Price controls don’t work and I told you so

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

By Dhananath Fernando

A story my biology teacher taught me when I was a schoolboy is even in the present day a formidable anecdote in the grey area of public policy and economic management. Once upon a time, deer and lions were living in the same forest. The then king was very fond of deer and felt that deer are treated unfairly as they often become prey to a marauding pride of merciless lions. The king ordered his guards to destroy all lions in the jungle. After a few months, the deer population grew rapidly and the king was very happy. A few more months later, the deer population grew exponentially and the food sources in the forest were not adequate for their consumption and they, in desperation, resorted to eating the barks of trees. This resulted in the death of the forest, which ultimately extended to the deer. Soon, there were neither deer nor a forest. The entire ecosystem had collapsed because of one single intervention. 

The public and economic policy have similar dimensions and that is why we should not intervene in markets but allow free exchange, as there could be a chain of unintended consequences, even though the initial intention was good. In the current global economic landscape interdependencies of two or more cogs in the global market make the wheel turn, and the time it takes from action to reaction could be a mere few seconds or just days. A good recent example is the price controls imposed by the Government on tinned fish and dhal which were revoked recently. The Government’s decision to revoke the price controls is commendable, but the damage to the market is done, at least for the moment. 

Markets are not limited to the supply and demand of goods and services so they have a mechanism to reach an optimal price and quality. It’s more than that. It is important that market sentiments are kept consistent so as to ensure the key wheels of the economy – investors, buyers, and sellers – keep turning as efficiently as possible. If this takes place, consumers, that is you and I, get the best products and services at the best price, without being prey to black-market racketeers. 

The domino effect

The Advocata Institute, and this column, highlighted why price controls are impractical and how they lead to the creation of black markets and shortages of food for people. Sri Lanka imports 90% of its tinned fish and has a 35% tariff on imported tinned fish. When the marked/market price is Rs. 225, but the legally allowed selling price is only Rs. 100, the obvious reaction of importers would be to stop importing tinned fish. It’s not the prerogative of a business to knowingly sell at a loss, regulated or not. 

Price controls during a pandemic like Covid-19 look insignificant, but it is not. The stories of the adverse effects of price controls haven’t been spoken about and the connection in this hullabaloo is not visible. It has had the most impact on the poor and vulnerable community in society who do not have a voice. Tinned fish was probably their most affordable source of protein, but instead had to shift to more expensive sources which is beyond their affordability, and in most cases, I’m sure that they stayed with empty bellies due to the unavailability of affordable and nutritious food.  

This has also resulted in the President having to sacrifice his political capital as a significant priority was given to price controls during his address to the nation, and now the decision has been revoked. Price controls in Sri Lanka are not a new phenomenon. Every government has imposed price controls and these have constantly and comprehensively failed, but are continually included in the political theatre to mislead the taxpayer. It is unfortunate that the taxpayers too continue to swallow the same trick, regardless of their past experiences. 

Price controls are not limited to tinned fish and dhal. There are price controls still in place for essential goods such as rice, milk powder, turmeric powder, big onions, and maize. The results from this will not be different from what we experienced with tinned fish and dhal. Not only food essentials, but LP gas and cement also have price controls. In the leisure sector, hotels have a minimum room rate. Our petroleum products (diesel, petrol, and kerosene for example) and bus fares have price controls.   

Price controls, more so than regulation and lack of competitiveness, are sure ways of stagnating any market or industry. Without going into detail, if you observe sectors like public transport, it is evident how the combination of price controls, lack of competitiveness, and overregulation has led to a terrible public service for the taxpayers.

Backward Sri Lanka

Although the world has moved from travelling from Earth to space over the last five decades, the brand of the buses, train compartments, and their service condition have remained the same during the same period in Sri Lanka. The reason is simple. Trains are a complete government monopoly and there is no competitiveness at all; no one can enter that market. As a result, the trains are late, always on strike, and overcrowded. The route permit for a bus is more expensive than the bus itself for most of the routes and is heavily politicised. 

Market entry is extremely difficult and prices are controlled. As a result, buses are always slow with very poor safety precautions. Passenger service is unimaginably terrible as a result of the absence of choice for people to shift to alternatives. Simply, bus owners have no incentive to provide a better service. Making things worse, private vehicular traffic to the city is increasing alarmingly, combusting more hydrocarbons and impacting the environment. As a side effect, we spend billions of dollars on importing fuel to burn on bumper-to-bumper traffic. This is just a single example of the disastrous combination of price controls, lack of competitiveness, and overregulation. 

The other two main macro decisions by the Government this column has highlighted are most likely to cause further unintended consequences with the gradual opening up of the Western Province from tomorrow (11) onwards.

1. Imposing import controls will have an impact on local industries and employment, along with shortages of essential items for consumption, and cause supply-side shocks and create inflation. 

2. Money creation (quantitative easing or money printing) will further depreciate our currency in the long run and create an artificial demand for imports. Already our rating has been downgraded by Fitch.  

Enhance competition

We need to realise that not making a bad decision is equal to making a good decision. Rather than controlling prices, we need to enhance competition with the gradual opening up of the economy, and not waste time during this crisis, without easing regulatory barriers such as price controls and opening up for regulation that is both consistent and transparent. Institutes like the Consumer Affairs Authority’s mandate need to be revisited and they should lead the promotion of competition instead of becoming the neighbourhood cop for price controls. 

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.