INCENTIVES FOR THE ADOPTION OF
GOOD AGRICULTURAL PRACTICES (GAPs)
1. BACKGROUND
Good Agricultural Practices (GAPs) covers a
wide gamut of on-farm and post-farm activities related to food safety, food
quality and food security, the environmental impacts of agriculture and often various
social objectives including animal health and welfare and agricultural workers
rights. A GAP approach to agriculture
involves the establishment of guidelines or standards for agricultural
producers and post-farm handlers, the monitoring of these standards, and the
communication of these standards through credible quality signals to downstream
firms, consumers and the public in general.
Concerns have been raised regarding the potential effect of GAPs on smallholders in developing countries. There are fears that stringent new GAPs could marginalise small producers, cutting off access
to export markets and imposing disproportionately higher production costs on
smaller producers given the investments that may be needed. There is also a fear that private sector GAPs driven by developing country supermarket chains are
not consistent with goals for sustainable agricultural and rural development
related to food security. On the other hand, it has also been argued that GAPs can provide the catalyst for improvements to
production techniques and supply chain infrastructure in developing countries (Jaffee, 2003a).
This paper examines the incentives and disincentives for the adoption of
GAPs by farmers and by downstream handlers of farm
outputs (traders, processors, retailers, importers/exporters etc)[1].
In examining the incentives for adoption, a number of key questions are
explored: What are GAPs? What are the objectives of GAPs? Why have GAPs evolved? What
are the different types of GAP and why are these differences important in
understanding the incentives to adopt GAPs? What are the respective public and private
sector roles in creating, operating and monitoring GAPs?
It is helpful to consider GAPs within the
context of the overall food supply chain. Figure 1 illustrates a simple food
supply chain flowing from production, through processing, distribution and
retail to the final consumer. The dotted
lines indicate that traders/exporters can play a role at multiple points in the
supply chain. There are two flows illustrated in Figure 1: physical commodities
flows and information flows. Physical commodities move from producers to
consumers through various routes depending on the institutional setting of the
market (e.g. role of traders, exporters, wholesalers, etc) and depending on the
nature of the commodity (degree of processing, perishability,
etc). Independent farms or firms may
operate at each stage of the supply chain, or a firm may be vertically
integrated owning two or more stages, such as a retailer that also performs
wholesaling functions or a farmer-owned co-operative that engages in
processing. The ‘food supply chain’ for
some smallholders practising subsistence agriculture is completely vertically
integrated from production to consumption within the same farm household, with
retailing and wholesaling functions being unimportant, whereas these functions
become more important for smallholders who also sell their produce.
Information flow is a two-way process. Information on consumer demands
and the requirements of the market place flow from consumers back through the
supply chain. Information on production techniques, quality verification and
identity preservation/traceability information flows forwards along the supply
chain from production through to retail or point of consumption. The
effectiveness with which information on consumer demands reaches producers or
the effectiveness with which information on production practices reaches
‘downstream’ retailers and consumers varies widely across supply chains. Good
Agricultural Practice approaches are a way of improving this two-way
information flow. Likewise, GAPs may also facilitate the production of food and the
physical flow of agricultural products along the supply chain. The incentives
for farms and food firms to adopt GAPs and good
manufacturing practices will depend on their relative gains or losses from
enhancing the physical product flow and/or the information flow through the
supply chain.
Raw Material supply
Figure 1: Basic Supply Chain
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Raw Material supply |
Information
1.1 What Are GAPs?
The FAO Committee on Agriculture proposed GAP framework (FAO, 2003a) provides
an insight into the scope and wide-ranging objectives of GAPs. The Framework identifies ten generic
components of GAPs, including soil management, water
management, crop and fodder production, crop protection, animal production,
animal health and welfare, harvest and on-farm processing and storage, energy
and waste management, human welfare, health and safety, and wildlife and
landscape conservation.
Some GAP programmes are market-driven. These can be private sector
supply chain-driven systems where a key player in the supply chain, e.g. the
retailer, introduces a set of proprietary GAP guidelines for its suppliers.
Alternatively, private sector initiatives can be sector-wide being driven by
industry groups, with key roles played by retailer and/or producer associations
in developing guidelines. Examples include the retailer-led EUREPGAP[2]
or the on-farm food safety initiative spearheaded by a number of producer
associations in Canada[3].
Other initiatives are the realm of ‘public sector’ action and may be
developed by governments within the national policy frameworks of individual
countries to enhance domestic competitiveness. For example, the Malaysian
Department of Agriculture is implementing a voluntary farm accreditation scheme
to encourage the adoption of GAPs among fruit and
vegetable producers, particularly the use of integrated pest management
(Agricultural Technical Co-operation Working Group(ATCWG))[4].
Finally, non-Governmental Organisations (NGOs) and international agencies have
also actively promoted the use of GAPs. The
Integrated Pest Management and the Better Banana project are programmes
promoted by NGOs that encourage the use of GAPs[5]
(FAO, 2003b). Table 1 in the executive
summary distinguishes between these four broad groups of GAP programmes.
GAPs cover a diverse set of objectives and have been developed by a wide
array of interest groups. The horizontal scope of individual GAPs, in terms of the breadth of their coverage across the
ten components, influences the incentives for adoption. The vertical scope, in
terms of the involvement of different supply chain participants – and
regulators or third parties – are also important influences on the incentives
to adopt. Stripping away the objectives of GAPs to
their core, it is clear that they attempt to generate or correct economic
incentives. Seen in this light, many GAPs can be seen
as an attempt to correct a ‘market failure’ by helping markets to function more
effectively or by assisting in the flow of information along the supply chain. A
review of these basic objectives is helpful in understanding why GAPs have evolved.
1.2 GAPs as a Means of Addressing Market Failure
In a functioning, well-developed market economy, the forces of supply
and demand send price signals that assist in the efficient allocation of
resources, facilitating investment and encouraging economic growth. For example, an increase in the consumer
demand for mangoes creates a short-run shortage of mangoes before supply can
respond, leading to an increase in prices.
Over time, mango producers respond to the increase in prices by
increasing their supply of mangoes as more resources move into mango
production. In the absence of impediments, the forces of supply and demand are
said to allocate resources efficiently.
However, economists have long recognised that markets sometimes fail. In
developing countries, with weak financial, legal and market institutions,
market failure can be a significant problem inhibiting investment and stifling
economic growth.
‘Market failure’ occurs when price signals fail to adequately reflect
society’s true valuation of a good, service or resource, leading to a
misallocation of resources. This can result in too little being produced of a
good or service that yields economic or social benefits. Alternatively, it can
result in too much of a good being produced that results in harm to consumers,
other producers, agricultural workers, the general public, etc. Regulatory
intervention to correct the market failure may be appropriate if the benefits of that intervention
outweigh the costs.
