in diverse condition was largelybeneficial and an effective mechanism for tackling rural poverty.11

Majority (88%) of the Lao small holder farmers who were surveyedconcluded to have improved their financial situation with contractfarming. Setboonsarng, Leung and Cai (2006) also unearthed in theirstudy in Thailand that contract farmers growing rice and usingorganic-based farming system had “significantly higher profit overvariable cost” compared with the independent rice producers who wereusing conventional farming system (e.g. use of chemical inputs andother synthetic-based fertilizers). This was apparently borne out ofthe premium farm gate price given for organic vis-à-vis non-organicrice. Moreover, the study observed that the yield of rice was similarfor both contract and non-contract farmers. Relatedly, Birthal, Jha,and Tiongco (2008), in their study in India, remarked that contractfaming contributed in the improvement of milk yield and reduction inproduction cost among small holder dairy producers. The study reckoned10 These studies were in the nature of “profit frontier methodology” using regressionand simulation models including hypothesis testing of the various relationships foundin contract farming.11 Diverse condition was defined to have taken place through “a wide range ofagreements and relationships’ between buyers and growers which tend to vary acrossdifferent crops and local context.

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that contract farming for dairy small holder producers was moreprofitable than independent producers, and the benefit came fromreducing the marketing and transaction costs in the disposal of milk.12

Interesting findings may be observed about these empiricalresearches. Contract farming using organic-based agriculture isprofitable as demonstrated in Thailand. The implication is organicagriculture can be a sound policy, reinforcing the agro-ecologicalapproach that it can work for increasing small farmers’ income. Inthe context of environmentally, sound and sustainable agriculture,including the new world order of global restructuring of the foodindustry (e.g. non-toxic based food), the study offers opportunitiesfor special niche market involving basic food staple, notably rice,with distinct advantage for small and marginal farmers in countrieswhose agriculture is essentially rice-based such as Lao PDR, Cambodiaand Myanmar. Second, the profit efficiency of contract farming is notinfluenced by formalities of contract arrangement, as found in LaoPDR. Written and/or signed agreements were no guaranty of betterprofits. Cabbage and maize farmers with verbal contract made higherprofits than those with written/signed contracts.

Equally, there are researchers who are critical about the povertyreduction impact of contract farming. These authors have zeroed in onthe negative impacts resulting in displacement of the small farmers inthe economic mainstream. However, conflicts and perceiveddisadvantages of contract farming can be remedied by ensuring thenecessary safeguards that work for the interest of both parties.Contract farming should be rather viewed in a dynamic context,influenced by the type of crops/commodities and market conditions inthe local and highly competitive global markets. Singh (2006) statesthree pillars of a contract arrangement: coordination, motivation andtransaction cost. Ensuring proper coordination and motivation andminimizing transaction cost in the least possible way can be achieved,as suggested by Singh, by observing some of these rules: (a) minimize

12 Simmons (2002) states three factors that affect transaction costs: boundedrationality, opportunism and asset specificity. Bounded rationality describesdifferences in information between contracting parties. Opportunism may occur whenthere are opportunities for taking advantage of the situation to the detriment of theother party in agreement, a classic example of which is tedious procedures for gettingthe required permits. Oftentimes this creates rent-seeking behaviour for people whoissue the documents. Asset specificity refers to risks associated with protecting sunkcost in processing plant, e.g. small holders’ investment in machinery and knowledge.

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production cost through the use of price signals; (b) minimize and/orshare risks and uncertainty; (c) reduce the cost of pre and post-contractual opportunism through contract rationing by selecting thebest and good farmers; (d) encourage group action to lower cost andensure compliance; (e) motivate long-term contract to reduce hold-upproblem; and (f) use transparent contracts.

4.2 Contract Farming Models in Lao PDR

Fullbrook (2007) in a study conducted and produced by the LaosExtension Agriculture Project (LEAP) has made very extensive casestudies about contract farming in Lao PDR covering a wide spectrum ofissues. Fullbrook described the “term 2+3” model which GOL adopted asa policy to promote contract farming. The term 2+3, accordingly wasan easy way of explaining the partnership that exist in contractfarmers and the term makes it clear that investors and villagersshould share responsibilities and benefits. Under a simple contract,farmers contribute land and labour (2 items) and investors contributeinputs, technical advice and access to markets (3 items). In realityand through the years, however, there are more than two partiesinvolved in contract farming.

Problems faced by both smallholder farmers and investors weredocumented. Solutions taking into consideration the views ofimportant stakeholders that have interest in the promotion of contractfarming were offered. The study concluded with the necessaryinterventions, considered by Fullbrook as “qualifying success”,elements needed to ensure “successful production agreements”. A closelook of these elements covered policy, social, physical and governancetopics. Clearly the recommendations were comprehensive and useful, butthey are also bound by limitations. In addition, the recommendations,being based on perceptible observations may warrant deeperinvestigations to be considered as valid.

Zola (2008) in a study cited in the Cross-Border Contract Farmingconducted by Manorom, et al (2011), enumerated five contract famingmodels in Lao PDR as follows: (a) wholesale market model operatingwith domestic investment; (b) plantations established on landconcessions awarded by GOL; (c) concession-share croppers’ model (avariant of the land concession model); (d) producers’ associationmodel; and (e) independent farmers group model. These models emerged

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through direct intervention by the government and developmentpartners. For instance, land concessions stemmed from the Land Law.Wholesale market and farmer association models were funded by the ADB-assisted Small Holder Development Project. Mixed observations on theoutcomes generated by these models were noted, some of them wereassociated with difficulties accompanying major innovation, change ornew venture.

The ADB-funded Small Holder Development Project promoted contractfarming through the construction of “wholesale” or primary marketswhose primary purpose is to serve as the venue where traders andproducers can conclude a marketing deal. Producers can bring theirproduct to these markets (instead of going to the border) and traderscan buy them on spot. Producers and traders can also use the venue tonegotiate for contract farming. It was intended as a “marketmatching” venue, where services were provided such as: (a)identification, screening, and registration of foreign investors; (b)promotion of local product in demand by local and foreign traders;and (c) provision of assistance to Lao PDR authorities by Thaiprovincial authorities in searching for Thai companies interested forcontract farming. The markets were self- liquidating, using rentalspaid by producers and traders as revenue to maintain the facility,under the jurisdiction of the district authority. The Small HolderDevelopment Project also funded the organization of farmers’associations, and accordingly these associations made it easier forcompanies to engage in contract farming than dealing with individualfarmers. Through this project, there was a strong intervention topromote contract farming by providing the market infrastructure(reportedly at a cost of $150,000 per wholesale market) andinstitutional support, which otherwise may not exist in otherdevelopment projects.

