Regulating prices: From price mandates to more competition

Originally appeared on Daily FT, Lanka Business Online, Colombo Telegraph, Ceylon Today and the Morning

By Thiloka Yapa

As price controls ultimately lead to instability in the system, a surer way to achieve stability and growth is to allow markets to flow freely and responsibly

The Government recently removed the maximum retail price (MRP) on rice with a decision to import a buffer stock of rice to prevent any shortages.1 This is an important step in the right direction. Opening up the market for more competition will reduce the market power of the alleged oligopoly of large-scale rice mill owners. While the removal of the MRP is commendable, the Government’s action on this front has been anything but consistent. Despite the frequent use of price controls and their appeal to politicians, economists are generally opposed to them, except perhaps for very brief periods during emergencies. While the pandemic is undoubtedly an emergency, Sri Lanka’s current economic problems are largely due to poor policies. 

Although the politicians who impose them may be motivated by good intentions, they are counterproductive, often leading to higher prices and damaging the market. 

The Parliament recently passed an amendment to the Consumer Affairs Authority Act which increases fines on traders who do not follow the MRP issued by the Consumer Affairs Authority (CAA).2 Raising the penalties seems to indicate that the Government intends to impose controls more strictly. The reason that some of the ill-effects of price controls were not experienced is because they were not strictly enforced. Previous research by Advocata Institute revealed that only larger producers and the larger retailers in the formal sector adhered to them; in the informal markets and among smaller retailers these were routinely ignored so the shortages and black markets associated with price controls were not widespread.3 Strict enforcement and larger fines could see products disappearing from shelves as traders find it no longer profitable to engage in the trade of the controlled commodities.  

Price regulation and its impact 

Price controls are administered through the Consumer Affairs Authority Act which has the power to regulate prices.4

Under Section 10(1)(b)(ii) of the Act, the authority, in protection of the consumer, can call retailers and wholesale traders to register their stocks and warehouses with the CAA. Moreover, under Section 18, the Minister in consultation with the CAA is empowered to specify any good or service, as essential to the life of the community, by way of gazette notification. Manufacturers and traders are restricted from increasing prices without the prior written approval of the CAA. A period of 30 days is provided for the authority to examine the application for any price revision and convey the decision to the applicant company. 

This Section permits the CAA to make decisions on behalf of traders in the market, whenever it regards a product to be ‘essential’. Further, under Section 20(5), the Authority can fix the maximum price above which goods and services cannot be sold. It was under this section that the recent MRP for sugar, rice and LP Gas was imposed. 

This regulation could be a barrier against market competition, as it may deter the entry of new firms and discourage innovation which curtails competition. Competition plays a vital role in a market economy. It incentivises firms to challenge each other, create new markets and expand existing markets. While this leads efficient firms to enter and grow, inefficient firms shrink and exit. Firms innovate, leading to lower prices and enhance consumer choices. While the objective of the Consumer Affairs Authority Act No. 9 of 2003 in itself is to promote competition and protect consumers, the impact of the provisions which allow the authority to regulate prices lead to the exact opposite, resulting in high prices and less choice for consumers.

Prices play a key role in a market economy. It is a signal, wrapped in an incentive. Change in prices incentivise individuals to respond; either by consuming less of a product, or shifting to alternatives. Price controls distort these signals. Since the Government defines market prices when controls are imposed, it forces the market to function based on the imposed price. As producers and consumers respond to controls, they produce an excess supply when the prices are set high or increase the demand when prices are set low. This leads to wastage and shortages, exacerbating the fundamental economic problem that the controls expect to solve. 

A 2018 report on price controls by the Advocata Institute revealed that price controls have limited value in controlling the cost of goods, particularly in the consumer market due to weak enforcement.5 The report highlighted other ill-effects: traders surveyed have admitted to the problem of low-quality goods being brought into the market, meaning that quality suffers as a result. As traders are under pressure to comply, they resort to importing substandard products to supply at prices close to the controlled price.

The enforcement of ad-hoc controls also adds up to the costs of suppliers, as these regulations distort their cost structures. This was the case when the Government slashed the Special Commodity Levy on sugar, big onions, dhal and canned fish in November last year, imposing an MRP on these commodities.6 The sellers who were impacted, opposed the MRP and continued their sale at high prices, claiming they would incur massive losses since the stocks were purchased before tax revisions, at a much higher price. 

