MSSD DISCUSSION PAPER NO.

20

RURAL ECONOMY AND FARM INCOME DIVERSIFICATION

IN DEVELOPING COUNTRIES

by

Christopher L. Delgado (International Food Policy Research Institute)

Ammar Siamwalla (Thailand Development Research Institute

Foundation)

Markets and Structural Studies Division

International Food Policy Research Institute

1200 17th St., N.W.
Washington, D.C. 20036 USA

Contact: Carolyn Roper

Phone: 202/862-5600 or Fax: 202/467-4439

October 1997

Paper presented at a Plenary Session of the XXIII International Conference of Agricultural Economists, Sacramento, CA,
U.S.A., August 10-16, 1997.

MSSD Discussion Papers contain preliminary material and research results, and are circulated prior to a full peer review in
order to stimulate discussion and critical comment. It is expected that most Discussion Papers will eventually be published in
some other form, and that their content may also be revised.
 i

Abstract

Farm-level diversification, the adoption of alternative income-generating

activities by farm households, is rarely deemed an explicit objective by
economists. Where agricultural transformation has occurred, markets function
well and agriculture is a waning portion of overall national product, such as the
rice growing regions of Southeast Asia, farm diversification might be a desirable
outcome of pursuing a market liberalization objective, but is probably not an end
in itself. In Sub-Saharan Africa, where these conditions often do not hold,
development depends on pro-actively commercializing rural areas. African
farmers tend to diversify their production activities widely to mitigate risk, but to
only produce one or two exportable commodities. High transaction costs are
common barriers to diversification into new export opportunities, especially for
the poor and less well-informed, who tend to fall behind during times of rapid
structural change. Identifying appropriate rural institutions to incorporate rural
people into new export opportunities is a major priority for relevant policy
research; contract farming and participatory cooperatives offer promise and
merit further study.
 1

Introduction

Farm-level diversification involves adding income-generating activities at

the farm-household level, including livestock, local non-farm, and off-farm
pursuits undertaken by farm people. The objective of the paper is to consider
questions arising from the apparent inconsistency between the fact that
policymakers seem to consider farm diversification a major "economic" issue,
thus as an objective, and the fact that economists typically neglect this area,
seeing farm diversification as an outcome from pursuing some other objective.
This lack of consensus is further reflected by disagreement over the extent to
which national policies should pro-actively seek to promote diversification of
farm-level output mixes in specific directions.

The Ambiguous Meaning of "Farm Diversification" for Economists

Governments in developing countries have an intense interest in promoting

increased output diversification at both the farm and national levels (Petit and
Barghouti, 1992; Siamwalla et al. 1992). Cited benefits of farm diversification
are: high and more stable farm incomes and employment, greater long-term
prospects for farm income growth, and more environmentally sustainable farming
systems. Economists, on the other hand, often change the subject at the first
mention of the topic.1

The simplest interpretation of farm diversification as an objective is that

farmers seek to generate a portfolio of income from activities with different
degrees of risk, expected returns, liquidity and seasonality, and adjust their
output mix accordingly. Thus farm diversification would be the allocation of
household productive assets among different income generating activities. Farm
diversification may be distinguished from village-level diversification, where
households become more specialized over time, but village economies offer a
wider array of goods and services for sale, the typical path of rural economic
development under commercialization (Timmer, 1988; von Braun and Kennedy,
1994). Similarly, farm diversification as an objective involves a different set of
issues than export diversification out of a few agricultural commodities, as a
means to stabilize foreign exchange receipts (Bautista, 1992).

1
The definitive literature review in agricultural development economics,
Agriculture in Economic Development: 1940's to 1990's, volume 4 in the massive
Survey of Agricultural Economics Literature edited by Lee Martin (1992),
contains over 1,037 pages. Yet none of the 440 subtitles of this work, and only
a very small handful of the nearly 5,000 titles of professional references
surveyed, mention "diversification," much less "farm diversification."
 2

Most economists in the Western tradition tend to see farm diversification

as the endogenous outcome of economy-wide polices or secular trends affecting
relative incentives. These policies can be primarily on the output or factor price
side (e.g. Schiff and Valdés, 1992) or on the input price or non-price sides, such
as "free" water supplies to farmers that encourage an over-production of rice, or
public investment choices for agricultural research priorities, or the creation of
infrastructure that favors one product over another (World Bank, 1990; Hayami,
1991). Thus farm diversification is perceived as a process of adjustment to
major changes in relative costs, benefits, risks and uncertainties of different
household income generation strategies.

