AN ECONOMETRIC MODEL OF THE MALAYSIAN COCOA MARKET

Amna Awad Abdel Hameed, Shri Dewi d/o Applanaidu , Fatimah Mohamed Arshad and Mad Nasir
Shamsudin
1
Abstract
This study aims to describe the important Iactors aIIecting Malaysian cocoa industry through Iormulating a
market model representing cocoa production, import, domestic consumption, export demand and prices in
addition to a stock equation as a closing identity. The model is estimated using two-stage least squares utilizing
annual data extending over the period 1978-2008. The results suggest the important Iactors aIIecting cocoa
production are cocoa beans and palm oil relative prices, interest rate and government rural development
expenditure. The key determinants oI domestic consumption are cocoa bean and palm oil prices, the Malaysian
economic activity and lagged domestic consumption. Furthermore, the export demand turned out to be elastic to
all the variables including cocoa world price, real eIIective exchange rate, world income and the export demand
lagged one year. The cocoa stock, cocoa world price and lagged domestic price are the main important variables
inIluencing the domestic price oI cocoa.
Kev words . Simultaneous Equations , Malavsian Cocoa , Counterfactual Analvsis
Field oI Research: Commodity Market, Aggregate Supply and Demand Analysis
I INTRODLCTION
The Malaysian cocoa sector has undergone dramatic changes during the last Iew decades as the development oI
the cocoa industry in Malaysia Iollows various national policies, inter alia, National Agricultural Policy (NAP)
and Industrial Master Plan (IMP). To attain national economic development on the road to maximizing income
through optimum utilization oI resources, these national policies Iocus on crop diversiIication and value added agro-
based industrialization (Azhar, 2007). Previously, with low production costs and eIIicient marketing structure,
cocoa production was a proIitable venture in Malaysia and the sector maintained an upward development in the
area and, subsequently, an increase in the production oI cocoa to reach their topmost levels oI over 414 thousand
hectares and 247 thousand tonnes in 1989 and 1990, respectively. However, since then declining world prices, higher
labour costs, loss oI production due to pests and diseases (which is the main reason oI economic decay in most
producing countries) along with a switch in the relative competitiveness oI other crops (particularly oil palm) have
transposed the previous trend, when production grew at a rapid rate. In 2009, the total area under cocoa stood in
the vicinity oI only about 21 thousand hectares with an estimated total production oI about 28 thousand tonnes
(Figure 1). The distribution oI the area among plantation categories also changed. Until 1989, most oI the cocoa area
was under Estate and the rest under smallholdings. During the ten years ending 1989 the minimum share oI Estate was
49 with an average oI 59. This ratio, however, was reversed later with a bigger share to small holdings (Figure 2).
Geographically, most oI the planting areas are situated in Sabah, while most oI the grindings and manuIacturing
are centred in the peninsula.
1
Research Fellow, Institut Kafian Dasar Pertanian dan Makanan, graduate student,Facultv of Economics and
Management,, Director, Institut Kafian Dasar Pertanian dan Makanan and Dean, Facultv of Agriculture, respectivelv,
Universiti Putra Malavsia.
2
Grindings

m
p
o
r
t
s
Exports
Production
Area
0
100,000
200,000
300,000
400,000
500,000
600,000
1
9
8
0
1
9
8
2
1
9
8
4
1
9
8
6
1
9
8
8
1
9
9
0
1
9
9
2
1
9
9
4
1
9
9
6
1
9
9
8
2
0
0
0
2
0
0
2
2
0
0
4
2
0
0
6
2
0
0
8
Q
u
a
n
t
i
t
y

(
T
o
n
s
)
0
100,000
200,000
300,000
400,000
500,000
A
r
e
a

(
H
a
)
Source: Malaysian Cocoa Hoard (2009)
Figure 1: Cocoa Area (Ha) and Cocoa Production, Imports , Exports and Grindings (Tonnes) in Malaysia,
1980-2009
L
s
L
a
L
e
S
m
a
ll-h
o
ld
ln
g
s
0
30,000
100,000
130,000
200,000
230,000
1
9
8
0
1
9
8
2
1
9
8
4
1
9
8
6
1
9
8
8
1
9
9
0
1
9
9
2
1
9
9
4
1
9
9
6
1
9
9
8
2
0
0
0
2
0
0
2
2
0
0
4
2
0
0
6
2
0
0
8

Source: Malaysian Cocoa Hoard (2009).

Figure 2: Distribution of Cocoa Planted Area in Malaysia by Category (Ha), 1980-2008
Peni ns ul ar
Mal ays i a
S abah
S arawak
0
50
100
150
200
250
1
9
8
0
1
9
8
2
1
9
8
4
1
9
8
6
1
9
8
8
1
9
9
0
1
9
9
2
1
9
9
4
1
9
9
6
1
9
9
8
2
0
0
0
2
0
0
2
2
0
0
4
2
0
0
6
2
0
0
8
P
L
a
n
t
e
d

