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

Since the seminal work of Adam Smith, markets have been considered an efficient tool for co-ordinating the behaviour of economic agents. The basic characteristic of a market economy is that the complex system of interaction among individuals is not centrally coordinated. Under the assumption of profit and utility maximisation (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 production and the intensity of input use in the various production processes. They do this 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 Eastern Europe (CEE) central economic planning had to be replaced by other forms of co-ordination. The general direction in all transition countries was towards a market economy, but the speed and depth of reforms towards an environment in which markets can evolve differed largely between countries, sectors and between different phases during the past 15 years. IAMO Forum 2005 focuses on this development and discusses the functioning of markets, the requirements for this, and the advantages and disadvantages of other co-ordination mechanisms under different environments in the agricultural and food sectors in Central and Eastern Europe. CEE agri-food markets deserve researchers' and policy makers' attention for several reasons. Two of them regard the high demand for support to policy decisions that aim to stimulate economic and social development in the region. In most CEE countries, the significance of the agricultural and food sector is relatively high with respect to income and employment. In particular, rural areas can benefit from the development of this branch of the economy. Also, there is marked indication that agri-food markets in CEE are not ensuring exchange as frictionless as possible. This means that large benefits can be expected if potential improvements of the economic environment are implemented and if individual agents adapt optimally to that environment. Another motivation for economic research on transition countries is that we are looking at a huge region that started almost as a vacuum with regard to institutional settings. This means that a wide range of substantially different settings were introduced in the respective countries, and were only weakly confined by political rigidities or path dependencies. From a distant perspective, the repeated fundamental shifts in recent economic policies almost evoke the impression of a trial and error approach. The consequences of distinctively different options (across countries and periods) can be observed in a way almost similar to a laboratory situation. Such unique opportunity has attracted economists, particularly those interested in institutional economics, to conduct research on CEE. However, this also means that the experiences made in CEEC can enhance the general understanding of what markets can do and what the limitations of market coordination are. This volume contains selected contributions presented at IAMO Forum 2005 and gives an overview of the major topics discussed there. Partial analyses of specific economic problems usually abstract from the general economic framework which is assumed to be more or less constant as expressed in ceteris paribus clauses. Oftentimes, the set of institutional conditions is even assumed to be sufficiently well-described by the framework used in neoclassical models. Particularly for transition countries, this has frequently led to spurious results because crucial aspects of the framework actually in place were not considered, and sometimes were not even thought of. An extreme and very obvious example is the neglect of the effects of the replacement of monetary by nonmonetary exchange in phases of a barter economy. There is no generic approach to avoid unintended omission of crucial framework conditions, but it must generally be emphasised that a broad look at the various interdependent markets and at 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 a broad look. The contributions of POPP, FERTÃ et al., WILKIN et al., and HEIN in the chapter Selected analyses from CEEC provide excellent examples, and focus on market developments in new EU member countries. On the one hand, the papers show the heterogeneity of problems e.g. due to largely differing farm structures. On the other hand, several common patterns can be observed: The market shares and power of large processors and retailers (hypermarkets, etc.) are increasing. Also, international (especially intra-EU) trade in commodities has increased in response to CAP-induced price harmonisation. Both tendencies weaken the market position of farmers, particularly small entities which cannot supply in volumes sufficient for large processing and trade firms. Within the food industry concentration increased as many smaller firms could not comply with EU processing standards and had to quit the market. The increased size and specialization of large producers, as well as of large processors, made many of those firms co-ordinate business with each other through long-term contractual agreements rather than by relying on spot markets. This tendency is very distinct in the fruit and vegetable sector, as WILKINâs contribution describes. Two contributions draw attention to the institutional framework itself, mainly by looking at circumstances which prevent market allocation from leading to an optimal outcome. HOBBS describes factors that impede investment and growth by drawing on transaction cost economics. Situations typical for transition countries are highlighted where e.g. transparency is not sufficient or the existence and reliable enforcement of contract or corporate law are not guaranteed. NUPPENAU stresses the need for the appropriate and precise formulation of land property rights, which should evoke a balance between governance and exclusion. The importance 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. This especially concerns information regarding all future contingencies. An uncertain future and the asymmetric distribution of information impose special problems when decisions have long-term effects and agents are linked together through investment 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 market outcome that is biased by transaction costs. Mitigating this bias should be a goal of public policy but it is also in the interest of (at least some of the) private agents involved. This issue is discussed in more detail in the papers dealing with alternative governance structures. A number of contributions to IAMO Forum highlight approaches for measuring the well-functioning of markets. While studies that aim to directly measure transaction costs are very rare and are necessarily limited to comparing only very specific portions of transaction costs, most studies focus on indirect indicators. These usually start from the idea that in a well-functioning, competitive market any supply or demand shocks are reflected in price changes, not only in the 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 marketing chain. Consequently, an approach for assessing the functioning of markets is to compare price differentials with processing-, marketing- or transfer-costs, or â since these costs are usually difficult to quantify â to observe price differentials over time. Accepting the assumption that the costs reflected by price differentials are more or less constant (or stationary) over the observed time span, any additional price changes or a lack of price co-movement is interpreted as an indication for insufficiently connected or insufficiently functioning markets. Three contributions in the chapter Analytical approaches for measuring market efficiency describe analyses which mainly focus on the vertical dimension, i.e., between market stages. BOJNEC, in his descriptive price analysis for several agricultural products in Slovenia since 1991, finds a heterogeneous development of the farm gate/consumer price spread: The processing and marketing margins increased for wheat and beef while they declined for grapes (processed to wine), sugar and poultry. BRÃMMER and ZORYA, as well as BAKUCS and FERTÃ, use cointegration analysis to describe the degree and nature of vertical price integration in the Ukrainian wheat market and the Hungarian pork market, respectively. Both studies find that price changes are transmitted vertically, that there is a tendency to "correct" any deviations from some underlying equilibrium price-relationship. However, such error correction mechanisms are found not to be a constant, universal force. In the Hungarian