The Madagascan vanilla crisis

Le Monde reported last month:

Nothing has gone as planned: The scheme devised by Madagascar to guard against a sudden collapse of the vanilla market by imposing a minimum price of $250 per kilogram (€228) for the past three years has resulted in gridlock. While hundreds of tonnes of unsold pods are piling up in growers' fields and exporters' warehouses in Sava, in the north-east of the island, Andry Rajoelina admitted his failure, on Thursday, April 13, by opening the way to a "liberalization" of exports. Stakeholders called for the decision, which is supposed to calm the furor that has been rising in the region for several months...

The equation Rajoelina has to solve today is not entirely a surprise. Doubts were expressed by buyers as well as some exporters back in 2020 when the new regulations were announced. They entailed a minimum export price; the obligatory repatriation of all foreign currency earnings; and the creation of a national vanilla council, whose prerogatives included granting export approvals.

For buyers, the price tag is "not in line with market realities."

Price controls are almost always a bad idea. Let's put aside the export controls for now (I may come back to these in a future post - see here), and focus on the domestic market for vanilla as if there was no exporting. This is shown in the diagram below. Without the minimum price, the market was operating at equilibrium, with a price of P0, and Q0 vanilla was traded. To complete our analysis, let's also consider the areas of economic welfare. The consumer surplus (the difference between the consumers' willingness to pay and the price, or the consumer's economic rent) is the area AEP0. The producer surplus (the difference between the price and firms' marginal costs, or firms' profits or economic rent) is the area P0ED. Total welfare (the sum of consumer surplus and producer surplus) is the area AED.

Now, consider the situation where there is a binding minimum price of vanilla, PMIN, which is set above the equilibrium price. The quantity of vanilla demanded decreases to Qd, while the quantity of vanilla supplied increases to Qs. There is a surplus of vanilla equal to the difference between Qs and Qd. Only Qd vanilla is traded in the market. The consumer surplus decreases to the area ABPMIN, while the producer surplus increases to the area PMINBCD. Total welfare decreases to the area ABCD, and the lost welfare (the deadweight loss) is equal to the area BEC.

So, the minimum price of vanilla leads to a large surplus of vanilla. Not all the vanilla that is produced is able to be sold. Vanilla consumers are made worse off, and Madagascan society overall is worse off (because total welfare is lower). On the positive side, the higher price might make vanilla producers better off (as per the diagram above), but it could actually make the producers worse off if the minimum price is set too high. As the article notes:

"This year, we have sold almost nothing. Families are hungry. Some have been forced to sell their houses or fields to pay off their debts to the banks," said Mounirah Philibert, president of the Vohémar organic growers organization.

The surplus vanilla essentially just sits around unsold. The vanilla producers have to store the surplus vanilla, or waste it. The Madagascan government didn't necessarily have to set up their price control in that way. They could have followed a similar path to many Western countries did when they had agricultural price supports (or still do, in some cases). When New Zealand had agricultural price supports, the government essentially guaranteed the price by agreeing to buy any surplus that farmers produced at the regulated price. There was still a surplus, but it was held by the government (which then had to store it, leading to the famous butter mountain in Europe, or waste it). Agricultural price supports implemented in this way are essentially a form of subsidy.

That situation is shown in the diagram below. The producers produce Qs vanilla at the regulated price of PMIN, and the domestic consumers buy Qd vanilla, and the government buys the excess supply (the difference between Qs and Qd). The consumer surplus remains the area ABPMIN, but the producer surplus increases to the area PMINFD (because the producers can now sell all of the vanilla that they produce). The government buys the vanilla at the regulated price of PMIN, and eventually they have to sell that vanilla, but in order to sell it all they have to accept the low price of P1 (at this price, the quantity of vanilla demanded is equal to the quantity of vanilla the producers supplied at the regulated price of PMIN). In other words, the government makes a loss on its sales of vanilla. The area of government loss is equal to the area PMINFGP1 (which is the difference in price, PMIN-P1, multiplied the by quantity of vanilla the government sells, Qs). Total welfare is now the area of consumer surplus and producer surplus combined, minus the area of government loss. It takes a bit of thinking through, because of the overlapping areas, but the area of total welfare is now AED-EFG. Total welfare is smaller than without the price support and government purchases, by the area EFG. That is the deadweight loss of this government intervention.

Price controls are almost always a bad idea. They distort markets, and there are often simpler ways that governments can redistribute welfare than using price controls. As the Le Monde article notes, it seems the consumers, producers, and Madagascan society overall are all being made worse off by the price control policy. When that happens, it is clearly time to re-think the policy.

[HT: Marginal Revolution]

[Update: See the follow-up post here]