Supply Chain Management can Mitigate Poverty

Supply Chain Management can Mitigate Poverty: Evidence from Madagascar

by Isabelle Koehler

Are global supply chains a threat or an opportunity for developing countries?
Does globalization rather exploit poor farmers or does it have beneficial effects?
This paper addresses this questions and shows recent evidence how the poor in Madagascar could benefit from integration in global supply chains.

Current situation and past supply chain improvements

Madagascar, an island at the coast of Africa with about 22.3 million inhabitants, is one of the poorest countries in the world and even the poorest in Africa. About 77% of the households currently live below the national poverty line, meaning they live on less than one dollar per day. Poverty is especially evident in the rural areas (World Bank, 2013).

After a major political crisis in 2009 and a subsequent severe economic downturn, Madagascar’s GDP has constantly grown at about 2-3% per year and currently amounts for 9.975 billion US$. The agricultural sector as the main driver for this growth represents almost 30% of GDP. However, the productivity of this sector is still on a very low level because it is mostly carried out by smallholders, who do not have efficient production techniques (World Bank, 2013; IFAD, 2013; GIZ, 2012).

The country also faces major challenges like enduring political instability as well as frequent exogenous shocks. Through its strong export-ties with Europe and the U.S., Madagascar is especially sensitive to global economic downturns and also suffers frequently from natural disasters like cyclones, droughts and flooding (World Bank, 2013; Country Overview, 2013).

While the value of Madagascar's exports increased by 36% and amounted to 1.5 billion US$ in 2011, it formed 15% of GDP. The most important export goods are seafood, rice, vanilla, gloves, coffee, cocoa, litchi, pepper and apparel. The agricultural exports thereby amount for more than 70% of total exports, which clearly shows its huge impact on the economy (UN Comtrade, 2012).

Due to a very unique biodiversity and a lot of unprocessed, cultivable land, the number of farmers and especially the number of those who export vegetables is constantly increasing (Minten et al., 2009, p. 1729; FAO, 2013).

Nevertheless, the farmers who are mostly smallholders face various adverse conditions: The most adverse condition is the infrastructure for transportation, communication and electricity which is still very underdeveloped. Bad roads raise the costs for shipment of the farmers’ produces and increase the prices they have to pay for transporting purchased agricultural inputs and consumer goods from the cities to the remote rural areas. Those high transaction costs burden the incomes of the farmers very strongly and create a physical barrier to the markets (World Bank, 2013; Vachani & Smith, 2008, p. 54; Poulton et al., 2010, p. 1413) (see Exhibit 1).

To improve this circumstance and mitigate the rural poverty, the government continuously strives to meliorate the economic and social conditions. By investing heavily in local infrastructure projects to develop rural areas and through strong investments in health care, they try to boost economic growth. But by doing this, they are entirely dependent from collaborations with international organizations: More than half of the government’s budget and so 75% of total public investments are sponsored by external aid, which comes mainly from the World Bank, the European Commission, the United States, and from the African Development Bank. Recent projects like the “Additional Financing for the Transport Infrastructure” of the World Bank aim at the rehabilitation of the infrastructure by mainly repairing roads and supporting railway operators to reduce future transport costs and facilitate trade as a whole (World Bank, 2013). Those efforts build a very important basis for effectively involving the producers at the ‘bottom of the pyramid’ in global supply chains.

Although in this way the overall situation has slightly improved over last few years, the donor’s cutbacks of their aid during the political crisis in 2009 caused major throwbacks for the economy and also stressed the macroeconomic stability as tax revenues have fallen considerably (World Bank, 2013; IFAD, 2013). So at the moment the economy has to recover from that severe incision and come back to its former path of growth.

However, in the last few years there were also many other projects launched by international organizations and enterprises that aimed at integrating poor farmers in global value chains to alleviate their poverty by improving their production and so to raise their incomes. To make it possible that farmers can participate in international trade, the UN has launched several initiatives like the Everything but Arms (EBA) initiative, which eliminated quotas and duties for developing countries like Madagascar and so gave their vegetables and fruits preferential access to the European market (European Commission, 2001). Madagascar also gained liberal access to the US market by the African Growth Opportunity Act (AGOA), which allowed them to export apparels duty-free and quota-free (ITA, 2000) and so to establish strong trade relationships. Those initiatives have also built an important basis for supply chain integration of the poor as they are a prerequisite for Malagasy exports.

More recently, more and more foreign companies are also attempting to integrate the Malagasy poor directly into their supply chains: Either they integrate them as suppliers from whom they can source or they use the micro-entrepreneurs as distributors of finished goods (Sodhi & Tang, 2013, p. 2). However, the first alternative seems much more prevalent in Madagascar at the moment.

Again, the poor face major obstacles when being used as suppliers. Apart from the transportation hurdle the farmers are exposed to asymmetric information as they lack information about market conditions and prices for their produces. They are also not able to assess prices correctly during the purchase of inputs and this major disadvantage can easily be exploited by better informed parties. Furthermore, the Malagasy smallholders lack knowledge and skills. They do not know how to achieve the best possible results out of their cultivations due to missing processing techniques and they also lack bargaining skills and knowledge where and how to sell their produces best. The prevalent illiteracy among the farmers plays an important role as well, as it hinders them to derive value from presented information and which easily results in missed income opportunities (Vachani & Smith, 2008, p. 55).

To break through those obstacles, a very well-working and recently even more used practice for using small farmers as suppliers while not exploiting the farmers’ disadvantages is “contract farming”. There, the companies create sales potential for the smallholder’s produces and improve their technical processes and sustainability of their agriculture. An underlying written contract between the smallholder and a company serves as a basis and specifies the input, credit conditions and prices by product. While the farmers consequently have to follow the rigid conditions, they are provided trainings and assistance during the production process. As most farmers could not afford buying expensive inputs like fertilizers and pesticides to leverage their production, the offered credit option is especially valuable for them. By this way they can buy those inputs in advance and pay the credit for it back when they receive income from selling their leveraged products. In addition, by granting fixed prices farmers are able to achieve a stable income which is not dependent any more from seasonality. Finally smallholders can profit from learning effects: They get to know efficient and modern production techniques which they can also apply to other cultivations than those under contract (Minten et al., 2009, p. 1729; Swinnen, 2007).

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