4.3 Contract Farming Models in NRI Project Sites

4.3.1 Contract Farming Investors

Contract farming is generally common in NRI sub-project sites,although published important information (e.g. area, number offarmers, villages covered) especially those dealing with the smallfarmers are scanty (Table 3). Four contract farming investors,representing different interests in so far as agricultural commoditiestraded are concerned, were interviewed: (a) domestic tea manufacturer,

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(b) foreign rice miller, (c) Chinese traders, and (d) domestictraders. The tea manufacturer has a buying contract with the DAFO.The contract with the DAFO is a buying agreement, allowing the teamanufacturer to have exclusive rights to purchase over tea productionin villages designated by the PAFO as the manufacturer’s buying zones.Indirectly, while the small farmers are not involved in the contract,the agreement in itself can be contract farming. While this agreementprevents other tea manufacturers to buy on these designated zones,there were reports that small tea traders defied the agreement andthus small farmers were selling their tea to these traders instead tothe manufacturer who has the buying agreement (e.g. Mong Chao). TheChinese rice miller (e.g. Muang Sing) has a contract with smallfarmers to produce hybrid rice. The investor has established anintegrated rice mill plant that include packing and grading thefinished product, i.e. rice. Chinese traders are working with smallfarmers cultivating water melon and other vegetables such as cabbageand green beans (e.g. Bountai District). Domestic traders have beenactive promoting contract farming with small farmers growing soybeanand peanut (e.g. Phaoudom District).

Table3 Indicative Extent of Contract Farming in NRI Project

Province District NRI sub-projectsite(First year implementation)

ContractFarming

Crops

Bokeo Houaxay Nam Tin SoybeanPhaoudom Nam Haad Right Peanut, soybean, and

job’stearsPaktha Houay Xo

Luang Nam Tha

Long Nam Ma Oune Banana

Nam Tha Hong KongSing Nam Dai Hybrid Rice

Phongsaly Boun Tai Nam Lan Water melon, cabbage andgreen beans

Gnot Ou Nam OuMong Chao Tea

Source: Environmental Scanning, PRA

The contract farming being practiced is essentially the term 2+3.Although in practice there are more than 2 agents or stakeholdersinvolved in the agreement. For instance, in the case of tea, aside ofthe persons involved between the manufacturer and DAFO, buying agents

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in selected villages are designated by the manufacturer who in turnbuy and collect teas from the small farmers using the cash advancesprovided by the manufacturer. In the case of the Chinese traders,there were reports that some performed only as financing providers anddelegated to local people the contracting with the small farmers.Other traders made a direct contract with the small farmers byrenting their land and uses as well the small farmers’ family labour(with pay) to grow the crop, the small farmers being akin to de factowage labourers. The practice of involving more than two stakeholdersin contract farming is believed to be motivated by the proverbial“level playing field” normally influenced by a convergence of factorscomprising of policy, infrastructure and institutional. Sections 5.1and 5.2 of the report will analyze this issue as it touches on thebroad aspect of policy and business environment of encouraging theharmonious relationships of all stakeholders in contract farming.

4.3.2 Salient Features of Contract Farming Investors

Table 4 summarizes the salient features of the contract farminginvestors. While generically it can be argued to be the term 2+3, thecontract farming variant/model can be likened as “guaranteed pricecontract”, at least for all of four (4) types of investors identifiedand studied. The investors provide the inputs and fixed the price ofthe inputs as well as the price of the outputs. The small farmersreceived the net pay after the investors have deducted all cost ofinputs, including cash for land preparation. It is likely that theinvestors may have included interest charges for the cost of theinputs given to the small farmers, although, it was unverified duringthe KII.

Table 4 Salient Features of Contract Farming Investors in NRI Sub-projectsites

Particulars DomesticcompanyTea

manufacturer (Phongsaly)

ForeignCompany

Chinese RiceMiller (Sing)

ChineseTraders

(Bountai)

DomesticTraders

(Houaxay &Phaoudom)

1. Year of establishment in NRI project site

2007 2008 2010

2. Type of contract Written (buying contract with DAFO)

Written Written Verbal

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3. Criteria for choosing farmers

Volume of tea production

Resource endowment such as irrigated land

Resource endowment such as land

Resource endowment such as land

4. Number of farmers under contract

60

5. Input supply seeds Seed and fertilizers

Seeds, fertilizers, plastic sheets, and pesticides

Seeds and cash for landpreparation

6. Flexibility to grow other crops

Not applicable due to topography limitation

yes

7. Mode of payment Direct payment

Payment afterdeducting cost of inputs

Payment afterdeducting cost of inputs

Payment afterdeducting cost of inputs

8. Advanced payment no no no no

9. Form of payment cash cash cash cash

10. Time of payment Upon delivery of produce

Upon deliveryof produce

Upon deliveryof produce

Upon deliveryof produce

11. Compensation in the event of crop failure

No Yes, compensation based on the value of production shortfall, e.g. poor germination of seeds

no Yes, farmers are given another chance to grow for the second time to repay for cost of inputs

12. Crops contracted Tea Hi-breed rice Water melon, beans and cabbage

peanut

13. Area 6 villages (200 ha)

20 villages 20 ha

14. Farming system No preference

conventional conventional conventional

15. Most common type of contract violation (e.g. selling to other buyers, not following technical guidelines, etc.)

Selling to other buyers

Not followingtechnical guidelines

Quality belowagreed standards, and selling to other buyers

Agreed price not enforced

16. Catchment area 200 ha (6 Muansing Bountai Nam Haad

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villages within Phongsaly)

