Agriculture is central to the economies of developing countries. Central to agriculture, in turn, are smallholder farmers, who traditionally sold their produce locally. Today, however, they have access to far larger, more distant markets, thanks to the Internet and the electronic platforms it has enabled. The problem for farmers, according to HKUST’s Ying-Ju Chen and co-authors, is to find the financing needed to take advantage of these new markets.

Smallholder farmers typically have little spare cash to “procure inputs such as seeds, fertilizers, pesticides and farm equipment,” according to the researchers. This “may significantly affect the supply of agricultural products or even the stability of the whole supply chain.” The remedy is to borrow the money needed, and here there are essentially three avenues open. Each has advantages and disadvantages in terms of incentives and profit. The authors set out to tease apart the various trade-offs using game theory.

Banks are the traditional source of financing. However, smallholder farmers tend not to be particularly creditworthy and lack collateral. They are high risk, and the bank either sets the interest rate accordingly, or may refuse the loan altogether. An alternative is the platform through which a farmer accesses a new market. Such intermediaries tend to have better credit than farmers and can either lend the money or guarantee a bank loan. “With the provision of a guarantee by the platform,” the authors note, “the farmer with low or no creditworthiness can then more easily obtain a bank loan to start the planting process.”

The researchers looked at how different forms of financing affect production and asked which are the most beneficial for the farmer and his suppliers. They also considered the conditions under which the platform should offer a guarantee or make the loan itself, analyzed the preferences of the different players, and examined the interplay between a farmer’s production cost, the platform’s fee, and the interest rate on the loan.

Their results suggested that farmers are most productive when the platform either lends the money or guarantees a bank loan, with the farmer’s preference depending on the production cost and the platform’s fee. They also found that platforms that have a mission of social responsibility can boost farmers’ incentive to produce by charging a lower interest rate on loans they make. This means that “both the farmer and the whole supply chain are better off, and the platform also reaps more social payoff,” the researchers state. “That is, an increase in the level of the platform’s social responsibility concern can lead to a win–win–win outcome for all parties.”

Given the importance of agriculture to developing countries and their growing populations, it is crucial to get the financing of the industry right. While this paper evaluates the options and their trade-offs, it does so on a theoretical level; the authors acknowledge the need to work from hard data. “It would be of empirical value to verify the adoption of the financing formats proposed in this study using real-world data,” they write. “The challenges will mainly come from collecting relevant data and teasing out the focal mechanism.”