The Abolition of State Price Regulation: How to Support the Business and Not Harm the Consumers

bespalko-price-regulation-graph
IERPC

From August 15, 2016, the government suspended for three months price regulation on social products to evaluate its effect on pricing. According to the Ministry of Economic Development and Trade, it is the first step towards complete abolition of state price regulation. We believe that if the state ceases to intervene in the pricing mechanisms, the profitability of enterprises will improve, investments will increase and administrative burden on business will be reduced. On the other hand, there are certain risks that were the reason why the government abolished this regulation in the form of experiment.

As the results of the annual assessment of the business climate (ABCA)* made by the USAID Program “Leadership in economic governance” show, the state regulates prices only for a fifth of small and medium enterprises (SMEs) in Ukraine, but such an intervention for a single enterprise is quite considerable. The price regulation covers products and services of 22% of SMEs. The government regulation of prices is primarily performed through establishing minimum and maximum limits of prices, fixing the prices of goods and services and limiting profitability.

Price regulation covers more than half of the goods and services in the case of each SME. According to respondents’ estimates, on average 55% of the sales volume of each SME are objects of price regulation. Authorities affect pricing of SMEs mainly in agriculture (on average 77% of agricultural products fall under price regulation) and industry (70% of goods). Thus, sectors that are the biggest drivers of the economy feel the effects of price regulation the most. According to the SMEs in trade and services sector, the government controls prices of 46% and 53% of their goods and services respectively.

Price regulation greatly hinders business development, so its abolition will have a positive impact on SMEs. This regulation does not allow SMEs to set a price that would meet the costs of production. This prevents the restoration of production facilities, innovation, and, consequently, improvement of production efficiency. Restrictions for retailers cause them to switch to products without these restrictions. This negatively affects both the manufacturer who loses available trade channels and the consumer who cannot find cheap products on the shelves of the nearest store. Primarily, it concerns small stores and not large retail chains.

Abolition of state price regulation will also facilitate the business environment due to the cancellation of price declarations. This will not only decrease government spending on maintenance procedures but also reduce corruption risks and administrative burden on SMEs. For example, SMEs whose products are subject to the state price regulation more often reported corruption as a barrier to running private business (34% versus 21% for companies whose products are not regulated). Similarly, SMEs whose goods or services are subject to price regulation put more emphasis on such obstacles as high regulatory burden (24% vs. 18.5%) or the inefficiency of the state apparatus (19% vs. 12.5%). Note that these percentages may be the result of not only price regulation, but also other unaccounted factors.

While limiting government intervention in price management is an essential element of decentralization, the Ukrainian society has no consensus on the timeliness of this step. Limits of the reform are also being discussed: complete abolition of price administration or partial when the state keeps the right to control the prices of certain product categories. The Ministry of Economic Development and Trade insists on full cancellation of price regulation. At the same time, the first results to assess the effect will appear as a result of the abolition of price controls for social products.

The main risk associated with this is the price increase for basic foods, including baby food, bread, flour, sugar, cereals, meat and dairy products, eggs, oil, etc. If state constraints are removed, prices for these commodities will float freely. Considering also that 53% of expenditures of Ukrainian population is spent on food (according to the State Statistics Service of Ukraine), rapid rise in prices may cause even greater poverty, with all the consequences. And the price increase can be steep – since the limitations are abolished for both producers and sellers.

The Ministry of Economic Development and Trade reassures that the prices will not increase, and argues in favour of the abolition of price control. Competition and market mechanisms will come in the way of food price increases. The abolition of price controls will encourage investment in social food products and increase the profitability of the sector.

In general, price regulation restricts only honest producers. In Ukraine, there is no effective mechanism of price controls, and entrepreneurs have long learned to bypass restrictions: reducing food weight, content of natural ingredients (such as meat) and using low-quality substitutes. For example, butter with 72.5% fat content (which is a social product) is less likely to be seen on the shelves, and the buyer is offered butter with 73.2% fat, which does not fall under this restriction.

Low profitability of production of social products prevents recovery of SMEs assets, leading either to their closure or to reorientation to other products and markets. Annually, production of bakery products decreases. The similar situation is in the flour-milling and dairy industries and so on.

It turns out that the social support system is only working by restricting certain categories of producers. Consumption of social products itself is not differentiated, the goods can be bought by anyone, including those who do not need social support. To support families with low income, it is necessary to use mechanisms that are more effective, e.g. targeted assistance and subsidies. Combination of these steps, on the one hand, would prevent further impoverishment of the population, and on the other, would support producers by providing conditions for development.

* The Annual Business Climate Assessment (ABCA) is a tool for monitoring and evaluation of the business environment, identifying barriers to the development of small and medium enterprises. Quantitative survey was conducted by the Institute for Economic Research and Policy Consulting in the framework of the USAID Program “Leadership in economic governance.” Period: November 2015 – January 2016. The sample is representative, 1827 enterprises. http://lev.org.ua/abca.html

The article was originally published here: http://forbes.net.ua/ua/opinions/1421064-skasuvannya-derzhavnogo-regulyuvannya-cin-yak-pidtrimati-biznes-i-ne-zashkoditi-spozhivacham 

 

Viktoriya Bespalko
The Institute for Economic Research and Policy Consulting - Kiev