Institutional insights into contract theories: A comparative approach to the French and German dairy industries under liberalization.

Author:Derville, Marie
 
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  1. Introduction

    The deregulation of European dairy markets has been rapid and recent; a 2004 reduction in guaranteed prices, which was partially compensated for by direct aid, was followed by a progressive increase in milk quotas until their permanent abolition in 2015. These changes occurred in a context of high instability in the world market prices of inputs and outputs. When this instability spread into the European market, a profound crisis resulted in 2009 (Kroll and Trouve, 2012). Additionally, the deregulation of dairy markets occurred simultaneously with the concentration and internationalization of the downstream end of the chain, i.e., dairy firms and distributors. This development resulted in a change in the competition regime and thereby weakened certain production systems (i.e., small farms in mountainous and low-density areas) and strengthened others (i.e., the Irish and Northern European systems) (Derville and Allaire, 2014b; Nicholson, 2015).

    In response to increasing concern regarding the social and regional influence of market liberalization, several initiatives were implemented at the European Union level: the creation of a high-level group of experts in 2010, the adoption of the Milk Package in 2012, the inclusion of provisions in the new single common market organization (CMO) Regulation of 2013, and the launch of a Milk Market Observatory by the European Commission in 2014. The Milk Package initiatives strove to ensure the future of the European dairy industry after the abolition of the quota system by reinforcing the milk producer's position in the industry. The initiatives offer a European framework to i) establish written contracts between producers and dairy processors, ii) encourage the creation of large producer organizations (POs) (corresponding to as much as 33% of the national collection and 3.5% of the European production), iii) provide POs with the possibility to collectively negotiate milk prices without ownership transfer, and iv) recognize inter-branch organizations. Finally, for protected designation of origin (PDO)/protected geographical indication (PGI)-labelled cheese, collective monitoring of the supply was also made possible.

    However, the new economic crisis that emerged in 2015 in the European dairy market (Trouve et al., 2016) highlights the vulnerability of the dairy industry and suggests that the new framework is either insufficient or is insufficiently applied. Indeed, contractual relationships may transfer the risk to the weaker link of the chain, i.e., the farmers, particularly when they are not collectively organized (Hueth and Marcoul, 2003; Henson and Reardon, 2005; Jongeneel and van Berkum, 2015; Trouve et al., 2016). Collective action in markets may support both a change in market structure and in market differentiation. By creating groups or cooperatives, farmers may indeed be in a position to reach economies of scale, innovate and gain negotiation power, thus overcoming entry barriers and allowing for value creation and capture (Markelova et al. 2009). Collective action is also key to venturing into differentiation strategies. Several studies on the designations of origin (1) have indeed highlighted the contribution of collective action not only to the qualification of the product but also to the value attached to it (Torre, 2002; Allaire, 2013). The design of quality and volume management collective devices appears to be key in the value-creation process as it supports market differentiation (Bontemps, Bouamra-Mechemache and Simioni, 2013; Derville and Allaire, 2014a). More widely, considering the similarities that have been identified between natural common resources and common resources in markets (Markelova et al., 2009; Derville and Allaire, 2014a), it is possible to build on the findings on common pool resources management to draw lessons for collective action in markets. Notably, it has been demonstrated that the capacity to collectively organize and cooperate in resource pooling is related to the physical and institutional characteristics of the transaction (Ostrom, 1990; Menard and Valceschini, 2005; Hagedorn, 2013). Therefore, a change in the institutional context is expected to generate issues for collective action.

    In this context, the objective of this paper is to shed light on the regional adaptation capacity of an industry to a change in regulation and to its consequences in terms of market-access conditions for producers through an institutional approach of contract theory. To do so, a historical comparative approach is chosen. Comparative economics is fundamental to provide a positive evaluation of economic systems (Brada, 2009). This approach enables researchers to explore the similarities and differences in complex situations by comparing configurations, pathways and outcomes across comparable systems (Marx et al. 2014). While comparative economics was initially mainly focused on national comparisons, the interest in subnational comparisons has recently been highlighted (Snyder, 2001). First, this method is a way to establish control over historical, ecological, and cultural conditions. Second, this method offers an indispensable tool for understanding the decentralizing political and economic trends of the contemporary era. The term 'region' is not understood as an administrative boundary but rather corresponds to the intermediary (i.e., subnational) level of the supply chains and market building. This interpretation is in line with the economic geography literature that defines a space as a social construct constituted by its social and economic content and utility for explaining social unity and outcomes (Lefebvre, 1991; Coenen, Benneworth and Truffer, 2012).

    Adopting an institutional perspective, we consider contracts to be a governance structure that efficiently addresses the question of dairy farmers' market access in relation to not only the contractual clauses, partner choice and transparency issues but also the physical and institutional characteristics of the transaction, i.e., the product characteristics and market structure as well as the formal and informal rules, such as quality conventions, that make contracts effective. In other words, we extend beyond transaction cost theory (Williamson, 1985) and adopt a Commons' (1931) definition of the transaction as an "order derived from the conflict" that enables one to take into account the role of institutions not only as a background but also as a social construct in a dynamic and multi-scalar perspective. This theoretical framework will be highlighted in section 2, and it supports the formulation of three hypotheses. First, considering that collective action structuring occurs over time and is spatially differentiated, the establishment of a regulatory framework that favours the formation of farmer groups and the development of formal contracts is likely insufficient to rebalance the power relationships in the supply chain. Second, as in an open market, economic players cannot directly control prices. Changes in the market structure and the producers' responsibilities and rights in the chain are required. Third, only by contributing to value-creation processes, including the building of immaterial regional and sectorial resources (e.g., rules relative to volume management and quality standards) and by monitoring compliance can producers improve their market access (shares and conditions).

    A comparative institutional approach is implemented to test these hypotheses and to disentangle the complexity of drivers of an industry transformation. The cases of Germany and France were chosen for several reasons: i) their social and institutional proximity, ii) their leading position in the European dairy sector (Germany and France, with 31 and 24 million tons of milk collected, respectively, are the first- and second-largest actors); iii) the diversity of their industries, and iv) their contrasting adaptation to change (Germany being among the European leaders in terms of production development during the period of 2008-2014, which is not the case for France). This historical comparative perspective will illuminate the social embeddedness of contractual relations, thus supporting a contextualized evaluation of their efficiency.

    The paper's second section provides a conceptual framework based on an overview of the diverse contract theories of the economics literature, which resulted in the choice to base the hypotheses on an historical institutional framework. The third section is empirical and thus facilitates an operationalization of the framework. The fourth section discusses collective action to improve farmer conditions for market access.

  2. Materials and methods: From a comprehensive comparison of contract theories to an analysis of regional competition regimes

    Coase's (1937) article on the nature of the firm is the source of contractual theories in economics. The central argument of contract theory is that if agents encounter transaction costs, if they can enjoy informational advantages or if non-redeployable investments must be made (i.e., specific assets), the same goods will not be exchanged at the same price, and the rules of a Walrasian market will not be followed. To make their activities compatible and to share the value surplus thus created, agents sign contracts that limit their behaviour and establish coordination mechanisms based on mutual obligations (Brousseau, 1997). Three main approaches have emerged: agency theory (AT), which is based on substantive rationality and considers the relationships between unequal parties (the principal seeking to align the behaviour of the agent with the principal's interests); transaction cost theory (TCT), which is based on bounded rationality and abandons the prescriptive approach to instead approximate the complexity of real phenomena by analysing the diversity of organizational forms; and the third approach...

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