How do Price Distortions Affect Domestic Commerce Today?
By Yudy Castro Morales – Nov 18, 2020
Monetary and, especially, exchange rate unification should be a step toward the homogenization of current methods of price formation and the elimination of distortions that affect internal and external trade and the enterprise system
How many times have we questioned why the same product has different prices in the market? An example would suffice to illustrate this.
A 1,500 ml bottle of Tukola soda produced by Los Portales costs 1.50 CUC in stores that operate in that currency. When this price is calculated according to the current exchange rate (1 CUC = 25.00 CUP), it becomes 37.50 CUP. However, this same product costs 25.00 CUP in some retail stores affiliated with the Ministry of Domestic Commerce. The same applies to this product in can format and to other merchandise that would make up an endless list.
These differences, which have been a constant source of concern within the population, reflect the profound distortions with which the economy has operated for several years. Distortions that derived, in good measure, from the dual currency and, especially, different exchange rates.
For this reason, unification, although definitely no magic wand in appearance or behavior, should contribute to homogenizing current methods of price formation and eliminating distortions that affect both internal and external commerce, and the enterprise system.
According to Margarita de la Caridad Acosta Rodríguez MSc, price policy director at the Ministry of Finance and Prices (MFP), Cuba has traveled a long route before reaching today’s distortions, dating back to the 1990s, when it became necessary to establish the monetary duality and adopt financial reorganization measures including price increases for nonessential products and an end to the provision of some goods and services free of charge.
It was not until 2003 that the Cuban convertible peso (CUC) was introduced in the relations between organizations and in the formation of wholesale prices, as a way of recognizing the imported component of productions and services, she recalls.
In 2004, stores designed to capture hard currency, began to charge in CUC and, one year later, retail prices in CUC of high demand products were frozen, she adds.
Since then, many measures have been implemented to attempt to correct the deformations emerging in the economic price category, one of the most complex and controversial because it has special links to wage, fiscal and trade policies.
In the opinion of Acosta Rodríguez, of special importance were measures taken in 2016 to increase the purchasing power of the Cuban peso, which included the reduction of prices for an important number of food, personal hygiene and cleaning items sold in CUC.
The prices of certain agricultural products were capped as well and, in June of 2019, it was established that there would be no increase in wholesale and retail prices, to avoid counteracting the positive impact of salary raises in the budgeted sector and increased pensions.
In summary, the economy has operated in an environment of a dual currency with a different exchange rate for two different arenas:
In relations between enterprises and in the wholesale market, used is the exchange rate of 1 USD = 1 CUC = 1 CUP.
In relations within the population and retail commerce, used is the exchange rate of 1 CUC = 25 CUP.
At the same time, the U.S. economic blockade has been aggressively escalated and the severe material and financial restrictions it causes remain in place. In addition, reducing the country’s dependence on imports has not been possible, despite attempts made. Cuba has not been able to escape the effects of the economic crisis and consequent price increases in foreign markets.
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We must also take into consideration the mandates included in key documents approved at the Sixth and Seventh Congresses of the Communist Party of Cuba (PCC), to review and comprehensively overhaul the price system, Acosta Rodríguez adds.
These documents provide the foundation for the diagnosis conducted, including factors that influence the system’s performance, aspects linked to accounting and supervision, as well as the identification of economic distortions that are expressed in prices.
Today, in general terms, the specialist explains, prices do not reflect the behavior of the market, due to the disconnection between wholesale and retail prices, which responds to the existence of subsidies and the intention of capturing hard currency via pricing of various products.
Perhaps the most “costly” distortion, economically speaking, is associated with the current exchange rate for relations between enterprises (1 USD = 1 CUC = 1 CUP). According to the MFP directive, “This prevents prices from serving as an objective measure of economic facts and discourages exports and the replacement of purchases abroad, based on distortions in the calculation of costs and expenses.”
In other words, with the 1 x 1 exchange rate for relations between enterprises, in general, the price of the imported product is lower than the price of a domestic one, which is totally contradictory and accentuates the tendency to import, undermining competitiveness and creativity.
In the words of Acosta Rodríguez, “Most of the productions, whether substitutes for imports or destined for export, receive significant subsidies or have implicit subsidies which are covered by the prices of other goods and services. However, there are wholesale prices that contain other converters, which are not at the 1 x 1 exchange rate.”
Evidently, the expert goes on, the context of monetary and exchange duality has limited the flexibility of price and tariff formation, which, for the most part, has been isolated from foreign market prices.
