Competition, improving productivity, the best form of price control - Advocata | Sunday Observer

Competition, improving productivity, the best form of price control - Advocata

24 October, 2021

The recent decision by the government to withdraw several gazette notifications imposing price controls is a step in the right direction, think-tank Advocata stated.

“Consecutive governments have used  price controls  to address equity concerns instead of undertaking the hard reforms needed to create competitive markets.  Prices are central to solving the core economic problems: how are scarce resources re-allocated to meet as many of the unlimited wants of consumers as possible? Allowing prices to carry out this function, so that more consumer wants can be met achieves the best outcome for an economy. From such a perspective, the recent decision to end price controls on essential foods (including milk powder and wheat flour), liquid petroleum gas and cement is a step in the right direction. Price controls create distortions such as shortages, rationing and the creation of a black market as well as substitution towards low quality alternatives.

“Although price controls are often introduced by governments to protect the poorest consumers in society,  they are  very inefficient, as a means of redistribution. Often these subsidies are biased against the poor as they consume less of these goods than the rich.

“Further, sharp increases in prices could have negative consequences on low income households in the short run.  Ideally such price increases should be made gradually so consumers can adjust to them or be able to shift to cheaper alternatives.  

“Administratively controlled prices particularly on goods and services provided by the government exert a huge burden on the fiscal, leading to high borrowings and debt.  It also affects the conduct of monetary policy by masking underlying inflationary pressures.  Fostering competition and boosting productivity is a better way of reducing the cost of living. This involves removing barriers to entry and deregulating the economy. A good example of this is in the cement industry. The industry is dominated by two players and competition is constrained by a government policy that restricts the number of plants that can operate in each port. 

“If a new factory is set up,  priority is given to existing operators in the port. This limits new investment and  competitive pricing. Another key issue that makes construction prohibitively expensive is the use of paratariffs (cess) on imports reducing contestability in the market. There is a misplaced perception that imports are not necessary, where there is local production, but it is the threat of imports that increases contestability, keeps prices low and improves consumer surplus. Further, it also incentivises domestic producers to improve productivity and competitiveness benefiting all stakeholders.  The same is true of the LP gas industry. There are only two players in the market.  One would expect that the presence of  Laughs Gas should create some competition in the industry.  However, strict governmental control over LP gas prices and barriers to entry for new players into the industry, have prevented an efficient market  from developing. The industry is highly capital intensive and the lack of storage facilities is the most significant  entry barrier.  Allowing  the use of common storage facilities along with opportunities in distribution will make the industry more competitive, exerting  a downward pressure on prices in the long run.  

“Our experience over the past few months illustrate the adverse impact of price controls on the economy.  At the same time, governments are also  concerned that removing price controls would generate inflationary pressures. However, through careful management and communication, one-off increases in prices need not feed into inflation expectations and wage negotiations.  This requires a tight rein over demand driven inflation and credibility that the Central Bank would use its monetary policy tools to keep inflation within its targeted range of 4-6 percent. 

“Hence, going forward, we urge the government to refrain from using price controls to address equity concerns. Instead, creating a competitive business environment and boosting supply is the best solution to lower prices in the economy.

“To support vulnerable households the government should provide a cash transfer to cushion the impact of price increases of essential commodities. This would require a re-examination of the Samurdhi scheme which currently excludes some of the most vulnerable households and tighter administration to ensure benefits accrue to those who need it most.”