We are living in interesting times, things changing so fast. Change is the basic fact of life. Those who embrace it, win the battles of life. Those who avoid it, lose. Today, economic landscape is changing at ever increasing speed. It brings fear to those who want to maintain status quo, while to the developing countries it promises new opportunities.
Economic maturity of a nation suggests their ability to respond in such a scenario. How do we deal with the coming oil shock? How fuel prices affect economy? Does economic policy involve any choices? Is raising gasoline prices the only solution we have? Let's try to handle these questions.
Fuel is the basic input of an economy. Changing it alters the way economy behaves. Higher fuel prices signal the scarcity of this resource and depress growth, equity, and stability, which are the primary objectives of an economic policy and serve as benchmark for helping and guiding the decisions. Life will be much easier if we analyse the impact of emerging oil shock on each of these basic variables and then proceed.
Increasing fuel prices lowers the aggregate demand, affecting both consumption and investment. People consume less when incomes are fixed and things expensive. Investment - the most volatile component of national spending depends on price of inputs, profitability, demand, and future expectations. Higher costs, lower profitability, falling demand, and gloomy expectations, all ensure less investment. This starts contraction in the economy and also reduces aggregate supply, which inhibits long-term growth. Shrinking economy, in the wake of falling demand and supply, will lead to higher unemployment and will increase both poverty and inequality. Now, the economy operates at much lower than its productive potential, and wastes the valuable resources of labour and capital. This leads to real instability - output, income, and employment varying increasingly, and the downward spiral begins.
Can we avoid raising fuel prices? Yes, we can. Economics is the science of choice and helps us mange resources in the presence of scarcity and constraints. Economic policy always involves choices which affect different people differently. One of the major responsibilities of government and the democratic process is to present all the options before public and arrange a frank debate. Today, our economic pundits claim that they have no choice but to throw the fuel bomb on public. How could they make such a bold claim without even discussing the alternatives?
The government has three choices: to do nothing, to increase prices, or to use fiscal and monetary means along with keeping the existing prices. Under extreme political pressure it is currently pursuing the policy of do nothing and restraint. Usually in ideal conditions of efficient, sincere, and fair government this would not be a bad policy. In turbulent conditions government shields public and run deficits. This short-term real stability means greater long-term growth, with lower debt. However, in the face of corruption and bad governance this policy may not make any sense to many. The second alternative of raising the prices seems to be an easy and favourite choice for the government. But, we have discussed the disastrous effects of fuel-induced inflation on economy and the dismal future which follows. Such a choice should always be avoided by any means possible.
Now, we come to the third and final option. Our government regulates fuel prices and is in much better position of insulating the economy from such an external shock. It has both fiscal and monetary instruments to deal with this kind of threat. On the expenditure side, it can run public enterprises like PIA, Railways, and Pakistan Steel efficiently, saving money. It can divert funds from Benazir Income Support Programme to stabilise economy. This programme only helps a fraction of society, whereas short-term real stability would benefit the whole nation. By the way, if the government gives charity of Rs 1000 or so, and raise fuel prices 10 percent or more, the recipients will be worse off. The government can also check holes in the form of corruption and will find billions.
On the revenue side, it can place the long overdue progressive income tax on agriculture. It is really amazing how many reasons and justifications can be given to stay away from this. The landowners tax the tenants around 50 percent, and avoid paying anything. Any regressive indirect tax, like Sales or VAT, will decrease equity and would be counterproductive in the name of balancing budget. The government can also address hundreds of billions of tax evasion, and the sincerity of these efforts will elevate their image and also the demand of sovereign bonds for external financing. On the monetary front it can lower the interest rates and ease the money supply, helping the starving investment. Studies show that moderate inflation (up to 30 percent) is not closely related to growth. When price and income both rise, the economic choices remain the same. We always prefer real stability over price stability, leading to better long-run outcomes. But this ordinary inflation should not be confused with fuel-based inflation, which changes the real dynamics of an economy.
Finally, after weighing all the options it is advisable to follow the path of real stability, by keeping the existing fuel prices, and using macro and micro tools for fine tuning. Economic policy always involves choices and should keep the public interests first. Growth, with equity and stability, provide us a powerful tool to analyse and direct our decisions. Ending on an optimistic note: "Progress and problems are the twins, Born together, they always go together; the bigger the challenge, the heavier the odds, the greater the rewards" (Saeed Rashid).