Restricting price rises does not stop inflation

PUBLISHED : Monday, 11 April, 2011, 12:00am
UPDATED : Monday, 11 April, 2011, 12:00am


The central government is in a bind. It is reluctant to allow prices to rise due to concerns about instability. But ever-higher labour costs and commodity values are making it difficult to keep inflation in check. Increasingly, it is turning to a new way of controlling prices - getting companies to agree to suspend rises. Price controls are typical of socialist governments. But while the Communist Party's aims are unquestionably socialist, the mixed economic system it has adopted contains many elements of a free market. Authorities have vowed to uphold these market principles, which has encouraged the setting up of profit-minded domestic and foreign companies. That some are now being asked to curb and even stop raising prices flies in the face of that regularly reiterated pledge.

Among the firms are companies producing pharmaceuticals and medicine - the Anglo-Dutch conglomerate Unilever, Tingyi, the Hong Kong-listed manufacturer of the mainland's top-selling instant noodles, Master Kong, and all brewers of beer and rice liquor. Not wishing to get on the wrong side of the government, they have apparently complied. That is obviously good for consumers, but not so for owners, investors and shareholders. Production costs are rising sharply, after all. Wages are rising which is clearly good news for millions of workers. The cost of raw materials and energy is rising which also puts pressure on manufacturers to increase prices. Beijing is trying hard to keep these down, but international trends make that challenging. It is struggling to get local and provincial governments to help.

Political instability in the Middle East has pushed oil prices up by 20 per cent since the start of the year. The government has managed to keep the rise down to five per cent, but this is not a sustainable policy if prices continue on their present trajectory. Demand is similarly driving up the cost of such necessities as iron ore, soya beans, copper and rubber. Rightly, officials have made it clear that they want to link domestic and international prices.

But their actions say otherwise. In November, the government announced that prices should be adjusted 'promptly and moderately', the cost of natural gas be maintained at a stable level and 'temporary price controls be imposed on important daily necessities and production materials when necessary'. The top economic planning body, the National Development and Reform Commission, has since been holding talks with companies to keep down prices.

Price increases, particularly for food, are sensitive for the party. Historically, they are associated with periods of unrest and upheaval in China. Economists have predicted that consumer prices will rise by more than five per cent in March, which would be the biggest increase for almost two years. Food prices are mainly to blame.

Asking companies not to raise prices is a flawed approach and not the solution. Prices should be allowed to rise according to the market. While firms should be socially responsible, they also have investors to satisfy. By intervening, the government is sending the wrong message and creating market uncertainty. Inflation is not easily tackled. The interest rate rises that the government has been employing are part of a solution. Effective cooling of the overheated property market might also help. Allowing the currency to appreciate could help offset the impact of higher prices China pays for imported commodities and energy. Simply restricting rises in the price of goods does not stop inflation - it merely hides it from view.