Political economy of wheat

Since last two months, overall food inflation along with a spurt in wheat and sugar prices has captured the headlines. As expected, opposition did not lose the opportunity to gain political mileage from this historically repeated episode. In its response, the ruling party had to play on the back foot by partly admitting 'governance failure' and partly blaming the unobserved 'mafias'. Historically since the 1990s, two such episodes of high food inflation had occurred. In 1995 at the time of PPP government it touched 16 percent and then again during 2007-2013 (last year of Musharraf/Shaukat Aziz government and PPP government) ranged from 10.4 to 23.8 percent.

A brief synopsis how the politics and economics interact in staple food cereal market in developing countries including Pakistan is in order: In developing countries, short-run demand and supply imbalances of food commodities are common (not the only) cause of spurt in food inflation. These imbalances arise due to: a) erratic weather conditions including pest attacks; b) inaccurate crop forecasting; c) leakages in cross-border trade (smuggling); d) differentials in cross-border prices; e) lack of storage capacity leading to laxity in procurement targets; f) price manipulation by the middle man and mafias; and g) urge to maximize foreign exchange earnings in the short-run through export of perceived or actual surplus of food commodities. In case of Pakistan, one can add an additional reason. The compulsion to balance the budget, may also compel the government to slip procurement targets of subsidized commodity in times of perceived or large carry-over stocks. The politico-eco implication is that frequent imports and exports as well restricting international trade in food commodities (to benefit domestic producers/consumers) through policy interventions (tariff, no tariff), even within a course of a single year, are undertaken to stabilize domestic food prices and stem political (votes) and social (rising poverty) costs at least temporarily from the vocal urban classes. In addition, frequent imports and exports of food commodities are based on the common perception among policy interventionist that in times of shortages, imports of food commodities stabilize prices or bring down food inflation, while in times of surpluses their exports tend to improve the returns to farmers without affecting the domestic price level.

An analysis appearing in the print media in the last few weeks has aptly covered a subset of above reasons for current short-lived wheat crisis. This article basically adds an empirical and political dimension to the argument to reinforce what has appeared in the press. The current crisis is violation and/or play of two laws in economics 101. A) proponents of the Washington Consensus may subscribe to the domination of law of 'one price' which states that "in the absence of trade frictions (in our case porous borders with Afghanistan and Iran, implicitly right up-till Central Asia), and under conditions of free competition and price flexibility, identical goods sold in different locations must sell for the same price when prices are expressed in a common currency". The law of comparative advantage suggests that a country should export those goods in which a country has a comparative advantage and import those in which has a comparative disadvantage. Comparative advantage depends on resource envelope that includes labour and land productivity in turn determined by technology, labour skills and physical resources. When these basic laws are violated, by a set of discretionary policy distortions, we enter into a realm of political economy where there is a set of gainers and losers from these policy decisions in form of taxing or subsidizing one group over the other. In other words, this has been happening to wheat and more blatantly in case of sugar since last 50-60 years. The political economy analysis is based on the empirical support from historical data. The first part of the article will focus on: a) what is the contribution of allowing wheat imports (quantity) in impacting overall food inflation and b) how cross-border differentials in wheat prices motivate changes in domestic prices and export of wheat.

A back of the envelope exercise was conducted by this writer on 27-year (1992-2019) data to examine question a) above, the impact of yearly wheat imports on food inflation index was assessed through a simple statistical model. The result was statistically robust but surprising and apparently counter intuitive. Wheat imports (both current year and lagged) lead to an increase in current food inflation. In the current scenario the model estimates indicated that allowing import of 300,000 tons of wheat, which is 60 times more than 5000 metric tons of wheat imported in FY19, will contribute to a rise in food index by 2.8 percent in the current year. A rational explanation of this strange result is that correlation of domestic price of wheat and its import is positive at 0.98. Historically, increase in domestic support price of wheat has moved in sync with wheat imports, as increases in its support price (at the sowing or harvest time) are usually followed by or follow wheat imports. Wheat imports are undertaken due to some of the reasons highlighted above. Historically, Pakistan could not afford imports of wheat in the medium to long-run due to foreign exchange constraints. Therefore, it had no option but to announce an upward revision in wheat support price(either above/or near the prevailing export price) justifiably or unjustifiably, on the pretext of increase in input prices to discourage its informal non-subsidized trade and/or restrict its formal subsidized export. According to some estimates, the landed price of imported wheat currently is between Rs 1440-1575 per 40 kg, while export FOB price is slightly above the domestic support price of Rs 1350 per 40 kg.

