Economic 

Research

Report

Number 76

United States 

Department 

of Agriculture

Economic 

Research 

Service

The Transmission of 

Exchange Rate Changes to 

Agricultural Prices

William Liefert

Suresh Persaud
www.ers.usda.gov

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Liefert, William

 The transmission of exchange rate changes to agricultural

 prices.

 (Economic research report (United States. Dept. of 

 Agriculture. Economic Research Service) ; no. 76)

 1. Foreign exchange rates. 2. Agricultural prices. 

 3. Agriculture and state.

 4. Produce trade—Developing countries. I. Persaud, 

 Suresh Chand, 1969-

 II. United States. Dept. of Agriculture. Economic Research 

Service. III. Title.

HG3877
United States

Department

of Agriculture

www.ers.usda.gov

A Report from the Economic Research Service

Abstract

Movements in countries’ exchange rates can substantially change the prices of goods 

faced by producers and consumers and thereby affect incentives to produce, consume, 

and trade goods. Exchange rate changes, however, might not be completely transmitted 

(passed through) to domestic prices. Empirical evidence shows that price and exchange 

rate transmission for agricultural products is low in most developing economies, partly 

because of trade policies but also because of inadequate infrastructure and other market 

deficiencies. During the last 20 years, developed and developing countries generally 

have moved away from support policies that impede price and exchange rate transmission toward trade policies that allow transmission, such as tariffs. The Uruguay Round 

Agreement on Agriculture of 1994 strongly encouraged this development. Despite 

these policy changes, market deficiencies remain as a cause of incomplete transmission. 

Incomplete transmission weakens countries’ integration into world agricultural markets 

and thereby reduces agricultural trade potential. Low transmission in developing countries also decreases their own benefits from trade, including the gains they could realize 

if there is further global agricultural liberalization.

Keywords: Agricultural infrastructure, agricultural policy, agricultural trade, exchange 

rates, exchange rate transmission, imperfect markets, institutions, price transmission.

Acknowledgments

The authors thank the following for their helpful reviews: Lars Brink (Ag Canada); and 

Carlos Arnade, Barry Krissoff, Mary Anne Normile, Mathew Shane, and John Wainio 

(USDA, Economic Research Service). Thanks also to John Weber and Victor B. Phillips, 

Jr. for editorial and design assistance.

William Liefert, wliefert@ers.usda.gov

Suresh Persaud, spersaud@ers.usda.gov

The Transmission of Exchange Rate 

Changes to Agricultural Prices

Economic 

Research 

Report 

Number 76

July 2009
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Contents

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Why Are Exchange Rates Important for Agriculture? . . . . . . . . . . . . . . 2

What Is Exchange Rate Transmission? . . . . . . . . . . . . . . . . . . . . . . . . . . 5

What Are the Possible Causes of Incomplete 

Exchange Rate Transmission? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

 Government Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

 Market Conditions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

What Are the Economic Effects of 

Incomplete Transmission? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

What Is the Empirical Evidence Concerning 

Exchange Rate Transmission? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

 Empirical Studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

 The Cause of Low Transmission for 

Developing Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

How Does Incomplete Transmission Affect 

Measures of Protection and Support? . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
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Summary

Exchange rate movements can change countries’ domestic prices, thereby 

affecting incentives to produce, consume, and trade goods. For example, 

consider an exporting country that has a depreciating currency. The price 

domestic producers receive for exporting a good should rise because the 

trade price converted into domestic currency is now higher. This benefi ts 

domestic producers and motivates them to produce and export more 

of the good.

However, many countries have trade policies or market conditions that 

prevent or reduce the transmission (or pass through) of changes in exchange 

rates to domestic prices. This blunts the domestic price and market response 

to exchange rate changes. In the example above, incomplete transmission 

could keep the domestic price, production, and export of the good from rising 

as much as possible. Incomplete transmission thereby can prevent countries 

from attaining the levels of production, consumption, and trade of goods that 

would bring them, and their trading partners, the most economic benefi t.

What Is the Issue?

The main reason exchange rate transmission is important for U.S. agriculture 

is because a large share of U.S. agricultural production is exported. Over 

the last 15 years, about a quarter of U.S. agricultural output has been sold 

abroad. Incomplete transmission of agricultural prices and exchange rates to 

domestic prices within countries means, however, that these countries are not 

fully integrated into world agricultural markets. They are not trading as much 

as they profi tably could. More specifi cally, as a group they are not importing 

as many agricultural goods from the United States as is in their, and the 

United States, economic interests.

What Did the Study Find?

The two main causes of incomplete exchange rate transmission for agricultural products are trade policies and poor market conditions. Trade policies 

that impede transmission include import quotas and systems of managed 

(or fi xed) agricultural prices. Poor market conditions can involve defi cient 

market infrastructure and the use of market power by large buyers and sellers 

to set prices. The defi ciencies can be in physical infrastructure, such as roads, 

transport, and storage, or in commercial and institutional infrastructure, 

such as systems of market information, fi nance, and law. Poor infrastructure 

isolates regional markets within countries from each other, as well as cuts 

them off from the world market, thus weakening transmission.

The United States has been moving away from transmission-impeding agricultural trade and support policies, it has fairly good infrastructure supporting 

the agro-food economy, and its agricultural markets are reasonably competitive. Thus, price and exchange rate transmission is not a serious problem for 

the workings of U.S. agriculture. Empirical research shows, however, that 

price and exchange rate transmission for agricultural products is lower in 

developing economies than in the United States and other developed countries. Analysis of 56 developing countries over a 30-year period found that 
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about a third of the countries had almost no transmission of border price 

changes to domestic prices, even after allowing for an adjustment period 

of 5-7 years. In 23 other countries, after 5 years, no more than half of the 

change in border prices was transmitted to domestic prices.

Policies within developing economies certainly account for some of the 

weak transmission. Yet, during the last 20 years, many developing countries 

have liberalized their agricultural policies, a process promoted by the 1994 

Uruguay Round Agreement on Agriculture, such that price and exchange 

rate transmission should improve. However, poor market conditions, such as 

weak infrastructure, continue as a serious impediment to price and exchange 

rate transmission in many developing economies.

Incomplete transmission has implications for the interpretation and use of 

standard measures of agricultural protection and support. These measures all 

involve some sort of gap between the domestic price for a commodity and 

its border price. This price wedge is typically interpreted as a measure of the 

degree to which government policies distort domestic prices, and thereby 

distort market incentives to produce, consume, and trade goods. However, 

measures of protection and support could be used to misidentify the cause of 

price gaps. This could happen if a large part of the price wedges were caused 

not by policies but by incomplete price and exchange rate transmission 

resulting from market imperfections, such as deficient infrastructure. 

By misidentifying the cause of price gaps, governments might adopt inappropriate policies intended to eliminate the gaps.

How Was the Study Conducted?

The study uses market and trade analysis to examine how changes in 

exchange rates affect a country’s domestic markets for agricultural commodities. The same conceptual framework is then used to analyze the causes 

and market effects of incomplete price and exchange rate transmission for 

agricultural commodities. The study also examines the empirical evidence 

concerning exchange rate transmission for the United States, other developed 

countries, and, particularly, developing countries, as well as evidence that 

market conditions alone can cause incomplete transmission.
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Introduction

Foreign exchange markets link a country’s domestic economy to world 

product markets by facilitating the conversion of foreign currencies into 

domestic currency. The degree to which exchange rate changes impact a 

country’s domestic markets depends on the extent to which the changes are 

transmitted, or passed through, to domestic prices. When only part of an 

exchange rate change is transmitted to domestic prices (called incomplete 

transmission), domestic prices will differ from border prices. Such price 

differences indicate that countries are not maximizing their total volume of 

trade, and, thereby, their potential economic gains from trade. This, in turn, 

means that the countries’ total economic welfare is less than it could be.

If countries fail to maximize their trade volumes and gains from trade, not 

only is their economic welfare reduced, but so, too, are the trade and welfare 

gains of their trading partners. The United States is the largest agricultural 

exporter in the world, with 2007 exports equaling $90 billion (10 percent of 

the world total; FASonline). About 25 percent of U.S. agricultural output 

is exported. Incomplete transmission for agricultural products that reduces 

countries’ trade therefore hurts the United States as the world’s leading agricultural exporter. 

