| Abstract: |
How does competition affect market outcomes when formal contracts are not
enforceable, and parties' resort to relational contracts? Difficulties with
measuring relational contracts and dealing with the endogeneity of competition
have frustrated attempts to answer this question. We make progress by studying
relational contracts between upstream farmers and downstream mills in Rwanda's
coffee industry. First, we identify salient dimensions of their relational
contracts (unenforceable provision of services in both directions before,
during and after harvest) and measure them through an original survey of mills
and farmers. Second, we take advantage of an engineering model for the optimal
placement of mills to construct an instrument that isolates geographically
determined variation in competition. Conditional on the suitability for mills
within the catchment area, we find that mills surrounded by more suitable
areas: (i) face more competition from other mills; (ii) use fewer relational
contracts with farmers; and (iii) exhibit worse performance. In contrast to
conventional wisdom, an additional competing mill also (iv) makes farmers
worse off; (v) reduces the aggregate quantity of coffee supplied to mills by
farmers; and (vi) conditional on the farmer's distance from the mill, lowers
relational contracts more for farmers close to the competing mill, suggesting
that competition directly alters farmers temptation to renege on the
relational contract. The finding that increased competition downstream leaves
all producers -- including upstream producers -- no better-off suggests a
potential role for policy in a second-best environment in which contracts are
hard to enforce. |