A modern commodity exchange improved the lot of Ethiopia's smallholder farmers. Now the model is spreading across Africa.
A farmer lives with two time horizons in mind. One is the months-long growing seasons his crops abide by. The other is the immediate reality of having to feed his family each day, regardless of the price of grain at harvest in three months, whether a drought will wither plants in the field, or whether perfect rains will yield a bumper crop.
Across rural Africa, such uncertainty hounds smallholder farmers—which is nearly everyone. In Ethiopia, 80 percent of the population of more than 80 million are small-scale farmers and produce 95 percent of the country's agricultural output.
If more and better information within agricultural markets can make uncertainty recede like darkness in front of a candle, the Ethiopian Commodity Exchange is a bank of high-powered floodlights. A commodity exchange that broadcast crop prices to rural farmers not only helps them get higher prices for their produce, but also improves the food distribution system to resist shortages in times of drought.
"It's basically a way to coordinate all the buyers and all the sellers in a sort of most efficient way of trading," Eleni Gabre-Madhin says. A former senior economist at the World Bank, Gabre-Madhin led the effort to establish Ethiopia's first commodity exchange, which opened in April of 2008, and is now its CEO.
Before it was established, lack of information and trust characterized Ethiopian agricultural markets. The only thing most rural farmers knew about the price of a crop was how much it was fetching at the nearest market; they had little inkling about national, let alone international, prices. Markets were not only hyperlocal but also closed—traders would usually buy only from producers they knew and trusted. Often, the only way to determine the quality of a sack of coffee was to open it up, pour it out, and inspect the beans. Product would change hands, and sacks, up to five times along the supply chain.
In 1984, famine struck Ethiopia and led to hundreds of thousands of deaths in the northern part of the country, despite food surpluses in fertile southern regions. In 2001 and 2002, despite bumper harvests, poor distribution networks prevented surpluses from getting to areas where food was scarce.
"Six months later, when there was a lack of rain and slight depressions in the food deficit areas," Gabre-Madhin says, "the government had to end up appealing for food aid."
This lack of food distribution mechanisms compelled Gabre-Madhin to search for ways to improve the agricultural sector in her native country. The Exchange (ECX) is transforming the sector by publicizing real-time price information to farmers across the country and providing reliable storage facilities. It has also instituted a third-party grading system to reduce fraud and created contracting standards that decrease risk and transactions costs.
Now, farmers can find out the price of coffee, maize, sesame, or any other crops traded on the ECX from electronic boards posted in rural areas. The Exchange also launched a system last year called IVR—interactive voice response—an automated toll-free calling service that provides updates every few seconds for each commodity being traded.
"You call in," says Gabre-Madhin, "and you pick the local language you want to hear the information in. You don't need to have a mobile phone, you don't have to know how to write."
Users place more than a million calls into the system each month, 70 percent of which come from rural areas. Price data is also available via mobile phone and on radio and television.
"The advantage of a commodity exchange is that you can smooth price over time," Marc Bellemare, a Duke University agricultural economist who has researched commodity prices in Ethiopia, says. "Within Ethiopia you can't hedge very well against what's going on outside Ethiopia, but the commodity exchange can still incorporate some outside information."
Before the ECX, if the price of coffee shot up on New York markets, the price of coffee in Ethiopia would rise—unbeknownst to farmers isolated in rural markets. Traders aware of the price spike could buy low from farmers and sell high on national markets.
"If everybody gets that information at the same time," says Gabre-Madhin, "then the local market follows exactly what happens in the national market, and even the international market, so that means those margins start to get squeezed."
Pre-ECX studies estimated that a farmer's share of the final export price of coffee was 35-38 percent.
"Now, we've been measuring it and tracking it between 65 and 70 percent," she says, "so that basically means that there's a tremendous shrinking of the margins between the rural and the national price."
Most farm plots in Ethiopia are so small that a farmer may have only three or four sacks of produce to bring to market, so he might organize within his village's co-op to fill one of the trucks that transports commodities to ECX warehouses throughout the country. Each truck holds 50 hundred-kilo bags, or five metric tons, which has become the standard contracting unit.
"We sort of took the same logic," says Gabre-Madhin, "as when Chicago started in the 1840s. The size of what went into a railroad car in the Midwest is what became the contract size because that was a logical unit."
With its warehouses, the Exchange has increased quality. Farmers used to haul harvests to market without knowing how their crops stacked up compared to others, and traders could often swindle them into selling high quality for a middling price. In the ECX system, commodities that enter a warehouse are immediately graded at a laboratory. Prices for each grade are available through the data system, and criteria to differentiate, for example, Grade 1 coffee from Grade 2 coffee are published and available to sellers and buyers. This third-party grading system circumvents buyers' incentives to under-value farmers' output.
At first, farmers at one co-op were angry because they perpetually received the lowest coffee price posted on the Exchange. A manager then pulled out the standards document and explained why their crop was graded poorly—shriveled beans weren't removed, the coffee hadn't been dried properly, dirt was mixed in with the beans. The farmers took notice and decided to control for quality. Over the first year-and-a-half it was traded, Ethiopia's volume of highest-grade coffee tripled.
"That's because these farmers," says Gabre-Madhin, "who for probably 20 years have been told to do the very same thing but saw no reason to, now had an incentive to actually invest time and effort into getting better quality to market."
"I think a lot of countries are excited about what we've done here in Ethiopia," she says, and it seems that other African countries are eager to build exchanges of their own. Ghana plans to open a commodity exchange based on the ECX by the end of 2012, with hopes of improving internal food distribution as well as bolstering agricultural exports.
Gabre-Madhin also sees eventual opportunities for countries to cooperate across borders, citing the example of a regional coffee index that could give East African countries more leverage on international markets, and provide more benefits for small-scale farmers in places Ethiopia.
"Many countries are interested [in cooperating], but's going to happen organically,” she says. "It's going to happen because there's a business logic to it."
Photo courtesy of ECX