GAPs can correct market failures by leading to the adoption of production
practices that are socially acceptable and environmentally non-degrading. They
can help improve the flow of information along the supply chain. Impediments to
the flow of information may result in market failure if downstream retailers or
consumers are unable to verify the true quality of a product.
Markets ‘fail’ for a variety of reasons, including the presence of
public goods, spillover effects, information
asymmetry and inadequate or under-developed institutions to govern market
transactions. These terms are explained below within the context of GAPs.
GAPs and
the Provision of Public Goods
Pure public goods are goods (or resources) which it is not possible to
prevent other people from consuming and for which one person’s consumption does
not affect another person’s consumption[6].
Typically the private sector under-provides public goods, as it is not possible
to control the supply or distribution of the product and therefore reap full
returns from the market. Resources with
public good properties are subject to over-use due to the ‘common property
problem’: the inability to exclude users results in rapid depletion of the
resource, for example fish in international waters.
Some GAPs are designed to promote the
production of beneficial public goods or to protect threatened public good
resources. For example, GAPs that focus on reducing
soil erosion, reducing run-off or protecting water resources. In Brazil, the
national zero-tillage Federation (FEBRAPDP) focuses on conservation agriculture
practices. The Quesungual system for improving
agro-forestry practices in Honduras provides alternatives to slash-and-burn
practices (FAO, 2003c). The objectives in these cases are to protect scarce or
endangered resources and promote conservation practices.
GAPs as a
Means to Address Spillover Effects
Market failure also arises in the presence of positive and negative
externalities that create spillover effects in
markets. A positive spillover
(positive externality) occurs when the social benefits from a good or
service outweigh the private benefits and as a result, the market
under-provides this good or service. An example is education. Education of
agricultural workers and farmers about good agricultural practices that enhance
food safety, reduce soil erosion, improve food security, etc. produces
widespread social benefits that may not adequately be rewarded in the price the
farmer receives for his/her produce or in the wage received by an agricultural
labourer. A core component of many GAPs, particularly
those targeted at developing countries, is education and extension. Balsevich et al (2003) describe the development of GAPs as an integral part of new supply chain relationships
spearheaded by Hortifruiti (the procurement arm of a
retailer) in Costa Rica. As well as
certifying a subset of its growers as following GAPs,
Hortifruiti provides technical assistance to its
suppliers with respect to cropping decision and production practices.
The EUREPGAP protocol for fresh fruit and vegetables lists as
requirements (“minor musts”) that harvesting workers receive basic instructions
on hygiene before handling fresh produce. It also requires, in general, that formal
training be given to all appropriate workers with respect to operating
dangerous or complex equipment in the interests of protecting worker health,
safety and welfare (EUREPGAP, 2001). In
addition to the direct worker and producer education or extension components
incorporated into some GAPs, the guidelines
themselves play an educational and extension role, for example, by explaining
the correct method of storing and handling potentially harmful agricultural
chemicals.
Some GAPs address negative spillover effects (negative
externalities). These are external costs that arise when the social costs from
a good or service outweigh the private costs incurred by the supplier. As a
result, the market over-produces an output that imposes costs on the rest of
society. Pollution, contamination of water resources, soil erosion, unsafe
food, etc. are all examples of negative spillovers
that can be addressed through GAP programmes.
Integrated Production and Pest Management programmes encourage the use
of non-chemical production and management techniques using naturally-occurring
beneficial insects to control insect crop pests. These GAPs
reduce negative spillover effects (external costs)
with respect to farm workers’ health, the environment and chemical residues on
food (FAO, 2003d).
GAPs as a
Conduit for Information Flows
Market failure can also occur when the flow of information along the
supply chain is impeded. This is known as ‘information asymmetry’, where one
party to an exchange (e.g. the seller) has more information about the true
quality of a product than the other (e.g. the buyer). Consumers and downstream
buyers (retailers, processors, traders, etc) may not have full information
about food safety and quality, or about production methods related to animal
health and welfare, environmental sustainability, agricultural workers rights,
sustainable development practices, etc. GAPs assist in the provision of credible information so
that consumer preferences for safe food, high quality food or sustainable production
methods are transmitted back to producers through price signals – higher prices
for food with desirable characteristics, lower prices for food with undesirable
characteristics.
From a buyer’s perspective, goods can have search, experience or credence
characteristics. Search characteristics can be identified and evaluated by the buyer
prior to purchase, for example, the colour of an apple, the exterior blemishes
on a potato or the size of an orange. GAPs might
address the reduction of blemishes on fresh fruit and vegetables as an
educational component in helping producers or food handlers improve production
and processing practices. However there is no information problem as consumers
can signal their like or dislike of this attribute through their purchase
decision.
It is more difficult for consumers to act on their preferences for
products with experience attributes.
These are attributes that a buyer or consumer can only detect after purchase
and consumption, such as the juiciness of an orange or the tenderness of a
steak. Food safety has experience properties if a consumer becomes ill
relatively quickly after eating a food item and can identity the cause of
his/her illness. Quality or food safety
signals assure consumers of the presence (absence) of beneficial (harmful)
experience attributes. These signals
enable consumers to express their preferences through the marketplace.
GAPs facilitate the provision of information signals to downstream buyers
and consumers by encouraging and certifying production practices that enhance
the quality or safety of food. For example, the Agricultural and Environmental
Integral Protection Program (PIPAA) in Guatemala introduced a Safety
Certification Seal for fresh produce.
Although not yet mandatory, Balsevich et al
(2003) report that companies supplying the biggest supermarket company in
Guatemala are upgrading their production system with the PIPAA safety
certification standards.
The information problem is more pronounced for credence attributes which a buyer/consumer cannot detect even after
consumption. Many of the production and process attributes that are addressed
by GAPs fall into this category – for example
production practices related to environmental protection, conservation of
scarce or threatened natural resources, animal health and welfare, agricultural
workers’ rights. Some food safety
problems also have credence properties if the problem is not immediately
obvious (BSE in beef) or it is difficult for the consumer to determine the
source of a food borne illness.
Without a quality signal indicating how the product was produced,
consumers who wish to express ethical preferences with respect to production
attributes are unable to do so. GAPs facilitate the provision of quality signals to
consumers provided that they are backed up by transparent, enforceable and
credible monitoring and certification systems.
The role of credible monitoring and certification is key to the
successful implementation of sustainable GAPs systems
for product attributes that cannot be easily (or economically) detected after
the fact through testing.
GAPs as a
Response to Institutional Failure
Finally, GAPs may correct market failures
caused by high transaction costs that result from institutional failure. Transaction costs are the costs of
carrying out an exchange, be it through the open market, between two firms in a
contract or strategic alliance or within a vertically integrated firm[7].
Transaction costs arise from the search
process of locating reliable buyers and suppliers, discovering potential prices
or evaluating quality prior to purchase. Transaction costs also arise from the negotiation of the transaction, such as
the fees charged by middlemen, the costs of drawing up a contract. Finally,
transaction costs are also incurred in monitoring
product quality, supplier production practices or buyer produce handling
practices after the transaction has been agreed to and in enforcing contractual agreements.
