Crisis in the rice market: Is it due to conflicting interventionist policies?

The rice market has been intervened by the government to attain two conflicting goals. That is to protect both the consumer and the farmer simultaneously.
To protect the consumer, several popular varieties of rice have been brought under price controls in the midst of a global rice shortage and the local prices exerting pressure for increases. To protect the farmer, the importation of rice has been under government control with a protective tariff system in place.
These two interventionist policies do necessarily conflict with each other.
Increase Market Supply
The upward movement of prices of any commodity takes place when there is a short supply of that commodity in the market. To release the market pressure, the market supply has to be increased.
It could be done by allowing imports to take place in adequate quantities or raising domestic production or resorting to a combination of both.
Price controls are necessarily short term policy reactions when a market has become chaotic and order has to be restored in the market as quickly as possible. Any price control which does not take into account the cost of production cannot work in the long run without harming the producers.
Essential features of price controls
Hence, two factors have to be taken into account by a government which plans to impose price controls on commodities. The first is that it should be a short term measure and has to be abolished as soon as possible, preferably with a pre – announced time frame. The second is that the controlled price should necessarily be above the cost of production so as to enable the producers to earn a positive rate of return. If producers do not get a sufficient profit, they have no incentive to step up the production and enhance the market supply to eliminate the shortage.
Kautilya’s recommendation
In such a situation, Kautilya did not recommend price controls, but profit controls. His recommendation was that in the case of domestically produced goods, the profit margin shall be fixed at 5 percent and imported goods at 10 percent. Prices were thus allowed to be flexible, and not controlled, depending on the costs. He specifically recommended that ‘prices shall be fixed taking into account the investment, the quantity to be delivered, duty, interest, rent and other expenses’. Such a profit control system permitting changes in the market prices does not harm the long term interests of the producers.
Price controls have not taken the costs into account
It appears that the cost of production (in Kautilyan sense, all costs) has not been taken into account when the controlled prices of popular varieties of rice were determined by the government. With the increases in the domestic costs due to the build – up of inflation over the years, it cost a farmer about Rs 50 to 55 to supply the paddy equivalent of a kilogramme of rice. Hence, controlling the price of rice at Rs 60 per kilo did not earn a sufficient return even for the farmer. No need to mention that all others who are involved in the rice trade, transporters, millers, wholesalers and retailers, were not adequately compensated by the controlled prices.
The result was the removal of the incentive system for the market to step up production. It in fact led to a gradual shrinkage of the domestic production of rice, as was evident by the decline in the Yala 2009 crop by 28 percent.
Natural growth in the demand for rice
Against this decline in production, there has been a natural faster growth of the demand for rice that aggravated the market shortage.
Historically, Sri Lankans have been gluttonous rice eaters compared to other nations that consume rice as their staple food. A Sri Lankan, on average, eats about 105 to 110 kg of rice a year, up from 95 kg which he ate 15 years ago. But his counterparts in neighbouring countries eat much less rice: Taiwanese 50; Japanese 60; Thais 65; Indians 81 and Chinese 96.
The increase in the per head rice consumption in Sri Lanka in the recent past has been due to two reasons. The first is the elimination of the subsidy on bread in the late 1990s, thereby removing its price attractiveness relative to rice. The second is the nation wide propaganda that was launched in order to promote the consumption of domestically produced rice.
Both have caused the demand for rice to increase faster than the supply of rice, thereby putting pressure for the market prices to move upward. This is a salutary development from the point of farmers. That is because the farmers will now get a rewarding price for their products. But, the consumers would not have viewed it in the same spirit, because they have now been forced to make painful adjustments to accommodate the rising rice prices in their already constrained family budgets.
Imports should have been permitted
When the production has fallen creating a shortage in the market, it could have been filled by allowing imports to take place. In this case, the government should have made two timely decisions. The first one was to free the rice market and the second was to remove or reduce the protective tariff. Neither decision was taken by the government in time and as a result, the shortage of rice continued to plague the market, exerting further pressures for the prices to move upward. At the end, no rice was available at controlled prices; even when it was available, such rice was of substandard quality.
Though superior branded rice was available at prices above the controlled prices, many traders did not dare to stock them for fear of being hounded by the government’s law enforcement agencies.
