How Effective is the Invisible Hand? Agricultural and Food Markets in Central and Eastern Europe

• Main Authors: Hockmann, Heinrich, Brosig, Stephan, Popp, Jozsef, Wilkin, Jerzy, Juchniewicz, Małgorzta, Milczarek, Dominika, Ferto, Imre, Forgacs, Csaba, Juhasz, Aniko, Kurthy, Gyongyi, Hein, Piret, Hobbs, Jill E, Nuppenau, Ernst-August, Brümmer, Bernhard, Zorya, Sergiy, Bakucs, Lajos Zoltan, Bojnec, Stefan, Svetlov, Nikolai M, Hurrelmann, Annette, Maack, Kai, Hanf, Jon Henrich, Glauben, Thomas, Herzfeld, Thomas, Wang, Xiaobing, Balint, Borbala, Lerman, Zvi, Shagaida, Natalya, Benner, Eckhard, Wandel, Jurgen, Nivievskyi, Oleg, Kuhn, Arnim
• Format: Book
• Language: English
• Published: 2005
• Subjects: Agribusiness; Community/Rural/Urban Development; Industrial Organization; International Development; Labor and Human Capital; Land Economics/Use; Political Economy

Since the seminal work of Adam Smith, markets have been considered an efficienttool for co-ordinating the behaviour of economic agents. The basic characteristicof a market economy is that the complex system of interaction amongindividuals is not centrally coordinated. Under the assumption of profit and utilitymaximisation (and a whole set of assumptions about the institutional framework),relative prices and their change over time provide the signals that guide,like an invisible hand, the allocation of resources, i.e., the structure of productionand the intensity of input use in the various production processes. They dothis by co-ordinating the activities of economic agents, i.e., of resource owners,producers, intermediaries, traders, and consumers.After system change in the former Soviet Union and in Central and EasternEurope (CEE) central economic planning had to be replaced by other forms ofco-ordination. The general direction in all transition countries was towards amarket economy, but the speed and depth of reforms towards an environment inwhich markets can evolve differed largely between countries, sectors and betweendifferent phases during the past 15 years. IAMO Forum 2005 focuses onthis development and discusses the functioning of markets, the requirements forthis, and the advantages and disadvantages of other co-ordination mechanismsunder different environments in the agricultural and food sectors in Central andEastern Europe.CEE agri-food markets deserve researchers' and policy makers' attention forseveral reasons. Two of them regard the high demand for support to policy decisionsthat aim to stimulate economic and social development in the region.In most CEE countries, the significance of the agricultural and food sector isrelatively high with respect to income and employment. In particular, rural areas can benefit from the development of this branch of the economy. Also, there ismarked indication that agri-food markets in CEE are not ensuring exchange asfrictionless as possible. This means that large benefits can be expected if potentialimprovements of the economic environment are implemented and if individualagents adapt optimally to that environment.Another motivation for economic research on transition countries is that we arelooking at a huge region that started almost as a vacuum with regard to institutionalsettings. This means that a wide range of substantially different settingswere introduced in the respective countries, and were only weakly confined bypolitical rigidities or path dependencies. From a distant perspective, the repeatedfundamental shifts in recent economic policies almost evoke the impression of atrial and error approach. The consequences of distinctively different options(across countries and periods) can be observed in a way almost similar to a laboratorysituation. Such unique opportunity has attracted economists, particularlythose interested in institutional economics, to conduct research on CEE. However,this also means that the experiences made in CEEC can enhance the generalunderstanding of what markets can do and what the limitations of market coordinationare.This volume contains selected contributions presented at IAMO Forum 2005and gives an overview of the major topics discussed there.Partial analyses of specific economic problems usually abstract from the generaleconomic framework which is assumed to be more or less constant as expressedin ceteris paribus clauses. Oftentimes, the set of institutional conditions is evenassumed to be sufficiently well-described by the framework used in neoclassicalmodels. Particularly for transition countries, this has frequently led to spuriousresults because crucial aspects of the framework actually in place were not considered,and sometimes were not even thought of. An extreme and very obviousexample is the neglect of the effects of the replacement of monetary by nonmonetaryexchange in phases of a barter economy. There is no generic approachto avoid unintended omission of crucial framework conditions, but it must generallybe emphasised that a broad look at the various interdependent markets andat the entire socioeconomic context of a country is needed before going into detail.Descriptive analyses of the situation in various markets form part of such abroad look. The contributions of POPP, FERTÖ et al., WILKIN et al., and HEIN inthe chapter Selected analyses from CEEC provide excellent examples, and focuson market developments in new EU member countries. On the one hand, thepapers show the heterogeneity