Global Poverty Research Group

Trade and social capital

The research question

One of the key policy issues in Africa has been the impact of agricultural market reforms on the efficiency with which the trading system operates. During the year, Marcel Fafchamps has been engaged in analysis of a major study of traders in Benin, Madagascar and Malawi. This subsection discusses some of its key findings and their importance for policy.

A large number of studies have addressed the question of market integration in the post-market reform era in sub-Saharan Africa. Relatively few have addressed the microeconomic behaviour of market participants, such as individual traders or firms. These studies highlight the importance of transaction costs facing individual traders, of the role of intermediaries, and of relationships and social capital. Even fewer studies have attempted to link trader characteristics and market behaviour with standards of market performance at the trader level.

The objective of this study was to fill this gap by documenting traders’ assets, their trading practices and commercial activities, and their capacity to undertake spatial and temporal arbitrage. The study presents original evidence for Benin, Madagascar, and Malawi on how traders’ assets, including financial, physical, human and social capital, influence their commercial activities and, ultimately, their arbitrage behaviour. An enduring puzzle in the market literature in sub-Saharan Africa, on which this study throws light, is why marketing margins remain high despite reforms and the relative lack of sophistication of liberalised markets.

The approach taken in this study was to empirically investigate traders’ assets and trading practices and link these not only to evidence on traders’ gross margins but also to their net margins using detailed data on marketing, operating and transaction costs. The study is based on a conceptual framework where policy, institutions and infrastructure are exogenous to the behaviour of traders in the market. Assets, which are specific to individual trading firms, include human resources, physical capital in the form of buildings and equipment, financial assets, and social capital. Trading practices include traders’ inspection of goods, methods of payments, their reliance on networks, their use of intermediaries such as agents and brokers, their contractual performance, their search behaviour, their enforcement of property rights, and their investment and specialisation in agricultural trade. Assets and business practices are also influenced by the existence or lack of formal market institutions such as commercial law and dispute settlement mechanisms, inspection services, referral agencies, trade associations and information systems. Both assets and practices, along with infrastructure such as roads, vehicle fleets, communications and public storage facilities, directly influence the extent of traders’ commercial activities, viewed in terms of purchases and sales, as well as their transport, storage and transformation of agricultural products. Finally, the analysis considers the links between traders’ assets and practices, as well as their commercial activities, and how efficient their market activities are, viewed in terms of the relationship between the costs faced by individual traders and their margins. This broad framework enables the analysis of whether better-endowed traders are more or less efficient, whether larger firms in terms of scale or scope of activities influence efficiency, and the impact of trading practices on commercial behaviour, among other possible experiments. The study takes a comparative focus on trader performance between Benin, Madagascar, and Malawi, which adds a rich dimension to the analysis. Benin, in francophone West Africa, represents an environment in which private market activity has a long history and in which government intervention has traditionally been limited, except in cotton. In sharp contrast, Malawi, along with other countries in Eastern and Southern Africa, has had, until recently, extensive state intervention in marketing and protection of smallholders. Madagascar represents yet another environment, with a history of governmental intervention in rice markets, leading more recently to a hands-off approach. Thus, the comparative focus provides insights on the role of history and tradition in shaping trading norms and in asset accumulation.

Many of the documented features of how agricultural traders operate in Benin, Madagascar, and Malawi were well known – small size of businesses, lack of equip­ment, rudimentary business practices and the dominant role of trans­port costs. Other features were less well known, such as the importance of personal travel, bagging practices, the short distances over which most traders operate, and the incidence of theft and breach of contract.

The study dispelled some myths. For instance, we documented the absence of speculative, inter-seasonal storage for the overwhelming majority of traders, and the relatively low returns to storage in general. We showed that advances from traders to farmers are of short duration – one to two weeks. Their main purpose is not to exploit farmers’ need for cash to finance agricultural production, but rather to provide a means for traders to secure future deliveries.

The picture that emerges from this analysis is one dominated by transport – for goods and for traders. Because trading enterprises are small, the quantities they can gather from any one market are limited by what the trader can reliably locate, finance and inspect. As a result, transport takes place in small vehicles – pick-up trucks for the most part. An inordinate amount of personal travel takes place as well, since traders must inspect the goods they purchase and payment is normally in cash upon delivery.

