No free lunch: Rising price of wheat flour: trust the market to deliver

Government must allow the principle of demand and supply to play its role.

LAHORE:

There is a famous Urdu couplet which translates like this: you go back to the same ‘hakeem’ for medicine, whose very prescription has caused you illness. This self-defeating tendency was featured in the policy prescriptions announced at the policy forum organised by Oxfam GB recently on ‘Food Price Volatility and Policy Options’ in the wake of rising food prices. While correctly noticing alarming price hikes in basic food items such as wheat flour and sugar, speakers have asked the government to intervene to regulate prices and save farmers and consumers from the exploitation of middlemen. The correct policy prescription should have been the exact opposite: save the consumers, producers and middlemen alike from the all-knowing, benevolent government!

By analysing some factors in the pricing mechanism of wheat flour, I will argue how government policies have distorted the market of the wheat flour and what should be corrective course of action.

Despite a bumper wheat crop this year and a flour processing industry having 300% excess capacity, Pakistani citizens have still to reap benefit from the surplus production which should have brought prices of wheat flour (Atta) considerably down. Instead, prices of wheat flour have risen by 78% in last three years. The free flow of supply and demand forces that drive prices does not seem to work here. The fundamental hurdle is the government. The rules which the government enforces actually define the conduct of individuals, encourage cartelisation and facilitate exploitation.

The typical critics of Free Market Economy, such as those who spoke at the Oxfam GB forum, would hold the free market responsible for the shortage and price hikes and would name the erstwhile middleman as key culprit. The judiciary will even take a suo motu notice on any letter that remotely relates the price hikes with human rights violation. The government will send in the price magistrates who will lock up the greedy and selfish shop keepers. The public will continue to suffer: perhaps more so by the absence and shortage of commodities, and less by their prices.

Despite all these self-defeating approaches, even an old parrot will tell us that price escalation of commodities usually results from shortage in supplies. These shortages can occur due to bad policy; any illegal coordination amongst the suppliers like cartelization; or due to a fall in production. The government response should match the fundamental reason behind the shortage, which could range from a policy correction to an assertive pro-competition act to play golf aka do nothing.

In the flour processing industry, no single player out of the 915 registered flour mills is large enough to influence the market. With this vast multitude of competing interests, this industry appears to function like a perfect competitive market. However the presence of quotas, as a tool to determine the level of production, not only distorts the market but almost guarantees rent seeking and corruption. These quotas are given by the government defining the level of production, which any mill can achieve.

In a freely functioning economy, a bumper crop of wheat, free market prices of wheat, and excess capacity in flour mills should only result in this scenario: ample produce for domestic market and value added exports of flour, coupled with a downward pressure on local prices. However, as our market economy is not free from rule-driven distortions, we only notice shortages, price hikes and unutilised capacities.

If the wheat prices are set by the government and production levels of flour mills are also set by the government, then two-third of mills should shut down, in case of a free market in this sector. However, they continue to operate and flourish. These mills primarily benefit from quota trade instead of flour trade. Further, a high support price for wheat, another government intervention, raises the cost of production Thus the flour price hike is a direct result of bad policy and not shortages.

The government must remove quotas and let inefficient firms shut down and let those firms who can, export their value added flour. Let market forces decide the price of wheat. Allow free movement of flour - both in domestic and international markets. Trust the market to deliver. Only then, we can learn how to deal with its failures. When a private sector firm fails, it has to close down. It is time that we also ask the government to follow this time tested principle of creative destruction.

The writer is a principal consultant at  Development Pool.

Published in The Express Tribune, January 16^th, 2012.