District district

17. Price fixation Pre-determined as certifiedby DAFO (3,000-5,000kip/kg)

Pre-determined (2,500,000 kip/kg to 2,600,000/kg)

Water melon (500kip/kg, minimum size is 3kg, below3 kg is rejected

Pre-determined (peanut, 6baht/kg, fresh or 100 baht/kg, dried, unshelled

18. Research and development (R&D) unit

no yes no no

19. Technical guidelines no Yes, traininggiven for 3 times

yes no

20. Processing unit no no yes no

21. Type of commodities traded

Green tea Clean Rice Water melon peanut

22. Market destination (domestic or foreign)

International (98%), domestic (2%)

International international international

Source: Key Informants’ interview with investors

A close look of the salient features would reveal that the basicelements for a successful contract farming do exists, among which are:(a) presence of contract, either written or verbal; (b) provision ofinputs; (c) pre-determined price for outputs; (d) technical advice forgrowing sophisticated crop such as hybrid rice; and (e) payment ofoutput upon delivery. In terms of managing production risk, two (2)investors (e.g. Chinese rice miller and domestic trader for peanut)provide compensation for crop losses. The Chinese rice millercompensate for losses in production due to poor germination of seeds,while the domestic trader on peanut contract farming allows thefarmers to grow for the succeeding dry cropping (same term as in thefirst contract) to recover production losses incurred during theearlier contract and be able as well to repay the cost of inputs. Itis still significant to note that there are investors who are willingto share the burden of production losses. Improper management ofproduction risk is normally the bone of contention between the partiesinvolved in contract farming. Management sharing of production risk isa certainly the pathway to foster better relationship between contractfarming investors and small farmers.

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4.3.3 Perceived Observations by Small Farmers

Perceptions of smallholder farmers who were involved in contractfarming were randomly taken during the KII and FGD with farmers. Afarmer leader of farmer production group (FPG) in Bountai districtrevealed their encounter with a Chinese Trader who entered into anagreement to grow water melon in 2007. The leader informed that thecontract farming, a sort of “guaranteed price contract variant” wasgenerally good during the early years, but later decided to withdrawfrom the agreement. The leader noted that they were not getting thebetter end of the profits, apparently because of plenty of “watermelon rejects” by the Chinese trader. It was informed, that fruitsbelow 3-kg weight were not bought by the Chinese trader and that leftthe FPG with less volume of production, reducing their profitsignificantly. The FPG now manages the growing of water melon and doby them the export directly to the border of China. Presumably, theFPG does this through cross-border negotiation under informalarrangement. If the FPG has been able to continue this practice ofinformal cross-border negotiation, it can be argued to be successful.

In a FGD with the village chief and some smallholder farmers onthe same district, it was reported though that contract farming withChinese traders still exists, mainly in the growing of cabbage andgreen beans. The fact that the contract farming continues until todate, the contract farming can be considered a success. As ameasure of success, Simmons (2002) uses the persistence of contractualarrangements over time as one indicator. “Farmers, who do not opt outof contracts, indicate that the contract is successful”.

The experience of the FPG that backed out of the contract after afew success demonstrates two important lessons: (a) the earliercontract farming agreement paved the way for the FPG to acquire thebasic technology and afforded them sufficient cash to manageproduction cum-marketing of water melon; and (b) with FPG doing bythemselves, they get better profits than with contracting. Thecontract farming served as the transition mode to sharpen theentrepreneurial skills of the members of the FPG. Contract farmingper se was not bad at all, even if it was discontinued. Thisexperience suggests that contract farming can never be a permanentrelationship but certainly can be a pathway to reach the objective ofincreasing farmers’ income.

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In another incident, farmers in Nam Tin and Nam Haad were nothappy with their contract farming (with domestic trader) growingsoybean and peanut, respectively. The farmers claimed they lose andwere in fact indebted as a result of the contract. This remark mayhave to be qualified. Indebtedness was the outcome of poor production.Farmers were not able to pay the cost of inputs provided by thedomestic trader. In the case of peanut, however, the traderinterviewed gave compensation for production losses by allowing thefarmers to plant peanut for the second time. In the soybean,meanwhile, it was improper cultivation that resulted in low yield. Itwas not clear whether the trader gave extension advice because thefarmer had already acquired the knowledge of soybean production from anon-government organization (NGO) that introduced the crop in thevillage.

The experiences described above reveal that success and failureare inevitable in contract farming. Simmons (2002) attributed theelements determining the success or failure of contract farming as:(a) strong markets, (b) macro institutional policies, (c)sophisticated technology, and (d) land ownership. Offhand, theseelements offer validity. For instance, strong market demand couldundeniably be one of the reasons why Chinese investors are still incontract farming, the same reason that the FPG in Bountai districtcompete and trade directly with the border in China. Macro and localinstitutional policies are equally important, which will be discussedin the succeeding section, as it sets the investment and businessclimate, an important consideration for both investors and smallfarmers especially in the context of multiplier effects.Sophisticated technology could be a sine qua non for specializedcommodities, those that are destined for special niche market. Atypical example is the growing of hybrid rice or organic rice as thelatter is by no means simple, especially in quality standards. Landownership is a basic resource endowment, one criterion being used byinvestors to select the farmers’ participant, as indicated in Table 4.It should never be construed, however, that those farmers who arelandless have no chance to participate in contract farming. Jobcreation is one of the multiplier effects of contract farming. Excesslabour, including the landless in the rural areas could likely beabsorbed in the labour market as a result of the deepening of thesupply/value chain brought about contract farming.

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V Policies

5.1 National

5.1.1 Private Investment

The legal and regulatory framework is embodied in the amended Law(2004) on the Promotion of Foreign Investment. The basic elements ofthe policy as espoused in the Sixth National Social EconomicDevelopment Plan (NSEDP) are well defined, as follows: (a) accelerateinvestment procedures, (b) develop technically educated workforce, and(c) review regulations on investment permits (e.g. land acquisition,fees, transport). However, there seems to be an observed perceptionabout the restrictive and complex laws governing business (procedural)in the country. One indicator is the time needed to complete thedocumentation, estimated to be about 93 days (World Bank), comparedwith the regional average (East Asia & Pacific) of 37 days.Certainly, this affects the competitiveness of the country to attractprivate investment whether big or small; and the burden may be feltnoticeably on small to medium contract farming investors workingwith smallholder farmers.

