Food Prices: Why are prices high despite production surpluses? by Kampamba Shula

1.1. Background
Government has challenged food security researchers to provide comprehensive answers for the continued high food prices despite having food surplus in the country.
Agriculture and Livestock Permanent Secretary Julius Shawa observed that the issue of food prices is complex and requires the involvement of all stakeholders.
During a policy dialogue meeting on food security and nutrition in Zambia organised by the Indaba Agricultural Policy Research Institute (IAPRI) and the International Food Policy Research Institute (IFPRI) in Lusaka, Mr Shawa noted food security had become more complicated with many issues that were cross-border and needed to understand the complexities in order to make strategic decisions.
“Our policy makers are asking why food prices continue to accelerate despite the surpluses the country has been recording lately,” Mr Shawa said. “Researchers and us as policy advisers need to look at that and provide answers.”
He noted that there were various issues that keep coming up regarding high food prices such high cost of production, marketing and that sometimes the blame goes to the middle men. Mr Shawa observed that researchers were key in provide the true findings because good decision making depended on solid evidence and rigorous information.
This paper is an answer to this call for comprehensive answers on the high food prices in Zambia.
1.2. Introduction
For all intents and purposes this article will mainly focus on the price of maize, even though prices of other food commodities have been rising. The reason for this is due to the apparent contradiction that a surplus in maize production coupled with higher prices has perplexed some of the policy makers. This paper will aim to shed light in this regard.
 
1.3. Review
Since 2009/2010 production season, maize harvests have been above 2.5 million metric tons each year
• Projected maize surplus between 2010 & 2012 was 4.4 million MT of which FRA purchased 83%
• Despite maize surpluses, there were widespread maize meal shortages & skyrocketing m/meal prices
The question that seems to perplex stakeholders is how could Zambia face maize shortages and high prices despite three consecutive bumper harvests, large subsidies to mills, and significant maize held by the FRA?
As its initial mandate, FRA was established to maintain national strategic food reserves
• After amendment of Food Reserve Act in 2005,
• FRA has become a major player in the maize market
FRA purchased nearly all surplus maize between 2010 & 2012
Because FRA bought more maize than what they could handle, there were greater levels of FRA maize spoilage estimated at 32% (2013 ministerial statement by MAL Minister). This loss translates to K2.5 billion - loss equals 60% Euro bond. Private sector loss is only about 5%
• Retail maize markets became thinly traded as many traders were forced out of business
• Informal sector squeezed out of market
FRA’s procuring nearly all surplus maize and selling it at subsidized rates to a few selected commercial mills squeezed out informal milling sector
Selected subsidies to large millers provided un-levelled playing field.
• Not all large millers received heavily subsidized grain
• Others lost market share and exited the market
• Concentration of the milling sector
Undermined competition as such mealie meal prices did not come down.
Because FRA purchased majority of the maize, commercial mills’ access to maize directly from the market became limited and this resulted into:
• increased risk of bottlenecks in maize supply chain
Exit of commercial farming sector from maize production
• Because large millers started waiting for cheap FRA maize, it led to loss of forward contracts with commercial farmers
 
