Following yesterday’s surprising news that Russia is instituting price controls on numerous basic food staples throughout the rest of the elections season, we thought it would be interesting to speak with an economist to get a perspective on what this all means. We’re pleased to present an exclusive interview with Dr. Craig Pirrong, Professor of Finance and the Energy Markets Director for Global Energy Management Institute at the Bauer College of Business, University of Houston. Dr. Pirrong maintains the excellent blog Streetwise Professor, which contains lots of great information and analysis on Russia. We’re grateful for his contribution.
Q: First, just the basics: Basic food staples such as bread, eggs, vegetable oil, milk and cheese have risen dramatically in recent years in Russia. A: It is part of an overall inflationary trend in Russia, traceable directly to the rise in oil prices and the central bank’s response to that. Q: When it was announced that food manufacturers had been pressured to voluntarily freeze prices, many journalists and observers immediately compared it to “Soviet-style” price controls. Is that a fair comparison or an exaggeration? How do the latest series of price controls differ from similar economic policies during Soviet rule? A: Right now it appears it appears to be much less formal and more extemporaneous than the rigid and formalized price controls during the Soviet period. Furthermore it should be noted that very similar “voluntary” efforts to control prices and wages have been attempted in the United States in the 1970s with disastrous results. The latest price freeze on food by the Russian government an ad hoc policy, directed toward solving a political problem However, from there, the question arises: what comes next? Is this a temporary, politically expedient move, or will there be an escalation to more formal restrictions, when, as is likely, these somewhat ad hoc measures don’t have the desired effect? Q: In your recent blog post on the subject, you write that “the consequences of this move are drearily predictable: shortages, empty shelves, lines in stores, black markets in foodstuffs.” Is that a real possibility in just three months? What do you imagine will happen when the controls are lifted following the elections? A: It all depends on whether or not the inflationary pressures continue on their current pace. There are plenty of reasons to believe that they will, as the economic factors causing inflation look to stay the same for a while. So if the price controls the Russians are about to institute really have some bite, if they are really going to dragoon the manufacturers into keeping prices artificially low, then yes, there will be shortages; it’s inevitable. If and when the controls are lifted, you can expect a big spike in prices. Let’s imagine six or nine months down the line, after the political issues have been sorted out, the government will be faced with six months of suppressed food price inflation catching up overnight, which naturally may cause them to hesitate and keep the controls in place a bit longer, making the problem worse. Price controls are like a bad guest – it’s easy to invite them over, but sometimes it can be hard to get them to leave. Look at rent control in New York—it was initiated as a “temporary wartime measure” in the Second World War, but persisted for decades afterwards. Q: Price controls of course aren’t the only way to try to force down food prices. Some countries also play with tariffs, slashing them for cheaper imports to come in, or raising them domestically to drive down prices. In fact, just a few weeks ago, Vladimir Putin promised to take action on high food prices by slashing tariffs for imported products. Does the fact that Russia is currently negotiating it accession to the WTO have anything to do with their choice of price controls over tariff adjustments? A. The WTO issue could be part of it, but I have read that Putin has also put forward the idea of a new export tax on grains, so they might be moving in that direction as well. Also, they are still playing various import restriction games with meat imports from Poland, as well as food products from Georgia. Food politics in Russia plays into the larger gamesmanship that is going on in the near abroad. From the Kremlin’s perspective, the food prices issue is a policy trade off; letting in more food imports from Poland, for instance, undercuts the pressure Russia is trying to exert on the Poles to influence their policies on other issues. Also, even if Russia is able to restrict some exports to drive down prices, then those inflationary pressures are going to begin to be felt elsewhere. Q: Many countries who face similar dilemmas of both inflation and a local currency appreciating against the dollar take on other strategies, generally known as the Sterilisation doctrine. We can see from Russia’s vast sovereign wealth fund, that the state is doing a fine job sucking up dollars, but why hasn’t the central bank taken the route preferred by Brazil, China, and India of issuing short-term paper to absorb rubles instead of freezing prices? A: Russia is faced with a choice: it can either let the ruble appreciate more, or live with the inflation. What they have chosen is to have inflation in ruble terms, essentially to protect their competitiveness in trade markets for domestic industry. Up until now, they have been willing to let inflation continue. However, now that inflation has become more of a concern, I imagine they will change their policy and let their currency appreciate more. Q: Price controls are widely acknowledged to cause dangerous distortions to the market, and even worse, they don’t work in the long run. Even Finance Minister Alexei Kudrin told RIA that controlling prices is impossible: “This is a market, and market prices do not freeze. It would be a mistake.” So why has the government selected this mechanism over other alternatives? A: The food issue is perhaps the most politically sensitive and widespread manifestation of broad inflationary pressures in the Russian economy. Milton Friedman used to say that inflation is always and everywhere a monetary phenomena, so it needs to be addressed through monetary policy. The challenge they face is over the exchange rate. This is an illustration of the kinds of overall adjustments the economy needs to make when you have such an intense resource boom as Russia has experienced with 80 dollar oil. Their choice is inflation or Dutch disease. A large shock like the oil price boom necessarily forces adjustments in the rest of the economy. Some of these adjustments can be painful for large portions of the populace. Q: Do you think that the price freeze tells part of a larger story of the way things are going for the future of the Russian economy? A: To me, just in my opinion as an observer, these price controls are part of a broader pattern of interventionism in a wide array of policies with this government, so in some respects, it is really is “back to the future.” Q: Are there any other considerations or lessons our readers should take away from this? A: One thing I would say is that we must be aware that price controls have serious ramifications for corruption. What is happening right now in Russia represents another opportunity for those with the political and economic muscle to function above the law, and to thrive as a result. Corruption flourishes when markets are distorted, and Russia’s attempt to freeze food prices represents a potentially big distortion—and hence a potentially big opportunity for the country’s “corruption entrepreneurs.” As if more such opportunities were really needed.