Consequently, the chronic shortage of rice which the market has been experiencing became an acute shortage.
Reaction of authorities
The reaction of authorities was to blame the millers and traders for hoarding rice stocks in order to make thumping profits later. This was presented to the market as a ‘conspiracy’ by these two groups against the consumers. In this way, these two important participants in the rice market were branded as ‘anti – social elements’ bent on exploiting the consumers in an immoral and unethical manner. It is difficult to prevent people, whether they are farmers, millers or traders, from trying to take advantage of a development in the market, since all of them are driven by the profit motive. Hence, he said that they shall be prevented from robbing people. The observation of Adam Smith was that when ‘people of same trade meet together, even for merriment and diversion, but the conversation ends in a conspiracy against he public or some diversion to raise prices’. While recognising this human frailty, both these authorities in their wisdom recommended that the prevention should be done through the promotion of competition and thereby removing the opportunities for collusive activity.
Promote trade and not controls
In this context, Kautilya’s recommendations were more specific. He recommended to the monarch to establish proper marketing systems throughout the kingdom. For this, even the commodities and products of the countryside shall not be sold in the places of their production, but brought to the city and sold after the payment of duty. It is the duty of the king to promote trade and commerce by setting up trade routes by land and by water and market towns/ports. He further said that trade routes shall be kept free of harassment by courtiers, state officials, thieves and frontier guards and from being damaged by herds of cattle. In order to compel state officials to protect trade, he said that frontier officials shall be responsible for the safety of the merchandise passing on the roads and shall make good what is lost.
Don’t blame millers and traders
Hence, blaming millers and traders will not enhance market supply and eliminate the current acute shortage of rice.
Both millers and traders, known as intermediaries, perform an important and indispensable service to consumers and farmers.
If they do not operate in the market, both farmers and consumers have to undergo the hassle of searching for the buyers and sellers, the prices at which rice is available, inconvenience of converting paddy into rice, stocking the same, financing the whole production process and bearing the risk of future changes in supply and the prices. These are known as transaction costs and the millers and traders contribute to reduce the transaction costs to near zero levels.
Kautilya knew of this important role played by traders and recommended to the king to protect the interests of traders in order to protect the interests of consumers. Even in the opposite case of an excess supply in the market and prices falling below the costs, his recommendation was that a price support should be given by buying the glut by paying a price above the market price and adjusting it appropriately when the price improves in the market.
Kautilya’s recommendation was not to go against the market, but to follow it so that the fundamentals in the market are not distorted.
What the govt. should have done
In the current case, what should the government have done?
In the first place, the price controls imposed should have been short – lived. When the market situation has improved and the pressure for the prices to move upward has been eased, the price controls should have been removed. But, the price controls imposed in 2008 have continued in 2009 as well, making it a permanent price fixing by the government.
Second, when the shortage emerging in the market was known, in the short run, the restrictions on the importation of rice should have been lifted. To strengthen the move, the protective tariff too should have been reduced. The government went for these two policy changes only when the market shortage became acute in late 2009.
This was a belated decision made. It will also harm the orderly adjustment of the rice market. This is because the orders placed for the importation of rice in January, 2010 will be delivered toward the end of March, 2010 when the first crop of the Maha 2009/2010 harvest would be released to the market.
By that time, the excess supply in the market will depress the price of rice causing farmers to suffer losses. Hence, a belated decision is as equally harmful as a decision made in the wrong time or a decision not made at all.
Budget packs inefficient
At present, rice in every shop is sold at a premium above the controlled price. Consumers have complained that the rice available at controlled prices in a few shops is of substandard quality. Hence, to relieve the consumers, a government trading institution has offered a budget pack containing rice and a few other consumer items at a fixed price through its retail outlets. Budget packs are an inefficient way of distributing goods, because they offer an ‘all or nothing’ proposition to consumers. Accordingly, those consumers who have no wish to buy the other items in the pack have no choice, but to buy them too in order to have the desired commodity, rice. This is an arbitrary interference in the tastes and desires of consumers and, therefore, will not work in the long run. Hence, budget packs, in a market shortage, will serve only as a propaganda gimmick.
Hence, in order to bring order to the rice market, what is essential today is the immediate removal of the price controls on rice