Price setting in an over-populated and import-dependent economy
Saturday, 2 January 2010
M. G. Mortaza
YET there exist loads of controversies among policy makers how prices are determined in an economy with largely dependent on imported commodities, both for inputs as well outputs and large population. Policy makers often fall in a baffling situation in explaining the prevailing higher inflation in the economy, before general public, who are mainly the final consumers of the product and also bears the ultimate burden of high prices.
In a fairly non-competitive market structure, where shortage of product supply is a common phenomenon, basically because of keeping less information about increasing demand structure (or, demand growth), policy makers find it hard to measure the exact dynamism of market structure and its price setting. With the absence of any particular meaningful analysis on price setting process in both fronts of the government and private sectors, it may be easy to believe that price setting operates through some kind of oligopoly structure of the market, where undefined syndicate system controls the prices of a good, especially imported one.
Starting with the basic economic theory, in normal circumstances, prices of a commodity go up when demand outweighs supply, if other things remain the same and vice-versa. Factors in 'other things' will be responsible for any deviation from the market-determined price. Though attempts have been made on several capacities to explain the recent inflation escalation in Bangladesh, most of them, however, considered factors in 'other things' as the villain.
Hither and thither a number of ideas have seen searching for roots. First in 2006, one such was -- that definitely came up by renowned macroeconomist Professor Taslim from the University of Dhaka -- higher international prices mostly responsible for higher domestic prices. No doubt, that probably has been the most striking reason for inflation in recent period. Yet one may carefully need to think why a large amount of import takes place in a low income country, if there is no demand pressure from population. And it is evident that the pass-through of international prices to domestic prices will be lower for those goods which has lower import ratio in total domestic consumption.
Food expenditure and Real GDP (FY05-FY09)
Source: Bangladesh Bureau of Statistics (BBS)
The Centre for Policy Dialogue (CPD), a civil society think-tank, in the beginning of 2007 came up with the empirical evidence of 'syndicate' hypothesis to explain recent inflationary impulse of Bangladesh, though the idea first introduced by journalists in their various analytical reports in the newspaper. Interestingly, CPD took the issue in consideration very seriously while hypothesising the whole inflationary impulse, took a country-wide vast survey and not surprisingly, found strong evidence in favour of the hypothesis. Who will say that there is no syndicate in market? Though it was highly appreciated by media, most of the theoretical economists, business persons and even policy makers, on the other side, completely disagreed with the non-competitive market hypothesis. The analysis itself gave enough opportunities for criticism as it surprisingly didn't consider conventional economic factors into the survey and thus the whole report became just nothing but an establishment of alleged knowledge. One serious missing point was that even 'syndicate theory' would not work in a situation with less demand and ample supply of commodities.
In late 2007, Professor Osmani, a renowned economist from the University of Ulster, in a dialogue interestingly organised by CPD, came up with methodical interpretation considering both demand- and supply-side factors of inflation and also brought some unconventional factors such as 'syndicate' in the analysis. Evidently, Osmani's attempt was much systematic than others and based on strong theoretical basis, and in a summary, he rejected the idea of prosperity hypothesis (alternatively, demand factors) behind the inflation escalation bringing Engel's law in his analysis and also just laughed at the idea of 'syndicate hypothesis' for not finding any economic rationale behind that.
In May 2008, Nobel Prize winner Professor Amartya Sen from Harvard, in his article in the New York Times - The Rich Get Hungrier - asserted that the global food problem is the result of accelerating demand, especially due to rapid economic expansion in developing countries with large population like China, India and Vietnam and pointed to the population growth for a modest part of the growing demand for food. Interestingly, Sen visualised a tale of two poor peoples, where if a country with a lot of poor people suddenly experiences fast economic expansion, only half of the people get new prosperity, spend a lot on food, and prices go up accordingly, unless there is excess supply. However, the rest of the poor must face higher food prices with less income. On this point, Sen provided the example of 1943 Bengal famine and also of world-wide food crisis in 2008.
Let's see a comparison. While Osmani rejected the application of prosperity hypothesis, Sen on the other hand accused the economic prosperity of one group of poor people in society for price hike and burden of still other half of the poor people. In a more structural (or, developed) economy, the hypothesis of Osmani will perfectly work and 'a much' theoretical Engel's law will be suitable to explain food demand behaviour; however, Sen's analysis prevails 'a more' practical problem that the developing countries are now facing.
And what does the following data say?
