ANALYSIS-Price controls are counterproductive, experts say

Sun Apr 6, 2008 8:03am EDT


(This is the latest in a series of stories on rising world food prices and their consequences)

By Lesley Wroughton

WASHINGTON, April 6 (Reuters) - When he took office in 1985, Peruvian President Alan Garcia ordered controls on the price of rice, sugar and other goods to try to keep those staples within reach of his country's poor.

But when shortages and a black market arose, Peruvians were forced to stand in line for hours for basic foods, and five years later his presidency dissolved in a spiral of hyperinflation.

As Peru again faces rising food prices -- this time along with the rest of the world -- a re-elected Alan Garcia has drawn on past experience and rejected price controls.

Other nations would do well to follow Peru's example, according to the World Bank, the International Monetary Fund and other international agencies.

From Argentina and Venezuela to Russia, China and Thailand, governments are meeting the challenge of rising food prices by imposing price controls -- fixing prices below market level -- hoping to ease the burden on their populations and avoid social unrest.

But evidence from past crises shows that such measures don't reverse price trends and can end up having the opposite effect, say international economists, who advocate aid for the poor instead.

"Governments need to take focused action, with direct subsidies for the poor rather than the whole country," said World Bank economist Don Mitchell. "Income transfers or food assistance for poor people will work more efficiently and sustainably than more general steps at the national level."

Although food prices have been on the rise since 2001, the situation collided last year with sharply higher oil prices, leaving many governments grappling for quick fixes and turning to old devices. Many have found the quickest, easiest and most popular are price controls.

In China, where inflation is at an 11-year high, authorities introduced controls on a range of goods from instant noodles to milk, calling it a temporary intervention to battle surging inflation. It was the first time in over a decade that Beijing waded into the food market.

In Thailand, the government is taking similar steps on instant noodles and cooking oil and in Russia, authorities are trying to cap prices of bread, eggs and milk.

In Mexico, the government is trying to control the price of tortillas after protests there, and Venezuela is capping prices on staples including milk and sugar.

Others include Russia, Venezuela, Mongolia, Kazakhstan, Cameroon, Yemen, Jamaica, Egypt, Tunisia, Maldives, Pakistan and Panama, according to the World Bank, which lists 21 countries that have controls on strategic staples.

International economists warn that price controls and other interventions lead to market distortions such as reduced supplies because they discourage domestic production, processing and trade. By dampening the underlying causes of inflation, price controls prevent market solutions, these experts say.

Already, some countries are finding this to be true.

Argentina, which imposed an export tax on grains, in addition to controls on domestic food prices, has been shaken by nationwide protests by farmers in response to the measures, leading to meat and dairy shortages and paralyzed grain exports.

Meanwhile, Malaysia's government has said it is reviewing controls on 21 food items including milk, salt, wheat flour and rice, because they have led to severe shortages and smuggling.

According to experts, controls are only likely to work where staple foods are a small share of total household spending, or when controls are implemented for a very short time, such as in Morocco in Ramadan. If price controls are kept too long, odds increase for a precipitous and destabilizing jump in prices.

VARIED RESPONSES

In poor countries, where food makes up a large share of what people buy, a global increase in food prices has a bigger impact and getting the right policy response is crucial.

Yemen, which imports about 2 million metric tons of wheat a year, has seen a doubling of wheat and wheat product prices that has sent more people into poverty.

"If no action is taken, this could fully reverse the gains in poverty reduction seen in the country between 1998 and 2005," said Thirumalai Srinivasan, an economist with the World Bank in Yemen.

While price controls may be seen as a tempting quick fix, there is little proof that they have worked to dampen inflation.

"The historical experience is that it rarely works for very long," said David Orden, a senior research fellow at the International Food Policy Research Institute.

"For a developing country food importer, it becomes very fiscally expensive to the government." Countries with limited fiscal resources resort to printing money, which in turn creates inflation.

In 1971, U.S. President Richard Nixon imposed a 90-day freeze on wages and prices to tame inflation above 4 percent, a level thought to be intolerable at the time.

The 90 day freeze turned into nearly 1,000 days and by the time the wage and price controls were mostly dismantled by April 1974, the U.S. inflation rate had exceeded 10 percent.

Similarly, government officials in China and other developing nations see their current price control measures as temporary and insist they won't cause long-term problems.

In China, the government has said its intervention is "not a price freeze," according to an official statement issued in January, but rather a step to halt "unreasonable" price hikes and reduce "inflation expectations of the public."

"The measures will be lifted once prices ease," the Chinese government said at the time. "But for now, it's necessary for the government to intervene as the prices of some products have risen substantially."

The key to dealing with higher prices, the IMF argues, is that governments tackle the problem with targeted cash transfers and nutrition programs, cautioning them to steer away from economy-wide subsidies or unpredictable trade policies.

"In general we don't like price controls," IMF Chief Economist Simon Johnson said. "We do recognize sometimes that governments want to buffer effects of shocks ... to slow down the pass-through to consumers," he added.

Re-elected 20 years after his first term in office, Peru's Garcia is focusing this time on tighter monetary policy to control inflation, a more orthodox approach in the eyes of the IMF and World Bank.

"The prices of basic products are rising -- gas, oil, corn, chicken and bread," Garcia told a local radio station in March. "This is what the people feel, and I understand that, but there is no miracle I can perform to force the world to lower prices." (For previous stories, graphics, pix and video, click on: http:/www.reuters.com/news/globalcoverage/agflation) (Reporting by Lesley Wroughton; Editing by Eddie Evans)




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