Starting from October 15, Georgian consumers have to pay about 5-10 tetri more for one loaf of bread. Many large producers increased their prices; smaller bakeries (“tone”) followed suit by either raising the price or reducing the weight of the traditional Georgian bread. While unpleasant, this change in the price of bread is nothing but a forced reaction to a sharp increase (25%) in the price of wheat in the global commodity markets dating back to July 2012. The question, therefore, is not why bread and flour prices increased. Rather, it is why these politically sensitive prices increased only now, with a three-four month delay.
This is the right question to ask because, like other small economies, Georgia relies on imports to provide many basic commodities, including wheat, rice, sugar, soya beans, etc. Typically, any changes in the prices of these commodities are very quickly passed onto food prices in Georgia. For instance, global wheat prices were on a downward trend from May 2011 till May 2012, triggering a parallel reduction in the domestic prices of wheat and flour (see chart). For much of 2010 and early 2011, we have seen the global and domestic wheat prices dancing tango in the opposite direction, reaching a peak in May 2011.
This parallelism came to an abrupt end in June 2012. Global prices shot up by more than 30%. Domestic prices stayed put. Until October 15.
What happened? How could producers resist the global price increase until October 2012? Has there been any fundamental change in the Georgian wheat market?
No, there wasn’t any.
Georgia currently imports about 70-80 thousand tons of wheat and flour every month, providing about 80% of total consumption. If anything, in the three months since June, Georgia has become ever more dependent on imports of wheat and other commodities as a result of unprecedented growth in tourism. For instance, wheat imports reached more than US$32mln in August compared to US$16mln in January 2012 (increasing from 3.3% to 4.7% of total imports).
One possible explanation of this puzzle is related to the theory of so-called “Political Business Cycles” (PBC) in economics. Economists have long observed the tendency by incumbent governments to “stimulate” the economy just prior to an election. Such politically motivated “stimuli” produce popular results in the short run (new roads and bridges, public sector jobs, price reductions, tax cuts, etc.). Yet, if pursued to excess, these very policies may have very unpleasant consequences such as inflation, accumulation of public debt, or depletion of foreign currency reserves. Needless to say, the task of cleaning up the Augean stables – rebalancing the economy and fixing bridges built to an election deadline – typically falls to the new government. Hence the rationale for the PBC, and the boom-and-bust pattern they induce.
Comments
I believe there is a missing link in what I read. Tax cuts, public job programs and infrastructure building are all directly controlled by the state. Can you tell the readers more about how the government could prevent the pass-through of the price increases to the domestic market? Is the wheat market controlled by the state?
A very good point, NP! There is a missing link here.
I cannot answer your question but know how I would start exploring it. First, I would look at the number of companies that import flour to Georgia, companies that do the local packaging, and companies that control the distribution channels. If the number of companies in each of these vertically related activities is not very large, I would ask myself how these companies are related to each other. It may be the case that there is, in fact, one vertically integrated company that controls the lion's share of the market. If that's the case, I would try get an idea who the owners of this company are and how they are related to the government. There are two options in the cards: 1) the owners are UNM sympathizers ; 2) the owners were "asked" to persevere a few months, until after the elections...
Importantly, if the company in question controls a large enough share of the market, its (monopolistic) pricing policy prior to the rise in global prices could be such that persevering a few months was not a problem...
These are just hypotheses at this stage, since I don't know the facts.
Thank you for your comment NP. You are right, it say nothing about how the government could prevent the pass-through of the global prices. I think this is another topic, where we can talk about the reforms in agriculture, which might reduce the dependence on global prices through reducing imports of agricultural products. Even though, I don’t think that Georgia has comparative advantage in wheat production.
The main point was just to underline that price of bread should have been gone up in late summer this year, and not after the elections. None of the factors indicate improvements of local wheat markets, therefore I believe that previous government artificially kept prices low.
Two comments. From what I have seen in the literature it's normal that global wheat prices are not immediately transmitted to domestic prices. One rough figure is that it takes around six months for half the international price hike for cereals to be transmitted to domestic prices. See http://ideas.repec.org/p/got/gotcrc/125.html.
The other comment is about the choice of January 2011 as a starting point for the graph. It's an unfortunate if not misleading starting point, as in January 2011 world wheat prices reached a new, higher plateau, after relatively low wheat prices between 2008 and 2010.