At the first look, it reveals that Engel's law is undeniably correct as household consumption expenditure on food items has been increasing less than income increase during fiscal year (FY)05-FY09. However, the applicability of Engel's law in this context to defend the prosperity hypothesis must be in question because share of food expenditure in total household expenditure increased during this period. Engel's law entirely puts emphasis on the relative increase in food spending, but not the nominal increase. In a country with large population and speedy growth of food-dependent population, it is the nominal spending that matters significantly, not the relative share. The multiplicative relationship between growth of food-dependent population and increase in the share of nominal expenditure on food soared up the inflation in recent years.
How does it work? First, as growth of food-dependent population is higher than other groups of population, growth of demand for food increases sharply and thus food inflation. Second, as earnings of a lower-middle-income and middle-income people rise, their consumption pattern changes significantly, shifting to processed food from home-made raw food consumption and thus overall food expenditure increases. The best example would be rapid expansion of fast-food shops, hotels and restaurants, in urban and semi-urban areas. Moreover, demand for raw food from the processed food industries also creates supply shortage of raw food and thus increases the prices of raw food. Engel's law doesn't consider these facets of food consumption as well as market behaviour and thus the applicability of that in inflation analysis of Bangladesh is not valid.
On the basis of Sen's analysis, one must not only see recent rapid gross domestic product (GDP) growth of Bangladesh for prosperity of low income peoples (even, the level of wage) through engagement in some fastest growing industries in Bangladesh such as ready-made garments (RMG), one also can't overlook high population growth of Bangladesh, especially among low and lower-middle income people, for rapid food demand. Just for the sake of observing income growth of low-income people, one may compare Rickshaw rents now and five years back, also the growth of wages of daily labourers, both in rural and urban areas and housemaid. While income of the lower-middle income people largely increased due to remittances, in the case of middle and high income groups, credits must go to the overenthusiastic growth of a few service sectors such as banking, mobile and industries like RMG and construction. Active involvement with ruling political parties, especially during the last one and a half decades, along with a big volume of bureaucratic corruption in the government sectors, also helped a large number of people to be prosperous within a shortest time. These should not be considered as negligible rationalisation of prosperity hypothesis, rather one way to explain Sen's claim about rapid economic expansion in developing countries.
From the government side, lack of proper monitoring of food stock situation and absence of effective and scientific forecasting mechanism creates asymmetric information about food supply and thus leads to prolong supply shortage in the market. On the other hand, better than asymmetric information is available to seller (or, producer) and importer, thus prices can be manipulated by them easily, and they often do. Again, in practice, domestic production per person of food items has declined over time, which has given importers of those items to perform their oligopolistic role in setting prices. No research, doesn't matter whether public or private, considered proper forecasting mechanism for supply of food commodities.
Moreover, with the absence of any dynamic study on market price behaviour, static micro analysis of price setting only provides the partial picture of market situation, and never considers the important factors such as population growth and demand pressure, which play a vital role in setting up the prices in the long run when demand is always high.
Unrestrained population growth provides the button of market price in the hand of fraudulent business opportunists whether wholesaler or retailer to control, and set their own price. With the presence of democratically elected, but irresponsible and non-committed government in power, policies in regard to effective birth control measures are totally absent. Either there are no long-term public interest policies, or policies have been ineffective. No doubt, leaving aside the policies for effective birth control, the democratically elected governments are pushing low-income people to be marginalized through compelling them to experience high food inflation, and leading to increasingly high income inequality in the society.
So where is my argument heading to?
It's not that simple, but it is the case. One group will not accept it easily, yet it is the fact. Economic prosperity, relatively high growth of food-dependent population as well as domestic supply shortage can explain the overall food inflation in Bangladesh. Without a doubt, higher inflation is directly associated with economic prosperity of low income peoples and high growth of population, especially at the low and lower-middle income peoples.
Higher food demand of these income groups makes a persistent supply shortage of food items in the market and induces the prices of those to rise. Commodity market always runs with supply shortage (or, excess demand). With the presence of high food-dependent population growth, syndicate theory will be effective and Engel's law will never be the Judge.
The writer is an associate member of the Bangladesh Young Economists Forum (BYE) and can be reached at
mgmortaza@yahoo.com. The views expressed in this article are those of the author and do not necessarily reflect the
views of BYE
YET there exist loads of controversies among policy makers how prices are determined in an economy with largely dependent on imported commodities, both for inputs as well outputs and large population. Policy makers often fall in a baffling situation in explaining the prevailing higher inflation in the economy, before general public, who are mainly the final consumers of the product and also bears the ultimate burden of high prices.
