Price Controls and the Inefficiencies in the Nigerian Economy

Photn By johan10 from Envato Elements

By

Chimere Iheonu

Date Published

October 7, 2022

Category

Political Economy

Nigeria has had a long history of price controls dating back to the 1970s when the government pegged the prices of commodities such as cement and milk, among other essential commodities. The prices of these commodities were increasing as a result of increased demand, which supply could no longer meet. The price control measures were aimed at ensuring that Nigerians had access to these commodities at affordable prices. However, there were unintended consequences. Suppliers adopted policy-defeating behavior like hoarding and arbitrage trade. The creation of a black market allowed them to enjoy high profit margins. These commodities became scarce and inaccessible to the wider population, effectively defeating the purpose of the policy.

According to the American Institute for Economic Research, no government intervention in a market economy is as certain to cause more harm than price controls. Price control does not just create scarcity but also leads to a decline in market participation for producers and suppliers.

Today, price control still exists in some key commodities such as fuel and the naira. In order to keep fuel prices low, the government has spent a significant proportion of its annual budget on subsidies. In 2021, ₦1.632 trillion was spent on fuel subsidies. Between January and July, 2022, the government spent ₦2.04 trillion on payment for fuel subsidies. In addition, while the official exchange rate of the naira to the United States (US) dollar is about ₦424, the black-market exchange rate currently hovers between ₦710 and ₦740. This large disparity between the official exchange rate and the black-market exchange rate has resulted in significant inefficiencies in the Nigerian economy.

Understanding Price Controls

Price control is the legal minimum or maximum price of a good or service, below or above which prices must not be exceeded. Such a policy is usually implemented by the government in a free market economy. Price controls are interventions aimed at improving access to certain goods and services such as petroleum products, rents, food, electricity, and other consumer staples. These controls can either be price ceilings, as is much of the case for Nigeria, where a price cap is placed on the price of goods and services, or price floors, which are minimum prices below which the price of a good or service cannot surpass. In the Nigerian context, an example of a price ceiling is the price of fuel, which the government has capped at ₦165. A good example of a price floor in Nigeria is the minimum wage of ₦30,000, below which employers are not meant to pay their employees. This means that suppliers are expected not to sell fuel above ₦165 and employers are expected to pay employees equal or above ₦30,000. While a price ceiling reduces the prices of the commodities, it also leads to a disruption in the market, losses for producers or suppliers (if such control does not come with a subsidy payment), and an eventual decline in the quality and quantity of such goods. Price controls can also be used as a policy tool in cases where the government wants to curb inflationary or deflationary tendencies.

Drawbacks to Price Ceiling

When a government implements a price ceiling policy, the price of the commodity falls from where it should be in the absence of a price ceiling. This increases the demand for such commodities as buyers would want to buy more of the product than they would normally have done without a price ceiling, while sellers would be willing to sell less than they should have done without a price ceiling at a higher price. The amount the buyer wants to buy exceeds the amount the seller is willing to sell, thereby creating a shortage. This leads to a shortfall in quantity supplied to satisfy demand and can create a black market where prices would be higher than without price control. This means that the price ceiling policy that a government implements to improve the accessibility of a commodity does not yield results and could even lead to a further decline in the accessibility of the commodity.

Additionally, price ceilings have the drawback of limited production and can act as a disincentive to investment in the industry that produces that commodity. This is because most investors believe that the potential to breakeven or make a profit may be limited due to the price cap on the commodity, constraining investment, productivity, and the aggregate supply of the commodity.

The Nigerian Context

A major commodity in the country that has witnessed a continuous price ceiling policy since the 1970s is fuel. However, the difference between the landing prices and the retail price has continued to be paid by the government as a subsidy. Recent developments have, however, demonstrated that fuel subsidies are no longer viable and such funds could instead be channeled into productive investments in education, health, and infrastructure. The downstream petroleum sector has historically seen little investment. The price cap connected with the sector is a major problem that has contributed to the lack of investment. The price ceiling acts as a disincentive for investors, which has caused the sector's inefficiencies. Fuel availability and quality in Nigeria have remained an issue, with frequent reports of product shortages leading to lengthy lines at gas stations. There has also been the issue of imported adulterated fuel that resulted in the damage of several car engines in the country.

One may argue that Dangote is building a refinery in Nigeria despite the price ceiling. This is achievable, the corporation claims, since even with a price cap, its calculations indicate that it would still turn a profit. But because most investors are unwilling to assume the risk, the private sector's involvement in the industry has been limited. In order to increase private sector participation and enable the invisible hand to work its magic, it is hoped that the Nigerian government will eliminate fuel subsidies and price ceilings.

Conclusion

Given the potential long-term effects on the availability and affordability of goods as well as the impact on the economy as a whole, especially the behavioral impact a price ceiling could have on the populace who would believe that price ceilings and consumption subsidies are a right, it is crucial for the government to exercise caution when enforcing price controls as they do not always work and could have negative consequences in the long run.

The government has to realize that intensional policies to boost productivity and raise supply, as well as liberalization policies, may bring about the desired fall in prices more quickly than an interventionist policy such as price control.

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Disclaimer: This information in this article is NOT investment advice. It is intended for information and entertainment purposes only.

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