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Anatomy of policy shortcomings
Facts and fiction about spiralling prices
M. A. Taslim

          ONE of the few things that is likely to hurt the ruling coalition’s fortunes in the next election is the spiralling prices of essential commodities. One would have expected the coalition to be bit more mindful of keeping essential prices in check to the extent possible. The general perception seems to be that the government has not done enough to control the prices.
Since spending on essential commodities such as rice, comprises a large part of the budget of the poor people, an increase in the prices of these commodities usually means a loss of purchasing power of the poor, thus pushing them into a more vulnerable position. Ordinary poor people are usually stoic, they doggedly persevere during bad times without losing faith provided they are assured that their misfortune is not the machinations of some greedy people.
A thorough inquiry by an impartial expert into the causes of spiralling prices of essentials and widespread public discussions could have served the purpose of containing public despair and anger if the price-hike was indeed due to unavoidable circumstances beyond the control of the government. During the early part of the government’s tenure there was apparently much discussion among the ruling coalition’s stalwarts. Many of them were hypercritical of the role of the Ministry of Commerce and held the then Commerce Minister responsible for the price hike. In the face of adverse criticisms, the Minister resigned.
The resignation of the Minister did little to improve the situation; indeed it worsened. The prices of essential commodities, especially foodstuff, kept on rising to unprecedented levels. But this time the coalition stalwarts did not make the same noise. It became evident that their earlier crusade was not meant to explain or solve the problem of spiralling prices, it was essentially internal feuding.
In the absence of any independent research on the underlying causes of the inflationary price increase, rumours and speculations became the main source of information. Anti-government forces had a field day. All too frequently fingers were pointed at the government as responsible for the price-hike. The activities of many of the government stalwarts lend credence to these allegations. It became difficult for anyone to publicly disagree even when some of the allegations were clearly untenable.
What were the underlying causes of the increase in the prices of essential commodities? This paper does not purport to provide a definitive answer to this query. That must await a thorough investigation by a respectable scholar. Media reporters and columnists, opposition spokespersons, and important government officials have at different times identified the following as the important factors causing spiralling prices: (a) hoarding by unscrupulous business people, (b) extortion, (c) bribery and corruption, (d) natural calamities and (e) increase in international prices. The purpose of this paper is to examine, in the light of economic theory, whether any of these provide an adequate explanation of a price hike.
Whenever the prices of commodities such as onions, pulses or powdered milk increase exorbitantly, hoarding by unscrupulous business people is usually held responsible by commentators in the media. However, a little thought would reveal that this cannot possibly explain the phenomenon of spiralling prices. Business people always set prices at levels that maximize their profits. Without a change in the market structure or conditions they have no incentive to either raise or reduce prices. If there are a large number of sellers in a market, hoarding by an unscrupulous section of the business community will not have much impact on the prices, but the hoarders will suffer losses as their market share will be taken over by others. If all of them hoard in unison, the market could behave like a monopoly and the price could rise above the competitive level. However, organizing such a coordinated move is very difficult.
Furthermore, when the prices have risen due to such collusion, every businessman has an incentive to cheat others by undercutting the price to increase his own profit. As a result such a coalition breaks up fairly quickly and the price comes down to its competitive level. Since prices of essentials go up periodically, one would have to assume that someone periodically organizes such a collusive coalition and holds it together to fleece the general public. To what extent this is feasible is a moot point.
If the market is monopolized to start with, then no gains can be made by reducing supply. Indeed, it can only hurt the monopolist and he would not engage in hoarding. Thus the popular notion that monopolists raise prices to increase their profits is false. He is already charging the highest price that the market will bear.