Price controls also result in policy uncertainty. This is a situation where there is ambiguity in the stability of future rules and regulations. While entrepreneurs in the market will then keep attempting to predict what regulators would do in the future, this comes at the expense of consumers, who would have otherwise been the main-focus of these businesses.7

What can be done?

Sri Lanka urgently needs to rethink government interventions that increase the costs of competing. At a recent discussion hosted by the Advocata Institute, the newly-appointed Governor emphasised the importance of growth and stability. He stated that the lack of stability would lead to uncertainty. As price controls ultimately lead to instability in the system, a surer way to achieve stability and growth is to allow markets to flow freely and responsibly. For this to happen, as one major reform, Sri Lanka needs to amend the sections in the Consumer Affairs Authority Act that permits the authority to regulate market prices. In doing so, it is also worthy to review Sections 34 to Section 38 in the Act, which aims to promote competition and revisit the mandate of the CAA. 

1.  Ruwani Fonseka, ‘Alagiyawanna explains removal of MRP on rice’, The Morning, September 28, 2021 https://www.themorning.lk/alagiyawanna-explains-removal-of-mrp-on-rice/ (accessed September 29, 2021)

2. Parliament of Sri Lanka, ‘Hon. Speaker endorses the certificate on the Consumer Affairs Authority (Amendment) Bill’, Parliament of Sri Lanka. September 23, 2021, https://parliament.lk/en/news-en/view/2263 (accessed September 25, 2021)

3. Advocata Institute, ‘Price Controls in Sri Lanka-Political Theatre’( Sri Lanka: Advocata Institute, 2018), 24 https://www.research.advocata.org/wp-content/uploads/2018/10/Price-Controls-in-Srilanka-Book.pdf (accessed September 25, 2021)

4.  Consumer Affairs Authority Act No. 09 of 2003 

5. Advocata Institute, ‘Price Controls in Sri Lanka-Political Theatre’( Sri Lanka: Advocata Institute, 2018), 9 https://www.research.advocata.org/wp-content/uploads/2018/10/Price-Controls-in-Srilanka-Book.pdf (accessed September 25, 2021) 

6. ‘Revised taxes, MRP complicate commodities market’, The Sunday Times, November 22, 2020 https://www.sundaytimes.lk/201122/business-times/revised-taxes-mrp-complicate-commodities-market-423077.html (accessed September 30, 2021)

7. Institute of Economic Affairs, ‘Flaws and Ceilings: Price Controls and the damage they cause’ (London: London Publishing Partnership, 2015) quoted in Advocata Institute, ‘Price Controls in Sri Lanka-Political Theatre’( Sri Lanka: Advocata Institute, 2018), 43 https://www.research.advocata.org/wp-content/uploads/2018/10/Price-Controls-in-Srilanka-Book.pdf (accessed September 25, 2021)
   
   ‘රටේ ආර්ථිකය හා අපේ හෙට දවස’ YouTube video, posted by “Advocata Plus,” September 25, 2021, https://www.youtube.com/watch?v=8JvWQWn7cHw (accessed September 25, 2021)
   

Thiloka Yapa is the Research Analyst at the Advocata Institute and can be contacted at thiloka@advocata.org. Learn more about Advocata’s work at www.advocata.org. The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute, or anyone affiliated with the institute.

Rice crisis: Just give our farmers their lands

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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By Dhananath Fernando

Rice, the main source of carbohydrates for the majority of Sri Lankans, is a sensitive political topic. I am sure we have all been experiencing this in the recent past. Most often, it is a political football where everyone passes the blame to one another without unpacking the economics behind the rice problem.

Increasing the harvest

If you ask any Sri Lankan the question “what is the problem with the rice market?”, there will be a few common answers. “A rice mafia/monopoly or oligopoly by rice millers” is the most popular. The second most common answer is the fact that the intermediaries are earning more, resulting in farmers being at the losing end.

The third most frequent response is the lack of modern technology in paddy fields which decreases our yield. Many economists and politicians support this argument with a popular statistic which states that agriculture contributes only to 8% of our GDP in comparison to 25% of our labour force involved in farming. In my opinion, the aforementioned concerns are just the tip of the iceberg.

Sri Lankans consume approximately 108 kg of rice per annum per person while the global rice consumption average is 54 kg. The conundrum is that in a country where consumption is twice the global average, farmers continue to be relatively poor.

