Beijing Pays a Price for Controls

China sells water and power cheaply. It now has to suffer shortages.

The Yangtze River area is experiencing its worst drought in 60 years. And the shortage isn’t merely in fresh water needed for factories and irrigating crops. Officials say the nation also is facing the most critical shortage of electricity since 2004.

In response, the government last week ordered the Three Gorges Dam to release water downstream and on Monday announced a one-time hike in electricity prices. But the real solution is simpler: Let the market determine prices.

Both shortages can be traced to government price fixing. Communist Party officials have been warning about a water crisis for a decade. Yet water tariffs averaged around $0.40 per cubic meter two years ago—lower than in many emerging economies and a fraction of the real marginal cost. At this price, farmers, factories and households guzzle water.

“Pricing bureaus” in local governments have tried to address the problem by raising prices in one-off cases over the past few years. But they’re beholden to Party or populist pressures. The city of Nanjing in the east raised prices by 12% in 2009 but simultaneously rolled out subsidies.

The political mandate to provide cheap electricity has similarly proved ruinous. Because power generation companies aren’t allowed to raise tariffs, they have had to swallow rising costs; coal-fired power plants controlled by the five top companies lost 60 billion yuan ($9.3 billion) from 2008-10. This year, as drying rivers cut off hydroelectric sources while rising coal prices world-wide hit thermal plants, power stations are bound to scale back production. Beijing approved a 3% increase in prices that took effect Wednesday, but this hardly provides relief to utility firms when annual inflation is running at 5%, especially since residential users are exempt from the hike.

The ideal fix to both markets is deregulation, so the market price can signal how a scarce resource should be allocated. Don’t count on this reform happening any time soon, though.

After all, Beijing’s response to inflation over the past year has been price controls. Rising prices might spur social unrest, the authorities fear. Last month, regulators decided to fine consumer-goods maker Unilever for daring to talk about price hikes (though they now seem to be backtracking). Costlier inputs would hurt the profitability of state-owned companies, while shortages mainly hurt the private sector.

This hurts efficiency and depresses incomes in the long run. As long as the world’s second largest economy suppresses the price mechanism, it will suffer from overcapacity in some sectors and crippling shortages in others.

The Wall Street Journal

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