Does ‘fixing prices’ of essential commodities work?

It is impossible for governments to administer lower prices and ensure proper supply and quality at the same time, writes Shahid Mehmood

Does ‘fixing prices’ of essential commodities work?
The season of rising prices is upon us. Given the upward trajectory of inflation in Naya Pakistan, prices of almost everything have gone up. Every day I hear the common refrain about government’s failure to “control” prices. Unfortunately, the anger is misdirected because it ignores historical evidence which is at odds with this belief.

Some time ago, when the Punjab was under Shahbaz Sharif’s iron grip, there was a shortage of ghee around Ramazan. As expected, the chief minister “ordered” that the prices be “brought down” and fixed so that ghee becomes affordable. As far as political gimmickry goes, the stunt worked well. But the end result was that the quantity that was available vanished from the market. In the black market, its price had quadrupled.

It was a self-defeating strategy, and one that had been tried many times before. Earlier, the denizens of the Punjab had gone through the “sasti roti” stunt. As soon as the scheme was initiated, flour vanished from the open market. It is another story that the machinery imported for this scheme is now gathering rust, and the Punjab government is paying interest on loans used for buying those machines. No marks for guessing who the real beneficiary of the scheme was! Failing to learn lessons from this debacle, the move to fix prices of basic commodities continues unabated. The irony is that it ends up hurting welfare of the consumer instead of helping them.

The federal government and the other provincial governments have also showed great infatuation with setting prices of goods and services. For example, a favourite item to fall victim to this policy is medicine, whose recent price hikes have elicited public outcry. Imagine this: between 2002 and 2013, the cost of production and overall price level went through the roof. Yet producers of medicine were not allowed to raise prices of their product under a policy of “price freeze.” The end result of this “welfare enhancing” scheme was that majority of multinational companies - those that produced quality medicine and brought much-needed investment - left Pakistan. Once 42, they are now reduced to six. Poor quality and shortages are rampant and much of the industry’s productive base has been destroyed.

Away from Pakistan, historical evidence also suggests the futility of such policies. Price controls have a long history. One of the earliest known incidents dates back to the Roman Empire. Emperor Diocletian issued an edict in the early 4th century CE that ordered a controlled level of prices of various commodities. The end result was debasing of currency (leading to more inflation), loss in total production, emergence of an underground economy, and availability of goods on even more inflated prices than the comparative market price. Similarly, in the early days of the French Revolution, when France was governed by the Convention, the imposition of price controls on flour led to some disastrous consequences. The controls were enacted in order to arrest the upward price movement of grain (largely the result of government’s procurement and distribution policies). Egged on by public fervour and worried about rising prices, the ruling junta imposed restrictions on flour prices. The end result was flour shortages and emergence of a black market where flour was available at a price higher than competitive market prices.

The above were just two historical examples. More recent examples abound. The rent control experiment in New York was a disaster as availability of apartments became scarce to the point that they were not available even on market prices. In the Soviet Union, long queues for basic staples like bread were common since it was never available to cater to the overall demand. This situation owed to the policies of price controls, administered from the top by the politburo.

Given that price caps or freezes ultimately fizzle out, what explains the attractiveness of price control policies? To begin with, they sound attractive to the consumer. Who doesn’t like an inexpensive good? However, historical evidence and research suggests that price reduction as a result of competition is superior compared to forced reduction of prices since the quality of the good is maintained. I gave the example of pharmaceutical products. People may be buying drugs at less than market rates, but they are not necessarily quality products. At worst, they are counterfeit medicines that can be fatal.

Another reason is that politicians are good readers of voters’ psychology and they cash in on this consumer bias towards lower prices. Hence, we have price control policies, which usually form a fundamental tenet of economic manifestos of various parties. These policies ultimately fail, but nonetheless are popular in their appeal.

There are various reasons why these policies of fixing prices do not work. Administratively, it is impossible for governments to administer lower prices and ensure proper supply and quality at the same time. Second, sellers and producers have more than one way of rendering this policy toothless. And more importantly, this kind of a policy is detrimental to the supply side of the economy. Producer and suppliers of services and products do not take up this activity as charity, but under a profit motive. If that motive is denied to them by using coercion, then the incentive to indulge in production recedes. Do the readers not find it strange that a lot of lip service is paid to industrialisation and its importance, but at the same time policies detrimental to industrialisation (like price fixing) are practiced with fervour? This explains, to a large extent, why Pakistani industrialists are increasingly moving to places like Bangladesh where they find more investor-friendly environments.

If policymakers are looking towards enhancing production, then the last thing they need to take recourse to is fixing the prices. If the aim is to manage unwanted increase in prices of basic commodities, then policies should be aimed at productivity improvements, technological application to production and effective governance machinery - the only time in Pakistan’s history when overall price level declined into negative was 1959 and 1961, when a coordinated, effective crackdown against hoarders was initiated. These all combine to ease supply-side difficulties that result in price increases of a manageable level. Moreover, policies should aim at more competition to ward off monopolies that can dictate prices to the market.

In essence, prices can be managed but not fixed. Let the market fundamentals of demand and supply take care of this issue. Government should regulate to ensure quantity and quality.

The writer is an economist

The writer is an economist. He tweets at @ShahidMohmand79