Do price controls reduce the cost of living? | Sunday Observer

Do price controls reduce the cost of living?

7 October, 2018
In attempting to comply with controlled prices, traders sometimes source large volumes of produce that are close to the end of shelf-life. File pic - Lake House Media Library
In attempting to comply with controlled prices, traders sometimes source large volumes of produce that are close to the end of shelf-life. File pic - Lake House Media Library

Last year, the Government imposed price controls on sixteen essential items, including dhal, sugar, potatoes, and imported onions. Has this reduced prices for consumers?

Unfortunately not. A recent survey by Advocata compared the controlled prices with the weekly market prices published by the Department of Census and Statistics (covering the main markets in the Colombo district). The survey found that the controlled prices are not being followed in most instances.

Interviews were then conducted with retail and wholesale traders to understand the behaviour of traders. For dry rations such as onions, potatoes, pulses, and rice, traders react to price control in two ways:

1. The controlled price serves as a guide, but is not strictly followed.

2. Low quality items are sourced, particularly bulk lots, close to expiry.

Traders do try to import goods that they can then sell at the controlled price. This is sometimes a possibility. When it is not, the controlled price is either ignored or adjusted temporarily. What traders do is source the cheapest possible items and sell at above the controlled price. The Consumer Affairs Authority conducts periodic ‘raids’ and if the trader is found out, they pay a fine.

As the fine is a nominal one it does not serve as an effective deterrent, nor does it create an incentive for corruption; but the final result is that the controlled price is not followed.

This explains the absence of shortages and queues; the typical problem associated with price control. Is the solution the strict enforcement of controlled prices? This would almost certainly cause shortages, because traders would then curtail imports if it was uneconomical to import.

The trader does, however, attempt to minimise the difference between the selling price and the controlled price, but the controlled price is not observed and quality suffers as a result.

In attempting to comply with controlled prices, traders sometimes source large volumes of produce that are close to the end of shelf-life.

These are cheap enough to be sold at the controlled price. Such items are quickly disposed, occasionally below the controlled price and before the items become unsaleable.

Sometimes quick disposal is not possible and rotten produce finds its way into the market. Recent raids have detected rotten vegetables and potatoes in Karagampitiya (April 2018) and substandard cooking oil in Dambulla (December 2017).

Some traders supply the supermarkets, who do a quality inspection and return items that are of poor quality. Traders sell the returned items in the public markets.

The worst items that cannot be sold in public markets are disposed to food processors. Older news reports (2013, 2014) reveal instances of rotten vegetables being used to prepare food in the National Hospital and also found in warehouses – apparently to be sold to eateries and bakeries.

All the traders surveyed by Advocata admitted to the problem of low-quality goods being brought into the market, but always blamed ‘other’ traders as the ones bringing in inferior goods.

Some bad consignments do get detected at the Customs - the annual reports of the CAA for 2014 (the latest available on its website) notes that 72 consignments of goods were re-exported due to non-compliance with standards. In the previous year (2013) 207 consignments were re-exported.

Perhaps the best way to minimise quality problems is to remove the incentive to bring low quality goods: removal of price controls. Given that controlled prices are not really being followed anyway it seems the simplest solution.

If price controls were rigidly enforced on these items, then shortages would occur, but either by design or by accident, enforcement is lax. Quality suffers as a result, and as almost all traders face similar pressures and import the cheapest available products, consumers are left with limited choice.

While citizens are made to believe that price controls are imposed to protect consumers, other government policies such as taxation and restrictions on imports, actually serve to increase, rather than cap retail prices. Many basics subject to price controls are also taxed, including potatoes, Bombay onions, ( taxed at Rs.40/kg) chillies (taxed at Rs.25/kg), and dried fish (taxed at Rs.102/kg*). The taxes add anything from 5% to 30% to retail prices.

The government attempts to minimise price movement in by changing the controlled price level or taxes, to compensate for movement in world market prices. Sometimes taxes are lowered when world market prices rise, and sometimes they are raised -as in the recent case of sugar-, when world market prices drop.

For example, taxes on sugar were increased by Rs.8/kg following a Rs.10/kg decline in world market prices; but the controlled price remains unchanged at Rs. 95/kg. Thus, consumers have to pay a higher price than necessary, thanks to the price control. A decline in world market prices has not been passed, instead has been split between the government and traders.

In this example, the government intervenes first to tax, raise costs, and then to set a maximum selling price. The tax is substantial at about 30% of selling price (and over 50% of landed cost) which raises prices; it then imposes a maximum selling price.

The two policies are mutually contradictory and resulted in consumers paying higher prices than if a free a market prevailed. This is true of several other commodities.

In the dairy industry a price control exists on powdered milk, but not on other products which are sold at much higher prices. In this instance, importers of powdered milk are large companies and the controlled price is easier to police.

Shortages do not occur as the companies supply even at a loss, but the controlled price is not reduced significantly when world market prices drop, in order to allow the companies to recoup losses incurred at times when prices are high.

There is greater stability in prices, but the controls reduce the level of risk and serve as a deterrent to price competition. Players seek to maximise returns when raw material prices are low to the detriment of consumers to compensate for anticipated losses when costs rise. Uncertainty in prices may also be a deterrent to new entrants, reducing the level of competition.

Politicians use price controls to gain approval from the public by being seen to do something about the cost of living.

Tax policy is frequently at variance with the objectives of the price control regime – taxes are imposed raising costs, even while selling prices are controlled. For example, almost all the commodities recently subject to price controls including dhal, sugar, potatoes, and onions are also subjected to import taxes, some of which add significantly to costs.

Far from improving welfare, it appears that the tangle of price controls and taxes actually raises retail prices. The price control regime appears to be little more than a charade. The way to reduce the cost of living is not through price controls, but by reducing taxes and dismantling the controls.

* Some of the taxes were reduced recently after the completion of the report.

The author is a Fellow of the Advocata Institute