WOULD PRICE CONTROLS SUFFICE TO CURB INFLATION?

 

Kenya’s year-on-year inflation rate accelerated to 7.9 per cent in June 2022- the highest level it has scaled since August 2017. A closer look at the consumer price index shows that the jump in inflation was largely driven by considerable upward movements in the costs of food and non-alcoholic beverages as well as the rise in fuel prices after a price review by the Energy and Petroleum Regulatory Authority (EPRA) in mid June.

In early June, there was a clamour by Kenyans on Twitter for the government to intervene in curbing the rising costs of living by imposing price controls on key commodities such as food. While the distress by Kenyans who have been pushed between a rock and a hard place by the rising costs of living is understandable, it is important to understand the ramifications of price controls.

Price controls are government regulations on prices or their rates of change and may take the form of setting either maximum or minimum prices. I shall make references to the cost of food since this is where the bone of contention primarily rests.

 By setting a maximum price on food items such as unga the government can reduce the price of unga and make it more affordable to a majority of the citizens. However, doing so would be neglecting the fact that prices are not determined exogenously. They are a function of supply which reflects the cost of production, and demand which reflects consumers’ incomes and preferences. This thus brings us to the first problem associated with setting a maximum price in a bid to control prices- the fact that a maximum price will lead to a shortage.

You’ll have to pardon me for getting a tad too technical.

The diagram above is a hypothetical analysis of the prices and quantities demanded of a packet of unga. The forces of demand and supply would lead the equilibrium price per packet of unga to settle at Pe while the quantity demanded settles at Qe. In the event that the government caps the market price at Pc, consumers will demand Qd packets of maize since it is slightly more affordable at this price while suppliers will be willing to supply only Qs since the price cap would cause them to cut back on production if they were to maintain initial profit margins. The distance Q on the diagram represents the shortage of packets of unga.

Secondly, price controls would lead to a lack of incentive among suppliers. Taking the unga example again, the rising costs of unga in Kenya is driven by a shortage in the supply of maize. The maize shortage is driven by the fact that we have had two consecutive failed seasons due to inadequate rains thus a decline in the number of bags harvested. In May, the National Cereals and Produce Board (NCPB) managing director declared that its maize stocks were depleted. To remedy the situation, the government opened a window for maize importation which is to last till August 6. Now, if the government was to cap the price of unga, the incentive by traders to import maize would be reduced because the set price wouldn’t accurately reflect the costs incurred to import the maize. Thus, they would import lesser quantities than they would without price controls. This therefore buttresses the fact that far from solving the problem, price controls would make the shortage last for longer.

The third and most fundamental argument against price controls is the fact that price controls are only a knee-jerk response to the problem of inflation. This is because price controls do nothing to tackle the underlying reason for inflation. In our unga case just as it is with most food items in the country, inflation is largely driven by cost-push factors. Imposing price controls does zilch to stem the intrinsic supply problem.

The blowback after former US president Nixon’s administration, in a fit of political fervor, imposed a 90 day freeze on all prices and wages across the United States on August 15, 1971 is a textbook example of why price controls don’t work. Daniel Yergin and Joseph Stanislaw in The Commanding Heights: The Battle for the World Economy write “Ranchers stopped shipping their cattle to the market, farmers drowned their chickens, and consumers emptied the shelves of supermarkets.”

For the Kenyan case, the most logical option for the government would be to institute subsidies as a stop gap measure before it can come up with concrete measures for the long run.