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| Sunday, 3 October 2004 |
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Business |  |
| News Business Features Editorial
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Wage increases and price controls-would they work? By Lloyd F Yapa When prices of goods and services escalate and erode their purchasing power, people demand, that government should either reduce prices somehow or that wages should be increased forthwith or both . The basis of the first belief is that government is as omnipotent as god 'sakra' himself and therefore should condescend to control or fix prices, in such instances. The basis of the second belief is that the government has unlimited resources and should not hesitate to increase wages. In fact politicians of all hues try to out bid each other confirming this possibility, when pursuing votes at elections. The vicious circle Practically all know, that the latest oil shock is the main reason behind the current escalation of domestic prices. Most people do understand, it is impossible for the government to influence the prices of such imported products, which are determined essentially by the interplay of world supply and demand conditions. What they do not appear to understand are the implications of relief measures suggested such as price control, increasing subsidies and wages in nominal terms. The resources of the government are very limited. Government is in fact indebted to the tune of about 104% of GDP. Government revenue is only about 16% in GDP terms, while expenditure is about 26%, because of heavy debt payments, the defence, public service wage/pension and the welfare/ subsidy bill. Most of these expenses do not contribute to economic growth, in terms of additional goods and services, nor to improvement of productivity, but add to the money supply. This means, that too much money chases after too few goods, contributing to the build up of inflationary pressures, which invariably bite into the purchasing power of the consumer. Any additional expansions in any of these payments including wage increases, which are not accompanied by productivity increases , would make things worse. Banks would have to raise interest rates to give their depositors a positive margin over the rate of inflation. This would discourage investment necessary for creation of employment and increasing production. When domestic prices rise in this manner, imports could become more attractive leading to a faster use up of foreign exchange reserves. Thus foreign exchange would become dear, and the currency would depreciate; the prices of imported goods in the domestic market too would rise adding to inflationary pressures. Politicians in their haste to please their relief seeking trade union followers and voters would start printing money (or borrowing from the Central Bank) having exhausted funds available (for borrowing by way of Treasury Bills) with the public, thus increasing the supply of money (further), chasing a stagnant or decreasing flow of goods and services. If any shocks like the hike in oil prices were to hit the economy in the meantime, the trade unions respond by intensifying their demands for higher wages again, the consumers follow suit by agitating for subsidies and the process of accommodation by the authorities goes on, inflation could spiral out of control. The housewife would ultimately have to carry so much money to make her daily purchases, that she will need a sizable sack to pack it in, employ a labourer to carry it and pay a security person to boot, to guard it against snatch thieves ! The government would be unable to honour its debt obligations and the country would be treated as a 'pariah' by international creditors and financiers. Surely we do not want our country to be caught in such a vicious circle and in be in such dire straits? The way out What then is the way out ? The price system in an open market system is the most efficient way of signaling to producers and consumers the scarcities and surpluses created by changes in the supply and demand conditions of goods and services. When demand increases relative to supply, prices rise, raising profit levels of producers, who in turn respond by increasing supply. Prices then fall back. Consumers reduce their purchases in the face of rising prices or turn to cheaper substitutes lowering demand for the product in question, thus helping to push prices down. Government or other interventions for alleviation of the misery of consumers invariably disturb this tendency towards normalization, as no administrator or central planner, however, efficient could anticipate the millions of changes necessary to accommodate some economic shock and plan the necessary adjustments, like the open market system. Only the older generations would remember the acute misery caused by the severe shortages of even basic necessities like infants' milk, bread or soap of acceptable quality, when producers and importers put up shutters faced with the losses following various price controls adopted by the authorities in the early seventies. Therefore the only solution is to follow the signals given by the movement of prices. For example, when an oil shock occurs and prices rise, give incentives to producers to reduce costs/improve productivity, or invest in alternate sources of energy, go all out to encourage consumers to conserve energy or turn to substitutes, convince militant trade unionists of the adverse impact of increasing wages in nominal terms on their purchasing power, restrain large firms with market power from raising prices to make abnormal profits by introducing more competition and applying regulations against indiscriminate price increases judiciously (without 'killing the goose that lays the golden eggs') and try to increase government revenue, while reducing unproductive expenditure (ignoring the irresponsible criticisms of the opposition, that promises of wage and subsidy increases be kept) and at the same time providing a 'safety net' to cushion the most vulnerable groups in society from the consequences of price rises. Above all it is essential to make people aware, that better times are bound to follow such short term austerity and sacrifice. It is difficult not to attempt to grant relief, when people are suffering. But much greater misery can be avoided by taking an appropriate mix of measures to quicken the natural tendency of markets to move towards recovery. Success in adopting this superior approach needs the co-operation of the opposition parties and of course a better understanding of the situation by the people. |
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