This report examines the possible causes and economic effects of incomplete 

exchange rate transmission. It looks at the empirical record concerning the 

magnitude of exchange rate transmission in countries throughout the world, 

with special focus on developing economies. The report also examines 

how incomplete transmission can lead to misinterpretation of conventional 

measures of agricultural protection and support, as the measures might overstate the importance of policies as causes of price gaps. This misidentification could motivate governments to make inappropriate policy changes in an 

effort to end the price gaps.
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Why Are Exchange Rates 

Important for Agriculture?

Exchange rates are a key variable in determining domestic prices for agricultural commodities, and, thus, the quantities of goods domestically produced, 

consumed, and traded. For tradable goods, exchange rates link domestic 

prices to world prices. If a country imposes no transmission-impeding policies and there are no domestic transport or transaction costs for a tradable 

product, the domestic price for a good (Pd) is determined by the world price 

(Pw) times the exchange rate (E), that is, Pd = Pw * E.

Figure 1 demonstrates how changes in the exchange rate can affect the 

market for a U.S. agricultural commodity. Assume in the figure that the 

world price equals 50 euros and the dollar/euro exchange rate equals 2 

(which means it takes 2 dollars to buy 1 euro). The commodity’s domestic 

price equals $100 (P2). At this price, Q2 of the commodity is domestically 

produced, Q5 purchased, and Q2Q5 imported. Assume now that the exchange 

rate falls from 2 to 1 (E2 to E1), meaning that now only 1 dollar is needed 

to buy 1 euro. (This means that the dollar has doubled in value vis-à-vis the 

euro, or alternatively, appreciated by 100 percent.) Because it now takes only 

half as many dollars as before to buy a given amount of euros, the dollar’s 

appreciation lowers the domestic price of all tradable goods initially priced 

in euros. In this example, the domestic price is halved from $100 to $50 (P1). 

At the lower price, domestic production falls to Q1, purchases rise to Q6, and 

imports increase to Q1Q6.

Alternatively, assume that the exchange rate rises from 2 dollars per euro 

to 3 dollars per euro (a depreciation of 50 percent). Because it now takes 50 

percent more dollars to buy a given amount of euros as before, the dollar’s 

depreciation raises the domestic price of all tradable goods initially priced in 

euros. In this example, the domestic price increases from $100 to $150 (P3). 

At the higher price, domestic production rises to Q3, consumption falls to Q4, 

and imports decrease to Q3Q4.

An increase in the world price of the good in question from $100 to $150 

would have the same initial market effect as the 50-percent depreciation in 

the dollar. Exchange rates, however, have more potential than world prices 

to affect domestic markets. The change in the world price for a specific 

commodity mainly will impact the domestic price for that good alone (with 

lesser effects on the prices of a few related goods), while a change in a country’s exchange rate can alter domestic prices for all tradable goods.1 The 

price changes for other tradable goods can, in turn, affect the market for the 

good in question (in figure 1, assume this good is beef). The depreciation of 

the currency as represented by the rise in the domestic beef price from $100 

to $150 will raise the domestic price of all domestically produced substitutes for beef, such as pork and poultry. The price increases for those goods 

will boost demand for beef to some degree through a consumer substitution 

effect, shifting the demand curve for beef to the right. This shift will offset 

some of the drop in quantity demanded for beef from the initial rise in its 

price from $100 to $150. The currency depreciation will also increase the 

prices for all tradable inputs used to produce beef. This effect will shift 

the domestic supply curve for beef to the left, reducing output and 

increasing imports.

1One might counter that the currency 

of a country has no single exchange 

rate but rather a separate rate vis-à-vis 

the currency of every other country. 

Although this is technically correct, 

countries’ exchange rates tend to move 

together vis-à-vis those of most other 

foreign currencies. If the rates did not 

move in such a way, currency traders 

could make large profits by combining 

trades in the currencies against which 

a country’s exchange rate did change 

with trades in the currencies against 

which the country’s currency did not 

change (called arbitrage).
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By affecting prices for all tradable goods, changes in exchange rates have 

secondary market effects for a single good beyond that identified in figure 1. 

Thus, exchange rate changes have a more complex effect on the market for 

an individual good than does a change in the world price for that good alone.

Exchange rates can have large swings in magnitude, which also makes them 

important for agricultural markets (fig. 2). Although the currencies of developing economies are characterized by such swings, developed economies’ 

currencies also can change substantially in value over time, as shown by the 

fluctuation in the value of the U.S. dollar and euro over the last 35 years.2 For 

most countries, exchange rates fluctuate not so much through annual movements in value up and down but rather through movement over multiyear 

cycles. The major changes in exchange rates over the course of these multiyear 

2The euro did not officially come into 

existence until 1999 (electronically at 

first, with notes and coins coming in 

2002). The euro exchange rate in figure 

2 is calculated by using trade weights 

to convert earlier currency values for 

the 12 future member countries to a 

euro equivalent.

Figure 1

Domestic market effects of exchange rate changes 

Source: USDA, Economic Research Service.

Price

Quantity

Supply

Demand

P3

 = Pw * E3 = 50 * 3 = $150

P2

 = Pw * E2 = 50 * 2 = $100

P1

 = Pw * E1 = 50 * 1 = $50

Q3 Q4 Q1 Q2 Q5 Q6

Figure 2

Real exchange rates

0

50

100

150

200

250

Index value

1970 1975 1980 1985 1990 1995 2000 2005

 

Note: Real exchange rates are nominal rates adjusted for domestic and foreign inflation.

1970 = 100, except for Russia, for which 1991 = 100. An increase (decrease) in the exchange 

rate index means currency appreciation (depreciation). For the United States, the exchange rate

is trade weighted. For all other countries, the exchange rate is weighted vis-á-vis the U.S. dollar.

Source: USDA, Economic Research Service, Agricultural Exchange Rate Data Set 

and Global Insight.

U.S.

EU

Brazil

Egypt

Indonesia

Russia
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cycles can alter domestic prices substantially. For example, from 1993 to 

1999, the dollar appreciated by about 10 percent vis-à-vis all other currencies 

in trade-weighted terms. Over that time, the U.S. farm gate price for wheat, 

soybeans, beef cattle, and hogs fell 24, 28, 14, and 33 percent, respectively 

(USDA, ERS, Agricultural Outlook). Although other market conditions probably contributed to these large price drops, the currency appreciation appears to 

have played a key role.
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What Is Exchange Rate Transmission?

As discussed in the previous section, if a country imposes no transmissionimpeding policies on a commodity and there are no domestic transport or 

transaction costs for the product, the domestic price for the good (Pd) will 

be determined by the world price (Pw) times the exchange rate (E), that is, 

Pd = Pw * E. Pw * E gives the commodity price in domestic currency at the 

border and therefore is called the border price (Pb). If Pd = Pb = Pw * E, 

the border price has been completely transmitted, or passed through, to the 

domestic price. Alternatively, one could say that both the world price and 

exchange rate have been completely transmitted to Pd. Although the words 

transmission and pass through often are used to describe the process by 

which changes in border prices affect domestic prices, the rest of this paper 

will use the word transmission exclusively.

Another test of transmission is the degree to which a change in Pb, Pw, or E 

is transmitted to Pd. The test involves computing transmission elasticities. 

The transmission elasticity (TE) involving Pb and Pd is defined as the percent 

change in Pd divided by the percent change in Pb, that is, %∆Pd / %∆Pb. If 

the TE equals 1, there is complete transmission of the change in Pb to Pd. If 

the TE equals 0, there is no transmission, and if the TE is between 0 and 1, 

the transmission is incomplete. One can also compute transmission elasticities specifically for the relationships between the world price or exchange 

rate and the domestic price. The exchange rate transmission elasticity equals 

%∆Pd / %∆E and also can be between 0 and 1.

In figure 1, assume that, initially, Pd = Pb = $50, such that Pw * E = 50 * 1. 

E then rises from 1 to 3, such that Pb increases from $50 to $150. If Pd also 

were to rise to $150, the TE involving E and Pd (as well as the TE involving 

Pb and Pd) would equal 200% / 200% = 1. The transmission of the change in 

the exchange rate to the domestic price would be complete. If Pd were not to 

change at all, the TE would equal 0. If Pd were to rise to $100, the TE would 

equal 100% / 200% = 0.5.

Because changes in both exchange rates and world prices can be transmitted 

to domestic prices, many of the issues discussed in this report involving 

exchange rate transmission apply also to world price transmission. This 

report focuses on exchange rate transmission because of the high degree to 

which exchange rates can fluctuate, especially for developing countries, and 

because a change in the exchange rate for a country’s currency can affect 

domestic prices for all its tradable goods.
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What Are the Possible Causes of Incomplete 

Exchange Rate Transmission?