A
r
e
a

(
0
0
0

H
a
)
Source: Malaysian Cocoa Hoard (2009)
Figure 3: Distribution of Cocoa Planted Area in Malaysia (Ha), 1980-2008
3
The Malaysian cocoa grindings and downstream industry has, however, expanded dramatically. Currently,
Malaysia, with a total grindings oI 324 thousand tonnes in 2008 is occupying the IiIth position among the largest
cocoa grinders in the world and the largest in the South East Asia. To Iill the gap between the local production oI
cocoa beans and the rising demand by the grinding industry, Malaysia increased its imports oI this commodity.
In 2008, Malaysia exported 8 thousand tonnes oI cocoa beans, 18 thousand tonnes cocoa paste, 104 tonnes oI
cocoa butter, 141 thousand tonnes oI cocoa powder and 27 thousand tonnes oI chocolate (Figure4). Cocoa butter
was the highest contributor to the total export earnings oI cocoa beans and its products in 2008 as it accounted Ior
63 per cent oI them (Figure 5). This is attributable to the premium price received Ior it as a result oI the special
characteristic oI the high melting point oI the Malaysian cocoa butter, which is advantageous Ior chocolate
products in warm countries.
Source: Malaysian Cocoa Hoard (2009)
Figure 4: Export Quantities of Cocoa Bean and Cocoa Products of Malaysia, 1981-2008
0
500
1,000
1,500
2,000
2,500
3,000
3,500
1
9
8
1
1
9
8
3
1
9
8
5
1
9
8
7
1
9
8
9
1
9
9
1
1
9
9
3
1
9
9
5
1
9
9
7
1
9
9
9
2
0
0
1
2
0
0
3
2
0
0
5
2
0
0
7
E
x
p
o
t

