How Africa's first commodity exchange revolutionised Ethiopia's economy

Eleni Gabre-Madhin on how a market has empowered Ethiopian farmers by focusing on distribution as well as production
MDG : Cereals in Ethiopia : partially harvested cereal fields
Cereal fields in Ethiopia's Arusi-Bale plains, where the commodity exchange has facilitated trade between buyers and sellers. Photograph: Joe Blossom/Alamy

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.

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 PhD on grain markets in Ethiopia. One of the things 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.

You'd see 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 that they'd have to inspect the grain or coffee visually to check if it was really the quality they'd been told it was. They would have to reweigh it and rebag 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 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 about this, 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 happened in 2002, when there were consecutive bumper harvests in 2000 and 2001, and Ethiopia was doing really well. Then six months later prices collapsed 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 at risk of starvation.

I was so shocked. By that time I had my PhD and I knew this was what I wanted to work on. I had the idea of a commodity exchange – I'd written about it in my dissertation. I did my PhD at Stanford, which is really specialised on commodity markets.

What other sorts of dialogues are ongoing about distribution? Now, there is more interest in markets and issues around distribution. In the Ethiopian debate about food security and famine, people would always say, "More seeds, more fertiliser, more irrigation – these are the things we have to do." And yes, we have to do all 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 PhDs in economics working on production issues, and four of us have written PhDs 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 prevent hunger in Ethiopia, and we have to think about the marketing side." That 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? Around Africa, our exchange in Ethiopia has gained a lot of visibility: 18 countries have come to visit it. There has been a huge amount of interest. Many countries are writing it into their policies – that they want to have a commodity exchange. Organisations like the UN Food and Agriculture Organisation, New Partnership for Africa's Development, UN Development Programme, the World Bank – all these organisations 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 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. I feel this is the natural next step for me.

And how will you do that? I'm setting up a company that will carry out precisely 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 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. We have members of the exchange that buy a membership seat, just like Charles Schwab and Merrill 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, 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, such as industrial processors, flour millers, exporters, roasters, etc.

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

On the buying side, we have a clearing house 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 the price and what the quantity is, then our clearing house will take the funds from the buyer from that pre-trade cash account and transfer it to the seller the next day. Also the 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.

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

That means we are a "T+1" clearing and settlement system; the day of trade being "T". T+1 means that tomorrow morning you're paid. Even stock exchanges that have been around for 20 years are still taking two 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 trying to get 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 who used to default on their export contracts because the supplier had not yet met their contract. Or processors, like millers, who 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 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? In our exchange, 12% of the members are farmer co-operatives 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 $10m 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. There are 15 million coffee farmers in Ethiopia, for example, and they are referencing their local market sales off 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. Even if the prices are going up, the trader is buying at the lowest possible price to get a big margin – that margin has 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 1.2m calls a month for market prices off the market data server, of which 70% come from rural areas. When the Tanzanian president, Jakaya Kikwete, came to ECX in May, 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."