Black-Hole Security
by James Roumasset
Working Paper No. 00-5 April 2000
Black-Hole Security
By James Roumasset1
1. Introduction
Government failure describes the failure of government-organized projects and policies that fail to deliver their expected benefits and/or impose large
unintended costs. A particular type of government failure concerns the case where government efforts to solve a problem actually make the problem worse. Black-hole government failure refers to a vicious circle as the worsening problem calls forth ever more costly public spending and market controls.
For example, the (alcohol) Prohibition policies in the U.S., during 1920 - 1933, resulted in a black-hole of spiraling enforcement expenditures, but with ever decreasing effectiveness. The greater the enforcement expenditures, the greater the difference between the "street price" of alcohol and its cost of production. These potential rents stimulated innovations and changes in market structure in the alcohol industry that lowered the risk of being punished for illegal activities, thus lowering the street price and stimulating new rounds of increased enforcement, thus stimulating new innovations etc. The same inexorable dynamic renders the U.S. "war on drugs" counterproductive (Roumasset, 1999).
Another example of black-hole economics concerns is government
monopolization of certain forms of transportation. In Honolulu, private operators are not allowed to compete with the city's bus system. When the City took over operation of The Bus in 1972, private profitability was barely positive, due to the reliance on private automobiles. Politicization of bus services and expenses gradually increased losses to $6 million per year. Meanwhile, the government went to increasing lengths to prevent private solutions to increased traffic from taking hold.
Both these cases exhibit two characteristics in common. First the
government regulation in question actually made the problem worse. Second, the failure of the programs led not to abandonment, but to ever greater expenditures
1
J. Roumasset is Professor of Economics at U. of Hawaii. This paper was prepared for the PRAEO meetings of the Int. Western Economic Association, Sydney, Jan 2000.
and regulations. Because there is no obvious limit to the economic waste created thereby, these programs are characterized as black-hole government failures.
A special case of black-hole failures may result from government attempts to enhance economic security. In what follows, I explore the particular case of food security in the Philippines, demonstrating how the rhetoric dramatically increases rice prices, decreases price stability, and stifles agricultural
development, all at an enormous cost to the Philippine taxpayer.
2. How the quest for food security begets food scarcity
Another type of governmental black hole relates to the provision of security especially as motivated by a false sense of scarcity. Many developing countries in particular pursue consumer-oriented programs designed to insulate consumers from high domestic prices of staple food commodities caused by domestic shortages and/or high international prices. The rhetoric of food security also includes the objective of increasing farm-gate prices in order to increase farmer incomes and to increase the domestic production of food for self-sufficiency. For example, the importation of rice in the Philippines is monopolized by the National Food Authority (NFA), a government marketing-board. The NFA is charged variously with providing low and stable prices to consumers, sufficiently high and stable prices to producers, promoting agricultural modernization, insuring food security, and reducing poverty. This is an impossible mission. Sections
2.1 and 2.2.show that government cannot sustain stable producer and
consumer prices above and below their respective equilibrium levels. Section 2.3 and 2.4 show in fact that NFA has not in fact stabilized prices, that it has increased consumer prices above the free-trade equilibrium and that it has caused producer prices to increase above the free-trade level, albeit at an enormous efficiency and financial cost. Agricultural modernization, food security, and poverty reduction have all been retarded.
2.1 THE SIMPLE ANALYTICS OF CONSUMER AND PRODUCER PROTECTION
Suppose that government endeavors to lower consumer prices and raise producer prices. Figure 1 illustrates the situation. In order to maintain farm prices above world prices, the government must pay producers a subsidy equal to the difference between producer and world prices (PF - PW) times the domestic
triangle plus the subsidy times the marginal social cost of public finance. The latter measures the tax friction associated with financing the subsidy payments through inevitably distortionary taxation (the marginal cost of public finance is typically assumed to be in the neighborhood of 30-40%2). Lowering consumer prices requires similarly subsidizing consumers by the amount, PW - PC, times the
entire amount QD plus an even larger amount due to tax friction. Such programs
would be extremely costly and politically unfeasible to maintain, due to the large increase in the implied tax burden.
FIGURE 1
EXCESS BURDEN OF PRICE CONTROLS
P/ton PD = MB PS = MC PF Pw PC Rice QS QD
Notes: PD and PS denote the demand and supply schedules. PF, PW and PC are producer, world, and
consumer prices respectively. QS and QD are the quantities domestically supplied and demanded,
respectively.
Government can achieve an equivalent result by banning all private rice trade, importing the amount QD – QS, selling the rice at a loss and continuing to
subsidize production as before. The required subsidies, excess burden, and tax friction will be exactly the same as before, although there are likely to be
additional costs associated with government inefficiencies.
