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Perspectives

Price controls enable corruption

We argued in the previous article that price controls are economically undesirable, and calculating controlled ...
Updated 13 Sep 2021

We argued in the previous article that price controls are economically undesirable, and calculating controlled prices properly is simply infeasible. Another reason why prices shouldn’t be controlled is that a price control regime creates at least three types of negative effects on governance.

First, price controls create inefficiencies, nepotism, bureaucratic corruption, and encourage the black market. To see this, consider how goods and services are allocated through the market price system.

In the market, anyone wishing to purchase an item has the option to bid up its price. When instead we allocate scarce items through non-market methods, these methods are wasteful (such as the formation of queues), and people often resort to personal networks or under-the-table payments to jump ahead in the queue.

Equally, when prices are too low, suppliers will be willing to supply less at official prices than consumers are willing to buy. For consumers left without the product, it is a win-win to approach the supplier and offer more than the government’s control price for the product. In an environment with good law enforcement, buyer and supplier have to weigh the benefits of transacting in the black market against the risk of being caught, but even so, price controls create a tendency towards undocumented transactions.

Let’s focus briefly on corruption, a favourite subject of the present government. The first lesson of economics is that people respond to incentives, and so it is not enough for us to rely on our bureaucrats’ good intentions: we must create an institutional environment that does not create unnecessary corruption opportunities. A price control regime incentivises both inspector-level bureaucrats and policy-setting bureaucrats to engage in corruption.

How price controls suffocate the economy

Consider this: this policy gives bureaucrats the power to monitor prices, investigate firms’ records, and set controlled price levels without creating any significant checks or limits on their discretion over how to set those prices. Moreover, for differentiated products (and nearly any product is arguably differentiated), bureaucrats have discretion over which brand falls in which price tier. Convincing the bureaucrat to set a high price thus becomes tremendously important to a firm’s profitability, and therefore it is not hard to imagine firms being willing to ‘invest’ in influencing the bureaucrat’s decision.

Second, price controls harm governance because any poorly-conceived policy, especially one that is near-impossible to implement properly, can only undermine respect for government functionaries, for the rule of law, and the state.

Every time a policy is pushed through without meaningful deliberation and debate, every time a plan is set in motion that is not backed by the practical implementation ability of the bureaucracy, and every time we experience corruption, violence is done, not only to our perception of the state in that moment in time, but our beliefs about how it will react in the future.

I wonder about the decision-making process that went into this new policy: was expert advice sought? I suspect not, because I would be shocked if any self-respecting economist would have signed off on it.

Was there any attempt to articulate a theory of why hundreds of markets affected by this new notification needed government intervention? Any attempt to find empirical evidence of the type of market failure posited?

The risk is that trying to deal with rising prices superficially through price controls will further delay the tackling of these important underlying causes of inefficiency

Was such a drastic policy first tried out in one market, one sector, or one region before being rolled out across such massive swathes of the economy? And has there ever been a review of the enforcement agency’s capacity? To answer in the negative to these questions is to betray criminal negligence by those involved, which would be shocking if it weren’t so common.

If price controls are notified, but bureaucrats lack the capacity to implement them uniformly, or if corruption in the price-setting process becomes common, the state’s credibility and thus ability to implement meaningful reforms at a later date – such as measures to increase the direct tax net – are both undermined. The government’s historic administration of Ramazan bazaars does not fill one with confidence in how future price controls will work.

Third, trying to control prices in this way detracts from more appropriate actions the government should focus on: there is a state role in the efficient provision of national infrastructures, such as farm roads; in bolstering research and development; in creating quality accreditation bodies and enforcing safety and environmental regulations; and in improving antitrust laws and their enforcement.

The risk is that trying to deal with rising prices superficially through price controls will further delay the tackling of these important underlying causes of inefficiency.

To suggest that we avoid price controls is not to suggest that we ignore the need to improve conditions for vulnerable parts of our society. We have policy options available – such as expanding income support and directed subsidies, that can be more efficient, cheaper, and overall more effective ways to achieve social protection.

From the US deregulation of airlines in the 70s to China’s experimentation with capitalism in the 80s, to India’s dismantling of the License Raj in the 90s, countries that have moved away from bureaucratic control of the economy have witnessed efficiency improvements and growth.

Last week’s notification and this week’s announcements run contrary to the lessons of recent economic history. One can only hope that the missteps taken with the notification this week will lead to course correction and an improvement in policy focus in the days to come.

Dr Ali Hasanain

Dr Ali Hasanain is the Head of the Department of Economics at LUMS

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