Price control proposal puts small businesses at risk

The use of price controls is widespread across emerging markets and developing economies, including for food and key imported and exported commodities. Although they are sometimes used as a tool for social policy, price con trols can dampen investment and growth, worsen poverty outcomes, cause countries to incur heavy fiscal burdens, and complicate the effective conduct of monetary policy. Replacing price controls with expanded and better-targeted social safety nets, coupled with reforms to encourage com petition and a sound regulatory environment, can be pro-poor and pro-growth. Such reforms need to be care fully communicated and sequenced to ensure political and social acceptance. Where they exist, price control regimes should be transparent and supported by well-capitalized stabilization funds or national hedging strategies to ensure fiscal sustainability. ... 1. Introduction Price distortions are defined as instances “when prices and production are higher or lower than the level that would usually exist in a competitive market” (WTO 2019). One source of such distortions is price controls. Price controls have a long history with well documented examples stretching back to Revolutionary France (Morton 2001). In the 20th century, these policies were used extensively in several Western countries during the Second World War, culminating with widespread controls in the United States and the United Kingdom in the 1970s (Coyne and Coyne 2015). Price controls were also ubiquitous in communist countries with planned economies, such as Poland (Tarr 1994). Generalized price controls fell out of favor in the 1980s, as inflation declined, and governments pursued deregulation. 1 However, controlled pricing for certain goods and services, including rent and pharmaceuticals, remain in use to this day (Morton 2001). Price controls can be imposed in a variety of ways. They may involve price ceilings, or price floors, imposed on selected goods and services by the authorities. Government management of prices can also occur as a by-product of other policies. For instance, preferential exchange rates for certain goods and the imposition of non-tariff barriers can all push prices away from that which would prevail in a competitive market. In emerging markets and developing economies (EMDEs), price controls on goods are often imposed to serve social and economic objectives. They may be part of government efforts to protect vulnerable consumers, by addressing market failures or subsidizing the cost of essential goods. Or they may be intended to maintain the incomes of producers, as part of a price-support program. Alternatively, they can serve the purpose of price smoothing, especially for key commodities subject to high volatility in international markets. This can lower uncertainty about households’ real incomes and firms’ production costs. The modern micro-founded theory of price controls was developed in part to examine the case of commodity producers in developing countries (Stiglitz and Newbery 1979; Newbery and Stiglitz 1982). More recently, for EMDEs, price controls for petroleum products have been studied extensively, while those on food products have received less attention (Verme and Araar 2017; Kojima 2013; Devarajan 2013; Murphy et al. 2019; Shi and Sun 2017; Clements, Jung and Gupta 2007; Ghosh and Whalley 2004). The World Bank’s Energy Sector Management Assistance Program (ESMAP) has conducted in-depth studies of subsidy reforms for energy markets across EMDEs (ESMAP 2019; Ore et al. 2018). The use of price controls for pharmaceutical products, wages and rent has been widely studied in advanced economies (e.g., Coyne and Coyne 2015; Nguyen et al. 1994). Studies for individual EMDEs include China, Indonesia and several MENA countries (Shi and Sun 2017; Clements, Jung and Gupta 2007; Verme and Araar 2017). ... measures for the poor, including expanding food subsidies. Moreover, the government used a share of the proceeds from the reforms to increase expenditures on health care and education provision (ESMAP 2017a). However, attempts to communicate to the affected public that they might eventually benefit from the diversion of energy subsidies to more equitable uses failed, largely because the country does not have the social security net to implement an effective system of cash compensation (Verme and Araar 2017). Starting in 2013, the Government of Morocco first transitioned to price indexation for petroleum products, and gradually moved to fully liberalize most energy products. In August 2014, prices of household utilities jumped as part of a multiyear effort to liberalize electricity prices. The reforms were implemented without triggering social unrest despite the absence of cash transfers to households. The fiscal savings from the reform were instead used to fund other reforms. The fiscal cost of Tunisia’s energy subsidies had risen to unsustainable levels (7 percent of GDP in 2013), and in response the government gradually reduced them beginning in late 2012 in tandem with reforms to social benefits. Petroleum and electricity prices were increased over 2012-13 and an automatic price formula was introduced for gasoline in 2014. In 2016, the government agreed to further reduce subsidies as part of a reform program supported by IMF lending. Energy prices were increased several times since then, with the goal of fully eliminating energy subsidies by 2022. Over the years, measures were implemented to cushion the impact of reforms on vulnerable households, including expanded social housing and higher income tax deductions. Reforms in Ukraine and India In Ukraine in 2015-16, the government raised the price of natural gas, which had been heavily subsidized for decades. These reforms