2
It is important to note that the government cannot maintain the target prices without subsidizing all rice produced and all rice consumed. Abstracting from quality effects, buying some rice at above farm gate and selling some rice at below market prices will result in multiple prices -- intramarginal prices and equilibrium prices. Political economy suggests that those who obtain the more favorable intramarginal prices are those with greater political influence and that the induced influence-peddling will partially dissipate the rents so expensively obtained. Yet this is the inevitable consequence of trying to control prices of a commodity that represents a substantial portion of the economy. Since it is fiscally impossible to subsidize all buyers and sellers, the government must implicitly compromise its ostensible objectives. In addition to operating intramarginally, the government will typically favor consumers or producers at the expense of the other group. In the Philippines, providing for consumers results in negative protection for
producers (see section 2.3 below).
To see the effects of such a policy, imagine that the government gives up on its objective of keeping producer prices above consumer prices and simply tries to lower the domestic price of rice to a target less than the world price by importing a fixed quantity. The effect can be analyzed as an outward shift in the supply curve resulting in a lower price than in autarky. Now suppose that the government fails to import a sufficient quantity such that equilibrium price falls to its target level. Selling imports at less than the equilibrium price cannot lower the equilibrium price. If the subsidized rice finds its way to those consumers with the highest marginal willingness to pay, there is no effect on equilibrium price. If some of the rice is consumed by low willingness-to-pay individuals (which is one of the
intended consequences), then equilibrium price will actually rise above its level without such subsidies. Now if the rent-seeking elite receive a disproportionate share of the subsidy benefits, the effect of the subsidy is exactly opposite of its ostensible objectives, i.e. the subsidy increases the equilibrium price (paid by the politically disenfranchised).
In other words, the current NFA policy emphasizing consumer provisionism is equivalent to three distortionary policies combined. The first is banning private imports and then importing (in most years) less than what it takes to maintain the target price. The second is to adopt a rationing mechanism for determining who is to receive rice at target prices. The third is to carry out these operations in less than a cost-effective manner. While it is conceivable that the rationing mechanism is successful in favoring target beneficiaries, it is quite possible that intended beneficiaries will be (unintentionally) discriminated against. Another alternative,
discussed in a subsequent section, is that all consumers receive the equilibrium price, and that traders and/or import quota administrators receive the rents created by restricting imports without rationing the import quota.
A case can be made for subsidizing consumption of the food staple by low income consumers when such consumption generates positive consumption externalities to the taxpaying public of the Philippines and the taxpaying
beneficiaries of international donor and lender institutions. The administrative difficulty lies in designing delivery mechanisms that target the low-income
population with minimal leakage to the rest of the population. The dilemma is that means-testing (i.e. identifying those who meet the selection criteria) may be
expensive, especially where there is a large number of low income households, and that non-targeted subsidies have extensive leakages. Unless and until cost-effective and targeted food-subsidy mechanisms are designed and a large
proportion of the population is poor, some amount of non-targeted price-subsidies are warranted, especially for inexpensive grains. Leakage to the non-target
population and spillovers in the form of lower farm prices may be minimized by marketing such commodities in low-income urban areas.
Targeted food-subsidy mechanisms may be simultaneously expanded. Self-selection via food-for-work programs is of particular interest. Given the rapidly declining cost of the requisite technology, electronic debit cards could also be used in some areas to facilitate the delivery of targeted subsidies. These will be more effective to the extent that they are redeemable for a very limited list of foodstuffs, especially for lower-quality items whose marketability is limited.3
2.2 THE ROLE OF GOVERNMENT IN COMMODITY PRICE STABILIZATION
The welfare consequences of price stabilization depend on the source of price fluctuations. Four sources discussed here are international price fluctuations, domestic supply disturbances, seasonal speculation, and exchange rate
movements, and.
If international prices are the source of fluctuations, it is a simple matter to demonstrate that stabilization, even by costless buffer stocks, is welfare reducing. Consumers gain more from low prices than they lose by high prices and producers gain more from high prices than they lose from low prices, except in the case of
3 The subsidy must therefore be less than that which would make the food item economically attractive as animal
perfectly inelastic demand and supply curves. The possible exception to this rule concerns the case of risk averse consumers and producers. But not a single
economist has been able to demonstrate that risk aversion is of the right type (i.e. amenable to risk sharing, not idiosyncratic and of a sufficient magnitude to
overturn the result just stated). Moreover, once the assumption of costless storage is dropped, one would have to demonstrate that the gains of stabilization were greater than the cost of storage. Finally, all imaginable storage and release rules may in fact be destabilizing, due to the inevitabilities of low prices in the face of insufficient excess storage or government purchase capability and high prices in the face of insufficient stocks (Williams and Wright, 1991).
