Basic economic theory suggests a tradeoff between unemployment and inflation in a phenomenon known as the Phillips Curve, named after the economist William Phillips. Based on the data from 1861-1957 in the United Kingdom, William noticed an inverse relationship between the two variables. When unemployment is low, the labour demands higher wages and firms are willing to pay the higher wage premiums because of the shortage, leading to an increase in wages and hence inflation. On the other hand, if unemployment is higher then firms can choose to hire the workforce a low wage rate and the bargaining power of workers is also lower, thus leading to a decrease in wages and hence inflation. Today, though, most economists do not rely on the Phillips Curve; however, the intuition and logic of the theory remain influential.

Before we analyse how the Phillips Curve applies to Pakistan’s flour mill industry, we need to differentiate between different types of inflation. The concern for the masses in Pakistan is primarily food inflation. Contrary to the popular narrative of ever-increasing food prices, from 2010 to 2018, the food inflation rate declined from 20% in 2010 to less than 3.5% in 2018. According to the United Nation’s Economic and Social Commission for Asia and Pacific (ESCAP), there has been an increase in mechanisation in widely consumed crops such as wheat, rice, and pulses. From land preparation to sowing, irrigation, spraying, harvesting, and threshing, over the last ten years, the country has gone through a second green revolution. The production of wheat, which accounts for about 40% of food and protein intake for most Pakistanis, has on average, increased from 21 million tons in 2010 to approximately 26.3 million tons in 2018. In absolute terms, this is a 25% increase over 8 years. In terms of per capita, it is an 8.3% increase, still adequate to meet the growing demand. Based on the data available, there is no shortage of wheat.

People do not consume wheat; it must undergo a process to be converted into flour and then to Roti, Chapati or Naan. In a nutshell, wheat must be cleaned, separated, brushed, rolled and purified before it could be dispatched to the retailers to sell it to the end consumer. Here comes the flour mill industry, which is responsible for buying the wheat from the farmers at the support prices which are fixed by the government. Nowadays, the industry is under a vicious verbal attack; we have seen terms such as “Mafias”, “Hoarders” and “Profit Maximisers”, hurled at the industry. Let’s hypothesise here that the industry is profiteering from the crises and market failures. Market failure means that when left to the forces of demand and supply, a good or commodity or service which has a higher societal benefit is under-produced and under-consumed. In the context of flour mills, firstly, the market does not seem to be perfect. Even though there are multiple firms, offering the same service, i.e. buying of wheat, little to no brand differentiation and geographically segmented, they still act as monopolists and monopsonists. A monopsonist is a firm that acts as a sole buyer of a product or service unlike a monopolist, which acts as a sole seller of the product or service. In a nutshell, the mills buy wheat at a lower price from the farmer and sell it for the higher prices to the retailers, making profits in between.

Such imperfect market competition exists due to another market failure that is public goods failure. In this case, the state utterly fails to provide legal oversight and price control mechanisms, necessary to keep such firms in check. Consequently, with no regulatory pressure from the state, such firms tend to act as a monopsonist and monopolist, thus underpaying the farmers their due prices of wheat and charging retailers high prices for flour. The hypothesis can be supported by observing the recent price hikes of flour in the country. Despite some provincial governments regulating the retail flour prices at Rs 43 per Kg, prices continue to fluctuate between Rs 70 and 150 per Kg throughout the country.

Now, let’s test the hypothesis that the flour millers act both as a monopsonist and as a monopolist and take advantage of the market failures.

In 2006, the support price for wheat was Rs 415 per 40 Kg or Rs 10.4 per Kg. By 2016, however, the government had increased the prices to Rs 1350 per 40 Kg or Rs 33.6 per Kg, i.e. an increase of 236% over the 12 years or 20% yearly increase.

In 2006, the prices of flour stood at Rs 13.1 per Kg, and in 2018, the rate stood at Rs 40 per Kg, registering an increase of 206%. When adjusting for inflation, the real change in prices of flour was 34% over the twelve years. Thus, the actual margins of flour mill owners declined by 30% (64-34) from 2006 to 2018. Based on the price analysis, we can easily dismiss the hypothesis that flour millers act as a monopsonist and monopolists and take advantage of the market failures. Evidence suggests otherwise. The flour mill industry is not operating in an imperfect market structure, and the government does enforce the support prices.

Phillips Curve, in the context of the flour mill industry, does apply. According to the Food and Agricultural Organisation (FAO), the constant decline in the profit margins of the flour mill industry (relative decline in flour prices) has led to the closure (unemployment) of more than 500 flour mills out of 1800 or so within a decade. The reduction in real prices (margins) has led to an increase in unemployment. The industry is experiencing a decline in profitability as it is squeezed between high support prices for wheat and the low retail prices for flour. If Pakistanis were hoping that they would not have to undergo another flour crises like that of 2008-09, they were mistaken. If the government does not close the ever-increasing gap between the prices guaranteed to farmers and prices charged by the flour millers, by providing financial incentives to the industry, more mills would be shut down, causing flour shortage and trigger yet another crisis. That will happen despite having a surplus of wheat production!