Yet the challenge posed by ‘commodity problem’ has resulted in growers becoming a highly exposed segment of productive sector, despite their contribution to industrial value chains. Roughly defined, the commodity problem describes the unintended consequence of improving productivity in crop outputs, which has resulted in long-term secular decline of commodity prices, leaving the supplier of primary commodities worse-off.
Political governments in countries where plurality of population is linked to agricultural economy in one way or another thus resort to market interventions that may shield rural constituents from adverse commodity price movements.
The need felt by well-meaning governments to act is further exacerbated by news stories every harvest season that depict ‘failure of market mechanism’. Papers are replete with pictures of farmers/middlemen destroying their stock of tomato or some other vegetable due to depressed prices resulting from supply glut. This then alternates with season of shortages when price of essentials run amok. Solution proposed each time take some form of minimum price guarantee – whether for cotton, maize or sugarcane, and more recently, even kinnow and onions!
Except time and again it has been shown that government interventions in commodity markets contribute to fiscal deficit; result in loss of consumer welfare; transfer wealth from one economic segment to another based on political considerations; are exploited by vested stakeholders especially if untargeted in nature; fail to reach the most marginalized segment of rural economy; and most of all, create perverse incentives that inhibit innovation by discouraging private sector risk-taking. The problem presented is thus not an indictment of guaranteed minimum returns to farm sector, but that the guaranteed price should stem from the market itself and not the government.
Because Pakistan’s crop output targets are determined by its food security and import-substitution considerations, it follows that incentive exists for commodity consuming segments to hedge the risk of adverse price movement long before harvest season sets in and crop outlook becomes clear.
Although contract farming is often presented as a solution, it has failed to take root because it requires commercial/industrial consumers to provide growers with stewardship in the form of quality inputs (seed, fertilizer, and pesticides), and best practices (drip irrigation, sowing techniques, etc).
A more ambitious yet easier way to transfer price risk from producer/consumer to the market could be for regulators to encourage formalization of agricultural derivatives. Of course, commodity trade in grain markets based on informal/over-the-counter forward contracts on delivery basis already exists (and possibly has been common for decades if not centuries).
But if the objective is to provide guaranteed economic returns to small growers currently beholden to price set by single/large-scale buyers, trading needs to shift towards derivative exchanges, even if initially on localized/ghallah market basis. Currently, farmers are dissuaded from entering contractual obligations at the time of sowing in the hope of receiving better price/windfall gains upon harvest in case the commodity is in short supply.
In contrast, introduction of exchange-traded commodity contracts – whether in the form of futures or options - will allow investors and speculators uninterested in possession of underlying commodity to enter the market to take advantage of price movement, in the process adding liquidity.
But such an event will not only to the benefit of speculators alone. Because exchange-traded contracts are premised on cash-settlement, if the commodity price in the spot market increases way above price contracted by growers on Day 1, the lower-priced contract will itself gain value. Conversely, if the market price falls way below contracted price, growers will still be able to receive the guaranteed fixed return, or the commensurate cash-settlement.
Either way, it will ensure that farmers no longer face the adverse prospect of losing out on opportunity of higher prices or being exploited by single large-scale buyers who even today offer fixed price at the time of sowing but take farmers for a ride by exploiting their fears of crop loss/productivity, based on asymmetrical information availability regarding output-price outlook.
Granted that derivative instruments have all sorts of stigmas attached to them. But well-meaning policymakers should consider this: given the traditional lens which routinely places mill owners in the role of ‘exploiters’ and growers in the role of ‘exploited’, why is it that support price mechanism is never opposed by the mills - if it is in fact meant to benefit the farmer at the expense of mills? Food for thought.