Mealie Meal subsidy example
A lot of
people have been having trouble understanding the subsidy in simple terms so I
decided to break the ice here with a clear example.
A farmer has
two sons and a brother. Every day he wakes up before everyone and goes into the
field to work. Before he leaves, he gives his brother money for house
essentials and transport for the sons to school.
The two sons
go to different schools. One son is called “Biggie” and the other is called “Smalls”. Sometimes the money for house essentials and transport is
not enough and one of the sons has to walk to school instead of using
transport, Smalls usually walks while Biggie takes transport. Smalls ends ups
missing some of his classes because he is usually late.
Exam time
comes and Biggie passes while Smalls fails .The farmer asks the teacher why
this is so and the teacher tells him that Smalls misses some his classes and
comes late. He goes home and finds out that Smalls misses classes because
transport is not enough some times.
This is what
the farmer chooses to do. He removes the money he usually includes for
transport so that both sons walk to
school. He saves this money and goes into town to buy both sons quality textbooks.
At the next
exam both sons pass with good marks.
Now in this
story the Farmer is the Zambian
Government, the Brother is the Food
and Reserve Agency (FRA).The two sons Biggie and Smalls are The Big Millers and Small Millers respectively. The transport money is the subsidy
which sometimes only goes to the Big Millers. The teacher is the economist and the textbook is the
expenditure that Zambian Government
wants to use to build universities
and schools and hospitals.
This is not
an accurate example but is the closest by comparison.
Subsidy Explanation
After the
recent subsidy removal by the Zambian Government there has been massive
speculation that general prices in the country will go up and by extension
Inflation will go up.
Now this
article addresses those concerns with Inflation data from the last 5 months.
Just so we
are all on the same page firstly what is Inflation??
In
economics, inflation is a rise in the general level of prices of goods and
services in an economy over a period of time. When the general price level
rises, each unit of currency buys fewer goods and services (Abel &
Bernanke, 2005) .
The term
"inflation" originally referred to increases in the amount of money
in circulation, and some economists still use the word in this way. However,
most economists today use the term "inflation" to refer to a rise in
the price level. An increase in the money supply may be called monetary
inflation, to distinguish it from rising prices, which may also for clarity be
called 'price inflation' (Bryan, October 15 1997) .
The
Inflation rate is calculated as the change in the consumer price index. The
consumer price index measures movements in prices of a fixed basket of goods
and services purchased by a "typical consumer" (Mankiw, 2002) .
We must now
look at the fixed basket of Goods and services and their weights in the
consumer price index to find out the effect of the removal of subsidies in
Mealie Meal.
Now
according to the JCTI Basic food item basket which comprises of Foods like
Mealie Meal, Cooking Oil, beans, beef, eggs, Kapenta, tomatoes, onions,
vegetables and other essentials.
Mealie Meal
Mealie Meal
accounts for 14 % of the basic food item basket. A 7 % change in the price of
Mealie Meal would have a 1% change in the basic food basket.
In September
2011, the Government of Zambia started heavily subsidizing the price of maize
held by the Food Reserve Agency (FRA) to maize millers. The expectation was
that, by receiving maize at subsidized prices, millers would pass along the
subsidy to Zambian consumers in the form of lower retail maize meal prices
(Jayne, September 2012).
Retail maize meal prices have remained
virtually constant since September 2011. These findings indicate that very
little of the treasury costs incurred in providing FRA grain to millers at
below-market prices have benefited urban consumers
THE Millers
Association of Zambia (MAZ) says the removal of the subsidy on maize does not
necessarily mean that prices of mealie-meal will go up.
MAZ
president Allan Sakala says the removal of the subsidy will provide a
favourable competition in the milling sector and will create a positive impact
on the prices of mealie-meal.
Assuming all
things remaining equal the removal of subsidies will not change the price
Mealie Meal by any significant margin.
Fuel Subsidy
The Fuel
subsidy is however a different matter altogether.
This is a
graph of Inflation since the beginning of the year. My calculations lead to an
inference that the effect of a 15% percent fuel increase will lead to a
possible 1/10 or 1/5 of a percentage point. In other words the Inflation might
go up from 6.5 up to 6.7% in the short term.
In the more
medium term, that is, later in the year however Inflation might spike up
further as the poor harvest of 2012/2013 comes into price effect as well as the
effects of expected inflation and as I worry built in inflation.
