An econometric analysis of spatial market integration and price formation in the Namibian sheep industry

Abstract

The Namibian government introduced the Small Stock Marketing Scheme (SSMS) for the sheep market in 2004. The SSMS is a quantitative export restriction. Quantitative export restriction policies decrease the tradable quantity of a commodity, and increases domestic supply of a commodity, causing a lack of equilibrium in spatial markets. This, therefore, has the capacity to hinder market integration. Moreover, a quantitative export restriction disrupts the domestic supply and demand, and ultimately the equilibrium prices. A policy such as the quantitative export restriction therefore determines the domestic price levels. The effect of the SSMS on spatial market integration and price formation remains unclear. A lack of empirical evidence on spatial sheep market integration and domestic price levels can create challenges for policy makers. This is because a lack of evidence could prevent policy makers from implementing evidence-based policies, which might buffer poor consumers and producers from adverse price shocks, and lead to improved resource allocation. This study hypothesises that the SSMS policy negatively affected the long-run equilibrium relationship and short-run dynamics between the Namibian and South African markets. The study further hypothesises that the policy negatively influenced the level of equilibrium prices. As a result, this study hence observes spatial price integration in the presence of the SSMS, by defining the long-run equilibrium and short-run dynamics. The spatial price integration analysis is evaluated by subdividing price series data into pre-SSMS (1999M01-2003M12) and post-SSMS (2004M01-2015M12). The long-run equilibrium relationship is conducted with the Engle and Granger (1987) method and the Johansen (1988) cointegration approach. Short-run dynamics are, in turn, determined with an error correction model (ECM) and vector error correction model (VECM). The study also examined the impact of the SSMS on domestic price levels. This was done by recognising the reaction of the domestic supply, demand, and price functions to the SSMS. The analysis is conducted within the partial equilibrium framework (PEF). Additionally, the synthesis generated a simulation with the PEF to determine the impact on price changes were the SSMS to be removed. The analyses acknowledged a long-run equilibrium relationship between the spatial markets. As predicted, the long-run equilibrium relationship is not the same, pre- and post-SSMS. The price transmission elasticity (0.94) post-SSMS is marginally higher than pre-SSMS (0.88) is, which contradicts a priori expectation that quantitative export restrictions weaken price transmission. The pre-SSMS evaluation indicated a presence of short-run dynamics. Post-SSMS, the VECM revealed no bidirectional effect. The VECM also specified that the Namibian prices are effecting the adjustments in the short run to return to the long-run equilibrium position. This implies that if there is a shock that disturbs the equilibrium between the two spatial prices, Namibian prices would move to restore equilibrium. Likewise, the study appraised the response of the supply and demand functions to the policy in the PEF, incorporating the SSMS as an export ratio variable. The PEF results displayed that the SSMS influenced the supply function negatively, because of the negative elasticity of 0.013. This denotes that in the presences of the SSMS a 10 per cent increase in the quantitative export ratio decreases supply by 0.13 per cent, in which the response is slow. A negative effect is bound to decrease supply, and increase domestic price levels. Furthermore, the SSMS had a positive influence on the demand function, with an elasticity of 0.03 for the export abattoir demand, and 0.93 for the non-export abattoir demand. A positive impact on demand means a decrease in the producer price increases demanded for live sheep. The price equation outcome revealed that the SSMS had an insignificant effect of -0.0044 on the domestic producer prices. The price equation result is attributed to the low elasticity of the SSMS in the domestic supply and demand equation; the continued increase in producer prices post-SSMS due to the drought; and finally, because the SSMS is allowed to vary. Based on the simulation results, the removal of the SSMS policy would increase domestic producer prices by 4 per cent and 6 per cent, in 2017 and 2018, respectively. The percentage increase is considered low, as a result, this suggests that other dynamic factors, such as drought and market structure, affecting prices. This study therefore rejects the hypothesis stating that the long-run equilibrium relationship and short-run dynamic forces had reduced post-SSMS price transmission. The price transmission and speed of adjustment improved, post-SSMS. The study concludes that the SSMS policy did not have a detrimental effect, which was contrary to what was anticipated. The synthesis further fails to reject the hypothesis stating that the SSMS influenced domestic price levels, but the influence was very minimal and negligible. Both the spatial price integration and price formation analyses conclude that the SSMS had no detrimental effect on the sheep market. As a result, the study indicates that a quantitative export restriction policy, which varies, is better than an export control policy that does not allow any variation.