Although a single seller in a competitive market or a monopolist cannot increase profits by raising prices, a small cartel of sellers in a multi-seller market may be able to increase profits through the abuse of state power. Such sellers (of say sugar or edible oil) may, for example, use their political clout to persuade government functionaries to delay the importation, or the release, of the commodity. The length of the period during which they can hold back the supply of the commodity from flowing into the domestic market would of course depend on the strength of the cartel’s clout. The temporary cessation of imports or delay in the release of the imported goods will cause a temporary shortage in the market. The market price will rise in response. The cartel can then sell from their accumulated stock to earn an abnormal profit. Once their stocks are depleted they would have no incentive to block importation or release of the commodity or item and the price will come down to its normal level.
If the whole process lasts only a few days, the cartel would have made their profits before others can organize resistance or protests. What is to be noted in this case is that the cartel gains at the expense of both the consumers and a majority of the other sellers of the commodity. This is not an unfair business practice in the ordinary sense, but an abuse of the state power by a cartel to create an artificial scarcity.
The second explanation for price-hike, i.e. extortion by mastans and their political godfathers, is not satisfactory. From news reports and hearsay, it would appear that mastans, including police, charge trucks carrying goods about Tk 200-500 (per truck). A truck usually carries about 7.0 tons or 7000 kg of a commodity. This would mean that its cost increases by about Tk 0.03-0.08 per kg. If the item being carried is rice or onions, such a small per unit toll does not have any appreciable impact on the price. It should also be understood that this toll was charged also before the price-hike, and hence it was already included in the price. Unless the toll itself was increased substantially, it cannot contribute at all to the price-hike.
The effect of bribery and corruption is similar to that of extortion since they are also extortion, albeit by persons in authority. Bribery and corruption raise the cost of the commodity, and hence, its price. Thus the price of the item already contains the cost of bribery and corruption and cannot be regarded as a cause of further increases in the price unless the bribe payments were to increase to a higher level.
A natural calamity such as a flood can raise the prices of some goods by reducing or disrupting supply. However, the extent of the price-hike will depend on the preparedness of the government and the people against such events. If the government can respond quickly to a flood, prices of essential goods need not rise. Otherwise, the losses to food crops and the difficulty of moving these goods to the affected areas would create a shortage situation leading to a temporary price inflation. Once the flood situation improves and supplies resume, prices should fall back to the normal level.
In contrast to these factors, a rise in international prices can have an immediate and sustained impact on the domestic prices of like-goods. A necessary consequence of globalisation is that domestic prices of tradable goods are strongly linked to international prices. The prices paid by US consumers of steel and cement are now influenced by the demand for these products in China and India, while the prices of clothing items or shrimp sold in these countries are strongly influenced by demand of US consumers. As long as there are no trade restrictions, any increase in domestic prices above the international prices will encourage imports that will quickly reduce the domestic prices to parity with the international prices. Conversely, any reduction in the domestic prices below the international prices will cause the goods to be exported that will reduce the domestic supply and raise the domestic prices to parity with the international prices.
It is possible that business strategies of importers may prevent immediate pass-through of the higher import prices to the domestic prices, but over a period of time this must happen. Government policies can also prevent immediate pass-through of import prices. This has been the case with the recent increases in the international prices of oil. The government has quite adamantly refused to raise the domestic oil prices during the first few months. It finally conceded to increase the local oil prices, but by less than the increase in the international prices. Such a policy can be pursued only at a cost as evidenced by the mounting losses of Bangladesh Petroleum Corporation.
Most essential products such as rice, wheat, edible oil, onions, pulses etc., are imported in varying quantities. Hence, the prices of these products will be strongly linked to international pries. International prices (in domestic currency unit) can rise because either the prices in the exporting country have risen or the value of the domestic currency vis-à-vis the currency of the exporting country has depreciated. In either case an increase in international prices will be passed through to the domestic prices. A systematic comparison of the domestic prices of tradable essential goods with the international prices should reveal to what extent domestic prices have been influenced by import prices. If the Ministry of Commerce had commissioned a study by an independent expert on this issue it could have perhaps saved itself and the government from much of the controversy if the price-hike was due mostly to higher import prices as it had claimed.