Without disagreeing, we argue that in some cases--but only in some

cases--it makes sense for both economists and governments to approach farm
diversification as a specific objective, even to the point of concentrating analysis
and interventions on favored sub-sectors or outputs. The key lies in the degree
of market development, the degree of prior agricultural transformation and the
relative importance of agriculture in the case concerned. Cases where
agricultural input, factor and output markets work reasonably well--typically
where agriculture has evolved to a point where it has become a commercial
sector just like any other--are very different from those where the
commercialization of family agriculture is still at a very early stage and many
markets are missing.

Where markets work well, by definition relative price changes are

transmitted throughout the economy (in the absence of distortions) and all actors
face a common set of prices (adjusted for distance, etc.). If agriculture is a
relatively well-developed sector, most farmers will be able to respond to those
signals. Since agriculture is only a small share of economic activity, cases that
deviate from the ideal are more an issue for equity than for growth, and can be
dealt with through other approaches besides output mix diversification.

Where markets do not work well, other events will need to occur before
adjustment to relative price changes in the macro economy can be transmitted to
the farm level. If agriculture accounts for a large share of employment and
exports as well, such adjustment in output mixes is crucial to growth as well as
equity. If agriculture is also pre-commercial, shifting into a new set of
commercial activities will require a host of major rural changes besides changes
in output mixes. Under these circumstances, it will be argued, a commodity-
specific approach may be needed to commercialize agriculture, to speed up the
transmission of incentives to the farm level and to promote adjustment of output
mixes in ways favorable for both growth and equity.
 3

Key Issues in the Economic Analysis of Farm Diversification for Different

Types of Economies

Farm diversification in countries with developed markets

In well-functioning market economies of the world, which in addition to the

traditional OECD countries probably includes much of Southeast Asia and Latin
America, the need for policies to specifically promote change in farm level output
mixes arises primarily because of the existence of prior distortions, such as
differential protection to specific crops. These policies have led to over-
specialization in these crops, and the subsidization of certain crop-specific
inputs, such as water, in the case of rice. The barrier to adjustment to new
relative prices--in effect, what prevents response to lasting changes in relative
prices--is typically a policy distortion that drives a wedge between social prices
and prices experienced by farmers. The likely policy recommendation is to do
away with the distortion.

Relevant research is not really a separate category of research from that

dealing with market liberalization generally. In fact, farm diversification would be
an endogenous outcome of pursuing a liberalization objective, not a target in
itself. Indeed, most economists addressing diversification issues today in the
context of functioning markets for inputs, outputs, and factors go out of their way
to insist that they are not trying to pick the winners.

In sum, in economies with strong markets, where agricultural

transformation has largely occurred, and agriculture is a relatively small part of
the overall economy, farm diversification as an objective is probably not a very
important economic issue in its own right, even though the outcome of other
policies for farm diversification is important. The relevant economic issues
concern how to overcome distortions--usually policy-mediated--that drive a
wedge between socially and privately optimal production and sales strategies.
Solutions are likely to be found in policy changes addressing the source of the
problem (such as free irrigation water) and farm diversification (or specialization)
will be an endogenous result of those changes.

Farm diversification in the presence of missing major markets at early stages of

agricultural transformation

In many parts of the world, while some markets for factors, inputs and
outputs may work well, some key markets for agriculture (such as land and
credit, for example) may not exist. Markets may be missing for a variety of
reasons, and we shall solely be concerned here with the case of market failure
from incomplete transformation and commercialization of subsistence
agriculture.
 4

In countries at early stages of agricultural transformation, small and large

farm households in rural areas typically do not have access to the same
technology, information, asset base, input supplies and market outlets. The
same is true for farm households in different locations. Under these conditions,
different farm households are likely to be subject to significantly different levels
of transactions costs for producing and selling the same output mix (Akerlof,
1970; Lopez, 1984; de Janvry et al., 1991). Broadly defined, transactions costs
are the full costs of carrying out exchange, presumably including marketing costs
(Coase, 1960).2 They include intangibles such as search, monitoring and
enforcement, and vary by product, type of agent in the marketing chain, and
individual agent within a category of agents.

Most high value-added products in agriculture are characterized by a high

ratio of transactions costs to final value, because of the high degree of
processing embodied in such items (Binswanger and Rosenzweig, 1986; Jaffee
and Morton, 1995). Examples would be animal proteins and horticulture, which
are prime candidates for farm diversification. Production of these items tends to
increase returns to family resources. They also tend to be products with high
income elasticities, which offer prospects for long-term growth. Rural
households with different asset bases are likely to face different levels of
transactions costs. Poorer households may have more difficulty diversifying into
new activities than more wealthy ones.