In developed countries, institutions have evolved to reduce transaction
costs. Market information institutions reduce search costs for producers by
providing price information[8].
Financial institutions reduce negotiation costs by facilitating ease of payment
over time and space. Commercial legal systems reduce monitoring and enforcement
costs by providing legal redress in the event of a breach of contract. In
developing countries, the absence or under-development of these institutions
significantly increases transaction costs, impeding investment and hampering
long-term economic growth and competitiveness.
The introduction of GAP systems can assist in institutional development
or act as a stop-gap to allow time for institutional adaptation to occur. GAPs may be a temporary measure in a rapidly evolving
economy as other institutions arise or as new production technologies are
developed that eventually make a specific GAPs
programme obsolete. Credible information about good agricultural practices
reduces search costs for producers in determining the requirements of buyers. It
reduces the search costs for buyers in locating reliable suppliers. Monitoring costs may be reduced for buyers if
a GAP system includes third party monitoring and certification.
The type of GAP programme affects the distributional burden of
transaction costs (refer to Table 1). A
‘public sector’ national or international GAP system developed, managed and
monitored by national governments, international agencies or NGOs reduces
monitoring and enforcement costs for downstream buyers (retailers, wholesalers,
etc). If effective, these firms can rely on the independent GAPs
certification to assure product quality attributes without having to conduct
additional quality monitoring. Private sector supply-chain driven GAP systems,
however, internalise these transaction costs, such that downstream buyers incur
costs in monitoring and certifying quality.
If a retailer or importer develops its own GAPs
programme, it incurs the costs of ensuring compliance among suppliers. In some
cases, a portion of these costs may be passed through to farmers through
cost-recovery third party audits. The
extent to which this occurs will depend on the relative bargaining strengths of
the parties and the availability of alternative sources of supply (markets) for
buyers (sellers) respectively. In
developing countries, farmers typically have weak bargaining power vis-ŕ-vis
downstream buyers. Of concern therefore
is the extent to which the transaction cost burden from a private sector
supply-chain driven GAP will be passed back down the supply chain to handlers
and farmers.
2. INCENTIVES AND DISINCENTIVES FOR FARMERS TO
ADOPT GAPs
Incentives for farmers to adopt GAPs differ
depending on the focus of the GAP programme and the market failure it
addresses. Broadly speaking, these incentives can be divided into economic
incentives, regulatory/legal incentives and human capital incentives. The disincentives for farmers to adopt GAPs include economic disincentives, institutional
infrastructure constraints and human capital constraints. This section will
begin by discussing the incentives for adoption before examining the
disincentives. It is important to note that the disincentives are often the
mirror-image of the incentives to adopt, in the sense that adoption of GAPs to achieve price premiums (an incentive) may be
accompanied by higher production costs (a disincentive). For clarity of exposition, the incentives are
treated separately from the disincentives, however, it is recognised that they
may occur simultaneously.
2.1 Economic
Incentives for Farmer Adoption
Economic incentives for individual farmers to adopt GAPs
broadly encompass an increase or stabilisation of revenue and/or a reduction in
costs. Farm households may have multiple goals, including the production of
food for sale and for home consumption, the reduction of farm labour, the
protection of farm assets for future generations, etc. GAPs
may facilitate an increase in revenue from output sold in the marketplace but
also could increase the return to the family farm by increasing the food
available for home consumption. Farmer decision making is determined by revenue
net of costs. While GAPs may increase gross farm
revenue, they could also increase costs, so that net revenue could increase or decrease. The potential of GAPs
to increase gross farm revenues is considered in this section. The potential
implications for cost increases are considered in the later section on
disincentives for farmer adoption.
If GAPs are market-driven, focused on
commercial production of food with attributes demanded by consumers, gross farm
revenue may increase through higher
prices. This includes programmes
that enhance food safety or improve the information flow along the supply chain
by providing quality assurance guarantees with respect to hidden (experience,
credence) product attributes such as environmentally sustainable agricultural
practices. Consumers may be willing to
pay a premium for these assurances, and a GAP programme provides the institutional
infrastructure through which premiums can be passed back to agricultural
producers if the institutions to facilitate this do not currently exist in the
country. Some programmes have attempted
to tie GAP standards related to the environmental impacts of agriculture to
‘fair-trade’ initiatives that guarantee farmers in developing countries a base
price covering cost of production. Price premiums (if they exist) are likely to
be a strong incentive for the adoption of GAPs among
commercial farmers (see Table 1[9])
and are most prevalent in private supply chain GAPs
programmes.
GAPs may be a means of securing access to markets dominated by supermarket
retailers, either domestically or in export markets. While still a relatively
small component of food supply in most developing economies, supermarkets are
growing in importance in many parts of Asia, Latin America and even in some
African countries. For example, Zambia has witnessed growing investment by the Shoprite supermarket chain, although supermarket retailers
still account for a very small percentage of food sales. Weatherspoon and
Reardon (2003) discuss how the rise of supermarkets in southern and eastern
Africa offers both opportunities and challenges to producers in these countries[10].
The challenges are most acute for small producers who risk exclusion from
growing urban markets due to changes in procurement practices and increased
emphasis on food quality and food safety by the supermarket companies.
Supermarkets have rapidly gained in importance in Central American
countries (Berdegué et al, 2003). For fresh produce
procurement, these retailers are increasingly turning to the implementation of GAPs with preferred suppliers as a means of differentiating
their fresh produce from traditional wholesale markets on the basis of safety,
cleanliness and quality. The
supermarkets perceive that local consumers are willing to pay a premium for
food safety and cleanliness assurances in the absence of effective or
enforceable food safety regulations (Berdegué et al,
2003). It is important to note that these systems do not always translate into
price premiums for producers. La Fragua, a retailer
operating in Guatemala and El Salvador operates a voluntary safety/quality seal
with its suppliers that may become mandatory but there are no plans to pay
price premiums to producers, instead the incentive is based on market access (Berdegué et al, 2003).
The growth of supermarkets in developing countries mirrors the growth of
the middle class and consequently is occurring at different rates across these countries,
making generalisations difficult. The
priority for the majority of consumers in most developing countries is access
to a secure supply of food, with concerns about the safety of food or the
method by which the food was produced remaining the luxury of affluent
consumers in developed countries. While
there may be a growing middle class in some of the more advanced developing
countries that also demand these attributes, for the most part, the major
source of demand in the short to medium run is likely to come from consumers in
developed countries. For now, the extent
to which adopting a GAPs approach that focuses on
food safety and food quality is beneficial for individual farmers in developing
countries depends on the relative importance of food produced for export,
versus household or domestic (within-country) consumption.
