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Economics

[2168] Of no to the policy of One Price

Prices of the same tradable items in different places tend to converge in a perfectly efficient market. Theoretically, motivated by profits, individuals and entities act as arbitrageurs. They will continue to arbitrage until there are no more profits to be made. That is when prices equalized and that is the essence of the law of one price.

Prices may not actually converge to one price due to several factors however because market can be inefficient. Limited access to information crucial for the purpose of arbitrage may prevent convergence. Transportation cost as well as government intervention in terms of taxation and subsidization are two of several other important frictions. Instead of prices equalizing, a price spread exists to reflect those frictions even as market participants exhaust arbitrage opportunity.

This is essentially the reason why there is noticeable price differential for the same tradable goods sold in eastern and western part of Malaysia. With the South China Sea separating Malaysia into two parts, it is only natural for prices to differ between the two regions. Even under the price and supply control mechanism that exists in Malaysia, a kilogram of sugar for example, is sold 10 sen cheaper in Peninsular Malaysia than in Sabah and Sarawak. Transportation cost is a considerable barrier preventing actual convergence.

This is a source of discontent for some. Member of Parliament for Kalabakan, Abdul Ghapur Salleh of UMNO said in November 2009 said, “We’re talking about 1Malaysia, but we don’t even have one price” while alleging that the price differential is more insidious in nature — discrimination against Sabah and Sarawak — rather than simple economic friction.

It is unclear how exactly he wants effort at standardization to proceed but the approach by the federal government is clear. In the same month, Minister Koh Tsu Koon supported the idea of standardized prices across Malaysia and proposed that transportation cost be shared by all; in other words, introduce subsidy. Nearly a year earlier, Domestic Trade and Consumer Affairs Ministry wanted to do the same: subsidize transportation cost. In Sarawak itself, perhaps a harbinger preceding a possibly wider similar nationwide policy, the same ministry plans to subsidize transportation cost with the intention of standardizing prices of essential items sold in urban and rural areas under its “One Sarawak, One Price” campaign.

They are turning the law of one price on its head. Rather than letting market forces find its equilibrium where a particular price fits a particular landscape through a narrow band, the government intends to impose unnatural standardized prices for all situations everywhere to force convergence. The government intends to introduce more inefficiency to standardize prices.

The discontent over price differential is overrated. Two economists — Lee Chin and Muzafar Shah Habibullah of Universiti Putra Malaysia — published a paper in 2008 showing that prices of tradable goods between Peninsular Malaysia, Sabah and Sarawak are converging. Furthermore, the recent liberalization of cabotage policy — a protectionist policy that contributed to persistent price differential between eastern and western part of Malaysia — will likely further strengthen the natural convergence trend.

Convergence aside, to iterate the idea of how the difference is natural, the price differential has nothing to do with discrimination between the two parts of Malaysia. It is a reality that there is a large body of water separating the two parts of Malaysia. It is likely that if the transportation cost is brought down either through liberalization or improvement in technology, prices are likely to equalize, all else being equal.

The price differential due to transportation cost or distance has nothing to do with the idea of unity as much as it has something to do with the idea of discrimination. In the United States for instance, gas prices in Michigan and in California are very different. Even in the same state, prices of gas in one town can be different from another town a mile away. That does not make the person who pays higher price as less American than the other person who pays lower price for gas.

This idea can be expanded to Peninsular Malaysia. The government should not standardize prices within Malaysia. This is not to say just prices between Peninsular Malaysia, Sabah and Sarawak, but within those regions as well. What a free Malaysia needs is not a Price Control Act, but a Competition Act or antitrust law to fight collusion among businesses in order to encourage competition — the most effective method at encouraging convergence and low prices — without suffocating entrepreneurial spirit.

On top of that, maybe, just maybe, the move of having manufacturers based in Sabah or Sarawak is a cheaper and a more profitable option compared to the option of transporting goods from Peninsular Malaysia or from abroad even after accounting for various other effects like clusterization.

If the subsidization program goes through, it removes that incentive and hence, the possibility of developing industries in eastern Malaysia. If a business owner could transport his or her goods free from western to eastern Malaysia, why would the business owner locate his or her factory in eastern Malaysia? There are better ports, roads, financial services — practically everything that matters in business — in Peninsular Malaysia than in Sabah and Sarawak. The subsidization program would continue to industrialize the Peninsula while leaving Sabah and Sarawak farther behind in terms of development.

Besides, the Prime Minister recently said that private initiates and market forces have to be given freer rein while subsidies be phased out. The standardization of prices across Malaysia through subsidization of transportation cost by the government clearly contradicts that. Is this a proof that there is no coordination within the government? Or does words mean nothing to the government?

