Supply chains in export agriculture, competition, and poverty in sub-Saharan Africa: A new CEPR/World Bank book

Nicolas Depetris Chauvin, Guido Porto

Millions of people in sub-Saharan Africa rely on cash crops for their livelihoods . This column presents a new CEPR/World Bank book exploring the effects of increasing competition in these markets. It finds that while competition improves welfare for farmers on the whole, policymakers should still consider the potential winners and losers in each case.

Cash crops are a major source of export revenue for much of sub-Saharan Africa, providing the livelihood for millions of rural households. Given their potential key role in development and as a vehicle for poverty reduction, it is not surprising that the policy debate has focused on how to promote the production of these crops, how to create the enabling conditions for smallholders to benefit from the opportunities created by commercial agriculture, and how to design public policies to facilitate this process (see for example Winters et al. 2004, Harrison 2006).

Until the mid-1980s, the purchasing, processing, and distribution of agricultural commodities in Africa was carried out mostly by state-owned and quasi-government clearing houses or marketing boards. These institutions were created with the aim of businesses preventing predatory behaviour by private firms and to partially isolate farmers from volatile international commodity markets. However, in practice, they also worked as an instrument of heavy taxation and were often regarded as inefficient and corrupt (Bates 1981, Cadot et al. 2009, Tschirley et al. 2009).

Low yields and tight fiscal constraints led to a process of reforms in the late 1980s and especially during the 1990s. This process, that was endorsed and encouraged by the international donor community (Abbot 2007, Cadot et al. 2009, Laven 2007, Tschirley et al. 2009), shaped the domestic market configurations that we observe today, where some countries have fully liberalised the market and price-setting mechanisms while others have only introduced marginal changes. The study of these domestic market structures is critical to understand the potential of agriculture as a vehicle for poverty eradication. The commercialisation of export agriculture is produced along a supply chain where intermediaries, exporters, and downstream producers interact with farmers.

Often, the sector is concentrated, with a few firms competing for the commodities produced by atomistic smallholders. This structure of the market conduces to oligopsony power. That is, firms have market power over farmers and are able to extract some of the surplus that the export market generates. The extent of oligopsony power depends on the number of competitors and on the relative size of each competitor. Changes in the configuration of the market will thus affect the way the firms interact with the farmers. In principle, tighter competition induced by entry or by policies that foster competition can affect farm gate prices and therefore household welfare and poverty.

A model of supply chains in cash-crop agriculture

In our recent book (Porto et al. 2011), we develop a game-theory model of supply chains in cash-crop agriculture between many tiny smallholders and a few exporters to study how the internal structure of export markets and the level of competition affect poverty and welfare in remote rural areas in Africa. Our theory is thus an improvement over reduced-form models of value chains based on conjectural elasticities (Sexton et al. 2007).

Our model allows us to predict, among other variables, farm-gate prices for cash crops under different competition scenarios. We combine those price changes with household survey data to estimate income effects at the farm level. We investigate 12 cases covering four crops and eight sub-Saharan African countries. We study:

the cotton sector in Zambia, Malawi, Burkina Faso, Cote d’Ivoire, and Benin;

the coffee sector in Uganda, Rwanda and Cote d’Ivoire,

the tobacco sector in Malawi and Zambia,

and the cocoa sector in Cote d’Ivoire and Ghana.

Unlike much of the literature that focuses on how external factors such as subsidies in developed economies affect poverty in Africa, our contribution is to explore the role of domestic conditions such as competition policies and market structure in export crops.

Cautious conclusions from competition

Our main conclusion is that competition among processors is good for farmers as it increases the farm gate price of the crop. Scenarios where the leading firm in the market splits or all the firms have equal market shares often generate sizeable income gains for producing households. On the other hand, small changes to the level of competition (for example, the entry of a new small firm) are unlikely to have significant effects on farmer livelihoods.

We were also interested in assessing the effects on farmers’ income of a reduction in competition among upstream firms. We studied the effects of the merging of the largest two firms in the market and of the exit of the largest (and most efficient) firm. We find the effect is the opposite to that under more competition, with smallholders receiving a lower price due to the increase in market power of processing firms.