Such procedures, she adds, have been based on methods of expenditure, which have led to the concealment of inefficiency and their cost transferred to the economy, made invisible by both structural and technological issues, difficulties in accounting records, the non-implementation of cost systems and other irregularities.
Another notable distortion is the sale of the same products at different wholesale prices, mainly due to the existence of a market in CUC and another in CUP. The same product is usually sold:
1. To state entities, at a price that contains components in both CUP and CUC.
2. To joint ventures, at a price that considers the total amount in CUC.
3. To retail chains and the tourism industry, at a price that includes the CUC component in most national products, while financing the industry for the difference in CUP.
Taking into account these deformations, the MFP directive recognizes that prices do not always cover all expenses incurred. To this should be added the approval of incentives paid in CUC to workers in various sectors.
Likewise, conversion rates other than 1 x 1 have been applied on an experimental basis to support the wages of workers in priority areas, as mechanisms to stimulate the workforce, an expense which is not considered in setting prices. Such is the case in:
-Foreign investment projects
-The Mariel Special Development Zone
-Construction of prioritized works
In all these cases, the formation of prices at the 1 x 1 rate is recognized; although this unquestionably implies an added burden for the state budget, which finances the difference at the approved conversion rate, she emphasizes.
The specialist also refers to the different approaches in the formation of prices for the state sector and the non-state sector and, in turn, emphasizes the disconnection between wholesale prices and those the population pays. Today, producers do not receive the majority of the final price, she adds.
Similarly, not to be overlooked is the high level of subsidy reflected in the retail prices of products that make up the regulated family basket of foodstuffs, including rice, beans, sugar, chicken and other regulated meat products, as well as basic services such as electricity, gas, water and basic telephone services.
The provision of subsidies to specific persons is still very limited, and issues identified in programmatic documents that support the updating of the economic model have not been addressed.
Acosta Rodríguez believes that other structural problems also affect price setting, such as the existence of many levels of circulation of goods prior to their final destination.
Although the approval of wholesale prices has been decentralized, the authority granted enterprises remains insufficient, in her opinion.
Meanwhile, many retail prices are still established centrally and little power has been granted to municipal authorities to adjust these.
All of this also contributes to shortcomings in complying with the constitutional principle of local autonomy.
The lack of qualified personnel in the area of prices, insufficient control and inspection work, gaps in training, and the lack of systemic public information work on the setting and approval of prices are all aggravating factors, which are equally relevant when analyzing any deviation.
Prices currently express the behavior of the economy with all its irregularities, the head of price policy at the MFP reiterates.
In her opinion, the lack of flexibility in both methods of price setting and the authority to approve prices at different levels of the enterprise structure, has limited autonomy in establishing prices. The consequences have become Gordian knots for the economy and translate into delays and low levels of efficiency and competiveness of national products and services.
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Furthermore, through July of 2019, when regulations limiting price increases were established, there was a strong tendency among enterprises to raise the category of their products to gain more earnings and increase pay-for-performance bonuses, which introduced a new distortion.
To assess the impact of retail price distortions on domestic commerce, it is essential to take into account the way the market is segmented: one regulated in CUP, one in CUP and CUC and, recently, one in freely convertible currency (MLC).
As for the regulated market, Yosvany Pupo Otero, general director of Services at the Ministry of Domestic Trade (MINCIN), recalls that in 1962, Law no. 1015 established the system of rationed supply of everyday consumer goods, the “libreta” that continues to live on.
He likewise noted the level to which the determination of prices in Cuba is concentrated, considering that among the substantive elements in this economic category involves who approves them and how they are set.
Today, Pupo Otero states, the approval of retail prices for products and services essential to the population is the responsibility of the Council of Ministers’ Executive Committee and the Ministry of Finance and Prices, with a view toward supporting social policies and basic needs.
Meanwhile, the determination of the value of another group of products and services is the responsibility of the Ministry of Domestic Commerce; the Wholesale Food and Consumer Goods Enterprise Group; the Industrial Products and Services Distribution Group; as well as the administration board in all provinces and the Isle of Youth special municipality.
As is known, the regulated market includes, basically, the family basket of foodstuffs, through which a group of products is made available to all at subsidized prices. In other words, for these products the population pays a price that is far below the real cost, and the difference is assumed by the state budget.
Similarly, other products sold at subsidized prices include items in special diets for some 11,817 children, and those for some 1,360,332 adults with health problems, Pupo Otero adds.