1.3.1. Summary
Less competition within large-scale milling sector which resulted into concentration of the sector
• Shortage of maize and mealie meal on the market
• Informal traders and retailers squeezed out of the market
• Overall surplus diminished by spoilage/wastage
• Commercial farmers’ maize production declined
• Major cost to national treasury & big opportunity cost to investments in R&D, extension, irrigation & infrastructure
Total estimated loss to national treasury through FRA maize marketing from 2010 – 2012
Total estimated operating LOSS: total grain sold x average loss/MT = (2.5 x 1,680)
• 4.2 billion kwacha rebased
• Loss more than Euro bond
1.4. Who sets the price for Maize?
Determining an FRA purchase price is a complex matter as it affects a multiplicity of factors that influence the performance of Zambia’s agricultural sector. The sustainability of a maize farmer, however, depends on that farmer’s price competitiveness, both locally and on the regional export market. Issues of adoption of new agricultural technologies and public goods investments that will reduce costs – such as feeder roads, improved agronomic practices, more productive seed varieties, meaningful extension messages, and ensuring the availability of fertilizer at the appropriate time -- are critical for the future competitiveness and viability of Zambia’s farm sector.
The FRA purchase price has normally been below the Lusaka wholesale price. The FRA must incur transport, handling and storage losses associated with moving grain from the outlying production areas to urban areas. As long as the FRA selling price to millers reflects these marketing costs, its selling price will be higher than its buying price. Hence it is unsurprising that the FRA purchase price should be set below the price in urban markets (otherwise its selling price to millers and other buyers would be uncompetitive compared to grain sourced by private traders). Therein lies the problem and effectively, the loss.
A major topical issue that can be informed with accurate production cost estimates is the price offered to farmers by the Zambian Food Reserve Agency (FRA) each year. The FRA sets its maize buying price each year to compensate farmers for the costs incurred during production and provide a reasonable return to their own land, labour, mechanical, and animal inputs. However, the setting of FRA’s producer price has never benefitted from national farm survey evidence on production costs. Rather, illustrative figures are provided by various stakeholder groups to lobby and influence the setting of FRA purchase price levels (Burke, Hichaambwa, Banda, & Jayne, 2011).
A key observation by a report done by (Burke, Hichaambwa, Banda, & Jayne, 2011) is that the FRA pan-territorial pricing policy does not reflect the wide geographic differences in costs and even among farmers in the same village. Geographic variation in production costs follow differences in agro-ecological suitability for maize production and input costs. The average production cost per bag in 2010 varied from as low as ZMK 34 in the Eastern and Northern Provinces (representing 35% of national production) up to ZMK 53 in the Copperbelt and Western Provinces (10% of national production). Within-village production cost differences arise due to differences in farmer ability and knowledge and the various management decisions they make.
These sources of variation result in a wide range of production costs in Zambia, which leads to the conclusion that there is no single “cost of maize production”. There is only a distribution of production costs across the millions of maize farmers in Zambia. This analysis reports the range of production costs for all maize farmers surveyed in the 2010 Crop Forecast Survey. The most productive 20% of farmers in the 2010 CFS produced maize at a mean of ZMK 15.567 per bag.
The next most productive 20% of farmers produced maize at ZMK 29.078 per bag. Mean production costs for the third and fourth quintiles of production costs were ZMK 42.776 and ZMK 64.341 per bag, respectively. The least productive maize farmers’ production costs were well over ZMK 100 per bag, which in many cases likely reflected unexpected events leading to partial or near total crop losses. In such cases, production expenses are extremely high when.
The wide variations in production costs per bag are due to variations in farmers’ production costs per unit of land planted, but especially due to variations in farmers’ yields.
The second key observation from the analysis of 2010 production costs is that 86% (2.06 million MT) of Zambia’s total maize output was produced at a total cost lower than the ZMK 65 FRA buying price. The mean cost of production per bag was ZMK 40.739. Cash expenditure on inputs per bag was ZMK 18.630 on average.
Thirdly, the majority of Zambian maize could be sold at a profit competitively in regional markets. At the beginning of the 2010 harvest season, the export parity price (the landed cost of maize in Lubumbashi, Democratic Republic of Congo (DRC), minus transfer costs from Kabwe to Lubumbashi) was roughly ZMK 59. Meanwhile, 1.8 million metric tons of Zambian maize was produced at costs lower than 50 ZMK/bag. It was found that smallholder households selling or expecting to sell maize produced maize at somewhat lower costs than the average (roughly 38 ZMK/bag). Among this group, 76-82% of the maize produced could have been competitive in regional export markets.
Fourth, there is a strong correlation between higher yields and lower costs of production. This is not surprising. Clearly, a key factor in increasing Zambian maize producers’ comparative advantage in the region will be the promotion of productivity enhancing technologies and agronomic practices.
Rural smallholder production remains highly labour-intensive. On average, family labour accounts for 62% of the total cost of maize production in Zambia’s small- and medium-scale farm sector. Promoting the identification and adoption of practices and technologies that save labour and /or identifying labour-productivity-enhancing technologies through research and development will therefore help to make Zambian maize more competitive and allow farmers to maintain profitability even at lower producer prices.
 

