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The problem of low contract compliance rate in grain transactions in China.

INTRODUCTION

Contract farming has emerged between processors and farmers in China since the 1990s. The Chinese government encourages partnership between leading enterprises (LE), the big agricultural commodity processing firms and farmers who are producers of such commodities. With the goal of increasing farmers' income and improving agricultural productivity through agricultural industrialisation, the government has helped to establish and promote contract farming systems through a mutually benefiting mechanism between LEs and farmers.

However, the lack of contract compliance has become a serious problem, as the partnerships often break down because of defaults mostly from the farmers' side. Living and operating in the small-scale agricultural economy, Chinese farmers are unfamiliar with modern agricultural systems and do not take contracts seriously. When the market price rises above the contract price, farmers tend to sell their contracted commodities to the market instead of their partners (i.e., the LEs); when the market price falls below the contract price, farmers may sell so much of their produce to the LEs that it exceeds their actual farm output through buying from the market. As a result, the LEs take on all the risk and their interests are often harmed.

This situation not only has a negative impact on the development of contract farming in China but also may impact national food security when the low contract compliance situation occurs in the grain supply chain. The leading food firms, including state-owned and big private food processing and trade enterprises, play an important role in food processing and marketing in China. When the relationship between farmers and LEs breaks down, food production fluctuates, challenging the already fragile food security situation.

This article addresses the problem of low contract compliance, a problem that is not unique to China. (1) The objectives here are to find the actual causes for the low contract compliance rate in China's grain supply chain and to provide some feasible measurements to raise it. Grain processors in China can be categorised into two groups. One group is the LEs, which establish their grain production bases by signing purchase contracts with large numbers of farmers who have farmlands. The LEs often provide free high-quality seeds and technical services to contracted farmers for production. The other group is individual grain merchants (IGM), whose scale is small and who often use backward processing technologies. There are a large number of IGMs in China who do not use contracts but depend on open markets instead, in the sense that during harvest season, they go to farmers' homes to offer a price slightly higher than the LEs' contract price. IGMs are strong competition for the LEs.

LITERATURE REVIEW

Previous research has concentrated mainly on the issues of contract compliance in developing countries or transition economies. In a case study of Mexico, Runsten concludes that contract design, choice of the contract parties and risk of funding arrangements are important factors attributing to contract compliance. Gow, Streeter and Swinnen (2) analysed the "self-enforcing" arrangements or "internal" private enforcement mechanisms using Juhocukor a. s., a Slovakian sugar processor, as a case study of an agri-business in a transition economy to demonstrate that "internal" private contract enforcement mechanisms can have a significant positive effect on output and efficiency for contract parties operating in an environment characterised by the absence of or ineffective public enforcement of institutions. Based on analyses of contract farming globally, especially in developing countries, Eaton and Shepherd (3) found that the success of contract farming depends on many factors such as reasonable contract design, provision of education and services, adequate law provisions and enforcement, and accessibility to agriculture technology and infrastructure. Gow and Swinnen's (4) research on private enforcement capital and contract enforcement in transition economies showed that contracts can be made "self-enforcing" by designing contracts that result in private losses due to a breach of contract. If the losses outweigh the potential benefits, there is some form of "internal" private enforcement. Zylbersztajn's empirical analysis, (5) based on 1,532 farmers in northeast Brazil, indicates that the contract compliance rate of tomato production had a positive relationship to the scale of farm operation, but was negatively related to the distance between farms and open markets. In addition, contracts with flexible prices that responded to market conditions had lower compliance rates than fixed price contracts.

