Why co-operatives in farming?

By Paul Walker 19/10/2012

A few days ago Ele Ludemann at the Homepaddock blog noted that Co-ops key to feeding world and in a sense she is right. Co-ops are more common in argiculture than any other sector of the economy. The big question is Why?

To see why start from the idea that there are two basic ways to organise production, via contracts or via ownership. So what are the costs of each? First consider the costs of contracting. In farming one reason for the formulation of co-operatives was monopsony power. Farming is a business with many producers of highly homogeneous commodities. It is one of the most competitive of all industries. In contrast, the middlemen-handlers and processors – who purchase farm products are often highly concentrated and hence have the potential for exercising a degree of monopsony power over the farmers they deal with. Such monopsony power can be accentuated by seasonality or perishability of agricultural products. Any individual farmer who simply grows and harvests his crop and then takes it to market risks encountering prospective purchasers who offer only a very low price _ which may in fact be less than the farmer’s cost of production – due to the knowledge that the farmer has very little time in which to market his crop and therefore cannot credibly threaten to hold out for long or to engage in an extensive search for other purchasers. A purchaser, in contrast, can often realistically threaten to turn to other farmers to satisfy his needs.

Such a cost of contracting results in farmers having an incentive to form cooperatives through which they can bargain collectively with middlemen, or with which they can displace the middlemen entirely. Such incentives have apparently played an important role in the formation of farm marketing cooperatives. In more recent times the use of forward markets has lessened the need for co-operatives to over come monopsony power. A farmer can sell his crop even before it is grown via the use of forward markets.

Next consider costly information. Asymmetric information about crop attributes and prices has sometimes served as a stimulus to the formation of farmer marketing cooperatives. An example would be grain elevators and warehouses in the late nineteenth century U.S. Proprietary operators, who understood the grading methods employed in the terminal markets better than did local farmers, would assign grain they purchased from a farmer an inappropriately low grade, paying the farmer only the price appropriate for that grade and then reselling it at the price prevailing for the higher grade.

More generally, farm marketing cooperatives economise on a variety of information costs for their farmer-members. If each farmer in a given locality were to decide separately when and at what price to market his crops, there would be substantial duplication of effort in gathering information about market conditions, prospective purchasers, transportation, and other matters. Cooperatives allow farmers to share these costs.

It has also been argued that there are marketing externalities available to co-operatives than are not available to investor-owned intermediaries. If there are barriers to entry into agricultural production, but processing is relatively competitive, then there may be opportunities for promoting a given commodity through advertising that are available to a co-operative but not to an investor-owned intermediary. This may help explain the success of the fruit and vegetable cooperatives. Entry into (and exit from) production for many fruits, and perhaps some vegetables, is relatively inelastic in the short run because the trees take time to mature and represent a substantial crop-specific investment with a long expected life.

Now what of the costs of ownership? The preceding discussion suggests that, while market contracting for agricultural products has some costs that offer an incentive for farmer ownership, those costs are not conspicuously high. The reason for farmer ownership may therefore to be found in the low costs of ownership for farmers.

First up consider the monitoring costs of farmer owners. The farmer-members of agricultural marketing cooperatives are in an unusually good position to exercise effective control over the firm. The result is that agency costs are, from all the evidence available, unusually small in these organisations. Farmers have both the incentive and the opportunity to monitor marketing cooperatives actively and intelligently. The. crops that the cooperatives market represent a major, and often the only, source of income for the farmer. Farmers commonly produce the same crop, and deal with the same cooperative, for many years and sometimes for generations. Farmers of a given crop tend to be geographically concentrated, making participation in governance relatively easy. And where a cooperative covers a large region, it is both possible and a common practice to structure the cooperative in ways that continue to permit active and informed member control. Farmer-members of cooperatives are commonly well informed about the cooperative’s affairs and take an active interest in them. Members usually know one or more directors personally. The directors play an important role not only in conveying the members’ views to management but also in conveying information from management to the members. Managers pass important or potentially controversial issues to the board for decision. Boards scrutinise managerial performance closely and not uncommonly replace managers who are not performing well. In this and other ways, management in the cooperatives is highly responsive to members’ interests.

The cost of collective decision making are also low for co-operatives. A critical advantage for farming cooperatives is the extreme homogeneity of interest among the typical cooperative’s members. Most cooperatives handle only a single agricultural commodity which is exceptionally homogeneous. Often the outputs of the various members of the co-operative are fungible. This means that the members of the cooperative all share the relatively simple goal of maximising the value of the commodity involved. Costs of collective decision making, as a consequence, are kept to a minimum.

One possibly high cost for the co-operative is the supply of capital. Mostly the equity capital required by farm cooperatives must generally be raised from the cooperatives’ farmer-members. There are obvious costs to having farmers provide such capital. Modern farms, though predominantly family-owned – as was argued in a previous posting – businesses, are relatively capital intensive. Therefore farmers are unlikely to have substantial amounts of liquid capital available to invest elsewhere. In addition, the returns to a farmer from investing in a marketing cooperative are likely to be positively correlated with the returns to his farm. Since farming is a volatile business in itself, this means that a marketing cooperative is a highly risky investment for a farmer.

In conclusion farm based cooperatives thrive even where the potential costs of market contracting appear relatively low, the costs of ownership are even lower. It has been argued that the success of the cooperatives does not seem to depend importantly on their own exploitation of monopoly power or on governmental tax preferences or subsidies. Risk bearing and accumulation of capital have apparently not been important obstacles. Henry Hansmann argues that

[ … ] where the costs of ownership are low-and, in particular, where the potential producer-owners have highly homogeneous interests-producer cooperatives can succeed even in the absence of serious market imperfections that would make market contracting costly for the producers.

The last question to consider is will the advantages of co-operatives continue and thus will the domination of co-operatives in farming continue? The answer seems to depend on whether or not changes in agriculture mean that the homogeneity of interest of farmers continues. Should the costs of ownership begin to rise investor-owned firms may become more common.