The main question with rice is: Should farmers increase the harvest or if the harvest drops due to external weather conditions, will they earn the same amount? At times when rice harvest is high, the prices plummet due to ample supply. During this period, we can frequently observe farmers protesting as they urge the government to purchase their seed rice for a guaranteed price or for the government to impose a minimum selling price for farmers as well as a minimum buying price for rice millers. Rice millers have two main solutions to this issue: Either they stop buying seed rice as they cannot sell it at a competitive price because their cost is higher, or they still buy it which results in rice prices in the market skyrocketing to Rs. 110-120.

The high price is not only difficult for consumers to afford but is also a price that political parties pay, which dilutes their political capital. As a result, the Government intervened in the market with limited and poor storage capacity and in some cases, rice was stored in airports. After a few weeks and months, the Government sold these rice seeds to large-scale millers for a lower rate than what they initially paid the farmers, incurring a massive loss of taxpayers’ money. Some of the harvest is wasted due to the lack of storage facilities and logistics failure. As a result, farmers lose out on their income and taxpayers’ money is lost.

The second scenario is the reduction in harvests due to harsh weather conditions which decrease supply and subsequently increase prices of seed rice. Since the total quantity of the harvest is low, the money earned by farmers too continues to be low. Regardless of whether there is a large or smaller harvest, the farmer’s earnings remain consistently low. Hence, farmers are not given an incentive to increase their harvest and overall yield. Playing to their advantage, rice millers have created an oligopoly and so decide on prices in line with their modern and expensive storage capacity.

Land issues

Then comes the question of why technology is out of reach for most farms. The preliminary reason is that most paddy lands are fragmented for small lands, so it is not possible to run a commercial-level operation with superior technology. The more significant reason is that 82% of Sri Lankan land is owned by the government (out of which approximately 30% is covered by forests) and the remaining 18% is available for people’s private usage.

A small proportion of government-owned land has been given to people for cultivation, but their ability to take loans from banks to invest in technologies such as greenhouses is far beyond their reach. Construction on paddy land is illegal, which means there is a lack of space for any transaction or technological investments.

Land issues are a sensitive political issue, but many believe that if farmers are given full ownership of the land, they will sell it to foreigners, which in turn challenges our sovereignty. However, the government ownership of farmlands for nearly a century does not change the destination or quality of life of our farmers. Making things worse, the regulation is such that the paddy lands cannot cultivate anything other than paddy and even if the farmer wants to move for a better high-yield crop, a license needs to be obtained via a cumbersome procedure at government offices.

Given these challenges, how likely is it that anyone would enter paddy farming even if they have a disruptive agricultural idea?

Loopholes in costing structure

Many Sri Lankans believe that we can easily upscale our farming for rice exports. I sincerely wish we could do that too, but unfortunately, this is far from the reality. Sri Lanka cultivates mainly short grain rice in comparison to long grain rice where the world’s demand mainly lies. Even following a good season and excess rice production after domestic consumption, it is not exportable and will further drive the prices down due to excess supply. Furthermore, water is becoming a scarcity due to environmental challenges and currently, we do not calculate costs for water consumed in farming.

Recent research has found that 1 kg of rice requires 2,500 (1) litres of water and more than half of that is consumed by the plant itself. If we consider the cost of water to be Rs. 0.20 per litre, the water consumed by the paddy plant itself adds up to about Rs. 280 which is almost three times the current-controlled price of 1 kg of rice. The cost of utilising land hasn’t been factored. Fertilisers have been provided with a subsidy and that cost needs to be added to our final cost if we are to create a comparable and competitive costing structure.

Solutions

The decade-long series of solutions are well known by most of us. For example, rice millers impose price controls on the selling price following raids by the Consumer Affairs Authority (CAA) at the retail level, and the list goes on. That has been the same response by most governments and it is pointless to further elaborate on what has happened. As a solution, we need to have an easier regulatory system and allow the farmers to own their land. The draconian regulations have trapped farmers in a never-ending cycle of poverty for decades.

From the supply and demand end, the only buyers are rice millers. When there is a single buyer in the industry, they inevitably get higher bargaining power. It is important to diversify our buyer category and the only way to do it is to make rice an industrial product. Today, rice is not only used as a source of carbohydrates; alcohol products, rice bran, rice perfumes, rice-based milk, and rice antioxidants are produced at a commercial level, which offer far higher prices to farmers at the buying stage. This is the solution to increase revenue for farmers and help them escape the vicious cycle of poverty.

The day our farmers have access to their own land will be the day the market is open for many categories of buyers, which will be revolutionary for farmers. Until then, we as the consumers need to patiently experience the price controls, higher prices for rice, and the political blame game.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.