The case against price stabilization is somewhat less devastating in a closed economy wherein a stochastic supply is the source of instability. In this case, if storage is costless and the stabilizing agency has perfect foresight, then
stabilization can lead to welfare gains. A simple demonstration of this result can be obtained by graphing high and low linear supply curves that are assumed to alternate in odd and even years. By stabilizing the price at its mean level, the agency procures additional grain when supply is high and sells it to the next year when supply is low. In the more realistic case wherein supply is random, not strictly alternating in odd and even years, the government will have to peg the price at something above the mean price and accumulate more (less) in times of plenty (shortage). This will lower the probability that stocks will eventually be exhausted during times of rising prices. But pegging the price at the higher level has the effect of wiping out the gains from stabilization that occur in the contrived example described above. In addition, two problems remain. There is still the possibility that stocks will be exhausted and price will move above its pegged level. Also the irregularity and varying severity of bad years implies that the average inventory period will be longer than the one-year period in the
hypothetical example, and storage costs will correspondingly be higher. Again the conclusion emerges that the buffer scheme has high costs and is likely to have negative welfare gains.4
4
Buffer-supported price band schemes are typically even more inefficient than price floor or price peg programs. The price band, like the peg, is inherently asymmetrical. With sufficient resources, the government may be able to prevent price from falling but it cannot always prevent price from rising. A price band scheme also incurs additional storage costs. Simply put, the problem is that the agency acquires grains at the floor price and then must wait until the price rises to the ceiling until the stocks can be released. That is likely to be a long wait, and storage costs (implicit rental on land buildings, and equipment plus interest foregone on the value of stored grain plus disappearance to spoilage, pests, and pilfering) are highly time sensitive. It would be much less costly to release the grains at a lower ceiling price, in the limit at the price floor. In other words, the optimal wedge between price floor and ceiling is likely to be zero (see Williams and Wright, chapter 14).
An alternative to stabilizing against domestic supply fluctuations with
buffer stocks is to vary imports so as to compensate for shortfalls or bumper crops (thereby smoothing out fluctuations in total supply). Despite the fact that this is likely to be welfare-reducing, it may be appealing as a second-best strategy to the extent that some degree of price fluctuation is thought to be politically
unacceptable. Allowing prices to fluctuate within a band is less welfare-reducing than a peg, and a proposed mechanism for managing domestic prices within an acceptable band is outlined in part.
Another commonly alleged motive for government intervention to stabilize prices is the need to control non-competitive rice traders. It is commonly believed that a rice cartel manages to buy low from farmers during harvest season and sell high to consumers during the lean season. This myth is remarkably resilient to evidence. For example, it has persisted with equal force both before and after Mears’ (1974)5 exhaustive study showing both the competitiveness and efficiency of rice markets in the Philippines and his similar study for Indonesia (1981). Moreover, if barriers to entry are present, they are due to the licensing and other requirements of the regulatory structure. The appropriate policy response is to liberalize those regulations, not to compound the problem with price controls.
A stylized fact of seasonal rice prices is that prices often rise faster than storage costs during the lean season and decline as inventories are released in anticipation of the wet season harvest. This pattern has not been carefully
confirmed due to the difficulty of knowing whether a particular week, e.g. the end of August is really before the wet season or whether it in fact coincides with early harvests. At any rate, the perceived pattern is suggestive of what may be a
speculative bubble, not the result of monopoly forces. It is well known that expectations of prices climbing faster than storage costs may induce owners of grain stocks to release them slower than the pattern that would prevail under perfect information and that those expectations thus become self-fulfilling. Eventually, however, traders realize that they will be left with excess stocks at harvest time and compete with one another to dispose of those stocks. Happily, there is a common solution to the problem of prices rising above their competitive equilibrium values, namely, private access to rice importation and easy entry into the rice trading business. Monopoly power is easily cured by entry, and
speculative bubbles would be offset by the countervailing expectation that high prices would call-forth additional imports. An additional advantage of private
5
importation is that the private sector is not burdened by the elaborate contracting, procurement, bidding, and other administrative requirements that delay
government purchases.
A special case of international price fluctuations results from a flexible exchange rate. Of particular concern is the risk that a country's exchange rate will suffer a severe devaluation. If the rice price is allowed to float as well, there is the possibility that the wage will also decline dramatically relative to the price of rice, thus forcing the poor to bear a disproportionate share of the burden of devaluation. This case is not well understood but suggests that comparative analysis of
exchange rate policies should include such considerations. Nonetheless,
devaluation risk can be considered as one justification for government's assuring that an emergency response rice-provision capability is in place for economic as well as natural disasters.
2.3 INDICATORS OF THE NATURE AND CONSEQUENCES OF CURRENT POLICY
As shown in section 2.1 and 2.2, economic theory provides a number of results germane to price intervention in grain markets:
1. Sustaining consumer and producer prices substantially below and above (respectively) international prices is fiscally unsustainable. Either the welfare of consumers or producers (or both) will be sacrificed in attempts to so distort prices. In addition, price controls are likely to be intramarginal in nature, if they are effective at all.