In a fairly non-competitive market structure, where shortage of product supply is a common phenomenon, basically because of keeping less information about increasing demand structure (or, demand growth), policy makers find it hard to measure the exact dynamism of market structure and its price setting. With the absence of any particular meaningful analysis on price setting process in both fronts of the government and private sectors, it may be easy to believe that price setting operates through some kind of oligopoly structure of the market, where undefined syndicate system controls the prices of a good, especially imported one.
Starting with the basic economic theory, in normal circumstances, prices of a commodity go up when demand outweighs supply, if other things remain the same and vice-versa. Factors in 'other things' will be responsible for any deviation from the market-determined price. Though attempts have been made on several capacities to explain the recent inflation escalation in Bangladesh, most of them, however, considered factors in 'other things' as the villain.
Hither and thither a number of ideas have seen searching for roots. First in 2006, one such was -- that definitely came up by renowned macroeconomist Professor Taslim from the University of Dhaka -- higher international prices mostly responsible for higher domestic prices. No doubt, that probably has been the most striking reason for inflation in recent period. Yet one may carefully need to think why a large amount of import takes place in a low income country, if there is no demand pressure from population. And it is evident that the pass-through of international prices to domestic prices will be lower for those goods which has lower import ratio in total domestic consumption.
Food expenditure and Real GDP (FY05-FY09)
| (i) FY05 (Million Tk.) | (ii) FY09 (Million Tk.) | (iii) Growth (%) | (iv) Annual average growth (%) (= iii/3) | |
| a) Household consumption expenditure on food | 1403131 | 2109896 | 50.4 | 16.8 |
| b) Total household consumption expenditure | 2700494 | 3982432 | 47.5 | 15.8 |
| c) Share of expenditure on food | 52.0 | 53.0 | ||
| d. GDP at market prices | 3707070 | 5458224 | 47.2 | 15.7 |
| e) Gross national income at market prices | 3896350 | 5942119 | 52.5 | 17.5 |
| f) Gross disposable national income | 3923158 | 5998832 | 52.9 | 17.6 |
| g) CPI | 153.24 | 193.5 | 26.3 | 8.8 |
The Centre for Policy Dialogue (CPD), a civil society think-tank, in the beginning of 2007 came up with the empirical evidence of 'syndicate' hypothesis to explain recent inflationary impulse of Bangladesh, though the idea first introduced by journalists in their various analytical reports in the newspaper. Interestingly, CPD took the issue in consideration very seriously while hypothesising the whole inflationary impulse, took a country-wide vast survey and not surprisingly, found strong evidence in favour of the hypothesis. Who will say that there is no syndicate in market? Though it was highly appreciated by media, most of the theoretical economists, business persons and even policy makers, on the other side, completely disagreed with the non-competitive market hypothesis. The analysis itself gave enough opportunities for criticism as it surprisingly didn't consider conventional economic factors into the survey and thus the whole report became just nothing but an establishment of alleged knowledge. One serious missing point was that even 'syndicate theory' would not work in a situation with less demand and ample supply of commodities.
In late 2007, Professor Osmani, a renowned economist from the University of Ulster, in a dialogue interestingly organised by CPD, came up with methodical interpretation considering both demand- and supply-side factors of inflation and also brought some unconventional factors such as 'syndicate' in the analysis. Evidently, Osmani's attempt was much systematic than others and based on strong theoretical basis, and in a summary, he rejected the idea of prosperity hypothesis (alternatively, demand factors) behind the inflation escalation bringing Engel's law in his analysis and also just laughed at the idea of 'syndicate hypothesis' for not finding any economic rationale behind that.
In May 2008, Nobel Prize winner Professor Amartya Sen from Harvard, in his article in the New York Times - The Rich Get Hungrier - asserted that the global food problem is the result of accelerating demand, especially due to rapid economic expansion in developing countries with large population like China, India and Vietnam and pointed to the population growth for a modest part of the growing demand for food. Interestingly, Sen visualised a tale of two poor peoples, where if a country with a lot of poor people suddenly experiences fast economic expansion, only half of the people get new prosperity, spend a lot on food, and prices go up accordingly, unless there is excess supply. However, the rest of the poor must face higher food prices with less income. On this point, Sen provided the example of 1943 Bengal famine and also of world-wide food crisis in 2008.
Let's see a comparison. While Osmani rejected the application of prosperity hypothesis, Sen on the other hand accused the economic prosperity of one group of poor people in society for price hike and burden of still other half of the poor people. In a more structural (or, developed) economy, the hypothesis of Osmani will perfectly work and 'a much' theoretical Engel's law will be suitable to explain food demand behaviour; however, Sen's analysis prevails 'a more' practical problem that the developing countries are now facing.
