Short-sighted policies, distorted prices

Microeconomic research shows how individuals decide to allocate various scarce resources. Another name for microeconomics is price theory, which tells us that prices play a key role in the efficient allocation of resources.

Let me start by emphasizing that one important reason why we are economically backward is that our government tends to set poor prices for the things it sells, distributes or influences – and thus creates inefficiency and misallocation of resources in the economy.

In fact, almost all shortages (or overcapacity) in, for example, gas and electricity, wheat and sugar, or cotton and sugar cane can be understood as a misallocation of resources due to poor prices. Prices set for political reasons, not based on sound economic principles.

Consider the recent corruption accusations leveled against its predecessor by the current government. It turns out that the recent wheat fiasco can be fully explained by wrong decisions of various governments based on political reasons.

The first culprit is the decision by the provincial and federal governments at the end of 2022 to increase the wheat procurement price from R2,200 per pound (40 kg) to R3,900 per pound. This decision had no economic justification; this was done purely for political reasons. This, of course, meant a huge transfer from the urban poor to the rural landowners.

Politicians also did not think through the consequences of this on the prices of flour and roti. If governments buy wheat at Rs 100 per kg and sell at Rs 115 per kg, of course the price of flour will go up to Rs 130 per kg or thereabouts. In fact, due to unnecessary inter-provincial and inter-district restrictions on the movement of wheat, the retail price of flour has reached as high as Rs 150 per kilogram.

One simple fact that my fellow politicians don’t seem to understand is that you can’t have expensive wheat and cheap flour.

Another mistake was that the overseers had to deal with high flour prices. They rightly facilitated the import of wheat, but did not impose any restrictions on it. In this case, wheat was imported into Pakistan at around Rs 90 per kg and very quickly we saw the price of wheat and flour come down. But at the same time, the Punjab government was unable to sell the more expensive wheat and did not want to lose money. It willingly subsidized farmers, but only at the expense of consumers, and not from its own budget.

The third mistake was repeated late last year or early this year when, even though the international price of wheat fell, governments continued to maintain the same high procurement price for wheat. In response to this price signal, farmers devoted more acreage to wheat and used expensive fertilizers to ensure a good wheat harvest. And we finished with a record wheat harvest of over 31 million tons.

The latest mistake is that the government is once again reneging on its promise to buy wheat at announced prices, leaving farmers with huge stocks. The price of wheat is therefore free falling and is around Rs 70 per kg. On the other hand, the price of flour has also come down to around Rs 85 per kg and with it the price of roti.

So now we have a spectacle in which politicians congratulate themselves on reducing the price of roti, but blame their predecessors for reducing the price of wheat.

Now let’s look at electricity prices and the recent discussions around net metering. Our government sells electricity at a subsidized rate of Rs 9 per unit to more than half of households that consume little electricity, and sells power to wealthier households at more than Rs 40 per unit. At the same time, the government is allowing duty-free and tax-free import of power-generating solar panels at a price of around Rs 10 per unit. Moreover, the government allowed consumers to produce more energy than they needed during the day and use the grid as a storage system through net metering.

Readers will immediately know which category of customers will install photovoltaic panels and which will remain on the grid. As expected, high-paying customers shifted as much of their demand as possible to solar panels. However, lower-income households receiving subsidized electricity remained on the grid. This, of course, meant that the price of energy would have to be raised even further for that which remained on the grid and purchased at already higher rates. This is exactly what is happening. These difficulties persist because policies and pricing are inappropriate. When the government realized the consequences of its policies, it tried to break out of the net metering agreements it had with consumers.

Also consider that all governments have been lamenting for years that we are not growing enough cotton (which is a sensitive crop that can fail if weather conditions become unfavorable) and we are growing too much sugarcane, which requires much more water.

But it never occurred to these governments that if they sold cotton farmers crop insurance and made water more expensive (to reflect the cost of storing it), the problem would be solved. Instead, governments create growing zones and restrict sugar production, in effect favoring existing mills in some areas and causing more disruption.

Then consider that there was a time when the government subsidized the industry through gas and electricity prices, causing disruption. Now we have gone in the opposite direction and priced industrial energy at a price much higher than production costs and higher than regional countries. This strategy is also wrong. We must stop mutually subsidizing industry or domestic consumers at the expense of each other. If the subsidy is justified, as is the case for poor consumers, it should come from the state budget and not from price distortions. Otherwise, in the next few years, the industry will go off the grid, leaving only poor consumers.

We often see shortages of gas, electricity, water, etc., all of which are provided by the government. But we are able to buy the latest mobile phone, computer or other such things that the market offers. The reason is that markets operate on price incentives and profit motives. Therefore, wherever possible, we must reduce government influence.

I am in favor of direct income transfers and believe that we should increase income transfer under BISP to one percent of GDP, or Rs 1,100 billion, from the current Rs 400 billion. In addition, we should strive to ensure that prices reflect actual costs wherever possible. Where necessary, subsidies should be structured in such a way as to avoid massive disruptions.

An area where we have been successful for years is rice exports, the annual value of which is estimated at over $3 billion, which is a record. The reason: many years ago, the government very graciously decided not to help rice farmers and exporters, leaving them to the whims of the market. Since then, rice farmers, consumers and exporters have performed very well.

It would be a favor to Pakistan if our government stopped wheat and sugarcane price fixing.

The author is an economist and politician. He tweets/posts at @Miftahismail