This section of the report is a conceptual discussion of the two general causes 

of incomplete exchange rate transmission: government policies and market 

conditions. Another section of the report, “What Is the Empirical Evidence 

Concerning Exchange Rate Transmission?” examines more deeply the prevalence of the specific policies and market conditions throughout the world that 

impede transmission.

Government Policies

During the post-World War II period, governments throughout the world 

(including in the United States and European Union (EU)) have maintained 

various policies for agricultural commodities that largely precluded transmission (table 1). These policies usually involved either explicitly fixing 

prices or defending targeted prices through government intervention into 

agricultural markets (say, by purchasing output). In the United States, such 

managed price policies have included the commodity loan program (used 

for wheat, corn, soybeans, and cotton, among other crops), the sugar price 

support program, and the dairy support program (see USDA, ERS, Farm and 

Commodity Policy Briefing Room).

During the same period, the most common EU transmission-impeding policy 

was intervention prices, combined with variable levies. In 1992, the EU 

reduced intervention prices, and in 1994, it abolished variable levies as part 

of the Uruguay Round (UR) Agreement on Agriculture. Nonetheless, the 

intervention price system combined with border measures still remains for 

certain commodities, such as milling wheat, barley, sugar, and dairy products, insulating domestic agricultural producer prices from changes in border 

prices (Agra Europe).

Trade quotas also prevent price or exchange rate transmission. In figure 1, 

assume that an import quota of Q3Q4 exists. The quota volume, combined 

with the shapes of the domestic demand and supply curves, determines the 

domestic price (P3), and, thereby, the quantity of the good domestically 

produced (Q3) and consumed (Q4). Assume that the border price also initially 

Table 1

Agricultural commodity policies and their effect on transmission

Policy Transmission effect

Managed prices Prevent

Quotas Prevent

State trading Prevent

Tariffs Prevent if trade prohibitive

Tariff rate quotas Prevent if quota is operative

Technical barriers to trade/ Prevent if take form of trade bans

sanitary and phytosanitary

 Source: USDA, Economic Research Service.
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equals P3 but then falls to P2. If the quota volume remains unchanged, the 

domestic price will also remain unchanged at P3.

3 Consequently, none of the 

drop in the border price will be transmitted to the domestic price.

Another government policy that can prevent transmission is state trading. 

State trading exists when a state or parastatal agency determines the volume 

of a commodity that a country will export or import (see Ackerman and 

Dixit, 1999). Examples of state trading agencies include the Canadian 

Wheat Board, AWB of Australia, and Fonterra of New Zealand for agricultural exports, and the Staple Food Department of the Japanese Ministry 

of Agriculture and Korea Agro-Fishery Trade Corporation for agricultural 

imports. (AWB formerly was the Australian Wheat Board, whereas Fonterra 

was formed from the merger of the New Zealand Dairy Board, New Zealand 

Dairy Group, and Kiwi Cooperative Dairies. Although privatized a few years 

ago, these agencies operate like state traders.) State trading agencies on the 

import side determine the volume of a commodity to be imported, and that 

volume functions like a trade quota. Just as import quotas insulate domestic 

prices from border prices, so, too, does import state trading in its most typical 

forms. Consequently, certain state trading practices also can prevent world 

price and exchange rate transmission to domestic prices.

The trade policy that most allows transmission is tariffs. This is especially 

true of ad valorem tariffs, where the tariff is calculated as a percentage of the 

border price. Given that the tariff charge is a proportion of the border price, 

any percent change in the border price (or more specifically, world price 

or exchange rate) can result in an identical percent change in the domestic 

price (assuming no domestic transport or transaction costs for the imported 

product). Thus, the transmission elasticity potentially is 100 percent. Tariffs, 

however, can be trade prohibitive, that is, so high that they discourage any 

trade whatsoever. By effectively cutting off domestic markets from world 

markets, prohibitive tariffs also prevent world price and exchange rate 

transmission to domestic prices.4

A policy related to tariffs that might or might not impede transmission 

is tariff rate quotas (TRQs). A TRQ is a two-tiered tariff, where a lower 

in-quota tariff is applied to a maximum volume of initial imports and a 

higher over-quota tariff is applied to all additional imports (see Skully, 

2001). Because TRQs combine elements of a pure tariff and a pure quota, the 

degree to which they allow price and exchange rate transmission depends on 

whether the tariff or quota part of the TRQ is operative.

Another major type of trade restriction is technical barriers to trade (TBTs), 

defined to include sanitary and phytosanitary (SPS) measures. Roberts et al. 

(1999) argue that the two most common TBT measures are regulations and 

testing requirements, both of which increase the cost to foreign suppliers 

of providing goods for import by the TBT-imposing country. These costs 

simply increase the price of traded goods and thereby do not retard the transmission of changes in either the world price or the exchange rate to domestic 

prices. TBTs, however, can take the form of a complete ban on imports, 

typically because the exporting country suppliers do not satisfy the imposed 

regulation or testing requirement. By completely preventing trade, trade bans 

block any transmission between world prices or exchange rates from the 

banned country to the domestic market of the banning country. 

3To see this, assume that the drop in 

the border price to P2 also initially results in the domestic price falling to P2. 

At this price, consumers would want to 

import Q2Q5 of the good. The quota, 

however, restricts imports to only 

Q3Q4. To eliminate the excess demand 

for imports, the domestic price must 

return to P3, at which price consumer 

demand for imports equals the import 

volume allowed by the quota.

4The other main type of tariff is a 

fixed charge per unit of good imported 

or exported. With a per unit tariff, the 

transmission elasticity between the 

border and domestic prices will not 

equal 100 percent. For example, assume that the border price for an import 

is $100 and a per unit tariff of $25 

exists. This will produce a domestic 

price of $125. Assume now that the 

border price doubles to $200, such that 

the domestic price rises to $225 (adding 

on the per unit tariff). The border price 

has increased by 100 percent, but the 

domestic price has risen by only 80 

percent. The transmission elasticity is 

therefore 80 percent / 100 percent = 

0.8. Note, however, that the full $100 

increase in the border price is passed 

on to the domestic price, which rises 

from $125 to $225. An ad valorem 

tariff creates a transmission elasticity 

of 100 percent because the domestic 

price changes proportionally with the 

border price. A fixed per unit tariff, 

on the other hand, does not produce a 

transmission elasticity of 100 percent 

because the fixed tariff precludes a 

proportional relationship between the 

border and domestic prices.
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During the last 20 years, countries throughout the world have been moving 

away from trade policies that prevent or lower price and exchange rate transmission toward policies that allow it, especially tariffs. The United States and 

the EU have been reducing managed price policies that can wholly preclude 

transmission (USDA, ERS, Farm and Commodity Policy Briefi ng Room; 

Agra Europe). These countries have moved to some degree to agricultural 

support policies based on direct payments to farmers. Under these policies, 

farmers receive direct monetary payments from the government largely independent of (decoupled from) prices and production decisions. Consequently, 

the payments should not much affect agricultural markets or prevent or 

reduce the transmission of border price changes to domestic prices. Yet, both 

the United States and the EU retain policies that impede price transmission, 

such as the U.S sugar price support program.

Before the late 1980s, the governments of most developing countries strongly 

regulated and controlled their agricultural economies, in particular, prices 

and trade volumes. These policies also largely insulated domestic prices 

from border prices. In the late 1980s and early 1990s, however, developing 

countries began to liberalize their agricultural policies so that their domestic 

agricultural markets became more integrated into world markets (see WTO). 

The effect has been to strengthen transmission between border and domestic 

prices. Developed and developing economies were motivated to liberalize 

their agricultural policies by the 1994 UR Agreement on Agriculture, which 

banned import quotas, nontariff measures maintained through state trading 

enterprises, and most other nontariff trade barriers, requiring countries to 

convert border measures to tariffs.5

In the 1980s, the countries with the strictest agricultural trade controls were 

the planned economies of the Soviet bloc. These economies kept domestic 

prices almost completely insulated from world prices and exchange rates so 

that no transmission from the latter to the former was possible. The collapse 

of the Soviet Union and Soviet bloc and the transition of the former bloc 

countries from planned to market economies that began in the late 1980s 

and early 1990s allowed for their expanding integration into world markets 

so that price and exchange rate transmission for agricultural products now 

became possible (see Liefert and Swinnen, 2002).