Regarding the impact of border prices on wheat exports, a back of the envelope statistical modeling exercise is performed on the data series of domestic price of wheat, its exports and ratio of domestic price to average price of imports and export prices (border prices) during 2005-2019, a period when wheat was exported and imported simultaneously albeit the latter was imported in nominal quantities during 2015-2019. The result of the single equation model indicate that if the ratio of domestic price relative to border prices (the 'ratio") falls by 1 percent (driven by border prices) in the previous year, domestic price of wheat in the current year rises by 0.21 percent and export of wheat rises by 0.58 percent. The quantity effect is more complex and interesting than the price effect as the latter is managed to please the urban voters.

The political economy aspects of wheat pricing are based on data series from 1994-95 to 2014-15 documented in a more recent excellent paper titled "Prices of food grains and farm inputs in Pakistan: Empirical Analysis of farmer's incentives and Terms of Trade" published by Pakistan Economic and Social Review (Winter 2017). The series is extended to 2018-19. During 25 years, the domestic support price was in favour of the urban consumer for 16 years and against the producers, as the above ratio was less than 1, meaning domestic price was less than the average of border prices. In other words, the producers were taxed and resources were transferred from producers to urban consumers. Since 2014, the domestic price had been more than the border price and resources were transferred from urban consumers to surplus wheat producers and exporters of subsidized wheat. The 'Great switch' or 'trigger' that added informal non-subsidized exports (politically named smuggling) to already formal/government subsidised exports began from FY20 when border prices in rupee terms (thanks to 40-50% devaluation) moved higher by 6-12 percent during Dec'19-Feb'20. Now there was no need to rely on the government for subsidy as exporting it informally and independently could yield return on old/new stock, piled up during surplus production years and below target procurement. So the 'law of one price' kicked in and resurrected itself with the help of 'mafias' specifically in porous border areas close to Afghanistan and Iran. Thus sticky support prices are a constant source of misallocation of resources either in favor of producers or consumers. Given the year-to-year fluctuations in international wheat prices, if domestic support price is lower than the border prices, it hurts the urban consumers and if it is higher, misallocation of resources is rewarded by subsidy to wheat surplus producers/ stockiest/ exporters in times of excess production.

In the end, what are the political economy (neo-classical) implications of above historical wheat pricing dynamics?: a) trade-off between pleasing the vocal urban class, (vote bank of PTI/PML-N) or rural wheat surplus growers (vote bank of PPP). By maintaining in essence the support price between 1300-1350 kg in the short-run to medium run, PTI has favored urban voters at the cost of rural surplus growers. Raising the domestic support price to Rs 1475 per 40 kg (also predicted by the model and suggested by agriculture experts), will no doubt in the short-run erode urban political capital in return for long-run gains in rural political capital as it will render; b) informal non-subsidized exports uneconomical; c) reduce hemorrhaging of valuable foreign exchange spent on wheat imports at the expense of domestic subsidy; d) wait for international prices to come down significantly which will lead to an automatic increase in the ratio and thus make non-subsidized informal exports uneconomical. This happened between 2008-09, 2011-12 and 2014-15; e) maintain the current support prices through administrative measures thereby allowing the surplus growers to take their sweet revenge (if the shift in border prices is permanent) by substituting for other Rabi crops in the medium term, provided the crop price substitution elasticities for large farmers are enticing. This would have the impact of lowering domestic production and forcing Pakistan to be a net importer of wheat; and f) devise an empirical-based complex wheat output price formula that would remove the stickiness in support prices, incorporate expected international prices, input prices and productivity dynamics, including depreciation of the rupee in order to encourage/stabilise formal non-subsidised exports and domestic production.

(The writer is a former Acting Chief Statistician of Pakistan Bureau of Statistics)