The value of face-to-face: Search and contracting problems in Nigerian trade

Mr. and Mrs. Alhaji* are the owner-operators of a successful wholesale textile import business in Lagos, Nigeria. They are educated, tech-savvy, and have more than 20 years of experience. Yet, every time they import cloth from China – or India, or Turkey – one of them travels to meet their overseas suppliers in person at substantial cost in terms of both time and money.

(Photo: Sunday Alamba)

Mrs. Alhaji attributes their decision to travel to two main factors. First, in a fashion-based business like theirs, it’s hard to figure out the attributes of new products over the internet. Second, they don’t trust their suppliers to behave honestly. In a recent paper, I use newly collected data on importing practices by traders like the Alhajis to show that these types of ‘search’ and ‘contract enforcement’ problems are substantial (Startz 2016). In fact, they pose nearly as much of a barrier to consumer goods trade in Nigeria as shipping and regulatory costs combined. Policymakers who want to promote trade or improve the standard of living for consumers in developing countries should look beyond tariffs and infrastructure, and consider attacking these ‘information costs’ of trade through policy channels such as travel regulations, the design of financial services, and information aggregation via trade fairs and credit bureaus.

Looking at the ‘how’ of trade

The study relies on a unique survey of Nigerian importers who deal in consumer goods like clothing and electronics. I combine information about the ‘what’ of trade (e.g. products and quantities) with variables describing ‘how’ trade is conducted (e.g. travelling to meet suppliers, payment terms). In the past, the fact that search and contract enforcement problems aren’t directly observable in the way that payments for shipping are has made it difficult to quantify how much they matter for trade (Anderson and Van Wincoop 2004). However, the things that firms do to cope with these problems – such as traveling – are observable. Firms’ willingness to pay for a costly and time-consuming solution like travel tells us something about the value they place on overcoming the underlying search and enforcement problems.

The data reveal a number of new patterns:

• Travelling internationally to make purchases is very costly relative to the size of Nigerian import businesses. At just under 10% of the value of goods purchased on the average trip, travel costs are equivalent to the costs of shipping and paying tariffs and fees combined.
• In spite of this, two thirds of importers travel internationally to meet suppliers and purchase goods, although they are less likely to do so when buying from countries that are costly to reach (Figure 1). This travel persists even in well-established buyer–seller relationships.
• Purchases made when traveling look very different from those made by phone or online: importers pay lower costs, charge higher markups, and are more likely to buy new products and switch suppliers when they are there in person.

Figure 1 Likelihood of travel is decreasing in the cost of reaching that country

The value (and cost) of trading face-to-face

All of these facts make sense in a world in which traders face large search and contract enforcement problems, which can be overcome with travel. A Nigerian importer who travels to Guangzhou can find the most cutting-edge and fashionable products in massive permanent trade malls, rather than staying home and relying on websites or waiting for samples to be mailed. In an environment without much in the way of legal contract enforcement – like transactions between small firms in Nigeria and China – there is little recourse if a supplier doesn’t send what was paid for. Once in Guangzhou, a trader can conduct a transaction on the spot, inspecting her goods before making payment.

Being there in person to look for the most recent products and inspect the purchase can be very valuable for traders. However, travel is costly. In the survey data, Nigerian traders reported that the average cost of a trip to China was $2,154, with $1,229 spent on a visa alone. For some, the benefits don’t outweigh the costs, and they choose to order products online or by phone instead. Those who choose not to travel are typically smaller businesses, whose purchases are not large enough to justify the fixed cost of a plane ticket and visa, or those dealing in products where staying up to date is less difficult, such as hardware or car parts.

The fact that so many traders choose to travel in spite of the cost, combined with strong patterns in which traders choose to do so, allows us to infer what the value of solving search and contracting problems must be across a variety of product types and source countries. My estimates suggest that search and contracting problems reduce welfare in Nigeria by about 23% across a group of consumer goods that includes apparel, electronics, toiletries, hardware, and homewares, and accounts for one sixth of consumer spending. This is over half the size of welfare losses due to physical and regulatory trade costs combined, comprising a large fraction of the total trade barrier faced by Nigerians for these goods. The losses reflect both lower profits for importers and harm to consumers, decreasing the variety of goods that are available (because some products simply aren’t profitable to import in the face of these frictions) and making those that are available more expensive and out-of-date.

Policies to reduce information costs

Trade facilitation policy typically focuses on interventions that address physical or regulatory costs, such as building infrastructure, or reducing tariffs or red tape. However, these findings suggest that a different set of policies, focused on addressing information costs, may be equally important for consumer goods in developing countries. Policies that affect the mobility of people will affect the efficiency of goods trade. For instance, liberalising the bilateral air services agreement (a treaty governing air travel) between Nigeria and China could substantially decrease the cost of plane tickets, which would in turn substantially lower prices faced by consumers in Nigeria. Policies that reduce the cost or difficulty of getting visas could have similar effects. Existing financial services don’t seem to mitigate the contract enforcement problem, and improving the design or lowering the cost of these services is also a promising area for policy action.

Interventions that attack information problems may be an effective way of achieving trade cost reductions, particularly in environments where tariffs are already low or are politically difficult to change, or where improvements in regulation or infrastructure are very costly. Tackling problems with the legal enforcement of small business agreements in places like Nigerian and China is a tall order, but introducing new escrow services or renegotiating agreements governing travel may be more feasible ways to achieve some of the same benefits.

Authors’ note: *name has been changed to protect privacy.

Editors' note: This article is based on this PEDL project.

Photo credit: Madzia71/Getty

References

Antras, P and C Fritz Foley (2015), "Poultry in motion: a study of international trade finance practices", Journal of Political Economy 123(4): 853-901.

Startz, M (2016), "The value of face-to-face: search and contracting problems in Nigerian trade", Working Paper.

Anderson, J E and E van Wincoop (2004), "Trade Costs", Journal of Economic Literature 42(3): 691-751