V
a
I
u
e
(
R
M

M
n
)
Cocoa Beans Cocoa Paste Cocoa Butter
Cocoa Powder Chocolate Total
Source: Malaysian Cocoa Hoard (2009).
Figure 5: Export Values of Cocoa Bean and Cocoa Products of Malaysia, 1981-2008
4
Malaysian cocoa industry plays an important role in the global market oI cocoa products. In 2007, it accounted Ior
15 oI the world exports oI each oI cocoa butter and cocoa powder and cake compared to 8 and 6 shares
respectively in 1990. Its share in the global exports oI cocoa paste increased Irom 1 in 1990 to 5 in 2007.
However, it decreased its share in the global exports oI cocoa beans Irom 9 in 1990 to 1 in 2007 to beneIit
Irom the value added resulting Irom manuIacturing its downstream products. Currently, 70 per cent oI the locally
produced dried cocoa beans are consumed by local grinders and manuIactures. Currently, there are 11 local
grindings and more than 40 chocolate and other cocoa products manuIacturers.
Owing to the growing importance oI cocoa to the Malaysian economy and the global cocoa industry, this study
attempts to estimate the supply and demand model oI the Malaysian cocoa to investigate the relationships between
the diIIerent market variables. Furthermore, as mentioned previously in this study, the Malaysian cocoa industry
has undergone drastic change during the last two decades, mainly the reduction oI land devoted Ior cocoa which
has been justiIied by the decline in the relative proIitability with respect to other crops specially palm oil.
Recently, with increasing cocoa beans and anticipated growth in the demand Ior cocoa products specially by
China and India, there are calls on increasing the cocoa planting areas. This study thereIore, also attempts to
assess the eIIect oI increasing the area under cocoa.
The contribution oI this paper to the existing literature on the Malaysian cocoa industry is twoIold. First, it employs
diIIerent model speciIication. Secondly, this study uses a relatively more recent data than those used in previous
studies on the Malaysian cocoa.
The remainder oI the paper is organized as Iollows: Section II brieIly reviews the literature on previous economic
studies on cocoa and the methodologies used Ior examining its market models, Section III outlines the empirical
methodology and Section IV reports and discusses the results while a summary and some conclusions are presented
in Section V.
II LITERATLRE REVIEW
The basic structure oI models proposed in the analysis oI agricultural commodity markets are Iormed Irom the
components oI the market model approach developed by Labys (1973) which suggests that Ior a particular
commodity, Iour equations supply, demand, price and stock (commonly used as an identity to reveal the market
clearing condition) are used simultaneously. To elucidate more complex structures oI the market behaviour, these
basic market models can be tailored and reIormulated. Incorporation oI more variables enables the market model to
be extended. In this section, relevant previous econometric studies oI perennial crops including cocoa are
highlighted with special reIerence to cocoa in order to understand the market model especially in the system where
the market model works.
The relatively simple generalized theoretical model oI Labys (1973) has widely been applied to most oI the
agricultural commodities. In Malaysia, it has been applied to analyze and model the palm oil (e.g. Shamsudin et al.,
1988; Shamsudin and Arshad, 1993; Shamsudin et al., 1994; Lubis, 1994 and Talib and Darawi, 2002, Ernawati,
2004, Amna Awad, 2005), rubber (e.g. YusoII , 1988a) and cocoa market (Rosdi, 1991, YusoII et al., 1998 and
Kox, 2000). The Ilowing paragraphs will brieIly review some oI the recent studies on the Malaysian cocoa
industry.
A study by Rosdi (1991) investigated the main Iactors that determine the cocoa prices Econometric cocoa models Ior
the world and Malaysian markets were developed. The models were estimated using annual time series data. Each
model consists oI supply, demand and price equations, with stock as the identity. His results show that domestic
cocoa prices are determined by prices prevailing in the world market. Domestic stock change is not signiIicant. The
world market itselI, stock and consumption are the main Iactors that inIluence the behaviour oI cocoa prices. World
consumption and export demand are signiIicantly inIluenced by the production index oI the industrial nations and
price oI cocoa. On the supply side, cocoa production is determined by cocoa price lagged by the gestation period.
This implies that investment decision on cocoa three to Iive years earlier is an important Iactor that determines
cocoa supply.
5
Shamudin et al.(1993) constructed a model oI the Malaysian cocoa market Iollowing the approach by Labys
(1973). The model consists oI production, demand and price equations in addition to stock as an identity. They
conducted their study utilizing data over the period 1965-1987. The Iindings oI their study indicate that the
Malaysian cocoa price is dependent on the world cocoa price. The study revealed that the industrial index oI the
industrialized nations is the key determinant Ior the demand oI cocoa and consequently, its price. Moreover, the
price elasticity oI supply with respect to cocoa has been Iound to be low (consistent with a priori expectations) and
is inline with the previous studies oI perennial tree crops.
YusoII et al., (1998) conducted a study to determine the Iactors aIIecting the supply and demand Ior the Malaysian
cocoa beans using annual data over the period 1973-1992. His supply sub-model Iollowed the work oI Alias et al.,
(1987) that diversiIied the supply into matured area and production equations. They also diIIerentiated demand into
domestic demand, speciIied as derived demand, and export demand. The results oI their study suggest that cocoa
hectarage is aIIected by the local prices oI dried cocoa beans, the price oI copra, the cost oI labour, and interest
rates. Production is Iound to be dependant on hectarage oI matured cocoa, quantity oI labour used, amount oI
Iertilizer applied and the level oI technology used. In addition, their results show that domestic demand Ior cocoa is
dependant on local prices oI dried coco beans and palm oil as well as price oI local cocoa- based beverage (MILO)
and the local demand oI the previous year. It is also revealed that among the Iactors aIIecting the Ioreign demand
Ior Malaysian cocoa are: the exchange rate oI the Malaysian ringgit against the US dollar, level oI world cocoa
grinding and one year lagged Ioreign demand.
Nasir (1998) conducted a study to explicate the economic implications oI an export levy on the Malaysian cocoa
industry. He used a model consisting oI Iive behavioural equations to describe the production, exports, domestic
demand, imports and export price; along with two identities to deIine the domestic price and stock level oI cocoa
beans. The results oI his study indicate that the imposition oI an export levy would lower producer prices and raise
export prices and consequently production and exports would decline while domestic utilization and imports, on
the other hand, would increase.
A study by Mohammad Haji Alias et al., (2001) has investigated the impact oI government rural development
expenditure, a proxy Ior government policy, particularly, public investment on the supply response oI three major
perennial export crops. Time series annual data Ior the period 1975-1997 have been used. The Engle-Granger two
step procedures Ior co-integration analysis have been applied. The response oI cocoa producers to government
expenditure is elastic in the long run, while yield has remained Iairly stable.
III METHODOLOGY
1.Model Specification
The basic market model which was proposed by Labys (1973) has been used to develop the Iramework in this
study. The market model can be summarized into supply (Q
t
), demand (C
t
) and price (P
t
) sub models in addition
to supply equal to demand (Qt C
t
) as market equilibrium condition , is as Iollows