Price premiums are a direct and tangible revenue-based incentive for
producers to adopt GAPs, however, price is only one
component of revenue. Another component of revenue is quantity. Access
to markets, through preferred supplier arrangements in closed supply chains
or achieving standards of production that are recognised for access to
international markets or by consortia of retailers, provides another strong
incentive for producers to adopt GAPs (see Table
1). Producers are interested in both the
level of revenue and its stabilisation over time. Reducing uncertainty over market access for
agricultural produce assists in stabilising revenues over the long-run. This
assists in long-run production planning, investments and the development of a
skilled, reliable labour force. When
evaluating a specific GAPs programme, it will be
important to evaluate the extent to which the programme will increase or assure
market access. Increased market access is likely to be a more important
motivation for joining a private supply chain GAPs
programme, although is also relevant for industry-wide GAPs
(Table1).
Some GAPs focus on improving farm management
and production decisions to increase or stabilise
yields in developing countries. This also assists in stabilising and/or
increasing the revenue stream for producers.
Production techniques that enhance or protect soil fertility can help
stabilise revenues over the long-run and across successive farm operators.
Improvements in post-harvest storage and handling techniques reduce crop losses
and increase the available quantity of product for household consumption and
for market. This contributes directly to farm revenue in the case of on-farm storage.
It contributes indirectly to farm revenue through potentially increasing the
net price downstream crop handlers can afford to offer for farm produce by
reducing their storage losses post-farm.
If improvements in storage result in a large increase in supply,
however, the positive impacts on revenue may be tempered by a fall in prices.
Economic incentives also operate on the cost side of the profit (net
revenue) equation. Improved agricultural practices that reduce storage costs, reduce
wastage or result in more efficient use of labour or other farm inputs can
reduce average costs. Farmers have a
direct economic incentive to adopt practices that reduce their average costs of
production. The dissemination of information to farmers on what constitutes a
‘good agricultural practice’ can help overcome market failures with respect to
producer education and training in good management practices, thereby reducing
costs and is a key feature of most private and public sector GAPs programmes (Table 1).
According to Jaffee (2003a), the competitive
pressure created by new and anticipated food safety standards in the EU led to
significant improvements in the cost competitiveness and supply chain
efficiency of the Kenyan fresh vegetable sector. The adoption of farm-level GAPs was an important component of this improvement in
standards, although Jaffee also notes the changing
structure of the Kenyan industry and the increased backward integration by
exporters into farm-level production.
In addition to direct effects on short-run profitability through revenue
enhancement or cost reduction, farm owner-operators have an incentive to adopt GAPs if they lead to long-run improvements in the asset valuation of the farm. Certification under specific quality
assurance schemes may require the producer to invest in long-run improvements
in soil management techniques, or production practices that reduce residue
levels in soils. For example, organic certification systems often require that
the land be farmed organically for several (e.g. three) years before
commodities from that farm can be certified as organic. This type of
certification requirement acts as a short-run barrier to entry, enabling
existing producers to capture higher economic rents from the marketplace and
from the land market. The strength of
this incentive depends on a number of factors, including: the demand for the
certified products that the farmer is producing; the ease with which other
farmers can enter this market segment (e.g. length of time before land is
certified organic) and; the existence of the institutional infrastructure
necessary for a viable land market (e.g. enforceable property rights).
Collectively, or individually, farmers have an incentive to adopt GAPs to protect themselves against market externality effects from other poorly managed farms. In
other words, GAPs could provide farmers with a means
of demonstrating their due diligence in practising good production and
management techniques with respect to food safety, food quality, etc. In the
event of a food safety problem within the industry at large, adherence to a
recognised GAP programme may protect the farmer from a loss in consumer or
buyer confidence as a result of negligent or poor management practices by other
farm firms or supply chains. This
incentive is stronger for private sector (supply chain and industry-wide) GAPs programmes (Table 1).
The strength of this incentive is highly dependent on the ability of the
marketing system to segregate GAP and non-GAP produce. In the absence of the
appropriate transportation and storage infrastructure, blending of GAP and
non-GAP output destroys the revenue incentive for farmers to adopt GAP. This is
likely to be a significant challenge in many developing countries with poorly
developed physical infrastructure.
Product separation is a strategy adopted by Kenyan fresh vegetable
exporters in supplying the EU market. To
ensure adequate control over quality, some exporters operate separate product
supply lines for more discerning clients who demand full traceability and
quality assurances, versus those whose requirements are less taxing. In practice, this often means
that vertically integrated exporters use produce from their own farms or from
large outgrowers to supply their more discerning overseas
customers, while produce from smallholders is sold to other market segments (Jaffee, 2003a). In the Kenyan context, Jaffee
(2003a) argues that the direct incremental costs of product separation are
small, involving the physical costs of maintaining distinct product flows and
the accompanying records at the packing house. Nevertheless, while large
exporters may have the capacity to practice identity preservation strategies,
this may be less feasible for smaller, more disparate market participants in other
developing countries.
2.2 Regulatory
and Legal Incentives for Farmer Adoption
Farmers may adopt GAPs to generate
environmental benefits or reduce environmental costs. Some of these yield
direct private benefits to the farmer, for example, improving soil quality.
Similarly GAPs that improve labour conditions for
agricultural workers could yield private benefits to farmers in the form of
increased labour productivity and reduced wastage. Farmers may feel that
membership of GAPs improves their social capital
within their local communities and among consumers. However, these private
benefits either directly or indirectly impact revenues and/or costs and are
therefore a subset of the economic incentives discussed above. It should be
acknowledged that some farmers adopt these practices for ethical or purely
altruistic reasons, although this is likely to be a luxury few in developing
countries can afford. In most cases this remains the realm of spillover effects (externalities), wherein the incentives
for farmers to adopt practices that increase social welfare are weak in the
absence of policy intervention.
Policies to correct these types of market failure seek to internalise
the external costs by transferring the burden of social costs back to the firm
(farm). Taxes, subsidies and regulations are the common means by which
policymakers change the incentive structure with respect to spillover
effects (externalities). As indicated
earlier however, regulatory intervention to correct a problem is only desirable
if the benefits of intervention outweigh the costs. If developing countries
lack the infrastructure to implement or enforce policies, then regulatory
intervention to promote GAPs may not be a viable
strategy.
Changing the property rights to scarce water, soil or environmental resources can encourage farmers to adopt GAPs. Well defined (and enforced) property rights enshrine the right to make choices about a property or resource, the right to extract rents from its ownership and the right to transfer its ownership without restriction (Cheung, 1982). In this way, resources can be allocated – and reallocated – efficiently among competing users. The economic value of the resource is maximised, and overuse from a common property problem (e.g. too many people trying to graze animals on common land, over-fishing in shared waters) is avoided. Since ownership of property rights confers potential wealth – or loss of wealth depending on the choices made – the distribution and protection of those property rights is crucial in determining whether resources are allocated in response to economic signals or as a result of perverse bureaucratic incentives, corruption or graft. Insecure property rights are a significant constraint on new investment and economic growth.
