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MARKET INTEGRATION AND PRICE TRANSMISSION IN SELECTED FOOD AND CASH CROP MARKETS OF DEVELOPING COUNTRIES: REVIEW AND

APPLICATIONS George Rapsomanikis, David Hallam and Piero Conforti[46] The article discusses time series applications to market integration. A number of important issues related to the definition of market integration and price transmission, the usefulness and limitations of time series econometrics and the interpretation of the estimated parameters are examined. The extent of price transmission is defined in terms of notional components such as completeness, dynamics and asymmetry of adjustment and a testing framework is applied with each component being tested individually. It is argued that, collectively, these tests can be utilized to assess market integration and the extent to which policies and other distortions affect price transmission. The testing framework is applied to selected food and cash crop markets of developing countries. 1. Introduction A fundamental issue when analysing trade policy reform in global agricultural markets is the extent to which domestic agricultural commodity markets in developing countries respond to changes in international prices. Price transmission

from the world to domestic markets is central in understanding the extent of the integration of economic agents into the market process. Studies on the transmission of price signals are founded on concepts related to competitive pricing behaviour.[47] In spatial terms, the classical paradigm of the Law of One Price, as well as the predictions on market integration provided by the standard spatial price determination models (Enke, 1951; Samuelson, 1952; Takayama and Judge, 1972) postulate that price transmission is complete with equilibrium prices of a commodity sold on competitive foreign and domestic markets differing only by transfer costs, when converted to a common currency. These models predict that changes in supply and demand conditions in one market will affect trade and therefore prices in other markets as equilibrium is restored through spatial arbitrage. The absence of market integration, or of complete pass-through of price changes from one market to another has important implications for economic welfare.[48] Incomplete price transmission arising either due to trade and other policies, or due to transaction costs such as poor transport and communication infrastructure, results in a reduction in the price information available to economic agents and consequently may lead to decisions that contribute to inefficient outcomes. Agricultural and food trade policy reform, especially, is a priority issue in the next

WTO negotiations, as trade liberalization is viewed as encouraging allocative efficiency and long run growth. Price transmission studies are ostensibly an empirical exercise testing the predictions of economic theory and providing important insights as to how changes in one market are transmitted to another, thus reflecting the extent of market integration, as well as the extent to which markets function efficiently. In addition to the body of research and application that tests economic theory, price transmission mechanisms feature prominently in all global agricultural partial equilibrium models, such as the World Food Model of the UN Food and Agriculture Organization and other models such as the that developed by Tyers and Anderson (1992). In these models the price transmission parameter values consist of key building blocks and play an important role in determining the direction, magnitude and distribution of welfare effects of trade policy scenarios (for a review of price transmission mechanisms in partial equilibrium models see Sharma, 2002). Given the increasing use of these models to address sensitive policy issues, such as trade liberalization and the distribution of benefits and costs across countries and population groups, there is an urgency to review these mechanisms and fine-tune them for further applications.

The objective of this paper is to contribute to the body of research and applications on price transmission focusing on both food and cash crop markets in developing countries and to highlight a number of important issues related to the definition of price transmission, the various econometric methods utilized to examine its extent and the interpretation of the results within a policy perspective. Section 2 provides a brief review of the literature and highlights the main findings on the factors that impede complete price transmission and market integration. Section 3 discusses a definition of market integration and price transmission and examines the underlying issues. Section 4 draws a testing framework for the empirical work. Section 5 presents the case studies and section 6 concludes the paper.

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