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FINANCIAL CHRONICLE™ » FINANCIAL CHRONICLE™ » Higher electricity prices: deflating a bloated economy

Higher electricity prices: deflating a bloated economy

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sriranga

sriranga
Co-Admin
by R.M.B Senanayake

A local TV station reports that according to a survey it conducted some 90% of the electricity consumers have said that it is unfair to raise the price of electricity. They don’t say why they say so. The Sinhalese press reflects the same lack of economic literacy. Nobody likes price increases even if it is to recover the true cost of producing the good or service. But how can anybody say it is unfair to recover the cost of producing something? Private firms cannot sell at a price below their cost and will have to wind up rather than continue to function. The public accepts this.

But the public wants a government or a government institution to sell its products or services below their cost because they know they can still carry on if the Treasury will fund the loss. But the Treasury has to collect the money from the public through higher taxation or inflation. If it is a general tax on all commodities like VAT it will tax those who consume electricity as well as the 10% that doesn’t have electricity at all. But it would be unfair to do so. Only those who consume electricity should be called upon to pay for it.

Why subsidize electricity?

Would people be better off if the electricity is subsidized through taxes or inflation? That will depend on the impact of inflation or the incidence of the tax on each person. The taxes are indirect and are payable by all people. So how much will the taxes have to increase per person or household if the electricity is subsidized? The subsidy will have to be divided by the number of household consumers which will have to be weighted by the number of units consumed by each household. In short the tax will be similar to the increase in price contemplated. What if the tax is a general one on all commodities like VAT. It would be unfair for why should those who use less electricity or no electricity at all, be called upon to pay more taxes to fund the electricity consumers, some of whom are affluent and consume more units of electricity than others.

Our people believe in a free lunch and don’t want to pay for anything if the supplier is the government. They therefore don’t like the government to recover the cost of producing any good or service. Politicians like to exercise arbitrary power and enjoy the power to dispense benefits to win the favor of the people. So they propagated the idea of a free lunch. But they fail to realize that they thereby create a ‘false economy’ .

Generally ‘false economy’ is an action that saves money at the beginning but which, over a longer period of time, results in more money being spent or wasted than being saved. There used to be a saying that if you want to make a man poor you should give him a second hand car. Economist Alan Beattie, wrote a book titled "False Economy,". It is a wider concept where through artificial controls, subsidized prices and excessive monetary expansion, a whole false economy is built up which does not reflect economic reality. Our $60 billion dollar economy is just such a false economy bloated by inflation and converted to dollars at an overvalued exchange rate.

Allocation of resources is better through market prices reflecting costs

Economists point out that the allocation of resources according to market prices is fairer and more efficient than any other method of allocation such as allocation by a government bureaucracy. The Communists did away with the market price system and fixed prices purportedly according to the decisions of the Central Planning Commission. But they could not do so efficiently and created a false economy where more guns were produced while bread was rationed to long queues of consumers. They could not equate supply and demand and created shortages on the one hand and unwanted surpluses on the other.

But Socialists still say the allocation of goods and resources through the market price system is unfair because the richer folk have greater market power. But in the case of a widely consumed product, it is the decision of the majority of consumers that has the most impact. Aren’t the prices determined by the majority fairer than what is fixed by some bureaucrat?

Market forces and market prices provide a simpler and more effective method of running an economy. But years of Communist propaganda against the free market economy misled our political leaders. They still think government should fix prices and they ignore the fundamentals of simple economics in doing so. So they fix controlled prices, fix interest rates and exchange rates and provide subsidies to the consumers and producers to win political favor. Local economists justified them on the ‘market failure’ theory. They cited various deviations from hypothetical "perfectly competitive" conditions which may cause market-determined prices to be distorted and outputs to be "inefficient," and in this event they say the government must intervene with taxes, subsidies, and regulations to bring the market into an efficient configuration. But the Economist Robert Higgs points out that market failure theory assumes information about demand, cost, supply that cannot be known except as they are determined in actual markets. So without actual markets how can market failure be diagnosed let alone corrected? This theory also assumes implicitly that the interventionist actions of the government are themselves without costs.

Hidden costs of the electricity subsidy.