paper, it could only be found for a sub-period of the observed time span, excluding the highly volatile early 1990s. Also, equilibrium was found to be achieved by adjustment of farm gate prices only while the retail prices were found to be exogenous, i.e., not responding to any disequilibrium. The paper on Ukraine shows that adjustment processes between wheat and wheat flour prices cannot be sufficiently described by a constant error correction mechanism for the period 2000 to 2004. In fact, four different regimes of adjustment processes were found to have been in force, reflecting particular phases of largely differing market situations and political interventions. The functioning of markets depends on several crucial conditions. One of these conditions concerns the availability of information. Only if agents have perfect and complete information will the exchange lead to an outcome in which no individual can be better off without reducing the welfare of others. However, in the real world this condition regarding information is not fulfilled. Information is not perfect, since the future cannot be predicted with certainty. Incomplete information results from, first, not all information being revealed, and second, individuals not possessing the mental capacity to collect and process all information. Moreover, because of its asymmetric distribution, information can be regarded as a resource that can be exploited by agents. This means that there are incentives to hamper the diffusion of information to the public domain. In general, the more uncertain the future is and the more information is tacit, the worse markets will function, and the more beneficial become alternative mechanisms of coordination. Three papers dealing with this issue of organisational choice. HANF focuses on governance structures within supply chain networks that are appropriate for allowing an optimal flow of information between the involved individuals while retaining the necessary hierarchy for efficient implementation of strategic decisions. MAACKâs analysis shows that there is strong mutual interest between producers and processors of berry fruits to reduce marketing and procurement risk, respectively. This can be achieved by switching from spot market exchange to contractual supply agreements. A prerequisite for such agreements is that a well-balanced distribution of risks and risk premiums between the farmer and processor is implemented. This means that processors, who â facing a multitude of small producers â are used to opportunities for exerting market power, have to agree to cover part of the production risk through appropriate contractual clauses. Finally, BALINT looks at the various marketing channels used by Romanian farmers and finds that a self-enforcing dualism exists. For commercially-oriented farmers who can supply large quantities, marketing directly to traders, wholesalers and processors is most favourable and involves relatively low transaction costs. Although this form of supply-relationship is usually not based on contractual agreements, it can still be characterised by a certain stability over time. In contrast, small farmers whose production does not considerably exceed the subsistence level incur relatively high (per unit) transaction costs in selling their produce on local markets and to other farmers. Another aspect of organisational choice is the question of whether ownership of production factors is transferred or only the right to use them temporarily. The uncertainty of future developments implies that the possession of resources cannot be only regarded from the point of view of income generation at a certain point in time. With perfect foresight, there is no difference whether a factor is rented or purchased, because the remuneration would be the same. This perfect substitutability is no longer given when the future is uncertain. Income generation, then, is only one feature of ownership. Additional aspects such as insurance, wealth, and speculation as motivations for possession affect the value of ownership and thus shift the demand and supply curves of the factor. HURRELMAN picks up this issue in her analysis of the Polish land market and shows the impact of additional grounds for valuing property on the decision to rent or to buy land. Uncertainty may also affect the specialization of factor use. Allocating a factor of production to different production activities reduces the risk of income instabilities, but at the cost of specialization gains through economics of scale. Moreover, the decision on income combination is â besides risk â affected by a complex interaction of other determinants. GLAUBEN et al., analyse these interactions for the case of part-time farming in China and show how the decision of income combination is affected by household characteristics, human capital and other variables. Incomplete and imperfect information not only causes individuals to choose optimal governance modes, often it is also understood as a call for government intervention. The selected papers in the chapter on policy intervention plead for careful selection and coherent implementation of policy instruments. BENNER, as well as KUHN, highlight the significance of information diffusion and argue in favour of government intervention in this area. However, both emphasise that these interferences should be used carefully and be adjusted to specific market failures. Both argue that setting up information systems would improve the functioning of markets. BENNER also discusses possible negative impacts if governments that engage in setting up and enforcing product and process standards try, at the same time, to foster a sector like agriculture through support in marketing. The latter activity affects the governmentâs (crucial) credibility in the first activity. KUHN points to negative welfare effects and budgetary requirements of an intervention system which is implemented to increase price stability. Moreover, when a government intervenes in market allocation or intends to provide rules that should facilitate the exchange on markets, it has to take into account that the new regulation has to be implemented in a coherent manner. This requires the various policy regulations and institutional settings to be complementary and not cause frictions which hamper the functioning of the system. LERMAN and SHAGAIDA highlight this aspect in their discussion of the Russian land market, where bureaucracy and high costs for the registration of property rights can be regarded as a major cause of the low number of land transactions. However, since economic activities take place in a dynamic environment, the comparative static point of view may lead to inappropriate policy formulation. WANDEL discusses this aspect in the context of competition policy. From a comparative static point of view, market power has to be assessed negatively because of the distortions of resource allocation. However, monopoly profits are an indicator of extra rents and thus provide incentives for market entry. On the one hand, this thread may lead to special pricing schemes and/or to the accelerated development of technological change so that a monopolist can consolidate its market position. But it is possible, on the other hand, that market entry may in fact happen. In this case, one would observe structural change, which would be accompanied by an improved use of resources. This in turn means that competition policy should not be oriented towards an optimal market structure but towards the facilitation of market entry so that competition can discover market opportunities and determine the optimal structure of the market. The present volume shows the wide range of interesting and controversial topics that are concerned when looking at co-ordination, particularly on markets in CEE agri-food sectors. It remains a hope that the heterogeneity and dynamics of the developments will decrease as successful constellations of framework conditions, organisational choices and individual behaviour become more and more obvious and widespread in the region. Conversion to sustainable, balanced patterns might take place, but this cannot be taken for granted. However, chances for such development are better the more stable and balanced political developments, as well as international co-operation, become. We hope that the academic community will contribute towards such goal.Agribusiness, Community/Rural/Urban Development, Industrial Organization, International Development, Labor and Human Capital, Land Economics/Use, Political Economy,

