Low competition undermines consumer welfare. Collusive agreements are flexible enough to deflect the effect of a small number of new traders.

Policymakers often lament the ‘food price dilemma’: smallholder farmers are better off with higher crop prices, but consumers want lower prices (Timmer 1983). Well-integrated agricultural markets can tackle both sides of this food-price dilemma, by pulling crops out of surplus areas (to boost prices received by farmers in rural communities) and pushing food into deficit areas (to reduce prices faced by consumers in urban communities).

But agricultural markets in sub-Saharan Africa show signs of poor integration. Wide variation in prices across regions and seasons is common (Burke et al. 2017), and large gaps between farmer and consumer prices are the norm. There are many possible causes. One issue is that trade is expensive to conduct in the region. To move crops from surplus to deficit areas, agricultural traders must pay high transport costs (Teravaninthorn and Raballand 2009), spend time and money searching for sellers and buyers (Aker 2010), and battle institutional failures like poor contact enforcement (Startz 2016). Yet, there may be another important driver of poor integration – one that has been voiced by policymakers but is much less well-documented empirically: agricultural traders may be engaging in imperfect competition and extracting rents.

Exerting market power: Imperfect competition and rent extraction

It’s easy to see how this could happen. Becoming a wholesale agricultural trader is difficult – it requires enough working capital to pay for a truck, warehouse, and inventory, as well as a large network of contacts to identify market opportunities. These start-up costs may create barriers to entry that allow traders who are already in the business to exert market power, paying below-competitive prices to farmers and charging above-competitive prices to consumers. However, empirically documenting this practice is difficult. Traders rarely keep detailed enough records to accurately assess their profits, and self-reporting bias may be a problem in an environment in which they are fearful of being seen as exploitative.

Consequences for policymakers: Targeting competition

Whether traders exert market power matters for policymaking. If they are operating in a competitive environment in which price gaps are purely due to high transactions costs, then policies that reduce these costs – road improvements, greater access to business loans, and trade intelligence systems for broadcasting prices, for example – would yield savings that traders would pass on to farmers and consumers. On the other hand, if traders are colluding, gains from policies that reduce traders' operating costs may not be fully passed on to farmers and consumers; instead, the bulk of these benefits may be captured by the traders themselves. To meaningfully improve farmer and consumer welfare in such an environment, policies may need to target enhanced competition.

The study: Testing competition in agricultural markets in Kenya

In a recent paper, I implement an experimental test to measure the degree of competition among agricultural traders (Bergquist 2017). In 60 markets in Kenya, I offer a subsidy to maize traders for each bag they sell. The subsidy is offered to all traders in the market for a full month.  The timing of the subsidy offer is randomised, allowing me to estimate how much of this subsidy is passed through to the price traders charge to consumers.

In a perfectly competitive market, traders should pass through 100% of the subsidy as they underbid each other to get the most customers. However, if traders are exerting market power, they will pass through only a fraction of the subsidy. The exact fraction depends on the curvature of consumer demand (this approach draws on a model developed by Atkin and Donaldson 2015). I also estimate this curvature experimentally This allows me to make predictions for how much of the subsidy will be passed through under several familiar models of competition.

The findings: Low competition

My estimates predict that traders would pass through 100% of the subsidy under perfect competition,1 55% of the subsidy under Cournot competition,2 and 26% of the subsidy under collusion.3

The actual rate of pass-through that I observe is  22.4%. This pass-through rate is remarkably close to (and statistically indistinguishable from) the collusive market prediction. Moreover, the observed pass-through is far below the predictions of a Cournot or perfectly competitive model. These results suggest a very low level of competition among traders, who appear to act as a single profit-maximising monopolist in the market.

Implications for welfare

What does this mean for welfare? I find that this lack of competition reduces the total welfare generated by these transactions by 15%. Of the remaining surplus, traders capture the majority at 79%, while consumers enjoy a mere 21%. Simulations suggest that consumer welfare would increase substantially with more competition (primarily driven by a transfer of surplus from traders to consumers, but also augmented by an increase in market efficiency).