Although there has been a general worldwide move during the last two 

decades away from transmission-retarding policies—and, especially, such 

policies as managed prices and quotas that wholly preclude transmission—

prohibitive tariffs, TRQs, and TBTs have expanded as trade restrictions 

during this time. As discussed earlier, these policies can also prevent transmission, which means their growing prevalence has mitigated the move from 

transmission-retarding trade measures.

Market Conditions

The move from policies that impede transmission enhances the importance 

of the second main cause of incomplete exchange rate transmission—market 

conditions, which can be divided into two subcategories: market power and 

defi cient market infrastructure. Market power exists when certain buyers or 

sellers of a product are so “big” that they are responsible for a large share of 

the product’s market transactions. Because of their infl uence on the market, 

5The actual trade-liberalizing effect 

of the Uruguay Round Agreement, and, 

especially, tariffi cation, was in fact 

rather limited, at least in the short to 

medium term. Countries were given the 

power to determine tariff rate equivalents for their own nontariff measures, 

with little outside scrutiny or challenge. 

Many of the new tariffs appear to have 

been higher than that yielded by a more 

objective calculation (Josling et al., 

1996). Yet, at least the principle of tariffi cation was accepted and implemented.
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these agents do not have to accept the prices at which products are exchanged. 

Rather, their “market power” gives them the ability to determine to some 

degree the prices at which they buy and sell, that is, they are “price makers” 

rather than “price takers.” This power to set prices can interfere with the transmission of changes in world prices and exchange rates to domestic prices.

Market power can impede exchange rate transmission when exporters engage 

in “pricing to market” behavior. For example, assume that the currency of 

the exporting country depreciates by 50 percent vis-à-vis the currency of 

the importing country. If the exchange rate change were fully transmitted, 

importers would pay 50 percent less for commodities purchased from the 

exporter, all other things equal. However, the exchange rate change might 

not be fully transmitted because the exporters might exercise market power 

to increase their markups in response to the exchange rate depreciation. In 

this case, importers would receive only some, but not all, of the benefit of the 

depreciation of the exporter’s currency due to incomplete transmission.

Market power also can affect exchange rate transmission when it is held by 

economic agents within a country’s domestic agro-food chain. In many countries, food processors and wholesalers have market power vis-à-vis the farms 

from which they purchase primary output. Assume that a country’s currency 

depreciates vis-à-vis all foreign currencies, which should increase domestic 

prices for all tradable agricultural products. Wholesalers and processors 

might use their market power to reduce the degree to which they pass on the 

price increases that they receive to their farm suppliers.

The other category of market condition that can reduce world price and 

exchange rate transmission is deficient physical, commercial, and institutional infrastructure for the agro-food economy. Developing and transition 

economies, in particular, can suffer from poor agricultural infrastructure. 

Undeveloped physical infrastructure involves such deficiencies as weak 

roads, transport, and storage. Poor commercial and institutional infrastructure involves such deficiencies as weak systems of market information, 

finance, and law, the latter failing to enforce contracts and protect property. 

Corruption by public officials can also be considered part of weak institutional infrastructure, if the political and legal systems cannot adequately 

police and discipline such behavior. 

Deficient infrastructure can have two main effects, both of which can impact 

exchange rate transmission. First, it can result in high internal transport 

and transaction costs for agricultural and food products. As stated earlier, if 

countries impose no transmission-retarding policies and there are no internal 

transport or transaction costs for moving goods, border prices will determine 

domestic prices for tradable goods. Most imported or exported products, 

however, require some transportation between the domestic site of production or consumption and the border (typically a port). Consequently, even in 

well-developed market economies, the domestic movement of tradable goods 

involves some transport and transaction costs. If market infrastructure is 

weak, however, such costs can be high, especially for perishable products. In 

some African countries, for example, trucking agricultural goods 100 miles 

might take almost a week and involve large expenses for documentation, 

tolls, and other taxes (often indistinguishable from bribes). Domestic transport and transaction costs could in fact be so high for certain goods that they 
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wholly preclude trade (which will occur if these costs exceed the initial gap 

between the goods’ border and domestic prices).

Fackler and Goodwin (2001) discuss the importance of transport and transaction costs for agricultural markets and trade, while Anderson and van 

Wincoop (2004) do so for trade in general. Anderson and van Wincoop 

identify four ways in which trade frictions can create transaction costs: (1) 

language barriers; (2) currency barriers; (3) information barriers; and (4) 

contracting costs and insecurity.

For an imported product, domestic transport and transaction costs (TT) 

increase the price domestic producers receive relative to the border price; 

that is, Pd = Pb + TT = Pw * E + TT (assuming that no policies raise Pd above 

Pb, such as a tariff). TT acts as a form of import protection for domestically 

produced output. For an exported product, TT decreases the price domestic 

producers can receive relative to the border price, that is, Pd = Pb – TT = Pw* 

E – TT. In this case, TT acts like an export tax, as it cuts into the export price 

(Pb) that domestic producers would receive.

TT affects the transmission of changes in world prices and the exchange 

rate to domestic prices because a strictly proportional relationship does not 

exist between the former and the latter. For imports, the existence of TT 

results in Pd > Pb. Assuming no change in TT, a given percent change in Pb

will generate a smaller percent change in Pd. As a result, the transmission 

elasticity between Pb and Pd (or, alternatively, between either Pw or E and 

Pd) will be less than one. For exports, the opposite is true. The existence of 

TT now results in Pd < Pb. A given percent change in Pb will therefore result 

in a larger percent change in Pd. Consequently, the transmission elasticity 

between Pb and Pd (or between either Pw or E and Pd) will be greater 

than one.

The second main effect of deficient market infrastructure is that it can create 

the market imperfection of incomplete information. In particular, producers 

in isolated areas might be unaware of prices (and, especially, price movements) at the border or in the domestic markets where their output competes 

with imports. Isolated producers often have to make commercial commitments before the final transaction prices in distant markets are known. 

Deficient infrastructure also creates market rigidities and holdup problems, 

such as delayed payments to farms, which reduce prices (especially when 

inflation is high; see Gow and Swinnen, 1998). Two of the causes of transaction costs in international trade identified by Anderson and van Wincoop—

information barriers and contracting costs and insecurity—can also impede 

the flow of market information and activity. Barrett (2001) and Barrett and Li 

(2002) discuss how poor infrastructure can create imperfect information and 

related imperfections for agricultural markets and argue that the consequence 

can be price disequilibrium that lasts for extended periods of time.

Deficient market information resulting from weak infrastructure can segment 

regional markets within countries from each other, as well as cut off these 

regional markets from the world market. Consequently, the transmission 

of changes in world prices and exchange rates to domestic agricultural 

producers might be low. If incomplete transmission exists because of imperfect information, then it will be the case for an imported product that Pd = 
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Pb + TT + G (again assuming no market intervention policy), and for an 

export that Pd = Pb – TT – G, where G is a gap between the border and 

domestic price that does not result from measurable transport and transaction 

costs. Barrett and Li describe the existence of G as market disequilibrium, 

or, alternatively, imperfect integration of the domestic market into the world 

market. This price gap contributes to incomplete exchange rate transmission 

not simply for the technical reason that the relationship between Pb and Pd is 

no longer strictly proportional. Rather, the price gap results because deficient 

infrastructure fundamentally disrupts the flow of information concerning 

price movements and commercial opportunities between domestic markets 

and world markets.

Deficient market infrastructure can result in both high TT and the transmission-impeding weak flow of market information, and related market rigidities, within countries. A tradeoff could in fact exist between the two effects 

for individual commodities. If border prices exceed the prices received by 

domestic farmers, the farmers have strong incentive to export, even if the 

transport and transaction costs of moving product from the farm to the border 

are high. The more product that is exported, the more domestic markets 

will be integrated into world markets, and the stronger will be the information flow between the world and domestic markets. Yet, the actions taken 

to strengthen market integration in this way, especially if made quickly, can 

raise the TT of exporting, which cuts into the price farmers 

can receive for exporting vis-à-vis the border price.

A relationship also can exist between deficient market infrastructure and 

market power. Wholesalers and processors, who tend to be larger and more 

“concentrated” than farmers, probably have better market information than 

the farmers as well. They can use this superior information in negotiating to 

gain power over their primary output suppliers.

The degree of transmission for a good also is typically related to how 

intensively a country trades it. The greater the share of exports in domestic 

production, or the share of imports in consumption, the closer the relationship between the border and domestic price is likely to be. In addition, many 

primary agricultural goods are used as inputs by the food processing industry 

to prepare final products for retail sale. Generally speaking, the greater 

(lower) the share of a primary good in the total value added of the final 

product, the higher (lower) the transmission between the border price for the 

final product and the domestic price for the primary good. 
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What Are the Economic Effects of 

Incomplete Transmission?

