Dual economy parable!

Here is a parable about dual pricing. Assume a country, Economia, with economically integrated provinces, Subsidonia and Marketonia. The one difference between Economia and other countries is that its government is elected by an electorate consisting of all the children under the age of 15!

One fine day, as a 'children's day' gift to its electorate, the government of Subsidonia decides to give 20 kilos of chocolates to each child at Rs 2 per kg every month, through its numerous Choco outlets. Since the prevailing market price of chocolates is Rs 15 per kg, the announcement receives overwhelming support. However, apart from small differences in quality, perceptible only to the most discerning, the chocolates sold at Rs 2 and Rs 15 per kg are basically the same.

This decision sets off a chain of reactions. First, the shop keepers of Subsidonia now have no incentive in purchasing chocolates from their producers (and distributors) at the high rates of Rs 8-12 per kg. They can source it at far cheaper prices (say, Rs 4-8) from a set of middlemen, who have emerged overnight and who clandestinely procures chocolates directly from the Rs 2 market.

Second, the massive demand for the Rs 2 chocolate, crowds out the supply for the private market. The result is that a supply starved regular market experiences a spurt in chocolate prices from Rs 15 to Rs 25. Third, the increased differential makes the Rs 2 chocolate even more attractive, and its demand increases even further. Some children start making fake documents to claim more than their share, and adults masquerade as children to partake of the Rs 2 bargain.

Fourth, since government bulk procurement agencies are not too keen about the quality of the chocolates delivered and the producers are assured of their prices in an assured market, they have little or no incentive in maintaining quality. Further, chocolates being chocolates, children too do not mind the inferior quality.

Fifth, the children of Marketonia, angry with their government at being shortchanged in comparison to their colleagues in Subsidonia, find that they too can partake of a share in the chocolates originating in the Rs 2 chocolate market of Subsidonia. The chocolates from this market finds its way into Marketonia's chocolate market and gets sold for a price range of Rs 6-10.

Finally, in extreme cases, the producers and their wholesalers sell their chocolates to the government, and later repurchases it back from the middlemen at Rs 4-8 and then sells it back again to the government. And the circle continues!

Now replace Economia, Subsidonia and Marketonia with India and any of its states, chocolates with rice, Choco outlets with ration shops and children with adults, and we have an accurate description of the competitive populism induced Rs 2 rice scheme being implemented by different state governments in the country.

Standard economic theories and experience from across the world, conclusively proves that it is impossible to maintain a regulated dual market, especially one with steep price differential, in any commodity,leave alone something as essential as rice. Incentive distortions resulting in the emergence of parallel markets in the rice trade are inevitable.

A more effective way of ensuring subsidized food grains for the poor would be to give food stamps or vouchers, and then reimburse the shopkeepers who produce these vouchers. Another option would be to directly transfer the cash differential to the accounts of the beneficiaries. Such alternatives do not require a parallel market in the commodity. Therefore, it would not distort the incentives of the various stakeholders and will ensure more efficient targeting of the subsidy.