Pricecontrols: Implications for Liberty and Welfare

Implications for Liberty and Welfare

Ali Salman

Supported by

The author wishes to thank all team members who worked tirelessly andenthusiastically on gathering and expressing valuable information on the sensitivesubject of price controls. The author also acknowledges the support ofFriedrich-Naumann-Stiftung für die Freiheit for providing financial assistance toconduct this research. The information presented here would not have been possiblewithout inputs from various stakeholders from the industry, government and civilsociety. Despite all the assistance received, the author personally assumes theresponsibility of any omissions.

Economic Freedom Network PakistanHouse 397, Street 64, I-8/3, Islamabad - PakistanTel: +92-51-486 06 13Fax: +92-51-831 60 24Cell: +92-300-520 74 47E-mail: [email protected]: www.efn.net.pk

Development Pool (member of Economic Freedom Network Pakistan)Apt. 2, Plot 7, Commercial Area, Tech Society, Lahore - 54590Tel: +92-42-529 36 22, 611 73 63 Fax: +92-42-529 36 71 E-mail: [email protected], [email protected] Url: www.developmentpool.org

supported by

Friedrich-Naumann-Stiftung für die FreiheitP.O.Box 1733, Islamabad - 44000 Pakistan Tel: +92-51-227 88 96, 282 08 96Fax: +92-51-227 99 15 E-mail: [email protected] Url: www.southasia.fnst.org

Research TeamAli Salman, Lead Author Khalil A. Arbi, MemberShammas Jalil, Member Saad Cheema, Member Arslan Asghar, Member

“Liberal social policy means helping peoplein need and making provision for potentialsituations of need. It does not mean equalizingsocial differences. Its aim is to avoid predicamentsthat would undermine individual liberty and theability to assume responsibility for oneself and forothers. Both direct aid by individual subsidies aswell as collective provision against risks whichindividual persons cannot cope with on their ownmust follow this and no other aim”.1

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1 http://www.freedomgatepakistan.org/freedom.php?page_id=29

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Table of Contents

Preface 1

1. Introduction 3

2. Government Intervention in Price Setting 7

Rationale for Government intervention 8

Market Failure 8

Lack of Competition 9

Types of government intervention 9

Drawbacks of government intervention 11

Price control in Pakistan 12

Price control in China 13

Price control in India 13

Price control in USA 14

4. Context of Crises 15

Sugar 15

Flour (Atta) 20

Poultry 21

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Price Controls: Implications for Liberty and Welfare

5. Price Determination Mechanisms and Role of the State 27

Sugar 27

Explaining Sugar Supply Line and Intervention

of Government 28

Flour (Atta) 31

The Mechanics of Sasti Roti Scheme 32

Supply Line of Sasti Roti scheme 33

Poultry 36

6. Government and Price Stabilization: 39

Subsidies: The case of flour 40

Price Control: The case of sugar 43

In sync with open market: The case of poultry 45

7. Price Controls: 10 Myths and Facts 47

8. Are liberals heartless? Liberal Options for the Poor 55

Direct personal aid instead of supply-side

subsidies or market manipulation 56

Invest in Agriculture, not in Subsidies or Price Controls 56

Design well targeted food support programs 57

Don’t punish hoarders: Push them to form Exchange 57

Use arithmetic intelligently 57

Price Stabilization through Subsidies should be

compensated with taxes 58

Embrace the market fully; avoid patch work 58

Complete overhaul does not have to be overnight 58

Table of Figures

Figure 1: Sugar Supply Line and Role of Government 30

Figure 2: Price Setting in Flour and Role of Government 35

Figure 3: Price Determination in Poultry: A typical Day 38

Figure 4: Government and Price Setting: A Continuum 40

List of Tables

Table 1: Sugar Production and Stocks – The Punjab 16

Table 2: Average Retail Prices of Sugar – The Punjab 17

Table 3: Average Retail Prices of Wheat Flour (20kg bag)

– The Punjab 23

Table 4: Average Rates of Poultry 25

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Price Report

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CPI Consumer Price Index CCP Competition Commission of Pakistan SPI Sensitive Price IndexTCP Trading Corporation of Pakistan PSMA Pakistan Sugar Mills Association

Acronyms

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The Pakistani state intervenes in the market by fixing prices of anincreasing number of commodities ostensibly for welfare of larger public.In some cases, the fixing of prices is pronounced and carried out with apolitical vengeance, whereas in some cases the fixing of prices is donequietly through administrative measures. More over, fixing of prices isalso done through collusion between the representatives of the state andthe market forces. In each scenario, liberal choices of the market arecompromised. The state uses the tax payers’ money and allocates itpolitically for announced goals of welfare. However this is often achievedat the cost of economic freedom, which essentially demands freedom ofchoice for both suppliers and the consumers. This state interventiondistorts the incentive structure, increases budget deficits and crowds outcapital allocation for public goods such as education, health andinfrastructure.

Abstract

With the above backdrop, this economic policy research is theoreticallybased on the ideas of efficiency, exchange and economic surplus ascontained in the classical economics framework. Basing on thesecondary data from government sources, media reports and interviewswith experts as well as policy makers, the study explores implications ofstate-enforced prices for the liberty and welfareof both producers andconsumers. This study draws generalized lessons for public policy in thecase of commodity pricing by focusing on three specific commodities:flour, poultry and sugar. It also examines the effectiveness of priceannouncement by analyzing the gaps between market prices andofficially announced prices. In the end, this report helps the advocatesof economic freedom in this country by providing them relevant data,deep insights and cogent arguments to support the case of greaterfreedom for even greater welfare.

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The opposite of good is well intended. Subsidies are among the topicswhen this German proverb becomes true. As this study shows clearly andintelligibly to every reader the most likely well intended introduction ofsubsidies for atta (flour) led to manifold negative effects. The same goesfor the fixing the prices for sugar where citizens, i.e. consumers, pay inmultiple ways more:

• a higher price than the real market price• subsidies by their tax contribution• lack of investment in the right places

Preface

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• increased corruption• strengthening of black-market economy• smuggle to other countries• time for queuing up at Utility Stores, etc

Additionally, more than half a century ago the Nobel Prize laureateFriedrich A. von Hayek has proven already that by fixing prices themarket lacks crucial indicators. It becomes dysfunctional and often moreinterference is demanded which aggravates the situation. Thus, it isastonishing that still wrong conclusions are drawn, inadequate measuresundertaken, and billions of Rupees wasted on monthly basis thoughpositive examples are obvious just next door: be it the poultry as shownin this study or the liberalization of telecommunication in a previous one.

On behalf of the Friedrich-Naumann-Stiftung für die Freiheit (FNF), theGerman Government funded non-profit foundation for freedom, I amgrateful to Ali Salman and his research team of Development Pool tohave undertaken the task of exemplifying the problems of price controlscientifically. Furthermore, it is the merit of Economic Freedom NetworkPakistan (EFN) to address these problems in its publication series. EFNthus has a further sharp machete in its hands to free the jungle ofregulations and restrictions and path the way towards a free market infavor of Pakistan’s citizens, consumers, businessmen alike.

Olaf Kellerhoff November 2009Resident Representative FNF Islamabad

Introduction

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Global recession has placed free market proponents in a defendingposition and has compelled, unfortunately, even free market practicingregimes to allow government intervention to save public and institutionsfrom market failure. Pakistan did not suffer a great deal from globalrecession but rising double digit inflation, and in particular food inflation,over last few years has eroded purchasing power of a vast number ofpeople. The inflation has badly hurt both producers and consumers,while various organs of the state have demonstrated various methods toarrest this problem. Fast rising inflation poses serious threat to health ofeconomy and in particular food inflation disproportionately hurts themost vulnerable segments of the society.

Under an unexpectedly rising inflation, price stabilization becomes amajor and urgent challenge for a popularly elected government. Thereare various methods of price stabilization but this report chooses threeof them – subsidies, open market operations, and price ceilings. It alsopresents a case where no direct intervention is made to contrast withsituations where such interventions have become a norm. The reportpicks three food items, which constitute essential part of millions ofkitchens every day. For subsidies, it discusses the flour pricing withparticular reference to ‘Sasti Roti’ scheme. For open market operationsand price ceiling, the report discusses the case of sugar. For presentingthe case of free market, the report discusses poultry market.