Subsidies are also reflected in retail process via programs to distribute non-food products to meet specific needs such as:
-Layette for newborns: textile module, mattress and cradle.
-A module for bed-ridden and incontinent patients composed of antiseptic fabric, towel, sanitary rubber and soaps. In this program, the payment is assumed by the state.
-School uniforms for students in primary, secondary, pre-university and poly-technical vocational schools. An annual average of 3.8 million uniforms are sold at subsidized prices, ranging from 2.00 to 9.80 CUP.
-Prophylactic footwear: sold by prescription, according to the distribution policy.
According to the Pupo Otero, these programs function on the basis of a few fundamental principles:
-Consumers can acquire these products only in assigned establishments.
-The purchase is noted in the ration book (in the case of the regulated family food basket) and according to established procedures for other programs.
-Sales are made on a fixed per capita basis, according to the distribution policy approved each year.
-The distribution is cyclical (monthly, twice-yearly, annual).
Regarding the setting of prices in the unregulated CUP market, Yosvany Pupo explains that a component in CUC is recognized as a rule for raw materials and imported materials, and a component in CUP.
To support understanding of these technicalities, he takes as a reference the construction materials program, in which several methods of price setting coexist.
On the one hand, products are sold at unsubsidized prices in some cases, in which the CUC component is considered at the 1 CUC = 25 CUP exchange rate and the CUP component of the wholesale price is recognized.
In the case of products that contribute to water saving and housing programs, the price setting algorithm is different and lower conversion rates are used, which affects enterprise earnings.
And, finally, this same program annually guarantees the requirements for basic housing units, in other words, subsidies for constructive work, reflecting the direction that the economy must take sooner rather than later: subsidizing people rather than products.
Pupo Otero cited a few other examples to illustrate the multiple existing distortions.
These include the most economical and subsidized prices applied in Attention to the Family (SAF) and school snack programs, both activities run by municipal food service enterprises.
In the first, meals with established nutritional requirements are sold at a price of 1.00 CUP, to benefit more than 76,000 individuals, more than 11,000 of whom receive social assistance. However, once again, the real cost of the product is higher, which affects the financial performance of these companies.
Regarding the school lunch program, the distortions are even more acute, since students and teachers’ lunches are provided free of charge, in a network of more than 774 schools, with 138,851 students and 30,984 workers.
In Havana, nonetheless, the experience of including the price of the snack in the teachers’ salaries has been favorably received since this allows them to make their own choices and pay with their earnings. More than the exception, this practice should be the rule in a future scenario of monetary and exchange rate unification.
As Margarita de la Caridad Acosta Rodríguez, director of Price Policy at the MFP, has already noted, undoubtedly, “The transformations foreseen regarding prices must be accompanied by other changes in strategic sectors, in commerce, wage and fiscal policies that, in a gradual, comprehensive manner, allow for important advances in the economic and social life of our nation.”
BASIC CONCEPTS:
PRICE: Monetary expression of the value of goods and products. In practice, prices are associated with the value of products and fees for services. When we talk about prices, service fees are also included.
PRICE SYSTEM: The interlinked set of different types of prices, including legal frameworks, regulations, entities and other actors involved in the setting, approval and application of prices, as well as the population, who as consumers, are a very important and dynamic part of the system.
PRICES CAN BE:
Wholesale: Paid by legal persons.
Agricultural: Paid by wholesalers to agricultural producers.
Retail: Paid by the population, including fees for services.
MONETARY REORDERING WILL INCLUDE:
-The minimum salary will be based on the cost of a basket of essential goods and services, respecting the principle of covering the needs of the worker and his/her family.
-Subsidies will be for persons, not articles or services. Insolvency requests will be addressed within 48 hours.
-In the first stages of monetary and exchange unification, the total subsidies for specific products for children from 0 to 6 years of age in Cuba will be maintained.
-Medicines for the treatment of chronic diseases will be subsidized.
-Some of the 42 products with centralized prices include yogurt, processed cheese, mortadella, pasta, sausage, fuel, electricity, water, cement, sugar, coffee, ground meat, compotes and milk.
-Enterprises will set other prices, but within limits.
-A salary increase has been designed to allow workers to pay the new prices when that day comes.
-A strategy has been planned to invest in companies with losses, to avoid closures, unemployment, and the deterioration of services to the population.
Featured image: The transformation of prices must be accompanied by other changes in commerce, wage and fiscal policies that, in a gradual, comprehensive manner, will allow for important advances in the economic and social life of our nation. Photo: Ariel Cecilio Lemus
