Price Stabilization, Spatial Arbitrage and Market Integration: The Experience of Ethiopia

Since 2003, domestic food prices in Ethiopia have been rising at a higher rate than international prices have. In response, the Ethiopian government pursued a wide range of policy interventions after 2008 to stabilize domestic grain markets. The purpose of this study was to investigate how Ethiopian government policy interventions have influenced price stability in domestic food markets. The dating periods for policy reform was obtained from the Food and Agriculture Policy Decision Analysis data. We chose policy interventions targeting food security, trade, and market on cereals and cereal products. International and domestic wheat and maize price series were obtained from the FAO Global Information and Early Warning Systems food price data. A regime-dependent Vector Error Correction Model and threshold co-integration approaches were used to examine the impact of policy reforms on the spatial equilibrium market performance on maize and wheat commodities. We find that involvement of the Ethiopian government in commercial wheat imports and distribution at subsidized prices has not insulated the domestic grain market from international price risks. This is not expected in a heavily regulated market because the government imports considerable amounts of wheat for distribution at subsidized prices, which private sectors cannot compete with. Despite the presence of a long-run relationship and absence of inappropriate price transmission, domestic wheat prices have surpassed the ceiling price during heavy government intervention periods (i.e. since 2008). This suggests that the Ethiopian government's food price stabilization efforts through a state trading enterprise have not only failed to stabilize prices, but have even exacerbated the price spreads between the domestic and world wheat prices. The policy implication is that, the Ethiopian government could restore stability and trust in the grain market environment by following rules-based state interventions in the domestic market and by allowing tolerable price fluctuations, and following price bands to gauge intervention. Such interventions would reduce the fiscal costs of food price stabilization by allowing the private sector to do the necessary price stabilization. Consequently, this would support the government in focusing on long-term market development by freeing scarce resources for investment in roads and agricultural research and extension.