In each of the food items, the central inquiry is this: what is the processof price determination and what role does the state plays in this process?This leads to another cross cutting supplementary question: what areimplications for each price stabilization measure for consumers,producers and macro-economic balances? Wherever data is available,benefits for consumers and producers have been quantified to get anestimate for benefit-cost ratio, where cost is generally assumed asgovernment expenditures to stabilize prices.

It may be noted that the emphasis of the research is on the price-determination process in terms of mechanics and role of stakeholdersand therefore issues regarding various factors, such as inputs, whichhave bearing on the prices, do not surface significantly. This distinctionis by design, as a discussion on the role of inputs ultimately drifts thediscussion to efficiency issues, whereas the thrust of this report is moreon the role of the state in price fixing. The underlying subtle assumptionis, as free markets believers would like to say, remove the state from themarket, and everything falls in place.

After the introduction, this report is structured as follows. Second sectiongives a brief overview of theory of government intervention. Third sectionpresents a historical analysis of developments especially with regards to

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the sugar and flour crises in Pakistan. Forth section presents a situationanalysis with respect to price setting process in each of threecommodities. Fifth section compares various stabilization measures withrespect to their implications for consumers, producers and macro-economic balances. Sixth section presents policy options focusing onthe price stabilization as well as liberal options to provide support forthe vulnerable segments. In the seventh section, an advocacy toolkit ispresented to help liberal friends argue their case with simple andeffective arguments when it comes to price control measures in the garbof welfare.

The primary objective of this report is to present readers a snapshot viewof what goes wrong when the state intervenes in price determinationbased on historical facts and convincing arithmetic. It also aims atarming the liberal friends with arguments to fight their case and advancethe message of personal freedom and rule of law. Advocating the caseof open markets in the midst of market failures is a daunting, but thenall the more important task. Borrowing from Friedrich Naumann: Theidea of liberalism has to be recreated. In the course of time it has lostso much of its clarity and attraction that it first has to rise like a newdawn in front of the people.

A.S.November 2009Lahore

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Introduction

GovernmentIntervention inPrice Setting

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Government Intervention is a phenomenon which means state orgovernment institution intervenes in the market functions throughdifferent measures like taxation, policies, rules and regulations, pricefixation of different commodities apparently for the sake of the largepublic interest. This section answers these questions:

• What are the rationales for government to fix prices ofcommodities?

• What are the effects of the role of the state in the price fixation?• How Pakistani government is intervening in the market and what

are some international practices?

Rationale for Government interventionGovernment intervene in the market for many reasons, more importantly,in case of market failure2, equitable and efficient distribution ofresources3 and to control monopolies.

Market FailureMarket failure rises due to imperfect competition, externalities and whenthe public goods prices are charged higher by producer or supplier. Inthe case of market failure government interfere to support market andmarket forces to reestablish market failure. Market failure usually takesplace when there is a huge gap between supply and demand of thecommodity. This gap can be artificial. For example in case of hoardingit is an artificial shortage in the supply of the commodity, due to shortagefree market equilibrium point changes and results in higher prices or lowquantity in the market. On the demand side demand raises due tomisinformation. Usually this happens with inelastic4 goods becausepeople have to buy those goods at every price, so unequal distributionof scare resources takes place. The disturbance of price mechanismprovides grounds to government and public sector to interfere in themarket

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2 http://cbdd.wsu.edu/kewlcontent/cdoutput/TR503/page7.htm3 http://tutor2u.net/economics/revision-notes/as-marketfailure-government-intervention-2.html4 Inelastic goods: goods whose demand does not decrease significantly even if pricerises significantly due to their necessary nature.

Lack of CompetitionIn perfect competition market forces compete with each other andequilibrium takes place where all the forces of the market are equallysatisfied. Another main reason for government intervention in the marketis to control monopoly and cartel. Perfect competition always providesbest allocation of the resources and also helps market forces to get bestvalue of their investment and profit. So each economy tries to establisha perfect competition market. In monopoly market system limited thechoices of the consumers and tries to get extra profit from market.

Government always interferes in the market to break cartels anddiscourage monopoly by allocation special loans and making specialpolicy to attract domestic and foreign investor to invest in the respectiveindustry, which limits the abuse of market power and improve overalleconomic efficiency.

So we can conclude that three basic rationales for governmentintervention in the market are equitable allocation of resources, toimprove market and economic efficiency and to promote competitionin the market.

Types of government interventionGovernment intervenes in the free market through different measures.Few examples are new rules and regulation, policies, Fiscal policy anddirect imposition of prices etc.

Rules and RegulationGovernment makes new laws and regulation to run market forcesaccording to its political and social interests. For example, newlegislation made to provide facilities to investor in energy sectors. A fewyears ago, the Pakistani government provided facilitation to the telecomsector to welcome foreign investment in the sector. In the same mannergovernment makes different policies to create competition in the market.Special budget is allocated for the investor in the form of loan.

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Government Intervention in Price Setting

Government revises tax laws on timely basis to have a control on themarket and also provide subsidies to encourage investor for investmentwhich brings competition in the market.

Fiscal PolicyAnother measure from government to intervene in the market is Fiscalpolicy. Government forces to change market equilibrium of differentcommodities by imposing new taxes, providing subsidy or revision in thetax rate.

Price fixationPrice fixation is another instrument used by government to run the marketaffairs. Most of the economist opposed the use of price fixation, as pricefixing distort the allocation of resources. Price ceiling discouragesproducer and supplier which creates shortage of the commodity andprice flooring creates surplus in the market.

Categories of government interventionGovernment intervention can also be categories in two types, Behavioraland structural.5

Behavioral interventionBehavioral intervention relates to control and monitor the behavior ofthe firm or industry. For example, setting price ceiling and price floorchanges the behavior of the supplier and demander.

Structural interventionStructural intervention relates to changes the structure of the market likeproviding facilities to investor so that competition in the market can beraise.

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5 http://cbdd.wsu.edu/kewlcontent/cdoutput/TR503/page7.htm

Filling the information gapAnother way of market intervention by government is to provideinformation to market forces and limit the information gap betweenthem. This measure does not affect the price directly but it affects thebehavior of the producers and consumers which result in change ofdemand and supply in the long run. Example of this type of interventionis warning statement on the packet of cigarette.

Drawbacks of government intervention6&7

Government intervention effects market and market forces in differentways. Generally it depends upon the situation of the market, commodity,and type and methodology of intervention. While the governmentintervention by lowering the price of a commodity may bring temporaryrelief for some customers, its overall and long term effect for theeconomy is not positive.

Some negative aspects of government intervention are:

• The price fixing process by the government is not very efficient,as government can not monitor this on daily basis and not evenon a large scale.

• Implementing of the policy is very inefficient. Due to lack ofpowers and authority of the government people, policy becomeinefficient in use and does not provide required results. Alsocorruption rises in the market and makes the system moreinefficient.8

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6 http://university-essays.tripod.com/government_intervention_market_system.htl7 http://www.econlib.org/library/Enc/PriceControls.html8 http://www.financialexpress.com/news/india-is-the-only-nation-to-adopt-costbased-price-control-system/175543/

• “Sustained reduction in prices by the regulator forced almost allplayers to exit production resulting in the Government with nochoice but to depend on expensive imports.”

• Another disadvantage is that price control ignores the valueadded and quality of the product. Imposition of pricediscourages producers to value adding, which limits theeconomic efficiency.

• Price ceiling restrict producers to produce more, as their profitdecreases so they transfer their resources to produce other thingswhich act as a multiplier effect on the shortage of products inthe market.

• Price flooring limits the liberty of consumer which result indecrease in the demand and this encourages producers toproduce more, so surplus creates in the market.

Price control in PakistanIn Pakistan government interfere and takes different measures to setprices of different commodities specially the prices of edible.Government communicates prices of different food items and tries toimpose these prices through different authorities like market price controlcommittee and price magistrate. The prices government publishes in themarket set by market forces on daily basis and government ensures theavailability of food items on the provided rates. In the recent yearsgovernment directly intervene in setting ceiling to prices of sugar, flourand roti. The reason for this price ceiling is that recently flour and sugarcrisis hits Pakistani masses badly and for the sake of public interestgovernment has claimed to intervene in the free market by fixing pricesof these commodities.

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Price control in China9

In China, the national development and reforms commission is theresponsible authority regarding market prices. Two sub departments,department of price and department of price supervision regulates andmonitor the prices of the commodities in the country.