In theory, regulatory action can be taken to alter property rights in
the face of a market failure such as a production practice that is causing
environmental degradation. Requiring the polluter to compensate for pollution
caused, or requiring that the user of a scarce resource (e.g. water) pay the
real social cost of that resource rather than using it for free, can provide
farmers with the economic incentive to adopt GAPs.
The costs of these resources would then be internalised into the farm
operation, encouraging conservation practices.
In practice, however, this may be difficult to achieve in a developing
country with poorly developed market, legal and governmental institutions[11].
Taxing undesirable agricultural practices is impractical in many developing
countries where taxes are difficult to assess and collect. Regulations may be
easy to announce but difficult to implement due to physical and financial
capacity constraints, corruption possibilities, etc.
Communal and customary rights to land or common assets play an important
social and economic role in many developing economies. Joint use of key water, land or other
resources requires a common GAPs approach across the
users of that resource. An individual producer would not have a strong
incentive to adopt GAPs with respect to water or land
management if other farmers using the same resource did not also adopt these
practices. Community rather than individual-based GAPs
approaches would be required in these cases.
Direct subsidies or indirect
support of GAP initiatives through cross-compliance measures that require the
adoption of GAPs for eligibility to government
support programmes represent the ‘carrot’ rather than the ‘stick’ approach to
regulatory intervention. Experience from
western market economies has shown that direct subsidies create a supply
response that distorts market signals, becomes a significant budgetary burden
for taxpayers and eventually becomes capitalised into agricultural land values
so that the intended recipients do not benefit in the long-run. Subsidies are also open to corruption and
manipulation by vested interests. Thus, while subsidies are a clear and direct
incentive for farmers to adopt GAPs, they come with
considerable economic and political baggage and may result in a budgetary-driven
race to the top which resource-constrained developing countries cannot hope to
win.
Other regulatory or legal incentives to adopt GAPs
are more subtle. For example, farmers may adopt GAPs
as a risk reduction strategy to reduce their liability in the event of a food safety, environmental or public
health problem. Under these
circumstances adherence to a GAP system is evidence of due diligence on the
part of the farm operation. Government
regulations with respect to food safety, environmental protection, or
protection of human health, etc strengthen the incentive for farmers (or
downstream processors and retailers) to practice due diligence. For example, the UK Food Safety Act (1990)
introduced a due diligence defence clause making all firms in the supply chain
responsible for the safety of the food they handled, regardless of the source
of contamination. The resulting increase in monitoring costs for retailers
encouraged closer supply chain relationships between retailers, processors and
producers (Hobbs, 1996). Most UK retailers now require that their suppliers
source meat only from farmers who are members of approved farm-assurance
schemes. The liability incentive is likely to be more important for private
sector (supply chain and industry group) GAPs, as
indicated in Table 1.
2.3 Human
Capital Incentives for Farmer Adoption
Farmers adopt GAPs as a means of developing
their human capital skills and to
access the human capital skills of other supply chain partners or third
parties. GAPs can be a means to expand upon core
competencies within the farm enterprise.
Individuals – and firms – are necessarily limited in what they know how
to do well. GAPs offer farms the opportunity to
expand their knowledge and skill base (core competencies) by accessing codifiable knowledge – i.e. knowledge that can be specified
in production protocols. They may also provide the opportunity to access tacit
knowledge – knowledge that cannot be specified in simple protocols but is
acquired through experience or shared between supply chain partners. Access to tacit knowledge is more likely to
occur in supply chain-driven GAPs if the relationship
between farmers and downstream buyers is interactive and includes mechanisms
for feedback on the result of good production and management practices. It is
less likely to be a strong incentive in generic GAP systems orchestrated at a
national policy level or by international agencies with little involvement by downstream
firms (Table 1).
2.4 Economic
Disincentives for Farmer Adoption
The disincentives or constraints for farmers to adopt GAPs include economic disincentives, institutional
infrastructure constraints and human capital constraints. The most obvious
economic disincentive is cost. GAP programmes may require farmers to adopt new
production techniques that increase variable costs of production, decrease
yield or lead to new capital investments.
Increased variable costs
include higher labour requirements or labour training to improve harvesting
techniques, increased record-keeping requirements, discontinuing the use of
cheaper inputs in favour of inputs that are harder to obtain and/or more costly
but that are more environmentally friendly, etc. Decreased
yields can result from less intensive use of agricultural chemicals or the
use of soil and water conservation techniques.
Reductions in yield increase average costs of production, assuming that
other input costs remain unchanged. New capital investments increase fixed costs and can include
required improvements in harvesting and storage equipment, energy and waste
management or investments to improve farm worker safety. Cost increases will be a disincentive to
adoption in any GAPs programme (Table 1).
The development of GAPs needs to be
particularly cognisant of the potential impact on farm-level costs and the
extent to which the proposed agricultural practices are conducive to local
growing conditions, knowledge and resource bases. Many GAPs tend to
be process-based, offering guidelines for good production practices, rather
than product-based programmes that rely on end-product (performance) testing as
a means of evaluating quality and safety.
This is appropriate for credence attributes that cannot be detected
through end-product testing (e.g. farm animal welfare). It is also increasingly
the approach being taken to risk management for food safety in developed
countries, for example, the Hazard, Analysis, Critical Control Points (HACCP)
system. Nevertheless, the ‘one size fits all’ approach of a process standard
can impose disproportionately higher average costs on small farms and firms as
the fixed investments necessary to improve management practices are spread over
less output.
While it is difficult to generalise about costs, some examples are useful. It has been estimated that national process-based GAPs increased costs for Chilean maize farms by 17%, with cost increases of up to 200% for peach farmers (Berdegué et al, 2003). Compliance costs are difficult to estimate accurately, however, as it is frequently difficult to disentangle the costs of adopting GAPs from the costs of business expansion or development that would otherwise have occurred (Jaffee, 2003a). In the Kenyan fresh vegetable sector, for example, Jaffee (2003a) reports that the certification process for EUREGAP cost one exporter US$6000 to US$8000 with an additional cost of approximately US$200 per month for continued documentation. This cost was relatively small compared to the costs of developing world-class vegetable farms that could be over US$1 million.
Compliance costs
are incurred at several points along the supply chain. While farmers incur costs in changing and
documenting production practices, first-stage handlers, processors and
distributors also incur compliance costs in upgrading processing facilities and
investing in apparatus for testing and in monitoring the quality of inputs (Jaffee, 2003b). The
extent of compliance costs varies considerably between industries and across
countries, depending on the extent to which incremental changes are needed
versus investments in major upgrades or new capacities (Jaffee,
2003b)[12].
