The official consumer price index indicates an annual rate of inflation in excess of 15%. Ordinary people believe that the official price index probably understates inflation, and they are probably right. But for fixed income earners, especially for the poor, whether the rate of inflation is a few percentage points above or below the reported rate offers no consolation.
This government, like most of its predecessors when placed with high inflation, is making vain attempts to “control” prices. Budget shops have been started but people know that they are mainly for propaganda purposes. A few shops in urban areas subsidized by the tax payer probably would help a few thousand middle class people but certainly would not check the escalating cost of living.

In the last few days the government has embarked on price control. A generation has passed since we last had, in the 1970s, extensive price control. Those who experienced that period would be aware of the disastrous consequences. Politicians who try to defy market forces invariably come a cropper. This time the minister entrusted with administering price control has imposed price restrictions on about ten essential consumer goods apparently at the wholesale level. We still do not know how serious the government is in enforcing price control. If they are serious, shortages of the commodities in question are guaranteed. That is easy to predict because unless the government is willing to subsidize traders, they won't buy and sell. It is as simple as that. But then the government may not be serious and talk of price control may be for propaganda.

The fundamental explanation for inflation has little to do with trade unless we are talking of a commodity such as oil. When oil prices rise causing inflation it is a trade-related matter. But in the past six months oil prices have come down from over $75 per barrel to less than $60 a barrel. This should actually cause inflation to moderate. But in Sri Lanka inflation has accelerated in the past six months. Here are a few reasons.

The deprecation of the rupee is a significant factor. The rupee has fallen by about 10% in the past twelve to fifteen months. That means all import prices also rise by the same percentage.
Second, if domestic production stagnates while expenditure (more money in the hands of the people to spend) increases a situation of too much money chasing too few goods arises. That of course will push up prices. You may ask how domestic production stagnates when the government is proclaiming an economic growth rate of 7% per year. Both of those could happen simultaneously. A good part of the 7% growth can be attributed to tsunami reconstruction and production of exports. They are not consumer goods that ordinary people buy that figure in the cost of living. To keep consumer prices in check production of food and other consumer goods and services must increase in line with rising wages. If that does not happen wage increases instead of raising living standards simply fuel inflation. Wage increases that cause inflation is like fool's gold.

The only solution to inflation is higher productivity. That means each and every worker has to produce more. That will allow more consumption without increasing prices. For that there are no short cuts. Most certainly price control won't produce higher productivity. If at all it will have the exact opposite effect.

For higher productivity we need more investment. But it has to be the right type of investment. Grandiose schemes such as airlines that purchase sub-standard aircraft of questionable airworthiness and airports in remote corners of the country will not increase productivity. But better roads to link towns with towns and rural areas with towns certainly will. Investment in education and health services will certainly help increase productivity. Foreign investors who establish industry to attract poorly paid rural workers to work in factories undoubtedly help increase productivity. Our point is that if we want to control inflation and raise the living standards of the people the first thing we need to do is get our economic priorities right. To get the priorities right we have to understand how the economy actually works. But many who decide policy show little or no understanding of that.