Surveyed traders appear to work effectively under the constraints they face, which are many – for example, limited external finance, no brand names or trademarks, no certified quality, no organised commodity exchange, extremely decentralised production and consumption. They rely on networks to share information and discourage breach of contract and are able to perform an essential trading function in a flexible and expeditious manner. But the end result nevertheless is a costly system that provides a limited service to consumers and producers.

The modernisation of agricultural trade requires that original solutions be found to the genuine problems that traders face. The only ‘modern’ technologies that traders in Benin, Madagascar, and Malawi seem to be using at this point are motorised transport and pest control. Telephones and banks are ignored. Brand recognition, grading and quality certification are non-existent. Brokers and agents are not organised in commodity exchanges. Quantities are not pooled for transport and storage so as to achieve returns to scale. Inter-seasonal and inter-regional arbitrage is outside the purview of most traders, who prefer to operate in a small territory on a day-to-day basis. By extension, an entire continent is fed using a rudimentary, costly and risky set-up.

The information presented in the study provides some important insights into how agricultural trade can be improved. Policy interventions can be conceived in four main areas: (i) increasing traders’ asset base; (ii) reducing transaction risk; (iii) promoting more sophisticated business practices; and (iv) reducing physical marketing costs.

In respect of margins, the comparison between Benin, Madagascar, and Malawi is instructive. Gross margins and unit profits are noticeably lower in Benin than in Malawi. At the same time there appears to be more competition and smaller trading firms in Benin. Prima facie, this would suggest that more competition favours smaller margins. Population density is also much higher in Benin than in the other two countries and crop production is spread more evenly over the year. This implies more geographical concentration in traders’ operations, and less need for storage. Together, these features could explain the lower costs of intermediation in Benin. These issues will be the object of further research.

Our work shows that rudimentary business practices can largely be blamed on transaction risk. Payment takes place at delivery, a practice that precludes invoicing and payment by cheque and complicates accounting. Business networks have developed as a partial palliative to these problems, but they are insufficient to eliminate them. It is not entirely clear how in practice transaction risk can be reduced. One institutional innovation that could potentially reduce transaction risk would be for market authorities to take a proactive stance. Membership of traders’ associations could in principle be used as a guarantee of good conduct. An association equipped with a grain-dryer and simple grading equipment could bag and certify its products in a manner that is difficult to falsify. Assured of the quality of the goods they purchase, buyers may be more willing to place orders by telephone.

Traders in Benin, Madagascar, and Malawi manage to feed the populations of their countries by collecting and distributing food among millions of producers and consumers. They do so in difficult circumstances and demonstrate great ingenuity. Perhaps even more remarkably, many of them appear to be making a living from their trading activity. All this notwithstanding, business practices appear inefficient. As argued earlier, exchange takes a cumbersome form. This enables a myriad of small traders to compete with larger ones. But cumbersome practices increase the costs of the entire marketing system.

For more information, see Marcel Fafchamps and Eleni Gabre Madhin, ‘Agricultural markets in Benin and Malawi: operation and performance of traders’: http://www.economics.ox.ac.uk/CSAEadmin/reports/main.html

Recent publications

Fafchamps, M. and B. Minten, 'Social capital and agricultural trade', American Journal of Agricultural Economics, Vol. 83 (3), pp. 680-85, 2001.

Fafchamps, M., 'Intrahousehold access to land and sources of inefficiency: Theory and concepts', in Alain de Janvry, Gustavo Gordillo, Elisabeth Sadoulet and Jean-Philippe Platteau (eds), Access to Land, Rural Poverty, and Public Action, Oxford: Oxford University Press, 2001.

Fafchamps, M., E. Gabre Madhin and B. Minten, ‘Increasing returns and market efficiency in agricultural trade’, CSAE working paper, 2002.

Fafchamps, M. and B. Minten, 'Returns of social network capital among traders', Oxford Economic Papers, Vol. 54, pp. 173-206, 2002.

Fafchamps, M., ‘The role of business networks in market development in sub-Saharan Africa', in Masahiko Aoki and Yujiro Hayami (eds), Community and Markets in Economic Development, Oxford University Press, forthcoming.

Reseachers to contact for this project

Marcel Fafchamps