WHERE IS THE FREE LUNCH?

WHERE IS THE FREE LUNCH?

The FINANCIAL -- An average Georgian household spends more than 40% of its budget on food. It therefore stands to reason that Georgian consumers are quite sensitive to food prices, which may be very good news considering recent developments in global commodity markets. According to the latest World Bank’s Food Price Watch, “international food prices declined by 14% between August 2014 and May 2015, sliding into a five-year low.” For lower-middle income households this could result in a 6% increase in disposable income, allowing households to spend more on other consumption items and invest e.g. in the education of their children.

But how much of this potential windfall does actually translate into lower prices for ordinary Georgian consumers? The answer to this question is, unfortunately, complicated. It is complicated because imported food commodities are priced in a foreign currency and when the price of that currency (in terms of Georgian lari) increases, so do consumer prices, in spite of positive winds blowing from the global commodity markets.

ISET’S FOOD PRICE INDEX AS A MEASURE OF PRICE TRANSMISSION

A good starting point for our analysis are the data on retail food prices which are being collected on a weekly basis since November 2011 by ISET’s Agricultural Policy Research Center. These data capture the movement of retail prices for 34 standard products (accounting for 75% of average household food spending) in Tbilisi’s largest supermarket chains: Carrefour, Goodwill, Fresco, and Spar.

To see how the reduction of global prices “transmits” (or not) into lower domestic prices we look at movements in the overall Food Price Index which we constructed using this data (applying appropriate weights) as well as any individual products on which the Index is based. Importantly for our purposes, for each product we monitor the prices of both domestic and imported varieties.

If we take a standard commodity, such as sugar, two trends can be discerned in our data. First, domestic producers of sugar (a final consumption good) seem to be able to reap the benefits of cheaper raw materials (sugar beet), which is mostly imported from abroad. Locally produced sugar currently retails at about 1.61 GEL per kg as opposed to 1.75 GEL in November 2014 (down by 8%). This improvement is best explained by the fact that Georgia imports the bulk of sugar beet from Ukraine, the currency of which has fallen relative to almost any currency in the world, including the lari. Thus, at least as far as sugar is concerned, we do observe some price transmission from global to local prices.

Second, quite the opposite trend is observed with respect to imported sugar. Instead of going down in price, imported sugar went up from 1.55GEL in November 2014 to 1.72GEL today, an increase of 11% (quite a puzzle if we consider that between August 2014 and May 2015 the world price of sugar declined by 23%). Thus, as far as imported sugar is concerned, price transmission appears to be greatly delayed and completely dominated by the almost 30% decline in GEL’s value relative to the dollar since fall 2014.

COMPETITION AND PRICE TRANSMISSION

Analysis of price transmission from global to local markets is a very popular topic with economists. One point everybody agree on is that domestic prices would be faster to adjust downwards in more competitive markets. When, say, the global price of sugar goes down, attempts by incumbent firms to fix prices will trigger entry by competing importers or local producers. The resulting downward pressure on domestic prices will be stronger in more competitive environments in which entry does not require a large fixed investment and does not face government licensing requirements or any other restrictions (such as access to distribution and retail networks).

As for upward price adjustments (=transmission of an increase in global prices), fierce competition at all stages of the supply chain (among retailers, distributors, producers and importers) would tend to delay price hikes. Thus, the fact that an almost 30% GEL devaluation has not triggered a spike in food inflation suggests that the Georgian market is becoming more competitive, at least as far as basic food commodities are concerned. Georgia’s average self-sufficiency ratio for agricultural products is quite low (34%), and yet suppliers and retailers have so far been unable to raise prices in the face of weak demand conditions and fierce competition.

Georgia remains a small country, and there is relatively little competition in each of its narrow market segments. For instance, the Georgian sugar market is completely dominated by Agara, the only Georgian producer of sugar (with reported production volumes of about 8,000-10,000 ton per year). Owned by the Azeri Sugar Corporation, Agara’s only competition are about 10 small companies importing and distributing sugar from Ukraine, Brazil and India. At least in principle, the small number of market actors makes it easier to collude in order to fix domestic prices and reap the benefits of lower global prices. Whether this really happened (or happens) is a question beyond the current essay. That said, we will continue monitoring retail food prices in order to inform consumer choice and help cultivate competitive business practices.