The economics of contracts in the US and Israel agricultures

Abstract

Research Objectives 1) Reviewing the rich economic literature on contracting and agricultural contracting; 2) Conducting a descriptive comparative study of actual contracting patterns in the U.S. and Israeli agricultural sectors; 3) Theoretical analysis of division of assets ownership, authority allocation and incentives in agricultural production contracts; 4) Theoretical analysis of strategic noncompetitive choice of agricultural production and marketing contracts, 5) Empirical studies of contracting in agricultural sectors of US and Israel, among them the broiler industry, the citrus industry and sugar beet sector. Background Recent decades have witnessed a world-wide increase in the use of agricultural contracts. In both the U.S. and Israel, contracts have become an integral part of production and marketing of many crops, fruits, vegetables and livestock commodities. The increased use of agricultural contracts raises a number of important economic policy questions regarding the optimal design of contracts and their determinants. Even though economists have made a substantial progress in understanding these issues, the theory of contracts and an empirical methodology to analyze contracts are still evolving. Moreover, there is an enormous need for empirical research of contractual relationships. Conclusions In both U.S. and Israel, contracts have become an integral part of production and marketing of many agricultural commodities. In the U.S. more than 40% of the value of agricultural production occurred under either marketing or production contracts. The use of agricultural contracts in Israel is also ubiquitous and reaches close to 60% of the value of agricultural production. In Israel we have found strategic considerations to play a dominant role in the choice of agricultural contracts and may lead to noncompetitive conduct and reduced welfare. In particular, the driving force, leading to consignment based contracts is the strategic effect. Moreover, an increase in the number of contractors will lead to changes in the terms of the contract, an increased competition and payment to farmers and economic surplus. We found that while large integrations lead to more efficient production, they also exploit local monopsonistic power. For the U.S, we have studied in more detail the choice of contract type and factors that affect contracts such as the level of informational asymmetry, the authority structure, and the available quality measurement technology. We have found that assets ownership and decision rights are complements of high-powered incentives. We have also found that the optimal allocation of decision rights, asset ownership and incentives is influenced by: variance of systemic and idiosyncratic shocks, importance (variance) of the parties’ private information, parameters of the production technology, the extent of competition in the upstream and downstream industries. Implications The primary implication of this project is that the use of agricultural production and marketing contracts is growing in both the US and Israeli agricultural sectors, while many important economic policy questions are still open and require further theoretical and empirical research. Moreover, actual contracts that are prevailing in various agricultural sectors seems to be less than optimal and, hence, additional efforts are required to transfer the huge academic know-how in this area to the practitioners. We also found evidence for exploitation of market powers by contactors in various agricultural sectors. This may call for government regulations in the anti-trust area. Another important implication of this project is that in addition to explicit contracts economic outcomes resulting from the interactions between growers and agricultural intermediaries depend on a number of other factors including allocation of decision and ownership rights and implicit contracting. We have developed models to study the interactions between explicit contracts, decision rights, ownership structure, and implicit contracts. These models have been applied to study contractual arrangements in California agriculture and the North American sugarbeet industry.