Our policy making in the last few decades has been, if not more, far from any rational economic thinking. Economic problems are not solved by thinking, but by band-aids and knee-jerk reactions.
Fixing the price of any good or service is one such tool that has been abused to no end and has consistently led to adverse economic outcomes for the country and the population. Whether it is a matter of fixing the price of an agricultural product, an energy source, a drug or a mundane service – there are no circumstances where a price floor or a price ceiling leads to better economic outcomes for consumers. This often leads to the creation of an ecosystem where a select few benefit from inefficiencies in the system, while the welfare loss is borne by consumers.
In a price floor, the government sets a minimum price at which no good can be sold, ultimately making the government a buyer at that particular price to ensure that the price does not fall further. Because of such a price floor, consumers do not benefit from lower prices and have to buy more expensive products compared to what they would have bought if there was no price floor.
A relevant example here is the support price given to wheat in the country. Without any economic rationale, the support price for wheat is rooted in the desire to ensure food security. However, food security cannot be achieved through a price floor alone. This requires massive investment in supply chain and storage infrastructure, meaning that any surplus can be stored so it can be used when stocks run low in later years.
To ensure food security, the local price of wheat has been higher than international prices for most of the last decade, even the poorer sections of the society are paying higher prices for wheat. To ensure the presence of a price floor, the government became the largest buyer of wheat, borrowing heavily from financial institutions to make such purchases, only to have it wiped out or smuggled.
As international prices rose, local shortages of wheat took a few months, as stocks suddenly began to disappear, or were smuggled into banks on the arbitrage available between local and international prices. Likewise, as recent floods have demonstrated, millions of tonnes of wheat stocks have been lost due to inadequate storage and exposure to the elements.
The intention of ensuring food security was noble, but the means used to ensure it were inappropriate, resulting in the transfer of wealth from the most vulnerable households and by the government to certain sections. As a result, a price floor takes away incentives to invest in improving yields, productivity, or supply chain infrastructure, leading to long-term productivity losses, as a benevolent government finances such purchases with more debt.
Because of such ambiguity in the market when prices rise, the government sets up price monitoring committees that can be rectified with supply chain infrastructure and voice, as collectors get opportunities for photo-ops, unaware that price hikes are a supply chain problem. Economic policy rather than photo-ops. The cycle continues until another commodity is flavored for the week and the photo-ops are repeated.
Another example is a price ceiling, where the government sets a price for a product above which it cannot be sold. In such a scenario, a shortage of that product is imminent, causing a huge welfare loss to consumers, while the government can proudly pretend that the price ceiling is actually working when the available quantity dries up at the fixed price. A recent example of this is how the government sets drug prices. Considering the largely volatile nature of medicine, a strong regulatory regime is certainly necessary. However, it is also important for the same administration to be nimble and work for consumer welfare by encouraging investment in infrastructure and through backward linkages. Attacking the low-hanging fruit of price creates more problems than it solves.
As the Pak Rupee has depreciated significantly against many global currencies over the past six months, the active pharmaceutical ingredient of many imported drugs has increased in price, resulting in higher production costs. However, since the retail price is fixed, beyond a certain threshold it does not make economic or financial sense to produce more of the drug, leading to potential shortages.
There is a moral argument that the drug should continue to be sold even at a loss during a crisis – that is certainly true, but not tenable. Heavy investment in supply chain infrastructure and technology is essential to localize critical raw materials to reduce import dependency of key medicines. However, due to the archaic and anti-competitive regulatory regime, there has been massive divestment from the pharmaceutical sector in the country. As predicted earlier, price ceilings cause more problems than they solve.
Fixing prices is an easy win for short-term and photo-ops. Fixing a supply chain that produces better prices and better welfare outcomes for consumers and producers alike is a complex policy-based process. Any government serious about fixing problems needs to stop relying on fixing prices to fix problems. The problem is not prices, the problem is fixed prices.
The writer is an independent macroeconomist.