POLICY NOTE 12 • February 2015 SUMMARY OF MozSSP WORKING PAPER 4 Synopsis : MARKET INTEGRATION IN MOZAMBIQUE A non-parametric extension to the threshold model Bjorn Van Campenhout Since well-functioning markets are important for economic development, policymakers need to make sure that the right policies that promote a vibrant market system are in place. This policy note is a synthesis of a technical paper that assesses the degree of maize mar- ket integration in Mozambique using a new technique—an iterative process between parametric threshold modeling and kernel smooth- ing—that allows one to estimate transaction costs in a more flexible way. Market integration is the most important measurement of how well a commodity market is functioning. A well-integrated agricul- tural market system linking production areas to consumer centers is important, especially for agricultural societies. It ensures that the right incentives (that is, higher prices than would be the case under autarky due to high demand from consumer centers) are in place for farmers, while at the same time keeping basic needs affordable (that is, lower prices than would be the case under autarky due to high supply from supply areas) in consumer centers. In particular, staple food market integration is extremely important from a food security perspective. This study finds that maize markets in Mozambique are far from fully integrated. As expected, the paper finds that maize markets that are closer to each other are better integrated. For instance, Nampula seems to be rather well integrated, particularly with other markets in the northern and the eastern parts of Mozambique. The least integrated market pair is the Maputo–Lichinga trade route. Moreover, the somewhat isolated Lichinga market is found to be less integrated with the rest of Mozambique. Generally, findings sug- gest that there is substantial room for the improvement of maize market integration. The first way to improve maize market integration in Mozambique is to better physically link markets to each other by improving the road infrastructure. The second, but at least equally important, way is to increase the flow of information between different markets. Third, the government should devise mechanisms that increase competition among middlemen. CONTEXT annually, making it the country’s most important crop. About half of the maize production occurs in central Mozambique In Mozambique, newspapers regularly report instances of pock- (Manica, Zambezia, and Tete provinces). Another 40 percent ets of hunger due to droughts and floods. Pockets of hunger are takes place in the North (especially Niassa province). essentially caused by adverse shocks from which the conse- quences cannot be spread over a large enough area due to a lack Maize is also the preferred crop for consumption in Mozam- of market integration. Different market integration studies indi- bique, and the region as well. The largest deficit consumption ar- cate that agricultural markets in Mozambique are far from fully eas are in the southern part of the country. Maputo is the largest integrated. In addition, previous studies underline the depend- city and the capital, which, together with its twin city, Matola, ence of Mozambique’s capital, Maputo, on South Africa for its hosts a population of about 2.5 million. Despite the considerable food supplies, instead of on its own hinterland. volumes of maize produced in central and northern Mozam- bique, the southern part of the country consistently imports Mozambique is an interesting case for the study of market maize from South Africa (Traub et al. 2010). integration for several reasons. It is a vast country with a rela- tively low population density, and so the provision and mainte- There have been several maize market integration studies on nance of infrastructure is a challenge. Similarly, because of a long Mozambique in the past. Generally, those studies indicate that civil war, road rehabilitation and investments picked up only re- the country’s maize markets are far from fully integrated and cently. In addition, recent climate shocks (excess rainfall and un- that there is significant variation in the level of integration of dif- usual droughts) have affected the supply and demand patterns of ferent pairs of maize markets across the country. agricultural producers. Moreover, pockets of hunger are fre- For instance, one study tests maize market integration in quently recorded in Mozambique, suggesting that markets are Mozambique in the 1990s using the parity bounds model (Pen- insufficiently integrated to deal with the aforementioned charac- zhorn & Arndt 2002). Using weekly price data, the study looked teristics. only at two markets: Maputo and Chimoio in Manica province in Maize is an important crop in Mozambique both from a pro- west-central Mozambique. The study estimates that about 25 duction and food security point of view. According to the report percent of the time the price difference between the two mar- on the 2010 Food and Agriculture Organization and World Food kets is above the parity bounds, and concludes that during some Programme Crop and Food Security Assessment Mission to periods the markets were not integrated at all. Mozambique, most maize in Mozambique is produced by small- Another study looks at 13 market pairs in Mozambique (Tos- holder farmers, who make up 81 percent of the total population. tão & Brorsen 2005). This study also employs the parity bounds Mozambique produces just under 2 million metric tons of maize method on a monthly price series that runs up to 2001. It finds that markets within the South are efficient more than 55 percent the market), extreme prices (both low and high) will be less ex- of the time, and markets within the central region are efficient treme and less common (as a price increase will attract more more than 84 percent of the time. However, it also finds that the traders from further away and price decreases will lead to ex- North is completely isolated from the Center and the South. An- ports to places further away). When markets become better inte- other study investigates whether the substantial road rehabilita- grated, price risk in a particular location will be spread over a tion begun at the end of the 1990s had an effect on market inter- larger geographical area. connectedness in Mozambique (Cirera & Arndt 2008). This study Market integration is also important as a driver for produc- also uses the parity bounds method, but it allows the probabili- tivity-enhancing technology adoption and structural transfor- ties of each regime to be a linear function of time. It finds that mation. In better-integrated markets, returns to increased out- maize markets tend to be segmented most of the time due to put diminish less rapidly than in locally segmented markets char- high transaction costs. But the impact of the road rehabilitation acterized by more price-inelastic demand—the change in quan- seems to be small and not statistically significant for most market tity demanded of a good or a service in response to a change in pairs considered. its price is small. Thus, the more segmented the market, the Two studies use a threshold vector error correction ap- more price inelastic the demand and the lesser a share of the proach to analyze the integration of four major maize market gains accrue to the productive producers. Based on this underly- pairs in Mozambique (Alemu & Biacuana 2006; Alemu & Van ing reality, some argue that households that have linkages to Schalkwyk 2009). In line with expectations, those studies find markets have a better chance to escape from poverty. that estimated transaction costs were higher between distant Methodology markets and when markets are connected by poor roads. The studies then compare actual price differences with the estimated Markets are said to be integrated if they are connected by a pro- transaction costs and find that price differences are mostly out- cess of arbitrage, which is the practice of taking advantage of a side the band formed by transaction costs for Chimoio–Beira and price difference between two or more markets to make a profit. Ribaue–Nampula, which are only 204 kilometers and 147 kilome- This will be reflected in the price series of commodities in spa- ters apart, respectively. For the market pairs that have the small- tially separated markets. Thus, as a measure of market integra- est observed differences outside the band, the estimated adjust- tion, the extent of co-movement between prices in different lo- ment speed also seems to be higher. cations has been suggested. While the first studies looked at cor- relation coefficients between prices of a product in different mar- CONCEPTUAL FRAMEWORK, kets, with the genesis of nonstationary time series analysis in the METHODOLOGY, AND DATA 1980s, market integration essentially became synonymous with co-integration. Conceptual Framework The realization that the existence of transaction costs cre- The basic idea behind spatial market integration is discussed in ates a nonlinearity in the adjustment process prompted the de- the classic work of Takayama and Judge (1971). This theory velopment of two competing models: the parity bounds model states that in a setting with free flow of goods and information, and the threshold auto-regressive model. Both of these models prices of a homogeneous good in two spatially separated mar- have been extended in various ways. kets should differ only by the transaction costs. This is so because if the price in one market is higher than the price in another mar- One of the main problems of the threshold auto-regressive ket plus the transaction costs—that would be involved if one had model is that it assumes constant transaction costs; however, to move the product from the market with the low price to the transaction costs are not constant—rather they change depend- market with the high price—unexploited profits would exist.