Michael, one has to look at the historical pattern of price transmission in Georgia (not the average in the "literature" or elsewhere in the world) to understand how fast (or slow) it is. The speed of transmission depends on the local market structure and local political economy conditions, and has to be analyzed strictly in the local context.
We have been studying this transmission mechanism in Georgia for the past four years, not since January 2011 (essentially, ever since we started collecting flour prices in August 2008). The data suggest that Georgia has been experiencing VERY fast transmissions from global prices, the fastest in the region. We have presented the data and written about this interesting phenomenon in a number of blog posts and Khachapuri Index columns in the past.
Another interesting aspect of the Georgian flour and bread market, is that it "equilibrates" at a much higher price than those in Armenia and Azerbaijan. That's also quite consistent with the "elections effect" hypothesis (see my response to NP to understand why).
PS. Your point about the unfortunate choice of January 2011 as the starting point is not clear. So what if prices reached a new plateau in January? We can redo the chart, going all the way back to August 2008. Would this change anything?
But this fast transmission mechanism is not apparent from the graph presented. If anything the graph shows that prices are much smoother than international prices, and that international price changes are not always translating into domestic price changes.
It would be great to see the chart all the way back to August 2008. Maybe that provide evidence for the hypothesis advocated in this blog post. The graph in this blog post in this blog post does not.
You are right. It is not apparent from this particular chart. We need to show previous episodes of prices hikes in the global commodity markets and how quickly they were transmitted to the Georgian market. We might even have enough observations to run a little regression...
Regardless of this exercise, would you agree, however, that having 0 transmission (local prices staying flat) for three months, which happen to correspond with a record high peak season in tourism (huge increase demand) does suggest that something is fishy here, would you?
I did run the regression using monthly data from Jan-2006 to Sep-2012. I tried to explain local wheat flour index by FAO Cereal Price Index and its lags. the only significant explanatory variable was the same month index and non of the lags. I have not played with econometrics much, but looking at longer time series data, it is obvious that price transmission from international to Georgian market takes less than month.
There is usually a reason one plays with the econometrics, but regardless.... let's assume for the sake of the argument one assumes that price transmission is almost instantaneously in Georgia. Then this would indicate that the wheat market is competitive, making it hard to artificially depress prices.
Michael, what makes you think that instantaneous price transmission is an indication that the flour market is competitive?
Wholesalers typically hold stocks, and don't have to buy all the time. They can run down their stocks if they think that the market goes crazy in a particular month or week. This is one source of delays in price transmission. The larger the stocks, the longer such delays.
Now, in a non-competitive market, a monopolist can use price signals from the global markets to raise domestic prices regardless of the size of his stocks (and he can raise them quite a lot given how inelastic flour demand is). This would not happen in a competitive market. The first guy to raise his price would not be able to sell.
Is your microeconomics textbook saying anything different?
Actually, while I cannot offer a formal proof, my hunch is that in equilibrium a monopolist would hold smaller stocks relative to sales volumes compared to retailers operating in a competitive market. If true, this would be yet another reason to think that price transmission would be faster (at least when going up) in a monopolized market.
A competitive market should be better at adjusting to lower global prices. Yet, a monopolist may be "convinced" to adjust as fast if not faster.
http://www.youtube.com/watch?v=ClcBrQGVbmw&feature=g-upl
Using an American John Deere no-till planter in Georgia last week in Imereti.
The main issue is not the delay in the price hike but the need to import so much wheat in a country that has the capability of growing it's own grains efficiently thereby protecting it's balance of payments and foreign currency reserves.
But, David, there are lots of things Georgia could produce and is not. Why wheat? While not let Ukraine produce wheat and focus on something else?
My comment on the following quote: "Georgia has become ever more dependent on imports of wheat and other commodities as a result of unprecedented growth in tourism. For instance, wheat imports reached more than US$32mln in August compared to US$16mln in January 2012 (increasing from 3.3% to 4.7% of total imports)". Personally I do not think that increased demand by tourists was a reason. Indeed, Georgia mainly trades with Russia and Kazakhstan. Harvesting period starts in July (Russia) and September (Kazakhstan). During this period, prices are cheapest due to increased supply on the wheat market. One of the biggest wheat trading company reported to me (personal interview) that most transactions are held during July-October. As to the other months, wheat is of course traded (as it is visible from this article) but with a less volumes.
P.S. In addition, winter time is not suitable for trade as wheat from Russia is imported via sea transport (from Azov sea ports to Poti port). Traders often need to use ice-cuter ships, which is an additional cost of transportation.