Price transmission in a deregulated Ethiopian coffee market

English: Ethiopia’s coffee industry has undergone numerous structural changes and deregulation measures as a result of changes in the political and economic landscape of the country since early 1992. The state-controlled marketing system has been replaced with markets run by the private sector. Such changes may have an influence on price transmission, the dynamics of shocks through marketing channels, and the performance of the industry. The principal questions addressed by the study are whether the deregulation of the Ethiopian coffee market has resulted in closer interrelationships among producer, auction and world or FOB prices in the vertically related coffee markets and whether it has improved dynamic interrelationship amongst spatially separated domestic coffee markets. Towards this end, the long-run and short-run dynamics between vertically and spatially related coffee markets were assessed employing the threshold vector error correction (TVEC) modelling approach extending the technique developed by Hansen (1999) to deal with inferential biases occurring as a result of specification errors that have been overlooked till to date by applied studies in the field. This study attempts to measure both vertical and spatial price transmission in two separate sections. In the first part, vertical price transmission is analysed by considering six separate markets, each of which has producer, auction, and world prices. This includes five major categories of Ethiopian coffee by origin of production (Sidama, Yirgachefe, Jimma, Wollega and Harar) and the national average price as representative of all coffee types in the country. The second part measures spatial price transmission between six selected pairs of spatially distinct local coffee markets. Monthly price data from the Central Statistical Agency and the Agricultural Market Promotion Department in the Ministry of Agriculture and Rural Development, as well as cross-sectional data from the 2006 coffee market survey, are used. The following salient results were obtained: Firstly, market deregulation in general has induced strong long-run interrelationship between vertically and spatially related markets. Secondly, of the six categories of vertically related market prices in the four groups (Sidama, Yirgachefe, Jimma and national average prices), auction prices are directly affected by world prices (exhibiting dynamic interrelationships) while producer prices are affected by world prices indirectly through auction prices (i.e. weak interrelationship with world prices). Hence the causality flows from world to auction price and then from auction to producer price. In general, producer prices lack direct interrelationship with world prices and are weakly responsive to shocks in world prices, whereas auction prices are highly interrelated with world prices and are responsive to shocks in world prices. Thirdly, in the case of Harar coffee, neither producer nor auction prices show interrelations with world (FOB) prices, which partly accounts for the high concentration of market power and malpractices in the Harar coffee auction and export markets. Fourthly, asymmetries were also found in price transmission where producer prices fell persistently within the equilibrium band from 1998 through 2006 despite unfavourable world prices. This may be partly ascribed to the high local coffee demand, which plays an important price stabilisation role. Fifthly, with regard to spatial price transmission, producer markets located adjacent to each other show clear short-run price dynamics and integration, while others show weak interrelation. As a result, of the six pairs of spatially separated markets, only three pairs show strong integration while the others do not. In general, evidence from vertically related market analysis reveals that coffee growers remain segmented from the world and benefit less compared to participants in the auction and export markets. Similarly, most spatially separated local markets either totally lack short-run dynamics or are weakly integrated. This segmentation and lack of short-run dynamics is partly explained by the current organisational structure of the Ethiopian coffee market system where coffee farmers lack strong producer cooperatives, which might enhance their capacity to bargain for a proper share of the market price. Hence, dismantling market parastatals and deregulation only is a necessary but not sufficient condition for efficient private markets to evolve. In the absence of appropriate infrastructure and institutions at grassroots level, smallholders remain at the mercy of traders. Thus it is important to shift from merely ‘getting prices right’ to ‘getting institutions right’ so as to address market failures arising from imperfect information, contract enforcement and property rights, as well as insufficient provision of public goods, in order to improve the lives of primary producers and thereby reduce poverty.