OP-ED: Soft Heart, Hard Head

Making good economic policy requires both a soft heart, to pay attention to the needs of the vulnerable, and a hard head to make sure that policies are effective and affordable. It is a difficult balance to strike. A “soft heart” seems evident in the recent efforts by the Government of Ethiopia (GOE) to combat high food prices, but some work may be needed to make these efforts “hard-headed” as well.

In order to provide affordable food to those who struggle with soaring food prices and to bring down the food prices in general, GOE recently imported 150,000 tons of wheat, and another 150,000 tons is said to be on its way. This is the first time GOE has used its own budget to pay for emergency food import, rather than relying solely on relief food from donors. This welcome change in the response to the food emergency has been noted by the international community. It demonstrates GOE’s commitment to protecting the wellbeing of the vulnerable population.

The way in which this 150,000 tons of wheat has been distributed, however, may not have been most efficient. It is reported that GOE has been distributing about 30 percent of this wheat to households through kebeles at 350 birr per quintal (100 kg). When the market price of domestic wheat was around 750 birr per quintal, this was significant help, though the quality of the imported wheat is apparently lower (and goes for only about 560 birr per quintal in the market, meaning GOE’s subsidy is worth about 210 birr per household). The rest is being distributed at the same low price to flour mills and bakeries with the understanding that the low cost would be passed on to the consumers, thereby stabilizing food prices generally.

To purchase the low-price wheat for households, however, people have to wait in long queues. Although that is an unproductive use of time, it is sometimes a pragmatic method to target the subsidy at those who really need it. The idea is that those who have a well-paying job will find the time for queuing too precious and opt out. But, this method can miss some important groups, for instance those families that are busy working all day just to make ends meet and can ill afford the time off to wait in line, and those that cannot pay 350 birr at once.

If it is not administered well, this approach can also create opportunities for abuse. In fact, there are reports that some people are buying the subsidized wheat, only to sell it off immediately, or even selling their coupons that entitle them to a quintal of subsidized wheat. Since one is supposed to present an ID card and a coupon to be able to buy the subsidized wheat, some improper transactions may be taking place. Those who sell their quota of wheat or even the coupons may well deserve the small “profit” they make. But, the rest of the “rent” must be going into the pockets of some unscrupulous people involved in the illicit transactions. The subsidy is surely not meant to enrich them.

Similar problems are likely to be happening with the subsidized wheat sold to the millers and bakers. Many of them may try to pass on the low price to the consumers. But, when there is so much money in the subsidized wheat (millers are allocated thousands of quintals), it is very probable that much of it is captured by people involved in the whole chain of transactions, and little is left to benefit the consumers. That the imported wheat is being sold at 560 birr, well above 350 birr, is a sign that this is happening.

Perhaps the price stabilization strategy of the government was to shock the market with infusion of low-price wheat. GOE might have hoped to convince dealers that the market price was about to fall due to the additional supply of wheat. Dealers would try to sell their stock of wheat before it is too late. Then the quantity supplied in the market would indeed increase further and the price would fall significantly. So far, there is little indication that such ‘bluffing’ has worked. The price of domestic wheat has remained largely unchanged.

A more straightforward approach would be for GOE to sell the entire lot of wheat in the wholesale market. It would certainly lower the market price, though one could not be sure by how much in advance. Apparently there were some concerns that this approach might lead simply to traders buying up the wheat and hoarding it in anticipation of further price hikes. Such an outcome seems unlikely. First, storing wheat is costly, because wheat does not keep well. Second, holding stock also costs money for both the storage space and the working capital that is tied up. Finally, private traders have little storage capacity of their own. They lease the space owned by the Government. Thus, GOE can easily make it expensive to hold excessive stock by raising the fee. (Besides, we should want traders to hold some stock, so that the wheat is available at all times.)

Another reason why GOE chose a more complex approach may have been to send a visible message to the consumers that it is extending a helping hand. That would explain the direct distribution of the subsidized wheat. For the price stabilization operation, a more market-based approach would seem just as effective in sending a signal to the consumers. Given the attention the wheat import has received, I am sure that any fall in the price would be seen by the public as the result of government efforts.

One might argue that the GOE’s approach would ultimately have the same effect as the simple option, for the amount of additional wheat injected into the market is no different. The problem is that GOE’s scheme is likely to give away huge windfall gains to various actors who can put their hands on the subsidized wheat. Had GOE opted for a direct sale of wheat in the market, then any “profit” would have accrued to GOE instead. Even if the wheat had sold at the import cost of 520 birr (i.e., no profit to GOE), that would have made inexpensive wheat available (even though the quality may not be as high as domestic wheat), and helped many households. In the mean time, GOE would have saved much money (180 million birr on 105,000 tons), which GOE could have used to finance additional efforts to help families under stress.

When the staggering excesses of “market system” in the U.S. financial market are headline news daily, arguing for a “market solution” may be met with some skepticism. Fair enough. The market system has its problems, and it needs to be regulated properly. One should not forget, however, that when it is mobilized appropriately, the market system is great at eliminating excess profits and stabilizing prices. In fact, other countries that face occasional food shortage, for instance Bangladesh, have used a market-based approach to stabilize domestic food prices efficiently. Using a market system, rather than providing direct help to households, may seem impersonal and cold. But, a hard head should not be addled by a soft heart.

Fortunately, Ethiopia now has Ethiopia Commodity Exchange, an institution that was established with government support to make commodities market more efficient. It is still new and has not traded such large volumes. But, it clearly has a very modern and transparent system to auction off commodities like wheat. Some might be concerned that putting some 100,000 tons of wheat through a nascent exchange might send a bit of shock wave through the market. But, that is precisely what GOE had wanted, isn’t it? I hope GOE will consider a market-based approach, possibly using the Exchange, for its next batch of imported wheat. For this approach to have maximum impact on the price of domestic wheat, it will be important to ensure the quality of the imports is comparable to that of domestic wheat. One way to assure a high quality may be to involve the private sector in the importation of wheat itself. Having to sell the wheat in the market, private importers will have every incentive to make sure the quality is good.

If GOE has confidence in its targeting system, it can adopt a quite efficient dual approach: first, selling 100 percent of the imported wheat in the market, and second, implementing a cash transfer program for vulnerable households. There is a good chance the market price of imported wheat will fall enough so that after the cash transfer, these families can buy a quintal at around the same price of 350 birr the government is targeting at present. All consumers should gain from the lower prices caused by the added supply of wheat on the market, and the poorest should gain the most, with added help from the targeted transfers. And, the whole program should cost much less than the current scheme. Furthermore, there is no rent to encourage profiteering. Both the hard-headed and soft-hearted can find something to like in this scheme, and especially those who try to balance the two.

The author is Ken Ohashi, the World Bank's Country Director for Ethiopia and Sudan