The economic folly of imposing price controls

PUBLISHED : Saturday, 19 January, 2008, 12:00am
UPDATED : Saturday, 19 January, 2008, 12:00am

Afriend from Beijing told me a story recently.

As the story goes, state leaders are eager to know the views of economists, in particular independent ones, given the uncertain economic outlook.

Accordingly, seminars are being organised, which understandably involves a speaker selection process, and the bureaucrats will choose only those with 'moderate' views.

Yet that is not the end of the screening. The chosen economists will be asked to make mock presentations for the bureaucrats, who will then provide 'feedback' and 'suggestions'. These test presentations could run to two, three or even four until the bureaucrats are satisfied. Only then will the economists be sent before the leaders.

I asked my friend if he was joking, but after hearing about the recent price controls, or 'stabilisation' scheme as Beijing calls it, I no longer think he was.

In an attempt to combat inflation, which has exceeded 6 per cent for five consecutive weeks, the State Council has banned price increases for petrol, natural gas, electricity, public transport, heating, and sightseeing tickets, as well as tuition and dormitory fees.

The state has also announced a 'temporary price intervention' in grain, cooking oil, milk, meat, poultry, eggs and liquid gas. Producers, wholesalers and retailers of 'a certain size' have to seek approval 10 days before implementing any price adjustments.

'Unreasonable' increases will not be allowed. Those found guilty of price manipulation will be fined up to one million yuan.

I don't need a degree in economics to understand the macroeconomic ins and outs; I have enough common sense to see the chances of success are minimal.

This is not the first time Beijing has made such a move. Price controls were imposed in 1993 when inflation exceeded 10 per cent. Along with other administrative measures, controlling prices basically shut down the economy.

Price controls will have some success in capping public utilities tariffs, which are largely controlled by the government. But excluding that, it will be very tough. Private business has mushroomed in the past 14 years. Private investors own a significant share of most industries included in the price control initiative. How do the bureaucrats expect to bring them in line?

Controlling price increases among state-owned farming and processing companies is also a tricky proposition. Who is to define a 'reasonable' price increase? How do you verify that cost rises remain within the official caps? What sort of profit margin is allowable?

The perils are all too obvious. Any fair-minded entrepreneur will cut production to force the government to yield. Any fair-minded housewife will stock up on goods before the government yields to market forces. Instead of cooling inflation, the measures may well fan it.

Only two months ago, the public saw Premier Wen Jiabao rescind a promise of no price increases after less than two weeks to permit a rise in petroleum prices when factories reduced supply and vehicles queued for hours at filling stations.

We see no reason the public should be convinced that this time will be any different, unless the government is ready to send armies out to the farms to milk the cows and slaughter the chickens.

Any first-year student in economics could tell you this. But why does Beijing, which has known the ills of a planned economy, resort to an old, futile path? Why does it not counter inflation with monetary controls?

Well, there are suggestions that the country is suffering from so-called 'structural inflation'; that the recent price controls focus only on agricultural produce and commodities, which tighter money supply cannot correct.

Some are also concerned that further increases in interest rates to stem money supply would fuel speculation in the yuan. Given the growing risk of a recession in the United States, too much of a credit crunch at home may result in 'double-jeopardy'.

All these theories become very handy for supporters of price controls. (How true these are cannot be ascertained - domestic media have been banned from carrying criticism of the structural inflation theory.)

The bureaucracy is never short of control suggestions. After all, controlling prices means power for bureaucrats. What can they gain with monetary measures that leave the market to work itself out from interest-rate signals?

You may call me cynical. Indeed, domestic media have carried positive headlines: 'Society widely acclaims price stabilisation effort'; 'National Development and Reform Commission well prepared for price stabilisation'; 'Liquid gas pricing drops upon new policy'.

But the fact is, the government has issued specific orders banning the media from discussing the effectiveness of price controls and academics have been told to withhold criticism of the new policy.

Controlling prices and gagging the media - it sounds all too familiar and all too desperate.