Lowering and reducing disparities of transaction costs across rural

households is therefore central in economies at early stages of agricultural
transformation to promoting farm-level adjustment of agricultural output mixes to
major changes in relative prices. Moving the shadow decision prices individual
farmers face (market prices plus transactions costs) closer to a common new
social optimum is central to growth; making sure that poorer farmers also adjust
is central to equity and poverty alleviation. The key issue is the extent to which
addressing high transactions cost barriers separating households from markets
requires a commodity-specific, or at least a commodity group-specific approach.

Policies for growth and poverty alleviation will probably involve increasing
access of farm households--and especially the poor--to information and assets

2
A non-exhaustive list of relevant transactions costs affecting the exchange
of agricultural and livestock products in developing countries is: a) spoilage, b)
quality differences depending on processing, c) lumpiness of initial investments,
d) lags in production, e) seasonal variability, f) search costs, g) screening trade
partners, h) bargaining, i) monitoring and j) contract enforcement (Hoff et al.,
1993; Jaffee and Morton, 1995). In addition, locational issues such as k)
transport, l) handling, m) packaging , and temporal costs such as n) storage,
should be included.
 5

for adjustment, primarily through infrastructure provision and institutional

development for collective action. Sectoral policies of governments play a key
role here, and they typically have important commodity-specific attributes,
particularly when dealing with high-value added commodities that typically have
high transactions costs associated with processing, such as milk and meat in the
tropics.

Present Patterns and Driving Forces of Farm Income Diversification

A snapshot of the process of diversification of the world's agriculture out of

cereals over the last decade can be gleaned from Table 1, which shows relative
growth rates for major farm outputs, excluding non-farm and off-farm income.
For the world as a whole, aggregate production of fruits, vegetables and tree
nuts grew faster from the mid-1970's to the mid 1990's than did cereals or other
crops. Livestock output grew faster than crop output. In developing regions
cereals output grew at slower rates than other crops or livestock, with the
notable exception of Africa. In Africa, cereals production grew at a high rate
than other crops over the period, which included some major droughts.3
However, Africa is the only region of the world where a large share (up to half) of
starchy staples come from roots and tubers (Alexandratos, 1995). It seems
likely that cereals are gradually replacing these crops, given the typically greater
labor intensity of the latter.

Table 1 also illustrates the rapid rise in livestock production in Asia over
the last two decades, where it is the key diversification activity (with fisheries,
not shown) at the farm and national levels. Generally the relatively strong
showing for output growth of livestock and horticultural products over the last
decade illustrates a broader pattern throughout the world of substitution of
horticultural products and animal products for starchy staples in human diets
over time, due to preferences for these items as incomes go up. Although Table
1 does not contain figures for non-farm income, it seems reasonable to suppose
that agricultural income continued to shrink around

3
These are rates of absolute increase. Africa's very high population growth
rate makes per capita growth seem paltry or negative.
 6

Table 1--Compound annual growth in production of major agricultural items by

major regions and selected countries, 1973-1996 (percent per annum)
Region All crops Cereals Vegetables and Livestock
fruits/treenuts
Africa 1.84 2.64 2.14 2.65
Burkina Faso 4.38 4.65 3.14 4.85
Uganda 0.94 1.32 0.64 2.40
Zambia 2.07 -0.20 2.44 1.77

Asia 2.88 2.74 4.41 6.36

Bangladesh 1.68 2.30 1.03 2.01
Indonesia 4.02 4.15 3.62 7.00
Thailand 3.89 1.84 1.45 3.67

South America 2.21 1.86 3.19 3.23

Chile 3.81 3.45 4.14 4.62

Europe -0.05 1.01 0.22 1.20

1984-96 -1.86 -0.69 -0.52 0.25

U.S.A. 0.60 1.03 1.21 1.95

World 1.42 1.76 2.67 2.87

Source: Annual production data from FAO, 1997.
Notes: Compound annual growth rate of annual output in metric tons.
Italicized values not significantly different from zero at 10 percent.
 7

the world as a share of total farm household income and employment, as found
for a selection of developing countries from 1965 to 1988 by Petit and Barghouti
(1992).

In looking at specific country cases, we limit our analysis to the virtually

polar opposites of Asian rice economies and African food/export crop
economies. The former represents cases where markets work relatively well,
agriculture has largely gone through a prior transformation into a commercialized
sector, and it is a shrinking part of the overall economy. The latter tends to
represent cases where some markets do not work well, agriculture is largely
uncommercialized, and it still accounts for the largest share of economic activity.

