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Tag Archives | price cap

Rent Control in Mumbai

By Shubham Paliwal

Demand and supply mismatch created by price ceilings causes poor and reduced accommodation for the lower income people.

 The ‘Bombay Rents, Hotel and lodging House Rates Control Act, 1947’ served its purpose in the short term but in the longer term it led to reduced supply of houses for rents, dilapidated houses, black income and reduced taxes to the government. The rent control act should have been modified and the second generation rent controls should have been adopted as was done by many European countries.

The ‘Bombay Rents, Hotel and lodging House Rates Control Act’ was introduced because of the acute shortage of houses in Bombay due to the world war and partition of colonial India. The purpose of the act was to prevent exploitation of the tenants and to prevent speculation. The prices were kept low to provide relief to the city’s migrants after the partition. It was supposed to benefit the tenants.

Under it, the state put a cap on the amount of rent a tenant paid to a landlord, and this amount remained virtually frozen irrespective of inflation and the consistent rise in the market rates over time. Rents at about 19,000 buildings were set at 1940 levels to prevent owners from charging excessive rates during a time of distress.

Rent Control bombay

In its initial years, the system served the purpose of creating affordable housing at stable rents but it failed in its purpose in the long run. It did help the tenants but it led to market distortion and negatively affected the interests of the landlords. The prolonged continuation of first generation rent control law led to various unintended consequences.

It led to a consistent degradation of housing stock because builders and developers had no incentive to generate more rental housing (as the rents were much lower than the prevailing market rates). Thus, almost all new housing being built was for ownership purposes (most of it for the upper-middle classes and above). Rent controlled buildings were often unkempt and dilapidated because the nominal rents did not motivate landlords to spend on maintenance.

An amendment to the Rent Control Act in 1999 allowed flats to be rented out, without rent control, on a leave-and-license basis for one year at a time. This lead to surge in the prices of uncontrolled rental properties due to market distortion created by the shortage of housing stock being built for rental purposes.

Rent controls gave rise to the informal pagdi (or pugri) system, where tenancy is transferred from one tenant to another at property rates a little below prevailing market rates and the landlord and tenants both have a share in it. As tenants held capital in the form of black money (share in pagri) the central government could not levy wealth tax and capital gain tax on it. Moreover municipal taxes were linked with rent, therefore, along with freezing of rent, income of municipality also got frozen and fixed. In order to make up for increasing service expenses, the municipality levied a tax as high as 142%, repair tax 402% (residential) and 755% (non-residential) for buildings repaired by the repair board. The pagdi amount being in black money led to increased investments in illegal trades and business. Even though landlords got tax free black money income on every transfer of tenants, they shuddered away their responsibility of repairing buildings on the plea of meager rent income.

Thousands of rent-controlled tenants are becoming millionaires as developers tear down crumbling colonial mansions to build luxury towers for the rich and pay huge sums to the tenants to vacate the apartments. In suburban areas, where old chawls were demolished by builders for new houses, old tenants of chawls were given free flats worth lakhs in the new building as alternate accommodation. A large section of the tenants got premises for residence and business at ridiculously low rates.

Tenancy rights continued even after the collapse of a 100 year old building. Old houses started collapsing for want of proper maintenance and repair. Instead of amending the Act, repair cess act was introduced under which landlords were exempted from liability to repair buildings and tenants paid repair cess upto 400 to 700%.

With rent control in place, people are lined up for housing, and therefore, the landlord can discriminate on the basis of who will take the most meager accommodations.

Price ceilings set below the equilibrium price arrived at through supply and demand, increase the demand for apartments. Landlords decide to withdraw from the market as they do not receive the full amount that they would be able to charge in a free market, for example by selling apartments and investing elsewhere. The supply of accommodation is therefore reduced leading to queues and waiting lists for apartments caused by the increase in demand. Some landlords may impose certain criteria on the tenants they accept, causing discrimination against certain categories of tenant.

Rent Control Bombay1

Thus, overall the rent control act was beneficial only in the short term for the economy. In the long term it prevented modernization and led to increase in black money at the cost of taxes that the government could have collected and used for other purposes. It led to market distortion by creating a mismatch in the supply and demand of houses. The benefits accrued by the tenants were way more than was desired or necessary, the loss to the economy in terms of taxes was huge and thus it was not a wise move by the government. The government should have modified the rent control law much before by learning from the experiences of other economies.