THE CLUSTER-BASED DEVELOPMENT STRATEGY IN KAZAKHSTAN’S AGRO-FOOD SECTOR: A CRITICAL ASSESSMENT FROM AN "AUSTRIAN" PERSPECTIVE

This paper challenges the uselfullness of the cluster-based development strategy to diversify and increase the competitiveness of Kazakhstan’s economy, regarding the case of the country’s agro-food sector. For this it refers to insights of the Austrian Market Process Theory. It is argued that already the theoretical foundations of the cluster concept suffer from severe difficiencies, because it widely neglects the function of competition as a discovery procedure with alert entrepreuneurs as the driving force. Moreover, it ignores the knowledge requirements and limitations in a modern market economy for any outside third party to identify and promote successful industry structures. The closer examination of the implementation of the cluster development program in Kazakhstan’s agro-food sectors shows that cluster facilitation in practice turned out to be another form of social engineering and picking winners. In the light of the Austrian understanding of the market system as an entrepreneurial discovery process the paper suggestes as alternative policy option to concentrate on the establishment of a stable institutional framework for the whole economy that stimulates the entrepreneurial discoveries of profitable businesses. Yet, such an Austrian approach is politically less appealing, for it might bring no quick results due to the prevalence of conflicting informal institutions which in the short run might be difficult to change

AGROHOLDINGS AND CLUSTERS IN KAZAKHSTAN’S AGRO-FOOD SECTOR

The paper provides an overview of the institutional arrangements on the micro level that have evolved in the agro-food sector of Kazakhstan in the course of transition. Emphasis is laid on more complex arrangements like "agroholdings" and "clusters", hitherto mostly unknown in the agro-food sectors of established market economies. It is shown that "agroholdings" are concentrated mainly in the northern part of Kazakhstan and to a large extent in the grain sector, while in the south a scattered small scale (individual) farm structure has emerged. Parallel to this market-driven development, the Kazakhstani government tries to promote other institutional arrangements that it deems to be of superior competitiveness, especially agro-food clusters. Refering to Hayek’s concept of pretence of knowledge and empirical evidence of cluster facilitation policies of other countries the success of the Kazakhstani cluster initiative is questioned

Integrated Structures, Market Forces and Competition in Russia's Agro-Food Sector: An Assessment from the Perspective of the Austrian School of Economics

Agribusiness,

THE DEVELOPMENT OF THE TEACHING ON AGRICULTURAL MARKETS IN RUSSIA FROM THE 18TH TO THE 20TH CENTURY

The transition to market principles in Russia’s agro-food sector forced the country’s agricultural institutes of higher education to adapt their curriculum to the new economic system. This included the introduction of the subject "studies of agricultural markets". The paper shows that until the collectivization of agriculture in the early 1930s Russia did, in fact, have an own tradition in this discipline, which was influenced by well-known Russian economists like Chaynov and Kondratyev

Agroholdings in Russia: Breaking the Vicious Circle?

