One of my favorite professors at Michigan (he was a visiting professor), Daniel Hamermesh is now blogging at Freakonomics of the New York Times. For those unfamiliar with him, he is the econometrician that authored the famed beauty paper which relates wages with beauty. According to that paper, the prettier the person, the higher the person’s wage will be, with all else being constant of course.
As stated earlier, he also has a marvelous blog maintained at Economic Thought of the Day.
We advocate no doubt Hayekian free enterprise but we don’t think Adam Smith’s invisible hand will be that responsive to the changing times. Hence, whenever necessary, to paraphrase John Kenneth Galbraith, we temper free market with an appropriate dose of state intervention to rectify the social inequities attendant on the interplay of pure market forces. [Full text of Anwar’s speech at CLSA forum in Singapore. Published by The Malaysian Insider. May 20 2008]
Only Anwar Ibrahim could advocate two violently opposing ideas in one go at the highest level. The former Deputy Prime Minister made it as if Keynes had slept with Hayek!
No, no, no. Not Salma Hayek. It is the great Friedrich Hayek.
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.
The ever amusing editors at The Economist.
I praised Shahrir Samad earlier but I am having a second thought now. Shortly after that announcement, he suggested for food production to be subsidized, much to my dismay.[1] Pragmatic may be but our current government policies are confusing. If there is a liberalization in our economy, the current trend does not seem to suggest that.
Take for example the recent effort to increase in local rice yield.
KUCHING: Sarawak will develop large-scale padi planting areas and mini-estates to achieve 100% self-sufficiency in rice by 2015.
Deputy Chief Minister Tan Sri Dr George Chan said the state government had identified eight areas totalling 43,821ha as suitable for large-scale padi production, with Sungai Seblak in Roban the first to be developed under the 9th Malaysia Plan. [Going big on padi yield. The Star. May 8 2008]
And then contrast that with call for price ceiling on rice.
JOHOR BARU: The Domestic Trade and Consumer Affairs Ministry wants ceiling prices on local varieties of rice to be imposed immediately to curb fluctuating prices.
Ceiling prices for the local 5, 10 and 15 per cent broken rice are supposed to come into effect on June 1, but retailers are taking advantage of the interim period to raise the prices of these varieties. [Shahrir: Impose rice ceiling price right away. New Straits Times. May 19 2008]
Price ceiling removes the incentive to increase production in a free market. Nevertheless, there is at least one way to increase yield despite the presence of price ceiling and that links back to subsidizing rice producers.
The size of the subsidy is inversely related to prices of rice under this scenario. The larger the subsidy, the lower will the prices be. We all better pray that the differential between the ceiling and market prices is small.
And dare not to even think that you will be enjoying lower spending under this scenario. Just think who is actually footing the bill for that subsidy. Yes, you and I. We are giving out our government with money to allow us to buy cheaper good. If that is unclear, we are paying the government to allow us to buy cheaper food.
How stupid is that?
We might as well not pay tax and pay for higher rice prices. A far simpler situation, do you not think so?
[1] — KUALA LUMPUR, Malaysia (AP) — Malaysia’s government is planning to subsidize locally-grown rice to prevent consumers from being hit by record high prices of the staple food in the world, a Cabinet minister said Monday. [Malaysia plans local rice subsidy. CNN. April 28 2008]