Insights into Editorial: Regulatory price controls reduce investments, not cost
19 July 2016
Inflation is said to be a monetary phenomenon as long as supply-side shocks are not there. Supply-side changes happen slowly and are greatly influenced by micro rigidities in that particular industry or segment. One such micro rigidity is regulatory control of prices. In the face of high inflation, the government tries to moderate it by controlling prices. Such control of prices looks like the right thing to do, but in fact it is exactly the wrong thing to do.
Performance of price regulated and unregulated price industries:
Comparing industries that are price regulated, such as electricity and railways, with those that are not, such as telecommunications and aviation, throws up interesting data.
- Over the past nine years, revenue realised by railways for carrying 1 person for 1 km has increased from 27 paise to 40 paise—a rise totalling 48%. If the same metric is applied for airline industries’ domestic business, we see a fall in cost of 9%, from Rs.5 to Rs.4.54.
- Looking at the cost of electricity using NTPC Ltd’s revenue realisation per kilo watt per hour as a proxy, it has risen from Rs.1.68 to Rs.3.22, an increase of 92%. While the cost of telecommunications, using Bharti Airtel Ltd’s domestic voice realisation per minute of usage, as a proxy, has fallen 65% from Rs.1.03 to Rs.0.36.
- Looking at the increase in ‘quantum of supply’ of these services, one notes that while the number of passenger kilometers of railways has nearly doubled, the number of domestic passenger kilometers flown by all airlines has tripled. The overall electricity produced in the country has gone up by 70%, while overall minutes of usage in telecommunications have gone up nearly 13-fold.
What can be concluded from the above analysis?
It can be said that the ‘unregulated price’ industries have not only seen a price fall but they have also witnessed an increase in supply. On the other hand, the ‘regulated price’ industries have seen price rise and a slower increase in supply.
Why price regulation is not good?
Price ceilings can have negative impacts on the marketplace. Suppliers are discouraged from producing more of an item when they can’t set their own prices, therefore, supply of key resources will decline, reducing availability to the market. Price ceilings also reduce the quality of products, as suppliers have less financial resources to reinvest in their business. Price regulation also does not seem to motivate companies enough to invest—as evidenced by the slower increase in their supply of services.
But, why is it necessary?
Price controls help prevent suppliers from engaging in price gouging, or charging outrageously high prices for limited goods or services simply because they are able to. Price ceilings are also beneficial for keeping the cost of living affordable during periods of high inflation. During high inflationary periods, prices increase faster than incomes, which reduce our purchasing power, making price control necessary for consumers to maintain their standard of living.
How to balance?
Economists theorize that in the long run consumers suffer, because price controls tilt the distribution of resources in favor of the rich and well connected. Price ceilings, for instance, cause shortages, because demand will increase as supply decreases. Therefore, governments should do away with long-term use of price controls, with the exception for brief use during periods of high inflation.
Generally price controls distort the working of the market and lead to over supply or shortage. They can exacerbate problems rather than solve them. Nevertheless there may be occasions when price controls can help for example, with highly volatile agricultural prices. It’s appropriate for the government to have a right policy in this regard.