When governments feel the need to regulate the prices of goods and services, one popular tool they use is ‘price controls’. Price controls are typically introduced during times of high inflation, when prices rise faster than incomes, leading to decreased purchasing power for consumers.
While price controls aim to stabilise prices and protect consumers, they can have significant unintended consequences on the economy, as seen in Sri Lanka.
Distortions in the economy
Price controls have a variety of effects on the economy. One of the primary consequences of price controls is the creation of shortages. When the government sets a price ceiling below the market price, the supply of goods and services decreases, as producers are less willing to supply goods at a price lower than what they would receive on the market. This shortage can lead to long queues, black markets, and rationing of essential goods.
Advocata Institute Chief Executive Officer Dhananath Fernando explains: “Price controls can create a situation where producers are unable to pass on increased costs of production to consumers, leading to reduced profit margins.” In such cases, producers may opt to reduce costs by using low-quality ingredients or compromising on other aspects of product quality, such as nutritional value.
Price controls also create distortions in the economy. By interfering with the price mechanism, price controls prevent resources from being allocated efficiently. For example, if the government sets the price of a good below the market price, it may create excess demand, leading to queues and rationing. This, in turn, leads to an inefficient allocation of resources, as consumers who are willing to pay the higher market price are unable to do so.
Finally, price controls can lead to reduced investment in the affected sectors of the economy. By limiting profits, price controls reduce the incentive for firms to invest in new production capacity, leading to a reduction in innovation and technological progress. This can have long-term effects on the competitiveness of the economy, as firms are unable to innovate and compete with other firms in the global market.
Sri Lanka has a long history of implementing price controls, dating back to the 1970s. In recent years, the Government has implemented price controls on a range of essential goods, including food, fuel, and pharmaceuticals. While these price controls have been popular among consumers, they have had significant unintended consequences on the economy.
One of the primary effects of price controls in Sri Lanka has been shortages. For example, in 2020, the Government imposed a price ceiling on rice, leading to shortages and long queues. These shortages have caused significant inconvenience for consumers and businesses alike.
Price controls have also had a significant impact on the agricultural sector in Sri Lanka. The Government has set price ceilings on a range of agricultural products, including paddy, vegetables, and fruits. While these price controls aim to protect consumers, they have had a significant impact on farmers, who are often unable to sell their products at the market price. This has led to reduced investment in the sector, as farmers are unwilling to invest in new production capacity when they are unable to earn a fair price for their products.
Positives and negatives
While price controls in Sri Lanka have had significant unintended consequences on the economy, they have also had some positive effects. One of the primary benefits of price controls is the protection of consumers from price spikes. For example, during the Covid-19 pandemic, the Government imposed price controls on essential medical supplies, such as masks and hand sanitiser, to prevent price gouging. These price controls helped to ensure that consumers were able to purchase essential goods at a fair price.
Another example is when the Government has implemented price controls on fuel in Sri Lanka, which helps to keep transportation costs down and make it easier for people to get to work and access essential services.
Price controls can also be used as a tool to manage inflation and stabilise prices. For example, the Sri Lankan Government has implemented price controls on certain goods during times of economic crisis, such as during the Covid-19 pandemic.
However, there are several negative consequences associated with price controls in Sri Lanka, as discussed earlier. Additionally, price controls can distort the market and discourage investment in certain sectors, as suppliers may not be willing to invest in goods or services that are subject to price controls.
(The writer is an experienced public relations personnel and is working as an assistant manager at a PR organisation)