For the answer to be no on both accounts, the policy of “One Price” must be rejected.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

A version of this article was first published in The Malaysian Insider on February 22 2010.

Categories
Economics

[2136] Of import quota policy is irrelevant to the objective of low stable prices

On December 7 in the Parliament, based on the Hansard, Deputy Minister for International Trade and Industry Jacob Dungau Sagan was asked whether the government intends to abolish a policy that grants exclusive permits for imports to limited entities and effectively, the granting of monopoly power to several companies over certain commodities such as sugar and rice. He effectively said no and went on to defend the policy.[1] I find the defense problematic.

He began his defense of the policy by stating it is the responsibility of the government to ensure that prices of such commodities, and specifically sugar, remain at affordable levels while promoting the sugar industry in Malaysia. According to him further, due to the fact that prices in Malaysia are lower than prices in neighboring countries, there is possibility that producers will not import sugar when prices in the international market are higher than local ones.

Approved permit policy however is an very suboptimal solution to the problem. His answer is similarly so.

Firstly, prices are lower because of price control. Remove the control and prices will go higher. If the local prices without price control mechanism is higher than international prices, then there will be no problem of flow. In fact, the approved permit restricts flow into the local market. If it is the other case, then while there might be problem with flow, the policy of approved permits does not address the problem. This brings us to the second issue I want to raise.

Second, import quota is useless when international prices are higher than local prices sans free trade. It is a redundant policy. Why is it redundant? The rationale is the same as having a minimum wage that is lower than all other wages paid by the market. Higher international prices compared to local price however does introduce the issue of flow. There is a way to address that concern and this is why I make the third point.

Third, the existing subsidy system alone is more than capable of ensuring that there is no large major outflow of sugar under the price control mechanism. How? Just pay (really, subsidize) the importers to bring in the sugar.

I wish to veer off course for a moment or two here. Do note that this does not mean that I support a subsidy system. Rather, it is only a demonstration of positive economics. It is not an exercise at proposing the best policy but merely an effort at proposing a better policy. The best policy remains one that returns to the principle of free market.

Returning to the issue at hand, another unsatisfying point the Deputy Minister made in defending approved permits policy for sugar involves price fluctuation. Again, the subsidy system already in place is able to confront that. There is an existing system in place: the previously used fuel subsidy regime.

Really, the import quota policy is redundant in addressing fluctuating prices. Quota itself does not lessen fluctuation of prices. Any considerable fluctuation in the international price of sugar will translate into fluctuation of local prices regardless of permits, unless a country is a complete natural autarky, which Malaysia is not. What it does is merely to increase average local unsubsidized prices. It does not decrease variance around the local average. In other words, quota just makes prices fluctuating at the same magnitude at higher levels.

The relevant policy should be only price control and subsidy to producers and importers. Two tools alone are sufficient to achieve both objectives of affordable and low prices.

I want to harp on this point again, just in case if it had not driven the point home. While it is important to understand that these two policies suffer grave weaknesses — two examples are smuggling and shortage; also opportunity cost — when juxtaposed alongside free market environment, import quota in no way addresses those weaknesses. Therefore, import quota is really an irrelevant policy, if the objective is low stable prices.

The real reason for import quota is to protect domestic producers. The Deputy Minister did mention this as a reason and he should mention only this as the reason without stating that the policy is there to ensure that prices are affordable and to ensure the availability of sugar. The import quota raises price of sugar, with or without subsidy, much to the benefit of importers and producers of sugar.

It is worth highlighting that there are only four sugar factories in Malaysia owned only two entities. These entities also monopolize the quota. Never mind that these two entities are closely linked.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

[1] — See page 18 the Hansard dated December 7 2009.

Categories
Economics

[2064] Of it’s the price and supply control, sweetie

Ask a layperson what he or she thinks of the definition of economics. If they do not say it is the art of making money, many of them will mention that it is a study of supply and demand.

In truth, economics is larger than either popular but otherwise misleading definitions. More accurately, it is a study of human behavior. A slightly more restrictive definition would lead to what students of economics typically understand it: economics is a study of the use of scarce resources.

While economics is more than able to explain and rectify the problem of production, distribution and consumption of resources, economic lesson may unfortunately have been lost on the federal government.

The manner in which the government responds to the issue of sugar availability may reveal how poorly they understand economics or, at least, how economics is being ignored by them.

This is not the first time Malaysians are facing a sugar shortage. Almost yearly, the issue keeps returning to the limelight.

The government previously blamed smuggling activities as the cause of sugar shortage. They still do. They have blamed suppliers and other players in the sugar supply chain of profiteering without shame. At other times, they blame Malaysians for consuming too much sugar.

