Tuesday, May 26, 2009

The over protected Sugar Industry

Dr. Umar Khan
Dr. Khan heads a Lahore based Think Tank

The over protected Sugar Industry

We are regularly reminded by the All Pakistan Sugar Mills Association that the sugar industry in Pakistan is in dire trouble. They think that the poor quality and high price of sugar cane has harmed the industry which is on the brink of collapse. To make matters worse the government has imported large quantity of sugar reducing its price. This can have detrimental effects the national economy, as the industry will shut down harming the farmers and the already weak banks with billions invested in the industry. The government must act immediately and bail it out. APSMA recommends increase of the price of sugar, lowering of the price of sugar cane and heavy taxes on imported sugar as the necessary steps. In additions it recommends fixing the price of sugar at Rs. 40 per kg if the price of sugar cane is fixed at Rs. 60 per kg.

The farmers think that sugar mill owners are inefficient and are in a habit of making exorbitant profits with the help of a captive market. They do not want to pay the farmers and want to have it all.

Sugar is a major industry of the country with a substantial amount of its meager savings invested in it. This is an alarming situation and must be taken seriously as millions of lives are dependant on it. It requires a careful study of the situation, weighing all arguments rationally and taking appropriate steps immediately. This leads us to some very interesting findings.

Price of sugar in Pakistan is the highest in the world.
There were only two small sugar units in Pakistan in 1947. now the number has risen to 77 with an excess installed capacity of over 45%. Although we are the fifth largest producer of sugar in the world we are also the costliest. The world price of sugar is around R. 18 per kg as compared to Rs. 28 in Pakistan. The total production is over 3.5 million tons resulting in excess cost of Rs. 28 billion annually.
Sugar is very expensive in Pakistan. The price of sugar cane is high with the average sugar content of 8.64% as compared to the world average of 9.9%. The sugarcane produced in Sind is better than the cane produced in Punjab. With this recovery rate the cost of sugar cane for production of 1 kg of sugar bought at Rs. 40 per 40 kgs comes to Rs.11.57. With the current prices it leaves Rs. 16.43 per kg with the mill owners for expenses, taxes and profits. This fact leaves us with a very interesting but painful observation that even our cost of production minus cost of sugar cane is also the highest in the world. If the price of sugar cane is fixed at Rs. 60 per 40 kg and the price of sugar at Rs. 40 per kg, as demanded by the APSMA this will leave Rs. 23 per kg with the producers. This is much more than the cost and profits of the sugar mills of the world and would be unfair rather cruel to the consumers.

Associations determining purchase and selling price are illegal
Our constitution guarantees every citizen right to form associations. But our law like the US, the EU and probably all other countries of the world does not allow producers of the essential commodities to determine the buying and selling prices. This is cartelization; unfair trade practice and is considered a felony punishable by law. Here I would like the famous case of the CEO of American Airlines who forced to resign for just making a phone call to the CEO of its competitor, Braniff. He claimed that it was just a courtesy call and price fixing or anticompetitive behavior was not proved, the simple doubt of such behavior was sufficient for his disgraceful exit. Interestingly the same owners who form associations and openly fix the buying and selling prices do not allow their employees to do the same and form unions. Recently the top officials of DeBeers, GE and Hoffman LaRoche were tried and punished by law but our sugar mill owners have been able to evade this law.
This behavior is against the law and must be discouraged. We may put a condition that the members of such associations should allow their workers to form trade unions. This will encourage competition resulting in increased efficiency and productivity. Nobody, no matter how resourceful should be allowed to openly break the law.

Local banks are hostages to the Sugar cartel
The government is regularly threatened that if demands of APSMA are not met they will default on the bank loans. I am not sure how this notion was conceived that the borrower has the right to unilaterally decide when to default on loan payments. It also leaves the impression that the borrower is not obliged to return the loan and is doing some kind of favor doing so. No where in the world is such behavior acceptable. Legally the borrowers take the responsibility to return the loan with interest in the stipulated period. This behavior is giving the message that because we have borrowed a lot from you and if we delay returning it, you will be in trouble, borders on blackmailing. This has effectively made banks hostage to industrial associations. We must keep in mind the money involved here belongs to the poor people of Pakistan.
Unfortunately because of our wrong policies and parochial interests we financed lots of big projects at the cost of small and medium enterprises and later got in the habit of bailing them out regularly. Our national savings rate is one of the lowest in the world leaving us with very limited resources to invest. This little should have been made to perform the most and directed towards productive projects but we made it nearly impossible for the small but competitive businesses to get any finances from the banks causing lot of harm to the national economy.
It must be made clear that hostage taking and blackmailing is unacceptable. The loan has to be repaid and for that the industry run efficiently otherwise the sponsors should be held personally responsible, as written in the contracts. This law must be implemented if the economy is to be improved. Allowing the borrowers to default at will, can ruin any economy.