Last year, during the price hike, especially in the food prices governmentbanned the price increases in few commodities, and government boundtraders and entrepreneurs to inform and to get approval of any priceincrease ten days ahead of the planned increase. Government also startscrack down against hoarding and profiteering. Through their strictcontrolling measure, government controls the prices and takes correctivemeasure for social justice and interest.

Price Control in India10

In India, price is checked more closely on wholesale level because atthat level prices can be monitored in the case of large number ofcommodities. Last time, India used price ceiling law in 1970s.11 Tocontrol price hike Indian government banned exports of the commoditiesand also reduced duty on the imports so that price hike can be controlledwith the help of increase in supply. Indian government does not fix pricesof commodities.

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9 National Development and reform Commission, People’s republic of China,http://en.ndrc.gov.cn/ 10 http://timesofindia.indiatimes.com/biz/india-business/Its-official-Food-prices-biting-buyers/articleshow/5201288.cms11 BBC News, April 4, 2008, http://news.bbc.co.uk/2/hi/7330045.stm

Price Control in USA12

In the USA, government does not put any price fixation except fewcommodities. Government fixes the price of gasoline, wages of unskilledworker and rent in few cities. However the government does intervenein the input prices of several agriculture commodities through hugesubsidies.

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12 http://www.econlib.org/library/Enc/PriceControls.html

Context of Crises

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SugarSugar cane is one of the country’s main cash crops, with the sugarindustry being the second largest agro- based industry in the country.The debate over government intervention in market forces to set priceshas been triggered once again in the wake of the recent sugar shortagein the markets. The advocates of government intervention say that theessential commodity which was available at Rs. 27 per kg was notavailable in the market even at Rs. 40.13 quoted Punjab Chief Minister

13 The News, Nov 13, 2009

Shahbaz Sharif as saying that it was the duty of the government to ensureample supply of such essentials to the people and the government hasto fix the sugar price to achieve this goal.

However, the advocates of free market economy term any such moveby the government an infringement upon one of the fundamental rightsof the people and allege that the government move is aimed at eithervictimizing political opponents or favoring the dear ones. According tothem, setting prices was not a government prerogative and market forcesshould be allowed to determine the price and any such manufacturedstability would be detrimental for the particular industry in the long run.

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Table 1: Sugar Production and Stocks – The Punjab (Hundred Metric Tons)

YearProduction

during the season

Sold in OpenMarket

Balance withSugar Mills

2002–03 22517 22058 11952

2003–04 24232 23351 12833

2004–05 21120 12990 20963

2005–06 16065 12132 24896

2006–07 22732 19959 27669

2007–08 29220 20350 36539

Source: PUNJAB DEVELOPMENT STATICTICS 2009, Bureau of Statistics, Govt. of the Punjab, Lahore

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Context of Crises

Table 2: Average Retail Prices of Sugar – The Punjab

Year/Month Sugar (Rs./kg)

2003–04 19.25

2004–05 23.27

2005–06 33.86

2006–07 34.17

2007–08 29.22

2007–08

July 29.38

August 30.35

September 30.53

October 30.56

November 30.56

December 30.41

January 28.57

February 27.00

March 26.99

April 26.58

May 28.63

June 31.06

2008–09July 30.50

August 31.63

September 33.27

October 37.14

November 37.21

December 35.89

Source: PUNJAB DEVELOPMENT STATICTICS 2009, Bureau of Statistics, Govt. of the Punjab, Lahore

Sugar Crisis: Back groundThe sugar crisis began in Pakistan firstly in 2004. “The origins of thiscrisis lie in 2003–04, when sugar cane growers produced 53 milliontonnes of cane from which four million tonnes of sugar was produced.With the addition of 0.5 million tonnes of carry-over stock from theprevious season and against an annual domestic demand of 3.5 milliontonnes, there was a surplus of about 0.8 million tonnes.”14

Every year it got worse and worse with a rise in the price of sugar forconsumers. In November 2005, price was Rs. 23/kg, while theinternational price was $225/ton (equivalent to Rs. 13.5/kg).Consumers in Pakistan were paying 70% more to local producers at thattime.15 But later in February 2006, prices in international market doubledand reached at the level of $468/ton (Rs. 30/kg), thus bringing localprices in parity with international prices.

The problem arose with the bumper crop of 2003–04, when productionof sugar cane was 53 million ton and subsequently production of thesugar also rises, which resulted in the surplus of sugar in the market anda reduction in the price of sugar. Now the millers faced a financial crisisand asked for bail out from the government. They refused to pay farmersfor the crop and disappointed farmers reduced their production nextyear by 11%, resulting in the rise of sugarcane prices and also a fall inthe production of sugar by 20% subsequent year. Up till now market wasworking freely and government was only helping millers by purchasingexcess amount of sugar from them. And when the production of sugarcane and sugar decreased government allowed duty free import of theraw sugar to overcome the supply of the sugar. Government alsoordered TCP to maintain the sufficient reserve of the sugar so that

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14 Naween A. Mangi, What’s Really Behind the Sugar Crisis, The Dawn, Feb 20,2006.15 Steps Urged to avert sugar crisis, The Dawn, Feb 23, 2006 http://www.dawn.comFeb 23, 2006 nat42.htm.

holders cannot exploit the situation and sugar can be released from TCPstocks in case of shortage.

In year 2008 price of sugar remained Rs. 30–35/kg. Mills producedsufficient amount of the sugar in the year to meet the consumption ofthe market. TCP issued tenders to purchase 200,000 tones of the sugar,but was only able to purchase 46,000 Ton. Millers exported the surplusof the sugar to international market in order to pay growers. Estimatedconsumption was 600,000 ton but due to export of the sugar it createdshortage in the domestic market and crisis again developed in thecountry. According to Pakistan Sugar Mill Association (PSMA), in 2008,demand of the sugar in the domestic market was 4.3 million ton andproduction was 4.7 million ton.16

In 2009, the crisis began before starting of Ramadan. In August marketfaced the shortage of the sugar. Government immediately interfered inthe market and asked mills to increase the supply of the sugar. Punjabgovernment also started raiding to control the “hoarding”17of the sugar,while the millers contacted the federal governments and the High Courtagainst this action of Punjab Government. After meeting with PSMA, thefederal Minister of Industries and Production had set the price of sugarRs. 49/kg ex-mill price, which led to the price of the sugar rise to Rs.52/kg for the retailers. This decision was considered as a totally politicaldecision in the favor of mills and stockists. Against this decision PunjabHigh Court and Supreme Court come in to action and fixed the price ofthe sugar Rs. 40/- for the details on the base of a report by CCP whichdepicts that average cost of the sugar is Rs. 39.60/kg (including Tax Rs.4.91/kg).18

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Context of Crises

16 Another Sugar crisis Lurking, Sher Baz Khan, The Dawn, July 3, 2008. 17 We caution that we do not endorse the use of the word ‘hoarding’ as it impliesmoral evaluation instead of a universally applicable economic theory or businesspractice. What is hoarding for one, may be a saving for another.18 Iftikhar A. Khan: Mirza commission criticizes fixing of sugar price, The News, Oct 20, 2009.

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Subsequently, the Supreme Court, ordered that only 30% of currentsugar stock may be sold to retailers for onward sale to household usersat Rs. 40/kg, whereas remaining 70% was allocated for the commercialusers of sugar like bakeries and confectionaries at Rs. 70/kg. TCPcontinued to supply sugar to the utility stores for sale at Rs.38/kg. Butoverall situation of the market is that sugar is not available to masseseven in the black market. Sugar is available on the utility store for thelimited time and in the black market sugar is available ranging from Rs.55–60/kg. Another development is that sugar is being smuggled to Indiaand Afghanistan where prices are higher then Pakistan. TCP doesn’t haveenough reserves that it can brought sugar to market in order to increasethe supply of sugar in the market.

Media also created hype in the market about shortage of sugar whichpsychologically threatened masses of the situation. This thing creates anextra demand of the sugar and millers and holders of the sugar exploitthe situation. CCP, Prime Minister and some other government officials’blames the Supreme Court and the Punjab government for this crisiswho set prices of sugar and threatened millers by raids and unwarrantedauthoritative measures.

Flour (atta)Since 1987/88 Pakistan has been a net importer of wheat, except for abreak from this trend between 2000/01 and 2003/0419. As part ofcommodity liberalization policies, wheat price in recent years hasgradually moved closer to the border parity price, exceeding it for thefirst time in 2002.

19 CMER WORKING PAPER No. 06–44, Prospects of Wheat and Sugar Trade betweenIndia and Pakistan: A Simple Welfare Analysis, Centre for management and Economicresearch, LUMS.