Tenancy rent controls (also known as second-generation rent controls) are much more common in the contemporary world. One important feature is the “vacancy decontrol” provision which frees landlords to set rents freely once a rental unit becomes vacant. The amount of rent increase a landlord can impose on a sitting tenant is also limited. It also regulates or prohibits the practice of collecting nonrefundable deposits, limits the ability of landlords to evict sitting tenants, and restricts the use of fixed-term contracts.

Shubham Paliwal is a part of the GCPP’13 cohort at the Takshashila Institute.

[This and the other three essays on Price Controls was submitted as part of the Economic Reasoning coursework. Students were asked to identify instances of price controls in the world; who the intended beneficiaries were; and what were the unintended consequences of the price control. The 4 best answers were picked. The other three were on Price Control on Prescription Drugs in Europe and Price Control on Milk Products in Vietnam, Price Control on Gasoline in the US].

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Price Control on Gasoline in the U.S. (1970s)

By Ashish Devadiga

The 1970s price controls had saved consumers between $5 billion and $12 billion a year in gas costs, but at the price of stifling domestic oil production and causing an artificial shortage of as much as 1.4 million barrels a day.

In the 1970s, when the price of crude oil tripled on the world market the then President of United States, Nixon imposed a price ceiling, on both crude oil and gasoline. There was a maximum price allowed by law to be charged for gasoline. Any gas station owner charging more than this maximum price would be guilty of fraud. Price controls were turned in to address the shortage of gasoline. This was done due to e public demand to keep the prices low. But the artificially depressed pump prices imposed during the oil crisis of 1973 — which stayed in place in various iterations through 1980 — brought about lines at gas stations and an artificial shortage of gas.

Dealers sold gas on a first-come-first-served basis, and drivers had to wait in long lines to buy gasoline. The price controls resulted in a fuel-rationing system that made available about 5 percent less oil than was consumed before the controls. Consumers scrambled and sat in lines to ensure they weren’t left without. Gas stations found they only had to stay open a few hours a day to empty out their tanks. Because they could not raise prices, they closed down after selling out their gas to hold down their labor and operating costs.

In an older version of Odd-Even policy, Oregan limited fuel supply to odd and even numbered cars on alternate days.

In an older version of Odd-Even policy, Oregan limited fuel supply to odd and even numbered cars on alternate days. Image Source: Business Insider

The true price of gasoline, which included both the cash paid and the time spent waiting in line, was often higher than it would have been if the price had not been controlled. In 1979, for example, the United States fixed the price of gasoline at about $1.00 per gallon. If the market price had been $1.20, a driver who bought ten gallons would apparently have saved $.20 per gallon, or $2.00. But if the driver had to wait in line for thirty minutes to buy gasoline, and if her time was worth $8.00 per hour, the real cost to her was $10.00 for the gas and $4.00 for the time, an overall cost of $1.40 per gallon

To meet the decrease in their revenues, gasoline stations would commonly charge for washing the windows, checking the tires, and so forth. The price of oil used in oil changes would be raised. Those having oil changes at the station were favored in access to gasoline during the years of the price ceiling. Some gas station owners ran the line to the gasoline pump through the car wash.

By the Iranian oil crisis in 1979, the controls had grown unsustainable as oil prices escalated in global markets. President Carter waived most of the controls on oil and gas prices to make more fuel available.

The resulting sharp price increases ushered in a new problem: double-digit inflation, as businesses quickly passed on their higher fuel costs and workers’ unions demanded cost- of-living increases to keep pace with higher prices. The surge in inflation put the Federal Reserve in crisis mode. It ordered it’s largest-ever increase in interest rates in October 1979, plunging the economy into a deep recession.

By the 1980s, Congress and the administration had figured out that price controls were not the answer. President Reagan, abolished the oil and gas price controls upon entering office in 1981.

Harvard University economist Joseph Kalt concluded that the 1970s price controls had saved consumers between $5 billion and $12 billion a year in gas costs, but at the price of stifling domestic oil production and causing an artificial shortage of as much as 1.4 million barrels a day.

