Regulating prices: From price mandates to more competition
A farmer carrying a sack of fertiliser.
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. 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). 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. 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.
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 a 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 to 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. 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. 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.
What can be done?
Sri Lanka urgently needs to rethink government interventions that increase the costs of competing. 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.
(The writer is a Research Analyst at the Advocata Institute and can be contacted at thiloka@advocata.org).