An additional economic disincentive arises if farmers must make investments
in assets that have little or on value in an alternative use. These are known
as asset specific investments. They
can include physical assets such as inputs or equipment that are specific to
one buyer or human capital investments such as highly specific skills. Asset specific investments can be made at any
point along the supply chain. Having made an asset-specific investment, the
farmer (or processor) is vulnerable to a trading partner behaving opportunistically
by trying to appropriate rent from the investment. For example, suppose a rice farmer invests in
production protocols related to land and water management that are specific to
a retailer in order to obtain GAP certification from that buyer. The farmer is
then vulnerable to the buyer attempting to re-negotiate the terms of the
transaction through offering a lower price or changing the delivery terms after
the farmer’s investment is has been made and is unrecoverable (a sunk
investment). The farmer is in a weak
bargaining position and may have few alternatives but to accept the buyer’s
less favourable delivery terms. This risk is relevant for private sector
supply-chain driven GAPs that tie a producer to a
specific buyer or group of buyers (Table 1). Farmer groups or associations can
play a role in counteracting the weak bargaining power of individual farmers in
these circumstances.
Clearly, the market access incentive for adopting GAPs
is a double-edged sword. If a GAP
programme places a farmer in preferred supplier list to gain access to a closed
supply chain it also leaves the farmer vulnerable to opportunistic attempts by
the buyer to re-negotiate the terms of their supply agreement once the farmer
is committed to that GAP programme.
Generic national or international GAPs that
are not tied to individual supply chains reduce the asset specific nature of
the farmer’s investment, reducing the vulnerability to opportunistic
re-negotiating by buyers, but may be less effective at providing access to
closed supply chains.
Obtaining agreement across buyers with respect to a common set of GAPs is a potential solution. The EUREPGAP system defines minimum standards
acceptable to retail groups in Europe and accredited to ISO 65 standards, with
the claim that under its GAP, products are “Certified Once – Recognised
Elsewhere”. In reality, EUREPGAP protocols set a baseline standard to which
individual retailers may bolt on additional quality assurance requirements
(EUREPGAP, 2001). In general, farmers are faced with a trade-off in incentives
with respect to value-added opportunities and market access through closed
supply chain GAPs and the vulnerability of asset
specific investments.
2.5
Institutional Infrastructure Constraints to Farmer Adoption
Lack of adequate infrastructure to support GAPs can
constrain adoption of all types of GAPs programmes
(Table 1). The EUREPGAP system has a number of requirements with implications
for institutional infrastructure. It requires that the farmer have plant health
certification for nursery stock. It requires evidence of residue testing and
that laboratories used for residue testing be accredited by a competent
national authority to a good laboratory standard, such as ISO17025. All fresh
produce must be traceable to the farm on which it was grown (EUREPGAP, 2001).
There are sound economic reasons for these protocols as they reduce the
transaction (particularly monitoring) costs for European retailers in sourcing
reliable, safe supplies of fresh fruit and vegetables. However, they also require that farmers can access
the necessary institutional infrastructure to verify the input quality, output
quality and source of the agricultural commodity. Clearly some farmers in the
poorest of developing countries may not have access to these types of services.
Again, GAPs present us with a trade-off. These types of protocols facilitate
meaningful, credible quality and safety assurances. They fill an institutional vacuum that would
otherwise result in prohibitively high transaction costs, reducing the
incentives for retailers to source products from developing countries or
reducing the net price they are willing to pay given the higher transaction
costs they would face in verifying quality.
On the other hand, shifting the burden of monitoring and quality
verification back to the supplier country may constrain the ability of farmers
to adopt these specific production protocols.
2.6 Human
Capital Constraints
Farmer adoption of GAPs is sometimes
constrained by human capital limitations, i.e. limits on the farmer’s ability to
apply the prescribed production and management protocols and maintain the
appropriate level of documentation. This will be particularly important in
developing countries with high rates of illiteracy.
The EUREPGAP system, for example, requires documentation that would allow
traceability of farm products (e.g. records of sales), records of chemical and
fertiliser inputs, etc. These records are transaction-cost reducing mechanisms
that facilitate trade over time and distance. Record keeping is also a part of
good management practice that allows a farm enterprise to review its status and
plan future production decisions. In developing countries with high rates of
illiteracy, significant extension activities are required to facilitate the
adoption and maintenance of GAPs among poorly
educated farmers. Without these steps, GAPs could lead to market exclusion for poorly educated or
illiterate farmers. If the technical details and procedures necessary for
compliance with EUREGAP or other GAP programmes are not readily accessible to
smallholders, they will be disadvantaged relative to larger-scale commercial
farmers.
Record and documentation requirements can also be costly in terms of the
opportunity cost of a farmer’s time –
i.e. the time spent preparing and maintaining records could more usefully be
spent on other activities. This can become a problem where multiple GAP systems
are emerging and farmers are faced with duplicative record-keeping tasks for
different commodities or to qualify for different GAP schemes. This is relevant for GAPs
programmes in developed as well as developing countries. The Canadian
government encouraged the adoption of on-farm food safety systems and
environmental farm plans in its 2001 Agricultural Policy Framework. The on-farm food safety systems are
commodity-specific, so that a mixed farm producing grain, beef, dairy and
poultry products could be faced with keeping four separate sets of records
pertaining to on-farm practices that affect food safety, in addition to audits
for each commodity. Multiple commodity audits are under consideration to reduce
the burden for farmers. Environmental
farm plans address environmental rather than food safety issues and will add
another layer of documentation requirements.
It is not yet clear whether the Canadian on-farm food safety systems and
environmental farm plans will remain voluntary or become mandatory. The
apparent duplicative record-keeping requirements remain a concern for many
producers.
Weak public extension services also constrain farmer adoption of GAPs in some developing countries. Berdegué
et al (2003) highlight this as a constraint to adoption of supermarket-driven GAPs in Central American countries. GAPs
with built-in extension components to some extent mitigate this disincentive.
3. THE ROLE OF MARKET FORCES
A number of market forces are affecting the economic environment for
farmers in developing countries. The growth of supermarkets has partly been
driven by urbanisation and the rise of the middle class, increasing the demand
for the quality of food and service levels provided by supermarkets. Incomes tend to be higher in urban relative
to rural areas, so urban areas represent a more viable market to farmers.
However, supermarket growth in developing countries is not confined to
servicing the middle class, as more efficient procurement channels have also
enabled supermarkets to expand into poorer areas as mass merchandisers, for
example in Kenya and South Africa (Weatherspoon and
Reardon, 2003).
Changes in procurement channels include the development of larger,
centralised wholesale markets in place of fragmented, local wholesale markets.
The larger wholesalers supply retailers in addition to having their own retail
functions. South African supermarkets
use a combination of procurement channels to procure fresh produce, using their
own distribution centres, direct contracts with growers and buying from fresh
produce markets (spot markets) (Weatherspoon and
Reardon, 2003). Improvements in
transportation, logistics, storage and communication infrastructure facilitates
the growth of supply chain relationships between supermarkets, wholesalers and
growers. Supermarkets often encourage
growers in direct supply relationships to follow GAPs. Spot markets not likely to be a viable market
for GAP produce given challenges in preventing co-mingling of GAP from non-GAP
produce after it has left the farm.
