Essay on Cyclone Induced Banana Shortage PDF

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ECONOMICS 2

AUSTRALIA’S BANANA SHORTAGE An economic analysis of Australia’s banana market, post cyclone Yasi.

Hilton Harvey n10233784 Tutor: Caleb Lo

Word Count: 2068

Bananas are Australia’s most popular fruit, selling more volume than all others (Paul, 2017). With 94% of households purchasing the golden fruit, banana growing is Australia’s biggest horticulture industry, currently turning over A$600 million per year (ABGC, 2018). The industry has long been characterised by government help, with Australia’s quarantine laws providing complete protection against foreign imports in more recent times . (Ko, Friiters & Foster, 2014). The justification behind these strict quarantine requirements has been called into question following the recent devastation of the domestic banana supply in the wake of the 2011 Cyclone Yasi (Irvine, 2011). This essay will analyse the before and after impact which the cyclone had on the economic welfare of both consumers and producers. Furthermore, economic models will be used to analyse the effect on welfare, should the ban be repealed. Recommendations will also be made regarding two alternative policy solutions.

Australia is completely dependent on domestic producers for its fresh banana supply, with 90% coming from far-north Queensland (UNSW, 2011). In February 2011, Cyclone Yasi passed through the Tully/Innisfail region. This devastated the local crop and wiped out around 75% of Australia’s banana production. In the days following, consumer prices rose from around A$2.00 per kilogram to upwards of A$15.00 (Durie, 2011). Banana plants take at least 10 months to bear fruit, leaving Australia with no ability to increase short term supply without importing (Ko et al., 2014). For this reason, the cyclone is to have a drastic effect on economic welfare, which is modelled below based on the given numbers.

Figure 1: Short-term Effect of Cyclone on Domestic Banana Market

It is evident that consumers as a whole are drastically affected by the cyclone. After the existing stocks of bananas have been sold off, the short-term supply (S1) is reduced by 75% to S2. The banana supply is determined 10 months in advanced and therefore inelastic in the short-term. This has resulted in consumers rapidly bidding up the price of the remaining banana supply with no reprieve from an increase in supply. Year on year, this spike in price was approximately 290% (Ko et al., 2014). Consumer’s economic surplus, shown by the blue shading, took up areas A, B and C. After the cyclone, it was reduced to area A. Consumers only willing to pay from P1 to P2 can no longer purchase bananas, as they previously could have.

Given its severe effect on consumer surplus, one would expect a similar toll for producers, however the model shows that net producer surplus was unaffected. Prior to the Cyclone, producers enjoyed a surplus represented by red areas D and E. Area E was lost, yet an equivalent surplus area B was gained. While as a whole, producers appear to be unaffected, this is not the case in practice. The destruction of 75% of Australia’s banana supply was not evenly distributed among Australian producers. Rather, it was concentrated in Tully and Innisfail area, where an estimated 95% of the crop was destroyed (Irvine, 2011). It can therefore be concluded that around 95% of surplus area E was transferred to the unaffected suppliers. The other 5% is enjoyed by the affected farmers who can now sell their unharmed crops at a premium. This new allocation of economic surplus can be expected to hold constant for the 10 months after the cyclone, required that Australia’s import restrictions are not relaxed during this period.

