You're reading: Business Sense: Robbing the ‘Breadbasket’

Leo Krasnozhon writes: Officials must end policy that benefits one insider firm at a major cost to whole nation.

Ukraine, one of the top grain exporters in the world and nicknamed the “Breadbasket of Europe,” is being robbed by its government.

It has become hostage to its mercantilist government. In October, the Ukrainian government, presided by a former apparatchik, Prime Minister Mykola Azarov, enacted a resolution requiring quotas and licenses for exporting grain.

The objective was to stabilize food prices and prevent a food shortage caused by last year’s poor harvest.

While the protectionist policy came under harsh criticism from both foreign and domestic observers, the government kept the export grain quotas for eight months.

On May 25, the Ukrainian government finally announced that it would replace the grain export quotas with export duties of 9-14 percent.

TheUkrainian delegation in the World Trade Organizationhas not submitted the official documents about the replacement of export quotas with export duties yet.

While the WTO is waiting for the papers, the Ukrainian government must answer several important questions.

Why did the state use non-transparent practices of allocating export quotas and licenses, wherein an unknown company Khlib Investbud received a lion’s share and gained the market power in the grain export industry?

The grain industry generates 15 percent of Ukraine’s exports – $7.5 billion. How did the controversial regulation kill the spirit of competition in the domestic grain market and push it towards monopolization?

What does the change in the current trade policy mean for the export-oriented Ukrainian agriculture and world food prices?

Who gains and who loses from the protectionist policy?

Quota and license are usually imposed to limit the quantity of a product and raise its price.

The grain export license is given to a company by the state to buy the grains from domestic farmers at the domestic price and resell these grains at the world price to foreign buyers.

Since the world price is higher than the domestic price, whoever receives the export license is guaranteed a profit of a middleman.

Moreover, the export grain quota limits the quantity of export that results in a price markup. For all grains exported with the quota, the markup could total to billions of dollars.

Thus, a licensed company that has an export quota receives a profit that is not earned through market competition.

The government regulation creates the profit for the middleman which causes market inefficiency and market monopolization and wastes society’s resources.

Replacing export quota with export duties is an old trick. The export duty that is a sales tax on export has the same effect as export quota.

The export duties discourage grain exports, reduce quantity of grain exports, and raise grain prices.

Foreign observers have criticized Ukraine’s trade policy on the grounds of its inefficiency.

Morgan Williams, the president of the U.S.-Ukraine Business Council, estimated that losses in the domestic food industry could reach billions of dollars as a consequence of the protectionist policy.

According to Martin Raiser, the World Bank’s country director for Ukraine, Belarus and Moldova, the present grain export quota system is inefficient and restricts the inflow of investment.

Even with these sharp criticisms from foreign observers, the Ukrainian delegation in the WTO defended the export quota system as essential to food security because of a poor harvest.

Since the government announced the replacement of export quotas with export duties, the Ukrainian delegation in the WTO has to come up with a new sales pitch for the continuing protectionist policy.

Officials must end policy that benefits one insider firm at a major cost to whole nation.

Grains that fall under the regulation are crops produced by most domestic farmers: wheat, buckwheat, corn, barley and rye.

In fact, the Ukrainian government has already lied to the WTO and the rest of the world to defend the protectionist policy. A “poor harvest in 2010” was a big fat lie.

According to Ukraine’s State Statistics Committee, the “poor harvest of 2010” was above average if you looked at the record of Ukraine’s grain production in the last two decades.

On average, Ukraine’s agricultural sector produced 36.1 million tons of grain between 1990 and 2010.

Ukraine’s agriculture hit the bottom in 2003 with a harvest of 20.2 million tons of grain while it reached the peak in 2008 with 53.2 million tons of grain.

Thus, the “poor harvest of 2010” that was 39.2 million tons exceeded its average by 3 million tons.

And we do not even taken into account 6 million tons of grain rolled over from the harvest of 2009.

The current protectionist policy is an absolute failure because it hurts Ukraine’s economy. The protectionist policy brought back nepotism.

It also sent a clear signal to foreign companies that Ukraine’s economy went back in the domain of the oligarchs.

The distribution of quotas was not transparent. Grain traders had only seven days to apply for the export quota after the government resolution was enacted.

As a result, most of the companies were unable to receive the grain availability certificate while an unknown company, Khlib Investbud, received the largest share.
Moreover, the export quota system that was designed to stabilize food prices failed to keep food prices from rising.

Domestic food prices have increased by 20 percent since the quota system was introduced. Ukraine’s State Statistics Committee reports that prices of bread, sunflower and corn oil have increased by 12 percent since January.

The grain prices rose by 15 percent in the first quarter of 2011. The domestic consumers are outraged with surging food prices.

The current economic situation is actually very drastic. In Ukraine an average pensioner receives around $100 per month. Given rising food prices, a large number of elderly Ukrainians find themselves below the poverty threshold.

Furthermore, the protectionist policy hurt domestic farmers. The cash-strapped farmers were forced to sell their grain at lower than expected prices because the Khlib Investbud company used its market power to dictate the prices in the domestic grain.

The Ukrainian government does not care that the protectionist policy hurts both sides of the international trade, exports and imports.

Lower profit margins do not allow the cash-strapped farmers to purchase essential machinery and fertilizer that are mostly imported from Russia, Belarus and the United States.

Khlib Investbud seems to be the only winner. However, any criticism of the trade policy or questioning the role of the Khlib Investbud is suppressed by the state.

Meanwhile, Ukraine’s government has made several trade policy concessions recently.

In March 2011 the government dropped corn from the original list and increased the total size of the quotas by 1.5 million tons to 4.2 million tons, or 10 percent of last year’s harvest.

On May 25, the government declared that the grain export quotas would be replaced with export duties of 9-14 percent.

The seemingly confusing policy has perfect timing. Since October 2010 Khlib Investbud backed up by Grain Ukraine has used its market power to accumulate around 2 million tons of grain.

Moreover, Khlib Investbud had exported 800,000 tons of grain before the government replaced the export quotas with the export duties.

As a result, the government gave Khlib Investbud a huge advantage over other grain exporters that must play by the new rules. Backed by the state, Khlib Investbud robbed the breadbasket!

The current trade policy signals domestic grain producers and foreign grain traders that President Viktor Yanukovych’s administration sticks to protectionism.

It also shows that the government can change policy without any legitimate economic reason at all.

The current protectionist policy can destroy the agricultural sector of Ukraine. If this policy continues, we will see capital leaving the agricultural sector for other industries.

If this outrageous grain robbery is not stopped, the European breadbasket will be completely emptied out for the benefit of a single company.

If Ukraine is still a democratic state, the government must explain why the benefit of a single company comes at the cost of the whole nation!

Leo Krasnozhon is a visiting assistant professor and graduate advisor with the Department of Economics at the University of Texas in Arlington.