1.4.1. High Maize Price
Truth be told, Zambia’s agriculture sector revolves around maize, never mind the growing of other crops and livestock. The bulk of the maize is grown by peasant farmers who are faced with regular droughts during the rainy season, an unreliable and expensive supply of fertilizer, and difficulties transporting the commodity to markets.
In 1986, Zambians in the Copperbelt and Lusaka regions rioted because the price of maize increased several fold when incomes were stagnant. Four years later, unrest over price increases even sparked a coup attempt.
High maize prices disadvantage many poor rural households Research results indicate that, unfortunately, the majority of households in Zambia, both rural and urban, are not sellers but buyers of maize.
Moreover, the rural poor in Zambia tend to be buyers of maize. Hence, a rise in the maize price surface to ZK 85 per bag would have adverse income distributional effects by transferring income from the majority of the population in Zambia who are relatively poor net maize buyers to large commercial farmers and to about 25% of the nation’s smallholder households who sell relatively small amounts of maize.
In perfectly competitive markets, prices in the domestic country are fully determined by international conditions. Therefore, price setting does not involve any local factors, such as cost or market structures (Dreger & Kholodilin, 2007). From the perspective of consumers an equal amount of money could buy the same bundle of goods and services at home and abroad.
1.5. Imports and Exports
The importance of import prices it is also expected that the FRA purchase price should be lower than the cost of importing grain from South Africa. This has indeed been the case for each year that the FRA has set a purchase price since 2005. As long as the Government of Zambia tries to keep maize prices in the country below import parity levels, the FRA’s buying price will be below the landed cost of imports.
The surplus crop of maize achieved in recent years presents an opportunity to export value added products to the region, thereby increasing demand for the local produce, which will in turn raise the maize prices for the farmers (Cottan, 2006).
DRC has the largest export potential, but lack of signed bilateral trade agreements between Zambia and DRC is restricting the formal flow of exports. The estimated population for the Katanga province including Lubumbashi is 9.5 million.
However, there is very stiff competition mostly, mainly from South Africa and Tanzania for both Maize Meal and Wheat flour. The Zambian millers should therefore find ways and means to minimise the cost of production in order to remain competitive on the export markets.
 