Economies with functioning markets, where agricultural transformation has

occurred, and agriculture accounts for a shrinking share of employment:
Examples from Asian rice areas

Agricultural diversification has mostly been a hot policy issue in Asian rice
growing countries. Indonesia, for example, went from being the world's largest
importer of rice to being self-sufficient in the decade ending in the mid-1980's
(Hayami and Otsuka, 1994). This pattern was not unusual in the region during
the Green Revolution period, and typically involved substantial policy support for
cereals production, through research and infrastructure investment, and even
outright protection (Pingali and Rosegrant, 1995). Pressure to diversify resulted
from the abrupt fall in world rice prices during the mid-1980's (World Bank,
1990).

Besides short-run price movements, the long-run outlook for many rice
producers in Asia suggests a need for diversification. Under post-Green
Revolution conditions, further growth of cereals production would lead to sharply
falling producer incomes as cereals--being more costly to produce than world
prices and having low price and income elasticities--encountered a domestic
demand constraint.4 Thus there are many pressures to diversify farm resources
into high-income elasticity of demand items, preferably having broad export
markets for outlets (Hayami and Ruttan, 1985).

The quickest form of market adjustment might be to let abrupt price

declines push small farmers and landless laborers off the land into cities. While
sharp declines in rice prices would presumably provide an impetus to diversify,
few governments would be able to ignore the welfare implications for millions of
small producers, even if the short run consequences for poor net consumers of
rice were favorable (Timmer, 1988; Taylor, 1994).

4
Viet Nam and Thailand may be exceptions, but it is hard to see
Bangladesh, Indonesia, and China as major rice exporters in the future.
 8

Given that subsidized provision of irrigation water is one of the main

incentive factors of the Green Revolution, diversification out of rice may be hard
to achieve in the absence of tradable property rights in water that match social
and private costs in water use (Rosegrant et al., 1995). Now that irrigation
infrastructure has been put in, passing on its maintenance cost will require
substantial institutional change (Siamwalla et al., 1992). We therefore need to
be careful about assuming that markets alone will ensure a smooth adjustment
out of over-reliance on cereals.

Equity issues in farm diversification are hinted at by Table 2, which shows

the share of farm household income across the household income distribution
coming from various sectors, for selected cases. The first two, from Pakistan
and the Philippines, arguably represent cases where local markets work fairly
well. The latter two, from Guangdong, China in 1989 and Viet Nam more
recently, represent the case of substantially transformed agricultures in the early
stages of privatization. In the first two, the share of crop profits increases with
income, whereas in the latter, it declines. Private ownership of land is critical to
wealth in the first two, whereas access to non-farm opportunities is more
important for income in the latter two.

The detailed data by income class available for Pakistan and the
Philippines shows that prime farm diversification activities, especially livestock
but also fruits and vegetables, account for a large share of the income of the
poorest households, and the share of these activities declines with increasing
income. Hossein (1988) also shows that livestock, backyard crops, and fisheries
play a special role in the income of the poor in Bangladesh, in both Green
Revolution areas and areas that have not undergone this transformation. David
and Otsuka (1994), in a comprehensive study of the impact of high yielding rice
varieties on income distribution in eight Asian countries, raise the possibility of
an adverse impact of the rice Green Revolution in high potential areas on
incomes in lower potential areas. They show that this was largely mitigated by
out-migration and diversification of low potential areas into non-rice activities.

Choices involved in fostering technological progress and providing rural

infrastructure are likely to remain critical for providing the incentives for
successful diversification of farmers faced with a structural need to adjust their
output patterns away from exclusive reliance on cereals. Efforts in Southeast
Asia to promote diversification while maintaining cereals production incentives
have only had success where technological advances
Table 2--Asian farm household income sources by income quintile (percent of household income, quintile 1 is the
poorest)
Country Quintile Crop profits Livestock profits Agricultural wages Non-farm activities Rents Transfers
Pakistan a
1 6 25 1 50 5 14
1986/87-1988/89, 2 9 24 0 48 5 13
3 province rural
survey 3 12 18 2 44 9 15
4 20 16 1 43 8 13
5 37 9 0 17 21 17
Philippines b
1 29 23 31 17 (Included in "non-farm activities")
1984/85, Mindanao 2 25 18 39 19
3 35 18 28 20
4 36 18 20 27
5 54 10 2 35
Viet Nam c
1 59 (Included with crops and 23 15 - 3
forestry profits)

9
1992/93, 2 57 20 20 - 4
National
3 48 19 28 - 4
4 40 22 35 - 3
5 18 23 52 - 3
Chinad
1 74 (Included with crops and (Included with 22 - 4
forestry profits) non-farm
1989, 2 64 activities) 32 4
Guangdong
3 60 34 - 7
4 48 47 - 4
a
Sources: IFPRI Rural Survey of Pakistan (Alderman and Garcia, 1993; Adams and He, 1995).
b
IFPRI/Institute for Mindanao Culture Survey (Bouis, 1991). Livestock includes fruits and vegetables.
c
Viet Nam, State Planning Committee, 1992/93 Viet Nam Living Standards Survey (1994). "Agricultural
wages" includes non-farm wages.
d
1990 Qingyuan County Farm Household Survey (Hare, 1994). Data is for quartiles. Agricultural wages
includes non-farm wages.
 10

have increased the profitability of alternatives (Hayami and Otsuka, 1994;

Siamwalla et al., 1992).

