Tuesday, January 22, 2008

It's funny what they CAN raise prices on. 

The Chavez administration just announced that it will be raising prices on something.

No it isn't gasoline.

Nor is it dollars.

Even less is it road tolls which in fact just got eliminated.

As we have heard time and time again prices can't be raised on those things because (gasp) it might somehow spur inflation, or make it difficult for people to travel abroad, or cause riots, or whatever.

So instead of raising prices on any of those things the government raised prices on, get this, milk.

First a little background. Milk, along with a slew of other produts, has been subject to price controls going all the way back to the oil strike of 02/03. The prices have been revised at times but they have always been controlled by the government and held artificially low.

This has had three predictable effects. First, by keeping the price low the government has made the products more affordable and boosted consumption. This is a positive effect and probably what the government wanted.

The second effect is that with enforced lower prices profits were reduced and possibly eliminated (ie producers would be LOSING money) so that no-one had an incentive to invest in producing milk or even to keep producing at current levels. Hence supply from domestic producers would stay pretty much the same or even drop.

The third effect is the result of the first two - with consumption up (good) and production not up (bad) you got the famous "shortages" with milk often not appearing on store shelves.

With prices frozen and costs for producers still going up over time the supply of milk was bound to get worse and hence the mismatch between supply and demand (ie shortages) would also worsen.

Hence, the governments response of raising the price of milk.

This was a very bad policy choice for several reasons.

First, it isn't likely to solve the problem of reduced supply. The reason is that all they did was raise the price - but prices are still controlled so they are now frozen at a higher level. Who is to say this new level is enough to give an incentive to produce milk? Futher, given that the new price is frozen even if it is currently adequate it likely won't be so for long and 6 months or a year from now producers will be incurring the same losses they were last week.

Yes, prices could be adjusted again in the future. But who knows if and when that will be done. And not knowing that and facing the possibility of future losses it is unlikely any farmers will invest in increasing milk production.

So this price increase is unlikely to do much to alleviate the problem the government wants it to alleviate.

A better course of action would have been to eliminate the price controls all together. But this leads us to the second defficiency in Chavez's action.

While raising the price of milk he did nothing help low income Venezuelans deal with the price increase. In other words, the idea behind the price controls to begin with was to make milk more affordable to low income people. That is good - the poor did need to eat better, and still do. But now with this increase they are going to be able to buy a lot less milk than they were able to afford last week. They will simply be priced out of being able to consume milk (while there will now be more milk on store shelves for affluent Venezuelans to buy!!).

So once again, we see this government now favoring the interests of the well to do over the interests of the poor. Some "revolutionary" government!! With revolutionaries like this who needs reactionaries!

In point of fact, the best solution would have been to eliminate the price controls altogther to boost production (and this blogger must admit he has been guilty of defending the controls for too long) but then announce new food subsidies for low income people so they could still maintain their consumption of food at high levels. That is, the government still should be taking action to help the poor get food it is just that it should switch the mechanism for doing that from price controls to a "food stamp" type program.

Low income Venezuelans could be given ration coupons entitling them to get heavily discounted food. Or the food could be sold very inexpensively through Mercal. But regardless of the exact mechanism the government should do something to guarentee access of low income Venezuelans to basic necessities like milk and not just let them be priced out of consuming it as famously happens in places like Mexico.

Now of course some will likely ask where is the government going to get the money from for yet another subsidy. Good question. But it really isn't all that difficult to answer.

A few weeks ago I pointed out that the government was losing tens of billions of dollars by giving away gasoline for free. If it raised the price of gasoline it could easily raise billions more in revenue which could then be used to pay for food subsidies (how ironic that this government apparently views gasoline as a more basic necessity than even milk and is completely unwilling to raise its price!!!!).

Or they could quit giving away cheap dollars for affluent people to take vacations abroad and buy luxury goods. With the savings they could make sure the poor had enough to eat.

Or lastly, they could put the tolls back on the roads and raise them to a reasonable level so that they would actually pay for road maintanence and maybe even mass transit construction. That in turn would free up money from the central government's budget that could be used for this subsidy.

So in point of fact the government COULD take actions that would help alleviate shortages, increase production AND ensure that the poor got the basic necessities that they need.

But to do that the Chavez government has to quit carrying out policies that direct so much of the current economic boom towards the upper classes. Unfortunatley this just announced new policy shows little change in that regard.

It is hard to tell if this is done through design or ignorance of basic economics. But either way, they are screwing up the economy and screwing their political base at the same time. So all this is not only bad economics, it is bad politics too.


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