This year, while the official line has yet to be made clear, the government-controlled media is blaming Malaysians yet again. According to them, consumers are panicking and rushing to the stores to get all the sugar they can get. The term that is gaining traction is panic-buying.

At this rate, I wager it would not take long before somebody claims that sugar monsters have been raiding warehouses all around the country.

Lest I am unfairly accused of being hopelessly partisan, that it is always the fault of the Barisan Nasional (BN), there are individuals and groups in both BN and Pakatan Rakyat governments that buy the panic-buying storyline.

Regardless of who is buying what, how does the government try to solve the problem?

The efforts to solve the problem are as wanting as the explanations: wider inspections to catch profiteers, greater enforcement at the border to discourage smugglers, and a campaign to encourage Malaysians to live a healthier lifestyle by consuming less sugar.

Yet, the problem recurs without fail, much like how Malaysians can expect the haze to be a yearly affair. In the past weeks, news in the mainstream media suggests that the same efforts, which have clearly failed, will see implementation again.

There is a reason why the problem of shortage keeps recurring and it is because the government refuses to admit one important aspect of the problem — the government is the problem. Specifically, it is the price control mechanism.

All other issues — be it profiteering, smuggling or overconsumption — are direct consequences of the control mechanism. All previous efforts have failed because they are only symptoms of an inefficient market and not the cause. The act of removing the inferior policy will remove the cause of the problem and address all the symptoms in one swift stroke.

Without doing so, apart from flooding the market with sugar through massive subsidization, the shortage will be a repeating phenomenon. This, by the way, happened frequently in the former Soviet Union, a communist state that implemented wide-reaching price and supply control mechanisms.

To understand how price control causes the shortage, one has to realize that prices act as signals to market participants, be it producers or consumers. Given a particular level of starting price, if it increases, it reflects growing scarcity in the market. That then it suggests that producers should or could produce more, or consumers should or could consume less, or both. If price decreases, it reflects growing abundance and that suggests that producers should or could produce less, or consumers should or could consume more, or both.

When the government imposes a friction in the market by placing a rigid price structure like the price control mechanism, it disconnects prices from levels of scarcity and, effectively, eliminates its function. This is a failure of pricing resources correctly. That failure then causes inefficient allocation of resources and in this case, sugar.

It is easy to identify how the term panic-buying is the failure of pricing and ultimately, a failure of government. It is an act of unneeded market intervention by the government, which causes unnecessary hardship to Malaysians.

The euphemism ”panic-buying” unfortunately strips the real cause of the shortage and shifts the blame from government to individuals. Really, panic-buying is simply an increase of demand. Increase in demand happens all the times before a huge occasion like Ramadan. There is nothing special about it.

In a free market, the possibility of shortages is tremendously reduced because prices adjust to reflect reality.

Prices simply go up to discourage consumers from going to the store and hoarding everything; the market punishes the so-called panic-buying by making it progressively more expensive to do so. In a controlled market, that possibility is ever a concern because sugar remains cheap when panic strikes. In a controlled system such as Malaysia’s, there is no feedback mechanism to counter the panic buying.

Oh, I am sorry. There is a feedback mechanism to counter panic buying. The government actually uses the mainstream media to convince consumers that there is ample supply of sugar and Malaysians should calm down. It is raining sugar, baby!

It is insulting to listen to that.

The real solution is to free the sugar market and, indeed, dismantle the control mechanisms imposed on consumer goods by the government. According to a 2008 list obtained by Reuters from the Information Ministry, 11 items have their prices controlled and another 20 items have their supply controlled. It is no accident that these items — among them flour, yet another item that Malaysians have to hunt for from time to time — are susceptible to shortage.

The control mechanism is typically defended as a mechanism to protect consumers. How creating a shortage protects consumers will be an interesting take.

Shortages only reduce Malaysians’ welfare. In fact, shortages should only occur in less developed countries, with communist or socialist markets.

Even if one does not believe in economics, for some reason preferring to believe in the existence of sugar monsters, then at least take note that all past explanations and efforts have failed. It is time to try a new approach.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

First published in The Malaysian Insider on August 18 2009.

Categories
Economics

[1663] Of food? Fuel? Dilemma?

Not all dilemmas are really dilemmas. Open up the lid and upon closer inspection, the dilemma unravels without much investment in effort. One such apparent dilemma concerns the production of food and biofuel. There is really no dilemma between food and fuel however. Free price is the scissor to cut the fake Gordian knot.

In explaining the current food crisis, the production of biofuel has been named as one of the culprits which forced food prices to go up. Some sources typically harvested for food are now being turned into fuel as a solution to high crude oil prices and to some extent, as a solution to an environmental concern as well.

