Written by Carmelo Ferlito, Senior Fellow of IDEAS
First published in The Edge on 18th of April 2020
Policies are designed to address issues, often with good intentions. However, the most difficult thing in designing policies is that they implied a balanced analysis of the trade-offs, to avoid a worse outcome than the initial problem. Price controls are usually introduced to curb rising prices during emergencies or in specific industries.
As the COVID-19 crisis continues in Malaysia, the government has imposed a maximum price control scheme on essential items starting from April 15 until the end of the movement control order (MCO) period. I believe that price control is not a good measure to reduce the upward movement of prices during a period of emergency. This is all the more true under the current scenario where the eventual price upward movement is not dictated by a shortage created by something like a natural disaster, but it is the consequence of the policy designed to contain the COVID-19 spread. In the present situation, producers are ready to “meet” the pressure coming from the demand, if they could do so.
In order to understand my point, it is important to have clear what prices are. “A price is a signal wrapped up in an incentive” (Alex Tabarrok and Tyler Cowen, Modern Principles of Microeconomics). This means that, if the price of a certain item is rising, the market is signalling producers: more profit opportunities are waiting to be exploited (incentive). To the supplier it is of little importance, the deep reason behind the upward movement; but he/she needs to know that this movement is happening, to react accordingly.
Under the MCO, consumers had to reshape their habits and the biggest shift was more Malaysian eat at home; therefore, Malaysians need to buy more food from the supermarket. This tendency was accompanied, in particular, at the beginning of the so-called lockdown, with a natural tendency to hoard food driven by the fear of a progressively deteriorating situation. The increasing demand is pushing some prices upward. The phenomenon is amplified by the supply chain disruptions created by the MCO itself: if the demand for eggs increases, pushing up prices, but the supply cannot easily adapt because, for example, some collateral products, such as packaging, are not available, then that upward price movement will be further exacerbated.
With price control, the government is showing its intention to intervene to protect people’s purchasing power. Unfortunately, good intentions do not always lead to the desired outcomes and economic science often warned us about the importance of the unintended consequences. In fact, price control would make things worse. With rising prices, suppliers receive the information that more product is in demand and they can do what is in their power to meet that demand and get higher revenues. With new supplies entering the market, the upward tensions can be mitigated and eventually prices can go back to their original level or even decrease if the supply grows beyond the actual demand (pushed by the initially rising prices). Such a readjustment process does not happen overnight, and neither is perfect; it takes time and evolves insteps. The interaction between the supply and demand curves explained in economics textbook hints the direction but does not render justice to the complexity of the underlying process. However, although prices need to be allowed to grow for a certain period for the market process to complete its readjustment process and the outcome will never be perfect, such an outcome is still better than the alternative–price control.
If rising demand, pushing prices upward, is met by price ceilings, suppliers will not get “the signal” that more product is in demand and will not receive the “incentive” from that signal. Therefore, they will not adjust their supply because the ceiling is blocking prices from playing their information transmission function. The result is that part of the demand will remain unsatisfied, which means, in less technical terms, empty shelves.
Moreover, to let prices free to adjust to the new context presents a few more advantages: 1. Market-determined prices do not need any legislation or enforcement mechanisms, while government price controls require enforcement mechanisms and prosecution, which can be costly and time-consuming. 2. Higher market prices will discourage the hoarding impulse that emerged at the beginning of the MCO; Conservation is encouraged; by keeping prices artificially low, precisely the opposite happens. 3. Higher market prices will be a drive for the supply to react as quickly as possible.
Knowing that in economic policy there are no silver bullets, here we have two alternatives: to allow prices to temporary grow to attract that additional supply that can ignite a price readjustment process; or to keep prices artificially low with the serious risk of a growing number of empty shelves.