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Saturday, 6 October 2012

The Logic of Floor Prices

By Kaela B Mulenga

When there is a restriction that prevents a price from falling below a certain level, it is known as floor price. Sometimes the government may feel that the market price is too low, hence it orders one above the market equilibrium price. This action normally causes a surplus. A simple graphical working of this price control policy is shown in the diagram below.
As we can see from the diagram above, the price flor (FP), which is above the market price (at point E) – the output demanded at that price is only Qd, which is well below the enticed output supplied (Qs). The excess surplus (shaded area) caused is the difference between Qs and Qd. When that occurs, the issue now becomes on what to do with these surpluses.

EU countries, Canada and USA often use this pricing policy instrument. In particular USDA (US Department of Agriculture) frequently uses it to boost the profits or incomes of milk or grain producers. Faced with surpluses generated from these policies – US government buys them and either stores it for future use; donates them as food aid to poor countries like Zambia or intentionally destroys them. Our surpluses would be used as food for the people.

Earlier this year Agriculture Minister Emmanuel Chenda set the price-floor of K65,000 per 50kg bag of maize or K1,300,000 per tonne. The Minister basically maintained last year’s price. By this order, FRA (Food Reserve Agency), the major purchaser of agricultural produce was not allowed to pay farmers less than this price – hence the name floor.

Of course the maize producers are happy, just as the 13 million plus Zambians should be. But some quarters – including the World Bank, charge that this is a subsidy on maize which is already enjoying other subsidies to small scale farmers through FISP (Farmers Input Support Programme) in form of seed and fertilizer supports. This is in addition to the beefed up extension services. Instead, World Bank recommends that Zambia continues with a policy of non-interference with prices.

The reasons advanced by the Minister were quite clear, among others: - since maize is a staple food, government wants to secure continuous supply of sufficient food stocks. Aside from food security, government cites exploitation of farmers by the private produce buyers, who have a tendency of undercutting the FRA prices. They want to buy cheap from farmers and sell at maximum profits. Because of the desperation of farmers during the marketing season (when some produce might rot), sometimes they do accept these abnormally low bids.

At the risk of being criticized by some of my readers, I strongly support Government policy. First, it is indeed essential to have large surpluses of food for the people – most of whom cannot afford anything else other than ‘nshima and relish’. Currently food supplies are stable but who knows what happens next?

Apart from food security issue, having surpluses is the best way to keep in check food prices. We’ve seen that in the last three years or so when Zambia produced enough (even exporting some to Zimbabwe and Kenya), food prices have tended to fall. Partly this is also because FRA was able to sell at a cheaper price to millers for local meal mealie supply than to all others like – traders, exporters and communities. But in short, the more we produce the cheaper will be our staple.

If Zambia continues to produce surplus maize, as it has done in the last few years – we will not only be locally food sufficient, but could become an important regional breadbasket, to rival South Africa which is currently the largest regional grain supplier. We must stay ahead of Malawi or before Zimbabwe is reinvigorated. Food before cash – is the philosophy.

At this floor-price of K65,000 per 50kg also implies that any private buyers who bought last year’s crop at the market price of say K50,000 per 50kg bag stands to gain. With low export sales, last year - the year of huge surpluses, somebody might have stored some of it. But those who bought it at K65,000 per bag will just break-even.

Those who believe solely in markets being ruled by the law of supply and demand, claim that during periods of oversupply (harvesting season for example), private buyers and not FRA (government) should be expected to set prices. This would be nice if the system was free of Kangaroo tactics. Our markets are never smooth, so we shouldn't pretend that they are.

Fears that price floor on maize might suffocate other commodities, is true to some extent. But with careful planning and monitoring, a good balance can be established.

More importantly, if this policy works to induce large surpluses in maize, year in and year out, why abandon it? In fact, shouldn’t it just be extended to other crops to play the same magic? High valued cash crops such as Soya Beans, Wheat, Tobacco, and Cotton can also benefit from these supports. Indeed, why not use it to promote livestock as well other non-traditional commodities like: - rice, sorghum, barley (a new one), groundnuts (peanuts) and cassava in the same way? These and several others can benefit from a deliberate policy adjustments similar to maize.

If that can be done, that would be the true expansion of the agricultural sector and diversification from mining to agriculture in earnest. Moreover, when agricultural surpluses are generated, we should not be thinking of only exportation to the neighboring countries because export prices might in some cases even be lower than the floor prices themselves, resulting in losses. Hence, we need a holistic plan.

While surpluses are good for the sustainability of food stocks, they’ve to be managed well. To begin with, government must make sure that enough storage facilities are built. Otherwise losses through rot, rain, wastage or even theft could wipe out all surplus benefits.

