Optimal Vertical Control in Agricultural Trade

Sierra Leone’s cocoa is of poor quality and receives poor prices in international markets. Farmers and traders at the top of the supply chain must invest in drying, fermenting and storage before exporters can obtain the amount of good quality cocoa they need to win a higher price. Market participants could fail to make these investments for two reasons: (1) the market does not “pay for quality”—the price premium for quality is insufficiently high to justify investment—or (2) there is limited access to technologies that improve quality (e.g. plastic roofed drying floors and fermentation bins), and so farmers and traders cannot work to improve it even if the price premium is high.

Policy makers have identified the absence of quality inspectors in the market as a key constraint on investment that functions through mechanism (1). If farmers are unable to assess the level of quality, but traders are, traders may be able to cheat farmers, paying them less than the market rate for quality cocoa in larger towns. Alternatively, if both traders and farmers both cannot assess the level of quality, traders may systematically price cocoa lower in order to avoid the risk of paying a high price for poor quality cocoa. In either case, farmers will not see a price premium for investing in quality, and will not find it worthwhile to invest in drying and fermentation, even if donors provide the technology.

This project developed an easily implementable, low cost method to grade cocoa quality at the farm-gate. This design could be easily scaled up. When we experimentally introduce inspectors to villages in Kenema and Kailahun districts, however, we find no effect on the prices transacted. A potential reason for this finding, we find, is that prices may often already be fixed on the day of transaction. In our experiment, inspectors merely met farmers and traders at the farm-gate where they transacted. It may have been difficult for farmers and traders to change prices on the spot, even with new information on quality. Farmers and traders engage in complex, repeated relationships in which prices and quantities are often agreed upon in advance, and credit is supplied to farmers with the expectation of future delivery. This suggests that for inspectors to have an effect, they must become a permanent feature of the market, which can be relied upon, daily, to verify quality before farmers and traders agree on prices. This work suggests that for quality inspections to work well, inspectors must be trusted, permanent fixtures of the community in order to affect on prices. We discuss a model of “village inspectors”, elected by farmers’ groups, that has the potential to benefit farmers, at low cost.