Where technology is available, the constraints become infrastructure and

institutions. Detailed work in Indonesia by Hayami and Kawagoe (1993) shows
that in countries with good infrastructure and a trader class, private marketing
initiatives can do much to promote the shift of producer resources into
diversification activities. Similar results have been reported for Thailand by
Siamwalla et al.(1992).

Yet much of the agricultural infrastructure built in the 1970s and 1980s in
Asia was built around the objective of cereals production, and in some cases is
fairly specific to that objective by virtue of location or function. Furthermore, not
all areas have the institutional capacity afforded by traditional Chinese traders in
Indonesia. Nineteenth century experience in Denmark (butter) and Japan
(sericulture) suggests that the combination of technological innovation in the
diversification activity (the cream separator and cold storage of cocoons,
respectively) and non-monopolistic institutions of collective action, such as
creamery cooperatives, were critical to historical diversification trends out of
cereals (Hayami and Ruttan, 1985; Hayami, 1991). The need for institutional
innovation for farm diversification will be greatest in economies that have not
gone through agricultural transformation and where agricultural markets do not
work well.

Economies at the early stages of agricultural transformation: Farm income

diversification in Sub-Saharan Africa

By definition, agricultural transformation has not occurred in these cases

and agriculture tends to remain the predominant sector for employment. Many
markets are missing or severely restricted, especially for credit and land. Not all
African economies fit this definition, and not all economies that fit the definition
are in Africa.5 Smallholders in Africa generate significant income from activities
other than growing crops and tending livestock.

The results from 28 household case studies of farm household income

generation across Sub-Saharan Africa are summarized in Table 3. Farm income
includes both income in kind and from net sales of crops and livestock. Local
non-farm income includes income earned by farm people working for wages
(including on someone else's farm) and local sales of

5
For convenience, "Africa" will be used as shorthand for the part of the
continent south of the Sahara and north of the Limpopo River.
 11

Table 3--Income sources for 28 samples of farming households across Sub-

Saharan Africa, various years (in percent of total household income)

Share of farm Farm income1 Local non-farm External non-farm

Income income2 income3
Maximum4 86 8 4
Mean5 63 28 8
Median6 63 20 16
Minimum7 37 51 11
Source: Compiled from data and independent studies listed in Table 1 of
Delgado (1997). The survey data were mostly collected for a single
harvest year, within the 1985/86 to 1988/89 period.
1
Notes: Income from net sales of raw crops and livestock plus subsistence
consumption.
2
Income from local wages (even on other farms) and local sales of
non-farm goods and services, including processed foods.
3
Income from migration, remittances, and transfers.
4
Gambia, uplands areas, 1985/86 (Puetz and von Braun, 1991).
5
Means for each income source separately, across the sample.
6
Zimbabwe, natural region IV, 1988/89 (Mudimu et al., 1993, cited in
Reardon et al., 1994).
7
Senegal, Sahelian zone, 1988/90 (Reardon et al., 1994).
 12

goods and services. External farm income consists of remittances and transfers
and does not depend upon buyers in local markets. These three types of
income have different risk profiles for smallholders, who tend to diversify their
income portfolios across different combinations of these three sources,
depending on local circumstances. Non-farm income in the farm surveys in
Table 3 ranges from 12 to 62 percent of total household income, with a median
value of 36 percent.

The relationship between local and external non-farm income is highly

variable across cases studied. The raison d'être for the two are in fact distinct.
Local non-farm income is largely a result of the development of the local farm
economy for other reasons, such as cash crop development. Spending by
households of cash crop income on non-tradable rural products creates
employment for any under-employed local resources (Bell and Hazell, 1980).
External non-farm income is largely the result of as deliberate effort by
households to diversify into income sources that are not highly co-variate with
local cropping outcomes (Reardon et al., 1988; von Braun and Pandya-Lorch,
1991). Not surprisingly, the correlation coefficient between the two forms of non-
farm income across the 28 cases was low (0.17) and insignificant.