The reasons
for this are as follows using the JCTI basic family basket expenditure. First
and foremost the Fuel increase will
directly affect the cost of production. This will create an incentive for
companies to pass that on to their consumers as a higher price, this may be
done gradually or immediately but the eventual effect will see more relatively
price inelastic goods absorb the price increases.
An example
of a price inelastic good is Mealie Meal. Price elasticity refers to the change
in demand of a good given a change in its price. Mealie meal is relatively
price inelastic because a change in its price will not change its demand by any
significant margin. This is for the reason that if the price of Mealie Meal
goes up, people will still buy Mealie Meal.
Secondly,
transport costs across the board will go up after the 15% increase. The
translation of this to a general price increase will depend upon the type of
goods sold and the distance covered to get them to their required destination.
Thirdly and
most worryingly is what is called in economics as Built in Inflation. In simple
terms what people expect Inflation or general prices to be in the near future
also matters, If they expect prices to increase this will have repercussions.
Built-in
inflation is induced by adaptive expectations, and is often linked to the
"price/wage spiral". It involves workers trying to keep their wages
up with prices (above the rate of inflation), and firms passing these higher
labor costs on to their customers as higher prices, leading to a 'vicious
circle'. Built-in inflation reflects events in the past, and so might be seen
as hangover inflation.
The Built in
Inflation I speak of will come into effect in September 2013.Let me explain
why.
Government
has increased salaries for civil servants with some getting as high as 200
percent effective September 1, 2013 (Lusaka Times, 2013) .The windfall follows
the successful conclusion of negotiations between Government and the Civil
Servants and Allied Workers Union of Zambia (CSAWUZ).
Other
benefits in the 2013 collective bargaining include the introduction of the
health personnel shift allowance at 15 percent of basic salaries for nurses and
other paramedics. The commuted night-duty allowance has been pegged at7%.
Transport
and housing allowances have been maintained at the existing rates of 10 and 20%
of basic salaries respectively. But given the Government’s recent hike in fuel,
workers have valid grounds on which to demand their transport allowances be
adjusted to absorb the Price hike, this I fear could cause the Vicious circle.
Solutions
Eleanor
Roosevelt said "It is better to light a candle than to curse the
darkness". I do not aim to attack the Zambian Government; all I wish to do
is give solutions to problems.
Problem 1
High price
of Fuel due to in Zambia compared to other countries due to losses in
• Feedstock Procurement to Dar es Salaam
• Comparison of CIF Dar es Salaam prices
paid by GRZ in 2008 & 2009 with reference (spot) prices shows over-payment.
‘The total “overcharge” vs good international practice was…..US$ 93 million
over the two years or 12.5% of total CIF costs
Solution 1
An agreement
is signed to purchase fuel (oil) using futures and options.
What is a
Future?
A futures
contract gives the buyer the obligation to purchase a specific asset, and the
seller to sell and deliver that asset at a specific future date, unless the
holder's position is closed prior to expiration
What is an
option?
An option
gives the buyer the right, but not the obligation to buy (or sell) a certain
asset at a specific price at any time during the life of the contract
Why will
this work?
Because the
Zambian Government has been procuring Fuel (Oil) at spot rates, in other words they
have been paying for what the price of fuel is at the time. This created a 5%
loss compared to other countries that use OMC at this stage.
Fuel prices change every day and
month, Options and futures reduce the risk of loss to such volatility.
References
Abel, A., & Bernanke, B. (2005). Macroeconomics
(5th ed.). In A. Abel, & B. Bernanke, Macroeconomics (5th ed.).
Pearson.
Bryan, M. F. (October 15 1997). On the Origin and
Evolution of the Word 'Inflation. In M. F. Bryan, On the Origin and
Evolution of the Word 'Inflation. Federal Bank Of Cleveland.
Lusaka Times. (2013, March 27). Civil servants
get pay rise. Retrieved May 22, 2013, from Lusaka Times:
http://www.lusakatimes.com/2013/03/27/civil-servants-get-pay-rise/
Mankiw, N. G. (2002). Macroeconomics (5th ed.). . In
N. G. Mankiw, Macroeconomics (5th ed.). Worth.
Jayne, A. N.
(September 2012). Is the Government of Zambia’s Subsidy to Maize Millers.
Lusaka Zambia: Indaba Agricultural Policy Research Institute (IAPRI).
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