| The point is to understand the conditions under which they
[markets] fail or function at an inefficient level and to determine if appropriate
policies grounded in an understanding of these conditions can fix such inefficiencies.
Debraj Ray, 1998
The agricultural marketing and pricing policies pursued by
developing countries have received considerable attention from the international community
over the last two decades. Almost all developing countries have pursued agricultural
(i.e., marketing and pricing) policies that have undermined domestic production and have
depressed rural incomes with the aim of spurring industrialization. In a number of African
countries, agricultural marketing boards provided a direct mechanism by which the price
producers received for export crops was suppressed relative to world market prices. This
was accomplished by granting marketing boards monopoly power over the pricing and
marketing of cash crops. Following the seminal work of Bates (1981), a wealth of research
has focused on the negative impact such policies have had on agricultural productivity and
economic growth in Africa (e.g., Arhin et al., 1985; Schiff and Valdes, 1995). A commonly
overlooked benefit of marketing boards, however, is their support of forward markets. A
forward sale (purchase) is simply an agreement to sell (buy) a given commodity at a future
date at a predetermined price. Marketing boards enabled forward sales to occur between
overseas buyers and exporters, exporters and the marketing board, and ultimately through
preannouned prices to domestic producers. In some countries, such as Ctte d’Ivoire,
forward purchases were mandatory for licensed exporters. In the absence of an
administratively determined minimum price, such transactions are particularly important to
producers; the ability to secure a price in advance of harvest reduces the exposure of
producers to market price fluctuations and enables producers to adjust their use of inputs
accordingly. Analysts have also argued that forward sales provide an income benefit to the
country as a whole by improving export earnings. This is because forward prices tend to be
higher that spot prices (McIntire and Varangis, 1999).
Since the early 1980s the World Bank has promoted pricing and marketing
reform of the cash crop sector in African countries, primarily through its structural
adjustment programs. Reform measures include price liberalization (in the context of
exchange rate reform) and the elimination of marketing boards (World Bank, 1994; Varangis
et al., 1990). Although such reforms are often justified on the basis of higher average
producer prices post-reform, in several countries price liberalization and marketing
reform have also been associated with the temporary collapse of forward markets. The aim
of this paper is to present an understanding of the conditions that have contributed to
this phenomenon, and to outline the key issues that policy interventions will need to
address in order for forward markets to be maintained during future reform programs.
Section 2 presents a brief discussion of marketing boards in Africa and the impact of
policy reforms on forward markets in Nigeria. Section 3 outlines the central elements of
the problem, discussing how asymmetries of enforcement and information can result in the
collapse of markets. Section 4 then highlights institutions that have emerged in several
African countries as a consequence of liberalization. Such institutions suggest that with
appropriate design, agricultural policy reforms need not result in the collapse of
forward markets. Section 5 offers policy implications and concluding remarks.
2. Marketing Boards and the Impact of Policy Reform on Forward
Marketing boards can be traced back to the colonial period,
established to promote the interests of farmers, notably price stabilization and
agricultural development and extension. Following independence, marketing boards were used
by African governments to control the distribution of inputs for agriculture, to purchase
farmers crops, and as instruments of political patronage. Attempts to stabilize commodity
prices rarely occurred, and African governments diverted an increasing share of marketing
board resources to general capital investment funds to support development initiatives.
(Bates, 1981; Arhin et al., 1985; Krueger, 1993).
Marketing boards typically auctioned their expected crop forward to
licensed private exporters prior to the actual harvest. Once exporters have purchased a
forward contract, they may wait for delivery and sell on the spot market, sell through
their direct contracts with overseas companies, or sell the forward contract forward to
overseas buyers (Shepherd and Farolfi, 1999). Forward transactions carry significant
risks, and in the absence of a margin system or recognized entitlement such as a warehouse
receipt, forward transactions will occur only if the forward seller has good credit
standing. This is because forward sellers have an incentive to renege on the forward
contract if prices subsequently rise ("non-delivery risk"). The risk of
non-delivery is reduced by the intervention of a marketing board. The marketing board, by
setting the price producers will receive and being the sole legal purchaser of export
crops, can be fairly certain of the aggregate crop it will have for the coming season.
Hence, a marketing board may be viewed as a reliable counterpart. Because the risk of
non-delivery, a marketing board is often able to sell its expected crop forward well in
advance of harvest. In Ctte d’Ivoire, for example, prior to the 1995 reforms the Caisse
de Stabilisation (Caistab) was able to sell cocoa forward up to 18 months in advance
(McIntire and Varangis, 1999).
