Implicit Contracts and the Grey Market for Fertilizer in China

A common occurrence in many countries is that policy outcomes differ from the official objectives of the policy directives. A good example can be found in China. In 1994, the fertilizer market in China underwent a significant change. In response to strong complaints from farmers in a number of regions about shortages and substantial price increases, the central government set the markup rate for fertilizer as it moved from fertilizer plants to farmers and granted the Agricultural Means of Production Corporations(AMPCs) a monopoly role as the supplier of fertilizer. The results of the 1994 policy reforms were not as expected. Controls on maximum retail prices failed to produce the desired effect and prices for agricultural inputs continued to increase by large margins. In both 1995 and 1996, the actual fertilizer price greatly exceeded the government-mandated price (Xiao, 1998). Nor did enterprises fully follow the controls in other respects. Some broke the allowed limit of 10 percent for products to be sold directly by fertilizer producers, and some trading agencies overcharged by adding more transport and handling expenses than were allowed (Zhou, 1996; Zhang and Ji, 1995; MOA,1996). In addition, although the AMPCwas to be the sole trader, the private traders in many provinces continued to play a significant role – the market share of the private traders ranged from approximately 5 percent in Yunnan province to nearly 25 percent in Shaanxi (Xiao, 1998). Thus, while private trading was not officially sanctioned, a well-defined grey market clearly existed in which private dealers purchased fertilizer from the AMPC and retailed it to farmers.