How Africa's First Commodity Exchange Revolutionized Ethiopia's Economy

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While government leaders, NGOs and corporations devise strategies to churn out more food for future generations, Eleni Gabre-Madhin is taking a different approach. Concerned by a 2002 famine in her home country of Ethiopia that followed bumper crops in 2000 and 2001, the Stanford-educated economist decided it was time to go beyond food production and take a hard look at distribution.

The result? Africa's first commodity exchange. As the founder and outgoing CEO of the Ethiopia Commodity Exchange (ECX), Gabre-Madhin established a reliable interface for buyers and sellers to meet - an idea that has inspired other African countries to follow suit. Gabre-Madhin won the Yara Award at the African Green Revolution Forum in Arusha, Tanzania, for her role in transforming Ethiopia's commodity market. She told AllAfrica's Lauren Everitt how a formal market has revolutionized Ethiopia's economy and empowered smallholder farmers.

What prompted your decision to found Africa's first commodity exchange in Ethiopia?

I had been doing research on grain markets and other agriculture markets in Africa for many years and as it happened I did my Ph.D. on grain markets in Ethiopia. One of things that I kept seeing over and over, which I'd seen in other parts of Africa, was just how difficult it was for buyers to find sellers and sellers to find buyers and how difficult it was to enforce the contract.

And so you'd see over and over that a seller, such as a farmer, for example, who sold grain to a trader wouldn't get paid for weeks, sometimes months. There were cases in the coffee market in Ethiopia where people had committed suicide because they had outstanding loans and their buyers hadn't paid them. So there were all sorts of cases of contract default.

Then from the buyers' perspective you'd hear over and over again that they'd have to visually inspect the grain or the coffee to check if it was really the quality they'd been told it was. They would have to reweigh it, re-bag it to see if it was the actual quantity and quality that they were contracting.

So these are all the problems in the supply chain that make us poor and make us food insecure. If people can't get grain where it's produced really efficiently to where it's needed, then you have markets that are segmented. You have pockets of surplus where prices collapse and places in other parts of the county where prices shoot up because there's a deficit and there's no grain coming in.

That's actually exactly what happened in 1984 in the big famine that claimed a million lives in Ethiopia. There was obviously a shortage in the north and yet Ethiopia had to go to the world and beg for food aid, but there was a grain surplus in the fertile parts of western Ethiopia.

When I found out as a student about this situation of the 1984 famine, I said, 'It can't just be about producing more - sure producing more is important but we've got to figure out how to distribute it. We've got to figure out how to make an efficient market work for everybody - for the farmers, for the buyers, because otherwise we're always going to be in this cycle'.

The same thing was repeated in 2002 when there were two years of consecutive bumper harvests in 2000 and 2001 and Ethiopia was doing really well. Then six months later prices collapsed completely almost to zero, and farmers could not sell the grain. Six months later, in mid-2002, Ethiopia went to the world for emergency food aid for 14 million people risking starvation.

I was so shocked. By that time I had my Ph.D. and I knew this was thing I wanted to work on. I think 2002 just crystallized that I needed to go back to Ethiopia and do something about this. I had the idea of a commodity exchange - I'd written about it in my dissertation, I did my Ph.D. at Stanford, which is really specialized on commodity markets.

What other sorts of dialogues are ongoing about distribution?

I think more so than 10 years ago, now there is an interest in markets and issues around distribution. In the Ethiopian debate about food security and famine, people would always say, 'More seeds, more fertilizer, more irrigation - these are the things we have to do'. And yes, we have to do all of that, but then here you are - you get a bumper harvest and six months later people are still going to starve.

Every crisis leads to an opportunity so that crisis led me to tell the government: 'We have 40 or 50 Ph.D.s in economics working on production issues, and there are exactly four of us who have written Ph.D.s on market issues, and that's how skewed our development policy is - we're always talking about production and we have to have a more balanced perspective on how we're going to get out of hunger in Ethiopia, and we have to think about the marketing side'. That actually somehow resonated, and the government decided to start up a whole initiative on markets. That's how I got invited to start the project on the commodity exchange and subsequently left the project and then started the exchange.

Has the idea of a commodity exchange gained traction elsewhere on the continent?

I think around Africa now our exchange in Ethiopia has really gained a lot of visibility. We've had 18 countries come to visit the exchange.

There has been a huge amount of interest. Many countries are writing it into their policies - that they want to have a commodity exchange. I think organizations like AGRA, FAO, Nepad, UNDP, the World Bank - all these organizations are now sort of saying, we have to take this seriously, and help countries think through initiatives like the Ethiopia commodity exchange.

