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A high price to pay for a living income?

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Why direct transfers are a better strategy for value redistribution in the cocoa sector.

by Rob Kuijpers, Ruerd Ruben, and Rik Habraken.

Increasing cocoa prices above market equilibrium is an expensive way to achieve living incomes for farm households. Besides excessive monetary costs, higher prices may have unintended adverse effects, such as on child labour and deforestation. Other alternatives, such as cash transfers or earmarked budget support, should be considered as potentially more cost-effective ways to redistribute value in global commodity chains.

Over the decades, numerous interventions have been implemented to achieve better incomes for farmers in international cocoa value chains. These included agricultural research and extension services, state marketing boards, fair trade and other forms of certification and farmer support programs. It is evident that these efforts have not been sufficient for achieving a living income for cocoa farming households, with an estimated 73 to 90% of households in Ghana and Côte d’Ivoire still below the living income benchmark.   

There is now increasing pressure towards traders and chocolate making companies to fundamentally change their purchasing arrangements and procurement practices. They are urged to pay higher farm-gate prices, in some cases up to the level of a living income reference price (LIRP):  the price needed for an average farm household with a viable farm size and sustainable productivity level to earn a living income from the sale of their crop.  

We recognize that cocoa farmers receive a relatively small portion of the chocolate price paid by consumers and understand the demand for chocolate brands and traders to pay higher farm-gate prices for fairness. However, we identify three practical problems with raising prices above the international market equilibrium to redistribute value and achieve living incomes

  1. it does not help the poorest farm households achieve a living income;
  2. it is a very costly solution for reducing living income gaps;
  3. it has undesirable economic, social and environmental effects.

We also outline some alternative mechanisms for redistributing value in the cocoa chain and discuss ways forward.

Problem 1: Higher prices don’t help the poorest farm households achieve a living income.

Higher prices are particularly attractive for larger commercial cocoa farming households, but hardly benefit those with small cocoa farms and low production volumes. Figure 1 shows the income composition for a sample of cocoa farm households in Côte d’Ivoire, equally divided into five groups based on their income levels. The graph reveals that large living income gaps remain for the poorest smallholders in particular, even when prices increase with 50 % (the additional cocoa income from a price increase is marked red in the graph). This is mainly due to the fact that poor households have small plots of land, produce low volumes of cocoa, and achieve low net margins.

Figure 1. Scenario analysis: what would an increase in price mean for households?

Problem 2: Higher prices are a very costly solution for reducing living income gaps.

One reason why price support is inefficient is that higher prices particularly reward farm households that sell larger volumes, while their families might already be earning a living income (see for example group 5 in Figure 1, representing the top 20% farm households with the highest income levels). Much of the extra money being paid for cocoa thus does not contribute to achieving living incomes but instead increases the income inequality between households.

Historical examples from price support programs in high- and middle-income countries (EU, India, USA) and of subsidized farm-gate prices in low income countries have taught us that price support also leads to excess market supply, permitting less efficient farmers to engage in cocoa cultivation. This ‘crowding in’  results in overall higher costs of production and an over-allocation of scarce resources – such as land and labour – towards cocoa cultivation at the expense of other goods and services, including food (see problem 3).

To avoid oversupply, extensive and costly bureaucracies would need to be put in place for restricting the production of cocoa (e,g, through quotas). This does not avoid all inefficiencies, as low-productivity producers would remain in the market. It is also questionable whether control of supply is feasible in a highly decentralized cocoa sector,  as it requires high governance and enforcement capacity.

Problem 3: Higher prices have undesirable economic, social and environmental effects.

Price premiums may result in incentives for farm households to increase their cropping area through deforestation and land clearing. There is also some well-documented evidence that higher prices could incentivize child labour, particularly among poorer households.

Moreover, higher commodity prices are likely to reduce the production of food crops and can thus decrease dietary diversity and the availability of a healthy diet in poorly integrated local markets. This is partly compensated when revenues from cash crop sales are used for the purchase of nutritious foods.

Promising alternatives

A less disruptive alternative to value redistribution is cash transfers paid for by chocolate making companies. These are direct (un)conditional payments provided to cocoa farming households, sometimes conditional on children attending school or the application of sustainable land use practices. Cash transfers can be targeted and therefore more effective in reaching the poorest farm households, particularly poor women. Moreover, they do not provide a direct incentive for cocoa farmers to expand production further, implying less pressure on forests, less oversupply, and less child labour.  Figure 2 presents a scenario based on cash transfers bearing similar value as increasing prices with 50%. And although living income gaps remain for the poorest households, they benefit more from cash transfers than they would do from price increases.

Figure 2. Scenario analysis: what would a cash transfer mean for different groups of households?

Cash transfers have been criticised for creating dependency and being unsustainable. However, if they become part of a company co-ownership model that pays dividends to farm households, it can be part of a systemic transformation of international markets in which farm households and companies become mutually dependent. There is a risk that large-scale cash transfers in one specific agricultural commodity may still crowd-in other farming households into the cocoa sector, bearing risk of inefficient resource allocation.

An alternative that could be considered is earmarked budget support for rural development to cocoa producing countries, potentially including social protection programs unconditional on the crop being produced and forest protection programs. Arguably, this is the least distorted way to re-distribute value to the commodity origin countries.

Ways forward

Prices not only distribute the value generated in the supply chain but also play a crucial role in coordinating supply and demand. They incentivise cocoa farm households to invest when supply is low and demand is high (as is currently the case) and to reduce investments during oversupply. For prices to perform this function effectively, they must be undistorted and determined by the market.

Higher market-determined prices can be achieved by de-commodifying cocoa, creating sub-markets for cocoa that meets specific product or production standards. New EU legislation (EUDR, EUCS3D) may invite companies to compete for “sustainable” cocoa, resulting in higher prices for farm households for meeting sustainable practices. Companies are generally willing to pay efficiency premiums for safe, high-quality products that foster long-term, trustful relationships and meet company and international traceability standards. These initiatives are the first steps toward de-commoditisation.

Finally, value redistribution alone likely is insufficient. Achieving a living income for all cocoa famers requires systemic change, including more conducive policies (e.g., recognition of a living income as a human right in the EUCS3D), less power imbalance (e.g., through co-ownership models), pricing in of social and environmental externalities, a  smart mix of interventions, including procurement practises, and stimulating structural transformation towards non-cocoa and non-agricultural sectors. Interventions should be fine-tuned to different types of countries and categories of farm households, and at the same time support broader rural development and systemic change in international commodity markets.

Featured Image: Larry Garcia Pezo

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