When it comes to explaining the recent hikes in the price of rice in the country, there are accusations flying around of rice hoarding by speculators.
Good, excellent in fact, because that is exactly the function that speculators perform -- they move prices through time.
Bilkis Irani of the Dhaka Tribune has been investigating the matter, and an excellent piece of reporting and research it is.
However, before we get up in arms in condemnation of speculators, let us think about what we’d like to happen in the event of a supply crisis.
Bad harvests and prices
Imagine that one of the harvests in a year is a little short. Rains didn’t come, or came too much, a pestilence arrived, maybe farmers just got it wrong, and we don’t have enough rice for all to eat.
At this point, we would want the price to rise.
Speculation can, in the extreme, prevent people from starving, which is a pretty good outcome caused merely by ‘greedy’ people trying to make a profit
A rising price has two effects, both of which aid in solving our problem. A higher price will encourage imports from areas which did not suffer from the problem, and thus increase supply so there is more rice to eat.
Those areas can be within country or outside. Transport costs will normally mean that we don’t move a bulky commodity around all that much but a higher price in a time of shortage means that we can.
In the face of the higher price people will also demand less rice. Not less food, overall, of course, but less of that specific type of food that we have a shortage of.
They may consumer more potatoes, wheat, sorghum, bread, etc to substitute for the fall in rice consumption.
Yes, obviously, for the truly poor, this can be a significant and serious problem and there’s a definite role for government in alleviating hardship so caused.
But look at what has happened as a result of the higher price: We have a greater supply as imported rice comes in from outside the affected area and the country. And we have a lower demand as a result of that substitution.
No change in price
Now think of what happens if there is no change in price following a bad harvest -- everyone continues to consume rice at the old rate, the one which assumes that there will be enough to go round until that next harvest.
Before long all supplies run out entirely.
Some people will have no rice at all to eat at some point in the indeterminate future. This is not a good outcome.
Our price rise is therefore not only justified, it is the very solution to our problem.
The role of speculators
This is also where the speculators come in.
If there is to be a shortage between or across harvests, then we actually need some people to be hoarding.
In fact, this is something that Adam Smith pointed out in his book The Wealth of Nations way back in 1776, long enough for us all to have come to grips with.
Let me explain: Speculators buy at harvest time at a low-ish price because the market is flooded with that newly harvested rice; they then store it at their own expense, in the hope of being able to sell it at a higher price during times of shortage.
This is exactly what everyone is complaining about, of course.
But look what happens: Their buying at harvest time increases the price then -- farmers gain more for their crop. When they sell again they lower the price.
Remember, if the rice price had not changed then there would be no rice at all just before the next harvest. But because of the speculation there is now some rice in the market instead of none.
Our speculators have moved the price through time. Instead of the price rising at the end of the stock of rice, just before the next harvest, it rose just after the harvest and is lower than it would otherwise be at the end of the stock.
This means that our imports, influenced as they are by the price, and our substitution, happen just after the harvest and not in a time of near starvation just before the next.
That, in turn, means that the price rises are less than they would be in the absence of the speculation, for we have the imports and the substitution for the entire period between harvests, not just in the last few weeks when there is no rice left at all.
Note also what happens if the speculators get it wrong. Imagine that they buy to store and sell at a higher price, but there is no shortage before the next harvest.
Well, the price doesn’t rise then, does it? They have paid for storage, invested their capital, but made no profit. If they really get it wrong then they’ll have to sell at a lower price than they paid. So, speculators lose money.
Speculators therefore do a favour to the market by taking on considerable risk and only making a profit if there really is a shortage. The very profit they make from their actions moves prices through time and thus reduces the size of the shortage itself.
Further, that very speculation reduces the size of the price changes themselves. All of this only happens -- the profits and the reduction in damage -- if there is a real shortage.
If there isn’t, then the speculators and hoarders lose money. The profit only happens if they benefit the rest of us, that is.
This is something that Adam Smith pointed out in 1776. It’s about time we all caught up with what is by now a pretty old idea.
In an open and free market, where supplies can be brought in from elsewhere in response to price changes, speculation is to our benefit.
It can, in the extreme, prevent people from starving, which is a pretty good outcome caused merely by “greedy” people trying to make a profit.
Tim Worstall is a Senior Fellow at the Adam Smith Institute in London.