Further, if enough planning was put in place – these surpluses, through value addition, could be used to create jobs. Labor on expanded small scale farms and in processing plants would go a long way in reducing unemployment especially among our youth. For example maize could be processed into vegetable cooking oil, corn flakes, feed stock, and other products not to mention biofuels. In USA, over 40 percent of maize is processed into biofuels. Surpluses from other crops like cotton could also help in resuscitating the textile mills; and barley for brewing. We cannot afford to dispose off these excesses at a loss.

Neither does it make sense to continue producing agricultural raw materials for the benefit of Multi National Corporations. Our focus should be to produce for ourselves – in terms of food and then as inputs for our local manufacturing plants. Exporting only the excesses.

These initiates have to be planned for by government in partnership with private investors. It would be a mistake to assume that these projects can be undertaken only by the private sector. In undeveloped economies, free entry and exit by private players are only encouraged by government incentives. Therefore, for a change, I would like to see Zambia demonstrate leadership in this area. Deliberate policies like price floors or ceilings and others must be designed, implemented and seen through. We can boost a lot of things by simply taking some tough decisions.

When Anglo Americans walked on Pres Levy Mwanawasa, he came up with a package which brought mining investors. The same could be done for the agricultural sector and tourism. We need a high level of investments in agriculture and related industries. Offering incentives such as concessions, tax holidays, free land, duty free on equipment, importation quotas and others, could create a boom for the agricultural processing industries.

Those critics, who insist that the market must be left alone to play the trick, want us to wait until end of time. Besides, we do not want to go back to the Frederick Chiluba way – who sold/privatized more than 200 Zambian public companies at no benefit at all to the ordinary people. People are tired of one-sided benefits accruing to foreign investors. Ordinary Zambians must also have some hope to see light at the end of the tunnel. Americans – through World Bank and IMF have counseled us enough. It is time we tried something on our own. Who wouldn’t want food surpluses or bumper cotton or tobacco outputs?

Moreover, these market lovers are ignoring few things. First, as alluded to earlier, competition and free prices do not work as efficiently as we might think in emerging economies. There are too many obstacles. Those with money for example, always try to manipulate things at the farm gate so that they can accumulate market power. This manifests itself when private produce buyers out maneuvers small and peasant farmers. They offer “take or leave it’ prices to rural producers who’ve sometimes no choice. A situation whereby a buyer is offering K2,000 per kg when the seller demands K3,200 per kg must be solved somehow. But exploitation of the farmer can’t be tolerated.

Also, we must underscore that – sometimes theories do not conform to ‘reality economics’. That is why you have market failures. Other times especially in underdeveloped economies, government intervention becomes a necessity.

Therefore, so long as the PF government will use these instruments in a measured manner and selective way and not as the order of the day – relying on price controls is tolerable. But that said we do not want to repeat what UNIP did by socializing everything ending up with a broken economy and long queues. Neither do we want Chiluba’s model which basically transferred all our major assets into the hands of non-Zambians.

As the country embarks on this road to solve food security once and for all, if the price control is the magic bestowed upon us, so be it. After all, USA and other countries use it, who are we not to take advantage of it? In this regard, the World Bank’s (WB) advice to Zambia should be ignored. In fact, somebody should remind WB that we tried SAP (Structural Adjustment Programme) under a more compliant Pres. Chiluba and it didn’t work for us.

Our vested interest should be in wanting to become the breadbasket in Southern Africa. If possible we should try to out-compete South Africa. Our weather and water resources are better than theirs. So all we need to do is to outthink them when it comes to agriculture, making no apologies along the way. Endowment in natural resources should help us to be competitive.

Just as maize production is successfully being increased, we can do the same to say beef. Subsidies for drugs, breeding stock, and feedstock – coupled with cheap financing can do the same trick. Therefore, we must resist all those who are trying to discourage us from using subsidies. As I said, every country relies on subsidies if it suites them.

The maize forecast for this year – the 2012/2013, is estimated at 2.85 million tones against the national demand of 2.59 million tones. This would leave a surplus of 260,000 tones. Last year Zambia produced a record 3.0 million tones with a surplus of 770,900 tones. Adding this to a previous surplus gave us a comfortable surplus margin. This is the way we want to keep it.

If we can improve productivity and cut production costs on farms – especially the smaller ones, lots of jobs could be created not only on the farms themselves, but through down the stream industries and services. That this is feasible does not require any consulting. It is obvious! The only missing link would be – policy and action.

Whenever we see a commodity experiencing persistent short supplies, we must never hesitate to look closely at that item and see what can be done to boost it up. You want more beef or goats for Middle Eastern market – study and see how you can improve the productivity in that area. Thus, the new price floors on maize should not be looked at in isolation. Price controls by nature are the tools available to manipulate the different outcomes (yield levels/incomes) in the agricultural sector.

