Joint Development & Dyson Workshop - Shahe Emran
Thu, 04/20/2017 - 11:40am
494 Uris Hall
In 2011, the Bangladesh government banned financing intermediaries called Delivery Order Traders (DOTs) in edible oils market. We exploit this policy experiment to discriminate among alternative models of price passthrough in a supply chain. The standard model of passthrough in imperfectly competitive markets focuses on double marginalization of rents, and shows that passthrough depends crucially on the curvature of the demand curve.
We extend the standard model of a supply chain to incorporate credit rationing faced by the wholesale traders. The financing intermediaries (DOTs) help relax the quantitative credit limits faced by the wholesalers by reducing moral hazard through informal enforcement mechanisms not available to formal banks. The elimination of the DOT layer from the market leads to higher passthrough rate and a lower intercept of the wholesale price equation both in the standard double marginalization model and in a model of financing intermediary where DOTs provide cheap credit without any quantity constraints. In contrast, a model with quantitative credit rationing yields sharply different predictions: the ban on DOTs raises the intercept and reduces the passthrough rate. The passthrough rate falls as the elimination of the DOTs tightens the credit constraints faced by the wholesalers and the effective wholesale demand curve becomes a rectangular hyperbola with a lower (unit) elasticity. We test the predictions using a difference-in-difference design with wheat as the comparison commodity and provide evidence that the research design is credible using a placebo reform date and a placebo treatment commodity (lentil). The evidence contradicts the standard models, and is consistent with the model of quantitative credit rationing. Contrary to the expectations of the policy-makers, prices were higher in the post-reform period when world prices of crude oils were declining, because the ban resulted in lower passthrough rate but a higher intercept in the wholesale price equation.
Event Categories: Development