The price ceiling did not really help and a better alternative would have been to let prices rise, giving oil companies an incentive to produce more and consumers an incentive to conserve.

Ashish Devadiga is a GCPP-13 alumnus

[This and the other two essays on Price Controls was submitted as part of the Economic Reasoning coursework. The question asked students to identify instances of price controls in the world; who the intended beneficiaries were; and what were the unintended consequences of the price control. The 3 best answers were picked. The other two were on Price Control on Prescription Drugs in Europe and Price Control on Milk Products in Vietnam].

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Price Control on Milk Products in Vietnam

By Hiren Doshi

A price cap on milk products in Vietnam led to shortages, illegal production and distribution, distortions in the market and a dramatic drop in profitability of manufacturers. 

In 2014, The Ministry of Finance in Vietnam set ceiling prices on 25 milk products (which was later increased to cover almost 600 products) for children below the age of six in a move to contain constant price hikes on the dairy market. This move was in response to hyperinflation in price of milk powder in few years preceding 2014 and was aimed to help make the milk for children affordable for the citizens. Vietnam has around 10 million children below the age of 6 and was considered price sensitive to milk prices.

The price of powdered milk had approximately increased 30 times since 2008 until 2014, at between 3-20 percent at a time. The retail price of powdered milk in Vietnam was about 1.4 per litre USD and almost 1.5X as compared with Thailand and Malaysia making it among the highest in the world. Powder milk market in Vietnam was very competitive, with almost 800+ milk products catering for children under 6 years old, forcing the manufacturer to routinely spend far in excess of permitted advertising and marketing cost which then translated into higher cost for the consumers.

The regulation which was to be in effect for 12 months brought down the recommended wholesale price ceiling 15-20% below the prevailing wholesale prices. The price ceilings were based on three grounds: the results of inspection at five dairy firms, price developments of the dairy market and prices of similar products on regional markets. Retailers were also mandated to reduce their costs, be reasonable with their profit margins and charge retail prices which did not exceed 15% over the wholesale ceiling.

Milk Price Hiren

Some of the consequences in response of price ceiling were as below:

1.    Some milk suppliers in Vietnam pulled products whose prices was to be capped under the regulation from shelves and replaced them with new ones a week before the ceiling prices become effective. They worked around the regulation by launching new products with new labels but similar ingredients at much higher prices, and reducing weights of products.

2.    Even though the ceiling on advertising spend for milk products was abolished, spends on advertising and marketing by milk producers came down due to limited margin after the price ceiling.

3.    According to the research carried out by Nielsen in 2015 in Hanoi and HCM City, it indicated that milk products for children less than six years old were reduced 10 percent and 9 percent in terms of quantity and price, respectively against the previous year, after enacting the price ceiling. This means the consumption actually went down after the price ceiling was in force. This was counter intuitive to the very reason of putting the price ceiling in place.

4.    After price ceiling was extended for one more year after being in effect from June 2014, Nielsen noted that milk prices in Vietnam have been no higher than prices found in the middle group in Asia. Its statistics in July 2015 revealed that average milk prices in the high end segment in Vietnam were similar to those in other countries in the region, such as Malaysia, Thailand and Philippines.

5.    In April 2015, the European Union removed milk production quotas which existed for more than 30 years, leading to the worldwide drop in milk prices. In 1984, quotas were applied to limit the over-abundant supply in Europe, and milk farms that produced over their quotas were fined. This made the cost of importing powder milk cheaper than sourcing milk from local cow farmers.

6.    In early 2016, prices of milk sourced from cow farmers in Vietnam were about VND12,000-14,000 (US$0.54-0.63) per kilo, nearly double that of milk shipped from the U.S., Australia, New Zealand, and European countries, which sold for about VND7,000-9,000 ($0.3-0.4) per kilo.

7.    One interesting outcome of locally sourced milk becoming non-competitive was that local cow farmers sold record number of cattle in the last 12 months. For instance, in Cu Chi District, Ho Chi Minh City, nearly 10,000 cattle of 40,000 being reared were sold in the last 1 year.

Price ceiling on milk products for children under six was introduced in response to large and frequent price increase of milk, making milk prices in Vietnam one of the highest in the world. It was meant to increase the consumption of milk and help reorganize the milk industry ecosystem which keeps the low prices sustainable. In the end this move did not make any of the stakeholder happy – consumers continued to complain about high prices, manufacturer’s sale & profit dropped while the poor cattle suffered change of ownership during the worst crisis for local cow farmers.