It has costs in the form of higher consumption of electricity – higher imports of household electrical appliances, higher imports of oil etc when we don’t earn sufficient foreign exchange to pay for them. Our external account is a huge deficit and has to be funded either by sale of our assets to foreigners (foreign investment in our real or financial assets) or by borrowing from foreigners. So by subsidizing we are providing a false standard of living for our electricity consumers through foreign borrowing. Are they the poor? Should we continue to do so? Should we supplement their real income to enable them to maintain a higher standard of living? Is that fair?

The problem of rationing

Allen Sanderson of the University of Chicago explains the subject of allocating scarce resources to his economics students by talking of the following problem. The first day of introductory economics, he says, there are always more students than seats. Say there are forty extra people and he can only accept ten more into the class. He asks the class: how should the 10 available slots be allocated? Some students say according to seniority because seniors won’t be able to take the class later; some say on the Quality Point Average (a measure of merit in USA) because better students will contribute more to the class and get more out of it; others say on the ‘first come first served’ rule by selecting the first ten people outside his office at 8 am the next day, since that shows the keenness of the students to follow the course. Some other students suggest selection through a lottery because it would be a random selection which is fair. One student says to auction the places to the highest bidder. If you auction the slots then they will go to those who are affluent and who can afford to pay the price. Some will say that it deprives the poor of entry. But economists would argue that if you auction the slots, they will go to the students to whom they are worth the most, Under any other method the slots can be re-sold to others willing to pay, giving windfall gains to those selected. Economists say the auctioning is efficient since those who value it most get the places.

In the case of electricity the supply constraint is the foreign exchange which limits what we can afford to import by way of oil or coal (though not hydro-power which normally supplies only 50% or less). Economists would say the scarce foreign exchange should be allocated on the basis of market prices of the imported goods with no distorting subsidies. Electricity Prices based on cost plus reflect the scarcity value of electricity while the market based exchange rate reflects the scarcity value of foreign exchange. Both are needed for an efficient allocation of resources. If we depart from them, we are creating a false economy.

Why borrow from foreigners to provide a higher income only for electricity consumers?

Since we don’t have enough foreign exchange to satisfy all our demands for imported goods, we borrow from foreigners to fund the difference. So is there a case for giving electricity cheaper and increasing the demand for it unduly and paying for it through foreign borrowing? If all prices reflect costs then it is the people who will decide whether to consume more electricity or more milk foods, chillies or potatoes. This is the core tradeoff of economics: fairness and efficiency.

If electricity is priced below the cost, more electricity will be consumed as people buy more electricity consuming household appliances like refrigerators, washing machines etc. This will increase the welfare of those electricity consumers who can afford to buy such electrical appliances by some amount. Shouldn’t they be willing to pay for that increase in welfare? Should they get a free benefit in welfare?

We are too obsessed with fairness rather than efficiency. By not allowing market clearing prices to function in the economy, we are sacrificing efficiency and creating false unsustainable living standards.
http://www.island.lk/index.php?page_cat=article-details&page=article-details&code_title=75343

http://sharemarket-srilanka.blogspot.co.uk/

RIO

RIO
Senior Manager - Equity Analytics
Senior Manager - Equity Analytics


Why should NOT the Electricity rates increased...??? it should...! cheers

Still, up to date most of the rural lads did not felt the burden of cost of living & the true picture of this Govt inefficiency...whom they voted to be the rulers of their own...!

I strongly believe that all subsidizing, including fertilizer should be suspended, then terminate all Samurdhi payments...[ PBJ will do this too...not too far...ha ha ha]

Then let the Govt borrow more & more to develop [they say so, but I'm not sure if it should called Development] few more Air Ports as they said, in Kandy & N'Eliya , then construct a set of stadiums & a games Village to accommodate 2016 Asian youth Games [already secured the event for SL], Built up the Colombo Marina city [ by filling the sea just south to Colombo south Harbor]..etc etc..

Then.... actually We can be come the Miracle of Asia with buildings & Iconic constructions, while the citizens would be just a photo print of Somalians... cheers cheers

Jaya shri Maharajaneni...! follow the instructions of PBJ & Cabba...!

