Thursday, January 24, 2008

Price Controls and Shortages...

One week ago, I discussed the likely consequences of the newly-introduced Mainland price controls here. I argued that "Price controls never have been, and in my view never will be, an effective policy to try to lower inflation." Previously, I've argued that price controls lead to shortages.

Well, guess what? From today's SCMP...

Worst-ever coal shortage sees stocks fall 40pc
Emergency measures taken as provinces ration electricity

The mainland has issued an emergency circular to ensure power supplies after an unexpected power shortage of nearly 70GW.

In an effort to ease inflation, the State Council had announced this month that power producers would not be allowed to raise electricity prices in the short term, preventing them from passing on the rising cost of coal.
"It's a battle between power companies and the central government," said Great Wall Securities analyst Zhou Tao . "While coal prices are going up and an electricity price rise is ruled out by the government, the electricity companies are reluctant to buy much."

Electricity prices cannot be increased because of price controls, but the cost of generating electricity is rising due to rising coal prices. Profit maximising electricity producers respond by reducing the supply of electicity, resulting in power shortages.

The best response? Deregulate electricity prices, allowing these to move with the cost of production. The most likely response? Regulate coal prices, to reduce the cost of electricity generation. But this would not work: it'll merely result in shortages of both electricity AND coal, as profit maximizing coal producers respond to decreasing profit margins by decreasing the supply of coal.


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