The futility of price caps

A few days back, a few dozen milkmen were jailed because they were selling milk at a price which was higher than what was mandated by the district administration in Karachi. In a saga spanning the last few weeks, there has been a shortage of Panadol which is the most generic of medicines, triggering a potential healthcare delivery crisis.  

The city pages of newspapers, and social media feeds are loaded with assistant, and district commissioners doing rounds of various markets to check whether prices at which products are being sold are at the mandated price or not. About a decade back, the Supreme Court gave a verdict regarding the price of a humble samosa. The government machinery, from the assistant commissioner, right up to the federal cabinet, and the Supreme Court likes to have a say in how prices are set.

The incessant fetish with controlling prices has created a market structure wherein there is no market, because there is an expectation that some government body, or functionary somewhere will intervene and distort market structure. In such a scenario, it makes more sense to be a rentier, rather than be market competitive.

The underlying behavior of incessant intervention is rooted in the overconfidence of government functionaries of being able to control things. The overconfidence that the wisdom of administrators is superior to the wisdom of markets has sadly been disproven time and again for thousands of years. But it is yet to be understood by those who undermine the wisdom of markets, and cannot fathom how supply chains are complex dynamics that can’t be fixed by administrative measures.

In the case of milk prices in Karachi, the increase in cost can largely be attributed to livestock losses due to floods resulting in constrained supply, resulting in higher retail prices. Even higher input costs, and second-round effects of inflation results in a soaring cost of production, resulting in an inflated retail price. The inability of administrators to understand how supply chains work creates more problems instead of solving the ones that already exist. By mandating a predetermined fixed price, they create incentives for the development of a shadow market. To conserve margins, milkmen can simply dilute the quantity of milk, and load it up with various chemicals. The price certainly gets fixed, but the product quality goes down substantially. Similar results can be seen for products across the board, without fail, whenever the government tries to fix prices.

In the case of pharmaceuticals, an arbitrary decision now requires that the price of medicine be fixed by the federal cabinet – effectively micromanaging prices. Due to such distortionary pricing regimes, there has been an exodus of pharmaceutical companies from the country. As the exodus continues, the unintended consequences include a lack of knowledge transfer, and potential shortage of medicine, eventually leading to greater and more costly healthcare imports. A pricing policy driven by administrative whims has never served any economy well.

In the case of energy, price caps for decades have led to creation of such a distortionary market that efficient allocation of energy remains a distant dream. We have wasted previous domestic energy resources, while relying on high-cost imported energy. Even when we import high-cost energy, we provide ridiculous amounts of subsidies such that to not rock the boat, and continue to encourage inefficient resource allocation, and utilisation.

The government and its functionaries instead of fixing prices should focus on developing and sustaining an enabling infrastructure: Policies that encourage investment, and more competition. As competition increases, prices eventually go down, and there is better value for the consumer. But such an infrastructure requires deliberate thought, and the ability to give up on administrative control, which at times is often a source of an ego boost. The decision is pretty clear; we can either enable growth of the economy, a competitive market, and welfare for consumers, or we can feed the egos of administrators that are a relic of the past, and can safely be described as a colonial hangover.

Ammar H. Khan
The writer is the chief risk officer for Karandaaz Pakistan, an organisation that seeks to promote financial inclusion in Pakistan. He has previously worked at several financial institutions in Pakistan, both in commercial banking and capital markets

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