January 19, 2022
There has been a hubbub lately about the decision by the Israeli Ministries of Treasury and Agriculture to reduce consumer prices by allowing more foreign imports from cheaper sources which will, in turn, reduce retail prices as well.
But is the controversy actually much ado about nothing?
At the core of this debate is the notion that retail prices are a function of wholesale costs. The argument is that Israeli farmers are charging too much for their produce, generating high retail prices for Israeli consumers. Yet the evidence doesn’t support that claim. On the contrary, per a report prepared by the Ministry of Agriculture’s economists, much of the increase in agriculture prices has been due to increases in the cost of water to farmers, which is purchased from Makoret — a government company. Per the same economic report, fruit and vegetable prices in Israel are not higher than prices in other developed economies, such as in European nations.
If we take this theory in reverse, higher retail prices must be the result of higher wholesale costs. Take a visit to the Supersol grocery chain’s four categories of stores: Supersol Extra, Supersol Deal, Supersol Shel’li, and Supersol Express. The same can of tuna fish sells at four different prices at the four stores, as does practically everything sold there. We can safely assume that Supersol, as a company, pays the same price for the tuna fish regardless of what category of store it sells it from. In reality, we get four different retail prices from the same wholesale price.
Similarly, if wholesale prices determine retail prices, we should have seen a drop in many retail prices over the past few months. A large number of what consumers buy in Israeli supermarkets are imported from abroad, with their wholesale price denominated in dollars. With the drop in the shekel/dollar exchange rate, the wholesale shekel price of these imports has been declining. And yet, we haven’t seen a drop in their retail prices, confirming that wholesale prices do not determine retail prices.
Economists, myself included, will tell you that manufacturers first look at the retail prices of what they want to produce and then ask themselves if they can produce it at a cost that will allow them a profit. Chances are slim that imports from Turkey, Jordan, Egypt, and China (the target countries to import from) will result in reduced retail prices.
Opening Israel’s borders to increased imports by reducing duties on these countries is, per the Ministry of Agriculture’s report, expected to reduce Israeli production of fruits and vegetables by as much as 40 percent. That of course will lead to further increases in imports from these same countries. Aside from the issue of whether Israelis want to increase our food dependency on specific countries that are often hostile to us, do we want to increase our food dependency on imports in general? Economic goals are not always the goals of a nation. Just as the U.S. has made reducing its dependence on imported oil a national goal, Israel has long pursued a policy of food independence.
In the background of the discussion about the rising retail prices (inflation) is a rise in wholesale or production prices. For those following inflation, the producer price index published by Israel’s Central Bureau of Statistics (CBS) is a hint of what is about to happen to retail prices. Per the CBS, the producer price index in November 2021 was up 13.5% from November 2020. The producer price index excluding fuel for the same period is 7.8% — meaning that 42.2% of inflation this past year came due to increases in the cost of fuel.
Similarly, as mentioned above, the cost of water to farmers has risen over the past 10 years by 80% while the consumer price index has risen 35% for the same period. Additionally, during the same period, the per capita supply of fruits and vegetables has been maintained (almost all of it from local farmers), so a shortage of supply or excess demand are not the causes of rising fruit and vegetable prices. The reason the cost of water to farmers has risen so much is a reform in water pricing to farmers over the past decade.
The argument for reducing water subsidies to agriculture is that the consumer pays for those subsidies via higher prices for the water they, the consumer, consume. True. No argument here. Except that when the subsidy is reduced and farmers have to pass their costs on to wholesalers, the increased cost to farmers requires an increase in their markup to wholesalers. Wholesalers then have to add this to their markup to consumers, which translates into higher prices at the supermarket.
When politicians proclaim that consumers are paying for water subsidies to farmers and that such subsidies are not fair and should be reduced, they ignore that as costs to production increase, the cost to farmers will be passed on anyways. The question is, which is the cheaper way of consumers paying for that water: Subsidies to farmers, or at the retail level? My business administration instructor tells me that it’s cheaper as a subsidy than as an increased cost to farmers.
Blaming farmers for inflation or high retail prices ignores the role of other variables, such as fuel and water, and when political leaders ignore these variables, that means they won’t be dealt with. This, in turn, means the inflation these variables cause will continue in the near future.
By: Professor Michael Humphries.
Michael Humphries teaches marketing and management at the Jerusalem College of Technology and is deputy chairman of the Business Administration Department at Touro College Israel, where he teaches finance.