By weakening the relationship between world prices/exchange rates and 

domestic prices, incomplete transmission can strongly affect countries’ 

markets for tradable goods. Figure 3 can be used to examine how incomplete 

transmission impacts agricultural markets, in this specific case, the market 

for a single imported product. Special focus will be on how the incomplete 

transmission affects the economic welfare of producers and consumers.

Assume that the domestic and border prices for a commodity are initially 

equal at P3. Q3 of the good is domestically produced, Q4 purchased and 

consumed, and Q3Q4 imported. The country’s currency then appreciates 

against the currencies of all countries that export this commodity, such that 

the border price falls to P1. Assume, however, that because of the weak flow 

of market information resulting from deficient infrastructure, the drop in the 

border price is incompletely transmitted to the domestic price, so that the 

latter decreases to only P2.

In this example, the incomplete transmission hurts domestic consumers 

and helps producers. Because of the incomplete transmission, consumers’ 

purchase of the good increases to only Q5 rather than Q6, and they also pay a 

higher price of P2, compared with P1. Producers, on the other hand, produce 

more of the good (Q2 rather than Q1) and receive a higher price (P2 rather 

than P1).6

Another effect of the incomplete transmission is that only Q2Q5 of the good 

is imported, rather than Q1Q6. The incomplete transmission also has one 

other welfare effect. Because the border price P1 now lies below the domestic 

price P2, traders can purchase the import at the border at the lower price and 

6The price elasticity of supply of 

the good with respect to the border 

price will equal the price transmission elasticity between the border 

and domestic price, times the price 

elasticity of supply with respect to the 

domestic price, that is, %∆Q / %∆Pb = 

(%∆Pd / %∆Pb) * (%∆Q / %∆Pd). In 

this example, the incomplete transmission between the border and domestic 

prices results in more of the good being 

produced (Q1Q2) than would be if 

transmission were complete.

Figure 3

Effect of incomplete transmission on a single market: the import case 

Source: USDA, Economic Research Service.

Price Supply

Demand

P3

P2

P1

Q3 Q4 Q1 Q2 Q5 Q6

A

B

C E

F

G

H J

Quantity
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then sell it to consumers at the higher domestic price. The profit from this 

price arbitrage (buying low and selling high) per unit sold is P1P2, and the 

total profit (or welfare gain) to the traders equals HBFJ. This gain to the arbitrage traders comes directly at the expense of consumers.

The concepts of consumer and producer surplus can be used to determine 

the net effect of these welfare changes. Consumer surplus is the difference 

between the maximum amount consumers are willing to pay to purchase a 

given quantity of a good and the amount they actually do pay. It therefore is 

the measure of consumers’ net welfare gain from purchasing and consuming 

goods. Consumer surplus equals the area below the demand curve and above 

the horizontal line anchored at the domestic market price. If the price fell 

from P3 to P1, consumer surplus would rise by the area P1P3EG. Because of 

the incomplete transmission, consumer surplus increases by only P2P3EF. 

The incomplete transmission deprives consumers of P1P2FG of additional 

welfare gain from the price drop.

Producer surplus is the difference between the minimum revenue producers 

are willing to accept to produce a given quantity of output and the amount 

of revenue they actually do receive. It therefore measures producers’ net 

welfare gain from producing and selling goods. Producer surplus equals the 

area above the supply curve and below the horizontal line anchored at the 

market price.7 If the price fell from P3 to P1, producer surplus would decline 

by P1P3CA. Because of the incomplete transmission, producer surplus 

decreases by only P2P3CB. The incomplete transmission saves producers 

from losing an additional P1P2BA of revenue, or welfare.

What is the net welfare effect of the incomplete transmission? The incomplete transmission deprives consumers of P1P2FG of additional welfare gain, 

while it saves producers P1P2BA of welfare loss. It also allows the arbitrage 

traders to earn HBFJ of profit. The net effect is therefore a welfare loss to the 

economy equal to the two triangles ABH and FGJ.

One might wonder why market forces would not eliminate the gap between 

the border and domestic prices, with the profit earned by the arbitrage traders 

in particular being a lure to lower the price gap. In a competitive market, as 

information flows over time, the gap likely would lower (weak infrastructure 

notwithstanding). For this reason, price and exchange rate transmission for 

many real-world commodity/country pairings is lower in the short run than 

in the long run. Incomplete price transmission resulting from weak market 

infrastructure is therefore a more serious problem for the short- to midterm 

than for the long run.

It might also appear odd in this example that both the domestic producer and 

consumer price for an agricultural good would be substantially above the 

border price throughout the country. If incomplete transmission results from 

poor market infrastructure, a more likely situation is that the infrastructure 

would segment the domestic market into regional markets. Those regional 

markets that are more distant from the border or have poorer infrastructure 

would be more isolated and have lower transmission and larger price gaps. 

The situation examined in this example could therefore apply to a regional 

market for a commodity within a large country.8

7A benefit of the concepts of consumer and producer surplus is that they 

allow a single quantitative measure to 

capture both the price and quantity effects on consumers and producers from 

market changes.

8Supplying regional markets that 

have poor market infrastructure with 

imports could involve high transport 

and transaction costs. The market 

analysis would have to be adjusted to 

account for these costs. The arbitrage 

traders would have to bear these costs, 

though they might be able to pass them 

on to consumers by raising the price at 

which they sell the imports. Probably 

the best way to adjust the analysis is 

with the border price, where the adjusted border price equals the arbitrage 

traders’ full per unit cost of supplying 

the regional market with imports. This 

full price equals the good’s actual border price plus the per unit transport and 

transaction costs of moving the product 

from the border to the regional market. 

The arbitragers’ per unit profit would 

therefore equal Pd – Pb – TT.
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The analysis of the market and welfare effects from incomplete transmission 

when a good is exported is similar to that for an imported good. Assume that 

the domestic and border prices for an export are initially equal, the border 

price then rises, but, because of incomplete transmission, the domestic 

producer and consumer price increases less. The incomplete transmission 

now hurts producers because the price rises less than the maximum possible 

and they produce less than they would at the higher price. Consumers benefit, 

however, because they pay less and purchase more of the good than they 

would if the price rose as high as the border price. As in the import case, 

arbitrage traders will also gain from the incomplete transmission. They can 

purchase the good from domestic producers at the low domestic price and 

then export it at the higher border price. The arbitrage profit per unit bought 

and sold will again equal the difference between the domestic and border 

price.

As opposed to the import case, in the export case the quantity domestically 

produced is greater than the quantity domestically consumed. As a result, 

the producers’ loss exceeds not only the consumers’ gain but the gain to the 

consumers and arbitrage traders combined. As in the import case, however, 

the incomplete transmission again results in a net welfare loss to the 

economy.

Another possibility is that a change in the trade price for a good or the 

exchange rate is asymmetrically transmitted to a country’s domestic 

producers and consumers of the product. For example, a country imports a 

good and its trade price rises. The price increase is fully transmitted to the 

price faced by domestic consumers of the product, but little if any is transmitted to the price faced by domestic producers. This effect might stem 

from consumers being concentrated in large cities, which typically have 

good physical and commercial infrastructure for bringing in imported goods. 

Many countries’ big cities are in fact coastal ports, such that the transmission of border prices for imports to consumer prices is very high (or more 

specifically, transmission is high for that share of the total value of final retail 

products contributed by the imports). On the other hand, many domestic 

producers of imported agricultural goods might be in the remote hinterland, 

which has poor infrastructure, such that transmission of border prices to the 

prices they face is low. In the example above, the country’s consumers of 

the imported product would suffer from the price increase, while the low 

transmission to the producers’ price provides little countervailing benefit to 

domestic producers from the price increase.

This analysis shows that the specific market and welfare effects for 

producers, consumers, and traders from incomplete transmission depend 

on whether a good is imported or exported, whether its price increases or 

decreases, and whether the transmission to domestic producer and consumer 

prices is symmetric. Yet, in most cases, incomplete transmission will result 

in a net welfare loss for a country.
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What Is the Empirical Evidence Concerning 

Exchange Rate Transmission?