Q
t
q (Q
t-1
, P
t-i
, Z
t
, U
t
) (1)
C
t
d (D
t-1
, P
t
, P
s
t
, A
t
, T
t
) (2)
P
t
p (P
t-1
, I
t
) (3)
Q
t
C
t
(4)
where;
Q
t
commodity supply
C
t
commodity demand
P
t
commodity price
P
t-i
prices with lag distribution
6
I
t
inventory or stock
Z
t
policy variables inIluencing supply
P
s
t
prices oI substitute commodities
A
t
economic activity level or income
T
t
technical Iactors
i 1,2,3.........
According to Labys (1973) and Pollak (1984), it is assumed that in the system oI equations, prices adjust to clear
the market. The supply oI the commodity depends on the lagged supply, lagged price and policy variables.
Demand is dependent on lagged demand, own price, prices oI one or more substitute commodities, level oI
economic activity and technical Iactors. Lagged price and changes in inventory can also be used to explain the
price. Since the supply process normally uses the general class oI distributed lag Iunctions so the lagged price
variables are included. The market model is closed using an identity which equates quantity supplied minus
quantity demanded.
i.Cocoa Beans Production
The speciIication used in this study Ior estimating the supply response Ior Malaysian palm oil production is based
on the model developed by Shamsudin et al. (1993) Shamsudin(1993 and 1998) . It also Iollows Mohammad Haji
Alias (2001) who included government expenditure and YusoI et al. (1998). by including the interest rate oI
agricultural sector lagged two years. The supply equation is speciIied as a Iunction oI the lagged production, price
oI cocoa, price oI cocoa at lag two, price oI competitive crop (palm oil) lagged two years, and the harvested area.
So, the supply equation is speciIied as Iollows
PRC
t
I (PRC
t-1
, CPM
t-2,
POP
t-2
, HA
t
, GOVDE
t-2
, IR
t-2,
U
1t
) (5)
where
PRCt Malaysian production oI cocoa at time t.
PRC
t-1
Malaysian production oI cocoa lagged one year .
CPM
t-n,
Local Price oI cocoa beans lagged two years.
POP
t-2
Local Price oI palm oil lagged two years.
HA
t
Cocoa beans harvested area at time t.
GOVDE
t-2
, Government agricultural and rural development expenditure lagged 2 years(RM million)
IR
t-2
Interest rate
U
1t
Disturbance term.
ii.Cocoa Beans Demand
According to YusoII et al.( 1998) and Nasir (1993 and 1998) the demand Ior cocoa beans is a derived demand as
it used as input Ior producing Iinal cocoa products such as cocoa butter, cocoa powder and chocolates etc. When
price determining Iactors change over time, Iirms in general do not respond immediately, but they rather, delay
their responses to changes aIIecting the demand. Thus, they spread their responses over some period oI time. The
nature oI such response would vary Irom commodity to another, the diIIerentiating Iactor being the durability or
perishability oI the commodity oI interest (Labys, 1973). Due to lagged or incomplete inIormation and
adjustment cost, the relaxation oI the equilibrium hypothesis in the general Iunction has usually been achieved by
speciIying a dynamic model within the Iramework oI a general distributed model. The demand Ior cocoa beans
does not oIten adjust immediately to the changes due to various institutional and technological rigidities.
ThereIore, lagged price variables were included, then, some oI them were dropped Irom the demand equations
during the general to speciIic exercise.
a. Domestic Demand
Domestic demand is assumed to depend on the domestic price oI coca and domestic economy activity as Iollow:
DD
t
I (IPIM
t
, CPM
t,
DD
t-1,
U
2t
,) (6)
where
DD
t
Domestic consumption at time t
IPIM
t
Malaysian industrial production index at time t
CPM
t
Domestic Price oI cocoa beans at time t.
7
POP
t
Local Price oI palm oil at time t
DD
t-1,
Domestic consumption lagged one year.
U
2t
disturbance term
b.Export Demand
The speciIication oI export demand oI cocoa beans is slightly diIIerent Irom the domestic demand in the variables
i.e. instead oI local price we used world price oI coca beans and instead oI the Malaysian Industrial Production we
used the world GDP as a proxy Ior the world economic activity . Incorporating a separate exchange rate variable
in the Ioreign demand models was Iound to be very important in previous studies(Schuh, 1974; Chambers and Just
(1979). Thus, export demand is modelled as a Iunction oI world GDP, real eIIective exchange rate, and world
price oI cocoa as Iollows:
DEX
t
I(WGDP
t
, REER
t
, WCP
t
, DEX
t-1,
U
3t
)(7)
where
DEX
t
Export demand Ior cocoa beans.
WGDP
t
, world GDP at time t.
REER
t
, Real eIIective exchange rate at time t.
WCP
t
world Price oI cocoa beans at time t.
DEX
t-1
Export demand Ior cocoa beans lagged one year
U
3t
disturbance term.
c.Import Demand
As mentioned beIore, Malaysia imports cocoa beans to meet the rising demand by the grinding industry.
The speciIication oI the import demand oI cocoa beans is similar to that oI the domestic demand with
slight diIIerences in the variables i.e. instead oI local price we used world price oI coca beans. Thus, the
import demand Iunction can be speciIied as Iollows:
DIMP
t
I
2
(WPC
t
, IPIM
t,
DIMP
t-1,
U
4t
) (8)
Where
WCP
t
world Price oI cocoa beans at time t.
DIMP
t
Import demand Ior cocoa beans.
DIMP
t-1
Import demand Ior cocoa beans lagged one year.
IPIM
t
Malaysian industrial production index at time t
U
4t
disturbance term.
iii. Price
Stockholding oI cocoa is assumed in the market place Ior the international trading. The price oI cocoa is
determined by the supply and demand. The price in the market is a result oI partial adjustment process. The price
equation can be speciIied as price oI domestic cocoa is regarded as a Iunction oI stock oI cocoa, domestic
consumption, lagged price oI cocoa, and world price oI cocoa.
PCt I (DD
t
, WCP
t
, SC
t
, U
4t
) (9)
where
CP
t
Price oI cocoa beans at time t.
CP
t-1
Price oI cocoa beans at previous year.
DD
t
Domestic consumption at time t
WCP
t
World price oI cocoa beans at time t
SC
t
Stock oI cocoa in period t,
U
3t
disturbance term
The model is closed by Malaysian palm oil ending stock as identity
SC
t
SC
t-1
PRC
t
DIMP
t
DD
t
DEX
t
(10)
Hased on the rules Ior identiIication, the structural equations satisIy both the order and rank conditions. The six
endogeneous variables, ten exogenous variables and eight predetermined variables are represented in Table 1.
Table 1: Definitions and Classification of Variables
8
Variables Definition
a. Endogenous Variables
1 PR
t
Cocoa production (tonnes)
2 DMP
t
Imports oI cocoa (tonnes)
3 DD
t
Domestic demand oI cocoa (tonnes)
4 DEX
t
Malaysian exports oI cocoa ( tonnes)
5 CPM
t
Domestic price oI cocoa (tonnes)
6 SC
t
Cocoa ending Stock (tonnes)
b. Exogenous Variables
1 CPM
t-2
Price oI cocoa lag 2 years (RM/tonne)
2 POP
t-2
Crude palm oil price lag two years (RM/tonne)
3 GOVDE
t-2
Government agricultural and rural development expenditure lag 2 years (RM million)
4 IR
t-2
Interest rate lag two years ()
5 HA
t
Harvested area (tonnes)
6 WCP
t
World price oI cocoa beans
7 POWP
t
Palm oil world price (USD/tonne)
8 IPIM
t
Malaysian industrial production index at time t (2000100)
9 REER
t
Real EIIective Exchange rate (RM/USD)
10 WGDP
t
World GDP at time t (Million USD)
c. Predetermined Variables
1 PR
t-1
Malaysian cocoa production lag ged one year (tonnes)
2 DMP
t-1
Import demand oI cocoa lagged one year (tonnes)
3 DD
t-1
Cocoa beans domestic consumption lag 1 year ( tonnes)
4 DEX
t-1
Export lag one year (tonnes)
5 CPM
t-1
Domestic price oI cocoa lagged one year (RM/tonne)
6 SC
t-1
Stock one period lag (tonnes)
2.Functional Form
For the appropriate speciIication the theory does not provide any speciIic suggestion on the best Iunctional Iorm
and the most pertinent measures oI variables involved in the analysis. An appropriate model was deIined as one
which produce unbiased (or at least consistent) and eIIicient elasticity estimates (Thursby and Thursby, 1984). In
the current study the linear Iorm has been rejected against the log-linear Iorm. In log-linear Iorm the equivalent
speciIications are
2
:

