Policy Issues

There are a variety of policy issues related to VCF and development. They can be classified in several groups: the enabling environment for the emergence of VCF; addressing rent distributional and efficiency concerns of VCF; and implications of VCF for public interventions in agriculture and agri-business development.

First, it is important to emphasize a general policy implication, which is to recognize the potential importance of VCF and, therefore, the need to explicitly integrate this into policy thinking and program strategies. One of the key findings of this review is that VCF is more widespread than generally recognized, albeit with significant variation across countries and sectors. Hence there is no one-size-fitsall VCF but instead several models of VCF, reflecting commodity characteristics, and stages of transition and development. There is no one-size-fits-all policy. Instead optimal policies and policy components will also need to differ and change to reflect these differences.

Second, policy implications are necessary for a good investment climate and the reduction of policy uncertainty, which is the primary concern of firms in developing countries. A poor policy environment has a negative effect on investments in the supply chain and on the beneficial effects of VCF programs.

Third, macro-economic stability is a key condition not only for the investments but, even more so, for various forms of chain-based finance. Since VCF is a financial activity, significant instability may cause such changes in the contract conditions that self-enforcement is no longer possible. Hence, macro-economic stability is not only necessary for more traditional finance systems but also for VCF.

Fourth, an important issue is the role of competition, both for efficiency and equity. Competition induces processors, retailers, and input suppliers to provide VCF and it constrains rent extraction of suppliers by upor downstream companies (Swinnen and Vandeplas, 2010). Given these strong benefits of competition for farms in the chain, ensuring competition is an important role for the government. Competition can be enforced through both domestic policies (competition policies, lower barriers of entry) as well as external policies (liberal trade policies). The importance of competition does not only apply to private companies, but holds also for the case when the government is directly or indirectly imposing a monopoly system and thereby extracting rents from farms. However, it should also be pointed out that some have argued that too much competition may be detrimental to VCF as it can undermine enforcement (Poulton et al., 1998).

Fifth, related to the competition issue, it remains important to encourage alternatives in credit markets. Empowering farmers in VCF relations with companies will come importantly from alternative options in accessing credit. The existence of alternative channels of credit or inputs will constrain rent extraction in the supply chains – and is good in general. Therefore, the existence of VCF does not necessarily diminish the importance of investments in alternative sources of farm finance, like bank credit to farmers, or leasing

Sixth, another area where governments can play an important role is investments in institutions to assist farms with credit contract negotiations and dispute settlements. As it is generally either not possible or too costly to resolve disputes in courts, alternative dispute settlement institutions can play an important role. Measures to increase the transparency of VCF contracts, to support alternative dispute settling arrangements, provide market benchmarks for price negotiations, training farmers in their rights/obligations as contractors, etc., are all important to increase the transparency of the VCF system, competition among systems, and thereby the bargaining position of farms.

Finally, governments (and development agencies) should look into supporting innovative finance instruments. A key conclusion is that the most successful VCF approaches have addressed specific constraints, are flexible, and allow adjustments to reflect changes in the environment. Some innovative instruments using chain-based financing are mostly private initiatives and there is only a limited role for the government. In other cases there may be a more important role, for example the regulatory and legal system, which is required for these instruments to function; or there may be a role in co-financing seed money to start up some of these innovations. The key conclusion is being open to innovations that explicitly take into account the value chain as a structural aspect of the financing problem.

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