By Hafiz Noor Shams
Prices of the same tradable items in different places tend to converge in a perfectly efficient market. Theoretically, motivated by profits, individuals and entities act as arbitrageurs. They will continue to arbitrage until there are no more profits to be made. That is when prices equalise and that is the essence of the law of one price.
In the real world, though, prices may not actually converge to one price due to several factors however, because the market can be inefficient. Limited access to information crucial for the purpose of arbitrage may prevent convergence.
Transportation cost as well as government intervention in terms of taxation and subsidisation are two of several other important frictions. Instead of prices equalising, a price spread of the same goods in different locations exists to reflect those frictions even as market participants exhaust arbitrage opportunity.
This is essentially the reason why there is noticeable price differential for the same tradable goods sold in the eastern and western parts of Malaysia. With the South China Sea separating Malaysia into two parts, it is only natural for prices to differ between the two regions. Even under the price and supply control mechanism that exists in Malaysia, a kilogram of sugar for example, is 10 sen cheaper in Peninsular Malaysian than in Sabah and Sarawak. Transportation cost is a considerable barrier preventing actual convergence.
This is a source of discontent for some. Member of Parliament for Kalabakan, Abdul Ghapur Salleh of Umno, said in November 2009: “We’re talking about 1Malaysia, but we don’t even have one price” while alleging that the price differential is more insidious in nature — discrimination against Sabah and Sarawak — rather than simple economic friction.
It is unclear how he wants efforts at standardisation to proceed, but the approach by the federal government is clear. In the same month, Minister Koh Tsu Koon supported the idea of standardised prices across Malaysia and proposed that transportation cost be shared by all; in other words, introduce subsidies. Nearly a year earlier, Domestic Trade and Consumer Affairs Ministry wanted to do the same: subsidise the cost of transportation.
In Sarawak itself, perhaps a harbinger of a wider similar nationwide policy, the same ministry plans to subsidise transportation cost with the intention of standardising prices of essential items sold in urban and rural areas under its “One Sarawak, One Price” campaign.
In short, they are turning the law of one price on its head. Rather than letting market forces find its equilibrium where a particular price that perfectly fit a particular landscape even in a narrow band that approaches convergence, the government intends to impose unnatural standardised prices for all situations at all places. The government intends to introduce more inefficiency to standardise prices.
The discontent over price differential is overrated however. Two economists — Lee Chin and Muzafar Shah Habibullah of Universiti Putra Malaysia — published a paper in 2008 showing that prices of tradable goods between Peninsular Malaysia, Sabah and Sarawak are converging. Furthermore, the recent liberalisation of cabotage policy — a protectionist policy that contributed to persistent price differential between eastern and western part of Malaysia — will likely further strengthen the natural convergence trend.
Convergence aside, to iterate the idea of how the difference is natural, the price differential has nothing to do with discrimination between the two parts of Malaysia. It is a reality that there is a large body of water separating the two parts of Malaysia. It is likely that if the transportation cost are brought down, prices are likely to equalise, all else being equal.
The price differential due to transportation cost or distance has nothing to do with the idea of unity as much as it has something to do with the idea of discrimination. In the United States for instance, gas prices in Michigan and in California are very different. In many times in the same state, prices of gas in one town can be different from another town a mile away. That does not make the person who pays higher price as less American than the other person who pays lower price for gas.
This idea can be expanded to Peninsular Malaysia. The government should not standardise prices within Malaysia. This is not to say just prices between Peninsular Malaysia, Sabah and Sarawak, but within those regions as well. What a free Malaysia needs is not a Price Control Act, but a Competition Act or antitrust law to fight collusion among businesses in order to encourage competition — the most effective method at encouraging convergence and low prices — without suffocating entrepreneurial spirit.
On top of that, maybe, just maybe, the move of having manufacturers based in Sabah or Sarawak is a cheaper and a more profitable option compared to the option of transporting goods from Peninsular Malaysia or from abroad even after accounting for various other effects like clusterization.
If the subsidisation program goes through, it removes that incentive and hence, the possibility of developing industries in eastern Malaysia. If a business owner could transport his or her goods free from western to eastern Malaysia, why would the business owner locate his or her factory in eastern Malaysia? There are better ports, roads, financial services — practically everything that matters in business — in Peninsular Malaysia than in Sabah and Sarawak. In other words, the subsidisation program would continue to industrialise the Peninsula while leaving Sabah and Sarawak farther behind in terms of development.
Besides, the Prime Minister recently said that private initiatives and market forces have to be given freer rein while subsidies be phased out. The standardization of prices across Malaysia through subsidisation of transportation cost by the government clearly contradicts that. Is this proof that there is no coordination within the government? Or do words mean nothing to the government?
For the answer to be no on both accounts, the policy of “One Price” must be rejected.
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Hafiz Noor Shams is a Fellow at the Institute for Democracy and Economic Affairs (IDEAS).
This article was published in The Malaysian Insider on (22 February 2010)
Image credit: malaysiatiens.wordpress.com