Price ceilings are counterproductive

Price ceilings are back among the policy favourites. The establishment is gung-ho about it. The business leaders have hailed the intent. Experience globally more often than not finds a major disconnect between intentions driving price ceilings and the outcomes they produce. Bangladesh's own experience provides little assurance of doing any better.

Ceilings in the making

The government wants to widen control over the market by setting prices. Rice, egg, cement, and rod will join edible oil, sugar, flour, onion, and lentil in the list of nine essentials. Their retail prices will be capped based on global price and local supplies. This list is open ended – more may be added if their prices do not behave according to the regulators' expectations.

Domestic market prices rose sharply following increases in the international market, fuel price hike and the depreciation of the taka. "They've not only been passing on the cost but passing it on even more" is a common refrain. The commerce ministry has conducted policing frequently to punish the alleged price gougers. The results in terms of price stability have at best been ephemeral.

The government wants to tighten the lid on prices. The Tariff Commission will suggest prices of imported goods for the local market. It currently sets the price of edible oil and sugar. The Consumer Rights Protection Commission and the Competition Commission will oversee implementation. Failure to comply with the announced prices will trigger legal action against the offenders.

The Essential Commodities Act 1957 empowers the government to intervene for securing the availability of an essential commodity at fair prices. Punitive measures are not limited to fines and forfeitures of property. There is a provision of maximum three years' rigorous imprisonment for contravention of orders invoked under the Act.

Cautious support from business

Leaders of several business associations have hailed the policy intent while voicing their aspirations from and concerns about the interventions.

The Bangladesh Auto Major and Husking Mill Owners Association "have no problem selling rice at the price set by the government. But before fixing the price of rice, the price of paddy must be fixed. If not, it will not have an effect." They want to pass on the lower price upstream to the farmers!

The Bangladesh Cement Manufacturers Association claim they are "now forced to sell rod and cement at a loss due to various reasons. It will be good for us if the government fixes reasonable prices." They seem to be expecting an increase in price!

The Dhaka Chamber of Commerce and Industry believes it will be beneficial for the people if the government fixes the prices of basic commodities. They point out, "it will be very challenging".

The Federation of Bangladesh Chambers of Commerce and Industry have no problem with the government intervening when a section of businesspeople manipulates the prices. They caution that "it's easier to fix the prices of imported goods such as edible oil and sugar as the government has the data…but tough to fix the prices of rice because of wide varieties of the staple and the fact that the government does not have the exact data on its production and stock."

The businesses may feel obliged to go along because of the evolutionary advantage from interaction with the competition authorities or uncertainty around enforcement of the regulations. We saw similar reactions from the bank owners and the CEOs on the lending rate cap not too long ago.

Conventional economic wisdom

Price control is an ancient form of regulation. History shows price controls are costly. The severity of the cost depends on the breadth of the control and the degree to which it changes the market price—monetary and real.

A price ceiling causes shortage of goods whose price is capped below the market determined level. Buyers want to buy more while sellers are willing to sell less. The resulting shortage may be exacerbated if users buy in excess of what they otherwise would in anticipation of a shortage. Sellers expecting future demand spikes may also hoard. The shortage necessitates some means of rationing. Which demands get satisfied may be determined by random chance or pernicious processes such as cronyism, corruption, non-price discrimination, or muscle power.

Collateral damages are too many. When the government imposes a price ceiling, a seller, facing more demand than can be supplied, has no incentive not to play favourites. Price ceilings cannot prevent consumers from directly spending non-monetary resources to acquire the goods. Consumers often spend such a long time in line that the time cost plus the money cost can actually exceed the market price without the ceiling. Companies skimp on the goods and services they provide, dubbed as shrinkflation. For instance, rice dealers reduce the weight of each bag while soybean oil sellers' tie-in mustard oil. Price ceilings on goods have often enabled a thriving black market. 

In theory, price ceilings can be beneficial in the presence of monopoly or collusion (syndicates). Appropriately capped price can raise output as well as lower price under imperfect competition. The difficulty lies in execution even when evidence nails abuse of market power as the source of the problem. In the populist discourse, collusion is taken for granted. Even so, no government entity is well informed enough to be able to choose the correct price, provide ongoing adjustment and ensure enforcement. Market policing often ends up making market prices more volatile.

Tighter price regulation is popular in periods of extraordinary economic stress such as the present. Rising profits and firm size are often cited as evidence that a sudden increase in greed, not changing economic conditions, is driving inflation. Greed being relatively constant is not a plausible way to explain a change. That big firms dominate the economy more today was true long before inflation took off.

The opportunities for the exercise of greed changes for sure. When the pandemic hit, some retailers in some markets, enjoying market power, were able to increase prices. At the same time, supply of certain essential items, such as hand sanitizers and masks, increased because of the entry of other manufacturers. E-commerce expanded like no other. No price ceilings were needed to manage the availability of changing essentials during the pandemic.

Damages are not just economic

Powerful firms, whom the ceilings attempt to disempower, can influence price-setting decisions. Competition shifts from production to political markets. There is already a sense that corporate capture of government is not a figment of imagination. Price ceilings increase the role not only of the bureaucrats but also of business lobbyists.

Political frictions result from creating winners and losers. When policymakers grant the privilege of buying cheap, they harm the sellers who then demand similar privileges. Fulfilling their demands by reducing the price of their inputs harms the input suppliers. The policy eventually morphs into providing subsidies paid by raising taxes or borrowing. Meanwhile, interventions pile up.

Unwinding accumulated interventions is messy. The political incentives are seductive. The government is seen as doing something that apparently "succeeds" at least for a time. Seeing the damage that price ceilings are doing don't necessarily make the administrations pull the plug. Their policy evaluations are based on intent rather than outcome. They regulate further seeking to maintain government legitimacy while producing private benefits for the connected stakeholders. Frédéric Bastiat had a point in writing: "The state is the great fictitious entity by which everybody seeks to live at the expense of everyone else."

The triumph of fancy over experience?

We seem to have the following control serving narrative: Inflation is a global problem. So, what can we do except hoping it will fade? But no, we can cut indirect taxes and expand social protection. No again because revenue is low. How about monetary solutions? Allow interest rates to rise, but no, this is capped too. Well, then blame it wholesale on syndicates. So, here we go: price ceilings which look deceptively like a precise approach to tame rising prices.

We need to be cognisant of the consequences of price ceilings in their entirety. A plethora of evidence from past crises show price ceilings dampen investment, grow fiscal burdens, and complicate the conduct of monetary policy. Government economists, no matter how well intentioned and well equipped with surveillance technology, cannot outperform the market in aggregating and transmitting highly dispersed information. Inflation unravels when the controls are relaxed and accelerates, especially if countries resort to monetary financing of budget deficits. 

It is wishful thinking to believe price ceilings are a scalable social policy solution to the problems of poverty. The system subsidises everyone including the affluent. The desire to repress prices cannot be carried out without anyone paying the unseen bills. A big, profitable firm won't go out of business when faced with a price ceiling. But ceilings deal a fatal blow to small and seasonal businesses, including farmers, facing thin margins and higher input costs. These small producers and traders matter for contesting the power of monopolies and cartels.

Government needs to be more proactive on social assistance. Initiatives such as providing rice, oil, onion, sugar, and pulses to the poor and low-income family card holders at subsidised prices once a month are promising. Social assistance programs need stronger financing, management and targeting to cover the bottom 25 to 30% of the population most ill placed to cope with high inflation.

Zahid Hussain is a former lead economist of the World Bank Dhaka office