1.6. “Price Floor”
A “price floor” is a government- or group-imposed price control or limit on how low a price can be charged for a product (McGraw-Hill, 1994). A price floor must be higher than the equilibrium price in order to be effective.
A “price floor” set above the market equilibrium price has several side-effects. Consumers find they must now pay a higher price for the same product. As a result, they reduce their purchases or drop out of the market entirely. Meanwhile, suppliers find they are guaranteed a new, higher price than they were charging before. As a result, they increase production.
Taken together, these effects mean there is now an excess supply (known as a "surplus") of the product in the market to maintain the price floor over the long term.
1.7. The Dilemma
The government has finally announced the maize “floor price” of K70 per 50 Kg bag of maize. Maize, Zambia’s staple food is grown by over 2.7 million agricultural households. The crop is not only used as source of food but is a source of income for many of the rural households. The income obtained from maize sales enables the families meet other basic necessities for livelihood and provides the resource needed to purchase inputs for the upcoming agricultural season.
According to (Nguleka, 2014) it is important to consider the economic conditions that farmers face especially in view of the fact that the floor price was last revised in 2009  (6 years ago). Taking inflation as the starting point, the prices of most goods and services in Zambia have continued to rise, with the magnitude of the increment varying from month to month and year to year. As mentioned earlier, the maize floor price has been static from 2009 at ZMK65/50Kg bag which means that while the prices of commodities that farmers face just like any other consumer has been rising the incomes of farmers remained unchanged. Looking at the inflation statistics below, the floor price was eroded by 36.6% from May 2010 to May 2014.  Had this taken into consideration, the maize price would have ranged from K70.79 in 2010 to K92.26 in 2014
Furthermore the costs of major inputs such as fertilizer and seed have been increasing. Fertilizer prices have risen by about 25 percent from ZMK160/50Kg bag during the 2009/10 agricultural season to about ZMK200/50Kg bag in the 2013/14 agricultural season in Lusaka. In other parts of the country, further from Lusaka, the prices of fertilizer are even higher.  The price of seed has also risen from about ZMK120/50 kg bag in 2011 to ZMK310/25 kg bag in 2013.
Other cost centres that should have been considered are;
The cost of fuel was adjusted upwards in April this year by 7.22% on petrol, 8.75% on diesel and 9.54% for kerosene. Increase in the price of fuel immediately raises the cost of transportation for the maize from farm gate to the market and the cost of transporting inputs onto the farmsteads.
The depreciation of the Kwacha drives upwards the cost of all imported farm requirements such as packaging bags, insecticides, fuel, etc.
Interest rates have gone up. The emergent and small scale farmers who have pushed up maize production get seasonal loans through a group lending scheme, the Lima Credit Scheme by depositing 50% of the value of the inputs as collateral to get double the value of inputs. Since last year the policy rate has been adjusted several times upwards and since April it is at 12% hence the cost of money has gone up hence commercial banks’ lending rates have gone up signalling a rise in seasonal finance costs in future.
Maize production is labour-intensive and wage related costs have gone up from ZMK12.200 to ZMK19.03 per man-day.
The general cost of doing business has gone up, the most recent is the increase in electricity tariffs which went up by 5.11% on large power MD3 /MD4 customers to 24.63% the highest on residential consumers. Small power MD1/ MD2 customers and Commercial consumers face an increase of 19.49% and 15.38% respectively while consumers falling in the social services bracket will face a 15.38%. Now since farming has different sizes of farmers falling in different electricity consumption groups what is not in dispute is that most farmers are faced with a double digit increase of 15.38% to 24.63% in the cost of electricity.
 Besides all the factors listed above, it is important to recognize that during the year, new fees/charges were introduced by some local council including toll fees on some main roads meaning that transporters will be adding all these costs to the cost of inputs. And for now since maize marketing is taking place, these costs will reduce the price paid to the farmer making farmers poorer and discontented. Therefore, the FRA floor price has an important bearing on the price that other traders pay the farmer.
At farm level, the rising costs of inputs means that a farmer producing maize at a yield of 2.26 Tons/ha which is the national average yield in 2014 requires a price of at least ZMK83/50Kg bag of maize grain just to break even without considering the fixed cost of production.  A price of ZMK108/50Kg bag of maize grain would make economic sense if the fixed costs were considered as well.  Some districts recorded yields as low as 1.5 tons per hectare, implying that farmers in such districts would need a price of at least ZMK159/50Kg bag to break even.
The inadequate return on the maize affects the productivity of small-scale farmers as they are forced to use less and less of the recommended inputs which reduces the yields even further.  This year, a national average yield of 2.26tons/ha of maize for small and medium scale falls way below the yield potential of hybrid maize varieties currently available on the local market.
Therefore, the maize floor price of ZMK70/ 50 kg bag announced is a source of misery because to a farmer in Kaputa with a yield of just 2tons/ha for a maize crop which cost over ZMK4, 700 per hectare to grow and whose breakeven price is K118.70 for a 50 Kg bag is a total disincentive especially that a fellow farmer in Zimbabwe is getting a price equivalent to ZMK119/50Kg bag (US$390/ton).  This will discourage farmers to continue growing maize because the price does not allow a farmer to cover the variable cost of production. It should therefore not come as a surprise that the yields will continue to remain low while farmers remain poor.

The farmers of Zambia have remained committed to producing the much needed food for the entire Zambian population and this has been demonstrated by the continued positive food balance sheet the country has enjoyed over last six years.  It is rather disappointing and difficult to comprehend that farmers should to get an upward adjustment of only one ngwee/kilogram as a reward after working so hard to produce a bumper harvest and more so after waiting for so long since 2009 when the price was last adjusted.

