Set up more markets to promote economic growth

Many economists and historians have stressed the development of markets and of the institutions which support markets as a vital break between the relatively static world of the pre-industrial economy, and the dynamic world of the Industrial Revolution. The market supposedly works its magic for economic growth by allowing specialisation and hence, increasing returns to scale. In the pre-market world, each family produces what it consumes, inhabiting an island economy, where self sufficiency is purchased at the cost of inefficiency. Only when institutions evolve, which encourage trade, can production be specialised by region and by worker, and can economic growth begin.
Last week at a seminar, there was a suggestion that we should set up Commodity Futures Markets. Perhaps they were referring to commodity forward markets, rather than commodity futures markets, which are more in the field of financial markets. The advantage of a forward market for grains such as paddy is that, the farmer can sell forward his crop before he harvests. When the harvest takes place by all farmers at more or less the same time, the paddy price falls. But if the paddy had been sold forward, and if the forward price was higher than the spot price at harvest time, then the farmer stands to gain.
It also ensures that the farmer gets a certain price for his paddy, even as he sows. He knows his costs, and if he can ensure that he gets a reasonable return, he will be motivated to cultivate as much as he can. It is possible that, due to harvest failures, the price of paddy after the harvest may be higher than the forward price at which he sold. That would be an opportunity loss for him. Unlike in forward sale, where the farmer is obliged to give delivery of the paddy he has sold forward at the agreed price, in the case of futures, he does not have to deliver, but has only to settle the price difference. He could still sell his paddy at the higher spot price, but will have to forego a part of his extra profit. Our governments have been supporting agriculture, particularly paddy farming, ever since Independence. For many years, there was the Guaranteed Purchase Scheme under which the government bought paddy at a fixed price above the market price. But the scheme did not give the benefit to the farmers, for middlemen also benefited. It is true that paddy production has gone up considerably. But the cost of production is too high and uncompetitive with rice prices in the world’s rice exporting countries. What has gone wrong?
One reason for markets not developing is the lack of access from the farming villages to the big market centres. Connectivity to larger markets improves the price to the farmer. Very often, it is the failure to maintain roads properly that has led to the breakdown of access to markets. We have not developed the culture of the proverb ‘a stitch in time saves nine’ –where regular maintenance prolongs the economic life of an asset.
One way of determining whether we have efficient market for paddy and rice is to note the price differences in various parts of the country. In an efficient market structure, there should be more or less a national price allowing for transport costs. An efficient market also means that prices will not fluctuate too widely between years. If the farmers build sufficient stores and store them then the surplus in good years could be carried forward for sale in the leaner years, where harvests have not been too successful.
Does anybody know how much paddy is stored and carried forward from year to year? Does anybody study the price differences in the surplus and short areas? The other day, it was said that there was a shortage of rice in Polonnarruwa - a surplus area, presumably, due to a failure of milling capacity. There is an organisation called the ARTI. One would expect such an institution to publish such details.
The poor functioning of our agricultural markets may be due to a variety of other causes. There is a general hostility to middlemen by persons who do not understand the necessity of middlemen for efficient markets. The people, as well as the government, looks upon middlemen with suspicion. The government usually intervenes in the price determination of rice and paddy, because rice is an important consumer good for the large majority of the people.
But such interventions by the government disturb markets and create opportunities for speculators to buy, if they anticipate a shortfall, to sell high when the lean season comes. The government must abstain from intervention by regulatory controls. If it wants to keep prices down, it will be at the expense of the farmers. If the government abstains, the market will develop its own mechanisms for arbitrage.
If markets functioned efficiently, and transport costs were low, the grain yield in a village should have had little effect on the price level. If yields were low there, but higher elsewhere, grain would flow in and keep prices low. If yields were high, but low elsewhere, then grain would flow out driving up prices here also. If, however, each village was isolated from the market, then the only determinant of local prices would be local yields. What happens elsewhere in the economy would have no impact locally. Since yields vary considerably from place to place in any given year, this should be a test of the integration of the market.
Storing grain to sell later in the year had two costs. The interest cost of the capital tied up in the grain and the physical costs of storage. The storage cost had two main elements. First is barn space. If such space can be rented out for a fee, then those farmers who could afford to do so would engage in it. Some government body should study the development of markets for paddy and seek ways and means to develop them.
The Indian government has actively promoted derivative markets and forward markets for commodities. There is a Commodity Forward Markets Commission and commodity futures markets. Since 2002, the country had 3 national level electronic exchanges and 21 regional exchanges for trading commodity derivatives. Commodities futures market in India has experienced an unprecedented boom in terms of the number of modern exchanges, number of commodities allowed for derivatives trading as well as the value of futures trading.
Our authorities should seek expert advice and guidance from India, where too, there are a large number of small farmers with all the difficulties they face in credit and marketing. As many as 80 commodities have been allowed for derivatives trading.
Our Central Bank has been talking of forward trading in commodities, but there are no published reports of what progress it has made in this field.
The government should obtain expertise from abroad and set up a Forward Contracts Commission and a Commodities Futures Exchange to develop both forward contracts as well as futures contracts, where, instead of delivery of the underlying commodity contracted for, there is a settlement in cash.