A student of economics would know that no increase in any price is possible unless there is a relative shortage of supply, or what amounts to the same things, an excess demand for the commodity. The relative shortage can arise due to either a reduction in absolute supply as during a devastating flood, or due to an increase in demand as happens during the Ramadan or Eid. Sometimes expectations could change supply or demand even though there are no changes in the actual conditions.
An investigation into the causes of a price-0hike should begin with determining if the price-hike is due to excessive demand or reduced supply. Once this has been determined, the next inquiry must be why the demand and supply conditions have changed. A determination of the underlying causes of these changes will suggest remedial measures that need to be put in place to arrest the rising trend in prices. While these measures may vary depending on the cause of the price-hike, what is generally true is that price can be brought down only by eliminating the relative supply shortage or excess demand, i.e. by increasing the supply of the commodity in the market.
For most products, the only way to augment supply in the short-term is through importation. For many products, in the production of which the country has no comparative advantage, even a long-term solution is also importation. Only by importing an adequate amount of the good, the price can be stabilized at the level of the import price (plus trade taxes and costs). It is interesting that some people who cry foul the shrillest when the prices of essential goods increase are also the people who oppose importation (i.e. support trade protection). You cannot have the cake and eat it too!
The discussion above pertains to prices of individual commodities. This should not be confused with the general price level such as the Consumer Price Index (CPI), which is a weighted average of the individual prices. The general price level needs not bear any correlation with the prices of a subset of commodities. Hence, it is quite possible for the general price level to fall when the prices of some of the essential commodities rise. However, if prices of all commodities rise then the general price level must show an increase.
The Ministry of Finance is concerned essentially with the general price level. It has an altogether different explanation of the increase in the price level. This is because the general price level is a macroeconomic concept whereas the prices of particular commodities or items, as under discussion above, are microeconomic in nature. The Ministry of Finance believes that an increase in the general price level is due essentially to an excessive supply of money. Hence, if the price level exhibits a tendency to drift up it tries to hold it back by resorting to a restrictive monetary policy in an attempt to reduce the growth of money.
This is what the Ministry of Finance (through the Bangladesh Bank) did a few months ago at the behest of the IMF when the latter was convinced that an inflationary spiral was about to take hold of the economy. Bangladesh bank has a number of instruments, such as the cash ratio, the liquidity ratio and the open market operations, to influence the money supply, and thereby the price level. However, individual prices cannot be controlled in this manner.
The maintenance of the stability of the general price level is clearly the responsibility of the Ministry of Finance. However, it is not clear which ministry or department should be responsible for the prices of individual commodities such as rice, onions and oil. There seems to be an expectation that the Ministry of Commerce should take appropriate measures to keep these prices in check. The Ministry of Commerce, however, points out that it does not have any effective instruments to control prices of essentials. It has a department, Trading Corporation of Bangladesh, which could be used to augment supply in the market in times of shortages by direct importation and distribution; but some time ago the government took a decision, on advice of the World Bank, to close it down such that the Corporation has been in a limbo for a while. The situation is confusing, and it has never been clearly stated by the Government how the essential prices is to be controlled and by whom. The current policy of holding meetings with the business people and exhorting them to reduce prices is clearly unworkable; altruism is not a motivation for engaging in business.
Another policy tool that might be utilised is to reduce trade taxes to offset rising import prices. Some countries have reportedly used it to moderate the impact of depreciation. However, this is not the domain of the Ministry of Commerce; trade taxes are set and altered by the Ministry of Finance. The Ministry of Commerce can at most make a request for a reduction of the relevant trade taxes. Since the Ministry of Finance is not perceived to be accountable for individual prices (as it is for revenue), it does not feel the compulsion of reducing trade taxes. Whether it will reduce the taxes would depend on the relationship between the two ministries and the general mood of the Government. If the relationship between the two ministries is strained then the Ministry of Finance has a good reason to procrastinate and let the Ministry of Commerce take the flak for the price hike. This has reportedly happened in the past.