Although a substantial amount of empirical work has been done estimating 

the transmission between agricultural world prices and countries’ domestic 

prices, only a few studies have isolated the impact of exchange rates on 

domestic prices. Consequently, this section presents results from work on 

world price transmission to gauge the magnitude of exchange rate transmission. In general, this is legitimate. As discussed earlier, the world price for 

a good and exchange rate together determine the good’s border price in 

domestic currency, which is then transmitted to domestic prices. Thus, the 

transmission of change in either the world price or exchange rate affects 

domestic prices through the same policies, market institutions, and distribution systems. World prices and exchange rates in most cases should therefore 

have fairly equal transmission elasticities.9 Some studies, in fact, compute 

transmission between border prices, which cover both world prices and 

exchange rates, and domestic prices. In discussing specific empirical studies, 

this report will identify whether transmission is computed for world prices, 

exchange rates, or border prices.

Another issue is how one assesses the magnitude of transmission estimates 

from specific studies. What constitutes high, low, or moderate transmission? 

A complicating factor is that studies can differ in their country coverage, 

time coverage, methodology of estimation, and data used. Even if two works 

cover the same countries and time period, they can use different methods and 

data in their estimation. Disparities in the transmission estimates between 

studies might therefore reflect these differences, rather than the underlying 

conditions (policies, market power, quality of infrastructure) that can 

affect transmission.

Most individual studies that estimate transmission elasticities for multiple 

countries use the same methodology and period of estimation, and often the 

same data source. To control for these factors, the main approach here in 

assessing the magnitude (and especially relative magnitude) of transmission 

elasticities is to compare results for different countries within the same study. 

Yet, a certain transmission elasticity estimate, say 0.5, might be judged 

relatively high within one study and relatively low within another.

Two other more technical points also should be considered in assessing the 

transmission elasticities. First, if transport and transaction costs (TT) exist 

that are fixed rather than proportional to the border price, the transmission 

elasticity between the border and domestic price for a good will not equal 

unity. This will be the case even if there are no policy or market impediments 

to transmission. If the good in question is imported, the fixed nature of TT 

will result in a transmission elasticity less than one; if the good is exported, 

the transmission elasticity will be greater than one. Some studies try to adjust 

for this problem by measuring and deducting TT, such that any difference 

between the border and domestic price does not reflect TT. Even so, error in 

measuring TT might not wholly eliminate this problem.

9The main exception to transmission equivalence for world prices and 

exchange rates stems from the role 

of expectations about the duration of 

changes in these values. For example, 

if the markets believe that the change in 

a price for a certain good or exchange 

rate will be very short run, and that the 

price or exchange rate will soon revert 

to its previous value, domestic prices 

might not react much to the change.
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Second, if the gap between the border and domestic price for a good is 

less than TT, the (relatively) high TT will preclude any trade (Balcombe 

et al., 2007). Another consequence is that if the border price changes but 

the change is small enough such that the price gap is still less than TT, the 

domestic price will not change in response to the change in the border price. 

The transmission elasticity between the two prices will therefore be zero.

Empirical Studies

Tyers and Anderson (1992) compute transmission elasticities for changes in 

border prices (covering both world prices and exchange rates) to domestic 

producer prices for 30 countries/regions and 7 agricultural commodities 

(or commodity groups) over 1961-83, for both the short and long run. The 

weighted average of the transmission elasticity for U.S. agriculture is 0.7 

in the short run and 0.78 in the long run. Compared with results for other 

countries in the study, the U.S. transmission is strong. The weighted average 

of the transmission elasticity calculated for the 10 member countries of the 

European Community (later called the European Union, or EU) is 0.17 in 

the short run and 0.38 in the long run. The short- and long-run transmission 

elasticities for Japan are 0.24 and 0.47. For developing countries, Tyers and 

Anderson find that in the short run, most commodity/country transmission 

pairings have a price transmission elasticity less than 50 percent, and in many 

cases the elasticity is less than 25 percent. Although the transmission performance for these countries is better in the long run, the elasticity values are 

still far below unity.

Quiroz and Soto (1995) compute an aggregate transmission elasticity for 

changes in agricultural world prices to domestic producer prices for 78 countries over 1966-91. They find that for the United States, 50 percent of world 

price changes are transmitted to domestic prices within 2 years. Although 

this result is not high in an absolute sense and is much lower than the transmission estimates for the United States from Tyers and Anderson, for the 

Quiroz and Soto study the U.S. transmission elasticity is relatively high. 

Only 4 of the 78 countries in the study—Australia, Canada, New Zealand, 

and Uruguay—have a better transmission record than does the United States, 

with half or more of a world price shock transmitted to domestic prices 

within 1 year.

Quiroz and Soto find that most European countries show no transmission 

between trade and domestic prices, even in the long run. The best European 

performers are the United Kingdom, Italy, and Spain, which take 5-7 years 

to transmit 50 percent of a change in world prices to domestic prices. Quiroz 

and Soto find no evidence of transmission for Japan, even in the long run. For 

developing countries, Quiroz and Soto calculate that about one-third show no 

transmission even in the long run, while for the rest, the majority take at least 

5-7 years to transmit 50 percent of a world price shock to domestic prices.

Mundlak and Larson (1992) compute transmission elasticities for world 

prices and exchange rates separately for 58 countries over 1968-78. They find 

that not only the United States but also most countries (including developing 

countries) have high transmission, in most cases close to one. Yet, Quiroz 

and Soto argue that the high transmission found by Mundlak and Larson 
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might be a spurious result due to a serious methodological problem, which 

they correct in their own study.

Even if one discounts the results by Mundlak and Larson, the findings by 

Tyers and Anderson and Quiroz and Soto show that price and exchange rate 

transmission for U.S. agriculture has been relatively high. This result stems 

in part from the United States having good supporting agricultural infrastructure—physical, commercial, and institutional. Transmission would be even 

higher if not for the effects of the various agricultural support policies that 

have existed in the postwar period (discussed earlier), some of which insulate 

domestic prices from changes in world prices and exchange rates.

Of the three works examined, Quiroz and Soto come closest in their period 

of coverage (1966-91) to the present, and their study ends in 1991. During 

the last 15 years, the United States has been liberalizing its agricultural policies. The main change has been a move toward support policies decoupled 

from both prices and production decisions by farmers. The main new type of 

support policy involves direct payments by the Government to farmers independent of prices and farmers’ production decisions on what and how much 

to produce (USDA, ERS, Farm and Commodity Policy Briefing Room). By 

not being linked to or affecting farmers’ market decisions, these payments 

do not impede price or exchange rate transmission. Thus, although certain 

policies have been retained that retard price transmission, such as the sugar 

program, if studies of the type done by Tyers and Anderson and Quiroz and 

Soto were done for the last 15 years, they would probably show higher transmission for the Unites States than these works reveal.

The low transmission of European agriculture results mainly from policies 

(within the EU, but also followed by non-EU members, such as Norway 

and Switzerland) that strongly insulate domestic prices from world price 

and exchange rate fluctuations. Like the United States, the EU also has been 

liberalizing its agricultural support policies during the last 15 years. As 

mentioned earlier, in the mid-1990s, the EU began reducing intervention 

prices and eliminated variable levies, which are transmission precluding. 

Yet, intervention prices remain for various commodities, as do high tariffs, 

which continue to impede transmission strongly (Agra Europe). Quiroz and 

Soto find that the developed countries with the highest transmission (even 

exceeding that of the United States) are Canada, Australia, and New Zealand 

(as discussed earlier). These countries appear to combine infrastructure equal 

to that in the United States with policies that are less transmission retarding 

than U.S. policies.

In addition to Tyers and Anderson, Quiroz and Soto, and Mundlak and 

Larson, a number of other studies calculate transmission elasticities for 

developing countries and also find generally low transmission. Hazell et al. 

(1990) compute the transmission of changes in world prices for 22 developing countries and 15 commodities over 1961-87. They find that transmission of world price changes to the prices at which countries export goods 

is generally high, but transmission to domestic producer prices is quite 

low. Baffes and Gardner (2003) compute transmission between world and 

domestic prices for 8 developing countries and 10 commodities from 1970 

to the 1990s (the end year of the calculation varies by country). The results 

for Mexico, Chile, and Argentina show strong transmission, while those for 
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Columbia, Egypt, Ghana, Madagascar, and Indonesia show little or no transmission. All the countries covered undertook major agricultural liberalization reforms during the mid-1980s to early 1990s, and the study calculates 

the change in transmission after reform begins. In some cases, transmission 

improves after a reform effort is made, but for most commodity/country 

pairings, transmission does not increase. The authors conclude that despite 

apparent reforms, protectionist policies continue (though in less overt form). 