As for contract violation, Beckmann and Boger (6) conducted an empirical analysis of compliance among 306 hog producers in Poland. Their study showed that only 38.5 per cent of the hog producers would settle their contract in court if the other party had violated the contract. The reason was not court inefficiency but the high cost of contract compliance. Their research also proved that the relationship between producers and buyers, features of transaction and the existence of enforcement mechanisms other than legislative ones would have an effect on the parties' use of court. According to Tregurtha and Vink, (7) in terms of contract compliance, the trust relationship between agricultural producers and sellers in the rural areas of South Africa was more efficient than the legal system. Beckmann and Boger (8) investigated, theoretically and empirically, the role of courts in contract enforcement in transition agriculture. They concluded that (i) the farmers' responses can be explained by cost-benefit calculations regarding the use of courts; (ii) the legal "enforceability" of contracts depends not only on the efficiency of the legal system but also on the attributes of the transaction, contracts and the relationship between buyer and seller; and (iii) the threshold of taking legal action is significantly influenced by the indirect costs of court enforcement, such as disruption of a valuable business relationship, and the availability of alternative enforcement mechanisms. Haji (9) investigated the enforcement of traditional vegetable marketing contracts between producers and traders in Ethiopia using the general conceptual framework of contract enforcement extended to capture the payment at risk, and empirical results show that despite its imperfections, compliance with contractual obligations is mainly due to mutual trust and brokers' mediation. Moreover, results demonstrate the necessity of contractual arrangements that guarantee flexibility without exposing trading partners to the risks of opportunism. A separate analysis of contract enforceability through brokers reveals that the farmer's age, whether a buyer is a trader, information access and trader-specific investment have a significant positive impact while family size, frequency of transactions, dependency on the trader, duration of the relationship and distance to the trader have a significant negative impact.

Contract farming studies for Chinese agriculture, both descriptive and quantitative, have been conducted by Zhou and Cao, Tan, Liu, Yin, Zhao, Hu, Guo, Guo and Jolly, Yu et al., and Wang et al. (10) These studies investigated the causes of low contract compliance rates, explored the conditions for contract fulfilment, and provided suggestions to improve the contract compliance rate to stabilise the food supply chain and agricultural development. However, all of the above studies are for non-grain commodities or an aggregated concept of agricultural products; very few specialise in grain contracts, thus discussions on the important implications of national food security have been omitted. Another limitation of existing studies is that they failed to analyse the role of IGM, a unique player in the game revolving around grain production. The existence of IGM adds some complexity to the grain market and makes for a three-party game, which leads to different behaviours from the traditional twoparty games.

THE GRAIN MARKET SITUATION IN [C.sub.H]INA

Participants

China has experienced several phases of market-oriented reform in its grain circulation system. The grain market has been opening up since 2004. Now, the grain price is determined primarily by the market while the government imposes only minimal control policies and regulations. Due to the reform and merger of state-owned grain processing enterprises, there remain only a couple of leading food enterprises in each county while the IMGs have taken on an increasing market share. Thus, there are three main players in the grain market, the farmers, the LEs and the IGMs, and are all seeking to maximise their own benefits.

The Difference in Food Quality

With improved socio-economic conditions, Chinese consumers have paid greater attention to food hygiene and safety issues relating to the use of chemical fertilisers and pesticides. As a result, the government has adopted policies to encourage the production of "green" food and established a suite of quality certification systems for processed products produced by the LEs. Food products in the market are broadly categorised as common food products or high-quality food products. For high-quality food, stringent quality control applies throughout the supply chain from seed production, planting and cultivation in special fields, to the finished products sold in grocery stores with quality labels. The cost of high-quality food is thus much higher than that of common food products.

Open Market and Barriers

Although both LEs and IGMs can enter the food processing market freely, they do face certain regulatory barriers. The central government's Grain Circulation Administration introduced new regulations in 2004 and authorised provincial governments to set up administrative licensing for food market access. To engage in grain purchases, operators must have adequate funds, own or lease grain storage facilities and be able to conduct adequate quality testing.

Characteristics of the Different Market Participants

(i) Characteristics of the Farmers

Generally speaking, farmers tend to be opportunistic. To maximise their profits, they sell their grain to an IGM if the quoted price is above the contract price.