Since the price can rise only if there is a relative shortage in the market, the only way it can be reduced is by alleviating the supply shortage situation. The shortage could be the result of natural causes such as floods or the inability of the productive forces of the economy to satisfy the rising demand of the people. In the case of the former, the only way to augment supply is the timely importation of adequate quantity of the good. In the case of the latter, the solution is long-term and involves building up productive capacity of the nation. Until this is done, price has to be kept in check only by importation.
If the shortage has been created artificially by the misuse of state power, the solution lies in the ability and willingness of the Government to prevent such abuse of sovereign power. If the recent shortages were artificially created, then the Government has not been very successful in containing the unfair practices. Despite the fact that there is no clear evidence of Government collusion, the general perception seems to hold the Government accountable.
Business people, with or without the collusion of the government functionaries, attempt from time to time to control the market in their favour. This is not peculiar to Bangladesh, but happens in just about all counties of the world. Such tendencies cannot be eliminated entirely, but there are ways of controlling them. Two instruments that are widely in use to control unfair trade practices are Consumer Protection Law and Competition Law. Higher prices are not the only method used by unethical business to deprive the consumers of their purchasing power, this can be equally well done by fraudulent reduction in quantity and quality. To protect consumers from such abuse, Consumer Protection Law has been put into effect in many countries. Bangladesh is one of the few countries that do not have a Consumer Protection Law. In the absence of such a Law the citizens are unable to seek redress when they are victims of unfair business practices. They have to depend on the government to act in their favour. This was clearly demonstrated by the recent drive against adulterated food by the authorities. It received huge media coverage and brought to light the massive malpractices that occur in the food industry.
What seems to have been not understood is that such a drive is not sustainable and cannot protect consumers against abuse. The government that is widely known to be corrupt, cannot be expected to run a clean drive against business malpractices for long. Sooner or later it will be corrupted just like any other government agencies. Furthermore, the government officials chose which businesses to investigate in such a drive, and the penalties accrue to the government. While this is certainly an improvement over the previous laissez faire condition, the consumers, whose cases are not chosen, do not get any protection. More importantly no consumer is compensated for the loss they suffer due to business malpractices. The existence of a Consumer Protection Law allows the consumers to take offending businesses to task in the consumer courts and seek compensation. Bangladesh Tariff Commission, on instruction from the Ministry of Commerce, had drawn up a Consumer Protection Law more than two years ago. Since then it has been substantially revised by other departments, but the Cabinet is yet to give it a stamp of approval.
The efforts by the business people to monopolise the market or form cartels or otherwise engage in anti-competitive behaviour can be held in check by Competition Law. The theoretical rationale for such a Law derives from the rigorous demonstration by economists that outcomes achieved in a competitive market cannot be bettered by any other system. In particular, monopolistic or oligopolistic markets decidedly lead to inferior outcomes – people pay more for less and the overall welfare declines (with the exception of the case of a natural monopoly). There is some prima facie evidence that some markets in Bangladesh are cartelized. There are allegations that occasionally unscrupulous business houses collude to restrict supply and increase prices. In the absence of a Competition Law prohibiting anti-competitive activities, there can be no legal recourse to such abuse of business power. The absence of a Competition Law can also encourage foreign companies to engage in anti-competitive behaviour to extract greater surplus from Bangladesh. This would be much harder to detect and prevent.
The most effective legal guarantees against business malpractices or abuse of market power are the Consumer Protection Law and Competition Law. These are designed to ensure fair competition in the market. Since a competitive equilibrium ensures the lowest price and the highest welfare, these laws provide the best legal protection of the interest of the people of the economy. Needless to say that the laws must be simple and rigorously implemented in order to achieve their objectives. The government should act expeditiously to frame and implement these laws.
The author is professor of Economics, University of Dhaka and former
chairman of Bangladesh
Tariff Commission


  More Headline
Facts and fiction about spiralling prices
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