Patchchasira


Equity Analytic
Equity Analytic
This I believe is a complex problem that needs to be solved in a practical realistic manner. Sri Lanka should limit the import of vehicles and reduce private vehicle usage on streets and provide better public transportation system to the people. The saving on the street can be converted to supply the required fuel to the CEB and other industries and the running of public transport of vehicles. The government should encourage net metering system and encourage people to go off grid where possible.The government should work out a scheme with the banks to allow people willing to fit their houses with solar panels a long drawn out payment scheme where by people will be less reliant on official sources of power which in turn result with saving that can be converted to lower electricity charges especially for domestic users.

samcader


Manager - Equity Analytics
Manager - Equity Analytics
Waste corruption and inefficiency in the CEB does require a closer look before revising Electricity Tariffs

Slstock

Slstock
Director - Equity Analytics
Director - Equity Analytics
We discussed this before in lengh and some resoltions.

I think a hike is needed to resolve internal debt issues but I do not agree with the unfair rate scheme.


Just look at the jump from 90- to 91 units and 180-181 units. Also it said it was open for public comments but are they not going to do any changes to the existing proposal to reduce anomalies?

Expert

Expert
Manager - Equity Analytics
Manager - Equity Analytics
I fully agree with you @Patchchasira.

@Patchchasira wrote:This I believe is a complex problem that needs to be solved in a practical realistic manner. Sri Lanka should limit the import of vehicles and reduce private vehicle usage on streets and provide better public transportation system to the people. The saving on the street can be converted to supply the required fuel to the CEB and other industries and the running of public transport of vehicles. The government should encourage net metering system and encourage people to go off grid where possible.The government should work out a scheme with the banks to allow people willing to fit their houses with solar panels a long drawn out payment scheme where by people will be less reliant on official sources of power which in turn result with saving that can be converted to lower electricity charges especially for domestic users.

My feeling is that the public transport should be regulated and improved instead of current trend of pushing it down.

Are we a nation going forward? Or rather backward?
Get into a private bus (even CTB these days has become not different to them) and see where the driver looking: Ahead? Never! They always look back. Either in their mirror or putting their head out and looking back to see whether there is a challenge to him from another bus; their famous way of taking passengers time is drinking water from a Mega bottle or washing their mouths or even their faces. So, always looking back, how can they move forward? The whole nation waste a whole lot of time inside these buses. I remember the time when there was only CTB. Yes, they had limitations and difficulties but, when we left home, we had an idea at what time we can arrive at our destination. Now, we do not know. It all depends on the driver and the conductor of the bus we get into. Their attitude is that we have no seating in our homes, no music at home, not time to rest in one place at home, etc.: so they do a favour to us by facilitating such things. These need to be fixed. Otherwise people will tend to use their own vehicles and get on the road to make sure that they get where they want to be on time.

If you look at railways, you will see that they have improved in some ways and increased the number of trains but with the newly imported Indial Powersets, they have effectively decreased the passenger capacity within a train. Now most trains run on time but again all of a sudden they cancel trains at their will. Yesterday I went to Colombo Fort Railway Station to go to Panadura. The time was around 12.45 p.m. When queried, the last train had departed at 12.10 pm. and the next is at 1.35 pm. I decided to wait as if I travelled by bus, it would take almost double the time that would be required by the train. Then almost at 1.35 pm. they announced that, that train is cancelled. What am I to do? Then again I had to go to their office, as no announcements are made as to when the next train would be, to find out that the next train would be at 2.10 pm but they themselves do not know whether it too would be cancelled!!! Fortunately it arrived, but a little late around 2.20 pm. Had I known of this cancellation on arrival at 12.45 pm and had I taken a bus, I could possibly have reached Panadura by the time I left Colombo Fort or a little after. Just an example of how these things operate.

On top of that I find the trains to be overcrowded these days as the fares are very low. Sometimes even by around 50% to buses. Either the capacity needs to be increased in trains or the fares need to be made similar in buses and trains.

Hope the authorities would take note of these at least by expensive foreigners' studies if they cannot hear us, and take remedial action.

What we are facing today is not just an electricity crisis but an energy crisis. We need innovation, as it was discussed in another thread under solar power to get out of this dependency on other countries for our energy requirements.

D.G.Dayaratne


Senior Vice President - Equity Analytics
Senior Vice President - Equity Analytics
I agree with Patchchasira

1 .Solar power generation at household level should be encouraged
Present cost is not affordable
2 Vehicle import has to be curtailed further
3 improvement of public transport system Not
Wimal Weerawansa's KEHLDALLA

4 Action should be taken to increase efficiency and minimize corruption of
public institutions which manage Electricity



Last edited by D.G.Dayaratne on Fri Mar 29, 2013 1:09 pm; edited 1 time in total (Reason for editing : correctionof Typing mistake)

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