Hiren Doshi is a GCPP-13 alumnus. 

[This and the other two essays on Price Controls was submitted as part of the Economic Reasoning coursework. The question asked students to identify instances of price controls in the world; who the intended beneficiaries were; and what were the unintended consequences of the price control. The 3 best answers were picked. The other two were on Price Control on Prescription Drugs in Europe and Price Control on Gasoline in the US in the 1970s].

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Price controls on prescription drugs in Europe

By Anjana Kaul

The unintended consequences of price controls on prescription drugs far outweighs the benefits.

Europe has had price controls on prescription drugs for decades. While this has helped the state save a lot in terms of healthcare costs, it has also had a number of unintended consequences that, in many cases, outweigh the savings on drug costs.

Healthcare services in most EU countries are provided primarily by the state. Hence the state stands to gain the most from such price controls. Each country has a regulator which negotiates the price of each prescription drug with the pharmaceutical company that is marketing the drug in that country. While an approval for efficacy and safety of a drug can be given by any EU country regulator and is applicable across the EU, the price of the drug has to be negotiated with each country’s regulator independently.

European countries have certainly benefited from these price controls. A 2004 study by Bain & Co states that in 2002 EU countries spent 60% less per capita on prescription drugs than the US. It also states that the EU countries have saved $840 Billion in the decade from 1992-2002 on drug costs.

However, these price controls have had many other consequences – some that can be easily quantified and others somewhat intangible.

Long price negotiations delay entry of new drugs into European countries. Pharma companies need to recover their R&D costs as early as possible to maximize returns hence they delay marketing drugs in countries with price controls. It was observed that in EU countries it takes anywhere between 7-19 months from drug launch to market availability while in the US it takes about 4 months. Moreover, when a regulator and the pharmaceutical company are unable reach a consensus on price on a drug, that drug remains unavailable in the country for even longer. These delays can sometimes result in higher healthcare costs for patients who otherwise would have been treated more effectively by the new drugs. It can also result in longer absence from work due to illness and in extreme cases can even lead to avoidable loss of life.

Drug approvals for efficacy and safety are not global so pharma companies first seek approvals for new drugs in countries or regions where they can maximize the price and quickly recover their R&D costs. It is easier to seek approval from a regulator if drugs have been developed and tested with a local country population in mind. This has led to a significant migration of pharma R&D activity from the EU countries to the US where drug approvals are faster and drugs can be released at higher prices.

This migration of R&D activity has reduced investment in pharma R&D in the EU, which is not just a direct economic loss to the EU countries but also compounded by the loss of network effects of R&D such as training, clinical trials, equipment manufacture, etc.

The number of drug patents from EU countries is declining causing loss of patent revenue. The controlled drug prices and the reducing patent revenues have resulted in declining profits for the European pharma companies.

When R&D divisions are shifted to the US, there is a flight of high value talent along with them. These R&D experts and their families would in turn have created their own network effects from high end services & retail activity that is an additional economic loss when they migrate.

Added to this economic loss is the reduced tax revenue for the state due to the declining profits of the pharma companies and the flight of high value talent.

Price arbitration across different EU countries creates opportunities for middlemen to profit by purchasing drugs in countries with lower prices and selling them in countries with higher prices. The lack of trade barriers amongst EU countries makes this very hard to control. This price arbitration gets extended to a global scale when drugs are sourced in Europe and illegally sold at much higher prices in the US.

The study done by Bain & Co illustrates with a case study of Germany that the benefit of imposing price controls on prescription drugs in fact leads to a net loss. In 2002, Germany saved $19 Billion on prescription drug expenses. However, if some of the costs of the above consequences were quantified (as shown in the study) they would add up to a loss of $22 Billion, a net loss of $3 Billion.

Anjana Kaul is a GCPP-13 alumnus 

[This and the other two essays on Price Controls was submitted as part of the Economic Reasoning coursework. The question asked students to identify instances of price controls in the world; who the intended beneficiaries were; and what were the unintended consequences of the price control. The 3 best answers were picked. The other two were on Price control on milk products in Vietnam and Price Control on Gasoline in the US in the 1970s].

