Author: Hafiz Noor Shams

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.

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