Uncontested use of the mass media
The sugar cartel by forming association and charging high prices has lots of resources at its hands and uses them for its interests. For the last many years, expensive eye catching ads by them for some kind of government support has become a routine. A couple of years back when due to certain reasons the world price of sugar increased above the local price they forgot the local market and forced the government to let them export. The very next year the excess production was exported to a hostile country with a hefty subsidy. Every time it needs just a few expensive ads in the mass media to reap great monetary benefits. Interestingly either there is no institution to counter these campaigns or lacks resources to do it. Consumer groups should contest these but our consumers have no protection of any kind, as there are hardly any organized, resourceful consumer groups. The other group capable of challenging these campaigns is the farmer’s but it is weak and lacks cohesion. The farmers are short of liquidity and cannot afford to challenge the enormous power of APSMA which on the other hand has resources to employ a full fledge team of professionals that keep a close liaison with the opinion and decision makers.
Consumer organizations with the state support are badly needed. They are the only organs that can keep the balance and check the producers charging exorbitant prices and making big profits undeservingly.

Pakistan has over 45% excess sugar producing capacity
Here the situation is even stranger. We have been repeatedly informed about the weak financial health of the sugar industry and its lack of profitability; rather losses, but strangely new sugar mills mushroomed mostly by the same sponsors. I have failed to understand why some companies are so fond of losses that they work hard to increase them. With only two small units in 1947, we have 77 today, 29 in the last decade at an exponential cost. With the installed capacity of 10,000 metric tons we have increased the capacity to millions of tons. There is no known method of making an industry viable, lest profitable having over 45% excess capacity and not being able to compete in the export market because of much higher cost of production.
This simple mushrooming of the sugar industry by very influential and resourceful people suggests that the poor health of the industry may be an exaggeration to say the least.

Competition the essence of free market is absent in our sugar industry
We are living in the times of free market. Recent history taught us that planned economy and nationalized industry breeds inefficiency and produces flab that is detrimental to the health of the industry and the economy. The way out recommended is that the industry should be managed by the private sector competing with each other and responding to the market demands increasing efficiency and productivity. The catchword here is competition, the essence of free market economy.
When the producers sit together and ensure profitability for everyone, they are acting against the interests of the consumers and the ultimate health of the industry as a whole. This leads to inefficiency and wastage. It is not surprising that hardly any sugar mill has changed hands, something so important to the concept of free market. This has resulted in lack of motivation and need to improve productivity producing even more flab and wastage of resources.

At times limited support may be temporarily needed
Still at times protection of the local industry may be from foreign competition. The Japanese protected their industry at times and even the leader US protected its industry from competition temporarily in the name of “retooling”. When done carefully and judiciously, it can yield good results. But there is no known case where the industry has not competed within itself, formed cartels and achieved good health, something we are doing here.
Even protection from the foreign producers must be temporary with clearly spelt time frame and gradually it should be removed. The industry demanding protection must spell out how it plans to improve productivity and make itself competitive. Unfortunately we have been rendering unlimited protection against local and foreign competition. This has made our sugar industry uncompetitive and a drain on the already weak economy. We must stop it.

Sugar industry must stop looking at Govt. for bail outs
It seems APSMA has gotten a misconceived notion that it is the responsibility of the government to bail it out and ensure profitability. For some reasons they have been successful in this campaign with the help of a few well placed expensive ads causing grave harm to the health of the industry and the national economy.
Nowhere in the world the governments have been able to do it neither can the poor Pakistani government achieve it. The responsibility to make the industry competitive lies with the people running it by increasing its productivity and cutting costs. It is absolutely against the word and spirit of the free market concept. If competitiveness is not required, then what is the need of having industry in private hands? With captive markets and exaggerated prices, even the state owned industries could be made profitable.
In this scenario with cartelization of an industry of a basic food item fixing prices we have gotten the worst of both worlds. High prices the state owned industries deliver with the inequality, the free market causes. Rather than supporting the industry in incompetent hands the state may do it itself.

