May 262008


ARTICLE (May 26 2008): International donor agencies have a set prescription for reform: allow the market to set the price; dictation of price through government decree is what these agencies are almost congenitally opposed to.
They allege that by interfering in the market mechanism through either setting a minimum or maximum price, whatever the case maybe, leads to distortions to the long term detriment of the consumer. Therefore the market is considered the best adjudicator of the price of a commodity.

This approach conforms to classic economic theory. The market has the inherent capacity to bring equilibrium to the price of any commodity through stabilizing at a point where supply equals demand. Thus, in times of scarcity, the price will rise if demand remains unchanged and, in times of surplus, the price would automatically come down.

However, there is one rider that economic theory is quick to make: the commodity in question must have a sufficiently large number of buyers and sellers so that no single buyer or seller can ‘influence’ the price, again to the detriment of the consumer; or perfect competition must be in evidence. Monopolies with a single seller, monopsony with a single buyer and oligopoly where a cartel artificially controls price, require careful monitoring and regulation, again in the interest of the community.

Within this context it is important to note that even in credit markets, influence will depend on whether the buyer or seller is large enough. Take the case of donor agencies: if there is a large buyer of credit then the capacity of the donor agencies to insist on any aid conditionality is extremely limited.

An example would be the case of India and China who are major clients of agencies like Asian Development Bank. In marked contrast, Pakistan which is fast emerging as the largest borrower, has still to learn to flex its muscles.

India and China’s increasing clout could also be attributed to the fact that both countries have graduated from being eligible for a mix of market lending rates and concessional lending to purely market lending. Donor agencies, in common with other credit institutions, have an obvious financial interest in lending at OCR rather than concessional rates.

Pakistan which has suffered serious economic setbacks during the last eight years is still eligible for concessional funding; therefore its influence is less than that of India and China. But with its increasing reliance on borrowing at OCR in the coming year, this situation is likely to change. One can only hope that our bureaucrats would be more rigorous in agreeing to aid conditions than they have been in the past.

In international trade, too, the same principles apply: products produced cheaply in one part of the world will be traded for goods that are produced more cheaply in another part of the world. The consequence will be perfect equilibrium with everybody happy as the lowest price would apply to products through international trade thus benefiting global consumers.

What is disturbing is that large importing countries are considered to have monopsony power while large exporting countries are said to have monopoly power in trade. It is little wonder that smaller countries have begun to band together to form large enough groups to be able to influence international trade.

Idealistic drivel is how allowing the market (domestic and international) free rein is now dismissed by developing countries forced to compete with farm products from rich countries. The reasons are common knowledge: rich countries impose import quotas, heavily subsidise their farm products, and in the past even destroyed/burned large quantities of food to keep prices of their heavily protected farm sector high. Thus with the rich countries indulging in market distortions trade with them cannot be free or fair.

Where does Pakistan fit into this one may well ask? Many a desi (local) economist argues that we do not have perfectly competitive domestic markets. Take the simplest case of a commodity that is perishable: fruit. Our retailer’s price is based on what he assesses as the ability to pay of the customer. Thus price may well vary if you go to buy fruit in a Mercedes, Toyota, an old battered Suzuki or indeed on a bike. Then again the beggars get an item free, the Zakat of the retailer for that day. Prices also fluctuate throughout the day, early to mid-morning having the highest rates for obvious reasons: perishable goods don’t keep if there are no storage facilities.

What about our trade with the rest of the world? Do we operate in a perfectly competitive market even though our major exports are farm products that should, by definition, operate in a perfectly competitive market? The answer is unfortunately in the negative. As mentioned above Western countries continue to impose quotas on farm products, including cotton, in an effort to indirectly benefit their own domestic producers.

The large agriculture subsidy given by the European Union to their farmers is also a measure of the protection extended to their farm sector – a protection inextricably linked to politics. Thus Pakistan together with other Third World countries continues to struggle against quotas in its effort to increase exports revenue.

Mr Dar, the PML (N) choice of Finance Minister who has since resigned for political reasons, never tired of complaining about the policies of the former government as being flawed and responsible for what is happening today. Thus there is yet another distortion that maybe at work: government policies leading to market distortions labelled as policy-imposed distortions.

Can one explain the ongoing wheat and rice crisis in the context of policy based distortions as claimed by members of the newly elected government? One would again be forced to respond in the affirmative.

Daboub, World Bank Managing Director, blamed the spike in international rice and wheat prices on a combination of factors, including growing demand, rising fuel prices, cuts in agriculture funding, increasing use of food crops for biofuels, distorting subsidies and trade barriers, financial speculation and bad weather.

In Pakistan, there was no shortage of wheat or rice, or in other words the rise in price has to be linked to factors other than the crop output for the year 2007-08.

With respect to wheat the problem began with the government setting a procurement price last year: farmers began arguing that the government was not willing to pay local farmers the same rate as applicable in the international market. Given that they too are suffering from a rise in input prices, they want a higher procurement price. The discrepancy in domestic and international prices of wheat has encouraged the farmers to resist selling to the government, thereby fuelling the greed of the smugglers who, at present, are selling Pakistani wheat as far as Central Asia. The government may well argue that as it subsidises farm inputs, including fertilisers, it is not willing to pay the local farmers the international rate.

But, the farmers maintain, shortage implies the need for import, a need that has been echoed by Prime Minister Gilani in his decision to import 2.5 million tons of wheat at the international price. Why not give the local farmers a price that is as high as the international price which would benefit all parties and lower the attraction of smuggling. Punjab Food Department officials privately admit that they could face a stiff competition from the private traders and speculators in case the federal government did not raise the official procurement price.

Salman Shah of the former regime argues that the “beneficiaries of this bizarre wheat policy have been middlemen (Arthis), officials of the Food Department, the flourmills, traders, and personnel of border security forces, all of whom connived in this smuggling racket.” This admission does not absolve the former government of being responsible for policy distortions.

The rice situation is rather similar. Pakistan produces approximately 5.5 million tons of rice against 2.5 million tons of local demand with about three million tons available for exports each year. This year a smaller supply of Indian rice in the international market opened up the market for Pakistani exporters and that’s where the problem started.

Exports, infinitely more profitable than domestic sales took precedence. And the beneficiaries were the same as in the case of wheat: everyone along the value chain of rice from the tillers to the feudals, from Arthis (wholesaler) to exporters, from loaders to transporters, from local godown owners to those who operate huge warehouses in cities, from those operating manual husking petty machines to modern husking plant owners mostly situated in Punjab, from truckers to operators of shipping lines all got a piece from the price premium pie. And this was all at the cost of the local consumer.

The government needs to deal with market and policy based imperfections. To go after smugglers and hoarders and raid warehouses has had limited impact. What is required is to take away the incentive to smuggle and hoard and this can be achieved only if the government withdraws as a player in setting the procurement price. A better option would be to procure wheat and rice at bulk rates, with an inbuilt element of lower bulk price rates, and target this solely to the very poor or those living under the poverty line through issuance of ration cards. Let the others pay the market price.

Courtesy: Business Recorder, 26/5/2008


 Posted by at 8:50 am

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