Quality Upgrading and Competition: Theory and Evidence from Uganda's Coffee Sector

This project studies how market structure affects incentives for quality upgrading along developing
country value chains.

There has long been interest in the process of structural transformation, moving from subsistence agriculture to the production of manufactured goods. Improving the value of agricultural exports is often considered an important first step in this process. In international coffee markets, the focus of this project, there appear to be large returns to quality management. On world markets, higher quality cofee - ripe, undamaged, and washed - can receive premiums of over 90% compared to low-quality coffee. However, farmers in developing countries consistently fall short of these quality standards, resulting in an estimated $20-30 million per year forgone in Uganda's Rwenzori region alone. What prevents these farmers from providing the high-quality coffee that international markets demand? One possibility is that, due to long supply chains of intermediation, farmers may not have access to the same quality premiums offered by the world market. Additionally, if farmers receive a smaller portion of the world price for high-quality goods than they do for low-quality ones, this will discourage production of high quality, relative to incentives under an undistorted quality premium.

This project will focus, through surveys and a field experiment, on one particular hypothesis for why farmers may face a depressed quality premium: that variation in competition may generate differences in the fraction of world price that is passed up to the farmer level for goods of different quality levels, thereby shaping the effective quality premium faced by producers.

Firstly, coffee farmers, traders and one large processor in the Rwenzori region of Uganda will be surveyed, to document quality premiums. Then, if survey evidence points in the direction of the differential competition hypothesis, the researchers will pilot a randomized control experiment to generate exogenous variation in quality premiums at different points in the value chain. One of Uganda's leading coffee procurement, processing and marketing companies will offer randomly selected traders different prices for high quality coffee beans, and for low quality. Moreover, in order to measure how saturation affects the pass-through rate to farmers, the saturation of various quality premiums offers to traders in a given geographic market region will be randomized as well, to generate exogenous variation in competition. Lastly, to measure how responsive farmers are toshort-run changes in quality premiums, the company will buy directly from farmers at randomized quality premiums.

There is strong demand for this project among policymakers. The Ugandan Coffee Development Authority (UCDA) has had discussions with the researchers for several years about the development of this project, including four separate formal presentations of the design, in which the UCDA has expressed great interest. Indeed, the coffee sub-sector is among Uganda's top contributors to export earning, and the country is home to roughly 532,000 smallholder coffee farmers, so promoting quality upgrading in this sector is a government priority.