The relative ease of doing business in any country is beingsurveyed annually by the World Bank.13 Lao PDR ranked 165 in the WorldBank survey (Doing Business) conducted in 2012. This rank weakenedcompared with the rank (163) it received in 2011. Comparison with theother countries in the region may be seen Table 5 below to appreciatethe relative ease of doing business.

Table 5 Doing Business, Ranking of Countries

Country Rank 2012Thailand 17Malaysia 18

13 The World Bank survey on Doing Business “provides an aggregate ranking on the ease of doingbusiness based on indicator sets that measure and benchmark regulations applying to domestic andsmall to medium-size businesses through their life cycle. Economies are ranked from 1 to 183 bythe ease of doing business base on an index covering 10 topics: dealing with constructionpermits, getting electricity, registering property, getting credit, protecting investors, payingtaxes, trading across borders, enforcing contracts and resolving insolvency”.

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Regional average (East Asia & Pacific) 86Vietnam 98Indonesia 129Philippines 136Lao PDR 165Timor-Leste 168 Source: Doing Business, World Bank

A further appreciation of the ranking of Lao PDR may be gleanedon Figure 1. The score on each of the topics covered is given. LaoPDR performed rather poor on the following topics: resolvinginsolvency (183), protecting investors (182), trading across borders(168), getting credit (166), getting electricity (138), paying taxes(123) and enforcing contracts (110). Topics that scored fairly,although still low by standards are: registering property (72),dealing with construction permits (80), and starting a business (89).

The finding above will certainly stifle the competitiveness ofdomestic and export-oriented businesses under contract farming. Thepolitical will to improve the business climate is timely andessential, otherwise the country will be left out in the region interms of attracting investments, especially FDI.

Figure 1 How Lao PDR ranks on doing business topics

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Source: World Bank, Doing Business 2012

5.1.2 Agriculture Sector

The sector policies enumerated in Annex 1 include: marketorientation, participation and human resource development,diversification, technology transfer and sustainability. The basicelements under market orientation which is closely linked to thepromotion of contract farming are consistent with the principles offree market regime. Participation and human resource developmentaddressed to the small farmers by way of vocational and on-the-jobtraining is likewise consistent with the principle of improving themanagerial skills of farmers, a critical element in concludingsuccessful contract with traders, millers and other investors.Diversification facilitates the minimization of risks associated withcrop failures. One of the elements being espoused is the growing ofcrops based on comparative advantage, again a fundamentally soundprinciple. Technology transfer calls for NAFRI and NAFES to work intandem with the small farmers in providing demand-driven technologyand extension. Sustainability espouses farming systems that are notdetrimental to agriculture and natural resources (ANR). This policythus encourages organic agriculture, a strategy that is gaining globalacceptance and fits well in the context of special niche market (e.g.organic rice and tea).

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All told, the national agriculture sector policies arefundamentally sound. Notwithstanding, the agriculture sector is stillbeleaguered by low intensity and low productivity (SAD). Reasonsbeing cited include: rural households risk aversion, limited number ofinput suppliers, lack of information concerning input use, inadequateworking capital and access to credit and financial services; andlimited access to markets due to physical barriers, poor roads, hightransport cost, poor logistics and marketing system dominated bytrader constraining downstream movement to the next link in themarketing system.

Contingent on how these policies are being implemented at thelocal level, most of the issues can be overcome by contract farming.The next section will look at the policy principles being carried bythe PAFO/DAFO and determine the congruency between nationalpronouncement and implementation at the local level.

5.1.3 Food Security

Improved “household food security” is a primary goal of theagriculture sector. Food security as described in the NGPES is “poorhouseholds must first and foremost secure their food supply”. Foodsecured households, especially in the rural areas and in thedefinition of GOL, is often equated with enough volume of rice to keepa family free from starvation throughout the year. The target is setat about 400-500 kg/capita/year or 3.3 million tons of paddy rice by2010 (SAD, 2011). The other indicator is increased production ofmeat, fish and other fresh products estimated at 40-50 kg/capita/year.Rice as a basic food staple, is foreseen to be produced at least on100% self-sufficiency level or in the broader context, every householdmust be self-reliant. Food self-sufficiency appears to be the mainpolicy to achieve food security.

There are limitations of relying on food self-sufficiency. In adominant rice-based agriculture, the shifting to other cash crops maybe derailed. Food self-sufficiency in rice, for instance, implies thegrowing of rice at a cost that may not guarantee any financialadvantage, the consequence of which is low or virtually no income forsmall farmers. Although this policy has achieved generally foodavailability through increased rice production, this has been “at a

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high cost and depended on great investments on irrigation andpostponed the growing of other high value crops” (SAD, 2011).Further, the current policy appears to have missed the otherdimensions of food security in the context of FAO definition, notablyfood access and utilization. Food access means generating cash income(besides increased production), and in a rice-based agriculture,shifts to higher value crops could be equally undertaken as a paralleloption to fulfil rice requirement via the increased income obtainedfrom growing other crops, besides rice.

The time may now be appropriate for GOL to rethink whether foodself-sufficiency should be unilaterally applied across all thecountry. The 2006 Comprehensive Food Security and VulnerabilityAnalysis (CFSVA) indicates that 70% of the food insecure householdsare only found in 7 provinces, and these provinces constitute only 31%of the country’s total population, mostly of the ethnic groupsresiding in the highlands.14 Given this situation, other high valuecrops for irrigated lowland where the households are not consideredfood insecure may as well be promoted to achieve increased farmincomes for smallholder farmers.

5.2 Local Government (NRI Provinces, Districts and Villages)

Through KIIs and FPGs with concerned PAFO/DAO executives, twocategories of policies have been observed: regulatory (e.g. permit),and local agriculture policies that affect contract farming.Regulatory is akin to getting the necessary permits and clearances tooperate contract farming ventures with smallholders’ farmers,including the transport of the product to its final destination. In abroader perspective, the relative ease of getting these permits isindicative of the friendliness of the local business environment.The agriculture policies stem from the national agriculture sectorpolicies. On both categories, the local governments have greatlatitude of interpreting and/or applying the policies, laws andregulations. This is inherent of the autonomous structure (fiscaland administrative) of the local government.