The paper discusses the accelerated emergence of agroholdings in the Russian Federation. It is argued that the foundation of these highly integrated structures I due to the special (macro-) economic and institutional condition of the transition process in Russia. Moreover, it is shown that agricultural enterprises which are part of an agroholding were lacking behind other organisational forms in terms of economic efficiency. One reason for this finding is the highly centralized decision structures which, as experiences in Western Europe shows, are only suitable for very special agricultural value chains, but not for agriculture in general

ANALYSE DER WETTBEWERBSPROZESSE IN DER POLNISCHEN FLEISCHINDUSTRIE SEIT TRANSFORMATIONSBEGINN

It is the objective of the present study to examine the competitive processes within the Polish meat processing industry during the first six years of transformation empirically. In particular, two questions were posed: How did the intensity of competition develop in this sector since the beginning of the transformation process? What are the factors that did further or impede individual firm growth? The intensity of static competition in input procurement did increase slightly during the transformation process, but the intensity of dynamic competition in selling output, which is still high, did decrease. The results of an econometric analysis of market share development showed that below average initial firm size and above average input procurement prices exercised a significantly negative effect on firm size growth, whereas a growing resource base in the firm's vicinity showed a significantly positive effect. Factors that were not found to have any significant effect on the market share growth of the firm include: above average initial firm size, below average input procurement prices, declining resource base in the firm's vicinity, and below or above average population density in the firm's vicinity

INDUSTRIAL ORGANISATION OF THE FOOD INDUSTRY IN LATVIA: RESULTS OF AN EXPERT SURVEY IN THE DAIRY AND MILLING BRANCHES

Based on the analytical framework of the structure-conduct-performance paradigm of the theory of industrial organisation, the paper analyses those economic conditions that determine the degree of competitiveness in the Latvian dairy and milling industry. The analysis is based on information from milk and grain processing enterprises acquired through a survey carried out at the beginning of 1998. It is shown that the development of market conditions and market behaviour in the sectors examined has in general progressed. Privatisation in both sectors has been completed. While in the dairy sector the majority of processing enterprises were privatised as co-operatives, in the milling industry all enterprises have become closed joint-stock companies. Since the legal status of a co-operative has turned out to be quite problematic for enterprise restructuring, more and more dairy enterprises have started to change into joint-stock companies. Competition in the investigated processing sectors can be considered as functioning. However, in the dairy sector tendencies of stronger horizontal concentration can be observed. The majority of enterprises react in quite an active way to the market conditions. Procurement and marketing channels have been diversified, and considerable investments have been undertaken. Further investments, however, are impeded by high interest rates for credits. As for performance, quite a considerable differentiation between the enterprises in the considered branches could be shown. The main problems seen by the processors are the saturation of the domestic Latvian market, the lack of investment funds, the unstable legislation, the absence of any substantial support from the government, and, in the dairy sector, the low quality of the raw milk

INDUSTRIAL ORGANISATION OF THE FOOD INDUSTRY IN LITHUANIA: RESULTS OF AN EXPERT SURVEY IN THE DAIRY AND SUGAR BRANCH

Based on the analytical framework of the structure-conduct-performance paradigm of the theory of industrial organization, the paper analyses economic conditions that determine the degree of competitiveness in the Lithuanian dairy and sugar industry. The study is based on information from milk and sugar beet processing enterprises acquired through a survey carried out at the beginning of 1998. The results reveal that the development of market conditions and market behaviour in the sectors examined has in general progressed. This holds especially for the dairy industry. In the sugar branch state intervention is still considerable, since the sector is regarded as "strategic". Privatisation in both sectors has been almost completed. Competition can also be considered as functioning, although horizontal concentration has increased over the last years. Economies of scale are of relevance in both food branches. They play a particularly important role in the sugar industry. With regard to capacity utilisation, the sugar industry is in a better situation. A common problem for both sectors is the low investment activity, mainly due to a lack of own funds and unfavourable credit as well as macroeconomic conditions. In addition, the Lithuanian dairy and sugar sector have to cope with a very fragmented input sector which leads to high transaction and transportation costs. In the dairy industry, high seasonality of production, state regulation in the procurement of raw material and unfavourable export conditions are regarded as additional major problems