t
t t t t t t
ir ha pop cpm prc prc
1
2 5 4 2 3 2 2 1 1 0

t
t t t t
dmp IPIM wcp dmp
2
1 3 2 1 0

t
t t t t
dd IPIM cpm dd
3
1 3 2 1 0

t
t t t t t
dex wcp reer wgdp dex
4
1 4 3 2 1 0


.

t
t t t t
wcp dd sc cpm
5
3 1 2 1 1 0


Expected signs
Following the above discussion the a priori expected signs oI the regression coeIIicients are as Iollows:
0 , 0 , 0 , 0
4 3 2 1
,u
5
0; 0 , 0 , 0
3 2 1
; 0 , 0 , 0
3 2 1
; o
1
~,o
2
~0, o
3
~ 0,
o
4
~0; 0 , 0 , 0
3 , 2 1

Estimation Methods and Data Sources and
The speciIied econometric model is estimated using the Two Stage Least Squares method (2SLS). the system
is solved using 2SLS estimates. Macro-economic variables are generally non-stationary in nature
and such non-stationary variables cause serious problems Ior typical inIerence procedures Irom OLS regressions.
Hsiao (1997a, 1997b) investigated whether similar problems arise in the context oI 2SLS regressions. His works
suggest that 'nothing needs to be changed in applying conventional 2SLS estimator Iormula to estimate the unknown
2
The lower case denotes the natural log oI the variables
9
parameters and Iormulate Wald type test statistics. One gets the same point estimates and asymptotic covariance
matrix. The resulting Wald type test statistic remains asymptotically chi-square distributed. In other words, non-
stationarity and cointegration do not call Ior diIIerent estimation methods or statistical inIerence procedures. One
can just Iollow the advice oI Cowles Commission in constructing and testing structural equation models . . . All one
needs to do in structural model building is to Iollow the conventional wisdom (Hsiao, 1997a, 1997b).
According to Sekhar (2003), 'the essence oI structural equation model is an explanation oI the movementoI
endogenous variables in terms oI the exogenous variables. Following his s recommendation, all the variables
appearing in each oI the equations are tested Ior stationarity using ADF and PP tests but the presence oI a long-
term equilibrium relationshipin this study is tested using the Hounds test instead oI Johansen cointegration method
because, unlike his case, the variables in this study are not integrated oI the same order.
To gauge the impact oI increasing the cocoa bean area a simulation excercise is coducted to Iind out what iI` the
declining trend in the cocoa area since the early 1990s is replaced with an inrease oI the are at an assumed annual
growth oI 10.
Data on the world cocoa price, the price indices oI Malaysia and advanced counties as well as the real eIIective
exchange rate are obtained Irom the International Financial Statistics oI the International Monetary Fund. The
data on cocoa production, area, imports and grinding (as proxy Ior domestic demand) are available at the
Malaysian Cocoa Hoard website and FAOSTAT.
IV RESLLTS AND DISCLSSION
Estimated Equations
The econometric analysis oI the data produced the results displayed in Table 2 below. The results, overall,
indicate that the model described in methodology section is the proper speciIication to examine the market
variables response. Moreover, the models are satisIactory in terms oI their explanatory powers.
The supply equation appears to Iit the data better according to the diagnostics and it shows a high explanatory
power. Furthermore, all the coeIIicients carry the correct signs and they are all statistically signiIicant excluding
the price oI palm oil at lag 2. The price oI palm oil variable is Iound to be negative, which indicates an existence
oI a negative relationship between and cocoa production. That is a plausible result since an increase in the price
oI palm oil leads to an increase in its proIitability and consequently, the investment in its production at the
expense oI cocoa or , in other words, the shiIt away Irom cocoa, which is highly probable as shown in the
historical data oI cocoa since 1980s (Figure 1). Due to the increase in palm oil prices a signiIicant area oI land has
been converted to palm oil in the early 1990s resulting in a continuous decline oI cocoa area. The harvested area
oI cocoa turned out to be an important determinant in supply equation due to the direct association oI cocoa
production and harvested land. The price oI cocoa beans lagged two years is another Iactor aIIecting its supply,
which indicates that the Iarmers take decision about cocoa production two years ahead. The previous year
production also emerged as a major determinant Iactor Ior the current one. Furthermore, the Government
agricultural and rural development expenditure lagged 2 years has been Iound to be signiIicant at 10 level. This
result is in line with Mohammad Haji Alias (2001) who included government expenditure in his paper as one oI
the supply determinants Iactors oI palm oil, rubber and cocoa and Iound it to be signiIicant. Finally, the interest
rate variable lagged 2 years has the expected negative sign but it is statistically insigniIicant .
Regarding the import demand, it is modelled incorporating the world price oI cocoa and Malaysia`s index oI
industrial production as well as the previous year imports oI cocoa beans. The results indicate that domestic
consumption is highly sensitive to all oI them. All the determinants carry the a priori expected signs and are
statistically signiIicant.
The domestic demand speciIication incorporates the local price oI cocoa and Malaysia`s index oI industrial
production in addition to the consumption oI the last year. All the coeIIicients carry the a priori expected signs
and are statistically signiIicant. The results indicate that domestic consumption is highly sensitive to the industrial
production index oI Malaysia, which is a reasonable result as most oI the domestic consumption oI coca bean in
Malaysia is to Ieed the grinding industry, which is directly aIIected by the development oI the country industrial
10
production activity. Similar to the commodity demand in all the studies presented above, the role oI the economic
activity level was Iound to be highly signiIicant. The coeIIicient oI one lagged domestic demand is highly
signiIicant and its value (0.66) indicates that the demand adjusts to its required level at a relatively moderate rate.