2. Buffer stocks are incapable of stabilizing domestic grain prices.
Consider a few empirical indicators of the nature and consequences of the present policy. Figures 2a – 2d show that NFA price maintenance policies are ineffective. Figures 2a and 2b plot actual consumer prices vs. official NFA prices for 1995 – 1999 for Manila and Davao. Figure 2c shows actual farm gate prices vs. official NFA buying prices for the “rice bowl” of Luzon. Figure 2d displays both prices for the Philippines. The divergence between official and equilibrium prices occurs largely because NFA is a relatively small player in the total rice market of the Philippines.
FIGURE 2a
CONSUMER RICE PRICE VS. NFA RELEASE PRICE, MANILA (1995 – 1998)
Sources: NFA Release Price: National Food Authority Retail Price: Bureau of Agricultural Statistics
FIGURE 2b
CONSUMER RICE PRICE VS. NFA RELEASE PRICE, DAVAO CITY (1995 – 1998)
Sources: Release Price: National Food Authority Retail Price: Bureau of Agricultural Statistics
0.00 2.00 4.00 6.00 8.00 10.00 12.00 14.00 16.00 18.00 20.00 Jan-95
Mar May Jul Sep Nov
Jan-96
Mar May Jul Sep Nov
Jan-97
Mar May Jul Sep Nov
Jan-98
Mar May Jul Sep Nov Month/Year P/KG Release Price Retail Price 0.00 5.00 10.00 15.00 20.00 25.00 Jan-95
Mar May Jul Sep Nov
Jan-96
Mar May Jul Sep Nov
Jan-97
Mar May Jul Sep Nov
Jan-98
Mar May Jul Sep Nov
Month and Year
P/KG
Release Price Retail Price
FIGURE 2c
FARM VS. SUPPORT PRICE, CAGAYAN PROVINCE (1995 – 1998)
Sources: Farmgate Price: Bureau of Agricultural Statistics NFA Support Price: National Food Authority Note: * Interpolated data points were inferred by regression.
FIGURE 2d
RETAIL VS. RELEASE PRICE, FARM VS. SUPPORT PRICE, PHILIPPINES (1995 – 1998)
Sources: Farmgate and Retail Price: Bureau of Agricultural Statistics
0.00 2.00 4.00 6.00 8.00 10.00 12.00 14.00 16.00 18.00 20.00 Jan-95
Mar May Jul Sep Nov
Jan-96
Mar May Jul Sep Nov
Jan-97
Mar May Jul Sep Nov
Jan-98
Mar May Jul Sep Nov Month/Year
P/KG
Farmgate Price NFA Support Price NFA Release Price Retail Price 0 2 4 6 8 10 12 Jan-95
Mar May Jul Sep Nov
Jan-96
Mar May Jul Sep Nov
Jan-97
Mar May Jul Sep Nov
Jan-98
Mar May Jul Sep Nov
Month/Year
P/KG
Farmgate Price NFA Support Price Interpolated data*
NFA Support and Release Price: National Food Authority
Table 1 provides a matrix of NFA releases by location and year. Releases have averaged less than 15% of rice consumption from 1995 through 1998. Table 2 provides the analogous data for NFA procurement, which averaged less than 1% of production over the same period.
TABLE 1
NFA RICE DISTRIBUTION, BY REGION, 1995–1998
1995 1996 1997 1998 AVERAGE REGION Quantity (tmt) % of consumption Quantity (tmt) % of Consumption Quantity (tmt) % of consumption Quantity (tmt) % of consumption Quantity (tmt) % of consumption PHILIPPINES 256.7 3.6 731.4 9.3 622.8 7.9 1628.2 22.2 809.8 10.7
Cordilleras Autonomous Region 11.2 7.4 22.7 13.7 16.5 9.9 25.2 16.3 18.9 11.9
Ilocos Region 7.2 1.5 39.3 7.2 22.2 4.1 48.7 9.6 29.3 5.6
Cagayan Valley Region 2.6 0.7 7.0 1.8 12.6 3.2 42.0 11.9 16.1 4.3
Central Luzon Region 19.7 2.4 66.0 7.3 83.8 9.3 232.3 28.3 100.4 11.7
Southern Tagalog 140.2 8.2 332.9 17.7 193.9 10.0 497.8 27.4 291.2 15.8
Bicol Region 15.9 3.1 51.3 9.0 60.5 10.7 169.0 32.2 74.2 13.6
Western Visayas Region 13.2 1.8 15.0 1.9 11.5 1.5 48.9 6.7 22.2 2.9
Central Visayas Region 14.1 4.7 34.3 10.4 34.5 10.4 98.6 32.2 45.4 14.3
Eastern Visayas Region 12.3 3.2 59.0 14.0 48.2 11.4 78.9 19.9 49.6 12.2
Western Mindanao Region 3.3 1.3 16.6 5.8 32.1 11.3 70.0 26.6 30.5 11.2
Northern Mindanao Region 6.0 1.5 31.4 7.1 30.9 7.0 92.1 22.1 40.1 9.3
Southern Mindanao Region 6.3 1.2 25.1 4.4 31.1 5.5 113.4 21.4 44.0 8.1
Central Mindanao Region 1.7 0.7 16.9 6.2 17.6 6.5 74.0 29.5 27.5 10.6
Autonomous Region of Muslim Mindanao