The survey data allowed us to distinguish the effect of the different simulations on poor versus non-poor households and across genders groups. In 9 out of the 12 simulations, increased competition shows larger income effects in male-headed households than in female-headed households. The three exceptions were the cases of cotton in Benin and Cote d’Ivoire and coffee in Rwanda. Only in 4 out of the 12 case studies has the increase in competition been pro-poor. These four cases where income gains on average benefited more poor households were coffee and cocoa in Cote d’Ivoire, coffee in Rwanda, and cotton in Zambia.

Despite these results, it is not obvious that more competition along the value chain is always beneficial for farmers, especially when we consider the prevailing market failures that are typically observed in the developing world. Take for instance the case of liquidity constrained farmers who do not have access to credit markets to finance inputs and working capital. In those cases, processing companies could provide those inputs to the farmers on loan to be honoured at the time of sale. These outgrower contracts, however, can succeed only if side selling is prevented (Kranton and Swamy, 2008). Given the existing low institutional capabilities to enforce contracts, especially in Africa, often the feasibility of the outgrower contracts depends on purchasers of agricultural commodities having some market power.

For that reason, we also present the results for a model that incorporates outgrower contracts. What we find is that with outgrower contracts, the benefits of increasing competition and the negative effects of a more concentrated market are both reduced. The impacts are, however, rather small except for the case of cotton in Burkina Faso. These results suggest that, while gains from increased competition in the export agriculture supply chain are likely to be expected in Africa, caution to prevent the collapse of the outgrower contracts must also be exercised. Any policy intervention should carefully review how these contracts work in the targeted country and crop and how this intervention will affect the interplay between farmers and firms.

Historically, the development process has been often associated with the industrialisation of rural economies by means of productivity growth in the agricultural sector and the development of export-oriented agriculture. Our study highlights an important aspect of the development of modern commercial agriculture, i.e. the role of competition among agriculture processing and exporting firms and its effects on smallholders’ welfare. How these domestic markets operate may not only affect the enabling factors for this economic transformation process to take place but also its distributional effects. Our book aims to help readers further understand how these complex interactions work in practice. We hope to see more work in this critical area to be able to better inform the governments and developing agencies considering different reform options.

References

Abbott, P (2007), “Distortions to Agricultural Incentives in Cote d’Ivoire”, Agricultural Distortions Working Paper 46. The World Bank.

Bates, R.H. (1981). Markets and States in Tropical Africa. The Political Basis of Agricultural Policies, University of California Press, Berkeley.

Cadot, O., L. Dutoit, and J. de Melo (2009). "The Elimination of Madagascar’s Vanilla Marketing Board, 10 Years On,'' Journal of African Economies 18(3), pp. 388-430.

Harrison, A. (Ed.), (2006). Globalisation and Poverty, forthcoming University of Chicago Press for the National Bureau of Economic Research, Boston, Massachusetts.

Kranton, R., and A. Swamy (2008). “Contracts, Hold-up, and Exports: Textiles and Opium in Colonial India,” American Economic Review 98(3), 967–989.

Laven, A. (2007). “Marketing Reforms in Ghana’s Cocoa Sector,” Overseas Development Department.

Porto,G., N. Depetris Chauvin, and M. Olarreaga (2011). Supply Chains in Export Agriculture, Competition, and Poverty in Sub-Saharan Africa. The World Bank and Centre for Economic Policy Research.

Sexton, R., I. Sheldon, S. McCorriston, and H. Wang (2007). “Agricultural Trade Liberalisation and Economic Development: The Role of Downstream Market Power,” Agricultural Economics 36: 253-270.

Tschirley, D., C. Poulton and P. Labaste (2009). Organisation and Performance of Cotton Sectors in Africa. The World Bank.

Winters, A., N. McCulloch, and A. McKay (2004). “Trade Liberalisation and Poverty: the Evidence so Far,” Journal of Economic Literature 42, 72–115.