There are significant regional differences in farm income sources within

Africa. Anecdotal evidence suggests that smallholder agriculture in Southern
Africa tends to involve a much smaller number of secondary crops than in inland
West Africa. In the Sahel, 20 to 25 crops per small farm, often inter-cropped in
several different combinations, is the norm rather than the exception, whereas in
the highlands of Eastern and Southern Africa, a dozen crops might be grown
with a much lower incidence of inter-cropping (Ruthenberg, 1976). Farm income
as a whole tends to account for a significantly higher share of total farm
household income in Southern Africa than in West Africa, with the exception of
the countries within the old South African Customs Union, which are heavily
influenced by migration (Delgado, 1997).

In semi-arid and savanna West Africa, the relationship between income

distribution and diversification out of agriculture appears to be monotonically
increasing (Reardon et al., 1994). At very low income levels, people are almost
entirely occupied with subsistence agriculture. As commercialization increases,
people diversify into non-farm income sources that provide some liquidity
outside the harvest period and insurance against risky agricultural incomes. This
appears to be the joint result of stagnant agriculture, risky returns in agriculture,
urban bias that boosted returns to capital in nonagricultural pursuits such as
commerce, and the fact that people principally involved in non-farm activities in
rural areas of the Sahel often still reside on farms, not in market towns.

Diversification into non-farm activities in Africa occurs through different

institutional forms than in Asia. In Africa, the same households tend to be
 13

involved in both farm and non-farm activities; in South Asia, households tend to
specialize, even though different households in the same village may have
different economic functions (Reardon et al., 1994). In the savanna and
Sahelian parts of West Africa, the term "household" itself is misleading. In these
zones, non-nuclear household compounds of more than 100 persons can be
observed, although there is considerable variation among households in the
number of nuclear units and persons.

The high degree of diversification of smallholder farmers in Africa, both

within agriculture and outside of it, appears to be closely related to risk
management strategies devised to cope with risky agricultural returns (Reardon
et al. 1988; Eicher and Baker, 1992; von Braun 1989). Furthermore, for those
involved in single-season agriculture susceptible to climatic risk, diversification
into non-farm activities may be the most appropriate solution. Yet, it seems likely
that such high diversification out of agriculture occurs at the cost of agricultural
intensification strategies, which generally require concentration of farm
investment and labor resources in farm production.

Farm diversification as a target seeks to promote a diversity of

commercially marketed commodities, which is both different from a diversity of
production activities and from actual experience in many African countries,
where major cash earning activities on the farm may be limited to one or two
crops out of the many grown. The solution often addressed for this is to promote
farm-level diversification in "non-traditional exports," or at least into farm
tradables that are different from the traditional agricultural commodity exports.
Thus "farm diversification" as an objective in African smallholder agriculture
should refer primarily to the part of farm household output undertaken
specifically for cash generation, which may be significantly less than half the
value of total output (Eicher and Baker, 1992).6

Experience with diversification into non-traditional commodities at the small farm-

level in East Africa through contract farming and coops

The impetus for farm diversification in these cases stems from the need to
adjust to fundamental changes in price relationships: sixty percent relative price
declines for traditional export crops during the 1980s, and phasing out of many
traditional agricultural subsidies at the farm level during the Structural
Adjustment era, offset by substantial devaluation of real exchange rates
(Hussain, 1994; Delgado, 1995).

6
This is different from the selling of occasional surpluses of grains grown
primarily for household use.
 14

It is often thought that the sum of these forces on Africa’s small, relatively
open economies has tended to increase the relative incentive for smallholders to
engage in production of non-traditional agricultural exports, such as fruits,
vegetables and spices. However, the anecdotal evidence suggests that the
main production response into non-traditional agricultural exportables, in those
countries that have in fact gone forward with macroeconomic adjustment
measures, probably concerns less than 15 percent of small farmers (Little and
Watts, 1994; Jaffee and Morton, 1995).
This raises the question of why other farmers have been slow to adjust
their production patterns and what can be done about it. Part of the explanation
is undoubtedly that proximity to infrastructure or physical access to other non-
price incentives is key for participation, and this is not possible for everyone at
the early stages of agricultural transformation (Lele et al., 1989). However, it is
hard to rule out the intriguing hypothesis that wealthier segments of the rural
population in terms of control of factors of production and access are the first
respondents to new opportunities. The issues then are how soon the rest of the
population will follow, and what can speed the process up.

Clearly rural production and marketing institutions are key in this

environment (Lele et al., 1989; Lele and Christiansen, 1989). Compare what is
required for farmers to diversify into non-traditional tradable activities to what is
available in economies at early stages of agricultural transformation. The eight
requirements are: a) transfer, adaptation, and extension of technology for
producing the item cost effectively; b) investment at farm level, often with some
lag before pay back; c) availability of specialized inputs; d) heavy investment at
the processing level, often in fairly activity-specific facilities; e) availability of
infrastructure (cold storage, roads, airports, etc.) f) a conducive regulatory
environment for commercial risk-taking; g) thorough knowledge of OECD export
markets; h) having an established reputation (trust) in export markets.

