I. What happened
Hard hit by COVID-19, Sri Lanka’s tourism sector was severely dragged in 2020. Its tourism revenue dropped from the highest of USD 450 million in December 2019 to nearly zero throughout the second and third quarter of 2020. As a result, the country’s economic growth in 2020 also shrank by 3.6%, following a rebound of 3.7% in 2021.
Since the economic crisis, Sri Lank local currency rupee (LKR) has been under a depreciating trend. Its exchange rate against the US dollar dropped from 181.35 in January 2020 to 190.5 in January 2021, and to 201.2 in January 2022. During the period, LKR depreciated by 9.86% against the USD. In May 2022 the rate soared to 355.8, almost a double compared to that of Jan 2020.
II. Price ceiling
In the middle of 2021, a food crisis broke out in Sri Lanka. The price of essential food items such as sugar, onion, and lentils was on the rise. To curb the increasing trend, Sri Lanka imposed a price ceiling on rice and sugar on 2 September 2021. According to the orders, the maximum retail prices of rice were set in the range of Rs. 95 to 125 per kilogram depending on the types of rice, and the maximum retail prices of sugar were set at Rs 125 and Rs 128, for white sugar and brown and red sugar respectively.
The government of Sri Lanka stated that the price control aimed at controlling the inflation, enhancing the affordability of food for low-income groups, and preventing traders from hoarding foods items. The government believed that the shortage was not real, and the rising price was a result of artificial manipulation of some sellers.
After the imposition of the price control, long queues started to appear outside state-run supermarkets. According to the news, the shelves at those supermarkets were running low and even empty. Some locals said to have waited for hours to buy stuff. Besides, a black market also emerged to sell the price-controlled products at higher prices. On 29 September 2021, the government rescinded part of the price control orders, in the hope of increasing the supplies of controlled foods.
Some economists argue that price control will lead to undesirable effects rather than eliminating the scarcity of the products. After Sri Lanka imposed price control, the arising black market marked up the price of rice and sugar, making the product less affordable than without price control. Suppose Sri Lanka citizen knows the price differences between the stores and the black market, they would be incentivized to be the first to stand in the line of the stores in the morning and buy as many products as they can in a bid to profit from arbitrage by reselling those products in the black market.
Besides, the long queues outsides supermarkets meant that it had to take a longer time to get the price-controlled items, increasing consumer’s time cost. The actual costs of a product include not only price but also other implicit costs, such as time cost, quality checking cost, traveling cost, and so on. Price control lowers the prices of the products but increase the time cost.
Sellers are free to adjust the quality of their goods and services according to market conditions. A higher price usually implies higher quality and vice versa. Some argue price ceiling at least ensures a cheaper product for the consumers, but the cheaper product may not be the same as the more expensive one. For example, the lower-priced rice may not have the same packing as before, may have a shorter shelf life or worse taste, and so forth.
A price increase can be due to multiple reasons. It can reflect changes in the market demand and supply, in the forms of competition, or in monetary policies. If the price of a can of coke has to increase to $10 to clear the market where quantity demanded is equal to quantity supplied, artificially capping the price at $5 would result in a shortage where the quantity demanded is larger than the quantity supplied. Why? Some consumers who once deemed the product too expensive are willing to buy it at $5, whereas some sellers who once deemed the products lucrative find the current market price unattractive and stop offering the products.