With government policy support, the LEs have established high-quality grain bases through recruitment of farmers with their land as grain producers. The LEs usually provide farmers with new, improved and high-quality seeds that they develop for free, as well as technical support, sending agricultural technicians to advise the farmers on cultivation methods. The LEs sign a purchase contract with the farmers, agreeing to buy the grain at a price 10 per cent higher than the minimum purchase price issued by the government (during the period of introducing new grain to the market, the government sets the minimum purchase price). Nevertheless, farmers focus on current profit-maximising and less on future losses. During the harvest season, IGMs approach farmers to purchase their grain and offer them a slightly higher price than the LEs. For their transaction with the IGMs, the farmers usually receive a few to a dozen yuan (equivalent to a few US dollars) more than they would in any transaction with the LEs (the traded quantity involved is about 500 to 1,000 kilogrammes of grain). This small price premium is a great incentive to farmers, and most of them betray their principles of honesty and integrity and default on their contract with the LEs to sell grain to the IGMs, despite receiving high-quality seeds and services from LEs for free. Such behaviour on the part of the small-scale farmers has existed for thousands of years in China. They are interested only in instant returns and benefits, not long-term interests. Unfortunately, they ultimately lose out. The LEs simply disqualify farmers who breach the contracts and bar them from future contracts. In consideration of the local investment environment, local government officials usually have greater concerns about the interests of investors and attempt to persuade the farmers to fulfil their contracts and not to sell their grain to the IGMs. However, the local government officials' persuasion does not constitute mandatory authority and thus has little effect. When a default happens, the officials prefer not to support the LEs in their lawsuits against the farmers, which causes widespread discontent. Instead, the officials persuade the LEs to empathise with the poor farmers. As a result, the contract compliance rate is very low.

(ii) Characteristics of the LEs

The strong economic foundation and research and development capacity of the LEs have stood them in good stead for being the dominant force in the grain processing market. To ensure high-quality grain production from the farmers, LEs invest heavily in establishing stable supply bases and constructing pollution-free and high-quality grain production bases. To ensure the accessibility of grains to farmers, LEs contract with the farmers in their bases, provide them with high-quality seeds and dispatch agricultural technicians to offer technical assistance. An LE is usually the better-informed and dominant party between the two parties in the contract, which therefore works in favour of the LE. Some LEs have developed into large-scale businesses, expanding in scope beyond the county, and even beyond the province.

(iii) Characteristics of the IGMs

IGMs came into the scene with the opening up of the grain market. The existence of IGMs breaks up the monopolies of LEs and promotes competition in the grain market, which safeguards farmers' interests. During the harvest season, they usually go to farmers' homes to make offers for grain. The IGMs have a good grasp of the farmers' psychology, and due to fierce competition, they offer farmers a price only slightly above the purchase price offered by the contracted LEs. If they offer the farmers a price higher than their allowable threshold, they would make a loss, so IGMs survive in the cracks and manage to thrive because of their business acumen. As IGMs adopt backward processing technologies, the quality of the processed food they produce is poorer than that of LEs. The IGMs thus sell the processed food at a lower price to meet the low-end demand. Therefore, the use of high-quality grains to yield lowquality processed food is deemed as sheer waste.

DATA SOURCES AND QUESTIONNAIRE DESIGN

Sichuan is one of China's 13 major grain production provinces. In this survey, the authors selected each of the 20 counties in Sichuan based on the following criteria:

(i) it is a national grain commodity base; (ii) it is a big agricultural county; and

(iii) it is an intermediate level of economic development in the province.

The authors investigated 19 LEs, all of which entered into contracts with farmers. The timeframe of the contracts varied: one LE signed contracts that were valid for seven years, one for six years, seven for five years, three for four years and three for a year. While they contracted with farmers for their grains, the LEs also utilised other purchase channels to meet their demand that otherwise could not be entirely fulfilled by purchase volume from the farmers' contracts. Thirteen LEs purchased grain in the market and 12 LEs bought grain from other operators. As for the type of account settlement being opted for, 15 LEs adopted one-time settlement; two LEs chose a form of two-time settlement that involves settling the account according to contract price first, and then offering farmers some rebates depending on grain quality later; the remaining two LEs chose another form of two-time settlement that involved settling the account according to contract price first, and then offering farmers some rebates based on LEs' profits later (see Table 1).

The authors also conducted a survey of 850 farmers. (11) One of the questions in the survey dealt with contract compliance and required them to choose from the following responses: (1) comply with the contract but the LE should adopt profit-sharing as a form of rebate to farmers after the sale of processed food; (2) strictly comply with the contract; (3) neglect the terms and conditions of the contract and sell only to those who offer the highest price; (4) ignore the fine imposed for breach of contract, and sell only to those who offer the highest price; and (5) comply with the contract only if there is a mandatory penalty stated in the contract. The results showed that 40.6, 22.9, 21.7, 9.1 and 5.7 per cent of the farmers in the sample chose options (1), (2), (3), (4) and (5), respectively.