Since year 2006, flour crisis has risen in the country without any cluesof its causes and creators. The flour prices were all time high in thecountry since 2006 without any sight of a relief. Two differentgovernments tried their best to solve the flour crisis but it got worse andworse by each passing day. The flour was available at Rs. 200 per 20kg bag during Ramadan (September 2009) is now being sold at Rs. 560per 20 kg bag – a 180% hike in just two months.

In last three years, Pakistan has produced the ‘bumper’ crops of wheatand even government officials also announced about the export of theexcess amount of wheat in the international market. On the other handPunjab government had set support price of the wheat Rs. 950/40kg.and claimed to purchase all the wheat from farmers. Punjab governmentprovided wheat to flour mills on subsidized rate to bring down the priceof the flour to end customers. Another initiative taken by Punjabgovernment was to start Sasti Roti Scheme.

Another factor of the flour crisis was export and smuggling of flour toAfghanistan. Higher prices in the Afghanistan urged millers and dealersto export flour to Afghanistan which created shortage in the domesticmarket. Punjab government banned the shipment of the flour to otherprovinces in order to stop smuggling and shortage in the domesticmarket. Government provided wheat to other provinces at subsidizedrate to ensure the food security.

PoultryWith the investment of over Rs. 150 billion, the poultry sector is one ofthe fastest growing sectors in Pakistan20. The products of poultry includeeggs and meat which are perishable products. Poultry production ismade at two levels, commercial and rural (domestic). Out of total poultry

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Context of Crises

20 Expert Advisory Cell; Ministry of Industries and Production Islamabad (2004): Digestof Industrial Sectors in Pakistan, p 328.

production only 10.75% is concentrated in rural areas21. Thedevelopment in the commercial poultry production is the result of theconcentrated efforts by both the private sector as well as theGovernment. It is believed that about 1.5 million professionals areengaged in poultry business and about 0.75 million tones of poultrymeat is produced every year22. Commercial poultry farming has bridgedthe gap between supply and demand of animal protein. It also keeps acheck on prices of mutton and beef.

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21 Ibid. p 332.22 Khalique Arshad, Chairman Pakistan Poultry Association Punjab: a joint pressconference at Lahore Press Club, Aug 05, 2009.

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Context of Crises

Table 3: Average Retail Prices of Wheat Flour (20 kg bag) – The Punjab

Year/Month Wheat Flour (20 kg bag)

2003–04 209.33

2004–05 238.90

2005–06 254.84

2006–07 258.50

2007–08 312.98

2007–08

July 278.38

August 281.14

September 295.77

October 297.50

November 301.40

December 302.60

January 314.62

February 298.70

March 296.30

April 334.42

May 337.50

June 377.50

2008–09

July 389.04

August 387.50

September 387.50

October 422.50

November 422.50

December 422.50

Source: PUNJAB DEVELOPMENT STATICTICS 2009,Bureau of Statistics, Govt. of the Punjab, Lahore

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Poultry sector can be contrasted with both wheat and sugar on variousaccounts. First, it does not fall under essential items of common kitchensand it is not thus monitored in CPI and SPI. Unlike wheat and sugar,which can be stored for a long time, poultry meat is a perishable itemand poultry production itself follows a much shorter life cycle.Nevertheless, poultry has become an important substitute for red meatboth due to its abundance and preference for white meat. In weddingsof all classes, a ‘chicken’ item is a common menu item, which pushesthe demand, and the price, especially in the winters.

The average selling prices of poultry products (eggs and broilers) haveincreased manifold since 1991 except in 1998–99 when there was aslight decline in the market prices of broilers due to over supply. It is dueto the increase of input cost of production of these products and thedemand size. The increase in feeds prices is the major factors behindthis other than labor, electricity, transport and poultry diseases. In justfive years from 2004 to 2009, the prices of eggs and broiler meat hasdoubled. The eggs prices have rose to above Rs. 80/dozen and meatprices to Rs. 150/kg.

Recently the federal government has allowed import of maize forutilization poultry feed and vaccines at zero duty aimed at reducing inputcosts in poultry production which will help in decreasing poultry pricesin the country. According to sources at the Ministry of Livestock, in orderto reduce input costs in poultry production, poultry vaccines, feed itemsand other inputs used in poultry feed have been zero rated. In order toreduce the poultry prices in the country, the federal government hasdecided to give Sales Tax exemption on un-cooked poultry meat toencourage establishment of value chain industry. To facilitateestablishment of value chain industry, government has allowed importof poultry meat processing machinery/equipment, poultry equipment’s(incubators, brooders, evaporation cooling pads, cooling system, grainstorage for poultry), at zero per cent custom duty. This will increase theshelf life of poultry meat, limiting middle man exploitation of farmersand consumers and assist in stabilizing the chicken prices to some extent.

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Context of Crises

Moreover, comparatively low prices of live chicken than muttonprompted more consumers’ preference and demand. The increasedinput costs like feed has also led to an overall increase in cost ofproduction of chicken attributing to increased prices.

Various diseases cause heavy losses sometime to this industry. The birdsdie in huge numbers whenever a disease outbreaks. This causes a gapin the supply side which sometimes becomes a factor of increase inpoultry product prices. In order to check these losses and stabilizing thechicken and eggs prices the federal government has allowed import ofmaize for utilization poultry feed and vaccines at zero duty aimed atreducing input costs in poultry production. The average commercialbroiler’s farm rates for the last eight years are shown in the followingtable.23

Table 4: Average Rates of Poultry

Years Average rates Production (000 Tons)

2001/02 Rs. 40.48 405

2002/03 Rs. 42.32 380

2003/04 Rs. 46.10 502

2004/05 Rs. 65.14 N.A.

2005/06 Rs. 62.69 N.A.

2006/07 Rs. 62.17 554

2007/08 Rs. 59.27 601

2008/09 Rs. 72.21 651

23 http://ppapakistan.com.

27

Sugar Federal government or provincial governments do not offer any sort ofsubsidy to end consumers of sugar. The government does intervene insugar industry through setting a minimum support price for sugarcaneand secondly it plays its role in setting refined sugar price in the market.As the commodity is considered as to be staple food and an essentialpart of daily dietary intake, the government tries to provide sugar at anaffordable price level of Rs. 38/kg at state owned Utility Stores as wellas special make shift markets, called itwar bazaar (Sunday Market).

Price DeterminationMechanisms andRole of the State

28


There are more than 6,000 utility stores in the country distributing40,111 tons of sugar each month sourced through TCP24 which is about10% of the total demand of the country. Due to controlled price at USC(Utility Stores Corporation) there is always rush like situation on USC tobuy sugar at subsidized rate. The difference of market price to USC sugarprice ranges between 2 to 20 rupees per kg. Thus, the net benefitsdelivered to general public only through utility stores varies between 80million to 802 million per month.

Apart from Utility Store channel the GOP is striving to implement the Rs.40/kg price decided by Supreme Court of Pakistan. According to a courtstatement by the Secretary Finance, the retail customers need around11,400 metric tons every day. It is difficult to assume that this entirequantity would indeed be supplied at control rates. GOP is strugglingto fulfill court order in its letter and spirit. Government of Punjab hasstarted an organized effort to assure provision of sugar at Rs. 40/kg. Ithas started to register whole sugar supply chain after mills and at thesame time it is also confiscating stock from millers and big dealers inorder to ascertain a reliable supply. The Trading Corporation of Pakistanhas also been advised to import immediately 500,000 tons of sugar.Despite all efforts from federal government and from provincialgovernment the current crisis of sugar seems to be worsening further.

Explaining Sugar Supply Line and Intervention of GovernmentThe intervention of government in sugar industry starts from setting asugarcane price in which government primarily attempts to safeguardthe interests of growers. The price set by government is often overlookedby mill owners. However government tries to assure the implementationof support price through its cane commissioners across the country.Once sugar has been prepared it is stored in godowns in mills’ premises.

24 The News, Nov 14, 2009.

29

Price Determination Mechanisms and Role of the State

Government of Pakistan lacks sufficient storage capacity. Sugar isdispatched or sold to big dealers and TCP at some agreed ex-mill price.The ex-mill price is set through consultation with government representedby Ministry of Food and Agriculture and Ministry of Industries andProduction. According to an official from cane commissioner officeLahore, the current arrangements after order from apex court states thatthe miller will be bound to sell 30% sugar stock at an ex-mill price of Rs.36/kg and the rest 70% stock will be on jurisdiction of the miller.According to these arrangements the margin of big dealers is set to beRs. 1.5 to 2/kg, margin of wholesaler will be Rs. 1/kg and the marginsfor retailers will range from Rs. 0.5–1/kg.