5.2.1 Regulatory

14 These provinces include: Saravane, Sekong, Oudomxay, Bokeo, Luang Prabang,Huaphanh and Xiengkhuang.

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Offices at the province and district have the same counterpartsat the national level. Getting the required permits to start acontract farming are very much akin to the activities at the nationallevel. If there were 10 topics as depicted by the World Bank study,the common activities that may be relevant at the province or districtwill be a minimum of 3 to a maximum of 7 depending on the nature ofthe contract farming investor. A plain Chinese and/or local traderwill probably comply with only 3 activities, while a food manufactureror miller will have to go through a longer route, as depicted in Table6.

Table 6 Activities in Complying with Business Permits, Contract Farming

Activities1 Food manufacturer/ricemiller

Trader

Starting contract farming Dealing with PAFO/DAFO/village Paying taxes Getting electricity Dealing with construction permits Registering property Enforcing contracts 1Adopted from the World Bank Study on Doing Business

The procedure for getting the required permits/licenses is

perceived to be time consuming based on the KII and FGD withinvestors. It may not be as complicated as the national but certainlythere are economic costs of lengthy procedures. Instead ofencouraging investors to register, they may shy away from registrationor simply circumvent the law15. Some Chinese traders avoid the lengthyprocedures by delegating the role to local people and the Chinesetraders act only as financiers of contract farming. In so doing, thelocal governments missed a number of opportunities. The more costlyeconomic implications are increasing transaction cost and rent seekingamong government personnel. The transaction cost of investors willlikely be on the high side and recovery of this cost is passed on tothe smallholder farmers by way of low farm gate prices. Rent seekingbehaviour among government personnel is encouraged and thus whatever

15 Empirical studies have noted the positive relationship between complicatedprocedures and number of business registered. In Mexico, simplified municipallicensing has increased the number of business registered by 5%. Similarly in India,eliminating licenses led to 6% increase in the number of registered firms.

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revenues that are supposed to be collected and remitted to governmentcoffers are undervalued. There are efforts to streamline theprocedures in the provinces. A good example is the one-stop-shopservice centre at the District Governor’s Office in Sing district. Thecentre houses staffs from all departments concerned. However, thiscentre facilitates only the payment and processing of fees and taxesrelated to trade matters. While the scope of services is limited,certainly the services can be expanded and can be a model (withexpanded functions) that is worthy of replication to other districts.

Dealing with the PAFO and DAFO is one activity that can beimproved within the purview of NRI project and thus facilitatesapproval of business proposal for contract farming. The PAFOcurrently approves the business proposal. The DAFO meanwhile is atthe centre of contract farming promotion as regards availability ofbasic information (village sites, number of smallholders, cropsplanted, resource endowments, etc.) However, these information are notreadily available. The investors wanting to venture into contractfarming, and accompanied by the DAFO, do the collection of theinformation at the village. The DAFO’s role is limited to introducingthe investor to the village authority. The DAFO could be responsiveby providing the production (e.g. crop profile, technology support)and market information (e.g. markets, farm gate/border prices,transport cost, etc.) that are both useful to investors andsmallholder farmers, as basis for making business proposal anddecision-making. The availability of information for both investorsand smallholder farmers could level the “playing field” (i.e.avoidance of asymmetry of information) and better options for bothparties. The information could be used by the DAFO as the startingpoint for market matching between smallholders and potentialinvestors.

5.2.2 Agriculture

Described below are the agriculture policies being currentlyimplemented by the PAFO/DAFO:

(1) Buying zone – The buying zone policy is being implemented(confirmed in Phongsaly, Bokeo and Luang Namtha) by the PAFO toprotect investors that executed buying agreement with the DAFO.The enforcement of this policy appears to have been engaged withinfraction. Other traders have reportedly been intruding on

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areas designated as buying zones and smallholder farmers were noteither prevented from selling their products (e.g. tea) to thesetraders. Overall, it appears to be ineffective for both contractgrowers and smallholder farmers. This policy also restrictsfreer competition to the detriment of the smallholder farmers ingetting fair and better prices.

(2) Rice export quota – PAFO restricts the volume of rice thatcan be traded, especially on areas where domestic supply of riceis insufficient (e.g. Bokeo). This policy appears to havestemmed from the rice self-sufficiency, where households arefirst and foremost obliged to secure their rice needs. The meritof this policy, although initially sound, must be looked in thecontext of available rice supplies. In areas where ricesurpluses are high, the restriction may have to be reviewed.Cases in NRI subprojects where rice surpluses are high includeHouay Xo (59%), and Nam Tin (24%).

(3) Minimum price setting – PAFO has a minimum price set forcommodities that are under contract growing (e.g. tea). Thispolicy is primarily for price stabilization, but its enforcementmay be constrained unless there is a budget for buying andeffective monitoring. If the intent is to protect undue pricesreceived by farmers, the PAFO must have a budget to resort forbuying when conditions are unfavourable to smallholder farmers.Second, no one from the PAFO/DAFO monitors the prices of basiccommodities and thus infractions are never known. Overall, thispolicy is useless.

(4) Tax free importation of fertilizers and other farm inputs –PAFO grants tax free importation of fertilizers and other inputsfor crops under contract growing. The objective of the policy isto reduce production cost. In the absence of strict monitoringon the use of the inputs, however, the policy may be abused,especially if the inputs are being diverted for other purposes.

(5) Promotion of organic agriculture – Organic agriculture is

being supported by the PAFO. This is sound and consistent withthe principle of agro-ecology. Through this policy, theprovinces can create niche market for special crops (e.g. riceand tea) that could improve the competitiveness of thesecommodities locally and globally.

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(6) Crop restrictions on lowland irrigated – The policy to limitthe cultivation of rice to lowland irrigated stems from theprinciple of rice self-sufficiency. Crop diversification, ingeneral, specifically higher value crops (HVC) may thus bedifficult to promote in the context of this policy. Maximizingfarm incomes is completely negated by this policy.