A THREE-PARTY GAME MODEL

In a three-party game system, the farmer is the partner that both the LE and IGM compete for. The relationship between the farmer and either one of the two is cooperative while that between the LE and IGM is competitive.

Game Set-up

The set of game participants is N{1,2,3}, which represents the farmer, LE and IGM, respectively. [P.sub.0] denotes the contract price, which is the lowest price for the grain; C denotes the farmer's production cost; therefore, the lowest profit for the farmer is equal to [P.sub.0] - C. [C.sub.H] denotes the amount of the LE's investment in high-quality seeds and technological services; and the LE's profit is calculated as the sale price of processed food ([P.sub.H]) minus the contract price it pays to the farmer ([P.sub.0]) and the investment cost ([C.sub.H]), that is, [P.sub.H] - ([P.sub.0] + [C.sub.H]).

There is information asymmetry among the participants: the farmer does not know whether the LE will penalise him if he defaults on the contract, and neither does he know whether the LE will give him any rebates. On the other hand, the LE does not know what measures, penalty or rebate can make the farmer comply. Lastly, the IGM knows the market price for processed food and the contract price between the farmer and the LE but does not know the default loss of the farmer as a result of the penalty or the gain from compliance rebate.

There are three steps in the game process:

Step one: To purchase grain from the farmers, the IGM adds a small price premium, [[epsilon].sub.0], to persuade the farmers to default. The offer price is [P.sub.0] + [[epsilon].sub.0], and the farmers' profit is [P.sub.0] + [[epsilon].sub.0] - C. If the sale price of IGM is [P.sub.L], his profit (spread) would be [P.sub.L] - ([P.sub.0] + [[epsilon].sub.0]). In this situation, for any given farmer, there is a probability, [p.sub.1], that he will be honest and comply with the contract, and a probability, 1 - [p.sub.1], that he will be opportunistic and default.

Step two: The LE gives the farmer rebates. If the LE does not take any action (behaviour a) against opportunistic farmers, the honest ones would also become opportunistic and this would further reduce the contract compliance rate. To boycott the IGM's behaviour, the LE has two alternatives: mete out punishment (behaviour b) or give a rebate (behaviour g). A penalty will increase the default cost for the farmer and the price premium can no longer compensate the default loss. Thus, farmers lose the incentive to default on the contract. Rebates will increase the farmer's profit if he complies with the contract, which increases the opportunity cost of default. Assuming that the amount of the LE's rebate is [[epsilon].sub.1], to attract the farmer to comply with the contract, [[epsilon].sub.1] > [[epsilon].sub.0].

Step three: The coping strategies of the farmer after the LE imposes a penalty or offers rebates.

* Coping strategies upon imposition of penalty. Since the exorbitantly high legal costs discourage LEs from taking up lawsuits against farmers, there has been no litigation case between a LE and a farmer for over 20 years. However, the penalty clauses in the contract do produce some deterrent effect on some farmers as the survey reveals that some farmers chose to comply with the contract because of the penalty clauses. Although the LEs have not taken any actual litigation against the farmers, they can disqualify the farmers from future contracts. This is an effective punishment. Assume the probability of deterrent effectiveness is [p.sub.2], then that of deterrent invalidity is 1 - [p.sub.2].

* Coping strategies upon receipt of rebates. Since the rebates will be issued in the future, whether the farmer complies with the contract depends on his trust in the LE; if he believes that the rebate, [[epsilon].sub.1], is more than [[epsilon].sub.0], he will comply with the contract ([[epsilon].sub.1] > [[epsilon].sub.0]), and the probability is [p.sub.3] while the probability of default is 1 - [p.sub.3].

Table 2 shows the profits of probability based on the above parameters and the steps of the game.

