The importance of social capital and institutional reform is increasingly recognized in current development reporting. This article illustrates the complexity of the institutional environment in which smallholders in developing countries operate and how institutional innovation can contribute to increasing farmers' incomes. A case study of small-scale farmers in the Transkei area of South Africa illustrates the success of new institutional arrangements via a project of the South African wool industry, which aims at improving the livelihoods of farmers by supporting wool production and securing market access. However, possibilities with respect to specialization are limited because of a peculiar institutional environment, in particular a communal land-tenure system.
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