These items by and large are not much in evidence in most African
countries. Furthermore, they all tend to be somewhat activity-specific. Even in
the case of roads where transport infrastructure is lacking, policymakers have to
decide whether to build the road to a cotton area or to a tea area, for example,
and the two are not good substitutes. Commodity specialization is required for
accumulating the knowledge required for success in marketing many of these
items, raising the transactions costs for diversifying into any one of them.

The institutions that have been brought to bear in East Africa for reducing
these transactions costs are vertical integration of production and marketing,
contract farming and various forms of producer cooperatives or village self-help
groups. Vertical integration through plantation agriculture tends to work well for
capital-intensive items where rural population density is low (easy access to
land), and quality is fairly uniform, such as palm oil in West Africa. However, it
is not a tool to diversify smallholder agriculture. Contract farming tends to offer
 15

a more attractive option for processors--and a viable means of facilitating

adjustment by smallholders to new structural incentives--where quality of the
item in question is intrinsically heterogenous and highly critical to success,
where land is scarce and labor intensity is high, such as horticulture in Kenya
and cotton in the Sahel (Minot, 1986; Watts et al.,1988; Lele et al., 1989; Jaffee,
1992; Little and Watts, 1994).

For smallholder producers, contract farming reduces risks and most

importantly provides substantial access to specialized information and assets.
For processing companies, it reduces costs and risks of labor supervision,
matches incentives to quality control objectives, and provides access to land,
and may provide some political cover against arbitrary government actions. The
key point for present purposes is that contract farming under the above
structural conditions tends to be successful where it succeeds in reducing farm-
level transactions costs for adjustment to viable commercial opportunities at an
aggregate level. It does this by focusing in an integrated fashion on commodity-
specific sub-sectors.

Producer cooperatives under some conditions might provide an alternative

to vertical integration of processors or contract farming. An example would be
the relatively recent explosion of private small-scale smallholder dairy
cooperatives in Kenya and Uganda (Jaffee and Morton, 1995; Staal et al., 1997).
Since 1990, devaluation of real exchange rates and an end to dumping of milk
powder by the developed countries has radically increased the potential
profitability of domestic dairy in Africa (Staal et al., 1997). The issue is whether
smallholders in zones that can support cattle will diversify their market-oriented
activity out of formerly subsidized items (such as maize in Zambia or peanuts in
Senegal) into the new dairy opportunity or not.

Requiring specialized assets (semi-exotic breeds of dairy cows), the end

product being highly perishable, and having a high share of retail value added
coming from processing, dairy production for market is full of transactions cost
barriers for smallholders. Vertically integrated companies might be an
alternative near major consumption centers. While providing domestic milk in
the short run, such schemes throw away one of the few viable opportunities for
integrating smallholders into economic growth, made possible by rapid
urbanization and macroeconomic reform.

Furthermore, East African experience suggests that vertically-integrated

milk farmers/processors typically run afoul of the high labor intensity of dairy and
the problem of feed costs; smallholders tend to do better on both through more
intensive use of family resources at a lower reservation wage. However,
allowing smallholders to benefit from the new commercial opportunity made
available by economic reforms at home and abroad will require promotion of
institutions of collective action. To date, small-scale producer cooperatives have
 16

played this role in Kenya and Uganda, often with a lot of top down involvement
by NGOs, government and foreign aid agencies. Over time, agricultural
cooperatives in Africa will need a certain amount of state intervention to provide
support for complex technological, financial and managerial functions. Yet they
cannot work unless they are run with substantial participatory involvement of
local people and good local government (Lele and Christiansen, 1989).

Summary and Conclusions

Whether farm diversification should be considered a distinct objective--

rather than an associated outcome--of good economic policy depends primarily
on the economic structure of the economy in question. In places such as the
Southeast Asian rice areas, where agricultural transformation has largely
occurred, markets for goods and factors generally work well, and the role of
agriculture in supporting overall growth and equity is waning, farm diversification
is an important issue. The analytical issues for economists, however, are more
in the area of market liberalization or property rights than in promoting
diversification per se.

In such areas, there is a concern to see farmers diversify into items less
likely to be subject to abrupt price falls in the future than are food grains, given
the low price and income elasticities of demand for the latter. The main concern
for diversification policies however is probably equity, not growth, and
governments probably do not need to be--indeed should not be--involved in
commodity-specific institutional innovation or other direct interventions on the
marketing or pricing side.