3.0 1.2 13.7 5.0 27.4 10.0 37.3 14.6 20.4 7.6
Sources: National Food Authority, Bureau of Agricultural Statistics
TABLE 2
NFA RICE PROCUREMENT, BY REGION, 1995–1998
1995 1996 1997 1998 AVERAGE REGION Quantity (tmt) % of production Quantity (tmt) % of production Quantity (tmt) % of production Quantity (tmt) % of production Quantity (tmt) % of production PHILIPPINES 8.19 0.08 124.31 1.10 100.47 0.95 97.41 1.14 82.60 0.81
Cordilleras Autonomous Region 0.92 0.47 2.86 1.36 1.37 0.63 0.81 0.48 1.49 0.75
Ilocos Region 0.75 0.09 21.11 2.13 18.21 1.69 36.39 4.26 19.11 2.02
Cagayan Valley Region 0.74 0.05 23.41 1.62 12.20 0.79 1.78 0.16 9.53 0.70
Central Luzon Region 0.14 0.01 11.69 0.62 3.48 0.17 0.12 0.01 3.86 0.22
Southern Tagalog 3.17 0.32 35.40 3.34 56.35 5.17 36.41 4.09 32.83 3.26
Bicol Region 0.01 0.00 5.39 0.82 2.00 0.29 1.59 0.32 2.25 0.37
Western Visayas Region 0.11 0.01 1.45 0.10 0.59 0.04 2.18 0.21 1.08 0.08
Central Visayas Region 0.00 0.00 0.23 0.10 0.12 0.05 0.01 0.01 0.09 0.04
Eastern Visayas Region 0.02 0.01 0.36 0.08 0.17 0.04 0.00 0.00 0.14 0.03
Western Mindanao Region 0.05 0.01 2.04 0.53 0.71 0.20 3.70 1.40 1.62 0.48
Southern Mindanao Region 0.44 0.06 6.72 0.90 0.91 0.13 1.74 0.28 2.45 0.36
Central Mindanao Region 1.19 0.16 8.41 1.01 3.16 1.08 11.34 1.76 6.03 0.96
Autonomous Region of Muslim Mindanao
0.42 0.13 3.30 1.01 0.68 0.82 0.70 0.31 1.28 0.53
Source: National Food Authority, Bureau of Agricultural Statistics.
NFA also attempts to lower consumer prices by requiring NFA licensed traders (who are allowed to buy NFA rice at 13 pesos/kg.) to retail their NFA rice at 14 pesos/kg. The standard analysis of this type of price control concludes that some form of rationing must result to determine which consumers buy at the controlled price and which will buy at the higher equilibrium price. However, this ignores the effect on equilibrium quality. Rice quality for example depends on the percent of grains broken in milling, the percentage of foreign matter, moisture content (and moisture absorption capacity), variety, taste, smell, and other characteristics. There is no grading system that captures these nuances; nor is even an approximate grading system enforced in retail rice markets in the
Philippines. Now suppose that the equilibrium price for average quality rice is 18 pesos but that government price controls require retailers who purchase NFA rice to sell NFA rice at no more than 14 pesos. The retailer is free to comply by simply lowering the quality of what is sold at 14 pesos until that quality is at equilibrium at the controlled price. There is no need for any rationing device (e.g. waiting time) nor any rent-seeking behavior by consumers to obtain below equilibrium prices. Any rents obtained when wholesalers acquire rice at subsidized prices are already built into the equilibrium prices charged to consumers.
Table 3 shows the nominal protection rate (NPR), i.e. the extent to which farmers enjoy domestic farm gate prices above those that would prevail under free trade, from 1995 to 1999. Table 4 shows the analogous construct for consumers, the implicit tariff. The implicit tariff (IT) measures the degree of negative
protection to consumers. The positive values of both indicators in 1995 show that farmers received positive protection and consumers received negative protection. Note, however, that the degree of positive protection afforded to producers is less than the negative protection imposed on consumers. The divergence between NPR and IT is shown in figure 3. On average, consumers paid about 75% more for rice than they would have under free trade. But farmers received only about half of that protection (37.6% in Cagayan and 39.4% in Nueva Ecija). The difference between these two measures is a reflection of government waste.
