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Thoughts on PepsiCo in Mexico

A few days ago, The New York Times had an article discussing the gains to trade created by contract farming arrangements between PepsiCo and smallholders in Jalisco, Mexico. What the article describes is typical in the academic literature on agricultural value chains:

“Mr. Ramos and some 300 small farmers here no longer sell their corn to middlemen but directly to PepsiCo, which guarantees the price it will pay for their crops upfront. The deal enables the small farmers to secure credit to buy seeds and fertilizers, crop insurance and equipment.”

This describes one of the important benefits for smallholders of participating in agricultural value chains via contract farming: insurance and market access. These smallholders promise to sell their crops to PepsiCo, in exchange for which PepsiCo (i) insures them against price fluctuations, which we know adversely impact these producers; and (ii) provides them with access to inputs, which they would otherwise not be able to access.

In fact, the economic institution of contract farming, in which a processing firm contracts out its production of an agricultural commodity to a grower, as described by the article, can resolve several such market failures, as denoted Barbara Grosh in a 1994 article that is probably more relevant today than it was when it first came out.

The New York Times article further notes that

“PepsiCo’s work with the corn farmers reflects a relatively new approach by corporations trying to maintain a business edge while helping out small communities and farmers. (…) A growing number of major companies have adopted similar business tacks aimed at profitability that also prove to be economically and socially beneficial for needy people. One of the earliest examples was Danone’s development of a vitamin-enhanced yogurt product that sells for 11 cents in Bangladesh. The product is profit-neutral, but has given the company valuable insights into the 2.5 billion potential consumers who live on less than $2.50 a day.”

Give me a break. “Helping out small communities” has nothing to do with it, and it’s easy to see why Marion Nestle wondered over Twitter whether PepsiCo’s PR people wrote the article. In fact, “helping out small communities” makes PepsiCo look good, but this is probably nothing more than a byproduct of profit maximization in this case.

Sure, there is probably a positive indirect effect to PepsiCo’s bottom line of looking like it is helping Mexican smallholders. But if I were a gambling man, I would bet that this indirect effect is infinitesimal compared to the direct positive effect on PepsiCo of outsourcing its production of corn to Mexican smallholders. Likewise, one analyst interviewed in the article notes:

“Mr. Gupta stressed that what was emerging was not ‘corporate social responsibility,’ a loosely defined concept typically driven by corporate marketing departments, which he said was ‘largely nonsense.’ ‘This is about a company’s core activity, which is something it is constantly thinking about and working to improve,’ he said. ‘Its impact on business can be defined and measured.'”

Having written an entire Ph.D. dissertation on applied contract theory, and having studied contract farming and agricultural value chains since 2006, one of the things I firmly believe about these arrangements is that we would not be observing them if they were not profitable for both the processing firm and the growers it contracts with.

From having written a paper on the welfare impacts of contract farming, I also believe that the institution can make people better off, both directly (i.e., by raising their income) and indirectly (i.e., by insuring them against price fluctuations), but that these effects tend to be overestimated in the literature because of identification problems.

Here is another paper that provides a useful conceptual framework to analyze the value chains within which producers like the ones discussed in the New York Times article operate.