Beyond suppressing the price producers received for their crops,
marketing boards were typically inefficient in the distribution of agricultural inputs,
with stories of fertilizer being delivered after harvest and other breakdowns of the
distribution system being quite common (Shepherd and Farolfi, 1999; Krueger, 1992). To
improve the terms of trade for domestic producers and increase agricultural output, the
World Bank has promoted the elimination or privatization of marketing boards as a central
component of its agricultural policy reform strategy. A key motivation behind the adoption
of market reforms is that the decentralized operation of a private-sector based marketing
system is more flexible than a centralized marketing board system, and can therefore
respond more appropriately to changes in market conditions.
Assessments of reform programs in Africa suggest, however, that in
countries where the government has fully withdrawn its activities, in general the private
sector has not been able to effectively replace the functions provided by the state (OED,
1997; Badiane, 1994). One evaluation of reform efforts concludes, "liberalization and
privatization have replaced often unreliable, high-cost, and centralized forms of state
marketing with private markets that are competitive but often lacking in information,
infrastructure, and are poorly integrated and coordinated with other key production and
market enhancing activities." (Jayne and Jones, 1996:4).
I argue that in African countries and in developing countries more
generally, problems of enforcement and information emerging at the time of transition
represent the key obstacles to the efficient functioning of forward markets. The simple
model of a smoothly operating market with complete information which underlies the
conventional argument for policy reforms is therefore misleading. Under conditions of
asymmetric information, there may be private traders who would like to secure their
quantity for export in advance, and similarly, producers who would prefer to "lock in
a price" for their crops in prior to harvest. In the absence of government
intervention, however, market forces alone need not result in a Pareto efficient
equilibrium. In Nigeria, for example, evidence of this market failure is the dramatic
decline in forward sales following policy reforms. After liberalization and marketing
reforms were implemented in 1986, producer prices increased, but forward sales in the
country’s major export crops also temporarily "disappeared." (McIntire and
3. Enforcement, Information and Forward Markets
A common explanation of the failure of local forward markets
focuses on problems of enforcement; in the absence of a margin system or collateral,
producers have an incentive to renege on the forward contract if prices subsequently rise
(McIntire and Varangis, 1999). Knowing this, private traders will be reluctant to engage
in forward transactions with producers. Overseas buyers, in turn, will be unwilling to
commit to forward transactions with private traders. However, similar problems have been
resolved through certain mechanisms in rural credit markets. Credit markets and forward
markets share the characteristic that a promise is made today, that may not want to
be fulfilled tomorrow. This section outlines the mechanisms used in rural credit markets
to induce borrowers to want to fulfill that promise, and then describes why such
mechanisms have not emerged in markets for exportable crops. The fact that such mechanisms
have not been established in exportable markets prior to the implementation of policy
reform does increase the difficulty of enforcing contracts. I argue in section 3.2,
however, that the common explanation of forward market failure overstates the risk of
In rural credit markets, it is common to see lenders employ indirect
mechanisms to enhance the probability that borrowers will pay back their loans. First,
lenders may use the threat of cutting off future access to credit to induce borrowers to
undertake the actions desired by the lenders. Hoff and Stiglitz (1993) point out that for
this incentive to be effective, borrowers must enjoy some surplus from obtaining loans.
"Those who are lucky enough to get loans get a consumer surplus, and that consumer
surplus, being denied to the unlucky, is in effect a rent." (1993:40).
Second, lenders may use cross-contractual terms to affect the
probability of default, thereby linking the terms of transactions in the credit market
with those of transactions in other markets. For example, traders in local crops, who are
also lenders, generally require their clients sell all their crops to or through them.
This trader-credit linkage makes information on the size of the borrower’s operations
available to the creditor and to no one else. A useful by-product is that the lender has
first claim on the crop (Ray, 1998).
Understanding the dual roles played by marketing boards also enables
one to gain an understanding of why similar mechanisms have not emerged to reduce the risk
of non-delivery for exportable crops. First, marketing boards themselves extended credit
to producers. As the sole purchaser of export crops, marketing boards could be confident
that that they would obtain repayment for this credit when they marketed the crop. Second,
marketing boards also subsidized and distributed agricultural inputs such as fertilizer
and pesticides (Bates, 1981; Krueger, 1992; 1993; Shepherd and Farolfi, 1999). Private
traders who now supply inputs have no guarantees with regard to credit repayment, and
consequently, input use for cash crops has dropped significantly (Shepherd and Farolfi,
1999). Both cases illustrate that because of the operation of a marketing board, the
informal institutions that would likely have developed in response to enforcement problems
did not need to emerge. The fact that such mechanisms have not developed prior to policy
reforms raises the difficulty in enforcing forward contracts relative to rural credit
3.2 Informational asymmetries and producer exploitation
Klitgaard (1991) observes that in many developing countries,
farmers are often poorly informed about market prices. A study in Malawi, for example,
shows that three-quarters of maize farmers did not know the price of maize that could be
obtained through the legal outlets; 50 percent of survey participants "had no
idea" of the current market price and were unwilling to even guess. The implications
of Klitgaard’s finding are striking - it is inconsistent to argue that producers will
renege on forward contracts if the market price rises above the forward price, while
observing that most producers are unlikely to even know that the market price has risen.