TABLE 3
NOMINAL PROTECTION RATES, CAGAYAN VALLEY AND NUEVA ECIJA
Rice Price / Cost Unit 1995 1996 1997 1998 1999
Cagayan Valley
Weighted Average Farm Gate Price P/Kg 7.40 7.70 7.30 7.99 8.291
Wholesale Price (1.76:1)3 P/Kg 12.69 13.20 12.52 13.70 14.21
Retail Price P/Kg 13.32 13.86 13.14 14.38 14.92
Border Price P/Kg 7.72 8.49 9.47 13.12 10.73
Nominal Protection Rate (NPR) % 64 56 32 04 32
Nueva Ecija
Average Farm Gate Price P/Kg 6.86 7.18 8.38 9.22 9.272
Wholesale Price (1.67:1) P/Kg 11.43 11.97 13.97 15.37 15.45
Retail Price P/Kg 12.01 12.57 14.67 16.14 16.22
Border Price P/Kg 7.72 8.49 9.47 13.12 10.73
Nominal Protection Rate (NPR) % 48 41 47 17 44
Source: Production and Farm gate price are taken from BAS. 1 Weighted average was extrapolated from 1998 and first half of 1999. 2Average farm gate price from January to June only.
3See appendix B
TABLE 4
IMPLICIT TARIFF RATES FOR RICE, YEARLY 1995-1999
Rice Price / Cost Unit 1995 1996 1997 1998 1999
Average Peso Exchange Rates
$/mt 25.7 26.2 28.6 41.0 39.8
World Price1 $/mt 250.0 271.5 267.0 274.0 215.0
Freight, Insurance (Bangkok to Mnl) $/mt 26.0 27.7 37.6 33.3 40.3
Cost Insurance Freight $/mt 276.0 299.2 304.6 307.3 255.3
Cost Insurance Freight (in Pesos) P/mt 7,093 7,839 8,711 12,599 10,160
Plus : Manila Port Handling2 P/mt 186.5 186.5 186.5 186.5 145.2
Landed Cost P/mt 7,279 8,025 8,898 12,785 10,305
Plus : Transportation to First Warehouse P/mt 134.2 152.2 129.8 129.8 233.0
Storage Cost P/mt 264.0 264.0 400.0 163.7 152.2
Handling Cost P/mt 44.0 44.0 44.0 44.0 40.0
In Situ Warehouse Cost P/mt 7,721 8,485 9,471 13,123 10,730
In Situ Warehouse Cost P/kg 7.7 8.5 9.5 13.1 10.7
Average Metro Manila Wholesale Price P/kg 15.0 17.4 16.9 17.4 18.0
Ratio of NPR to Implicit Tariff, Cagayan 0.68 0.53 0.41 0.13 0.48
Ratio of NPR to Implicit Tariff, Nueva Ecija 0.51 0.39 0.61 0.53 0.65
Source: World Bank Commodity Price Data, Bureau of Agricultural Statistics
1 Based on World Bank Commodity Price Data, Thai 35% broken, WR, milled, indicative survey price, fob, Bangkok
2 1995-1998 data is based on NFA costs while 1999 was taken from a survey of private freight forwarders.
FIGURE 3
MEAN IMPLICIT TARIFF COEFFICIENT VS. NOMINAL PROTECTION COEFFICIENT
In summary, NFA attempts to control prices do not work. Setting support prices is ineffective because NFA procurement volume is less than 1% of
production. Setting wholesale and resale prices is ineffective because the quality of rice sold at the control price adjusts downwards until equilibrium is restored. What does make a difference to domestic prices is limiting imports. This has the effect of driving up consumer prices. But since the pattern of storage and
distribution of those imports is also distorted, the policies drive a wedge between consumer and producer prices.
More often than not, NFA policy causes domestic prices to rise above and fluctuate more than prices that would prevail in the absence of trade restrictions. Figure 4 plots the fluctuations of consumer prices, farm gate prices, and
international prices over the last four years (Jan., 1995 – Dec., 1998). For these years, the respective coefficients of variation were 13.91, 15.35 and 9.89. Apparently, international prices are more stable than domestic prices, not less. (Recall from footnote 4 that reported domestic prices overstate stability due to
0 .0 0 0 .2 0 0 .4 0 0 .6 0 0 .8 0 1 .0 0 1 .2 0 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 Im p lic it T a riff N P R fo r C a g a ya n V a lle y N P R fo r N u e va E c ija
inappropriate sampling methods that confound equilibrium prices with more stable, official prices).
FIGURE 4
CONSUMER, FARMGATE AND INTERNATIONAL PRICES FLUCTUATION (JAN. 1995 – DEC. 1998)
Source: BAS, FAO Food Outlook, Market News (WTO) (Nov. 1998 Issue) and NEDA
Note: Interpolated data were generated for international prices in months Jan-Feb. ’97, May ’97 and March ’98.