Australia’s banana producers have long been beneficiaries of the country’s stringent positi on on biological imports. In June 2000, Biosecurity Australia (BA) received an import application from the Philippines, requesting to bring fresh Cavendish bananas into the country (Stephen, 2009). This sparked a decade long tension between Commonwealth and Philippine governments, the latter of which claims its position is consistent with the WTO’s Sanitary and Phytosanitary Agreement 1994. This agreement allows for countries to enforce quarantine policy, provided it is economically justified and not “excessively restrictive of trade” (Mumford, 2002). Despite this, Australian’s import requirements have proven to be prohibitive, given not a single box of foreign bananas has reached the country since the initial application (De Vera, 2017). The Australian Banana Grower’s Council (ABGC) claims that Australia’s lack of diseases gives the country a competitive advantage, which would be lost if foreign imports were allowed in (Stephen, 2009). The council raised A$2.2 million to fund research and lobby efforts against the import of foreign bananas. Subsequently, in 2008, Biosecurity Australia (BA) revised its import risk analysis to effectively prohibit foreign banana imports. The analysis cited risks of various banana diseases and the negative impacts they would have on domestic output (Biosecurity Australia, 2008). This effective ban on imports leaves consumer welfare vulnerable to shock events such as the recent Cyclone Yasi (Irvine, 2011). It is only when these shock events hit that the dispersed costs of this protectionism become noticed by consumers, who whiteness a dramatic deviation from global prices (Weinberg & Bakker, 2012). In 2011 retailers requested that imports be allowed to curb the exorbitant banana prices, however this was swiftly denied by the federal government in a bid to protect domestic farmers from exotic diseases (UNSW, 2011) (The Daily Telegraph, 2011). Costs associated with lifting this import ban are long-term, meaning an economic model must be extended into the long-term to adequately capture the effects should the government comply and lift the import ban.

Figure 2: Long-term Effect of Lifting Import Ban on Domestic Banana Market

Moving from left to right in figure 2, its apparent that consumers would gain a considerable amount of economic surplus if the ban were to be lifted. In normal years, Australian consumers have been paying an average 1.9 times over global prices. However, when accounting for cyclone affected years, the domestic premium rises to an average 2.7 times the global price (Ko et al., 2014). Lifting the ban would quickly curb inflated banana prices, providing swift relief for consumers in the face of negative supply shocks such as Yasi. Producing around 118 million tonnes, the global market dwarfs Australia’s, which makes up approximately 0.3% of global production (Margetts, 2014). Consequently, consumers would enjoy the lower and more stable prices of the large and competitive global market, which is indifferent to domestic demand. (Evans & Ballen, 2012). Considerable price decreases would provide great relief to low income earners, who find price a barrier to fruit consumption (Sacks, Yi and Nonas 2015). Given the health benefits of bananas, increased consumption would likely generate positive externalities of consumption, such as reduced health expenses (Singh et al., 2016). Additionally, many businesses using fresh bananas as an input would see improvement in their cost structures. Various studies have attempted to quantify this gain in surplus by calculating the relative elasticities of banana supply and demand, not taken into account in figure 3. The consensus from two peer reviewed articles finds a gain of A$175 million in annual consumer surplus (Le Roux & Maclaren 2011) (Javelosa & Schmitz 2006). While it is readily accepted that consumers would benefit from imported bananas, they only represent one side of the equation when analysing social welfare. The immediate effects are quite the opposite for Australian banana producers, who are projected to lose A$66 million in surplus by the same estimates (Le Roux & Maclaren, 2011). Domestic farmers would no longer receive a premium for their crops but rather a 46% discount on normal banana prices (Ko et al., 2014). Without quarantine restrictions, producers lose surplus area B to consumers and retain the relatively small area D. This surplus represents their ability to sell below the world price. Once domestic supply meets the world price, consumers can be expected to opt for the cheaper imported bananas, meaning domestic producers face marginal costs greater than marginal revenue. For this reason, producer surplus does not extend above this intersection in free trade. Furthermore, with imports comes the threat of 122 species of pest and disease, identified by BA. Of these, 21 are said to pose an “unacceptable level of risk” (Le Roux & Maclaren 2011). A 16 to 100% chance of establishment is given. If this chance were realised, the domestic supply curve would shift leftward over time due to increased costs, decreased efficiency and trade restrictions, all associated

