Treasury Looks for Way to Cut Food Prices

Preferring to rely on competition, many economists doubt price controls are effective in reducing Israel’s high food costs, but officials at the Finance Ministry think it’s just a matter of tweaking the formula – at least for now

Tomer Appelbaum

The Finance Ministry is working to make changes in the state price controls on basic food items in an effort to halt the extreme price rises the current system allows.

Many economists, however, say the system itself is the problem. The nonprofit consumer advocacy organization Emun Hatzibur says the current mechanism has failed to curb price increases.

While the treasury acknowledges that the system has many drawbacks and that it would be better to ensure lower prices through competition, officials think they can tweak the formula to achieve a short-term solution.

The debate over price controls comes as the government casts about for ways to reduce the cost of living. In a report it issued a year ago, the Knesset Research and Information Center estimated that food prices in Israel are 25% above the European Union average.

Price controls have not provided a simple solution. Not only does price-controlled food tend to be expensive, but the mechanism is inflexible: There is no quantity discount on larger packages.

Developed in the late 1990s, the current Israeli price control mechanism is based on ensuring a return on capital of between 6% and 12% for food manufacturers, although the benchmark can be as low as 4% or as high as 14%.

A committee that was appointed to make recommendations to reform the mechanism reportedly wants to set a different benchmark for each category of price-controlled food items in order to create a better fit. The guaranteed return on capital would be reduced, as would the number of factors in the calculation.

In particular, the new formula would not recognize discounts that manufacturers give retailers unless they are passed on in full to customers. This issue is particularly contentious at the moment for the bakeries that provide price-controlled bread items — they want the discounts to be counted in the price-control formula even if the savings remain in the retailers’ pockets.

In addition, the Finance Ministry is pushing for a legal amendment that would substitute fines for the criminal sanctions now imposed for violating price controls. The change was due for inclusion in the Economic Arrangements Bill, the supplementary legislation that accompanies the state budget, but the budget was not approved as a result of the calling of early elections.

Marginal concerns

In recent months, the panel that oversees price controls has taken a closer look at the profit margins at supermarket chains, a subject that has gotten little attention in the past. Profits on eggs seem particularly high. Although the wholesale price is controlled, the major chains have managed to win discounts from producers and there are even differences in price among different stores in the same chain.

The committee will launch a new website within a number of months, with information not only about price-controlled products but also price comparisons with similar items abroad. A price comparison carried out Emun Hatzibur places the entire price-control concept in a problematic light.

The comparison doesn’t take into consideration the added costs of kashrut supervision or the fact that Israeli dairy farmers are paid more for milk than their European counterparts. Emun Hatzibur found that food items in the price-control regime cost between 30% and 330% more in Israel than in the United States, Britain and Australia. The organization used the websites of Walmart in the United States, the Mysupermarket website in Britain and Coles Supermarkets in Australia for the prices used in the comparison — which it adjusted for local purchasing power.

“One of the main reasons that price controls lock in high prices is that they are based on data that the businesses subject to the controls provide, enabling them to considerably influence the price by manipulating the numbers,” says Emun Hatzibur’s head of research and assistant director, Ronen Regev.

“In the food sector, in which companies that produce products under price controls also export products that are not controlled, it is common for the cost of production of the noncontrolled products to be included in the producers’ costs that are recognized for production of the controlled items, and that then serve as the basis for setting the price-controlled price, ” he says.

The panels that determine the retail prices for price-controlled foods have wide authority to demand data from the producers as part of their work. In practice, however, most of them don’t do so very often and frequently accept the producers’ data without independent verification. The price committee is aware that producers could manipulate data, so it has hired external auditors to review producers’ financial records.

Double whammy

Emun Hatzubur’s study of the dairy sector failed to take into consideration the fact that dairy prices in Israel are affected by the price farmers receive for raw milk, which is about 33% higher than in Europe. The biggest disparity is in the price of low-fat milk, which is generally more than double in Israel what it is in Britain or Australia.

The dairy sector suffers a double whammy of sorts because the government sets the price that farmers get for their milk based on a formula that does not provide an incentive for them to become more efficient, and some dairy products are then subject to price controls.

In addition to the absence of incentives to economize, the sector is dominated by three major dairy producers — Tnuva, Strauss and Tara, whose current situation is rather comfortable for them and doesn’t encourage competition.

Although the price control mechanism sets a maximum price and does not bar retailers from selling products for less, in practice price controls usually create a situation in which everyone steps into line and sells for the maximum. Standard bread (lehem ahid in Hebrew), the price of which is controlled, provides a perfect example. Even though the major supermarkets get substantial discounts from the bakeries for it, they usually sell the bread to the consumer at close to the maximum, while keeping most of the discounts.

Even Rami Levy, the discount supermarket chain, has problems with the system.

“We need to eliminate all price controls. A totally free market has to be created. At the same time, regulatory agencies need to monitor and severely punish monopolies that exploit their power or coordinate prices. We’ve seen in the cellular service sector, which didn’t need controls, that prices dropped the moment that the market was opened up,” says Levy. “ The same holds true for food. We need to eliminate customs duties and the bans on imports that protect farmers, and if the government sees that a farmer is hurt by imports, then the government needs to subsidize this and compensate him as they do in Europe.”

And a representative of a food manufacturer, some of whose products are under price controls, expressed an interest in reducing the system because he said in most instances the profitability on the products was less.

“In the long term, price controls are not good for the consumer because all of the chains fall into line and charge the maximum. Since there is an assured price, there is no innovation. It’s not worth it for us to invest money in a price-controlled product because the profitability is not high,” says the manufacturters, who asked not to be identified.

On the other hand, an executive from a medium-sized food retailer insists that price controls have their benefits.

“Controls are an effective tool since they place limits on both the producer and the retailer,” he says. “The chains lose money on price-controlled dairy products and on non-dairy products we generally break even, but that’s good for us. We would need to sell the price-controlled items at very low prices in any event. These are basics that all of the chains want to sell at a low price.”

But former antitrust commissioner Dror Strum says the idea that controls can be a substitute for competition has been dispelled. He takes politicians to task who have been touting the benefits of controls, calling their actions “political charlatanism.” Price controls, he says, have never solved the problem of the cost of living.