Even if policy allows more transmission, poor infrastructure could also 

impede it.

Sharma (2003) computes transmission between world and domestic prices 

for eight Asian countries for wheat, maize, and rice over 1990-99. Like 

Baffes and Gardner, Sharma examines transmission over a period of time 

when the countries considered were beginning to liberalize their agricultural 

support and trade policies. Yet, he also finds transmission not to be high in 

the short run. For his statistically significant results, the simple average of all 

shortrun transmission elasticities is 0.27. The simple average of all statistically significant longrun elasticities is considerably higher at 0.65.

During the last 20 years, many developing countries have liberalized their 

agricultural support and trade policies, to varying degrees. The studies by 

Tyers and Anderson, Quiroz and Soto, and Hazell, Jaramillo, and Williamson 

capture little or none of that reform effort. Although the work by Baffes and 

Gardner and Sharma cover some of the reform period for certain countries, 

they find little evidence of improved transmission. Nonetheless, as with 

transmission for the United States, one would expect transmission during the 

last 15-20 years for many developing countries to be higher to some degree 

than that during the years before the mid-1980s. At a minimum, one would 

expect the negative effect of policy on transmission to be reduced. Countries 

also might have made improvement in infrastructure. Yet, most developing 

countries continue to have weak agricultural market infrastructure, which is a 

major transmission impediment.

The Cause of Low Transmission 

for Developing Countries 

Is low transmission for developing countries the result of mainly government policies or market conditions, in particular weak infrastructure? The 

empirical studies on transmission presented earlier do not provide an answer, 

as they do not allow one to apportion the calculated levels of incomplete 

transmission by cause. It would be useful at least to determine empirically whether market conditions (especially weak infrastructure) can also 

contribute substantially to incomplete transmission.

Evidence regarding the impact of market conditions on price transmission is 

rather general but nonetheless revealing. Fackler and Goodwin (2001) and 

Barrett (2001) acknowledge that most empirical tests for agricultural markets 

reject the “law of one price.” This “law” states that if one adjusts for the 

effects of market intervention policies and transport and transaction costs, 

then a product should have the same price everywhere within a country (or 

however one defines a market area). For traded goods, border prices should 

equal domestic prices. The failure of empirical tests to support the law of one 

price may stem from problems with measurement, especially of transport and 
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transaction costs, which usually are quite challenging to gauge (see the experience of Barrett concerning agricultural trade among Pacific Rim countries, 

2001, p. 21-22). Yet, the empirical results suggest that in addition to policies 

and transport and transaction costs, nonpolicy-related incomplete transmission could create gaps between border and domestic prices. 

Work by the Organisation for Economic Co-operation and Development 

(OECD) in computing producer support estimates (PSEs) can be used to 

provide more specific evidence of the effect of market conditions. The PSEs 

consist of two elements: budgetary transfers to producers and market price 

support (MPS), which results from policies that create a gap between border 

and domestic prices. In computing MPS for developing and transition economies, the OECD sets MPS equal to zero for a specific commodity/country 

pairing in the following situations, even if a gap exists between the border 

and domestic prices: (1) the good is exported, the domestic producer price is 

below the border price (in domestic currency), and no taxing policies can be 

identified (such as an export tax); and (2) the good is imported, the producer 

price is again below the border price, and some type of protection policy 

either can or cannot be identified (OECD, 2007). In the second case, even if 

a protection policy can be ascertained, because the domestic price is less than 

the border price, the negative price gap is not attributed to any policy.

In computing MPS, OECD adjusts for observable domestic transport and 

transaction costs. This means that if a price gap exists for a commodity that 

is given an MPS of zero, the price gap cannot be attributable to policies or 

observable transport and transaction costs. One can argue that by default, 

market conditions should be largely responsible for most of the gap. Some 

measurement error (especially concerning transport and transaction costs, 

product quality, and nonhomogeneity) could occur in OECD’s price gap 

calculations (as OECD admits). Nonetheless, the OECD-observed price gaps 

can serve at least as a rough measure of the degree to which market conditions, including deficient infrastructure, maintain disparities between border 

and domestic prices, or alternatively, the degree to which market conditions 

impede transmission of changes in border prices (world prices or exchange 

rates) to domestic prices.

OECD has calculated PSEs for Brazil (OECD, 2005a) over the period 1995-

2004, China (OECD, 2005b) over 1993-2003, and South Africa (OECD, 

2006) over 1994-2003. The products for which OECD judges the MPS to be 

zero, in all or most years, are beef, pork, poultry, eggs, apples, and peanuts 

for China; beef, pork, poultry, sugarcane, and cotton for Brazil; and beef, 

pork, poultry, yellow maize, sunflowerseed, and groundnuts for South Africa. 

Given that for all three countries, the zero MPS commodities include the 

major meats (beef, pork, and poultry), the zero MPS commodities constitute 

a substantial fraction of the total value of these countries’ agricultural output.

Based on OECD’s MPS data for these commodities, domestic producer 

prices deviated from border prices for nonpolicy reasons on average by 24 

percent in Brazil, by 15 percent in China, and by 21 percent in South Africa. 

For each country, the figure is derived from a weighted average of the price 

gap for specific commodities (for which MPS = 0) computed within years, 

and is an unweighted average of the annual aggregate price gap over the 

period for which OECD computes PSEs. The results suggest that market 
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conditions can create gaps between border and domestic prices, which occur 

because transmission between the two prices is incomplete.10 China, Brazil, 

and South Africa are hardly the least developed countries in the developing 

world, and their agricultural infrastructures are probably superior to those in 

many other countries, especially in sub-Saharan Africa. In the least developed economies, price gaps could be higher, and price and exchange rate 

transmission correspondingly lower, than in these countries.

OECD acknowledges that weak infrastructure and other market coditions in 

developing and transition economies can cause incomplete transmission and 

price gaps. In its 2007 review (Annex A, p. 166) of agricultural policies in 

nonmember countries, OECD states

. . . markets are characterized by various imperfections, while it takes 

time and cost for agents to react to new market signals. Therefore, 

market inertia creates price differentials independently of government 

price interventions. The degree of such non-policy “noise” increases 

in the case of non-OECD economies. Markets in these economies are 

characterized by underdeveloped physical infrastructure, poor information and weak market institutions, which impede price arbitrage. 

These deficiencies are even more pronounced in the countries with 

large territories, like Brazil, China, or Russia, where natural vastness 

exacerbates the effects of weak market organization.

These results also support the argument that fluctuating exchange rates 

often combine with market conditions to create enduring gaps that poor 

infrastructure and other market imperfections prevent from quickly closing. 

Of these three countries, Brazil has the largest price gap and also a volatile 

exchange rate. China, on the other hand, has the smallest price gap. Because 

of its policy of pegging its currency (the yuan) to the U.S. dollar (followed 

throughout the period for which OECD computes PSEs), China has had the 

least potential for currency movements to cause price gaps. OECD (2007, 

Annex A, p. 166) also acknowledges the major role fluctuating exchange 

rates can play in creating price gaps:

The majority of non-OECD economies went through periods of 

serious macroeconomic adjustments. Such adjustments—whether 

controlled or crisis—brought about shocks to relative prices. For 

example, macroeconomic reforms in Brazil, South Africa, and Russia 

were associated with massive exchange rate devaluations. Following 

the major reforms, all these countries saw additional currency shocks 

of varying intensity. The exchange rate devaluations pushed world 

prices, expressed in local currencies, above domestic price levels, 

and opened wide price gaps. Such abrupt and strong price disparities, 

emerging due to factors not related to agricultural policies, take time to 

dissipate and inevitably affect the measured price gaps.

10As discussed earlier, a situation 

could exist whereby the domestic 

transport and transaction costs for a 

good exceed the initial gap between 

the good’s border and domestic prices. 

The high transport and transaction costs 

would preclude any foreign trade. In 

addition, the price gap for such goods 

computed from OECD price data 

should be attributable to these costs, 

rather than to market conditions that 

impede price transmission. Yet, this 

point does not mar ERS’s calculations 

and interpretation of the price gaps 

for the zero MPS commodities for 

Brazil, China, and South Africa. For all 

the commodities and years for which 

OECD sets MPS equal to zero for these 

countries, the commodities were traded. 

This means that for each commodity in the aggregate in each year, the 

condition that domestic transport and 

transaction costs exceeded the initial 

price gap did not hold.
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How Does Incomplete Transmission Affect 

Measures of Protection and Support?