The demand oI cocoa beans is negatively related to its own price, which is consistent with theory, and the
relationship between them is statistically signiIicant. However, the own price elasticity oI cocoa beans Ialls in the
inelastic range. Previous studies on the demand Ior the agricultural primary commodities have shown that the
price elasticities, both in the short and long run were generally low and inelastic. Similar results oI the studies
were obtained Ior cocoa by Hateman (1965), Hehrman (1968), Melo (1973), Hwa (1981) Claessens (1984)
Shamsudin et al., (1993) and YusoII (2001). These Iindings were consistent with most oI the other studies on
other primary commodities which were presented earlier such as on palm oil (YusoII, 1988b and Shamsudin et al.,
1988), and on rubber (YusoII, 1978 and Mohammad Haji Alias, 1988).
The export demand estimation results show that the world GDP parameter carries the expected positive sign and
is statistically signiIicant. World income elasticity Ior cocoa export demand Irom the model compares Iavourably
with the results obtained by Shamsudin et al., (1993) who Iound 1.7640. The export demand Ior cocoa is also
signiIicantly related to real eIIective exchange rates. Another important determinant oI the export demand is the
world price oI cocoa which is Iound to be negative, statistically signiIicant. The results also indicate that export
demand Ior Malaysian cocoa is highly sensitive to the world price oI cocoa.
Table 2: Estimated Structural Equations
Supply
Production
pr
t
-1.6781*0.000050cpm
t-2
* 1.9461pop
t-2
2.3354ha
t
*** - 0.0486ir
t-2
0.1317govde
t-2
*0.7046 pr
t-1
***
(-1.98) (1.83) (-1.02) (-5.30) (-0.75) (1.74) (10.47)
R
2
0.9889 h1.16
Imports
dmp
t
33.866*** 2 6.3627wcp
t
*** 3.3607l IPIM
t
** 0 .17000dimp
t-1
***
(3.23) (-4.03) (2.33) (5.61)
R
2
0.7128 h -1.600
Demand
Domestic Demand
dd
t
0.0146 - 0.2457cpm
t
* 1.702 IPIM
t
*** . 0.664dd
t-1
***
(0.01) (-1.88) (10.41) (-2.13)
R
2
0.8935 h 1.8615
Export Demand
dex28130.4 8.7538 wcp
t
*** 8.045reer
t
* 5.5217wgdp
t
*0.9849dex
t-1
***
(-0.62) (-4.84) (1.76) (1.91) (10.11)
R
2
0.9251 h -1.600
Domestic Price
cpm
t
1.0105 - 0.0719
t
sc ***0.0188
t
dc 0.7536wcp
t
***0.3604 cpm
t-1
***
(-1.43) (-4.91) (1.5825) (7.44) (3.592)
R
2
0.8944 h 1.200
Identity
Stock: SC
t
SC
t-1
PR
t
DMP
t
DD
t
DEX
t
Note: Number in parentheses are t-values.
*** SigniIicant at 1 percent level
** SigniIicant at 5 percent level
* SigniIicant at 10 percent level
All the estimated parameters in the price equation, carry the expected signs and, apart Irom the parameter oI cocoa
beans stock, they all statistically signiIicant. Although the coeIIicient oI the domestic consumption variable has
the expected positive sign, it is statistically insigniIicant. The results also indicate that the domestic price oI cocoa
is determined by the lagged local price and the world price oI cocoa. The coeIIicients on lagged price and world
11
price oI cocoa are Iound to be positive and statistically highly signiIicant. One percent increase in average world
price oI cocoa would increase the domestic price by about 0.8 percent. However, the elasticity with respect to the
one year lagged local price is very low which indicates that it is more elastic to the world price than to its previous
year`s level.
Effects of Increasing the Harvested Area
To gauge the impact oI increasing the cocoa bean area a simulation excercise is coducted to Iind out what iI` the
declining trend in the cocoa area since the early 1990s is replaced with an inrease oI the are at an assumed annual
growth oI 10. The simulated values oI all the endogeneous variables then were compared to the baseline
solutions. The counterIactual results are given in Table 3.
Table 3: Simulation Average Value (1980-2008) for all the Endogenous Variables and Baseline Compared to 10
Increase in Cocoa Bean Harvested Area
Variables Baseline Increased Harvested
Area
Percentage
Change
PR 115,156 129,518 12.5
DD 118257 149510 26.4
DMP 153303 159873 4.3
CPM 4310.8 3902.8 -9.5
DEX 67191.3 67569.1 0.6
On the whole, the directions oI response are consistent with theory. The increase oI 10 percent in the harvested
area oI cocoa leads to about 12 increase in the estimated growth in cocoa bean production. The increase oI
production is expected to increase the domestic and , consequently, the world stock oIcocoa beans will increase
pushing its world price down. The domestic price will be aIIected by the world price which turned out in the
estimation results to be the most equential Iactor aIIecting the domestic one . The results show that under the
simulated scenario the prices are expected to go down 9.5 lower than the baseline. The decline in the domestic
price is expected to boost the domestic demand 26.4 higher than the baseline Hoth import and export demand
quantities are expected to increase but to lesser magnitude than the domestic demand as they are not eIIected by
the domestic price.The increase is in the Iormer ones is a result oI the movement oI the global import and export
demand which will be pushed up as a result oI decreasing world price.
V CONCLLSIONS
The main objective oI this paper is to examine the market variables oI the Malaysian cocoa. The 2SLS technique
is employed to investigate the domestic supply, domestic and Ioreign demand, as well as domestic price responses
to the main determinants. All the models are consistent with theory as all the variables carried the correct signs. The
results oI the diagnostics test indicate that the model described in methodology section is the proper speciIication
to examine the market variables response. Moreover, the models are satisIactory in terms oI their explanatory
powers. The Iindings indicate that the cocoa production is mainly determined by its planted area and its previous
year production (signiIicant at 1). The domestic price oI cocoa lagged two years and the Government
agricultural and rural development expenditure lagged 2 years are also important Iactors at 5 signiIicance level.
The impact oI palm oil price lagged 2 years, however, appeared to be insigniIicant. The Malaysian cocoa beans