1.8. Analysis
Let us first understand that price floors are only an issue when they are set above the equilibrium price, since they have no effect if they are set below market clearing price.
Now here is the issue. FRA sets a “floor price” of K70 per 50kg bag. Then the FRA buys ALL the maize from farmers at that price. FRA then sells this maize to millers who in turn place their mark up and sell to end consumers.
It must be noted that the control that FRA places on the maize price is a PRICE CEILING and not a price floor. These two terms cannot be used interchangeably because they mean two different things. So as long as the Zambian government regards the price ceiling as a price floor, then policy direction on this issue will be misguided.
Now one might ask why it should be called a price ceiling instead of a price floor. The reason lies in what exactly is the effect of the actions of the FRA. Let us break it down, FRA “recommends” a price at which farmers should (I use this term loosely) sell their maize to FRA. Now the farmer has two options, he can either sell his maize lower than the price at which FRA sets to other “briefcase” dealers or he can endeavour to sell it at a price higher than what the FRA sets. Selling maize lower than the FRA price is possible but selling higher is impossible because any other dealer would not pay for maize at a price higher than what the FRA is paying. This is the reason this is a price ceiling and not a price floor because it prevents farmers from selling at a higher price but allows them to sell lower at a disincentive of course.
A price floor can only be effective if it is above the equilibrium price level. Factoring in inflation and other costs of production which have increased since the last time the “price floor” was set in 2009, the equilibrium price is actually higher than the price FRA sets. This means FRA is actually setting a price ceiling rather than a price floor. Which means whilst they might believe they are helping the farmers in an effort to keep prices low and protect consumers they are actually hurting farmers.
Now what does this mean effectively? The logic for having a price floor and a price ceiling by government are very different. The main reasons why a lot of government will try to fix the prices of a commodity below a certain limit is that they want to protect consumers from exploitation by suppliers. However the effects of prices control can hurt the economy if it is carried out for long periods without adjustments. If the government continues to impose the price ceiling the supply will continue to reduce hence negatively affecting that sector (This is seen by the increase in disincentive of some farmers to farm maize). The government should therefore not impose policies to protect consumers from exploitation when the real problem is undersupply not exploitation.

Apart from having a price ceiling, the maize market in Zambia is dominated by millers who purchase maize from FRA and resell to consumers. These millers have not always passed on price cuts to consumers (as was evidenced by the unsuccessful subsidies on grain programme).
With the presence of FRA in the maize market there are effectively three mini markets which make up the whole maize market.
The first market is a closed market with occasion intruders between Farmers and FRA. This market is occasionally intruded by briefcase dealers looking to buy from farmers at a low price and sell to FRA at a higher price. This is the market in which FRA sets a price ceiling which it unfortunately mistakes for a price floor.
The second market is the market between FRA and Millers. This was the market in which the subsidies where introduced. FRA would sell subsidized maize to millers in this market but millers never passed on the cost saving to consumers.
The final market is the one between Millers and Consumers. This is the market in which the ordinary person buys the mealie meal which the take home and consume.
If the market was liberalised this would be a two way market, one between farmers and millers and one between millers and consumers. But this is not the case. What is happening is that government is actually setting a price ceiling in the Farmer-FRA market and a price floor in the Miller- Consumer market. What government intends to do is actually set a price floor in the Farmer-FRA market and a price ceiling in the Miller-Consumer market.
This is distortion of policy is what is creating the illusion that higher surpluses will translate to lower prices while the market dynamics between the three mini markets do not support such an assertion.
There is always a trade-off. Government will have to decide an appropriate way to address the welfare of consumers as well as households who make their income from maize. But to do this Government will need to see the maize market for what it really is, a three tier market with little homogeneity formed into one. Under these market dynamics production surpluses will not translate into price decreases due to the inherent difficulty in such a market structure.

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Cottan, P. (2006). PROSPECTS FOR REGIONAL . Lusaka: Millers Association of Zambia (MAZ).
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McGraw-Hill. (1994). Economics.
Nguleka, E. (2014, June 24). Zambia National Farmers’ Union- Press Statement On Maize Floor Price. Retrieved September 15, 2014, from http://www.znfu.org.zm/: http://www.znfu.org.zm/article/zambia-national-farmers%E2%80%99-union-press-statement-maize-floor-price