As the outgoing CEO of the Ethiopian Commodity Exchange, what will you do next?

I've seen this enormous demand, and that's going to be my next chapter - to sponsor that demand, which in a sense has been created by the initiative in Ethiopia. So that I feel this is the natural next step for me.

And how will you do that?

I'm setting up a company that will precisely do this kind of project for different countries, bringing in knowledge, technology and management experience. At this point there are about six countries, I would say, that are really moving quite aggressively on getting commodity exchanges set up in Africa, and that's really exciting.

You have talked about a disconnect between buyers and sellers - how does a commodity exchange address that and hold both parties accountable?

Basically it's a membership-based system. So we have members of the exchange that buy a membership seat, just like Charles Schwab and Merill Lynch are seat holders on the New York stock exchange or Cargill is a member on the Chicago Board of Trade.

When you buy a membership seat, then you use that seat to trade either on behalf of yourself or clients, who you may sign up. We have members of the exchange who trade on behalf of farmers, who themselves are farmers, and members who are buyers like industrial processors, flour millers, exporters, roasters, etc.

The members of the exchange follow the rules of the exchange in the sense that they will bring commodity to our warehouse, get it graded, certified, weighed and essentially stored in a warehouse that we are operating. This means that now we have a guarantee that we know what the quality is, we know what the quantity is and we know that it will be delivered at sale.

On the buying side we have a clearinghouse that takes the buyer's funds into a pre-trade cash account that is used for exchange trading purposes. The exchange has no involvement besides providing the platform for the buyer and seller to physically or virtually meet, and once they've agreed on the terms of what the price is and what the quantity is, then our clearinghouse will take the funds from the buyer from that pre-trade cash account and transfer it to the seller the next day. The same next day we will take the warehouse receipt from the seller and transfer the ownership to the buyer. So the exchange is the third-party guarantor of the transaction, and that's the key point.

By being a guarantor for the transaction it means you didn't need relatives or special connections. You don't have to go beg people to pay you or chase after them. You don't have to go check if the quality is really grade one. The exchange is guaranteeing the quality, the quantity, the payment and the delivery. That's a very big value-add proposition to the market - that if you trade through the exchange, you will receive your payment the next morning.

That means we are a T + 1 clearing and settlement system. The day of trade being "T" and T + 1 is tomorrow morning you're paid. Even stock exchanges that have been around for 20 years are still taking two days after trade or three days after trade to effect payment. We're settling the next day. This is a financial revolution in Ethiopia - that somebody who sold is guaranteed payment the next day, especially when you imagine how many people have committed suicide or spend a large part of their time getting paid.

This is a very big change in our market - that people can go to market saying, 'I'm going to sell at whatever price I want, and I will get paid'. Same thing for the buyers: 'I will get my delivery, I will get my commodity when I want it, not months later'.

There are exporters that used to default on their export contracts because the supplier had not yet met their contract. Or processors, like millers, that would get a delivery but it would be full of sand or stones. They'd put it in their machines, and their machines would break down. All of these problems are not going away because of our system.

The smallholder farmer was the theme of the African Green Revolution Forum. Are they able to access the commodity exchange easily?

Twelve percent of the members of our exchange are farmer cooperatives that are representing 2.4 million small farmers in Ethiopia. That's a massive number in just four short years and relative to the amount of investment. Millions and millions are being spent on linking farmers to markets, and here with less than U.S.$10 million we've accessed 2.4 million farmers in four years.

More importantly, even if they don't trade directly through the exchange, because of the transparency around the pricing, all the farmers in the country are now using the ECX price as the reference price. In the case of coffee, there are 15 million coffee farmers in Ethiopia, and they are referencing their local market sales off of the ECX price. This basically means that the margin between the local price and the ECX price has narrowed almost by half. So if a trader knows what the central market price is, but the farmer doesn't know, the trader will try to bring it down. So even if the prices are going up, the trader is buying at the lowest possible price to get a big margin - that margin has now shrunk down to half of what it used to be because of the transparency of the system and because everybody's using the same system.

We're getting 1.2 million calls a month for market prices off of the market data server, of which 70 percent come from the rural areas.

When Tanzanian President Jakaya Kikwete came to ECX in May 2012 he asked a trader who was part of our meeting, how do you negotiate with the farmers? How do you set prices with the farmers? And she looked at him and said, 'Mr. president, even if I wanted to cheat farmers I can't, because they know the prices before I do'.