What can be done about rising prices?

There are two principal ways to constrain the market power of the likes of Araliya and Nipuna-Menaka-Hiru. One is to empower the small rice millers. The other solution is to import rice to discipline the cartel – Pic by Shehan Gunasekara

Citizens are being hit by rising prices on one side and reduced incomes (except for most State employees who get paid whether they work or not, and a few at the top) on the other. The Government is falling back on the failed 1970s playbook of price controls, permits for everything, and rationing. Price controls, even when backed by emergency powers and military muscle, have failed, as demonstrated by the total decontrol of the price of rice. What can be done?

The Government’s resistance to debt restructuring and fiscal discipline is accelerating our descent into crisis. People are beginning to feel shortages and rationing of consumer goods. Producers in all sectors are beginning to feel shortages of critical inputs, caused by the Government’s import restrictions. Probably the decision makers in Government feel nothing, ensconced in their cocoons.  

Citizens are being hit by rising prices on one side and reduced incomes (except for most State employees who get paid whether they work or not, and a few at the top) on the other. The Government is falling back on the failed 1970s playbook of price controls, permits for everything, and rationing.  

Price controls, even when backed by emergency powers and military muscle, have failed, as demonstrated by the total decontrol of the price of rice. What can be done?

Prices of fuel

If the Government is compelling a firm to sell below the cost of inputs, there can be only one outcome: the firm will cease to supply: LAUGFS is a case in point. This would apply to a whole series of goods where the inputs are priced in dollars and retail prices are set in depreciating rupees. But if the firm is State-owned like Litro, it may limp along join the ranks of perennial loss makers like SriLankan that have to be rescued with public money.

A solution is to allow controlled retail prices to rise according to a formula. This is feasible for regulated utilities with a limited number of regulated suppliers such as those for petrol/diesel and LPG. 

It would then be logical to allow the electricity supplier to also increase prices because one of its principal inputs is increasing in cost. This will continue to ripple through the economy. For example, electricity is responsible for close to 30% of the cost of producing drinking water. 

If formula-based pricing is used for fuel, many downstream products will increase in price. The alternative is to compel entities such as electricity and water operators to operate at even bigger losses.

But can a government simply let prices increases caused by world market movements and/or exchange rate fluctuations directly affect the consumer? In many countries, this is normal. But Sri Lanka’s practices and expectations are different. Let’s take the example of cooking gas, based on data from 2016 Household Income and Expenditure Survey (HIES).

More than half the households in the Western Province cook with gas. In the Colombo District, 74.1% use LPG for cooking. Only 4% use kerosene, and the rest use firewood, according to the 2016 HIES, the latest available. If the 2019 HIES report had been issued on schedule, we would likely see even greater LPG use.

This means that pretty much the entire urban and semi-urban population of the Colombo District uses gas. They have invested in gas cookers. The old ways of supplying kerosene no longer exist. The bullocks who pulled the kerosene carts are no longer among the living. Firewood is not an option for those living in most forms of urban housing. The ill-effects of indoor smoke pollution are well known. What is true for the urban and semi-urban parts of the Colombo District is also true for most major urban centres.

To avoid shortages, the prices of these items should be set using a carefully designed formula that precludes the inclusion of padded costs and kickbacks. So, for example, prices actually paid for purchasing gas should not be used; some benchmark price such as Henry Hub with appropriate adjustments should be used. 

Because Sri Lanka is a highly unequal society (Household Income Gini Coefficient is 0.45 (urban sector Gini is worse, at 0.48)), price increases in essential items such as cooking fuel are likely to hurt households in the lower deciles. But, as demonstrated by recent experience, irrational price controls cause shortages, an even worse problem. Those in tenements cannot buy firewood bundles from Kapruka.

What can be done for the poor when the prices of essentials go up?  India operates a massive LPG subsidy program. Sri Lanka subsidises Samurdhi and other designated beneficiary groups through discounts applied to NWSDB water bills. In 2018, the Government spent Rs. 5 billion on kerosene subsidies for owners one-day fishing boats and certain Samurdhi beneficiaries. Thus, it is feasible to direct targeted subsidies from the Consolidated Fund for those in the lower income deciles who face difficulties because of formula-based pricing. The cost to Treasury will be lower than that of covering the losses of the suppliers/subsidising all.

These kinds of clauses can be included in an IMF stabilisation program. They will serve to convince debtors that we are serious about managing our finances and will help gain agreement to restructure our debt. This will be especially useful because the IMF has begun to focus on rational pricing for petroleum products when domestic prices are out of sync with world prices. These subsidies are also compassionate, demonstrating sensitivity to the needs of citizens.

Price control in these conditions is mostly intervention theatre, as evidenced by camera crews being given pride of place in the ‘raids’. When supplies are constrained because of foreign exchange shortages and/or when inflation is being fanned by excessive money printing, the Government wants to show that it is doing something. Efficacy is immaterial

Prices of other goods

The availability of a plethora of goods and services sold by a multitude of vendors is the sign of a modern economy. The general approach in consumer protection is to seek to reduce the information asymmetry between buyer and seller, and to set in place mechanisms to ensure quality is as described. It is unusual to attempt price control of general merchandise. But it appears the Government may be of such a mind.

Price control in these conditions is mostly intervention theatre, as evidenced by camera crews being given pride of place in the ‘raids’. When supplies are constrained because of foreign exchange shortages and/or when inflation is being fanned by excessive money printing, the Government wants to show that it is doing something. Efficacy is immaterial. 

Price controls generally lead to shortages and/or degradation of quality and/or black markets and corruption. The garlic and sugar scams are illustrative.

Price controls cannot be sustained in markets such as those for rice, sugar, coconuts and such. If the Government wants to go beyond theatre and wants to ensure adequate supplies and quality it will gradually slide toward supply through State-owned retail outlets and/or a limited number of State-franchised and highly-regulated sales outlets, because of the near impossibility of excluding various forms of abuse in a complex private system subject to price control.

This is foreshadowed by the Trade Minister wanting to sell everything, including price-controlled underwear, through Sathosa outlets. But the abuses will reappear within the State system too, as well demonstrated in the 1970-’77 period.

What is the alternative? Causes must be addressed, not symptoms. If supply is inadequate to meet demand, prices will rise. If suppliers are few enough to be able to coordinate prices (as evidenced by the joint announcement of prices by large rice millers), prices can rise even without a contraction of supply or an increase in demand. These are the causes, beyond inflationary effects, devaluation of the 

rupee, etc.

There are two principal ways to constrain the market power of the likes of Araliya and Nipuna-Menaka-Hiru. One is to empower the small rice millers. That was the Shakthi Rice Initiative which sought to bring the small millers into cooperative structures so they would be able to pose a credible threat to the big four or five.

Unfortunately, that initiative was discontinued after the election. That solution works with local players and does not involve imports. The debate on the wisdom of avoiding rice imports if such supplies are cheaper can be left for another day.

The other solution is to import rice to discipline the cartel. Given the nature of the market, with big spikes in supply at various times, this cannot be one-off. The point is not to compete with the big millers, but to create a credible threat that they will be undercut if they price too high. 

So far, the Government has not done too well in the credibility department, so its efficacy is doubtful. Does the Government have the will to keep importing and selling at low prices until the big millers buckle? And how will all this play out in the context of supply reduction caused by the self-inflicted harms of the fertiliser, weedicide, etc. ban?  Cheap imported rice will not be organic, so there will be questions to answer on that front too.