Consequently, by assuming that farmers have perfect information regarding prices, the
common explanation of forward market failure is likely to overstate the risk of
non-delivery. I suggest that an important, though largely ignored risk is the risk that
private traders will use such information asymmetries to their advantage, for example, by
offering producers a less than fair forward price. More importantly, traders have an
incentive to mislead producers on price. When no widely known forward price exists, each
transaction is conducted by bargaining and the trader will collect excess profit by
inducing the producer to think that the forward price is lower than it actually is.
Understanding this, the producer cannot overcome asymmetric information simply by asking
each trader about price. Even if enforcement is perfect, informational asymmetries may
drive the market to a Pareto inferior equilibrium in which no forward sales take place,
and neither the producer nor the trader, when acting individually, has an incentive to
change his behavior so as to help move the market to a Pareto efficient equilibrium.
The exploitation of farmers by private traders is not uncommon in
African markets, or for that matter, in developing countries generally. Price exploitation
has been observed in Ethiopian markets, for example, through the covert use of false
weights and measures. Price exploitation by "unscrupulous traders and
speculators" was also observed in a number of markets in Zambia during the early
1980s (Klitgaard, 1991:38). Moreover, because marketing boards offered producers an
administratively determined price, producers had no incentive to form cooperative
organizations or develop the skills necessary to engage in price discovery. McIntire and
Varangis (1999:23) note that in the absence of a marketing board, the lack of such
organizations and skills result in producers being "dependent" on both the
government and well-organized private exporters.
3.3 Explaining the temporary collapse of forward markets in
The case of Nigeria is interesting, in part because it
represents the "worst practice" in terms of managing a transition. In December
1986, the government abolished the six marketing boards that held a monopoly on the
pricing, subsidization, purchase, and marketing of oil palm, cocoa and coffee, rubber,
cotton, groundnuts, and grains. These changes were made rapidly and with little planning.
The roles to be played by the private sector were not clearly defined, and steps were not
undertaken to ensure that major functions being carried out by the marketing board were
adequately transferred to the private sector. Also, administratively determined prices
were liberalized "overnight", but indicative prices were not provided (Shepherd
and Farolfi, 1999).
There are obviously a fair amount of policy mistakes in this example,
and isolating the specific factors that lead to the forward market collapse would be
difficult. In the preceding sections I have presented two general points: first, informal
enforcement mechanisms require time to develop; and second informational asymmetries
emerge at the time of transition. When no widely known forward price exists, such as this
case, I have argued that asymmetric information is likely to drive markets to a Pareto
inferior equilibrium. While it is arguable that this collapse was driven by other factors,
it is unlikely that poor contract enforcement is a sufficient explanation, as forward
sales surged three seasons later under similar conditions of contract enforcement
(Shepherd and Farolfi, 1999).
I have argued that in African countries, and developing countries more
generally, enforcement problems and informational asymmetries emerging at the time of
transition represent the key obstacles to the efficient functioning of forward markets. An
understanding of these two conditions is necessary if development organizations and
country governments wish to pursue export sector liberalization while also maintaining
forward markets. The following section presents institutions that I believe reflect this
4. Overcoming Problems of Enforcement and Information
Established after liberalization and marketing reforms were
implemented in several African countries, commodity exchanges have shown that it is
possible for institutions to be designed to overcome problems of information and
enforcement in the agricultural marketplace. The process of price discovery at these
exchanges is transparent and market-driven, and prices are widely disseminated. In
addition to conducting spot and forward transactions, commodity exchanges also provide
services such as transportation, storage, and information dissemination. For producers,
forward transactions can minimize the costs related to storage as well as the risks
associated with price fluctuations. Contracts are also fairly standardized, which tends to
enhance market liquidity and reduce transaction costs (Lovelace, 1999).
Although transactions are not handled through a clearinghouse system,
several mechanisms are employed to mitigate the risk of non-delivery. First, producers
much purchase a membership in the sponsoring farmer’s association to be eligible to
participate in the exchange. Second, producers are often required to adhere to rigorous
time schedules for delivering their crop. Third, producers must agree to abide by the
constitution and rules of the farmers association or risk financial penalty or expulsion.
Here too, "membership has its privileges." In addition to participation
in the Agricultural Commodity Exchange, members of Zambia’s National Farmers Union,
for example, are also eligible to received technical assistance, financial advisory
services, legal advisory services, and a monthly newsletter. Exchanges in Zimbabwe,
Zambia, Kenya and Uganda are described below.