As soon as we master how to raise surpluses from one crop (say maize) and be able to sustain it, that would be the key we need which can be extended to other crops and products. And this is the basis on which to commend Mr. Chenda’s intuition. We all must support him. Cheers!

Dr. Kaela B Mulenga, a Fulbright Scholar, taught economics for many years as a Senior Lecturer at the University of Zambia. He is one of standing contributors on Zambian Economist. More of his contributions can be found here


  1. Some of the flaws in this argument:
    -A significant amount of the bumper harvests of the past few years is attributable to good weather rather than good policy. How much, we will not know until we have a drought.
    -The subsidised maize surplus comes at a huge cost to the taxpayer, including subsidising our neighbors. Exporting subsidised maize is not something to boast about.
    -There are cheaper ways to increase production such as improving yield through better management. Provision of farmer management training was hampered by lack of funds as FiSP and the maize subsisdy cost so much.
    -There are other ways of evening out the seasonal price variations (such as providing cheap credit to maize buyers) and reducing the difference between farm gate and market price (by grading the roads).
    -There are other constraints to job creation in processing which need to be removed before this goes far. Zambia is a very expensive country to manufacture in so our cornflakes would probably be unable to underprice south africa. Using subsidised maize for biofuel does not make economic sense when there are other biofuel crops that would not need subsidising to be viable.
    -FRA selling maize at subsidised prices damaged private processing and marketing by artificially lowering the mealie meal price.
    -The biggest subsidy to maize prices is actually provided by farmers underpricing their own and family labour input. This needs to change if rural poverty is to be tackled.
    -Mealie meal prices would be less of an issue if more people were employed as evidenced by the fact that more breakfast meal is sold than Roller even though the price is much higher. Generally employed people are able to pay more. Job creation is therefore central to solving the problem.

    I do support continuing some level of subsidy but I think that the current levels are too high and favour a limited number of farmers at an exorbitant cost.

  2. If subsidies are producing “any” surpluses whatsoever, that’s the way to go. We simply do not have time and luxury to be inventing and experimenting, once more with other methods. We have done that for too long and nothing is happening.

    The private sector players always end up being the benefactors leaving farmers holding the hot end of the stick. Occasionally they simply bully their way through using donors’ influence, cheat, or hoodwinking our weak and corrupt government officials. We must now do what catches the attention of the farmer directly. Scarcity is what causes the expenses associated with processing agricultural commodities in Zambia. Have produce aplenty, costs would go down.

    Simply put, if farmers are responsive to subsidies whatever the source – like FISP or others, expand the program rather than reducing it. That is to say, instead of sending an army of politicians to go round asking farmers to produce this or that – market mechanisms are showing that they are more effective. “Nanny” or “do this” commands have not worked well for us in the agricultural sector. It’s time we abandoned them.

    Besides, what’s good for America and Europe should also be good for Zambia.

  3. In the 2011 marketing season, the winners were:

    1) The minority of farmers (ie the ones that sell into the market as opposed to subsistence or net buyers) who received a higher-than-market-price

    2) The millers, which received the bulk of the subsidy under the buy-high-sell-low policy of the FRA

    3) The regional markets which received maize at a price subsidised by the Zambian tax-payer

    4) The fungi, rats and weevils that consumed a scandalous amount of the crop in FRA storage

    The losers were:

    1) The national treasury (and by extension the Zambian taxpayer), which had to divert almost 2% of national GDP towards buying a single crop, from which the larger farmers - i.e. the ones that sell most into the market - necessarily benefit the most. This implies the FRA is a very 'blunt' and expensive tool when it comes to a rural social welfare policy

    2) The rural economy for which the opportunity cost of the almost K2trn spent on maize buying wasmore productive investments in roads, infrastructure, research and development

    3) The agricultural economy, for which such a heavy handed state intervention 'crowds out' private investment in marketing, storage, financing and, for farmers not eligible for FRA purchase, even the growing of maize

  4. The logic of the arguments made in this post are so unbelievably flawed that it becomes difficult to argue with. One of the paragraphs in this blog actually states that one of the benefits of raising prices is lower prices! How insane can you get?!?

    One point that should be made is this: Nearly all economists (and most voters) with any working knowledge of American or European subsidy programs agree that they are a social burden that should be eliminated. It's not a matter of "what's good for America and Europe" being good for Zambia. Rather, what is bad for America and Europe is also bad for Zambia. The difference is that when richer countries implement these horrible policies it is barely noticed because they have revenue from other sources to back it up and when poorer countries do it people die.

    Wake up.


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