Efficient Policies That Offset Market Failures

In the absence of market failures, all commodity price policies are distorting because they result in losses of efficiency for producers, consumers, or both. When product and factor markets operate efficiently and thus determine prices that reflect fundamental scarcities in an economy, no price policy can improve this already efficient outcome. But if some markets do not generate efficiency (social) prices, efficient government policy can intervene and correct the market failure. Ideally, the government should attempt to use the policy instrument that most directly offsets the divergence and thereby creates the largest efficiency gain.

Some of the most common efficient interventions are attempts by governments to control the movements in the domestic prices of principal food staples. In perfectly competitive conditions, insurance or futures markets are assumed present, so that producers can buy any desired amount of protection against instability. But in developing country agriculture, such markets almost never exist, and governments intervene directly to stabilize prices. Successful price stabilization can reduce price risks in agricultural production, guarantee stable markets, and obviate the need for costly adjustments by both producers and consumers to fluctuating prices and profits. These efficiency effects are also supplemented by the impact of price stabilization on nonefficiency objectives. Food price stabilization permits governments to maintain control of a critical parameter affecting the production decisions of farmers, the real incomes of urban consumers, and the nutritional status of the poorest people.

Indicators of success in stabilizing domestic food prices are sometimes available within the PAM framework, but only if the PAM data have been collected for a number of consecutive years. The purpose of stabilization is to hold the domestic price within some desired range irrespective of movements in the world price. Some countries attempt to follow expected world prices and to reduce domestic price variation relative to that found in the world market. Successful stabilization requires keeping the domestic price within the targeted range by supporting the floor price to producers through purchases of crops and holding the ceiling price to consumers through injections of food stocks. Performance can be gauged by the contrasting of movements in actual intra-year prices with those in the targeted range. Over time, the impact of the stabilization program can be found by comparison of the variation of domestic consumer and producer prices with that of world prices. Stabilizing effects of domestic stock policy can be identified if the variation of real (inflation-adjusted) domestic food prices is less than that of real international prices. Price stabilization policies entail costs for accumulation, storage, price monitoring, and distribution of a food commodity; and the calculation of these costs facilitates judgments of policy success.

Market failures can also be associated with commodities that create externalities, such as pollution and congestion. Such failures are often difficult to identify and measure accurately. Price policies sometimes over- or undercorrect for divergences because of these information problems or because the policies are aimed mainly at nonefficiency objectives. Only rarely are corrective policies targeted explicitly to particular market failures. As a practical matter, therefore, PAM analysts can only approximate adjustments in the net policy transfer (L) to show the effects of efficient policy. Under conditions of complete efficiency, all price policies would efficiently offset all market failures, and the residual distorting policy transfer (L) would be zero. But information sufficient to permit the realization of this ideal policy outcome almost never exists.