2.4 THE AVERAGE EXCESS BURDEN OF PRICE DISTORTIONS
Figure 5 shows the economic waste that would be generated if NFA were able to pursue its ostensible goals of raising producer prices and lowering
consumer prices. As shown in tables 3 and 4 and in figure 3, however, the actual effects of NFA policy were quite different. Consumers pay prices that are 35-100% higher than would be possible under free trade. This is primarily due to the import ban and to the fact that NFA imports and releases fail to make up for what would be achieved by private traders. Moreover, this “protection” against foreign imports does not confer commensurate benefits on Filipino farmers.
The combined cost to rice consumers, farmers, and Philippine taxpayers of these distortions is illustrated in figure 5, based on production, consumption, and
0 . 0 0 1 0 0 . 0 0 2 0 0 . 0 0 3 0 0 . 0 0 4 0 0 . 0 0 5 0 0 . 0 0 6 0 0 . 0 0 7 0 0 . 0 0 8 0 0 . 0 0 Jan-95
Apr Jul Oct
Jan-96
Apr Jul Oct
Jan-97
Apr Jul Oct
Jan-98
Apr Jul Oct
M o n t h / Y e a r
US$/MT
F a r m P r ic e C o n s u m e r P r ic e I n t e r n a t io n a l P r ic e
price estimates for 1999. Production is estimated at 7 million tons at a producer price of 14.5 pesos/kg (including the conversion of palay to rice and marketing costs up to the wholesale in situ warehouse point). Consumption is at 7.8 million tons, corresponding to a consumer price of 18 pesos/kg, which is 64% above the border price of 11 pesos/kg. If this protection were achieved by an import quota of 0.8 million tons, the resulting equilibrium domestic price would be 15.63 pesos/kg, with both rice consumers and “producers” (including the marketing sector) facing the same domestic price. In actuality, consumers are paying
substantially more and producers receiving somewhat less. This wedge between consumer and full-producer prices is due to inefficiencies and non-competitive elements in rice marketing that result from current government policies. The consumer price, at least before the wet season harvest, has been in the
neighborhood of 18 pesos. But the producer price, marked up according to
efficient margins has been approximately 14.5 pesos. This result could have been obtained by a combination of a tariff sufficient to limit imports to .8 million tons (resulting in the domestic price of 15.63 pesos) and consumer and producer taxes sufficient to further raise and lower the consumer and producer prices respectively. The cost to the taxpayers of failing to obtain these revenues is 3.7 billion pesos in forgone tariff revenues, 18.49 billion in foregone consumer tax revenues, and 7.91 billion in forgone producer tax revenue, for a combined total of 30.1 billion pesos. Since taxpayers are therefore paying 30 billion worth of taxes unnecessarily, and since those taxes impose roughly 30% of the tax revenue in deadweight loss (due to the distorted incentives imposed by distortionary taxes), this implies an
additional 9 billion pesos in losses. To this one can add the excess burden of unnecessarily high marginal production costs and the consumer benefits denied by restricting imports. Adding these amounts of excess burden (see figure 5 and the accompanying notes) to the costs just described gives a total estimated cost of almost 49 billion pesos.
But instead of taxpayers gaining from NFA operations, they in fact were losing. The cost to taxpayers includes not only the budget subsidies paid to NFA, but the increase in debt (which obligates future tax payments) and the infusions of new government equity. From this must be subtracted the value of new assets. Table 6 shows that the financial subsidies to NFA for 1998 appear to have been in excess of 6 billion pesos even valuing the increase in rice stocks at almost 4
billion pesos.6 Even if the financial subsidies for 1999 turn out to be roughly half
6 Other newly acquired assets were not included. While net investment (minus depreciation) would normally be
subtracted along with increased inventories, such assets should be valued according to their social utility, which has already been seen as negative or zero.
of what they were in 1998, that still leaves a total cost of rice policy equal to almost 52 billion pesos.
For some years the total cost of Philippine rice policy was higher and in some cases lower than in the scenario for 1999 as estimated above. To calculate the total costs for other years, one simply needs to apply the same methodology as illustrated for 1999. Note however from table 4 that the average implicit tariff for 1995-1998 was 78%, whereas that assumed for the 1999 estimate was only 64%.To the extent that the implicit tariff dominates in the calculation of total cost, this suggests that the 1999 estimate is not above average.7
FIGURE 5
EXCESS BURDEN OF PRICE CONTROLS, 1999
0 Notes:
7 The exception was 1998, when the implicit tariff was half of the assumed level for 1999, implying lower excess
burden and foregone producer and consumer tax totals. But foregone tariff revenue was much higher (22 billion pesos), partially offsetting those reductions.
