Why Rouhani should think beyond price controls to contain inflation

Turbulent fluctuations in the value of the Iranian currency on the open market in 2018 led to the establishment of the Supreme Economic Coordination Council. Economic pundits at the time were of the opinion that this new body — bringing together the heads of the three branches of power — would prepare the ground for major and broad long-awaited economic reforms, as this entity was deemed to foster the convergence of uniform policymaking among the country's three branches of power to save the downbeat economy from tanking deeper. Nonetheless, it opted to grant more regulatory and supervisory authority to an old state agency called the Consumers and Producers Protection Organization (CPPO).

Historically, Iranian governments have been reluctant to fix the ailing domestic economic system. Instead, they have been more keen on adopting conventional impractical tools to curb liquidity growth, e.g., by intervening directly in the markets, albeit in the process ruining market economy efficiency.

An analysis in the leading economic daily Donya-e Eqtesad this past November argued that a surge in supervisory roles of the CPPO and relevant bodies in Iran has burgeoned in parallel with rising inflationary pressures over different time periods in the last 50 years on the back of loose monetary policies. This denotes that the average peak-up in consumer price indices has been the byproduct of liquidity and not inflation, as mistakenly assumed by many ordinary Iranians. In plain words, the policymakers have attempted but in vain to root out the problem at a microeconomic level at a considerable cost and energy in lieu of trying to reform monetary, financial and currency policies. This is while macroeconomic imbalances are thought to be the major culprits behind structural inflation over the past half-century in the country.

Seeking policies such as unjust price adjustments, mounting market regulations and prosecution of firms apparently violating price caps — particularly in areas that are not related to public goods — are doomed to fail. Such measures have had immense devastating repercussions over Iranian enterprises, the private sector in particular, in the previous episodes of strict state oversight. This time around stands to be no exception. Currently, this has immensely disturbed the functions of market mechanism and led to the misallocation of scarce resources and diversion in economic activity.

However, the CPPO — striving to manipulate prices for the sake of short-run political interests — is slated to exert huge economic and social costs on the incumbent president and following administrations in the long term.

In the short run, the first side effect of state pricing is that price controls are bound to lead to shortages of goods in formal markets combined with the formation of dramatic demand for purchasing goods at a lower government rate. By doing this, the supply of goods tends to decrease alongside stoking artificially the demand side. To eradicate the queue of demand, at this stage, governments will inevitably be subject to set sales quotas to control consumer consumption. Of note, Hassan Rouhani's Cabinet has recently decided to ration frozen meat delivery — an essential component of shopping baskets in Iranian households — as purchasers need to introduce their national ID cards to the sellers at certain shopping centers.

The second side effect is the formation of the black market, as supply at subsidized prices will not push back rising demand. This will, in turn, create the incentive to acquire commodities at discount rates to sell them higher in the black market. Under such circumstances, the producer and the final consumer will become total losers, with a huge margin for intermediaries. This was the case with the tire industry in the recent months, as the spread between subsidized and nonsubsidized prices was widened extremely.

In the long run, pursuing pricing policy may bring about the bankruptcy and withdrawal of private firms from the market. In that case, the supply side is positioned to get hit hard on the one hand, and part of the country's labor force is destined to lose their jobs on the other. Altogether, this will lead to lower production and higher prices, resulting in total losses to the economic output.

Price control has also other long-term destructive effects. In a competitive market, firms compete to survive and increase their market shares. This competition leads to more innovation, better quality and lower product prices. In an economy where the government acts as the sole distributor of resources or determiner of prices, competition among businesses becomes a competition among political factions. The rivalry between political groups to take on the role of the central authority that gives rents and determines commodities prices ends up in much deeper inefficiencies in allocating economic resources to the detriment of the actual private sector. Another drawback to price control is that enterprises will gradually tend to produce those items that are not subject to state pricing. This will, nevertheless, decrease the production capacity of the essential items and increase the shortages of goods in the markets.

In addition, in a competitive market, the shortage of goods and a subsequent spike in demand for them will normally hike its prices, thereby encouraging inclinations among relevant businesses for lifting their production. This market perception helps to allocate resources optimally. But state manipulation of the prices undermines the capacity for proper signaling in the economy for the manufacturers to raise production for a typical item out of stock.

In the end, it should be emphasized that direct government intervention in a market economy and its manipulation of proper pricing mechanism will inevitably lead to a loss for all stakeholders, including producers, consumers and workers. Nonetheless, this initiative will undermine Rouhani’s purported policy of creating more jobs, as the outlook for more employment is highly likely to be enormously impacted by erroneous readings of macroeconomic indicators by his administration. What has come out of the Rouhani administration’s decision-making thus far has been the waste of scarce economic resources at the expense of concealing the shortcomings of the economy at large.