In addition to the growth of supermarkets within developing countries,
supermarkets in rich developed countries also influence the adoption of GAPs through their procurement strategies. The increased
focus on food safety, food quality and the environment among consumers in
developed countries has been powerful a market force driving the adoption of
GAP programmes. Market driven GAPs produce food or
non-food agricultural commodities with attributes that are valued in the
marketplace. However, these attributes only have value if they can be verified
to buyers. The involvement of several stages of the supply chain is usually
crucial in providing level of identity preservation necessary to reap market
returns for GAP-produced attributes.
GAPs can be an integral part of a ‘value chain’ approach to agriculture.
Successful value chains are usually championed by a ‘channel captain’ – a firm
or organisation in the best position to co-ordinate the value chain and be a
conduit for information flows from the market back to producers and from
producers back to the market. The
co-ordinating role may be played by a retailer, a farmer co-operative or a
processor, etc. Communication, transparency and trust are also essential
features of a successful value chain based on GAPs. To assist in communication and transparency,
GAP schemes often have detailed production protocols covering all aspects of
the on-farm production environment. The
EUREPGAP protocol for fresh fruits and vegetables, for example, lists 15 areas
for which mandatory requirements and voluntary guidelines are clearly specified
(EUREPGAP, 2001).
GAP systems that are part of a value chain approach to providing quality
and safety assurances to consumers are only one component of providing credible
quality and safety assurances. Good
Manufacturing Practices, or food safety management systems (HACCP), or quality
assurance systems also need to extend to downstream processing and retailing
activities. For example, the Scottish meat industry launched a joint initiative
‘Quality Meat Scotland’ that encompasses several stages of the supply chain for
beef, pork and lamb. Protocols are developed and monitored for each stage of
the supply chain from livestock feed suppliers, farmers, livestock hauliers and auction marts, to processors and retail
butcher shops. The protocols emphasise animal husbandry, health and welfare and
traceability of the meat products and the raw materials, as well as food safety
and food handling practices at the processing plant (Hobbs, 2003a).
In contrast to the industry-wide scope of
quality assurance schemes such as Quality Meat Scotland, Tracesafe
was a small farmer-owned supply chain in the UK that targeted a niche market in
the wake of BSE and growing consumer concerns over the origin and safety of
food. Tracesafe differentiated its beef on the basis
of its ability to trace the history of individual meat cuts to the animal of
origin, with an implied safety assurance. GAPs formed
an implicit part of the Tracesafe system, which used
a network of cattle breeders and finishers rearing cattle to specific
production guidelines. The production
protocols specified the purchase of feed from a set of contracted feed mills
and included an extensive system of on-farm record keeping. The beef was sold
in specialist retail outlets and restaurants under the Tracesafe
brand name (Fearne, 1998).
The Tracesafe case
illustrates how relatively small-scale, farmer-owned firms (albeit in a
developed country) can gain a first-mover competitive advantage in the
marketplace by their flexibility and ability to respond quickly. Larger-scale processor and retailers, relying
on economies of scale and large throughputs to maintain their competitive edge
can be poorly placed to respond to new market opportunities that require
traceability or identity preservation, simply because their production systems
are set up to handle large quantities of fairly homogenous commodities. The
beef packing industry in the US and Canada has become consolidated into fewer,
larger firms with large-scale packing plants relying on large throughputs to
achieve tight margins. To some extent
this has put them at a competitive disadvantage vis-ŕ-vis smaller niche players
providing traceability and quality verification. However, the situation is changing rapidly as
the technology to facilitate traceability and identity preservation becomes
available (for example, bar-coding, electronic implants, DNA-sampling, etc.).
Several of the large North American beef packing firms have introduced branded
beef programmes that embed GAP principles within their production protocols for
producers (Hobbs, 2003a). Nevertheless, these initiatives represent a very
small proportion of total beef sales in the US and Canada.
Improvements in traceability and identity
preservation technologies facilitate the segregation of agricultural products
produced under specific GAPs from the wider pool of
commodities. Potentially this allows
producers following GAPs to earn greater returns from
the market. The accessibility and
applicability of these technologies to developing countries, however, remains
an open question. The bar-coding and DNA
technologies referred to above are likely to be too expensive for most firms in
developing countries. Indeed, it is too
early to tell whether these technologies are commercially viable in a developed
country context, let a
Some of the (economic) incentives for
retailers, processors, importers, exporters and other downstream firms to work
within GAP schemes are similar to those for farmers, in the sense that they may
be a means of increasing revenues and/or reducing costs. Strong economic
incentives include the ability to access reliable supplies of a consistent
quality product. Increased consistency
reduces wastage and reduces the monitoring costs for downstream firms in verifying
product quality, thereby lowering average costs of production.
Access to products produced through
market-driven GAPs gives these firms a competitive
advantage if they can provide consumers with quality or safety assurances
specific to their product. This can be part of the firm’s product differentiation
strategy based on a private sector supply chain-driven GAP (Table 1). Food industry advertising reflects this
trend. Maple Leaf Foods in Canada launched an advertising campaign in 2003 for
its chicken meat, focusing on the quality of the feed ingredients fed to the
chickens. The company has also placed a
major emphasis on traceability, referring to it as the “holy grail of the food
supply chain”, and is reported to be funding the development of DNA identification
technology to facilitate the traceback of meat to the
farm of origin (Powell, 2002).
Regulatory-driven incentives for downstream processors and retailers
include the need to demonstrate due diligence and reduce legal liability, as
discussed in section 2. Social incentives – the improvement of social capital,
improved labour conditions, conservation and environmentally-friendly
processes, etc. may be important for downstream firms in projecting the image
of a good corporate citizen. This manifests
itself as an economic incentive if a good public image encourages buyer loyalty
or shareholder investment.
4. ESTABLISHING GAP GUIDELINES: WHOSE ROLE?
As the earlier discussion and Table 1 indicates, GAP systems run the
gamut from individual supply chain initiatives, to industry-wide programmes,
national initiatives, and programmes guided by international agencies. Some of these differences depend on whether
the GAP is addressing a demand for a private good (e.g. demand by consumers for
higher quality food) or a public good (e.g. the need to reduce environmental
degradation from agricultural practices). Where there is a strong market-driven
demand for products with specific quality or safety assurances, GAP systems are
likely to emerge within private sector supply chains. Where ‘market failures’ exist (such as
environmental problems), however, other actors become involved in establishing GAPs. There may be a
role for producer industry associations or retailer associations in
establishing generic GAPs if producers would be at
risk from making investments in assets that are specific to one firm further
down the supply chain.
Public sector agencies can play a role in assisting the establishment of
GAPs in clear cases of market failure due to
externalities (spillovers) or information asymmetry
(where quality attributes are hidden).