A farmer's expected profit under alternative situations is determined by the non-compliance measures of the LE. If the LE does not adopt any measures, the total profit of a given farmer is:

[E.sub.1]([alpha]) = [p.sub.1]([P.sub.0] - C) + (1 - [p.sub.1])([P.sub.0] + [[epsilon].sub.0] - C) (I)

If the LE takes action to penalise the farmer, the expected profit of a given farmer is

[E.sub.1]([beta]) = [p.sub.1]([P.sub.0] - C) + (1 - [p.sub.1])[p.sub.2]([P.sub.0] - C) + (1 - [p.sub.1])(1 - [p.sub.2])([P.sub.0] + [[epsilon].sub.0] - C) (II)

If the LE gives rebate, the expected profit of any farmer is

[E.sub.1]([gamma]) = [p.sub.1]([P.sub.0] + [[epsilon].sub.1] - C) + (1 - [p.sub.1])[p.sub.3]([P.sub.0] + [[epsilon].sub.1] - C)

+ (1 - [p.sub.1])(1 - [p.sub.3])([P.sub.0] + [[epsilon].sub.0] - C) (III)

The profit of the LE will be different if it chooses alternative actions. If the LE does not adopt any action to deter non-compliance of the contract, its expected profit is:

[E.sub.2]([alpha]) = [p.sub.1](Ph - [P.sub.0] - Ch) - Ch(1 - pO (IV)

If the LE takes penalty action against farmers, its expected profit is

[E.sub.2]([beta]) = [p.sub.1](Ph - [P.sub.0] - Ch) + (1 - p0[p.sub.2](Ph - [P.sub.0] - Ch) - Ch(1 - [p.sub.1])(1 - (V)

If the LE gives rebates, its expected profit is

[E.sub.2]([gamma]) = [p.sub.1](Ph - [P.sub.0] - Ch - [[epsilon].sub.1]) + (1 - [p.sub.1])[p.sub.3](Ph - [P.sub.0] - Ch - [[epsilon].sub.1]) - Ch(1 - [p.sub.1])(1 - [p.sub.3]) (VI)

The expected profits of the IGM under the three different situations are listed below. If the LE does not adopt any action to deter non-compliance of contract, the IGM's expected profit is:

[E.sub.3]([alpha]) = (1 - [p.sub.1])(Pl - [P.sub.0] - [[epsilon].sub.0]) (VII)

If the LE adopts penalty action against farmers, the expected profit of IGM is

[E.sub.3]([beta]) = (1 - [p.sub.1])(1 - [p.sub.2])([P.sub.L] - [P.sub.0] - [[epsilon].sub.0]) (VIII)

If the LE gives a rebate, the expected profit of IGM is

[E.sub.3]([gamma]) = (1 - [p.sub.1])(1 - [p.sub.3])([P.sub.L] - [P.sub.0] - [[epsilon].sub.0]) (IX)

Analysis of Profit Maximisation in the Three-Party Game

At the initial stage, due to lack of experience, the LE may not adopt any measures on the possible default of the farmers, thus they can only purchase grain from honest farmers and lose the investment capital spent on the opportunistic ones. On the other hand, some honest farmers will be lured by the price premium offered by the IGM and turn opportunistic. The contract compliance rate then plummets further and the LE suffers bigger losses. Hence, the LE will inevitably take actions that include both imposing penalties and offering rebates to raise the contract compliance rate.

A comparison of the changes in the profits of the three parties can be made from Table 2, which shows the changes in the probability of the contract compliance rate.

The expected profits of the farmers under alternative situations can be analysed. Substituting and subtracting equations (I)-(II), one gets [E.sub.1]([alpha]) - [E.sub.1]([beta]) > 0; and by substituting equation (III)-(IV), one will get [E.sub.1]([gamma]) - [E.sub.1]([alpha]) = [p.sub.1][[epsilon].sub.1] + (1 - [p.sub.1])[p.sub.3]([[epsilon].sub.1] - [[epsilon].sub.0]). When [[epsilon].sub.1] - [[epsilon].sub.0] > 0, [E.sub.1]([gamma]) - [E.sub.1]([alpha]) > 0, maximum profit for the farmers is expected if the LE gives them rebate ([[epsilon].sub.1] - [[epsilon].sub.0] > 0); minimum profit is expected if the LE penalises them; and a median profit if the LE does not take any measure.