12.48 7 7.8 8.4 P / kg Rice quantity (mmt) 9.62 5.12 P = 1.5 + 1.857Q P = .015 + 1.857Q P = 48 - 3.85Q Pc = 18 15.63 Pf = 14.5 Pw = 11
Equilibrium with quota: P = 15.63
Foregone Tariff Revenues = P (15.63-11) /kgs. x (7.8-7) billion kgs. = P 3.70 Billion
Foregone Consumer Tax Revenues = P ( 18-15.63) /kgs. x (7.8) billion kgs. = P 18.49 Billion
Foregone Producer Tax Revenues = P (15.63-14.5) /kgs. x (7) billion kgs. = P 7.91 Billion
Tax Friction = 0.3 P (3.70 + 18.49 + 7.91) billion = P 9.03 Billion Excess Burden for consumer = (1/2) x P (18 –11) /kgs. x (9.62 –7.8) billion kgs. = P 6.37 Billion Excess Burden for producer = (1/2) x P (14.5-11) /kgs. x (7-5.12) Billion kgs = P 3.29 Billion ______________________________________________________________________________________ Total Cost of Rice Policy not including the financial subsidies to NFA = P 48.79 Billion Demand as function of price: Q = 12.48 – 0.26P
Supply as function of price: Q = .54P - .81
Table 6: Financial Costs of NFA Operations (1998)
Operational Subsidy (Budget) P 1.22 B Equity Infusion P 0.17 B Increase in Debt P 8.78 B Less: Increase Value of Rice Stocks P -3.89 B
Total P 6.28 Billion
Apparently then, NFA raises consumer prices and implicitly taxes farmers, all at a large financial cost to Philippine taxpayers. In other words, the benefits of NFA’s rice program are negative and its costs are high. How can such a wasteful program persist? The answer lies in the realm of political economy. The harm that government intervention causes is not readily apparent. Indeed the present rice and food security policies appear to some to be helping consumers and
producers, who are unaware that they would be better off under free trade. Neither they nor the taxpayers are therefore motivated to seek reforms.
Meanwhile the present rice policy is potentially very lucrative for well-connected rice traders and political insiders. A NPR of 78% means that importation can potentially earn 78% profit above costs reckoned up to the
wholesale warehouse. To what extent these potential profits are actually realized by particular individuals or wasted through inefficiency is unknown.
More specifically, the following categories must sum up to the total potential profits (roughly, e.g. 78% times net8 imports).
1. Unnecessarily high commissions paid to import-brokers.
2. Bribes paid by rice traders and/or wasteful lobbying/favor-currying to obtain import rights.
3. Government-to-government contracts whereby the Philippine government contracts to buy low-quality rice at high market prices, permitting pertinent parties to pocket the prize.
4. High-profits extracted by importers and wholesalers (above their legal and illicit payments for import rights and lobbying expenses).
5. High-profits extracted by cartelized retailers.
6. Other unnecessary costs due to inefficiencies in marketing and distribution.
It is not necessary to apportion potential profits across the six categories. Indeed one or more of them may be negligible in the Philippine context. The point is that all of them represent losses to taxpayers, rice consumers, and producers.
It is usually assumed in economic analysis that if government policy restricts imports below their free trade level and thereby raises consumer prices, domestic producers will be protected against low international prices. But Philippine farmers receive only half of the protection implicit in the import restrictions. Usually such spreads between consumer and producer prices are associated with taxation, e.g. the notorious 18% tax once imposed on Philippine producers of coconuts (Clarete and Roumasset). But in the case of rice, there is no offsetting tax revenue to ease the pain of low producer prices. Instead, tax
revenues are, in effect, negative, i.e. NFA rice marketing requires substantial subsidies from the government (direct government subsidies plus increased debt attributable to rice operations). The total cost to taxpayers includes these
subsidies plus the foregone tax revenue that could have been obtained in driving the wedge between consumer and producer prices and between domestic and world prices. This amount must be equal to the sum of monopoly profits earned by the private marketing sector, unofficial accruals to government officials, dissipated rents, and unnecessary marketing expenses. (Again, this statement is meant as an accounting identity; one or more of the categories may be negligible.)
The last category includes unnecessary marketing expenses due to
inefficiencies in the spatial and temporal pattern of production and consumption. Since these last two are the most difficult to understand and the least developed in the literature, the following is devoted to exploring these distortions.
3. Concluding remarks
The apparent quest for food security results in food insecurity, a fiscal drain of major proportions and a stagnant agriculture. Such an enormously wasteful
program can only be rendered politically feasible by a combination of ignorance and fear. One can find parallel examples in energy security, environmental security, and even military security. In each case there are elite rent-seekers who benefit from the public expenditures and regulations. But public sentiment would be overwhelmingly against wasteful programs were their true nature understood.
The same combination of rent-seeking and ignorance produces similarly wasteful programs in the apparently diverse realms of transportation policy in Hawaii and the drug war in the U.S. In each case one can identify rent-seeking objectives that motivate the protagonists of the existing policies and the fears that inhibit potential opponents -- fear of scarcity, fear of change, and fear of
immorality. All of them result in artificial scarcity which motivates further distortions. The remedy is replacing the fear of scarcity by its understanding. When transparency is used to allow scarce resources to find their highest and best use, abundant opportunities for progress can be created for all segments of society, not just the privileged elite.9
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