Incomplete transmission of changes in world prices and exchange rates 

to domestic prices has implications for the interpretation of conventional 

measures of protection and support to agricultural producers and consumers. 

These measures include the nominal protection coefficient, nominal assistance coefficient, and producer support estimate (see box, “Measures of 

Protection and Support”). The measures were created mainly to gauge the 

effect of policies on markets and producers and consumers, with the producer 

support estimate being conceived specifically to measure support to agricultural producers. The measures all involve some sort of gap between the 

domestic price or value for a commodity and its border price or value. The 

price wedge is interpreted as a measure of the degree to which policies distort 

domestic prices, and thereby distort market incentives to produce, consume, 

and trade goods, as well as the degree to which producers and consumers are 

affected by the distortion.

Measures of Protection and Support

The simplest measure is the nominal protection coefficient, which equals 

the domestic producer price for a good divided by the border price. 

(The Organisation for Economic Development and Co-operation (OECD), 

however, calculates this coefficient as the producer price plus per unit 

output subsidies, divided by the border price.) The nominal rate of 

protection is the protection coefficient, but with the border price subtracted from the 

domestic price in the numerator. Another measure is the nominal assistance 

coefficient. This equals the domestic producer price plus per unit budget subsidies 

to producers, divided by the border price. This measure gives the full “incentive 

price” received by producers relative to the per unit revenue they would receive 

in the absence of any government support policies (the latter being simply the 

border price). The nominal rate of assistance is the assistance coefficient, but 

with the border price again subtracted from the domestic price in the numerator.

The producer support estimate (PSE) for a country’s agriculture measures 

the monetary value of gross transfers from consumers and taxpayers to 

producers from policy measures that support agriculture. It equals the value of output 

measured in domestic producer prices minus the value measured in border prices 

(the aggregate price gap), plus budget transfers (subsidies). The percent PSE 

is the value of the producer support estimate divided by the sum of the value of 

output measured in domestic producer prices and budget transfers. This measure 

gives the support producers receive from government policies, relative to the full 

revenue received by producers. All these measures make an adjustment between 

the domestic and border price for domestic transport and transaction costs. 

Before 2007, OECD computed not only the aggregate PSE for countries’ 

agricultural producers, but also commodity-specific PSEs. In 2007, however, 

it discontinued calculating commodity-specific PSEs. The move toward 

noncommodity-specific direct payments by many countries, such as the United 

States and the EU region, made it conceptually inappropriate to attribute 

budget subsidies to specific products. OECD, however, continues to compute 

commodity-specific market price support, which is the difference between a good’s 

domestic and border prices.
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Deficient market conditions, and especially weak infrastructure, that impede 

price and exchange rate transmission can make it difficult for policymakers 

to interpret these measures. As discussed earlier, poor infrastructure can 

have two main effects—high transport and transaction costs and incomplete transmission between border and domestic prices. In computing and 

interpreting these measures of support, however, the convention has been to 

assume that weak infrastructure has only the first effect—transport and transaction costs.11 Under this assumption, any difference between domestic and 

border prices not attributable to policies is attributed to these costs, such that 

markets are always in equilibrium. The convenience of the assumption is that 

if transport and transaction costs are deducted, any remaining gap between 

border and domestic prices can be attributed exclusively to policies.

Implicit in the assumption is that market conditions alone (independent of 

policy) cannot impede transmission between border and domestic prices, 

such that no gap can exist between the two prices that cannot be attributed 

to either policies or transport and transaction costs. Yet, the previous section 

of the report provided evidence (based on work by OECD) that deficient 

market conditions in Brazil, China, and South Africa can cause incomplete 

transmission between border and domestic prices. If true for these countries, 

it is probably even more true for those developing economies with weaker 

agricultural infrastructure. The conclusion would be that nontrivial price gaps 

can exist for periods of time that cannot be attributed to either market intervention policies or transport/transaction costs. This means that conventional 

measures of agricultural protection and support for developing economies 

must be interpreted with care, given that the interpretations could overstate 

the effects of policies in creating price gaps and distorting market incentives.12 If governments misidentify the cause of price gaps as revealed 

by the measures, they might adopt inappropriate policies intended to 

eliminate the gaps. 

11An example of this attitude and 

approach is the guide by Tsakok (1990) 

on computing and using measures of 

agricultural protection, support, and 

comparative advantage. In the methods described for computing these 

measures, Tsakok assumes that the 

sole effect of deficient infrastructure is 

transport and transaction costs.

12OECD’s work in computing 

producer support estimates (PSEs) is in 

fact a major exception to the convention of assuming that weak infrastructure cannot cause any incomplete 

transmission. In its calculation of PSEs 

for the transition economies of the 

former Soviet bloc, and, more recently, 

developing economies, the OECD has 

consistently acknowledged that sizeable 

price gaps could result from incomplete transmission of changes in world 

prices, and especially exchange rates, 

to domestic prices, and where deficient 

infrastructure could be a major cause of 

the incomplete transmission, such that 

domestic markets are not in equilibrium 

(OECD 1998, p. 144; Melyukhina 

2003, pp. 125-126; World Bank and 

OECD 2004, pp. 77-78). As discussed 

earlier, when OECD computes the 

market price support (MPS) part of 

PSEs and a gap (adjusted for domestic transport/transaction costs) exists 

between the domestic and border price 

for a good that cannot be attributed to 

any identifiable policy, OECD sets the 

good’s MPS equal to zero. Yet, if any 

policy can be found, OECD includes 

the entire calculated gap in the MPS.
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Conclusion

One of the main features of the globalization of the world economy during 

the last 20 years has been the move toward freer trade and greater integration of countries’ domestic markets into world markets, in agriculture as well 

as in other sectors. In the late 1980s, many developing countries liberalized 

their agricultural production and trade policies, while the collapse of the 

Soviet bloc resulted in those countries moving from closed planned economies to generally open market systems. The Uruguay Round Agreement on 

Agriculture contributed to the liberalization of agricultural trade and support 

policies, as it banned quotas and other quantitative trade restrictions and 

pushed for converting trade measures into tariffs.

For countries to maximize their volume of trade and the resulting welfare 

gains from trade, changes in the world prices for goods and exchange rates 

must be transmitted to the domestic prices faced by the countries’ producers 

and consumers. Trade liberalization eliminated many systemic and policy 

constraints to agricultural trade and market integration, and, more specifically, ended or reduced systemic and policy impediments to price and 

exchange rate transmission. However, many developing and transition 

economies suffer from a different type of impediment to transmission and 

market integration—deficient market conditions, such as weak market infrastructure and market power held by large domestic producers. These conditions cause gaps between domestic and world prices, and in so doing reduce 

these countries’ trade volumes and economic gains from trade.

The current Doha Round of multilateral trade negotiations has been called 

the “development round” because a major goal is to help developing economies reap more of the gains from trade and integration into world markets, 

especially in agriculture. Within the round, developing countries have been 

pushing for developed countries to end policies that reduce world agricultural 

prices. Yet, for agricultural producers in developing countries to benefit from 

such policy changes, the rise in world prices must be transmitted to their 

domestic markets. If market conditions within developing countries inhibit 

the transmission of higher world prices to their domestic prices, they lower 

the gains the developing economies can receive from trade liberalization.

The surge in world agricultural and food prices from mid-2006 to mid-2008 

also demonstrates how developing countries might suffer if market conditions impede price transmission. During this time, food prices faced by urban 

consumers in many developing countries rose substantially, indicating fairly 

strong transmission of world prices to consumer food prices. This effect 

stems from cities having good infrastructure for the inflow of food and other 

goods and for economic activity in general. Although consumers suffered 

from the price increases, agricultural producers within developing countries, 

many of whom are poor small plotholders, had an opportunity to benefit 

from the rising prices. Yet, weak and undeveloped rural and agricultural 

infrastructure within these countries might have reduced the price transmission and thereby the benefit these poor farmers actually received. The price 
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surge likely affected developing countries asymmetrically, in that their food 

consumers were hit hard, with little offsetting advantage of higher prices 

to farmers.

If market intervention policies are the main cause of incomplete transmission, governments have it within their power to improve transmission 

through policy reform. If the main cause of incomplete transmission is 

market imperfections such as market power or weak infrastructure, governments can adopt corrective policies, but progress can take long and be expensive. Weak infrastructure is largely a problem of economic development, 

for which there is no quick solution. Yet, for many developing countries, 

improving market infrastructure and other market conditions may have more 

potential to improve price and exchange rate transmission and expand trade 

than reducing existing agricultural market intervention policies.
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