Blog Competition on Suitable Finance for Agricultural Households
– By Ben Rump, Centre for Innovative Financial Design
The Centre for Innovative Financial Design (CIFD) recently entered the survey stage of a research project concentrating on the welfare of India’s sugarcane farmers. Sugarcane is one of the biggest cash crops in India and, because it is supplied by a large number of small farmers, the efficiency of the market has important consequences for the country’s rural poor. The focus of the study is on the relationship between these small farmers and the large sugar mills that purchase and process the raw sugarcane and, in particular, how this relationship is influenced by the ownership structure of the mills. There are reasons to suspect that privately-owned mills might behave differently towards sugarcane farmers than publicly-owned or cooperative mills and that these differences may affect the financial well-being of the farmers.
It’s often assumed that, because they’re disciplined by market pressures, private firms will adapt to run businesses more effectively than publicly-operated firms. Because it requires industrial investments in large mills and there exists a lag between the choice of quantity supplied at planting and quantity demanded at harvest, the sugarcane industry is a complex business in which mills must successfully coordinate supply with production capacity and harvest schedules with processing schedules. Aside from operating its factory smoothly, a mill can also ensure itself a ready supply of raw cane by extending loans or providing seeds and fertilizer to its farmers. Without exposure to competition and the incentive to maximize profits, public mills may not operate their factory smoothly or may not assist their farmers adequately, and either failure would cause sugarcane to be less profitable for India’s small farmers than it otherwise could be.
If this were the full story, one could readily conclude that private mills are preferable for the sugarcane industry. However, as is often the case, the reality is more nuanced. Like a poorly instituted public mill, a privately owned mill is not exposed to the competitive forces regularly assumed in introductory economics. This arises because of the previously mentioned large fixed investments required for sugarcane processing and the lag between planting and harvest, and also because sugarcane dries quickly after harvest and so must be processed immediately. Because of this structure, a private mill acts as a monopoly buyer at harvest and, theoretically, could “hold up” the small farmers by forcing them to sell at a price lower than what was expected at planting. This works as follows. When the cane is harvested, if the mill nearest a certain farmer demands a lower price, then there is little alternative for that farmer. It can’t sell it’s cane to a distant mill because the cane will dry and lose its value during transport. There are no other mills nearby because, in order for the investments in the large factories to be economical, mills cannot afford to share any nearby cane. Obviously, because factory construction takes time, no new mills can immediately sprout up to offer the farmers a higher price and steal market share from the incumbent mill. And so, since the cane has already been grown, and since there are many farmers with cane they’d rather sell cheap than leave to dry, our farmer is compelled to sell his cane at a discount.
However, this problem may never actually arise in practice; it may not be in the long-run best interest of a private mill to permanently sour its relationship with suppliers by holding them up in the short run. If they’re fleeced in one year, farmers may react by cautiously undersupplying cane in the next, making it more difficult for mills to maximize profits in the future.
Including the cooperative mills – the third type of ownership structure – in the analysis doesn’t change the conclusion: based on theoretical speculation alone, it’s impossible to determine which form of ownership structure is ideal for India’s sugarcane farmers. A case can be made for each, but a case can also be made against each. Therefore, the matter can only be settled by carefully observing and comparing the actual relationship between farmers and their mills, and this is the purpose of the study.
The relationship between the farmer and the mill is a complex one
The study takes advantage of the unique legal structure of Tamil Nadu’s sugarcane industry: for each mill, a “command area” is designated, and any farm within a mill’s command area is legally obligated to sell their cane to that mill. The study will focus on farm plots along the borders between private and public or cooperative mills, where factors such as climate and soil quality should be constant on both sides of the border, so any differences in output between plots should be traceable to differences between the mills themselves. Such farm plots have recently been identified and a sample has been randomly selected. Now, a survey team is being trained to question farmers about their sugarcane output and the relationship they have with their mills.
The project touches on a couple of economic questions and the project’s focus on rural Indian farmers introduces the chance to address an issue in line with the CIFD’s mission of helping India’s low-income households acquire access to financial services. As mentioned above, mills may supply loans, seeds, and fertilizer to the farmers that supply them. This is important, because these farmers may otherwise lack sufficient access to credit and so may be unable to make the necessary upfront investments required for cultivation. Although banks may be reluctant to lend to the farmers, a mill’s firsthand knowledge of the industry and regular interactions with its farmers reduces its monitoring costs and may make lending more economical, while a mill’s dependance on adequate supplies of cane may make lending more compelling. So while a productive mill will create the demand for a farmer’s sugarcane, financing from the mill may be necessary to create supply. A portion of the survey is devoted to financial assistance farmers receive from their mills, and, from this, it may emerge that one type of mill more readily provides credit for the benefit of Tamil Nadu’s sugarcane farmers.