The total profits of the LEs under alternative situations are analysed as follows. Substituting and subtracting equations (V)--(IV), one will get [E.sub.2]([beta]) - [E.sub.2]([alpha]) > 0. Similarly, substituting and subtracting equations (VI)--(V), one will get [E.sub.2]([gamma]) - [E.sub.2]([beta]) = (1 - [p.sub.1])([p.sub.3] - [p.sub.2])([P.sub.H] - [P.sub.0]) + [p.sub.1][p.sub.3][[epsilon].sub.1]. Based on the empirical readings, [p.sub.3] is 40.6 per cent and [p.sub.2] is 5.7 per cent, so [p.sub.3] - [p.sub.2] > 0, that is, (VI)--(V) > 0, which implies that minimum profit for the LE is expected if it does not take any measures, whereas its profit increases if it takes punitive action, and its profit is at a maximum if it gives farmers rebates.

The total profit of the IGMs under alternative situations was calculated by substituting and subtracting equations (VII)-(VIII)-(IX). For [E.sub.3]([alpha]) > [E.sub.3]([beta]) > [E.sub.3]([gamma]), it can be deduced that if LE does not take any measures, IGMs are expected to get their maximum profit, but if the LE gives rebates, IGMs are expected to receive minimum profits. The profit level of IGMs hovers between the maximum and minimum if the LE takes punitive action.

To summarise, in the three-party game, both the farmer and LE enjoy maximum profit if the LE offers rebates to the farmer; if the LE does not take any measures, only the IGM gets maximum profit. Therefore, the optimal state for contract farming happens when the LE offers rebates to the farmer.

Total Social Benefits in Different Situations

The total social benefits under three different situations can be calculated by taking the summation of the profits of the farmer, LE and IGM using equations (I) to (IX):

* The LE does not take any measures:

S([alpha]) = [E.sub.1]([alpha]) + [E.sub.2]([alpha]) + [E.sub.3]([alpha]) = [p.sub.1]([P.sub.H] - [P.sub.L]) + [P.sub.L] - (C + [C.sub.H]) (X)

* The LE penalises the farmer:

S([beta]) = [E.sub.1]([beta]) + [E.sub.2]([beta]) + [E.sub.3]([beta]) = ([p.sub.1] + [p.sub.2] - [p.sub.1][p.sub.2])([P.sub.H] - [P.sub.L]) + [P.sub.L] - (C + [C.sub.H]) (XI)

* The LE gives rebates to the farmer:

S([gamma]) = [E.sub.1]([gamma]) + [E.sub.2]([gamma]) + [E.sub.3]([gamma]) = ([p.sub.1] + [p.sub.3] - [p.sub.1][p.sub.3])([P.sub.H] - [P.sub.L]) + [P.sub.L] - (C + [C.sub.H]) (XII)

As the quality of processed food produced by the LE is better than that by the IGM, the price of processed food from the LE is higher than that of the IGM, and this implies [P.sub.H] - [P.sub.L] > 0. The difference between the welfare levels in the first two scenarios is positive, S([beta]) - S([alpha]) = [p.sub.2](1 - [p.sub.1])([P.sub.H] - [P.sub.L]) > 0, suggesting that the total social benefits in the situation if LE takes punitive action are greater than the situation if LE does not take any measures.

According to this survey, [p.sub.3] is 40.6 per cent and [p.sub.2] is 5.7 per cent, so [p.sub.3] - [p.sub.2] > 0. The difference between the welfare levels in the last two scenarios works out to be positive, where S([gamma]) - S([beta]) = (1 - [p.sub.1])([p.sub.3] - [p.sub.2])([P.sub.H] - [P.sub.L]) > 0, suggesting that total social welfare is maximised when the LE offers a rebate.

CONCLUSION

It is important to provide farmers with economic incentives to encourage contract compliance in the three-party game. If the LE offers the farmers some rebates, they will choose to adhere to the contract and the contract compliance rate will increase greatly (i.e., at 40.6 per cent) while both the LE's profit and total social welfare can be maximised. Currently, however, only 21 per cent of the LEs give farmers rebates. This may be the main reason for the low contract compliance rate in grain contract farming. Therefore, it is imperative for LEs to share their profits with farmers through rebates and better interest mechanisms between the LEs and farmers in order to improve the contract compliance rate and total social benefits.

While most existing studies deal mainly with non-grain commodities or an aggregated concept of agricultural products, this article focuses on grain contracts and discusses the important implications for national food security. Another important contribution of this article is the analysis of grain contract compliance in the context of a three-party game involving the farmers, LEs and IGMs. Existing studies have failed to analyse the role of IGMs. Given that IGMs operate in a complex grain market involving the three-party game, current studies are unable to offer insights into the actual competition relations in a complex agricultural product market.

