How Pakistan’s sugar industry extracts rent

Published in The Express Tribune, May 8th, 2020.

Co-authored with Dr. Adeel Malik.

While an inquiry on the sugar sector has been made public for the first time, the crisis that necessitated this inquiry is a recurring feature of Pakistan’s sugar industry. Rattled by a controversy every 18 months, why is the sugar industry so prone to crises?

To answer this, we must use a basic principle of political economy: rent-seeking. Imagine this: you want to open a restaurant, but there is a lot of competition. You want to make more money but other restaurants, serving better food at cheaper prices, keep opening up. Along with other restaurants, you lobby the government to require all new restaurants to have a new licence to operate. The government sets up a special committee to issue these licences. You convince them to put you or your friends on this committee and ask them not to issue new restaurant licences. The supply of new restaurants goes down, allowing you and other existing restaurant owners to capture the market. The money you make now isn’t profit, they are rents.

Rents are fundamentally exploitative: it implies that the business is making more money than it would otherwise in a competitive, fair market. They are rigging the game in their favour. This is how our sugar industry works: through administrative actions rather than the standard rules that govern a functioning market. Let’s consider three questions to illustrate this point.

First, who can open a sugar mill? You can’t unless you are politically connected and able to obtain a licence from the government, granted under the provincial Sugar Factories Control and Sugar Licensing Controlling Orders. Punjab has an outright ban on new sugar mills, in effect since 2003. Existing owners have used their political connections to path a way around it: rather than establishing new mills, many existing sugar mills have successfully sought permission to set up their “branches” in other regions.

The result of this has been a high degree of concentration of the industry in the hands of a few — nine families own more than half of the country’s sugar mills. And, six industrial groups control half of the total national production. Three of these six are owned fully or partially by a current (or a former) member of parliament, who sit on all sides of the political divide. One is a member of the current federal cabinet, the second is a member of the cabinet in all but paper.

Second, how are sugar prices determined? Normally, the price would be determined by the interaction of supply and demand i.e. how many people want to buy sugar and how much sugar can be produced in a country. Since the demand for essential food items, such as sugar, is relatively inelastic (large price increases have little effect on demand) and predictable (for example, demand increases during Ramazan), what happens on the supply-side is more important for sugar prices.

One key determining factor in sugar price is the minimum support price that is guaranteed by the government to sugar growers every year to shield them from income and price fluctuations. These support prices have increased by three times during the past decade and are typically negotiated between millers and sugarcane commissioners who are provincial civil servants. The second is the recovery rate or the amount of output that can be recovered from a typical length of sugarcane. These are declared by sugar mills. As indicated by the sugar inquiry report, the recovery rates are typically unverified. Even mills in the same region and using the same variety of sugarcane document different recovery rates.

Another factor that impinges on the supply of sugar is when support prices are announced and when mills start the crushing period. The former determines the incentives of the farmers to grow sugarcane and the latter influences the available sugar stock in the market. Both decisions are routinely delayed in ways that benefit sugar mills. Given greater bargaining power and control over the state’s administrative machinery, the millers exert a disproportionate influence on how sugar prices are determined.

The industry also benefits from a formal lobbying group, the Pakistan Sugar Mills Association (PSMA). When, in 2010, the Competition Commission of Pakistan launched an inquiry into the sugar industry, the PSMA earnestly went to the court and got a stay order, derailing the inquiry. Cleary, the fuel which runs our sugar mills is not competition. It is extraction.

Third, are there any special privileges provided to this sector? There are more than we can count, including high import barriers through tariffs and regulatory duties which restrict competition from foreign producers. But, the clearest privilege is export subsidies: when global sugar prices are surging or there is an excess stock for sugar available, sugar producers not only get permission to export but also get subsidies to do so. This export of sugar is typically followed by a drawing down of the national sugar stock, creating the perfect conditions for a price rise in the domestic market in the following season.

Unproductive rents harm all of us but benefit a few well-placed people who use political connections to restrict competition and extract benefits from the government. How much does it cost all of us? Between 2006 and 2010, calculations done by one of us estimate that Rs585 billion was transferred from the pockets of ordinary people to the sugar industry. This is likely to be much higher when we consider the costs of broader misallocation this creates in our economy. Another implication is that Pakistani farmers are moving away from cotton to growing water-intensive sugarcane. In 2010, this resulted in $1.4 billion in terms of lost exports of cotton.

Over time, this rent-seeking has been institutionalised — whichever party may be in power, the underlying vested interests remain the same. In an efficient economy, firms compete with each other fairly, lowering prices, innovating, and upping quality. Firms which can’t, fail; people who work in them move to other, better-performing firms. Ask yourself this: when did the last sugar mill collapse in Pakistan? Take the protection and subsidies away and see what happens.

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