Spurious Argument on Prices

On occasion, it has been said that a reduction in real price incentives for agriculture is a healthy effect, since it is presumed to stimulate improvements in the sector's productivity. It is true that policy should encourage productivity increases, because in the long run the standard of living of farming families depends strongly on agricultural productivity. Nevertheless, in countries in which yields and total economic productivity are low in agriculture, often it is found that agricultural profit margins are already very low, and thus producers would not have the capacity to make the investments required to raise productivity - and banks will not lend to them for that purpose either when rates of return are low.

The argument that the economic screws have to be tightened on agriculture is flawed in two other respects. First, if it is beneficial to reduce real prices and returns, why is not the same policy applied to other sectors, including banking services, insurance, advertising, legal services and so forth? Secondly, if reducing real prices is an effective medicine for the sector, where is the dividing line between a healthful dose and an overdose which may kill the patient? Is it a reduction of real prices by 25%, by 50%, by 80%, or by another magnitude? Answers to these questions have not been provided in any country - a fact which indicates that the argument lacks a foundation.

This contention that a policy to lower real prices for the sector necessarily stimulates productivity improvements rests on confusion about the effects of competition. When a new firm with lower costs enters a market, it brings with it an improved technology (whether in management, marketing or production itself) which provides the basis for reducing output prices. With or without the new technology, existing firms will be forced to reduce prices as well, and those that survive are likely to adopt either the new technology or some other improved way of doing things.

In the words of Christopher Adam, 'a contestable market is one in which any firm is constantly exposed to actual or threatened competition from more efficient producers who can enter the market easily, undercut the incumbent's price and acquire market share. The threat of this profit-reducing competition is thus the spur to efficient operations by all firms in the market'.1 This is the mechanism by which competition reduces prices, and it should be noted that in agriculture the entry of new producers is particularly easy, as compared with some other sectors.

However, a real price reduction imposed on the sector from the outside (by policy), instead of through competition, does not bring with it the technological basis for producing at lower cost. Hence, it does not function in the way that a competitive market does to reduce costs. In fact, the price reduction makes more difficult the adoption of technological improvements, since it reduces the capacity of producers to finance such improvements. Granted, some firms may manage to stay afloat under an externally driven price reduction, but innovations may arise equally, or more so, out of the normal workings of competition in the sector, without an imposed price reduction. In addition, under the externally generated fall in real prices, some firms that could have survived may collapse economically. In a context in which most of the 'firms' are in fact low-income rural households, the equivalent of collapse is deeper impoverishment.

The studies mentioned in Chapter 1 have shown conclusive evidence that a policy of reducing real agricultural prices leads to slower growth not only in the sector but also in the entire economy.

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