In praise of middlemen: the regulations of market intermediaries in developing economies.

Author:Tafara, Ethiopis

Agriculture was civilization's first great achievement, and agricultural development remains a measure of economic progress around the world. Even in the United States, which is thought of as one of the most industrialized economies in the world, agriculture is one of our most important export industries--more important than steel, aircraft, or even Hollywood movies. (1) It is little wonder, then, that the first concern of so many developing nations is their agricultural market.

So far in this conference you've heard discussions of some of the institutions necessary to make agricultural commodity markets work, specifically, institutions designed to improve the transparency of markets, commodity certification, and supply chain coordination. I've been asked to comment on another set of important market institutions: those institutions designed to protect property rights and enforce contractual arrangements.

My interest in this issue dates back to before I joined the Securities and Exchange Commission (SEC), to my time working for the U.S. commodity markets regulator, the Commodity Futures Trading Commission (CFTC). The CFTC is something of a younger sibling to the SEC, but the markets it oversees are nearly as old. Indeed, an interesting feature of the U.S. economy is that the regulators tend to be much younger than the markets they oversee. The first American securities exchange was formally created in 1792 by a group of twenty-four market middlemen who gathered to conduct business under a buttonwood tree along Wall Street in New York. (2) The first U.S. agricultural commodities market was formed by eighty-two merchants in Chicago in 1848. (3)

The challenges the American commodity markets faced more than 150 years ago were not much different from what they face today--or, for that matter, what African markets face today. In the United States' case, American farmers grew their grain and raised their livestock hundreds of miles away from the big cities of New York, Philadelphia and Boston. (4) Back then, there were no rapid, affordable mechanisms by which farmers could learn about what prices these commodities were fetching in these distant markets, and transportation costs were high.

Today, in the United States, communication and transportation costs are much lower, but information transparency and transaction costs still determine whether a particular market is successful and whether commodity producers prosper or suffer. And today, just as was the case back in the 1850s, market intermediaries--brokers, traders, and other middlemen--are the key to increasing information flow to the market and lowering transaction costs. Of course, most advanced commodity markets now measure time in milliseconds instead of days or weeks, and transportation comprises just a fraction of the total transaction cost. But these miracles are possible because of those early middlemen in Chicago and elsewhere. I believe middlemen will be the key to creating a modern agricultural market both in Africa and other developing regions as well.

I recognize that these days it is not so fashionable to praise middlemen. In much of the world today, with the growth of the Internet, mass customization, and electronic trading markets, "middlemen" are something to be cut out and eliminated. And, in historical terms, this is a relatively charitable view. When it came to commodity markets, market intermediaries often were loathed--and none more so than those middlemen we would now call commodity brokers, those who were not actually involved in the business of transporting goods from one place to another.

These middlemen were widely viewed as little better than parasites. For example, in 1613 an English Puritan minister, in a sermon rifled The White Devil, or the Hypocrite Uncased, described a grain broker in this manner:

He prayes for raine in harvest, night and day, To rot and to consume the graine and hay. But if a plenty come, this ravening thiefe Torments & sometimes hangs himselfe with griefe. (5) The earliest laws reflected this view of market intermediaries. At the time this minister gave his sermon, English common law, upon which American laws are based, specifically outlawed many practices that we now take for granted. A broker who purchased grain before the harvest and who later resold the grain--what we now call a futures contract--was guilty of "engrossing." A broker who purchased grain outside of a market and then resold it on the market--taking advantage of an arbitrage opportunity--could be imprisoned for "forestalling." (6) As one contemporary legal scholar described it, these "engrossers" and "forestallers" engaged in "practices which tend to make the commodities of the Realm more dear." (7)

We now see things differently. We have come to understand that brokers and other intermediaries provide a service not just by transporting commodities over great distances and by matching existing buyers with sellers, but also by transporting goods over time, matching future buyers and future sellers. Intermediaries help bear the risk in times of scarcity and spread out the benefits during times of plenty.

That is not to say that market intermediaries are universally loved. There are few countries where farmers have kind things to say about commodity brokers. In the United States, the common accusation is that the prices offered by market intermediaries are too low for small farmers to make a living. (8) But most farmers, being businessmen, recognize the value brokers and wholesalers offer. Even those farmers who have "cut out the middleman," so to speak, and deal directly with large agricultural companies or sell directly to consumers through...

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