Stimulating economic development by promoting price discovery

A war of discovery

The process of economic development, or stimulating economic growth, is essentially one of enabling price discovery. The process of price discovery is not just about figuring out what price a good should sell at, but also what good should be sold at all.

If you're looking to buy a new car – something you are unlikely to be doing sufficiently often to have a complete understanding of all available products and prices – you will visit a few show-rooms, test-drive a variety of cars, and compare prices across a range of dealers.

If buying a car were more like buying shares at a stock exchange, then all the car dealers would gather in one place and you could compare all the different types of cars against each other, as well as what they are currently being bought and sold for. This makes buyers and sellers happier.

Most of the prices of the world's commodities are now set on international markets. Futures markets allow producers to know, with reasonable certainty, quite far ahead as to what their products will be sold for.

All of this information allows manufacturers and producers to closely match their production and supply chains with international markets. However, consider what would happen if circumstances prevented you from knowing any prices or information about products?

Grocery shoppers would only know what they were going to pay after their basket of food was rung up at the till. Farmers would only know the price of the grain they produce once it was harvested. Producers could only know the price of their goods at the point of sale.

This would be a disaster. Companies and consumers wouldn't be able to manage their costs and the result would be inflation as wanted goods become scarce, and waste as unwanted goods are discarded.

No-one could be sure that their expenses wouldn't outpace their incomes. Spending would collapse as savings are protected, resulting in further production declines as buyers for goods vanish.

This is the current state of the world economy. But this will recover as government spending and stimulus packages prop things up. The world's impoverished nations are, however, in this state perpetually.

The reason is simple: the world's poorest countries and regions have very poor price discovery mechanisms.

Saudi Arabia has used their oil wealth to desalinate sea-water and use that water to irrigate vast sections of desert to produce the most expensive wheat in the world. Or, at least, it would be if their farmers had to pay the real price of irrigation and soil preparation which high oil prices allow their government to pay for.

When Kenya's election violence destabilised what is the largest cut-flower producing country in Africa, many producers moved to Ethiopia. The Ethiopian government saw an opportunity and decided to subsidise the new farmers. There are now 90 producers who sold over $100 million of flowers in 2008.

Why does Saudi Arabia produce a product that costs more to grow than they get when sold? Why didn't Ethiopian farmers “know” that cut flowers would be a good business?

The short answer is poor legislative environments. The Saudi government has picked a winner and spends money supporting it. No-one is going to try other products as long as they're getting free money to produce wheat. The subsidies supplied by the Ethiopian government to flower sellers merely overcome what is one of the most inappropriately regulated economies in Africa. And that kickstart wouldn't have happened at all save for the Kenyan conflict.

The process of price discovery is slow and expensive. When it fails, investors lose their money and workers lose their jobs. When it succeeds, it creates whole new industries that employ thousands and create massive new opportunities.

Governments that wish to promote economic development need to realise that price discovery can only happen in a flexible and supporting legal environment.