Zimbabwe Agricultural Commodity Exchange. The Zimbabwe Agricultural
Commodity Exchange (ZIMACE) was established by a group of farmers in 1994 in response to
the gradual liberalization of state-controlled agricultural marketing. The Exchange
conducts spot (i.e., cash) and forward transactions in a number of commodities, including
maize, wheat, sunflower seed, groundnuts, cottonseed, popcorn, sorghum and recently, live
pigs. Maize transactions tend to dominate trading activity, however, the trading volume of
wheat contracts are increasing steadily (ANS1, 1995; ANS2, 1997).
Zambia Agricultural Commodities Exchange. The Zambia
Agricultural Commodity Exchange (ACE) was established in 1994 by the Zambia National
Farmers Union (ZNFU) and the Commodity Research Institute. The Exchange conducts spot and
forward transactions in wheat, white and yellow maize, sorghum, oilseeds and groundnuts.
The success of the ACE has contributed to the development of the Kapiri Commodity
Exchange (KCE) in Zambia’s central province and the Eastern Agricultural
Commodity Exchange (EACE) in Zambia’s eastern province, both launched in 1997
(ANS3-4, 1997). ACE, in conjunction with South African Futures Exchange (SAFEX), also
publishes SAFEX prices ex-Lusaka – futures prices on SAFEX plus transport, duties,
and clearing differentials, thereby enhancing liquidity in both markets.
Nairobi Coffee Exchange. The Coffee Board of Kenya set up the
Nairobi Coffee Exchange as a separate entity in 1998. In doing so, the Exchange replaced
the functions previously performed by Kenya Coffee Auctions Limited. Equipped with an
electronic trading system, the Exchange aims to become the hub for coffee trading in
eastern Africa, and eventually expand its coverage to include additional agricultural
commodities. If successful, it is possible that futures and options will be listed in the
future (ANS5, 1998).
Uganda Commodity Exchange. The Uganda Commodity Exchange (UCE)
is expected to begin operations in 1999. Basic commodities to be traded include coffee,
maize, cocoa, wheat and rice. The Exchange is expected to evolve in stages. The first
stage will be a coffee shop, lasting for six months. The coffee shop will bring buyers and
sellers together without the use of graders (testers) or inspection by UCE. The second
stage will be a spot exchange, in which trading will take place using samples under UCE
supervision. The final stage will be a cash exchange, in which spot and forward trading
will take place. The latter two stages have two-year development windows (ANS6, 1998).
5. Policy Implications and Concluding Remarks
Klitgaard (1991:37) has stated, "When information is an
obstacle to fair and efficient markets, information may also be part of the
solution." Examples both from other markets and from other countries suggest that
when markets fail to generate sufficient information, governments or third parties should
intervene to perfect their workings. This paper has argued that enforcement and
information problems are the primary reasons why forward markets are likely to fail
following export sector liberalization. It has challenged the conventional
"wisdom" of market failure in local forward markets, suggesting that, because it
assumes that producers have perfect information regarding prices, this view overstates the
risk of non-delivery. It has also drawn attention to a largely ignored risk, the risk that
private traders will mislead producers on price to capture excess profits. Even if the
trader’s profit margins are small, the resulting equilibrium is likely to be socially
It concludes that, while formal legal institutions and enforcement
mechanisms are both important and necessary, the key to maintaining forward markets during
policy transitions lies with providing information and carefully managing transitions.
Managed transitions, rather than rapid transitions, are likely to provide the time
necessary for producers to function effectively in a liberalized environment and informal
enforcement mechanisms to develop. Enhancing the flow of information through widely
disseminated pricing and other market information and fostering the development of
producer and producer-trader associations are all options that warrant attention. It has
been said, "The role of governments should be to try to create conditions where a
climate of trust between the farmers and private sector can be developed." (Shepherd
and Farolfi, 1999:75). Commodity exchanges illustrate the possibilities when such virtuous
conditions are created. As Debraj Ray notes, if policymakers look beyond the surface and
understand how information and enforcement problems can lead to market failure, then
appropriate policies grounded in an understanding of these conditions can be designed. If
they do not, I imagine that policy reforms will continue to expand markets in advance of
the institutions required to manage them and ensure their sustainability.
African News Service, Inc. (ANS):
_____,ANS1 - "Zimbabwe Farming Commodity Exchange Seen
Growing." August 25, 1995.
_____,ANS2 - "Zimbabwe: Private Exchange Looks Bullish."
March 25, 1997.
_____,ANS3 - "New Commodity Exchange Firm Set Up." May 17,
_____,ANS4 - "Zambia; East Unions Form Body." June 23, 1997.
_____,ANS5 - "Kenya: New Coffee Auction System a Great
Boost." May 4, 1998.
_____,ANS6 - "Commodity Exchange to Ease Marketing."
September 11, 1998.
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By Jason A. Lovelace
Woodrow Wilson School of Public and International Affairs