The delineation between private and publicly established GAPs can be blurred.
The on-farm food safety programmes in Canada are being established by
producer industry associations for individual commodity sectors. But a Federal Government agency, the Canadian
Food Inspection Agency, acts as the third party verifier, approving the
individual systems for launch and accrediting the certifying agencies who will
carry out the on-farm audits.
The provision of credible third party auditing is crucial to the
successful operation of GAP systems.
Quality assurance and auditing is a burgeoning industry in developed
countries and is a function frequently performed by the private sector. In developing countries this industry is
likely to be under-developed, leaving an institutional gap that may be filled
by the public sector. However, this will
only be effective if public sector agencies can be relied upon to perform third
party certification services. In resource-constrained developing countries,
public sector agencies may be unable to fulfil this role adequately.
Transparency and freedom from corruption or graft are essential if public
sector auditing and quality assurances are to be effective.
The costs of establishing GAPs include the
administrative costs of identifying the critical points in a production process
where ‘good practices’ are needed – for example, pesticide application
procedures or water use practices. This
could include an extensive audit of existing farm operations to determine local
conditions, practices, etc., followed by the development of a set of good
agricultural practices. The costs of
implementing GAPs for an individual producer will
depend on the extent to which the GAPs programme
requires new investments, a change in practices, training, etc. Monitoring and certification of GAPs practices, such as testing for residue levels, may
require investment in monitoring or testing equipment.
Following the establishment of a GAPs system,
producers and third party monitors incur costs in conforming with and verifying
GAPs. As
discussed earlier, extensive testing may not be feasible in many developing
countries with limited infrastructure and financial resources. In these cases, GAPs
that emphasise relatively simple improvements in production practices and the
verification of those practices through certification (i.e. a process-based
rather than a product-based approach) will be more appropriate.
The complexity of the GAP system determines the appropriate governance
structure. Relatively simple technical
messages – codified knowledge – can be conveyed through written production
protocols communicated by a buyer or through written or oral protocols
presented in an extension setting. More
complex GAP management protocols may include the transfer of tacit knowledge
between downstream firms and producers. This will likely require an
inter-active relationship among supply chain participants. Third party
monitoring and verification will be more important in this setting.
Figure 2 illustrates some of the incentives for establishing GAP systems
through private sector versus regulatory actions. The figure is a highly stylised
representation of GAP systems and focuses on market-driven GAPs
related to verification of product quality. Given the complexity of
alternatives alluded to earlier, it is not possible to depict all GAP
alternatives in one diagram. Nevertheless, the figure illustrates some of the
key points that have been made in this paper, particularly with respect to the
role of third party monitoring and certification.
There are three decision-makers depicted in Figure 2: an industry
association, a regulator and a representative firm. The industry association is faced with a
decision about introducing an industry-wide GAP quality verification system
through which products will be labelled for consumers. There are three main paths in Figure 2
indicated by the bold shaded lines: voluntary industry GAP system, mandatory
regulated GAP system and no GAP-quality verification system[13].
Starting at the far left-hand side of the graph, assume the industry
association introduces a voluntary GAP system for its sector. Third party monitoring is assumed to play an
integral role[14],
revealing true product quality with probability p. The firm chooses whether to produce high quality (complying with
GAP guidelines) or low quality. The dotted lines indicate that the firm does
not know at which node it is located given uncertainty over the accuracy of
third party monitoring. The consumer then makes a purchase decision (not
shown). The lower the probability that third party monitoring will reveal true
product quality (i.e. the lower is p),
the more uncertainty consumers face over product quality. It is anticipated that probability p would be lower in developing
countries, resulting in more quality uncertainty for consumers. Lack of
credibility for third party monitors, widespread graft or corruption will
increase this uncertainty.
In the second path, the industry association opts not to introduce an
industry-wide GAP system but the regulator can decide to mandate GAPs if a market failure is perceived to exist. The industry expects a regulator to impose a
mandatory system with probability m. Accompanying a mandatory system is third
party certification by public sector agencies, which is assumed to be effective
(reveal true product quality) with probability s. If certification by public sector agencies in developing
countries is hampered by resource constraints or corruption, s will be low. The firm makes its high/low quality
production decision, and the consumers purchase the product (not shown).
If neither the private sector nor public agencies introduce a GAP
system, the situation is as depicted on the far right-hand side of Figure 2
(the third path). A firm makes a
high/low quality production decision without the over-arching umbrella of a GAP
system and without third party quality monitoring. Consumers face quality
uncertainty in the absence of a quality verification and labelling system.
The ‘payoffs’ to the firm are indicated at the base of the tree and
reflect the incentives for firms to adopt and comply with GAP systems. Four variables affect the payoff to the firm.
The revenue from the sale of output is defined at three levels: RH is
the revenue from selling a “high quality” good producing using GAPs, RL is the revenue from selling a “low
quality” good, and RA is the revenue from the sale of a good whose
quality is not signalled ex ante to the consumer. RA represents an
average or “pooled” revenue and depends on consumers’ expectations regarding
the proportion of ‘low quality’ (versus ‘high quality’) goods in the market. It
is assumed that consumers prefer high to low quality and that this is reflected
in the price of the good and the revenue to the firm, therefore, RH
> RA > RL.
There is also a “goodwill premium”, G, available to the firm for
participating in an industry-driven GAP programme. The premium reflects marketing and public
relations benefits to the firm from voluntarily participating in GAPs rather than adopting them only because it is a
regulatory requirement[15].
Two types of costs affect the payoff to the firm. The first is the cost of implementing a GAP
system: VV is the cost to firms in the industry of introducing a
voluntary GAP quality verification system, while MV is the cost of a
mandatory system imposed by a regulator. It is assumed that MV >
VV, as
voluntary adoption allows the firm/industry flexibility in designing GAPs to suit the production environment in which it
operates rather than having to conform to a “one-size-fits-all” mandated system
of GAPs and quality verification. The second cost is
the cost of production: CH is the cost of producing a high quality
good under a GAP system, while CL is the cost of producing a low
quality good that does not conform to GAPs. It is assumed that CH > CL.
If the industry introduces
voluntary GAPs, the representative firm complies with
the GAP protocols (producing a high quality good) and the consumer purchases
the product, the firm’s expected payoff is RH+G-VV-CH
regardless of the effectiveness of third party monitoring (outcomes i and iii). However,
there is an incentive for firms to cheat by free-riding on the GAP system to
obtain a price premium without incurring additional production costs. If the
firm cheats and sells low quality (non-GAPs) output
misrepresented as high quality produced under GAPs,
its payoff is RL-VV-CL with probability p (outcome ii), or RH+G-VV-CL with probability 1-p (outcome iv). If third party monitoring
reveals this cheating, the firm would not earn the goodwill premium as the
quality assurance system would not be credible to consumers.