exports are inIluenced by cocoa world price, world GDP, the real eIIective exchange rate oI the Malaysian ringgit
along with its previous year`s level. The domestic demand appears to be dependent on its own price and the
economic activity oI Malaysia. The previous year domestic price as well as the world price oI cocoa emerged to
be key Iactors inIluencing its current price. The price is also, aIIected, to less extent, by the demand whereas stock
level is Iound to be an insigniIicant Iactor. The estimated model appears to explain the cocoa market in terms oI
its major structural elements. Thus, it is able to simulate the impact increasing instead oI decreasing the harvested
Cocoa area. The counterIactual analysis oI changing the actual scenario oI decreasing the harvested area during
the last two decades by assuming another scenario with a sustained 10 percent increase in the harvested area
reveals a direct eIIect oI a 12.5 in Malaysian production oI cocoa beans. The indirect eIIects via increasing the
domestic stock and global stock , causing the global and domestic prices to sink down. The later is expected to
undergo a 9.5 decrease. The decrease in the domestic price will enhance the domestic demand i.e. grindings by
Formatted Table
Formatted Table
12
26.4 while the drop in the world price will boost the cocoa beans trade. The Malaysian imports and exports
will increase by Iar less amount oI 0.6 and 4.3, respectively, which is in Iavour to the industry because the
increase in production is required to Ieed the downstream industry and increase the exports oI the cocoa products
rather than cocoa beans. Although increasing the area under cocoa seem to produce beneIicial eIIect on the
industry the land limitaion Iactor in Malaysia conIines the expansion in the cocoa production areato certain limit.
Thus the increase in area should be accompanied with enhancing productivity. Further research is required to
address the impact oI increasing productivity which has been stagnant Ior long time.
References
Abdul Rahman Lubis (1994) "Malaysian Market Model Ior Palm Oil: Some Policy Simulations," PhD Thesis
(unpublished), Universiti Putra Malaysia, Serdang, Selangor.
Amna Awad Abdel Hameed (2005). An Econometric Study oI Palm Oil Import Demand in the Middle East and
North AIrican Countries, PhD Thesis (unpublished), Universiti Putra Malaysia, Serdang, Selangor.
Azhar, I. (2007). 'The Ways towards Sustainability oI Cocoa Industry in Malaysia, presentation at the ICCO Round
Table on A Sustainable World Cocoa Economy, International ConIerence Centre Accra , Ghana, 3-6 October
2007.
Hateman, J.R. (1965). 'Aggregate and Regional Supply Functions Ior Ghanaian Cocoa, 1946-1962. Journal oI
Farm Economics. 47 (2): 384-401.
Hehrman, M.J. (1968). 'Monopolistic Cocoa Pricing American Journal oI Agricultural Economics. L:702-719.
Chambers, R. and Just R. (1979). A Critique of Exchange Rate Treatment in Agricultural Trade Models.
American Journal oI Agricultural Economics, 61, 249-57.
Ernawati (2004). Trade Liberalization Impact on The Indonesian Palm Oil Industry," PhD Thesis (unpublished),
Universiti Putra Malaysia, Serdang, Selangor
FAOSTAT online database oI the Food and Agriculture Organization oI the United Nations
http://Iaostat.Iao.org/deIault.aspx , accessed on 30th August 2009.
Hsiao, C. (1997a). Cointegration and Dynamic Simultaneous Equations Models.
Econometrica, 65(3), 647-670.
(1997b). Statistical Properties oI the Two Stage Least Squares Estimator Under Cointegration.
Review oI Economic Studies, 64, 385-398.
Hwa, E.C. (1979) 'Price Determination in Several International Primary Commodity Markets: A Structural
Analysis. IMF StaII Papers. 26:157-188.
IFS online data-base oI the International Monetary Fund http://www.imIstatistics.org/imI/logon.aspx, accessed
on 30th August 2009.
Kox , Henk M.L. (2000). The Market Ior Cocoa Powder: Modeling and Forecasting the Market Ior Cocoa
and Chocolate, paper prepared Ior the Ministry oI Foreign AIIairs, The Netherlands.
Malaysian Cocoa Hoard (2009). Malaysian Cocoa Hoard website http://www.koko.gov.my/l accessed on 12
September 2009.
Melo, H.D. (1972). An Analysis oI World Cocoa Economy in 1980. Ph. D. Dissertation, North Carolina State
University.
13
Mohammad Haji Alias (1988). 'Pembinaan dan Pemilihan Model respon Penawaran dan Pengeluar Getah Asli
Jurnal Ekonomi Malaysia. 18: 3-25.
Mohammad Haji Alias, Anizah Md Ali dan Maria Abdul Rahman. (2001). The Impact oI Government
Policy on the Supply Response oI Malaysian Palm Oil, Rubber and Cocoa Producers. Utara
Management Review. 2(1):41- 64.
Mohammad Haji Alias, Mansor Jusoh and ZulkiIli Senteri, (1987). 'A Model oI Malaysian Agricultural
Sector: Preliminary Results . Paper presented in the Fourth economic Meeting (MIER), Kuala Lumpur.
Rosdi M. L. (1991). An econometric Analysis oI the Malaysian Cocoa Prices: A Struc-
tural Approach, Masters Thesis , UPM.
Schuh, G. E. (1974). The Exchange Rate and U.S. Agriculture. American Journal of Agricultural Economics,
56, 1-13.
Sekhar, C.S.C.(2003) Price Iormation in world wheat markets implications Ior policy, Journal of Policv Modeling ,
25 (2003)85-106
Shamsudin, M. N., Rosdi, M L. and Ann, C. T. (1993). Malaysian Cocoa Market Model. In Arshad,
F.M., Shamsudin, M.N. and Othman, M.S. (Eds) Malaysian Agricultural Commodity Forecasting
and Policy Modelling. UPM: Center Ior Agricultural Policy Studies.
Shamsudin, M.N. (1993), ' The EIIect oI Import Liberalisation oI Cocoa Heans on Malaysian Cocoa
Industry. Horneo Review 4: 97-111.
Shamsudin, M.N. (1998), 'The EIIect oI an Export Levy on the Malaysian Cocoa Industry, Pertanika J. Soc. Sci.
& Hum. 6(1): 23-29 (1998)
YusoII, Mohammed (1988a). 'Malaysian Natural Rubber Market Model. Pertanika, II (3): 441-449.
YusoII, Mohammed (1988b). 'Production and Trade Model Ior the Malaysian Palm Oil Industry. Asean
Economic Hulletin: 169-177.
YusoII, Remali, Chee, M. and Senteri ZulkeIli (1998). ' Supply and Demand Model oI the Malaysian
Cocoa Industry , Horneo Review, 9 (1) pp: 67-86.
14
The estimated model is simulated over a 20-year period, without and with the export levy. For this exercise, a duty