Convergence of economic and political power
Looking at the list of the owners of our sugar mills one finds that there are a few families who own a substantial chunk of the industry. Leaving apart a few old business families, most of them have been part of the previous governments. This may be because due to exorbitant prices this industry was so profitable that successful governments doled out sugar mills as political favors. Both political sides are equally involved in it. The Zardaris, Chaudhries, Mians and Shariffs control more than substantial part of the sugar industry. This happened in the 14 years of civil rule between 1985-99 when political corruption prevailed. Probably this was the reason why APSMA enjoys such unparalleled political clout. This also explains the generous subsidies and terms were repeatedly given to the sugar mills owners. This has led to stories of lavishness of the sugar mill owners not much different from the stories of the Arab Sheikhs with many of them owning lavish cars and aero planes in a poor country like ours.
This concentration of economic and political power in the hands of a few led to a host of other problems. Because they enjoy a lot of economic clout over the local farmers this gets converted into votes with a little coercion. Political power is used to increase the personal wealth which in turns further increases political power ultimately resulting in grave social in equalities and unhealthy concentration of wealth and influence. This concentration in a few unscrupulous hands leads to blackmailing of the banks, governments, consumers and the farmers.

Limited supply of water
We have limited supply of water and it is worsening. Intellectuals tell us that the future wars will be fought over water not land, and we are already witnessing differences over the use of water between provinces causing serious misunderstandings. Because of different geographical factors precipitation over Pakistan has gone down resulting in reduced supply of water for agricultural purposes. Building more dams to store water and using the water judiciously in the most productive manner can solve this problem. We cannot build more dams because we cannot risk annoying the small provinces but we can certainly use the available water more productively
The sugar cane crop needs 3-4 times more water than cotton, which is sowed at the same time. Our cost of production of cotton is less than the world price. Using the water so generously to support sugar mills in the cotton belt, we can irrigate and develop much more wasted land. The potential cotton crop that we can substitute with sugar cane would be worth many times the price in the world market and that also in hard currency.

Industry must improve productivity and produce bye products
It is about time APSMA stops looking for the government support and starts working hard and improve its productivity, something badly neglected so far. In the rest of the world, valuable by products play a substantial role in making the industry productive. Molasses can be used for making industrial alcohol and the residue can and should be used to make building material instead of burning, as is the routine here. Substantial amount of theft occurring at the time of purchase by the mill employees should not be hard to eliminate.
All over the world sugar mills invest a lot in research and constantly develop new and improved seeds, something we again fail to do. Educating and supporting the local farmers is beneficial to the mills and should be invested in, but over here a kind of hostility exists between them. APSMA is also partially responsible for the poor quality of the sugarcane crop. Despite its resources it has not setup any research institutions of any stature or given any scholarships.
These are just a few steps that are practiced in the world but ignored here that can help the ailing sugar industry.

Hence we see that facts and reasons paint a picture different from the scenario painted by the APSMA. It is over protected, cartelized, heavily financed and inefficient using lots of resources of the state. Actually it is reducing rather than producing value. It is artificially kept alive with the state support at the expense of the poor tax payers and the consumers. This policy of wrong pricing causes wrong allocation of resources and further damages the economy. The major cause of this inefficiency is cartel formation and lack of competition, which must be taken care of for the sake of the industry and the national economy. In our present system the mill owners have absolutely no incentive to increase efficiency. We must make the industry compete within itself and gradually make it competitive in the international market. The cost would be more than recovered by the increased cotton production. Let the sugar mills increase their efficiency or get into more efficient hands using the limited national resources in the most productive manner. Price fixing must be abolished and the government should not allow uncompetitive practices.
If members of APSMA work as hard of increasing efficiency as they work on influence peddling and cartelizing, they can become much more competitive. Industries should help and support the economies rather than being a burden as our sugar industry is. It is ironic that we are spending more on supporting our sugar industry than on education and health. Does this make any sense?

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