The finance adviser has acknowledged the problem in some of his public statements. It is also one of the major issues in his budget speech. He has valiantly tried to come out with a formula to curb the price hike. However, it is not at all certain that his antidote will cure the disease or worsen it.

The adviser has announced a three-pronged policy attack against essentials' price inflation: (1) a reduction in import duties, (2) improvement in the marketing and distribution system and (3) incentives to increase agricultural production. Each of these policies would seem to follow from a different assumption regarding the causes of the price hike.

The first appears to be based on the assumption that market prices bear a strong positive correlation with import costs and if import costs are reduced, market prices would fall, too. The only element of import costs that the government controls is the import duty. The adviser had already reduced import duties to zero for some essential items such as rice and wheat. In the FY 2007-08 budget, he has proposed zero duty on some other items including edible oil and lentils. Although until recently the popular belief was that syndication and hoarding were mainly responsible for essentials' price hike, there is now little doubt that import costs were the principal factor behind the price hike. The syndication theory was not only untenable, but it had misguided the previous government to the extent that it had not taken any action to reduce import costs until toward the end of its tenure.

The second policy is based on the assumption that the marketing and distribution channels of essentials do not function competitively. Many seem to believe that powerful middlemen hold the farmers (as well as retailers) hostage to extract extortionate surplus. To the best of my knowledge, none has yet demonstrated convincingly that the middlemen in the essential products marketing chain behave non-competitively. Recently, CPD had undertaken a survey that revealed that the principal middlemen, the millers, received about 23 per cent of the retail price of rice. This share was regarded too high, and the CPD predictably reached the conclusion that middlemen were causing the rice price to be too high. It peddled the idea to a gullible media. Presumably the finance adviser has also been influenced.

A problem with the conclusion is that the CPD is just assuming the 23 per cent margin for the middlemen to be uncompetitive; it is not demonstrating it. Are any of the middlemen in the chain unnecessary, and if so, how do they survive in the market? What are the opportunity costs of the middlemen's services and funds? What are the risks and costs of carrying stocks? What are the margins earned in similar businesses at home and abroad? If they are earning abnormally high profits, why aren't other business people entering the market? Are there entry barriers? Are the essential commodity markets contestable?

There was a widespread belief in the earlier decades that the rice market of the country was uncompetitive. Much research was done to investigate this aspect of the rice market, especially at BIDS. After more than a decade of research, BIDS economists were convinced that the rice market was actually highly integrated and competitive. [A colleague of mine, now a notable economist overseas, did a study in 1980-81 and concluded that the rice market was competitive. His findings were not appreciated at that time.] The CPD has now reopened the issue and hypothesised the opposite without giving any convincing evidence. That the finance adviser has apparently accepted the CPD diagnosis and based a serious policy measure on an unsubstantiated claim makes it all the more worrying. If it turns out to be incorrect, such a policy of disturbing the marketing chain can slow down the flow of goods and impose huge costs on the economy. We have already witnessed what happens when the government acts on the basis of a false diagnosis.

The third policy would appear to be based on the assumption that an increase in agricultural production through subsidies and agricultural research would increase the domestic supply of essential commodities and thereby bring down the prices. This would be true 20-30 years ago when the country severely restricted trade. During the last two decades or so, the country has gradually integrated itself into the global economy under pressure from multilateral organisations. A necessary consequence of this process of globalisation of the national economy is that prices of tradables are now determined in the global market. Domestic prices are not linked to domestic production unless trade is restricted.

Furthermore, the third policy (increasing agricultural production) requires an increase in prices and hence is contradictory to the objective of the first policy, which is to reduce prices. A reduction in essential goods prices is a powerful disincentive to produce these goods and the reduction in duties removes the protection enjoyed by these farming activities. To compensate for the price disincentive, the budget proposes subsidies on fertilisers and diesel up to Tk 2250 crore. However, a quick back-of-the-envelop calculation suggests that whatever the farmers may receive of this amount will be far smaller than the loss suffered due to reductions in prices of cereals of even one taka per kg. However, if the policy fails and the prices do not come down, but the subsidies are given, farmers will have some incentives to increase production. Notwithstanding whether prices come down, the government should provide support for increased agricultural production as this will help raise income and standard of living of the farmers.

The proposed policy package for containing essentials' price inflation does not give much hope of bringing any quick relief to people groaning under the pressure of rising living costs. Only the first policy could reduce prices of essentials in the short term. However, duties on many essentials including rice and wheat were very low at 5 per cent. Reducing these to zero will have a minimal impact on prices. Only in the case of products such as onions and edible oil, will the reduction in duties be sizeable that could have a visible impact on retail prices. The duty reductions will fail to reduce prices at all if these are offset by increases in international prices. The second policy has the potential to destabilise the market if the marketing chain is disrupted in a misconceived drive to improve the efficiency of the chain. The third policy can improve the situation only in the medium to long term and hence not of immediately relevance. Hence, just about the only way some relief from the spiralling prices can be obtained in the short term is if there is a fall in international prices. This is not something that the government can influence.

The author is a professor of economics, University of Dhaka.