Among the policies described above, the promotion of organicagriculture (item 5) stands out to be consistent with the promotion ofsustainable agriculture. Tax free importation of farm inputs (item 4)can be a valid tool to reduce production cost in the short-term,especially for basic food staple. However, its’ continued use may beprone for abuse and thus, its basic purpose is defeated. All otherpolicies are considered distortions in the promotion of market-oriented agriculture. In the context of contract farming, thesepolicies are seen as deterrents and restrictive. While the localgovernment may have valid justification to enforce these policies,especially in the short term, the opportunity to review them incoordination with MAF is now proper in light of the overall policy toremove distortions in the agriculture sector. A summary of the likelyimpact of these policies on contract farming is shown below.

Table 7 Likely Impact of Local Government Agriculture Policies on ContractFarming

Policy Province Likely Impact on ContractFarming

Remarks

Buying zone Phongsaly, Luang Nam ThaBokeo

The policy promotes buyer-driven bargaining power inthe context of the value chain and prevents freer competition leading to monopolistic tendencies tothe detriment of smallholder farmers. Smallfarmer have few options tosell their product.

Not workingeffectively and canbe eliminated

Rice export quota

Bokeo Prevents maximization of farm income

Can be lifted onrice surplusproduction areas.Review of these

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surplus areas mayhave to be made asbasis for lifting

Minimum price Phongsaly Not essential Can be eliminatedTax free importation of inputs

Luang Nam Tha Good as long as it is intended for farmers use

Requires effective monitoring

Organic agriculture

Phongsaly, Luang Nam Tha

Good Should be promotedand continued

Crops restriction on lowland irrigated

Luang Nam Tha Prevents maximization of farm income

Decision to producebest crop mixshould be left tothe smallholderfarmers

VI Conclusions and Policy Recommendations

6.1 Overall Findings and Recommendations

6.1.1 On Contract Farming Practices

1. Formality in contract is not a sine qua non of higher profit in contract farming. Formality is defined as having writtenand/or signed agreement vis-à-vis verbal or oral agreement.The study conducted in Lao PDR revealed that written and/orsigned agreement did not give any financial advantage tosmallholder farmers who ventured into cabbage, maize andsugarcane contract farming. Smallholder farmers who hadverbal or oral agreement had higher profit compared with thesmallholder farmers who had written and/or signed agreement.The significance of this finding is that formal contractshould never be imposed as a matter of policy. The decisionto use formal or informal agreement should be left to thecontracting parties, so long as the agreement is based ontrust and goodwill16. However, written contract should neverbe construed as useless. Written contracts “can benefit bothparties by clearly specifying out the rules of therelationships”.

16 Verbal or oral contract is very common in Lao PDR because of the low adult literacyamong smallholder farmers, an observation found in most of the NRI sub-project sites.

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2. Contract farming using organic agriculture is meritorious .Contract farming in rice using organic agriculture has beenfound to be more profitable compared with independent farmers(non-contract) using the conventional technology (i.e. highsynthetic input-based). This finding suggests that organicagriculture through contract farming is a viable option forincreasing small farmers’ income. The finding reinforces thepolicy of the government to support organic agriculture,especially for Lao indigenous crops such as rice and tea.

3. Success in contract farming implementation is associated with contract renewals (i.e. repeat contract). Small farmers who donot opt out from contract farming are said to be successful.These groups of small farmers are believed to be satisfiedwith the profit they get from contract farming. If there areareas of intervention where the value chain could be deepened,these groups may offer the best potential area because oftheir existing knowledge and skills.

4. Contract farming investors’ shares in production risk. Casesof these investors exist (in the NRI project sites) and oughtto be encouraged by way of facilitative support from the localgovernment. Production risk sharing promotes healthyrelationship with the smallholder farmers and could furthersharpen the entrepreneurial skills of the smallholder farmers.

6.1.2 On Contract Farming Model

1. The “guaranteed price contract” model is working . The“guaranteed price contract” model of contract farming in NRIproject appears beneficial to smallholder farmers. Althoughthe success of this model may require a deeper study, (e.g.with some farmers reporting lower profit), it neverthelessassured the small farmers of modest farm income, which couldnot have otherwise realized if they opted for independentproduction. In general, the term 2+3 in Lao PDR could beexpanded by way of the “guaranteed price contract” variant.

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6.1.3 On Policy Principles

1. The national agriculture policies are generally well defined to promote contract faming. Offhand, and although there issome misconception on the interpretation of the food securitypolicy, the policies are generally supportive for a favourableenvironment for contract farming. The success of contractfarming especially for smallholder farmers will, however,greatly hinge on the effective implementation of thesepolicies. There is divergence between policy pronouncement andimplementation, the latter of which has not been dealt withextensively in the paper.

However, at the local government level (i.e. NRI projectsites), the agriculture policies (with the exception of thepromotion of organic agriculture) are considered as“distortions” for an open and free market regime. The effectsof these policies are not yet felt at the moment, but sooneror later the restrictive nature of these policies will notmake contract farming a viable option for poverty reduction.The objective of increasing farmers’ income will not beachieved in an environment of increased production cost forsmallholder farmers’ and higher transaction costs for contractfarming investors.

2. The burdensome regulatory procedures are inherent in the complex laws. The World Bank Study on “Doing Business” is thebest objective testament to this finding. Only the politicalwill of GOL to speed up the reform process is the key to thesecumbersome procedures. And in view of the GOL’s desire tobecome a member of the World Trade Organization (WTO) and toexit from the least developed country (LDC status) by 2015,it is likely inevitable that the process will be accelerated.

The local government generally apply rules and regulations,oftentimes subject to their own interpretation, by virtue oftheir administrative and financial autonomy. Most localgovernment are not aware of the disadvantages of thesecomplicated procedures, but there are efforts, to streamlinethe procedures through the one-stop- shop service centre beingpromoted in the District Governor’s Office in Sing District.

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While the function of this centre is limited in the processingof fees and taxes, they should be encouraged and supported aswell in other offices. Certainly the concept can promote afriendly business climate.