Policy implications: Facilitating market entry

Given the large potential benefits from increased competition, what policies could be implemented in this environment? Antitrust regulation would probably be difficult to enforce.  Direct state intervention into the market to supplant the private sector might create more problems than it would solve, as seen during the largely unsuccessful experience with state-run markets in the region in the 1960s and 1970s.

Instead, policies facilitating market entry (and therefore greater competition) may be more feasible. To test the power of such policies, I run another experiment in the same 60 markets in which I generate exogenous entry by randomly incentivising new traders to sell in the market for the first time. The experiment results in an additional 0.6 traders per market-day, a 13% increase in the number of traders in a typical market. However, I see no effect on prices, suggesting that new traders are able to readily enter into the incumbents’ collusive agreements. My results therefore cast doubt on the power of entry by a small number of new traders to dramatically improve market competition in this setting.

Conclusion and way forward

In a nutshell, I find that the level of competition among traders in Kenya is low, leading to a 15% reduction in total welfare. Further, I find that policies aimed at bringing a small number of firms into the market may not offer much promise as a solution, as this has limited power to impact prices.

Identifying ways to meaningful increase the level of competition in these markets is an open challenge, given that collusive agreements seem flexible enough to incorporate at least small numbers of new traders. The physical layout of the market may contribute to this flexibility. Traders sell right next to each other, so they can easily see each other’s prices and quickly respond to any deviations from agreement with a rapid price war. Further, consumers typically only shop in their local market, so they are captive to the traders there. More fundamental changes to the market environment may be needed to really enhance market competition.

New technologies, such as cell phone-based marketplaces, hold some promise here. On these platforms, collusion is more difficult, because a larger pool of sellers interacts more anonymously. Furthermore, buyers can access a variety of sellers (and vice versa), rather than just those close to home. However, technological solutions still need to address the real-world constraints of high transportation costs, limited trust, and other barriers that discourage exchange between new parties. Craig McIntosh and I are currently testing the impact of one such mobile marketplace in Uganda and hope to be able provide further evidence soon.

Editor’s Note: An earlier version of this column can be found on World Bank’s Development Impact Blog.

Photo credit: Neil Palmer (CIAT)/flickr.

References

Atkin, D and Donaldson, D (2015), “Who’s Getting Globalized? The Size and Implications of Intra-national Trade Costs”, NBER Working Paper No. 21439.

Aker, J (2010), “Information from Market Near and Far: Mobile Phones and Agricultural Market in Niger”, American Economic Journal Applied Economics, 2: 46–59:

Bergquist, L F (2017), "Pass-through, Competition, and Entry in Agricultural Markets: Experimental Evidence from Kenya", Working Paper, University of Chicago. 

Burke, M, Bergquist, L F and Miguel, E (2017), "Selling Low and Buying High: An Arbitrage Puzzle in Kenyan Villages", Working Paper.

Startz, M (2016), "The value of face-to-face: search and contracting problems in Nigerian trade", Working Paper.

Teravaninthorn, S and Raballand, G (2009), Transport Prices and Costs in Africa, World Bank.

Timmer, P (1986), "Private Decisions and Public Policy: The Price Dilemma in Food Systems of Developing Countries", Michigan State University, Food Security International Development Paper 7.

Endnotes

[1] Perfect competition is an economic model that describes a market in which buyers and sellers are so numerous and well informed that all elements of monopoly are absent and the market price of a commodity is beyond the control of individual buyers and sellers.

[2] The Cournot competition is an economic model that describes an industry structure in which competing firms that make the same homogeneous and undifferentiated product choose a quantity to produce independently and simultaneously.

[3] Collusion is an economic model that describes a market where rivals make non-competitive, and sometimes illegal, agreements that attempt to disrupt the market's equilibrium resulting in an unfair market advantage.  These agreements can either be explicit or tacit.

 [P1]Hyperlink to: http://voxdev.org/topic/firms-trade/value-face-face-search-and-contracti...

 [P2]Hyperlink to: http://voxdev.org/topic/firms-trade/how-high-intra-national-trade-costs-...

 [P3]Not easy to understand

Trade Competition Kenya Market Food prices