were coupled with a strong public communication campaign highlighting social assistance mechanisms targeted to cushion the impact on low-income households. The reforms were successful in allowing public utilities to achieve cost recovery, with the targeted support measures estimated to have reduced the poverty rate (ESMAP 2017b). In India starting in 2012, the government reformed its subsidy regime for liquified petroleum gas (LPG). LPG subsidies to households encouraged the formation of black markets where subsidized LPG distributed to households was diverted to the commercial sector. The government gradually increased the price of LPG for households while implementing a large-scale targeted cash transfer mechanism. The program successfully eliminated distortions in the LPG market, with limited adverse consequences for the poor, and the fiscal savings obtained from the reduction in subsidies fully offset the costs of the targeted cash transfer (ESMAP 2016). 4. Challenges of price controls While they may be introduced with the best intentions to improve social outcomes, price controls often undermine growth and development, impose fiscal burdens and can weaken the effectiveness of monetary policy. At least in part, this is because price controls cause a shift in consumption towards the subsidized good, and away from other non-subsidized goods. Moreover, when there are trend increases in international prices, or when they interact with barriers to entry, price control measures frequently morph into distortive subsidy regimes. Important social, fiscal and environmental costs are likely to follow, as well as adverse consequences for investment and employment, and productivity growth. Growth challenges The use of price controls can have adverse consequences for growth for several reasons. Price ceilings can depress producer margins and discourage domestic investment and entrepreneurial activity, as in Zimbabwe’s transportation sector (Newfarmer and Pierola 2015). If margins depend on subsidies to local businesses to compensate for price controls, they can discourage foreign investment in those sectors by increasing the country risk premium facing global firms (Sabal 2005). In the opposite case, where the controlled price is above that required for a competitive return to investment, its maintenance requires barriers to entry or costly government stockpiling of excess supply (a common occurrence with price support schemes in agriculture). Price-support controls can depress competition and sustain high producer margins (e.g., Rwanda’s transportation sector; Teravaninthorn and Raballand 2009). Price control regimes may also tilt the allocation of resources towards the subsidized sector. In LICs, this is often most visible in the agricultural sector where output price controls have been complemented by input (especially fertilizer) subsidies. Yet, such policies can end up reducing productivity, and worsening income inequality (Goyal and Nash 2017). They may lead to inefficient use of subsidized inputs (Jayne, Mason, Burke and Ariga 2016). They can also adversely affect incentives to adopt productivity-raising new technologies. Empirical evidence suggests that market-oriented structural reforms, including the reduction of price controls and their related subsidies, are strongly associated with improved firm-level productivity in EMDEs (Kouame and Tapsoba 2018). Conversely, in the case of petroleum products in the Middle East and North Africa, high subsidies that underpin price controls appear to be associated with lower per capita output growth (Mundaca 2017). Moreover, price controls that distort consumption towards price-controlled goods, can cause chronic shortages of these goods, the formation of parallel markets with higher prices, and substitution towards lower-quality alternatives (Weitzman 1991; Patel and Villar 2016; Fengler 2012; Winkler 2015). Similarly, producers of price-controlled goods may turn to black markets which have elevated transaction costs and lack basic regulation (Murphy, Pierru and Smeers 2019). In addition, the situation encourages production to shift to firms in the informal sector, which avoid regulation (De Soto 2000; World Bank 2019a). Price controls in the financial sector, such as ceilings on interest rates, can distort financial markets (Maimbo and Gallegos 2014). These measures reduce the supply of credit to safer borrowers and small and medium-sized enterprises, increase the level of non-performing loans, reduce competition and innovation in lending markets, and increase informal lending. Moreover, they can exacerbate inequality by limiting the poor’s access to lending. At the same time, price controls and subsidies on energy products may heighten vulnerability to climate change and inhibit the transition to a climate-resilient, low-carbon economy. ... LICs are also more vulnerable to the collateral damage from other countries’ price controls on food and energy, because of the high share of food and energy in their consumption baskets and trade. Policies by individual countries to contain the effects of spikes in global commodity process in their local markets have been shown to have had the perverse effect of raising global prices (Laborde, Lakatos, and Martin 2019). Export restrictions in major commodity producers exacerbate global shortages, thus contributing to higher prices on the international market. In the case of the 2007-08 surge in food prices, a majority of EMDEs put in place policies to insulate domestic markets from the rise in international prices (World Bank 2009). 5. Policy implications Price controls have been used to mitigate the impact of commodity price volatility on the most vulnerable members of society. For instance, the use of temporary stabilization funds, as introduced in