According to market sources the retailers have refused to work on thesemargins and everyone is charging a different price. To overcome thisissue the Government of Punjab has taken decision to register someselected shopkeepers and provide them subsidized sugar direct frommills. For this purposes the DCO offices have been advised to registerthe shopkeepers and make recurrent spontaneous visits to these shopsand ascertain that these shops are selling sugar at the desired rate.

Terming the involvement of PSMA in price setting process as a collusivebehavior, the Competition Commission of Pakistan, in its inquiry reportissued on 21st October 2009 has termed this process against theCompetition law of the country and has recommended initiating actionagainst PSMA and its members.25

Following diagram shows the entire process of price determination inthe case of sugar.

25 Shaista Bani and Umair Javed: Inquiry Report, Competition Commission of Pakistan.

30


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31


Flour (atta)In history we find numerous examples of GOP intervention in the marketforces and introduction of a support price for various products. Amongsuch examples wheat is major commodity for which Government ofPakistan had set a very attractive support price of Rs. 950/40kg inSeptember 2008.26 Surprisingly the support price was 52% more thanthe open market price. Numerous justifications can be presented to thishuge price elevation but the fact is artificial price setting of a commodityin any case will never get realized into actual cash proceeds.

In order to provide cheap flour and roti for poor peoples, currently,Punjab government is providing Rs. 15 billion for wheat and floursubsidy. Government is providing subsidized wheat to flour mills andthen that flour is distributed to registered tandoors27(local clay madeovens) to provide sasti roti. Government also distributes subsidized flourbags through Friday and Sunday bazars, and through special sale points.

Punjab government launched a Sasti Roti (Cheap Bread) scheme in May2008. This scheme has been introduced to apparently increase thepurchasing power of poor people who can not buy bread at marketprice. Last year the government of Punjab has allocated Rs. 20 billionfor subsidy of various food items. Out of this Rs. 20 billion almost 10billion was spent on Sasti Roti and Ramadan Packages for poor. InRamadan Rs. 7.6 billion was given on the name of subsidy in just onemonth whereas Rs. 3 billion was released to Sasti Roti scheme in year2009–10. To handle the Sasti Roti scheme the Government of Punjab has involvedits full administrative machinery to make this scheme successful. TheDCOs of all districts are directly responsible for the execution of this

26The Nation, 30 September 2008 http://www.nation.com.pk/pakistan-news-newspaper-daily-english-online/Politics/30-Sep-2008/Wheat-support-price-Rs950.27A cylindrical oven made of clay, heated to a high heat through gas or wood and islocally used for baking bread.

32


scheme. Following departments/institutions are directly and indirectlyinvolved for the proper functioning of this scheme.

• the Provincial Food Department (procurement and supply) • the Revenue Department (revenue collection and disbursement) • the Agricultural Marketing Department (channelizing the supply)• the Agricultural Storage Department (procurement and supply)• the District Commissioner Office (monitoring and controlling)• the local Members of Parliament (MPA or his/her representative

for approval of the tandoor)• local town nazims (coordination and verification of tandoors)

The Mechanics of Sasti Roti SchemeSasti Roti scheme is meant to deliver a 100 gram roti (bread) at anaffordable price of Rs. 2/kg. Initially this scheme was introduced toprovide sasti roti at all tandoors situated in Lahore area but soon thescheme got popularity and government has widened it to whole Punjab.From its advent till date the scheme has faced many changes. As thisscheme was meant to provide leverage to poor people but with the timeit has been observed that many profiteers are gaining unfair advantagefrom the scheme. This has led government to change its strategy tofurther assure that only poor people can get the utmost benefits. It wasdecided to select only those hotels or tandoors which are situated inpoor localities. A scrutiny procedure was defined in which any personhaving tandoor in poor locality can apply to participate in the scheme.According to the officials from DCO office Lahore they have receivedmore than 7,000 applications at the outset and after scrutiny now thereare almost 3,700 tandoors in Lahore area which have been issuedofficial “Pass Book” to participate in this scheme.

The issuance of “Pass Book” is considered as major success from a poortandoor person as government has created very tough conditions for it.Before a person gets “Pass Book” he must made several visits togovernment officials, office of town nazims and also to the office of

33


representatives of local MPA. The approval from town nazims and MPAhas made the whole issue politicized.

The surveyors have been informed that after getting “Pass Book” thetandoor person then gives estimate of his daily demand of flour. Thisdemand is subject to verification by many persons from abovementioned government offices and from local MPA. This verificationprocess is made lengthy and cumbersome. When every visiting personagrees on a single figure then the person is allowed to get his demandedsubsidized flour from designated flour mills.

When the scheme was launched it was decided to provide cashdisbursement to flour mills where the door tandoor person gets flour. Asthings got worst and people started cheating then government haschanged its strategy to provide subsidized flour to the flour mill insteadof cash. This shift in policy and tight scrutiny process of tandoor personsmade this scheme efficient.

Supply Line of Sasti Roti schemePunjab Food Department (PFD) keeps total wheat reserves of theprovince. It releases the wheat to flour mills according to their predefinedregional quotas. The flour mills have two sorts of mechanisms for wheatprocurement from Punjab Food department; one is subsidizedprocurement which currently costs Rs. 410/40kg and second is marketprocurement which costs Rs. 975/40kg. After processing the wheat theflour mills have then two types of delivery channels. One is direct saleto the market dealers which has average rate of about Rs. 560/20kgand the other is subsidized sale to registered tandoor owners at Rs.250/20kg. The subsidy amount is settled against subsidized wheatprocured. The subsidized channel is duly monitored by town nazims andthe DCOs of the concerned districts.

The tandoors are made certain that they sell 100 gram roti at Rs. 2. Anytandoor not complying the conditions is immediately excluded from the

34


list. We have been informed that this Sasti Roti scheme has boosted thebusinesses of many tandoor owners as the provision of subsidized rotihas raised the sales of other subsidiary food items available at thetandoor. As a result many tandoor owners have gone for expansion andstarted installing mechanical tandoors. Mechanical tandoors prepare ina very less time huge number of breads. Government of Punjab is nowtrying to spread mechanical tandoors all over the province as concernedeconomies of scale make the processing of roti further cheaper.

The diagram below elaborates the supply line of Sasti Roti scheme.

35


Subs

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36


PoultrySince there is little intervention from the government, poultry prices areset by the principles of free market economy. There is no singleregulatory authority, private or public, to set poultry prices. The pricesare announced in the market on a daily basis. Feed expense is 70% ofthe total cost of production and hence is the main factor behind theincrease and decrease of the chicken meat and eggs. The feed millsowners have no check of government in fixing the rates of their differentqualities of feeds. Here again the government has little intervention. ThePakistan Poultry Association (PPA), an autonomous body, only plays aliaison role between mill owners and commercial producers of broiler.

Demand and supply formula is applied in the price fixing of theseproducts on daily basis. The market forces (commercial meat and eggsproducers, market traders, Pakistan poultry associations) are free in theiranalysis of demand and supply situation in the country and in the pricefixing of the poultry products. However a representative of live stockdepartment of provincial government is member of a committee of fourincluding other representatives from market traders, broiler productionwing of controlled houses and a member from Pakistan poultryassociation.

Variation in the prices of poultry products is the result of varying factorsinvolve in each stage from the availability of Grand Parent Chicks (GP)to the reach of poultry products in the market, eggs and meat.

• Grand Parent Chicks, being pure hybrid are imported fromabroad.

• Day old chicks are taken as the result of hatching eggs fromparent stocks of these Grand Parent chicks.

• Broiler (for meat) day old chicks and Layer (for eggs) day oldchicks are sold to farmers on daily basis.

37


• Farming of these day old chicks under different conditions (feed,labor, transportation) and environments (type of farm houses,disease control are related with production of finished availablepoultry products on daily basis. Hence they affect the dailyprices.