A shortcoming of this paper is that it is geographically limited to Sichuan Province. Ideally, the authors would have expanded their investigations to include more provinces, which would then have yielded more convincing results.

(1) David Runsten and Nigel Key, "Contract Farming in Developing Countries: Theoretical Aspects and Analysis of some Mexican Cases" (in Spanish), 1996; Charles Eaton and Andrew W. Shepherd, "Contract Farming: Partnerships for Growth", FAO Agricultural Services Bulletin (Rome: Food and Agricultural Organization, 2001); Decio Zylbersztajn, "Tomatoes and Courts: Strategy of the Agro-industry Facing Weak Contract Compliance", working paper for the School of Economics and Business, University of Sao Paulo, August 2003; and Volker Beckmann and Slike Boger, "Contract Compliance in Transition Agriculture: Theory and Evidence from Poland", conference paper for the International Society for the New Institutional Economics (Sept. 2002): 27-9.

(2) H.R. Gow, D.H. Streeter and J.F.M. Swinnen, "How Private Contract Enforcement Mechanisms Can Succeed Where Public Institutions Fail: The Case of Juhocukor a.s.", Agricultural Economics 23 (2002): 253-65.

(3) Eaton and Shepherd, "Contract Farming: Partnerships for Growth".

(4) Hamish R. Gow and Johan F. M. Swinnen, "Private Enforcement Capital and Contract Enforcement in Transition Economies", American Journal of Agricultural Economics 83, no. 3 (2001): 686-90.

(5) Zylbersztajn, "Tomatoes and Courts: Strategy of the Agro-industry Facing Weak Contract Compliance".

(6) Beckmann and Boger, "Contract Compliance in Transition Agriculture: Theory and Evidence from Poland".

(7) N.L. Tregurtha and N. Vink, "Trust and Supply Chain Relationship: a South African Case Study", conference paper for the International Society for the New Institutional Economics, (Sept. 2002): 27-9.

(8) Volker Beckmann and Slike Boger, "Courts and Contract Enforcement in Transition Agriculture: Theory and Evidence from Poland", Agricultural Economics 31 (2004): 251-63.

(9) J. Haji, "The Enforcement of Traditional Vegetable Marketing Contracts in the Eastern and Central Parts of Ethiopia", Journal of African Economies 19, no. 5 (2010): 768-92.

(10) Zhou Liqun and Cao Liqun, "Commodity Contract is Superior to Factor Contract", Economic Research Journal, no. 1 (Jan. 2002); Tan Yanwen, "The Game Analysis on Breach Behavior of Contract Farming and its Preventive Mechanism", Farmers' Daily, 18 Jan. 2002; Liu Fengqin, "Incomplete Contract and the Barrier to Performance", Economic Research Journal, no. 4 (2003); Yin Yunsong, "Research on the Type of the Commodity Contract and its Stability", Chinese Rural Economy, no. 8 (2003); Zhao Deyu and Gu Haiying, "The Establishment Problem of Grain Order and its Improvement", China Rural Survey, no. 4 (2005); Hu Dinghuan, "A New Marketing Model: Supermarket + Processing Companies + Farm Households", Issues in Agricultural Economy, no. 1 (2006); Guo Hongdong, "Dragon-head Companies and Enforcement of Contract-farming between the Agribusiness Firms and Farmers: Theory and Practice in Zhejiang Province", Issues in Agricultural Economy, no. 2 (2006); Guo Hongdong and Robert W. Jolly, 2008, "Contractual Arrangements and Enforcement in Transition Agriculture: Theory and Evidence from China", Food Policy 33 (2008): 570-5; Wang H. Holly, Zhang Yanping and Wu Laping, "Is Contract Farming a Risk Management Instrument for Chinese Farmers? Evidence from a Survey of Vegetable Farmers in Shandong", China Agricultural Economic Review 3 (2011): 489-505.