3. The practice of informal cross border negotiation (a practicebeing resorted by FPG in Nam Lan sub-project) appearssuccessful. Although, there are policy implications of thispractice, especially in terms of whether the FPG are gettingthe better deal of the arrangement, they should be continuedand ought to be supported by ensuring that the FPG are skilledin negotiation/contracting. But this is easier said than done,because the FPG represents a minor group that does not havecontrol over the dominant and well-resourced Chinese tradersat the border. For the time being, the FPG should have a goodaccess to market information to improve their bargainingposition.

6.2 Recommendations

6.2.1 On Contract farming Practices

1. Beneficial contract farming practices. Beneficial contractfarming practices described and mentioned in the overallfinding should be supported and encouraged. Existing contractfarming arrangement on NRI sub-project sites should be allowedto continue and NRI need not intervene on these existingarrangements.

6.2.2 On Contract Farming Model

1. “Guaranteed Price contract”. This contract farming model as avariant of the term 2+3 should be encouraged. There may beimperfections, and should be corrected through dialogue andnegotiations. Such dialogue should be initiated by thePAFO/DAFO.

6.2.3 On Policy Principles

1. Policy Implementation. For the time being, the analysis ofagriculture policies considered deterrent to contract farming,especially at the local government should be a basis for

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advocacy to change. Advice to the local government to modifythe deterring policies should be initiated by the MAF throughconsensus building.

2. Regulatory and Administrative Procedures. The current reformsbeing undertaken by the GOL are steps to streamline thetedious documentation procedures. The local government canalso take the cue from this on-going reform. In due time,these on-going reforms are expected to be accelerated due tothe anticipated accession of GOL to the World TradeOrganization (WTO) by end 2012 and possible exit from theleast developed country status by 2015. The resolution ofthese procedural flaws which cuts across several sectors,including those at the local government should be initiated byexisting sectoral committees established to tackle suchissues.

6.2.4 In the Overall Context of NRI Implementation

The paper acknowledges its limitation for the scanty primary data(i.e. numerical) being used in the analysis. Notwithstanding, thepaper has documented, among others, salient features of contractfarming investors, successful parameters for contract farming, andpolicy principles that ought to be promoted, all of which exist or arebeing practiced in most of the NRI sub-project sites. These sets ofinformation serve the boundaries where NRI project could usefullyintervene in the promotion of contract farming as follows:

1. NRI need not intervene on existing contract farmingarrangement, whether formal and informal. These contractfarming arrangements are believed to be profitable and havebeen concluded purely on economic grounds.

2. NRI should focus its support on the dropout or beginnercontract smallholder farmers who are staying in villagescovered by NRI sub-project sites and are willing to renewinterest in contract farming. As a matter of strategy, NRIshould concentrate on contract farming mainly for niche

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market on a pilot scale17. The following sub-project sites arerecommended for implementation:

Sub-project site Technology CommodityMong Chao Organic TeaNam Tin Organic/SRI

OrganicRiceSoybean

Nam Haad Organic Peanut

The decision to select the above sub-project sites were basedon: widespread use of organic technology by smallholderfarmers, existence of village organic fertilizer plant, PAFO’ssupport for the promotion of organic technology, and existenceof potential contract farming investors who are supportive oforganic technology. While NRI supports this contract farmingactivity, the decision is purely based on economic andtechnical realities and the final choice should be made by thesmallholder farmers.

3. NRI through the PAFO/DAFO should only facilitate thepromotion of contract farming on pure economic and technicalconcerns and not as a development model based on politicaland social considerations. The PAFO/DAFO is at the centreof contract farming notwithstanding the complex proceduresof getting the permits and licenses to start contractfarming. In this regard, NRI should focus the capabilitybuilding for the PAFO/DAFO on fostering stronger linksbetween smallholder farmers and contract farming investorsthrough: (a) the DAFO as the focal link of initiating thepartnership between smallholder farmers and contract farminginvestor through initiation of say farmer-management forum;(b) the DAFO as the focal centre to promote good agriculturepractice (GAP) technologies, notably environment friendlytechnologies, such as use of organic farming and integratedpest management (IPM); and (c) the DAFO jointly with thevillage as the forum to resolve disputes arising from

17 Niche market involves a distinct market segment. For instance, commodities usingorganic technology are preferred by customers who are conscious about the deleteriouseffects of conventional mode of production (e.g. high synthetic-based inputs). Thispaper, through an empirical study, recommended for GOL to take the lessons fromThailand about the profitability of growing organic rice. The study remarked that Lao

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contracts. Certainly this requires honing the skills ofboth the PAFO/DAFO and the farmers.18

PDR has the comparative advantage of producing organic rice because of favourableenvironment (e.g. physical, social, etc.).18 A separate parallel paper is drafted on the capacity building approach toactualize the capacity improvement program that would improve the link of thesmallholder farmers to markets.

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Annex 1 Policy Matrix Governing Contract Farming

Policy Sixth National SocialEconomic DevelopmentPlan (NSEDP) 2006-2010)

National Growth and Poverty Eradication Strategy (NGPES)Strategy for Agricultural Development (2011-2020)

Legal and Regulatory Framework

1. Private Sector Investment

Accelerateinvestmentprocedures

Developtechnicallyeducated workforce

Reviewregulations oninvestmentpermits (e.g.land acquisitionfees, transport,telecommunication

Law on thePromotion of ForeignInvestment(2004)

2. Agriculture Market

Orientation

Removal of distortion for agribusiness development in thefunctioning of factor markets such as subsidized credits, andfertilizer, clarification of laws and regulations (e.g. licensing)to reduce impediments and transaction difficulties experienced bythe private sector

Increased credit availability through strengthened AgriculturePromotion Bank and other financial institutions; structured loan tomeet farmers’ needs and facilitate micro-finance

Facilitation of land occupancy entitlement, land tenure, titlingand village management

Training of MAF staff at all levels in principles of market-basedagricultural system

Strengthening the ability of communities to compete in local andregional markets including through the establishment of marketinformation system

Support for establishment of agro-processing by private sector andfarmers’ group

Trade facilitation and regional economic integration; expand theCommon Effective Preferential Tariff Inclusion List

