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Market integration for price stability

September 04, 2006

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In the past, the government has tried to stabilise prices in various agricultural markets through price supports or producer subsidy which have yielded mix results.

If markets are well integrated, governments stabilise prices in one key market and rely on arbitrage to produce similar outcomes in other markets. This reduces the cost of stabilization considerably.

As market integration is viewed as a long-run phenomenon, this means spatial prices can temporarily deviate from each other in the short-run and still be consistent with the idea of an integrated market in the long run.

The concept of spatial arbitrage is to visualise traders buying in low priced market, transferring the item to a high priced market, and re-selling the purchased good in different localities. These tend towards equality and move together with each other in integrated markets.

Markets that are not integrated may convey inaccurate picture about price information that might distort production decisions and contribute to inefficiencies in markets, harm the ultimate consumer and lead to low production and sluggish growth, specifically in rural economy that is the lynchpin of the most of the developing countries including Pakistan.

About 23 per cent of the GDP comes from agriculture sector and more than 65 per cent of the country population lives in the rural areas and earns its living from agriculture sector.

The main interest of studying price integration among local markets is to be able to identify sets of markets that lead other markets in the price transmission process.

Besides locating factors at macro-level that affect the integration process, the main purpose of this exercise is to critically examine the integration phenomena among various markets, to see the government intervention policies for markets like wheat, rice, cotton etc., and drawing policy guidelines that enhances positive competition and avoids black marketing and helps in protecting small farmers who are a big portion of the agricultural economy.

The government intervention in the market place is one such condition which provides incentives to domestic producers and consumers that differ from the incentives in the world market.

Interventions in agriculture may take many forms. Major interventions that were followed by successive governments in Pakistan are in the form of import/export duties, subsidies, import/export quotas, trade embargoes, exchange rate policies, dumping, preferential trade policies and agreements, monopolies in state trading, production, marketing and input subsidies, fixation of consumer, producer and input prices, production aids, supply control programmes including production quotas and area reduction measures.

Market integration provides better signals for optimal supply and consumption decisions, improves supply in the market on reliable prices and removes transaction costs. The high degree of market integration means the markets are quite competitive and provide little justification for extensive and costly government intervention designed to improve competitiveness to enhance market efficiency.

Reverse is the case if markets are not well integrated. In highly integrated markets where there exists interdependence of price changes across spatially separated locations in the long run, the government may limit its market interventions.

Fixation of prices must be undertaken on the basis of corresponding export parity prices rather than seeking guidance from discretion and cost of production studies which remains the common practice in Pakistan over the years.

Since parity prices tend to be higher than procurement prices, favourable incentive efforts of the recommended policy on investment, production, trade, employment and income distribution would become obvious and ultimately help as an instrument for increasing farm income and reducing (rural) poverty. It also ensures food supply on sustainable basis to urban dwellers and somehow helps in avoiding time variant hunger shocks and famines common in most of the areas of Balochistan and Sindh.

However, as parity prices are likely to vary directly with highly volatile world prices, the stability of agricultural commodity prices at home can be ensured if they are determined by the trend lines of past parity prices. In this way domestic prices would be higher than parity prices in the years of low world prices and lower than in the years of high world prices. As cyclical fluctuations around the trend would be cancelled out over time, it is not difficult to envisage that this recommendation would conspicuously be made by the absence of any implicit taxation of agriculture.

The results of research on the issue of market integration show that certain markets are not well integrated with each other in Pakistan as well as in most of the developing countries.

In order to achieve the goal of integration, the government should promote information and develop communication within markets at sub-regional, regional and state level. To accomplish this goal, better interaction and integration among the markets and infrastructure facilities should be provided by the government to the targeted markets.

The government should facilitate the environment that encourages the limited role of middlemen in the market functioning so as to avoid black marketing as well as malpractices.

The support price policy has played a limited role in increasing the output in various agricultural commodities e.g., wheat. Rather, unprecedented increase in wheat support price has caused huge welfare losses and worsened income distribution.

According to a study, the high degree of market integration is consistent with the view that Pakistan’s wheat markets are quite competitive and provide little justification for extensive and costly government interventions designed to improve competitiveness to enhance market efficiency and equity goals.

Implications, relevant to Pakistan’s agricultural marketing policy can be derived from the above insights. Rather than seeking guidance from discretion and cost of production studies, the fixation of prices must be undertaken on the basis of corresponding import and export parity prices.

Second, the government intervention in agricultural commodity markets serves no useful purpose. In fact, most of the parasitical organizations suffer from gross inefficiencies, with immense costs to producers, consumers, and burden on the exchequer.

To save these costs and to promote the cause of liberalization and privatization, the government would be well-advised to desist from active and direct engagement in procurement, storage, distribution, and from external trade on a massive scale and leave these tasks to the private sector.

The government in its new role must be watchful of private sector activities, ensure competition in agricultural commodity markets, and play a vital role in managing the private sector activities through its functionaries like the Monopoly Control Authority (MCA) in the major agricultural commodity markets to safeguard against monopolistic tendencies, excessive profiteering, rent seeking behaviour and rising stable commodity prices.

Third, in highly integrated markets where, there exists interdependence of price changes across spatially separated locations in the long run, the government may limit its market interventions to an extent that will not hit the market and its functionaries adversely.

As the study showed that markets of some agricultural commodities e.g., wheat are highly integrated so by managing relatively small amounts of easily controlled buffer stocks in times of good harvests at few well-chosen sites, the government can control the price structure within the system.

By letting the private sector contribute as much as possible, the government will achieve its food security objectives without high costs. That will serve, on one hand the purpose of reducing food poverty, malnutrition - pervasive in rural as well as urban slums - and making rural dwellers more prosperous and productive to contribute to the economic growth process.