oI 20 oI export price oI cocoa beans is assumed. The average simulated values oI the endogenous variables,
without and with export duty, are presented in Table 2. The imposition oI an export levy means that producers
will receive a smaller share oI world prices. It is Iound that the imposition oI an export levy oI 20 lowers
producer prices by an average oI 14.4, and raises the export price by 3.9. This means that producers have to
bear the burden oI 70.5, and importing countries bear the burden oI 29.5 oI the 20 levy oI export prices.
Thus the outcome oI the levy Ialls mainly on the producers rather than the Ioreign buyers. This is expected since
the domestic price is basically determined by the world market, which in turn is inIluenced by the global Iactors
such as supply, demand and stock levels. As the export price becomes relatively higher with the imposition oI
export duty, a resultant decrease in exports is expected. Exports oI cocoa beans decrease by an average oI 0.6.
Production also declines, at 6.4 due to lower domestic prices. The domestic utilization and imports, however,
increase by an average oI 0.8, respectively, since the domestic price oI cocoa beans is lower with the imposition
oI export duty. The increase in imports is due to the complementary relationship between imported and local
beans Ior blending to obtain the desired Ilavour and colour oI cocoa products.
CONCLLSION
In light oI the prevailing low cocoa bean prices, the imposition oI an export duty as an instrument to discourage
exports, and simultaneously encourage domestic downstream activities, should not be recommended since it will
Iurther lower the domestic prices and hence production. Furthermore, due to the inelastic export demand, the
eIIect on exports is only marginal. While it is recognized that the domestic grinding and downstream activities
should be encouraged, other strategies should be sought to overcome the problem oI shortages oI the local supply
oI cocoa beans. One such strategy is production eIIiciency through labour-saving and land-augmenting
technology. Like the palm oil and rubber industries, the cocoa industry is Iacing labour scarcity problems, i.e. the
land/labour ratio is high. Labour productivity as such can be raised signiIicantly by adopting modern technologies
which will simultaneously improve land productivity. The progress in tree mechanization has hitherto been
relatively slow. Universiti Putra Malaysia has conducted studies on mechanized cocoa pod breaking, cocoa seed
separation, Iermentation and an integrated roasting system. With increasing shortage and rising cost oI labour,
there is a need to intensiIy research in this area. Collaboration between research institutes and other agricultural
engineering organizations abroad, as well as with local universities, is desirable in order to develop a suitable
technology Iramework Ior more mechanized intensive operations in the cocoa industry. To date, there is still a
wide disparity between estates and smallholders' yield. The poor perIormance oI the smallholder sector is
attributed to non-optimum production and marketing practices and Iinancial constraints. Farm management
practices are still much below the recommended ones. Thus agronomic management to improve the smallholder
Iarming system must be emphasized to improve yield. An inventory to determine technology transIer and
adoption among smallholders and Iactors that inIluence technology adoption should also be undertaken.
Harvesting, postharvest, Iermentation and drying practices can inIluence cocoa yield.
Harvesting must be done at right maturity. The use oI sharp knives to harvest the Iruits and uniIorm harvest
intervals should be practised. Care should be taken to ensure that the beans are not damaged during pod splitting,
and the inIected and healthy beans are separated. If pod storage is practised, the pods should be kept as drv and
aerated as possible bv placing them in the shade Ior not more than nine days. Cocoa beans which have undergone
spreading and pod storage beIore Iermentation would have a higher recovery rate (around 40) compared to those
which are Iermented immediately aIter harvest (33-35). Drying under the sun or at 50-60C iI
using an artiIicial dryer will ensure that the resultant beans are plump and the shells are easily loosened during the
winnowing process. Proper drying also decreases the percentage oI double and clump beans. During secondary
processing, the level and eIIiciency oI roasting, grinding and winnowing processes must be controlled to minimize
the percentage oI waste (nib in shell, dust).
The transIer oI technology model in Malaysia still Iollows the traditional approach which was introduced in the
1950s. In this approach, technology is created at the research institutes and transIerred to the target audiences.
Such an approach does not consider the diIIerences among the Iarmers in a speciIic locality in terms oI Iarm size,
education level, age, manpower, capital and the like. 1 ot only does this result in only the 'resource rich' Iarmers
adopting the recommended technology but in a generally low level oI adoption. While eIIorts in agricultural
production research and extension are vigorous, it appears that marketing and marketing extension have not been
Iully emphasized and developed in the past. In the chain oI agricultural development, marketing in general (and
15
marketing extension in particular) appears to be the weakest link. This lack oI emphasis on marketing extension
has been due to greater attention being given to other aspects oI Iarming, lack oI suitably trained personnel and the
complexity oI the marketing system. Thus it is very timely that marketing extension should be emphasized not
only to producers but also to marketing intermediaries to obtain better quality oI beans and returns and hence
production. The eIIorts oI the Malaysian Cocoa Hoard and the Department oI Agriculture to jointly embark on a
programme to rehabilitate the smallholding sector are very timely. Together with the on-going rehabilitation
programme undertaken by the estates, the productivity is anticipated to increase and will partially oIIset the
production loss through reduction in hectarage.