Formalising cross border trade flows

Law on Water and Water Resources

Land Law Agricultur

e Law Environmen

tal ProtectionLaw

Participatio Fully decentralized “bottom-up” planning

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n and Human Resource Development

Strengthen capacity of communities to participate in developmentplanning and to take responsibility in for natural resourcesmanagement

Extend and improve the quality of the school system, as aninvestment in upgrading the skills of farmers and their ability toparticipate effectively in community interest

Extend and improve the informal education system, to improveliteracy in rural areas especially in the poorest districts

Introduce farmer vocational training and on-the-job training,particularly in the poorest districts

Support women’s groups to participate in the review of training andextension services

Train provincial and district agricultural personnel in planning,monitoring, evaluation, project formulation and implementation

Review of the Land-Forest Allocation Programme to make it moreparticipatory and community-led, by the following measures:

Technical assistance to improve land allocation process Develop capacity at provincial, and district levels to

better address land allocation Undertake periodic reviews of allocation procedures

concerning NBCAs Promote community-based irrigation plans and farmers’ organization Regarding integrated watershed management and transformation of

lowlands the responsibilities are: Provincial Level:

Ranking of watershed Strategic development options

Priorities for sub-watershed Diversificat

ion Strengthen multi-sector approach to reduce shifting agriculture Indicative planning based on comparative advantage and rural socio-

economic indicators Assist shifting cultivation farmers to become successful sedentary

farmers Assist poppy growers to develop alternative livelihoods Strengthen and extend irrigation system to sloping and lowland

areas Design and implement pilot groundwater irrigation schemes Promote seed multiplication nurseries Strengthen the animal health control system and livestock extension

system Introduce a meat inspection system

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Provide technical assistance to private sector for animalimprovement and breeding

Establish participatory extension systems to promote inlandfisheries

Promote private sector participation in plantation forestry andagro forestry

Promote cultivation of NTFPs Technology

Transfer Develop an integrated extension system to transfer agricultural

production technologies to the poor people and upgrade the capacityof NAFES in extension, particularly for upland areas

Ensure that research (NAFRI) and extension are demand-driven Extension programme for adaptive research and demonstrations on

farmers’ fields Introduce basic post-harvest handling and processing methods to

farm families and communities Develop area-based applied technology and agro-zoning Develop suitable technologies for overall improvement in livestock

production Develop applicable technology for inland fisheries, including pond

management and feeding. Also develop improved varieties of fish Sustainabili

ty Raise awareness of government officials and farmers regarding need

for sustainable practices Strengthen the capacity of provincial and district offices to

undertake natural resource planning and management Education and training in modern agricultural technology and in

local farming techniques and knowledge Promote farming systems that are best suited to soil and hydraulic

structures to prevent degradation and minimize siltation and runoff Prevent encroachment, illegal activities and bio-diversity

degradation in NBCAs by law enforcement, capacity building, andvillage participation in conservation

Control unsustainable harvesting and exporting of NTFPs Map flood risk areas and strengthen and extend flood control

structures Identify and conserve local aquatic resources

3. Food security Food self-sufficiency and/or self-reliance for every household toprevent food insecurity

Source of Basic Data: Sixth National Social Economic Development Plan, 2006 National Growth and Poverty Eradication Strategy

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Strategy for Agricultural Development, 2011

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REFERENCES

(http://www.fao.org/ag/ags/contract-farming/en/

Asian Development Bank. Small Holder Development Project

Berdegue, J.A., E. Bienabe and L. Peppelenbos. 2008. Innovative Practice In Connecting Small-Scale Producers with Dynamic Markets, www.regoverningmarkets.org

Contract Farming and Plantations. www.laofab.org

Coulter, J., A. Goodland, A. Tallontire and R. Stringfellow, ODINarural Resource Perpectives Number 48, 199,http://www.odi.org.uk/nrp/48.pdf

Fullbrook, D. 2007. Contract Farming in Lao PDR: Cases and Questions, Laos Extension Agriculture Project (LEAP) for the Government –Donor Sub-working Group on Farmers and Agribusiness

Glover, D and LT. Ghee. 1992 ‘Contract Farming in South East Asia,Three Country Studies’, Institut Pengajian Tinggi/Institute for Advanced Studies/Universiti Malaya/University of Malaya, Kuala Lumpur

H. Baumüller and Lazarus, K. Agribusiness Investments in Laos: Risksand Opportunities in Poverty Alleviation, OXFAM Hong Kong Workshop,Power Point Presentation, December 14, 2011

http://data.worldbank.org/country/lao-pdr

Millennium Development Goal, Lao PDR

Law on Land, Lao PDR

Law on the Promotion of Foreign Investment, Lao PDR. 2004

Manorom, K., D. Hall, X. Lu, S. Katima, M.T. Medialdia, S. Siharathand P. Srisuphan. 2011. Cross-Border Contract Farming Arrangement:Variations and Implications in the Lao People’s Democratic Republic,Research Report Series, Greater Mekong Subregion-Phnom Penh Plan forDevelopment Management, Volume 1, Issue No.2

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National Growth and Poverty Eradication Strategy

Setboonsarng, S., P. Leung and J. Cai. 2006. Contract Farming andPoverty Reduction: the Case of Organic Rice Contract Farming inThailand,’ ADB Institute Discussion Paper No. 49

Simmons, P. 2002. Contract Farming Overview, University of NewEngland http://www.ruralfinance.org/servlet/

Singh, S., (2006) ‘Leveraging Contract Farming for Improving SupplyChain Efficiency in India: Some Innovative and Successful Models,’Centre for Management in Agriculture, Indian Institute for Management

Sixth National Socio Economic Development Plan, 2006

Strategy for Agricultural Development 2020, Ministry ofAgriculture and Food

Vientiane Times, April 10, 2012. The contract is under Ayeyawady-Chao-Praya Mekong Economic Cooperation Strategy

World Bank, Doing Business 2012

World Food Programme, Food Security Situation in Lao PDR, 2006.

Zola, T. 2009. A Preliminary Assessment of Contract Farming Arrangements and Plantations in Agriculture and Natural Resources Sector of Southern Lao, PDR, Vientiane: Asian Development Bank

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