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Sebastian Senesi, Marcos Daziano: Institutional turbulence renders modern technologies insufficient

28 September 2018

The extensive agricultural production sector in Argentina is based mostly on a medium to large scale business model. The production units are connected horizontally by means of (mainly) land leases and (to a lesser extent) ownership in order to increase the scale of production, distribute fixed costs and generate higher income in a generally low-margin business. This way Argentina's large scale farming can be described as a network of agricultural players which cooperate based on contracts rather than vertical and horizontal integration. Sebastian I. Senesi, Director of the Food and Agribusiness Program of the Agronomy School at the University of Buenos Aires, and Marcos F. Daziano, Head of consulting at the same Department, explain what can be expected with regard to evolution of different types of large scale farming in Argentina. How did large scale farming evolve in Argentina?

Sebastian Senesi: Until the 1990s, the agricultural production sector in Argentina was dominated by traditional family farms. The domination of this model ended due to a poor output, low economic growth and low volume of foreign trade. Institutional changes were implemented by the government in the early 1990s in order to move away from the high levels of inflation, unemployment and uncertainty and in order to achieve import substitution. The reform included the privatization of state-owned companies; attaching the local peso to the US dollar to decrease volatility of the exchange rate; and elimination of export taxes for agricultural commodities and reduction of import tariffs on farm inputs, which resulted in a significant reduction of distortions between domestic and international prices.

Marcos Daziano: This resulted in the emergence of more complex forms of organization of agricultural production, designed to benefit from economies of scale and scope and to take advantage of profitable investment opportunities in the agri-food sector. Consequently, the structure of farming enterprises in Argentina shifted from traditional small and medium scale, family-owned farms to a larger scale model of agricultural production based on horizontal growth through ownership, that is integration, and contracts, that is coordination. Now agribusiness constitutes one of the main sources of income for the Argentine economy as the most important exporting industry. The agricultural production in Argentina has grown at a rate two-times faster than the area farmed during the last 20 years. What are the main characteristics of large scale farms in Argentina?

Sebastian Senesi: There used to be five different categories of agroholdings in Argentina in the 1990s based on their organizational form: corporate farms, informal hybrid forms, networks of networks, agricultural trust funds, and investor-oriented hybrid forms. Corporate farms integrate all farm operations into one centrally-governed, privately-owned unit. Informal hybrid forms are built upon contractual relationships based on trust and reputation. The network of networks organizational form centralizes general coordination, while delegating farming coordination to local units. Agricultural trust funds are financial vehicles created with the sole purpose of farming but using this configuration to ensure more security for external investors. Investor-oriented hybrid forms use external funding for farming, contracting services but integrating management, coordination and sales.

Marcos Daziano: The evolution of these different organizational structures shows that just the first three of the identified forms have survived on a wide scale since the end of the1990s until now. Why did the other types of farming fail?

Marcos Daziano: Changes in terms of norms and regulations can reduce or increase uncertainty and transaction costs. With respect to Argentina’s institutional development, there appears to be a strong relation between the level of institutional uncertainty and investments in agriculture and, respectively, organization of farming. As a result of persistent uncertainty, hybrid forms of horizontal and vertical coordination rather than vertical or horizontal integration are pervasive in today’s Argentina. Only big (international and local) investors with local dynamic capabilities such as know-how, reputation and long-term relationships may afford vertically integrated large-scale farming.

From 2008 up to the present, the agricultural area has been steadily growing, although at a lower rate than before. Despite this continuous growth, the share of farmland operated by agroholdings has decreased due to relatively lower commodity prices, higher production costs and, especially, increasing transaction and agency costs. But this did not affect all types in the same way. Corporate farms and smaller hybrid forms were less affected. It appeared that the introduction of modern technologies was not sufficient to overcome the challenges posed by an ever-changing institutional environment and the agency costs that arose from managing such large operations.  What about the sizes of agroholdings in Argentina?

Marcos Daziano: Company mergers can go up to 100,000 ha.

Sebastian Senesi: In some cases, even up to 200,000 ha. You mentioned institutional shortcomings, production and transaction costs. What other problems do large scale farms face in Argentina?

Sebastian Senesi: The problems that large scale farms face in Argentina arise from their relationships with the local society and the way in which they manage the business with respect to input use, human resources and so on. Large farms, which are not publicly traded, are also very reluctant to publish information about their activities. I think that these are the main problems associated with large scale farming in Argentina nowadays. Achieving high profitability is not a problem. Of course, it is always the main objective for a for-profit organization, but I think that environmental and social issues have to be paid more attention to, if we aim for sustainable development of agriculture in Argentina.

Marcos Daziano: I could add the logistics issue as the main bottleneck, especially for larger farmers, because they have to transport a lot of inputs, crops, products, etc. While agricultural production is spreading from the central region to the North and the West of Argentina, logistics becomes an important issue because about 90 % of our freight is done by trucks. It is pretty expensive compared to train or barge transportation. What about the future? Do you think that large scale farming has better development opportunities than farms operating on a smaller scale?

Sebastian Senesi: In my opinion, agriculture will be much more concentrated in the future. If institutional constraints disappear or their effect is reduced, large farms will have the possibility to increase their size. I think that Argentine farms are really able to grow further. Either way this discussion is related to the strategies that companies pursue. Some of them are constrained in growth because they chose to operate based on land lease contracts and this induces high costs of control. Some of them chose to face high cost of capital that prevents them from further growth.

Marcos Daziano: I think that we forget about the fact that the bigger the company gets, the more difficult it is to manage. We live in a really big country, thousands of kilometres from one border to the other. So, at least spatially, there is potential for growth. Probably, the use of modern technologies can partly solve the problem of management and allow big agricultural companies to succeed.