Price controls must be resisted even in times of inflation4 min read . Updated: 30 Nov 2020, 09:50 PM IST
Arbitrary price caps tend to distort market mechanisms and also yield unpleasant side-effects
In February 2017, the National Pharmaceutical Pricing Authority (NPPA) reduced the top price of base-metal and drug-eluting stents by a whopping 85%. The price caps would make a basic stent available at ₹7,260 instead of ₹45,000. Stents are mesh tubes made of metal and inserted in blood vessels to improve blood flow. With India’s high prevalence of heart disease, this treatment has become widespread and reliable. Since they relate to critical healthcare, the government thought it fit to impose a price ceiling to make them affordable. But was this the best way to curb stent-price inflation? A prominent doctor and former medical director of Mumbai’s city government wrote that while the intent to control their prices was laudable, the way it was done was misdirected. Today it was cardiac stents, he added, tomorrow it could be orthopaedic implants and oncology drugs. He predicted that those who could afford better quality stents would go to Singapore, Bangkok or even Colombo for implants. Meanwhile, at home it would lead to underhand cash deals and other malpractices. Hospitals would find ways to charge through other means, like operation-theatre rentals and overheads. Foreign companies like Abbott, Medtronic and Boston Scientific asked for an exemption for high-end stents, failing which they would withdraw these products from the Indian market. This was like a threat. The government responded by resorting to an emergency clause requiring medical suppliers to sell at specified prices or less. Such actions don’t exactly inspire investor confidence. The operation of inserting a stent is often a life-saving procedure, and not being able to afford it becomes an emotive issue. So governments and politicians trumpet their victory over high prices through ceiling diktats. But such actions don’t work. Shortages, black markets and malpractices are an inevitable fallout. Is there any other way to achieve cost reduction? Just last week, the Chinese government announced a centralized government procurement scheme covering 10 varieties of stents. The bidding was won by eight companies, including two American, the very same Medtronic and Boston Scientific, and six other Chinese companies. The purchase order was 1.07 million units per year. And the price reduction? A whopping 95%. The lesson to learn is that this price reduction was effected without imposing any arbitrary price ceiling. The power of large-scale procurement, combined with competitive bidding, ensured it. This works better than price caps, assuming that the government has the resources to deploy for their purchase, storage and eventual recovery of costs from patients. In India, something similar was tried to scale up usage of light emitting diode (LED) bulbs. Here too, state procurement played a big role in slashing prices.
The urge to tame inflation through price controls is omnipresent in all governments. India’s NPPA has been busy capping drug prices since 1995. The number of drugs under price control has gone up from 74 in 1995 to 860 in 2019, as per a research report by Amir Ullah Khan.The latest victims of price control are ride-hailing apps. The ministry of transport and highways has mandated that “surge" pricing used by the likes of Ola and Uber to cater to rush-hour spikes in demand cannot be more than 50% of the base fare. Even the cancellation fee has been capped. School fees is another political favourite. The Gujarat government passed a law in 2017 capping fees charged by private schools. Surprisingly, this interference was upheld even by the high court. This past month, Gujarat cut fees of private schools by 25%, citing covid and the closure of schools. An instinct for price controls is also manifest in the Centre’s new education policy. It reaches into the domain of unaided, fully self-financed educational institutions, which were hitherto untouched, and recommends price controls. The much-publicized Udaan scheme, providing air connections to smaller towns and cities, mandated a price ceiling of ₹2,500 per seat per hour. Airlines are expected to make up losses by bidding for viability gap funding.
The farmers’ agitation is motivated by a desire to get a minimum support price (MSP) for their crop. This too is price fixing, from below. But what they are asking for is insurance, just in case free market prices collapse. An MSP works as a safety net because it is backed by government procurement, much like the Chinese policy on stents, or India’s on LEDs. But the government always tends to betray a control-orientation. At a time when India’s mandi system (and hence crop pricing) was being deregulated through new farm laws, it banned onion exports. It also tinkered several times with the prices of lentils and pulses through import tariffs. It won’t let the international price of crude oil pass through to retail pumps.
An era of higher inflation is coming. Some of it might be because of excessive liquidity, or inadequate investment in new production capacity, or higher import tariffs erected as protective barriers for domestic industry. As prices of commodities start to rise, be it steel, coal, cement, proteins or healthcare, not everything can be fixed through price ceilings or large-scale state procurement. Any measure that suppresses price signals, or fiddles with the “thermometer" that shows the market’s “temperature", is bound to lead to unpleasant side effects like black markets. Most often, it’s better to let the price mechanism work, and use direct transfers to provide the vulnerable with safety nets.
Ajit Ranade is an economist and a senior fellow at The Takshashila Institution, an independent centre for research and education in public policy.