The daily rates quoted in the price list issued by Market Committee ofAgriculture Department are communicated by Pakistan PoultryAssociation (PPA), North Zone in Punjab. The committee comprises fourpersons each one from live stock department, market trader association,broiler production wing of controlled houses and a member from PPA.Trend for sale on daily basis in the open markets is taken from all zones.Then district wise analyses are made. Demand note from poultry farmerfor booking of their stocks for sale is taken into consideration. Afterreaching to the consensus considering all these factors, the rate isannounced for next day sale and is communicated to all marketcommittees and DCOs to have check over it. This mechanism showsthat government role is very minimal in the fixing of prices of poultryproducts in the country. In other words the government does not set theprices, nor does it control the demand and supply.

The entire process of price determination is shown in the followingdiagram.

38


1

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39

In this study, three food commodities have been discussed with respectto the role of government in price stabilization. It is now obvious that theeach of these commodities-flour, sugar and poultry- tread a differentpath when it comes to the role of the government in price fixing. In thecase of flour, government has given price subsidies to the flour mills,which have supplied subsidized flour to the registered tandoors and laterto retailers and the utility stores. In the case of sugar, no direct subsidyis provided to sugar mills on selling sugar, but the government and laterthe Supreme Court introduced a price ceiling. In the case of poultry, therole of government is more symbolic; the rates are still issued by the

Government andPrice Stabilization:Analysis of current

Policy Options

40


government, but only after they have been decided through marketcommittees on the basis of information about supply and demand.

We can therefore observe a continuum of the government role in pricesetting for the singular goal of price stabilization – from a substantiveaction of subsidies in the case of flour to an administrative role of priceceiling for sugar and then to a symbolic role of the government in thecase of poultry. If we consider these three strategies of the governmentrole as three alternative options, it may be instructive to divulge intoimplications for each of three options. We argue that each policy optionhas different implications with respect to consumer welfare, producerwelfare and macro-economic balances.

Subsidies: The case of flour Considering the provision of subsidized flour as a case study, we candiscuss the implications of subsidies for consumer welfare, producerwelfare and macro-economic balances. For consumer and producerwelfare, we base our analysis on a rapid survey conducted last year inwhich about 20 tandoors in low to middle income areas of Lahore weresurveyed in the month of Ramadan28. The survey results conform to an

Figure 4: Government and Price Setting: A Continuum

28 Some twenty tandoors were surveyed in localities such as Model Town, Sabzazar,Mughal Pura, Gari Shahu, Taj Bagh, Jallo More, Harbanspura, Sing Pura and FaisalTown and other different areas of Lahore. This was conducted in 2008 by a group ofstudents under the supervision of one of the authors. These students were: MubashirSabir, Safeena Khizer, Ali Asad, Anam Khan, Mustafa Shah and Haris Rasheed.

41

Government and Price Stabilization: Analysis of current Policy Options

established economic theory: subsidies might bring gain for consumers,their overall impact on economic development, here measured in termsof economic surplus, is negative. In the sampled tandoors, sasti roti hascaused Rs. 1.45 million loss in the economic surplus in just one month.

For proper execution of the scheme five provincial departments aredirectly engaged in it. Although on this scheme the direct money paid interms of subsidy in one year is Rs. 3 Billion but if cost of this

Key Assumptions of Survey

Equilibrium Price: Rs. 4/rotiOpen Market Price of a 20kg bag of flour: Rs. 420

Controlled Rate of a 20kg bag of flour: Rs. 250Equilibrium Quantity: Rs. 2 million only

(for sampled tandoors only)Buyer’s Reservation Price: Rs. 5

(maximum price which a buyer may pay)

Seller’s Reservation Price: Rs. 2

Results of Survey“Consumer Surplus increases, producers surplus

decreases, total economic surplus decreases”

Before Price Subsidy under open market ratesConsumer Surplus: Rs. 1 millionProducer surplus: Rs. 3 million

Total Economic Surplus: Rs. 4 million

After Price subsidy under controlled ratesConsumer Surplus: Rs. 2.175 million

Producer surplus: Rs. 375,000Total Economic Surplus: 2. 55 millionLoss in Economic Surplus: 1.45 million

42


administrative machinery is reckoned with this amount then the totalexpenditures incurred on this scheme stand far higher as compared tothe claimed subsidy amount. Involvement of five administrativedepartments means more problems for tandoor persons and moreavenues for corruption.

Macro-economic balances: Present Government of Punjab has come under fire of opposition forbankrupting the kitty by its huge spending on subsidies. In the provincialbudget 2008–09, total 13 billion rupees were allocated for foodsubsidies (8% of development budget), which increased to Rs. 20 billionin the Fiscal Year (FS) 2009–10, out of which Rs. 8 billion were allocatedexclusively for Sasti Roti scheme.

Another study by one of the authors has placed Punjab after Sindh andNWFP in terms of economic freedom.29 The current trend of spendingwithout regard for economic recession seems to support the finding ofthe earlier study. Greater the size of a government, lesser is the level ofeconomic freedom available, and has a ‘crowding out’ effect on theprivate sector investment.

An earlier study by the World Bank has shown that untargeted subsidiesare the worst policy to ensure consumer welfare, in comparison withwell-targeted programs like food coupons. The study proves that thatthe benefit-cost-ratio of a targeted food coupon system is more than 40times the benefit-cost-ratio of untargeted price subsidies.30

The allocation for agriculture in the Punjab budget has always beeninadequate. Out of Rs.175 billion annual 2009–10 development plan

29 Salman, Ali / Khalil A. Arbi, 2008. Economic Freedom in Pakistan: Sub-nationalIndex 2009, published by Friedrich-Naumann-Stiftung für die Freiheit, Islamabad. 30 Mateus, Abel, 1984. Targeting Food Subsidies for the Needy: The use of Cost-Benefit Analysis and Institutional Design. World Bank Staff Working Paper # 617.

43


(ADP), only Rs.3.2 billion are allocated to agriculture.31 This is quiteinteresting to note that only 1.8 per cent of the overall developmentoutlay has been made for a sector, which forms 22 per cent of theprovincial GDP, provides around 45 per cent of employment.Government has preferred to spend as much as Rs. 20 billion for directconsumption against expanding the developmental base of the sector.The allocation of government to development side of the sector is verysmall if overall miserable situation of the sector is taken into account.The sector is mired by many issues like, price hike in fertilizer, poor seedquality for various products, poor agricultural marketing system,declining yield in many major crops, water shortage, electricity shortageand land degradation. The country is in perennial deficit of fertilizer sincemany years. Had even half of this subsidy amount been spent of settingup fertilizer factories or installing power generation or on R&D of betterseeds and yields, the rural poverty could have started dropping onsustained scale in next few years. But, the government seems interestedin handing out fish to people rather than teaching them how to catchone. The government has taken all steps that bring immediate politicalmileage and ignored all long-term development possibilities.

Price Control: The case of sugar The case of sugar price control in Pakistan aptly describes all inherentproblems with such non-discriminatory price stabilization measures. Thegovernment has jeopardized the functioning of a free market both by itsactions and inactions. Later the involvement of higher judiciary in amarket phenomenon has only helped in aggravating the sugar crisis. Ithas become obvious now that consumers have suffered badly notdespite, but due to, price controls. Long queues of customers waitingfor their turn in front of utility stores present a testimony. Due to anuncertainty led shortage, the price of sugar, if available, has risen

31 Ahmad Fraz Khan, The Dawn Economic & Business Review, June 22–28, 2009.

44


sharply, and it is selling at around Rs. 60, almost 50% more than theofficial price.

The sugar mills are reluctant to start crushing, which is badly affectingthe interests of the poor farmers. The wholesalers have suffered hugelosses due to price differentials. The retailers are reluctant to sell thesugar at a profitable price due to fear of adverse action by a pricemagistrate. Finally, the consumers are left with little or no sugar in theirkitchens. Paradoxically, this has happened despite surplus stock of sugarin the country, as neatly documented in a recent article.32 Accordingly,the available stock of sugar in the year 2009 is around 4.4 million tonsagainst the total demand of around 3.7 million tons. Thus there areadequate supplies of sugar to meet the effective demand.

Apparently, the sugar mills have netted handsome profits due to thissituation. Although government puts the figure of profits earned by thesugar mills during third quarter of year 2009 around 25 billion rupees,an independent assessment considers these profit to be in the vicinity ofRs. 170 billion. Traders, wholesalers and retailers have received theharshest possible treatment by media and policymakers alike by beingclassified as hoarders, full stop. However, the wholesalers have alsosuffered huge losses due to price differentials. When the dust of currentsugar crisis is settled one needs to closely look at the overall surplusmade by producers and traders, as currently no mill or dealer is willingto share any data.