X. Yu, D. Abler, Y. Zeng, "Contractual Arrangements of Traders in Chinese Wholesale Markets", a paper prepared for presentation at the International Association of Agricultural Economists Conference, Beijing, China, 16-22 Aug. 2009. Using a survey data of 700 traders, X. Yu, D. Abler, Y. Zeng scrutinised contract choices and enforcement for agricultural traders in China and found that market service and environment are very important factors. Better market service and environment can increase the propensity of using contract and the probability of contract enforcement for both purchase and sales of products. Education and memberships of special associations are also important for contract choices and enforcement. Higher education and affiliation to special associations for traders can increase the propensity of contracts and reduce contract breaches. However, the formats of contracts, whether oral or written, are not important for contract enforcement.

(11) This survey was conducted at the end of September 2009 when farmers harvested their rice. The local officials led investigators to the companies and farmers' homes in villages. When they arrived at a village, they usually went door-to-door to see if the farmers were at home. The farmers were surveyed in the same region as companies. All the farmers surveyed signed contracts with the corresponding LE and obtained free high quality seeds from the LE.

Ye Luo (arfwto@yahoo.com) is a PhD student at the Western Economic Research Center of the Southwestern University of Finance and Economics in Chengdu, Sichuan. His research is in the field of agricultural economics.

Xingming Fang (xingmingf@163.com) is Professor in the School of Economics at the Southwestern University of Finance and Economics in Chengdu, Sichuan. He did his PhD in Macroeconomics at the same university. His research interests are macroeconomics, energy economics and the problem of food.

H. Holly Wang (wanghong@purdue.edu) is Professor in the Department of Agricultural Economics at Purdue University. She obtained her PhD in Agricultural Economics from Michigan State University. Her research interests include risks, marketing, and Chinese agricultural and rural economics.

TABLE 1
Contract Time Limit, Type of Purchase and Settlement of 19 LEs

                          Number of LEs   Percentage (%)

1. Timeframe of contract (years)
  5                              7              36.8
  4                              4              21.1
  1                              4              21.1
  6                              2              10.5
  7                              2              10.5

2. Type of purchase                             19.0
 Contract                       19             100.0
 Market                         13              68.4
 From other operators           12              63.2

3. Type of Settlement
 One-step settlement            15              79.0
 Two-step settlement *           2              10.5
 Two-step settlement **          2              10.5

Notes:

* Settle the account according to contract price first and then the
LEs offer farmers rebates depending on the quality of the grain
delivered.

** Settle the account according to contract price first and then the
LEs offer farmers rebates depending on LEs' profits.

TABLE 2
Profits of the Three Parties under Alternative Situations

              Comply with        Default (probability 1 -[p.sub.1]
         contract (probability
              [p.sub.1])              LE does not
                                       adopt any
                                   measures [alpha]

Farmer       [P.sub.0] - C           [P.sub.0] +
                                 [[epsilon].sub.0] - C

LE       [P.sub.H] - [P.sub.0]        -[C.sub.H]
              - [C.sub.H]

IGM                0             [P.sub.L] - [P.sub.0]
                                  - [[epsilon].sub.0]

         Default (probability 1 -[p.sub.1]

                  Punishment [beta]

          Comply with         Default
           contract        (probability
         (probability     1 - [p.sub.2])
          [p.sub.2])

Farmer   [P.sub.0] - C      [P.sub.0] +
                         [[epsilon].sub.0]
                                - C

LE        [P.sub.H] -       -[C.sub.H]
           [P.sub.0]
             - CH

IGM            0            [P.sub.l] -
                            [P.sub.0] -
                         [[epsilon].sub.0]

         Default (probability 1 -[p.sub.1]

                      Rebate [gamma]

            Comply with           Default
             contract          (probability
           (probability             1 -
            [p.sub.3])          [p.sub.3])

Farmer      [P.sub.0] +         [P.sub.0] +
         [[epsilon].sub.1]   [[epsilon].sub.0]
                - C                 - C

LE          [P.sub.H] -         - [C.sub.H]
            [P.sub.0] -
            [C.sub.H] -
         [[epsilon].sub.1]

IGM                             [P.sub.L] -
                                [P.sub.0] -
                             [[epsilon].sub.0]
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Article Details
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Title Annotation:COMMENTS & NOTES
Author:Luo, Ye; Fang, Xingming; Wang, H. Holly
Publication:China: An International Journal
Article Type:Report
Geographic Code:9CHIN
Date:Dec 1, 2013
Words:6019
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