Economic Catastrophe: The Effects of Price Controls

Originally published in the Informanté newspaper on Thursday, June 18, 2015.

Namibia is in the grip of a housing shortage. With the ruling party Swapo having established a special committee to address the provision and availability of housing and serviced residential plots, it has certainly become a governmental priority. Unfortunately, rumours abound that this government intervention will not focus on addressing the issue of supply, but rather on the price of property around the country.

And prices, unfortunately, is the mechanism whereby buyers and sellers maintain equilibrium in a market, i.e. where the amount supplied equals the amount demanded. When there is a shortage of the quantity supplied, prices increase, incentivizing more people to sell, while simultaneously reducing the demand due to decreasing affordability.

This can lead to cries that a price is ‘not fair.’ But fairness is not an objective standard – ask any two people what they think is a fair price for an item, and you’ll get different results. Yet by applying pressure to their elected representatives, they encourage a government intervention. And with a shortage of supply, it often seems like high prices are simply price gouging by the sellers.

An attractive solution to this ‘price gouging’ is to impose price controls. Yet when there is a shortage of supply, price controls only exacerbate the problem – increasing demand and reducing supply – and have numerous adverse consequences. This is not only a prediction of basic economic theory – it has a long empirical history as well.

Price controls were first tried about four centuries ago. The Egyptian Pharaohs, attempting to prevent famine, established price controls on wheat. With no profit motive, farmers began producing less and less, until one day, they simply left the farms, unable to make a living off them. The end result? Famine set in, the economy collapsed, cities were abandoned, and the reign of the pharaohs ended.

And in a famous example, the Roman emperor Diocletian implemented price controls in the third century CE. Of it, Lactantius describe the end result that "much blood was shed for trifles, men were afraid to offer anything for sale, and the scarcity became more excessive and grievous than ever. Until, in the end, the law, after having proved destructive to many people, was from mere necessity abolished."

Every time over the successive two thousand years that price controls were implemented, the promises remained the same. “Everything will be cheaper.” And every time the results have been quite predictable: Shortages. And all the ills that follow with it – the destruction of capacity in the price controlled industries, and a commensurate drop in the quality of its product. Of course, with property, there will be an additional economic shock – the collateral on home loans will vanish. With banks over-exposed, lending will be curbed dramatically, resulting in Namibia’s very own credit crunch, if not the outright collapse of our financial institutions. 

And the incentives to evade these controls will be ever-present, and their forms numerous. Tie-in sales is only the most obvious example. Attempts to curb evasion will cause an expansion of government oversight and enforcement – not only expanding its bureaucracy and increasing its costs, but also allowing more opportunities for bribery and corruption. And since any bureaucracy expands to meet the needs of the expanding bureaucracy, specific price controls will eventually expand into general price controls.

Namibia only has to look to Venezuela to see the catastrophe that price controls bring to an economy. Nobel prize winner Milton Friedman said: "We economists don't know much, but we do know how to create a shortage. If you want to create a shortage of tomatoes, for example, just pass a law that retailers can't sell tomatoes for more than two cents per pound. Instantly you'll have a tomato shortage.” 

As they say in the medical community, “Treat the cause, not the symptom.” Our high property prices are a symptom. Perhaps we should rather be focusing on the cause.

Corruption: Sapping the Strength of a Nation

Originally published in the Informanté newspaper on Thursday, June 11, 2015.

During the tenure of President Pohamba, Namibia started a long overdue drive to root out corruption of all forms in our government. And with President Geingob’s declaration of assets, and his urging to Members of Parliament and his Ministers to not only also declare assets, but divest themselves of the responsibilities of running private businesses on the side, this drive looks sure to continue.

But as the corruption scandal engulfing FIFA has shown, corruption stretches far and wide. But efforts to stamp out corruption can be effective, as even the entrenched Sepp Blatter is not protected when the probes are deep enough. 

The study of corruption in economics has a long history – effectively grounded in the examination of what economists call ‘rent-seeking.’ Rent-seeking, in basic terms, is the expenditure of resources on activities, political or otherwise, that aims to increase a person or organization’s share of existing wealth instead of creating wealth.

This misuse of power, whether monetarily or based on governmental authority, causes the economy to not function properly, according to its natural laws. The President of the World Bank in 1996 called it the ‘cancer of corruption,’ and it certainly is an apt moniker. Corruption inhibits the optimal allocation of resources, weakens property rights and undermines the rule of law. It is the antithesis of democracy itself.

Worst of all, it is the poor who shoulder most of the burden of corruption in society. An increase of only 0.78% in corruption causes a corresponding drop of 7.8% in the income growth of the poorest 20% of the population, according to an IMF study. This is not only as a result of ‘leakages’ of aid to the poor, but also due to the diversion of expenditure away from critical areas such as health and education. In addition, corruption can reduce governmental tax revenue by up to 50%, further impeding economic development in a nation. 

For a country such as Namibia with a Gini Index of 61.3 (a quantified representation of income inequality), this is especially worrisome. Namibia has the fourth highest income inequality in the world, and we cannot afford such inequality to get worse. Even worse, World Bank studies revealed the countries with a high level of corruption also have an infant mortality rate of three times the norm of countries with a low level of corruption, and a literacy rate that is 25% lower as well. 

But what allows corruption to thrive? Trade restrictions, government subsidies and price controls allows high-level government corruption, along with sociological factors, with public officials being more favourable to relatives. Low level corruption is especially rife where civil service salaries are low compared to fines that could be levied. 

While Namibia has made great strides in combatting corruption, as a nation, we still have some way to go. With Namibia ranking 6th in Transparency International’s Corruption Perception Index in 2014 in Sub-Saharan Africa, we only ranked 55th internationally. And with a score of only 49 out of 100, we still have some way to go. 

And this effort will not be wasted. The World Bank states that: “countries that improve on control of corruption and rule of law can expect (on average), in the long run, a four-fold increase in incomes per capita. … Similarly, such a country could expect, on average, a 75% reduction in child mortality.”

Namibia currently has a GDP per capita of approximately US$ 5700. If President Geingob’s measures are implemented and effective, Namibia can have a bright future. Just imagine where we’ll be with a GDP per capita of US$ 22 800.