with contamination. (Biosecurity Australia, 2008). The worst case scenario is one wherein Australian producer surplus is entirely eliminated, in which case losses in producer surplus are estimated to max-out at A$132 million (Javelosa & Schmitz, 2006). Despite uncertainty about the establishment of pests and diseases, producers are still certain losers if the import ban were lifted, as they face the overseas competition regardless. Evidently, lifting the import ban is the optimal solution as the loss of producer surplus is outstripped by the gains in consumer surplus , despite the uncertain trajectory of Australian’s banana industry. Estimates indicate social surplus will still increase by A$43 million in the worst case scenario (Le Roux & Maclaren 2011) (Javelosa & Schmitz 2006). In terms of the economic model, this implies that surplus area C is greater than D. Economic theory suggests that capital will be freed up for more productive uses, thus improving allocative efficiency. Nevertheless, the loss of producer surplus represents the end of an entire industry along with the many rural communities and the 10,000 fulltime jobs it supports (Biosecurity Australia, 2008) (Margetts, 2014). However, it should be noted that the industry currently faces decline even with strict quarantine. Various diseases including: TR4P; Freckle; Black Sigatoka and Moko have been discovered in the northern territory, where production has been on the decline since 1990. These diseases are predicted to constrain future production. The industry also faces rising costs and a shortage of future growers (Margetts, 2014). As the industry faces more internal challenges, the costs of protectionism increases. Given these dull prospects, the case for quarantine policies is further weakened. Should the government choose not to lift the ban, policies promoting effective crop management may serve to offset the effects of a negative supply shock, such as cyclone Yasi. Following Cyclone Larry in 2006, the ABGC worked with the government to develop crop management practices, which are designed to mitigate the damage caused by tropical cyclones. The main practice developed was canopy removal, which aims to reduce the wind resistance of crops prior to a cyclone. The Department of Agriculture’s report states that growers benefited by an average A$9,703 – 70,191 per hectare, where crop canopies were removed prior to a cyclone. A leftward shift in the demand curve is inevitable, however canopy removal reduces this shift. Thus, consumers and producers are likely to endure a net increase in surplus, represented by areas C1 and C2 in figure 3, below. Canopy removal was found to lower output by up to 50%, meaning surplus could be unnecessarily forgone due to a false flag. For this, the report recommends the creation of a database for farmers to share cropping production timetables. It is claimed that this will hel p them better execute canopy removal, which has shown to be effective in mitigating cyclone induced supply shock (Comiskey, 2012). As an alternative policy, it is therefore recommended that a commission be established to develop and subsidise this database.

Figure 3: Short-term effect of crop management in mitigating negative supply shock

A price ceiling is a second policy which could be used to mitigate effects of a negative supply shock. Unlike effective crop management, a price ceiling cannot increase the economic welfare. However, it can be used to redistribute surplus in a way which reduces the shock caused by cyclones. Figure 4 models a scenario in which the government sets a price ceiling at the original price (P1). In this case consumers regain surplus area B, which was originally forgone due to cyclone Yasi, as the unaffected producers must sell their crop at the pre-cyclone price. The ceiling may be imposed without risk of short-term dead-weight loss, due to the inelasticity of supply (Coglan, 2016). While this new allocation of surplus benefits consumers as a whole, bananas are no longer reserved for consumers who gain the most marginal benefit. This is reflected in figure 4, where demand (Q1) far outstrips supply (Q2). The ceiling does have potential to create deadweight loss in the long-term, which is not captured in figure 4. For these reasons, it is recommended that a price ceiling only be used as a temporary stopgap measure, for the support of price stability and consumer relief.

Figure 4: Short-term effect of price ceiling in mitigating negative supply shock

Australia has faced two tropical cyclones in recent years, both drawing attention to viability Australia’s protected banana industry. It is evident that strict quarantine requirements are excessively restrictive of trade, as they reduce social welfare and allocative efficiency. The government should resolve to lift the import bans immediately, despite the expense to rent-seeking producers. As a result, capital will be freed from the declining industry and reallocated to more productive uses. This course of action maximises net social surplus and provides consumers with effective relief from domestic supply shocks such as cyclone Yasi. Should the government opt to maintain the import ban however, it is recommended that crop management practice and a price ceilings are utilised to mitigate inefficiency and promote price stability in the face of future negative supply shocks.

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