of problems e.g. due to largely differing farmstructures. On the other hand, several common patterns can be observed: Themarket shares and power of large processors and retailers (hypermarkets, etc.)are increasing. Also, international (especially intra-EU) trade in commoditieshas increased in response to CAP-induced price harmonisation. Both tendenciesweaken the market position of farmers, particularly small entities which cannotsupply in volumes sufficient for large processing and trade firms. Within the food industry concentration increased as many smaller firms could not complywith EU processing standards and had to quit the market. The increased size andspecialization of large producers, as well as of large processors, made many ofthose firms co-ordinate business with each other through long-term contractualagreements rather than by relying on spot markets. This tendency is very distinctin the fruit and vegetable sector, as WILKIN’s contribution describes.Two contributions draw attention to the institutional framework itself, mainlyby looking at circumstances which prevent market allocation from leading to anoptimal outcome. HOBBS describes factors that impede investment and growthby drawing on transaction cost economics. Situations typical for transition countriesare highlighted where e.g. transparency is not sufficient or the existence andreliable enforcement of contract or corporate law are not guaranteed. NUPPENAUstresses the need for the appropriate and precise formulation of land propertyrights, which should evoke a balance between governance and exclusion. Theimportance of appropriate and reliable institutions to avoid flaws is emphasised.But even with suitable institutions, transaction costs cannot be reduced to zero.The main reason for this is that since agents may gain form a head start of information,incentives to reveal their knowledge are quite restricted. Furthermore,some of the information required to make correct decisions is not available. Thisespecially concerns information regarding all future contingencies. An uncertainfuture and the asymmetric distribution of information impose special problemswhen decisions have long-term effects and agents are linked together throughinvestment decisions. This offers possibilities for opportunistic behaviour, i.e.,when an agent behaves in a way that allows him to extract rents from the partners'activities. The friction induced in such situations may result in a marketoutcome that is biased by transaction costs. Mitigating this bias should be a goalof public policy but it is also in the interest of (at least some of the) privateagents involved. This issue is discussed in more detail in the papers dealing withalternative governance structures.A number of contributions to IAMO Forum highlight approaches for measuringthe well-functioning of markets. While studies that aim to directly measuretransaction costs are very rare and are necessarily limited to comparing onlyvery specific portions of transaction costs, most studies focus on indirect indicators.These usually start from the idea that in a well-functioning, competitivemarket any supply or demand shocks are reflected in price changes, not only inthe particular market where the shock occurs but also in other, related markets,i.e., in different locations or at different stages of the production and marketingchain. Consequently, an approach for assessing the functioning of markets is tocompare price differentials with processing-, marketing- or transfer-costs, or –since these costs are usually difficult to quantify – to observe price differentialsover time. Accepting the assumption that the costs reflected by price differentialsare more or less constant (or stationary) over the observed time span, any additionalprice changes or a lack of price co-movement is interpreted as an indication for insufficiently connected or insufficiently functioning markets. Three contributionsin the chapter Analytical approaches for measuring market efficiencydescribe analyses which mainly focus on the vertical dimension, i.e., between marketstages. BOJNEC, in his descriptive price analysis for several agriculturalproducts in Slovenia since 1991, finds a heterogeneous development of the farmgate/consumer price spread: The processing and marketing margins increasedfor wheat and beef while they declined for grapes (processed to wine), sugar andpoultry. BRÜMMER and ZORYA, as well as BAKUCS and FERTÖ, use cointegrationanalysis to describe the degree and nature of vertical price integration in theUkrainian wheat market and the Hungarian pork market, respectively. Bothstudies find that price changes are transmitted vertically, that there is a tendencyto "correct" any deviations from some underlying equilibrium price-relationship.However, such error correction mechanisms are found not to be a constant, universalforce. In the Hungarian paper, it could only be found for a sub-period ofthe observed time span, excluding the highly volatile early 1990s. Also, equilibriumwas found to be achieved by adjustment of farm gate prices only while theretail prices were found to be exogenous, i.e., not responding to any disequilibrium.The paper on Ukraine shows that adjustment processes between wheat andwheat flour prices cannot be sufficiently described by a constant error correctionmechanism for the period 2000 to 2004. In fact, four different regimes of adjustmentproc