Oil: Why domestic prices don’t respond to global trends

The brand of capitalism that we chose is keeping Ugandans preyed on by whoever wants to make quick money!

Last week, particularly to downward trajectory? In other words, what causes the stickiness in prices for goods and services in Uganda? The downward stickiness does not only apply to oil prices; it is also prevalent in prices of other commodities, products, and services such as commercial bank lending rates, processed food prices, beverages, and other general merchandise.

I have spent two weeks trying to make economic sense of this. I often tell my students pursuing a career as economists thus, “When you get out of here, try to be as practical as possible. Few economists are relevant in the real world. Don’t join the crowd of these economists who, after seeing that something works in practice, ask if it can also work in theory.”   

To avoid becoming the first victim of my own diagnosis, let me first delve into what economic theory has to say about sticky prices before I go ahead to analyse what exactly is going on in Uganda.

Anyone who has ever sat in an economics class, and kept themselves awake, knows that macroeconomic theorists have devoted enormous time, thought and energy to search for better answers for macroeconomic behaviour. Nowhere has this search borne less fruit than in seeking answers to the question we are grappling with here. 

Theory suggests that prices and wages are slow to adjust. They in particular display downward rigidity, in the sense that business people are reluctant to accept cuts in their margins in the same way workers detest cuts in their nominal wages. So if you give traders, such as our oil dealers — operating in an industry with imperfect information — the opportunity to decide when to reduce or increase prices, it doesn’t require a genius to know what is likely to happen.    

Oligopoly market for oil

Because the fuel industry is oligopolistic in nature (i.e. there are a few firms operating under imperfect information, with interdependence that leads to a concave kink in the demand curve, and with firms always assuming for the worst), the dealers prefer not to engage in open competition in prices and instead create a cartel where they agree on prices to charge and quantities to supply.

If the oligopoly market players are greedy (isn’t this the typical characteristic of capitalists?), then they will keep raising prices in order to make large profits. Of course once they get used to the huge profits it becomes difficult for them reduce prices. That is why smart managers take their time to increase prices, because they know it will be difficult to reduce them if conditions dictate so.

For instance, when Coca-Cola was first introduced in 1886, the price of a bottle was set at 5 cents (about Shs. 140 in today’s shilling). The Coca-Cola Company did not change this price again for more than 70 years, despite experiencing a number of large increases in its costs over the period — including a threefold rise in the price of sugar in the 1920s.

In Uganda, our fuel dealers, and other business people, often cite high costs of producing, transporting, storing, and marketing goods as justification for charging exorbitant prices. The problem in Uganda is not high cost of doing business per se; it is high appetite for large, quick profits that make firms raise prices to unsustainable levels.

“Regulatory capture”

A number of fuel dealers I talked to attribute the recent phenomenon to huge inventory (stock) of fuel I had. That they had stocked large amounts of fuel before prices started to reduce, and thus they could not sell the old stock at prices which were lower than what they had incurred to purchase the products.

They also blame the high prices on the high cost of doing business, high taxes in the form of excise duties charged by government, and the ongoing exchange rate depreciation.

Although these factors make sense to any economic analyst, they don’t fully explain Uganda’s main problem. I asked some of our oil traders why their colleagues in Rwanda, who face similar challenges, if not worse given the longer distance from the sea, had reduced prices at a much faster pace than them, one of them bluntly said, this is Uganda!

Indeed this is Uganda. Like I have written in these very pages before, the level of market liberalisation we adopted here is unsustainable. What is happening in Ugandan economy today can only be tolerated in Uganda, and by the gullible Ugandans. Elsewhere leaders and policy makers know the difference between liberalisation and deregulation. They liberalised their markets but continued to regulate the players so that they don’t play a dangerous game.

One of the reasons our traders take Ugandans for a ride is because the current government got over excited with liberal markets and left the economy to the mercy of traders. I often tell my students that one would be stupid not to take full advantage of our economic system to make money. Fuel traders are doing exactly that, just like bankers, transporters, telecom companies, etc are doing.        

Uganda’s oil market is distorted. It is littered with cartels, syndicates, and “regulatory capture”. It is in Uganda where you will find a regulator who owns a business that is operating in the very sector he/she is supposed to regulate. Now tell me, how do you expect a man who owns a fuel station to police himself? Or one who owns a bank to regulate the banking sector! We need to get serious. Just get the list of chairpersons and members of the various regulatory bodies in this country, and follow them up. You will find them owning businesses or stakes in businesses that are operating in the very sectors they are supposed to regulate. We even justify it! “We need someone who is knowledgeable and experienced in the sector they regulate”! Uganda!
 
It is George Stigler who in his 1971 work, “The Economic Theory of Regulation”, explained that a sector may suffer from cognitive capture. This is when the mindset of regulators is captured by those whom they regulate. In Uganda, it is happening everywhere right from Bank of Uganda to the lowest sector in the economy.

That is why you find a would be regulator sweating in front of cameras as he/she belabors himself to explain why prices should go up or stay up, even in absence of any empirical justification.  

Therefore, my well considered view is that although some structural rigidities may explain the stickiness in Uganda’s domestic prices, it is mainly the brand of capitalism that we chose which is keeping Ugandans preyed on by whoever wants to make some quick money. Someone told us that traders like fuel dealers have capacity to self-regulate. Yet those who preached this gospel do not want to practice their theory in their own countries. What is even more painful, we seem unable and unwilling to learn, let alone to say enough is enough.                    

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