Price controls do not bring any relief for macro-economic balance. Astudy by the World Bank33 argues that:

Control food prices as an anti-inflationary measure does notseem to be appropriate because it introduces large distortions

32Niaz, Shafi M. 2009. Addressing the chronic sugar crisis. The Dawn, Economic andBusiness Review: Nov 2, 2009.33Ibid.

45


in relative prices and disincentives to production. Besides, it isonly a temporary measure: the increase in expenditures wouldbe translated in a larger and larger budget deficit that wouldcause inflationary pressure, before a new round of priceincrease.

In our view, government intervention by abject price control has resultedinto non-availability of sugar in the market despite surplus quantities.This would certainly push the price further upwards. That the pricecontrols are bad, seen from either public policy or economics angle,should now be a given. However, when price controls are subject to beimplemented through a weak and corrupt administration, it is onlynightmare. As these lines are being written, a remarkable piece of policywith respect to sugar has come up. The government will now sell sugarduring fixed hours! This will almost certainly create unfortunate scenesof stampede thus putting people’s lives to risk. Thus, a bad policy backedwith a weak administration, backed up by even poorer designs will nowlead a sugar surplus nation into a sugar-rioting community. This is notjust bad economics; it is also bad, and bloody, politics.

In sync with open market: The case of poultryIt has established in the foregoing analysis that the government does notintervene in the price setting process of poultry meat substantially, itrather sits on the back seat and trusts the market forces to arrive at arealistic price. Consequently, despite of price surge, owing to highdemand and at times shortage in supply due to diseases, the poultrymeat remains available. As no government money is involved, there isno implication for macro-economic balances. Obviously, as notedabove there are fundamental differences between poultry products andwheat or even rice. The wheat is a highly inelastic good, whereas poultryis relatively elastic. If one day, poultry meat is found to be extra ordinaryexpensive, people will less of it, thus its demand will shrink, which willgive the signals to producer to bring down the price. On the other hand,

despite of a doubling of wheat price in just two months, its demand willnot be reduced as its substitutes are not culturally acceptable and it isthe main staple food for Pakistanis. For low income households, wheatflour consumes as much as 24% of their budget.

A deeper look at how price determination actually works in the case ofpoultry meat, reveals that the poultry market operates like an efficientstock exchange, in which information about various stocks is readilyavailable and communicated and it also influences the daily price levelsof ‘underlying assets’. Using the modern communication tools likemobile phone and fax machines, the demand and supply positions ofdifferent market players is converged into the broker, who usually ownsthe transport business. As the product itself is perishable, the marketcannot take too long to take a position or to sustain a position, andhence it clears rather quickly and the equilibrium is achieved.

46


Key Findings of Report

1. In the case of subsidies for sasti roti, a survey reveals thatthere is a net economic loss, when both consumers’ gainsand producers’ losses are accounted for.

2. Government of Punjab has allocated Rs. 3.2 billion foragriculture development in FY 2009–10 whereas for foodsubsidies, it has allocated Rs. 20 billion, which increases toRs. 32 billion when food support program is also considered.

3. In the case of price controls in the sugar, government directintervention has created uncertainty, which has led to supplyhalts leading to price escalation.

4. The sugar supplied through utility stores reaches to about10% of total consumption levels in the country.

5. The poultry meat market operates like an efficient stockexchange, in which information about various stocks is readilyavailable and communicated to all stakeholders in real timethus influencing the daily price levels of ‘underlying assets’.

47

An Advocacy Toolkit for Liberal FriendsAdvocates of free markets, not that they are many out there, usually haveto face questions and criticism from various quarters. In the times ofalleged market failures and global recessions, it is a daunting exerciseto confront these questions as they are often couched in concerns forwelfare, economic justice and populism. When it comes to food items,the price controls become even more favorite for politicians, policymakers and community workers. We present a few commonly held mythsand their corresponding facts, which may help in understanding howmarkets work. It may be noted that the myths have been derived frompopular media debates, public statements by elected officials and duringgeneral discussions while facts are grounded on history and proven lawsof economics.

Price Controls: 10 Myths and Facts

48


Myth 1: Price Controls offer protection againstInflation.Poor people need protection against rising inflation and price controlson basic items like roti and sugar provide them a cushion whilemaintaining their purchasing power.

Fact: Each subsidy carries forward a hidden inflation, as the pricecontrol only artificially brings the price down; it does not actuallydecrease the price. Thus as soon as these subsidies are lifted, theprice hikes are usually more sharp and bring even greater burdenfor the purchasing power than a normal increase in the price.

Myth 2: Economic ‘injustices’ can be undone by courts. Flour mills and sugar mills owners exploit the poor consumers inconnivance with the government therefore some higher body likeSupreme Court must intervene to ensure ‘justice’.

Fact: When ever government intervenes through administering controlfor example by the price magistrates, the retailers simply stopsupplying the commodity. When the court intervenes through itsown formulations of resource allocation, the market does respondby further increasing the distortions. For example, when theSupreme Court announced that 70% of sugar be supplied toindustrial consumers at ‘free market price’ and 30% to retailcustomers at ‘controlled price’, the millers allocated more than70% to the industrial and commercial sector in the natural searchfor more profits.

49


Myth 3: Direct provisioning and production by the government is the final solution. Government should directly control production and distribution ofthese food items by investing in production facilities and distributionchannels.

Fact:Centralized production and government controlled distributionsystems have been tried extensively in Pakistan and badly failedduring 1970s. Bureaucrats who assume control of State OwnedEnterprises work without any incentives and are not trained inbusiness. Therefore any attempt of direct production anddistribution by the government is bound to fail due to bothstructural and historical reasons. The announcement ofmechanical ‘Roti Plants’ by present Punjab Government and itsseizure of sugar stocks is in fact a reverse step.

Myth 4: Price controls are popular. Price controls bring popularity and a democratic government needsvotes to stay in power to serve the masses.

Fact: Price control can bring temporary popularity as long as they areeffective and in place. The implementation of price controls lawsneed honest and efficient administrative machinery, which is simplyabsent in Pakistan. Therefore each announcement of price controlmeeting with failure actually brings bad repute to the politicalgovernment as bureaucrats do not assume any risk of failure. Pricecontrol in the hand of a weak and corrupt administrationultimately proves unpopular and damage the reputation ofpolitical governments.

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Myth 5: Traders are hoarders and must be dealt withsevere punishment.The real problem lies with traders – who act like hoarders – and resistsmooth supply to consumers. The government must curb hoarding byinspections and stringent price magistracy system.

Fact: Traders are business people, who invest in certain commodities,assume risk of loss, keep a profit and then provide the goods toretailers or direct consumers. In fact, hoarding is hard to defineas each businessman has the right to store some raw material andback up stocks for smooth functioning of the business, particularlyin an uncertain environment. The government manhandlingcreates uncertainty in the market and forces the traders to stockmore than the usual requirement of the business thus creatingsupply disruptions and artificial shortages.

Myth 6: Price control bears no costs. Price control is the most cost effective method to protect vulnerablesegments of population.

Fact:Price control may sound inexpensive as it all needs is agovernment notification and using its administrative muscle toensure implementation. However, price control drives privateproducers out of the market as they lose incentive to get profits.This leads to an overall reduction in the supplies, which furtherincreases the price levels thus setting off a vicious circle. Thus pricecontrols ultimately invite government to compensate for reducedsupplies through imports which disturbs the accounts and tradebalance. Thus while price control may seem cheap in the shortrun, it proves to be expensive in the long run.

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Myth 7: Price control effectively helps the poor people. As price controls are introduced to protect the vulnerable from pricesurges or market anomalies, poor people benefit the most, as theyconstitute the majority in a developing country.

Fact:Price control does not distinguish the consumers on the basis oftheir income levels- they are untargeted subsidies. Rich or poor,you pay the same Rs. 2 for buying a Sasti Roti (cheap bread) fromone of the registered tandoors (traditional earth oven). There isno way to guarantee that only the poor, or in fact, mostly the poor,would take advantage of price control. Often, the poor resides inrural areas, as in the case of Pakistan, who does not enjoy anequivalent access to the market. Thus the urban consumers, whoare more vocal, tend to take more benefit of price control becauseof greater access.

Myth 8: Government. Government. Government. All crises are direct result of government failure to act efficiently andtransparently. If government officials and elected representatives are vigilant and honest, no one can do anything wrong.

