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Government Regulation Goes Bananas

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08/27/2007Dean Peng

This year banana producers in China suffered a disastrous loss. Banana prices plummeted in Canton and Hainan, the two tropical provinces that provide almost all the domestic bananas. Tons of ripe bananas rotted in their plantations. Almost all planters lost money; some went bankrupt.

Rumors spread. Someone had to be blamed. Had local demand for bananas fallen because of fears of contamination? Cell phone text messages circulated, claiming the SARS virus had been found in domestic bananas. Police investigated and found nothing.

It turns out that banana sales had not fallen; on the contrary, they increased slightly due to the fall in prices. Consumers had never taken the rumors seriously.

It soon became clear that the real cause for the fall in banana prices was overproduction. Bananas had been selling well in recent years, and many new producers moved to Hainan to open new plantations. The result was a serious over-supply. The consumption of bananas falls significantly when prices are high, but does not rise that much when prices are low. The price fell to 16 Renminbi cents (2.4 US cents) per kilo. Bananas still didn't sell.

Thus arose calls for new regulations. For many people, the only reasonable resolution to imperfections in the market is more government regulation.

The strongest form of regulation is central planning, where the state decides what is to be planted, how much is to be planted, and who is to do the planting. History has proven central planning to be the least efficient arrangement. There are very few people left who call for all-around planning. What now prevails in public opinion is the idea of "limited regulations." But any amount of government regulation is bound to be blind. To understand why requires economic wisdom.

Let me first explain why overall-planning doesn't work. It abolishes competition, which is a process of discovery. It is impossible for a government office to know who can plant bananas with the least cost, who can plant the best, what new species of bananas are to be introduced, how to improve species to better satisfy consumers, what kinds of bananas and how much are to be planted under certain prices, etc. All these questions are answered through competition in the market.

The market is diverse, but it is by no means disordered; it is directed by prices. All producers follow prices, otherwise they are out of the game. Prices will regulate producers, although not in a perfect way. An overall reasonable plan is of course desirable, but it is impossible without information acquired through free competition. Reasonable plans are only possible afterwards! Which is to say that they are impossible.

A program on China Central Television (CCTV) did a story on bananas and suggested that "government provide planters with accurate market information in advance, with good species, even with sales access to help farmers cope with the market in a perfect way." Good. Excellent! Only one minor issue: again, it's impossible.

What is to be done, then, about "market defects"? Regarding bananas, as well as all other agricultural products, there is a certain production period. Farmers would have to plan for present production with estimated future prices, and so-called market defects come into being when this estimate is wrong, as was the case with this year's banana production in China.

However, the market itself has developed a mechanism to deal with these severe price fluctuations: they are called futures options. Banana distribution has been specialized by companies purchasing, wholesaling, and retailing bananas. In harvest years, these companies are at the mercy of planters; in sterile years it is the other way round. Both sides suffer from risks, and it is to the interest of both to reduce risk to a minimum.

Planters, after this year's loss, will not plant blindly. They will ask for contracts from distribution companies. These companies will naturally share information to avoid losses. When these companies feel they have enough contracts, they will cease to sign new ones. And planters will understand they should not plant more.

The problem today is that government is not only regulating banana production blindly, but it is also, in an attempt to prevent "monopoly," prohibiting companies from sharing information. This is really ironic. The biggest monopoly comes from the government, and it is practiced in the most brutal way by coercive force in the noble name of "preserving market order."

Banana production should be regulated by market prices. There already exists a market mechanism to reflect future prices, and the most capable candidates for the job are the distribution companies in whose interest it is to minimize risk. If they had the freedom to share information, it is reasonable to expect that they would do a good job.

The unhampered market has the power to resolve its "defects."


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