With all that, the food sector suddenly finds it is competing with the fuel production industry for supply; cross-elasticity of demand ensures that. Cross-elasticity is basically a fancy way in economics of saying changes in prices of one item affect the quantity demanded for another item. This happens when a product could substitute another dearer item. Coming back on track, as crude oil prices continue to rise, so too demand for alternative fuel. In this case, it is biofuel.

Price is essentially a signal of scarcity. Price reflects all available information about the associated good. In a market free of state intervention, all market participants will face prices that reflect the true situation of the market.

With free prices, market participants including producers will base their decisions on the true market situation. Within the context of food and fuel production, when there is relative scarcity of one item to another, production of the scarcer item will see an increase.

In the end, there will be a dynamic equilibrium between food and biofuel production closely matched to the reality on the ground.

With deeply statist policies in place however, information about the reality on the ground does not get relayed to market participants. Through subsidies, prices floor and ceiling and other mechanisms set in place for purposes ranging from welfare to environmental and development of new technology, prices are unfree. From there on, prices stop acting as a signal of scarcity. As market participants, consumers and producers alike choreograph their decisions based on these flawed prices, their actions will not approximate the true situation of the market.

The larger the effects of statist policies, the harder it is to estimate the true situation of the market, setting the stage for a painful fall. An extreme scenario would lead to a violent collapse of the state as the market would eventually overwhelm the state.

To a statist and even more to a populist, the question of food and fuel production is a dilemma. Price increases of food and crude oil require a hike of production of food and biofuel. Yet, there is a trade-off of production between the food and biofuel.

A statist in the end sits at his desk, trying to think which is more important to the society or in most cases, to the stability of the state. He has to devise a model, whatever the model may espouse, to decide on the matter.

An adherent of free market principles would deal with the question with an ease that would insult any statist. The free market solution is simple: let the market decide for itself.

Before that can happen, the prices have to be set free, especially from policies which suffer deadweight losses. This includes most if not all of welfare-based policies. As for policies on externalities and development of technology which could push the supply curve outward, it should be judged on a case-by-case basis. Let prices with true reflection of the market reach all market participants without unnecessary friction.

Once the market is free, the dilemma will dissolve into oblivion.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

p/s — a version of this article was first published at The Malaysian Insider.

Categories
Economics

[1623] Of price and supply control in Malaysia

This is just for my own future use.

Following is the list of 11 price-controlled items:

  1. Petrol
  2. Diesel
  3. Liquefied petroleum gas
  4. Steel
  5. Cement
  6. Flour
  7. Sugar
  8. Condensed milk
  9. Bread
  10. Chicken
  11. Cooking oil

Following is the list of 20 supply-controlled items,
whereby supplies are regulated ensure demand is always met.

  1. Sugar
  2. Milk (including condensed, powdered milk, cream)
  3. Salt
  4. Cement and clinker
  5. Flour
  6. Cooking oil
  7. Fertiliser
  8. Insecticide
  9. Formic acid
  10. Mild steel, round bar
  11. Kerosene
  12. Preserved fish
  13. Rice (in Sabah state only)
  14. Paddy (in Sabah state only)
  15. Petrol
  16. Diesel
  17. Liquefied petroluem gas
  18. Bread
  19. Fuel
  20. Chicken [Malaysia’s web of price and supply controls. Reuters. March 26 2008]

What are the implications of the two control methods?

Price control will cause shortage or surplus when the list prices are disconnected from that of the market. Shortage occurs when prices are set lower than it should be. Producers will not have the incentive to produce as much as the level they would produce under free market condition while consumers will demand more than what they would normally do under free market. When surplus occurs, prices are simply set too high compared to what free market would call for; producers will produce too much and consumers will demand too little.

Supply control affects only the supply curve but it distorts the market nonetheless. This method forces prices that consumers pay to go higher than what equilibrium would otherwise produce when supply is set less than free market quantity. This is a producer-friendly policy as producers are able to charge consumers with higher prices than what free market would dictate. In other words, shortage is beneficial to producers. The exact opposite of the mechanics is true when supply is set higher than equilibrium.

The two methods reach roughly the same conclusion but the dimensions which each method tackles must be noted.

The two methods have one common characteristic: it amplifies an effect called price stickiness. There is always a lag in updating the set prices or quantity to match the prevailing situation of the market. In that way, these controls are inferior to free market mechanism as information disperses among participants of the market faster than those in the state responsible for the controls could react.

That brought me to an intriguing question: if those in the state could react faster to some relevant information with those controls compared to those in the market, would that make the market as an inferior tool to the controls?

Maybe that is a good thesis to explore. Hmm…

And I am done with my mental masturbation for today.