Farm diversification acquires a more strategic aspect as an economic

issue in areas where agriculture is still a large share of the economy, farming is
only partially commercialized, some major agricultural markets for goods or
factors do not work well for structural reasons, and the level of technical
progress is low. It is strategic because overall economic development depends
on finding a viable way to commercialize agriculture, and a coordinated policy
approach to sub-sector development will probably be necessary. In many
countries of Sub-Saharan Africa, farm household income is already highly
diversified, although the number and quantity of agricultural items produced
explicitly for sale from any one farm tends to be low.

While smallholder-led agricultural growth is critical for such economies,

intensification paths for such farms are less clear than in the historical case of
the Asian Green Revolution in rice. Increasing farm value-added through high
yield cereals cultivation will not be extended as easily as it was in Asia, because
of the much greater diversity of the agricultural resource base. Promotion of a
variety of high value agricultural tradables will be necessary to provide viable
 17

incomes in rural areas and to provide the rural income base for non-agricultural
spending.

These high value products tend to be subject to very high transactions

costs for market entry by smallholder producers. These high transactions costs
vary across rural households, as they are based on differential access to assets
and information. To some extent this is true outside Africa as well, except that
the institutional base for reducing these transactions costs is especially weak in
economies at early stages of agricultural transformation. In this context, the
poor and the less well informed in rural areas in Africa run a higher risk of being
left behind in the adjustment of farming to a radically new set of relative
incentives in the post-Structural Adjustment period. For these reasons, farm
diversification in the sense of identifying promising candidates among tradable
agricultural outputs seems a necessity for both growth and equity, through
agricultural research, infrastructure investment, and through appropriate
institutional development.

Contract farming is an institution that has worked well in some African

situations, although the total number of farmers involved to date is still low
compared to the number who are not participating. Producer cooperatives have
also had some success in some sectors, such as dairy. However, there have
also been many failures in government attempts to pick winners and become
involved in their marketing in Africa. It is clear that monopolistic approaches to
institutions of collective action are not desirable. Actions taken need to
encourage the use of markets, not replace them. On the other hand, failing to
consider the probable need for a commodity-specific focus in promoting
smallholder agriculture under these conditions is not helpful either.

Farmers and traders have usually been more successful at identifying

lucrative opportunities than economists or governments, and Africa is no
exception in this regard. However, the role of government in acquiring and
sharing information and making assets available to small farmers is still very
large in Africa. Identifying the appropriate rural institutions to mobilize
participation and to incorporate the asset- and information-poor in post-
Structural Adjustment economic growth is clearly a major priority for relevant
policy research in Africa today. The right institutional forms to promote
diversification of marketed output in Africa undoubtedly will involve a mix of
public and private, and will need to associate the skills of better-off farmers with
problem-solving for the smaller farmers. Such research could begin by looking
at existing forms of contract farming and cooperatives to assess their economic
viability, overall impact, and extendability to large numbers of people. Research
should attempt to quantify the barriers to participation in high-value markets by
the poor, and their determinants. It should also develop quantified scenarios for
different investment options to move forward, and the overall impact of these
investments on regional economies. The latter would take into account spin-off
 18

effects of commercialization through high-valued commodities on local regions

where under-employed resources can be brought into economic activity through
the spending of increased farm incomes.

The second set of policy research priorities concerns the links between the
incentives driving farm diversification, on the one hand, and the incentives for
sustainable intensification of farming systems. To the extent that intensification
will probably require moving farming systems in Africa towards less diversity in
total output (even if there is more diversity in commercial output), the present
strong risk management incentives for diversification are likely to prevent such
intensification, at least until market development can make food supplies on the
market more reliable.

A third set of economic research priorities concerns ways and means of

better using growth in dynamic areas--say rice-driven growth in the Mekong
delta--to stimulate growth in remote areas without a comparative advantage in
rice production, except perhaps for local consumption (say the central highlands
of Viet Nam). Experience shows that farm diversification can be a critical
component of strategies to promote national economic integration, and research
is needed to identify the degree to which coordinated government intervention is
necessary on the non-price front (targeted research, roads, extension, credit,
etc.) to allow the non-Green Revolution areas to profit from growth elsewhere.

Finally, environmental concerns have become especially important in the

motivation of governments to promote diversification in Asian rice zones away
from repeated sole cropping of rice. While such concerns are a cost factor
pushing for farm diversification, the economic externality concerns how to share
social costs with private producers. This points to the urgent need for policy
research on water pricing. While resolution of these issues is of undoubted
relevance to farm diversification as an outcome, we have chosen not to attempt
to deal with it as an objective, as this is best done within the general set of
issues on property rights and the environment.
 19

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