And what does the following data say?
At the first look, it reveals that Engel's law is undeniably correct as household consumption expenditure on food items has been increasing less than income increase during fiscal year (FY)05-FY09. However, the applicability of Engel's law in this context to defend the prosperity hypothesis must be in question because share of food expenditure in total household expenditure increased during this period. Engel's law entirely puts emphasis on the relative increase in food spending, but not the nominal increase. In a country with large population and speedy growth of food-dependent population, it is the nominal spending that matters significantly, not the relative share. The multiplicative relationship between growth of food-dependent population and increase in the share of nominal expenditure on food soared up the inflation in recent years.
How does it work? First, as growth of food-dependent population is higher than other groups of population, growth of demand for food increases sharply and thus food inflation. Second, as earnings of a lower-middle-income and middle-income people rise, their consumption pattern changes significantly, shifting to processed food from home-made raw food consumption and thus overall food expenditure increases. The best example would be rapid expansion of fast-food shops, hotels and restaurants, in urban and semi-urban areas. Moreover, demand for raw food from the processed food industries also creates supply shortage of raw food and thus increases the prices of raw food. Engel's law doesn't consider these facets of food consumption as well as market behaviour and thus the applicability of that in inflation analysis of Bangladesh is not valid.
On the basis of Sen's analysis, one must not only see recent rapid gross domestic product (GDP) growth of Bangladesh for prosperity of low income peoples (even, the level of wage) through engagement in some fastest growing industries in Bangladesh such as ready-made garments (RMG), one also can't overlook high population growth of Bangladesh, especially among low and lower-middle income people, for rapid food demand. Just for the sake of observing income growth of low-income people, one may compare Rickshaw rents now and five years back, also the growth of wages of daily labourers, both in rural and urban areas and housemaid. While income of the lower-middle income people largely increased due to remittances, in the case of middle and high income groups, credits must go to the overenthusiastic growth of a few service sectors such as banking, mobile and industries like RMG and construction. Active involvement with ruling political parties, especially during the last one and a half decades, along with a big volume of bureaucratic corruption in the government sectors, also helped a large number of people to be prosperous within a shortest time. These should not be considered as negligible rationalisation of prosperity hypothesis, rather one way to explain Sen's claim about rapid economic expansion in developing countries.
From the government side, lack of proper monitoring of food stock situation and absence of effective and scientific forecasting mechanism creates asymmetric information about food supply and thus leads to prolong supply shortage in the market. On the other hand, better than asymmetric information is available to seller (or, producer) and importer, thus prices can be manipulated by them easily, and they often do. Again, in practice, domestic production per person of food items has declined over time, which has given importers of those items to perform their oligopolistic role in setting prices. No research, doesn't matter whether public or private, considered proper forecasting mechanism for supply of food commodities.
Moreover, with the absence of any dynamic study on market price behaviour, static micro analysis of price setting only provides the partial picture of market situation, and never considers the important factors such as population growth and demand pressure, which play a vital role in setting up the prices in the long run when demand is always high.
Unrestrained population growth provides the button of market price in the hand of fraudulent business opportunists whether wholesaler or retailer to control, and set their own price. With the presence of democratically elected, but irresponsible and non-committed government in power, policies in regard to effective birth control measures are totally absent. Either there are no long-term public interest policies, or policies have been ineffective. No doubt, leaving aside the policies for effective birth control, the democratically elected governments are pushing low-income people to be marginalized through compelling them to experience high food inflation, and leading to increasingly high income inequality in the society.
So where is my argument heading to?
It's not that simple, but it is the case. One group will not accept it easily, yet it is the fact. Economic prosperity, relatively high growth of food-dependent population as well as domestic supply shortage can explain the overall food inflation in Bangladesh. Without a doubt, higher inflation is directly associated with economic prosperity of low income peoples and high growth of population, especially at the low and lower-middle income peoples.
Higher food demand of these income groups makes a persistent supply shortage of food items in the market and induces the prices of those to rise. Commodity market always runs with supply shortage (or, excess demand). With the presence of high food-dependent population growth, syndicate theory will be effective and Engel's law will never be the Judge.
The writer is an associate member of the Bangladesh Young Economists Forum (BYE) and can be reached at
mgmortaza@yahoo.com. The views expressed in this article are those of the author and do not necessarily reflect the
views of BYE