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A Ban on Surge Pricing will Create Shortages

By Anupam Manur (@anupammanur)

Instead of a price ceiling on cab prices, the government should look at all the ways in which it can increase the travel options within the city.

Karnataka’s Transport Minister Ramalinga Reddy recently unveiled a new policy to regulate cab aggregator services such as Uber and Ola. While Karnataka previously had a policy to regulate regular taxis as ride-hailing services under Radio Taxi Scheme, 1988, Uber and Ola were not covered under the law, as they were aggregator services and not companies that own and operate vehicles for hire. However, as the app-based on-demand cab aggregator companies became increasingly popular, the government sought to bring them under the regulatory ambit.

The policy has introduced a few concessions for the cab aggregators, in a move to increase the supply of cabs. They have dropped the restrictions on the age of the vehicles, reduced the number of years that a driver had to be a resident in Karnataka from five to two, and has allowed drivers to switch between the ride hailing apps, as per their choice. They have also halved the license fee and security deposit. All of these moves will benefit the companies and the customers alike.

However, the biggest policy that will have a detrimental effect on the state of urban transport in Bangalore is the decision to disallow surge pricing for these companies. Both Uber and Ola use an algorithm to determine the prices based on real time demand and supply. If the demand for cabs were considerably higher than the supply, then the app would tell the customer that prices have surged. The surge pricing not only reduced demand, but is also a tool to increase the supply. A higher price will automatically incentivise more drivers to go to the area with surge pricing. However, the surge prices can, at times, be quite ridiculous, which is what caught the authorities’ attention. On New Year’s Eve, for example, Uber had a surge pricing of 10X, that is, ten times the normal amount.

7u

Effectively, the government has put a price ceiling on what these companies can charge the customer. It has given a band with a fixed upper limit, within which the price charged to the customer has to fall. While, this might seem like something to cheer about for the customer at the first glance, a closer inspection will reveal that it will actually end up hurting the customer as well as the companies.

Price ceilings simply do not work, as economic history has repeatedly taught us. A price ceiling will simply create a shortage in the supply of the good in question and create distortions in the market, which will hurt the very customer that such laws are intended to protect. In this case, a ban on surge pricing will lead to a reduction in the number of taxis available in the market, thereby creating welfare loss to the customers who demand the taxis.

The supply of any commodity depends on the price. At each price point, a supplier (driver in this case) will decide whether it is profitable to sell at that price point. Auto rickshaws normally charge 1.5X from 9PM – 6AM, in a bid to be compensated for working late hours and at times that other would not be willing to. Imagine if a similar price cap had been put in place for autos, there wouldn’t be any autos available for hire after 9PM.

Similarly, during peak hours and other times of high demand, in the absence of surge pricing, an Uber driver would not consider it worthwhile to switch on the app or accept ride requests and thus, leading to shortages.

Another major impact of this ruling would be that Bangalore would lose out on the new investment that these companies had pledged. Uber, which has now partnered with 30,000 cabs in the city had planned to expand to about 1,00,000 cabs in the next few years. Uber and Ola combined had pledged to invest around Rs. 15,000 crores in the next few years in Karnataka. With regressive laws such as this, the state could easily lose this investment to neighbouring states. The other worry is that other Indian states could follow this bad example. Maharastra was considering a similar move and it could get buoyed by the Karnataka move.

Finally, the government must rethink whether this is the best method to achieve its objectives. The intention behind this move is to increase the supply of public transport at affordable rates for the consumers. Instead of creating distortions in the market by implementing a price cap, the government should look at other ways to make the market more competitive and remove entry barriers. The government could consider allowing flag down taxis on the streets, like they have in all other major metros in India, which will surely increase the supply of taxis. It could also allow shared autos to ply on Bangalore roads for fixed routes, which will ease the demand for taxis. Another related measure is to allow private busses of all sizes on Bangalore roads, which is currently disallowed. In short, the government should look at all ways to improve public transport in Bangalore and ways to increase the number of options available for customers to travel in the city. This will surely reduce the excess demand for Uber and Ola, which will automatically make surge pricing redundant.

Anupam Manur is a Policy Analyst at the Takshashila Institution.

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