Fact:The influence of government on markets, supply and demand isfast vanishing as evident from a shift from direct provision toenabling regulations. Government intervention and presence is acause of problem in the first place and solution should not beexpected from the problem itself. We know for instance, that foodinspectors ‘seek rent’ for granting favors to selected market playerslike flour mills and yet we insist on sending more inspectors andmagistrates. It only increases the chances of collusion andcorruption.

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Myth 9: Political elite spends their own money for the poor. Political leaders and government officials spend money to protect poorpeople from the vagaries of market.

Fact:Political leaders and government officials get their salaries and allother expenses from the tax payers’ money and in Pakistan everyonepays taxes, if not direct than indirect. The money which administrationclaims to spend on the poor people welfare is not their own money;it belongs to the people and people have the first right on this money.In fact, the political leaders spend people’s money to perpetuatethemselves into power.

Myth 10: Replace people and things will fall in place. The best strategy to deal with such crisis is to bring ‘honest’ people atthe helm of affairs. Once the leaders are honest, they will ensureeverything works out well for the people.

Fact: Good people cannot fight with bad laws and path to hell is pavedwith noble intentions. One should argue for reforms in the systeminstead of searching for noble people. In markets, the best strategyis to allow free market come full circle by ensuring level playing fieldto all players. It would mean that the government should graduallywithdraw subsidies both for producers and consumers. For example,if domestically produced sugar is not enough to meet local demandand the Trading Corporation of Pakistan cannot place import orderdue to any reason, the private sector, if it were allowed, could haveimported sugar much earlier and eased off supplies in the localmarket. Similarly, if Atta is expensive, then the farmers should be paidcompetitive price so that they grow more wheat in the next seasonand thereby bringing the price of the flour down by increased supply.

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Economists agree that there is a trade off between economic growth andwelfare spending. It is true that if subsidies are withdrawn totally, a largenumber of people would suffer. This is particularly true in the case offood commodities, which has a direct bearing on the nourishment andhence the level of productivity of a nation. Therefore budget allocationfor provision of appropriate and sufficient food to all segments of thesociety should be seen as an investment rather than as consumptionexpenditure.34 Thus we argue that liberals or proponents of free market

34 Mateus, Abel, 1984. Targeting Food Subsidies for the Needy: The use of Cost-Benefit Analysis and Institutional Design. World Bank Staff Working Paper # 617.

Are liberalsheartless?

Liberal Optionsfor the Poor

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are certainly not against instituting support mechanisms for the poor,and especially when it comes to food provisioning. The bone ofcontention is not on the goal but on the methodology. We presentvarious liberals options in this section to achieve the objective of welfareof the poor without distorting the price indicators along with somegeneral advice for the ‘reformers’.

Direct personal aid instead of supply-side subsidies ormarket manipulation“Liberal social policy supports persons in need directly and individuallyand not by manipulating market mechanisms or prices and thusconcealing real costs. Market manipulation and supply-side subsidiesinevitably produce distortion and undesired side effects and alsonecessitate an abundance of rules and regulations. Direct personalsubsidies, on the other hand, do not interfere with anybody's right to self-determination (except that of the tax-payers who provide the funds),supply help where there is genuine need and, by leaving market forcesintact, ensure that the resources needed for social measures are fullyavailable.”35

Invest in Agriculture, not in Subsidies or Price ControlsThe best strategy is to redirect untargeted expenditure to investment inagriculture. It will not only raise the living standards of the rural people,where most of the poor live but will also provide incentives for farmersto enhance their cultivation thus bringing more supplies to the market.It may be noted that in FY 2009–10, the Punjab government allocatedRs. 3 billion for agriculture investment where as Rs. 20 billion forsubsidies. This is the major fault line of economic planners and politicalleaders.

35 http://www.freedomgatepakistan.org/freedom.php?page_id=29

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Are liberals heartless? Liberal Options for the Poor

Design well targeted food support programsWe have shown that targeted food support programs through coupons,or stamps, are at least 40 times more in terms of benefit-cost ration thanuntargeted price control or subsidies. Thus a well-designed food stampprogram can deliver the goal of welfare far more effectively than anuntargeted subsidy. Various developing countries have successfullyimplemented such schemes with a very low leakage level. In our case,a successful coupon system exists in form of Education VouchersScheme36, which has been successful in reaching out to the intendedbeneficiaries.

Don’t punish hoarders: Push them to form ExchangeAs the example of poultry market reveals, if the so called hoarding ischanneled into formal financial markets, the ‘hoarders’ can well be ourtraders of ‘futures’. If wheat trading and sugar trading is allowed throughcommodity exchanges, such as the one working in the case of cottonalready, lot of risks can be hedged. Businessmen should be rewardedfor a good insight about future and should be punished for a bad stockpick!

Use arithmetic intelligently Why the Punjab government, and other provincial governments, decidedto spend all subsidy money for the flour in the month of Ramadan? If anoverall subsidy is deemed necessary, then spread the subsidy money overthe usage of flour in one year instead of one month, albeit offering lessersubsidy per unit so that general prices can be kept low. During Ramadan,the government ensured supply of flour at Rs. 200 per 20 kg bag, butnow just within two months, it has crossed Rs. 560 per 20 kg bag.

36 For a detailed analysis, please see, Salman Ali, 2009. Liberate to Learn: A Study ofthe Education Voucher Scheme in Lahore. Alternate Solutions Institute, Lahore.

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Price Stabilization through Subsidies should be compensated with taxesIf subsidies are considered the only option for stabilization of pricesduring the time when the general prices fare above the trend, then theyshould be designed in a way that taxes ought to be introduced when thegeneral prices fare below the trend. Thus in the medium to long run, thebudgetary impact of price stabilization measures should be nil.

Embrace the market fully; avoid patch workA major stumbling block in success of our policy reforms is the half-hearted nature of reformists. When confronted with challenges andopposition to a reform, reformers always duck instead of pushing thereforms further. If we accept that market forces allocate the resourcesmore efficiently, then remove crutches from every process. For instance,if farmers are being paid a competitive price for their crop, then withdrawsubsidies on inputs like fertilizers.

Complete overhaul does not have to be overnightWhen reforms are being implemented, the reformers are usually in rushfor the fear of a prolonged resistance from the electorate. Thus reforms,especially in price structures, must never be rushed. Complete adoptionof market should not be done overnight; rather gradually over variousphases. Reformers must push their agenda slowly but surely.

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Are liberals heartless? Liberal Options for the Poor

List of Persons Interviewed

Name Designation Contact No. Organization Name

Dr. Saqib AliNoorani

Area Manager 0300-8433954Hi-tech Poultry

Breeders

Dr. Farooq ZafarAhmed

Area SalesManager

0300-8448727Hi-tech Poultry

Breeders

Dr. Mustafa Kamal Director 0300-8450403Big Birds Group

of Poultry

Dr. SerwatDy. District Officer

(Livestock)0300-4250936

Maj(rtd) JavaidHussain Bokhari

Zonal SecretaryNorth Zone

0423-6151845Pakistan Poultry

Association

Shahid CheemaAsst. Director

Agri Marketing0344-6336162

Agri Marketing Department

Sajid Abdullah Director 042-35714688 Sunny Flour Mills

Munir Ahmed Secretary 0300-4076165Pakistan flour

Mills Association

Madam Kulsoom DCO Office N/ACity District

Government Lahore

Mahmood Officer for Tandoor

registration0300-4616867

City District Government Lahore

Nafees Ahmed 0300-9409421 DFC Lahore 1

Zikria N/A DFC Lahore 2

HaroonComputer Operator

042-99212544Punjab Statisical

Department

Ch. Ameer Hussain

Asst. Account Officer

042-99212550Punjab Statisical

Department

Khwaja Zia Group Manager042-35714074-

5Abdullah Sugar

Mills Limited

Siffat HussainSherazi

042-99210294Cane Commissioner

Lahore

The Economic Freedom Network Pakistan (EFN) is an informal network

of economic experts and entrepreneurs working together to contribute

towards economic freedom – which they consider to be central to

successful reform. The aims of the network include: Promoting open and free

markets, stronger property rights for the less powerful and poor members of

society; deregulation and privatization in the interests of job creation. EFN

Pakistan exists to promote human development and economic growth. To

influence the public policy advisors and political decision-makers; to broaden

the debate on the merits of free markets and limited governments, the EFN

Pakistan provides a platform for political dialogue, public education and

academic exchange.

[email protected]

www.efn.net.pk

Documents

Pricecontrols: Implications for Liberty and Welfare