01 February 2007

Inflation 101

We have an inflation problem. Being that most Bahrainis live on low wages (see Bahraini salaries), this is creating quite a stirr in Bahrain. Parliament of course jumped on the wagon and suggested really dumb solutions, so the government decided to establish a "committee" to find a way out.

So far so good. Now someone please explain to me why the Ministry of Commerce & Industry is in charge of this committee? It doesn't take a genius to realize that this is an economic policy issue. That ministry does not even have an economic analysis section! As far as I know, it also has zero economists! Still, that didn't stop it from announcing conclusions and suggesting remedies. It announced that we should increase government subsidies and subsidizing new commodities (e.g. rice, sugar, and cooking oil)

OK. First of all, as an economist, I can pretty much say that our subsidization policy is illogical. We are giving blanket-subsidies to commodities like meat and chicken. Really what this means is that our government is spending most of subsidies financing consumption of the wealthy, the biggest consumers of those products. If we had any sense, we would be replacing those with targeted assistance directed only to the poor, rather than artificially lowering prices. Second, nowhere in this bright plan do I see the word competition.

I mean, come on!! A company like the Al-Arabiya Mawashi company is still the only importer of livestock.. and we're still rolling our eyes as to why the price of meat is increasing? Dude, it's a monopoly! By the way, do you know that Bahrain is one of the few countries in the civilized world with no competition law? Even Saudi has one. It's actually not that hard. All you need is a basic antitrust law and an agency to oversee competition in the market! The UN even issued a "model competition law" for retarded nations like ourselves who are too lazy to write their own laws.

We really have no other way, whether the entrenched big family business interests like it or not. As Dr. Jassem Hussein finally spoke out, the government's options are limited. We can't fix prices because that'll just kill any prospect of a real market economy and it'll just be too random anyway. Monetary policy options are out, since our currency is fixed against the $US and we're following US interest rate trends. In terms of fiscal policy, the best bet is to manipulate taxation but we don't have taxes in Bahrain so it's out. Increasing government purchases and transfer payment should also be a good fiscal tool, except, as my main man Jassem Hussein said, "our government just hates to spend." In 2005, it set aside BD 503 million for development projects, then spent only around 53% and ended up with a surplus.

And no, increasing wages will not help either. It will actually raise inflation even more. Besides, I wish I can tell parliamentarians who asked for "raising the minimum wage" is that WE DON'T HAVE A MINIMUM WAGE! There is a minimum salary in government civil service and they can raise that, but this will just widen the gap between public and private sector salaries-- something that labor market reforms are trying to fix. They can also INTRODUCE a minimum wage, but again they will have to battle the labor reforms that rest on the concept of market-based wages.

Now I hate to disturb anyone's sleep, but I think one important task for the Central Informatics Organization (CIO) is to revise the basket of goods used to determine the inflation rate and reach a more accurate measurement. Another important task is to sit and come up with a reliable "poverty line" measure (not the cut-and-paste one we have now). Using those two, some good government economists should decide upon the targeted inflation rate and implement targeted subsidies for families at or below the poverty line, while other economic-policy makers should be working on the competition law issue. Is that too much to ask?!

13 comments:

TariqKhonji said...

I once suggested targetted subsidies to an economist from some bank, Standard Chartered I think, only to be told that sometimes it can cost more to pick and choose rather than just apply the subsidies as a blanket.
Also, the subsidies cannot be lifted all at once because it would cause huge economic problems, they would have to be very, very gradual.
Plus, there would be illegal goings on that would allow the subsidised goods to get into the wrong hands anyway and this would cause a lot of other problems.
I tried to write a column about this, but shied away because it is apparently much more complicated than it appears.

TariqKhonji said...

Although, I must say that subsidies in any way are not something I generally support. Much better to give out loans to make people invest and work rather than give handouts.
Also, subsidising things like electricity and water encourages people waste.

LuLu said...

Well most, if not all, published economic studies so far indicate that targeted subsidies cost less-- but I would be interested to know that economist's rationale.
On the impact point, the idea is not to lift subsidies but to target them. The government now spends BD9 million on meat, chicken, and flour subsidies, but the impact is in the range of a few fils per unit. The world average of poor-families benefiting from blanket subsidies is 30% at best. If we target them we can at least ensure a more substantial impact. I personally don't think subsidies to the poor are a bad idea in general, especially since we have so many deficiencies in our economy to start with.

Anonymous said...

Dear Lulu,

Why you deleted your post about the crown prince and the dinosaur?

I thought you are a brave lady!

LuLu said...

Thanks anonymous.. believe it or not I deleted it by mistake (brave yet technically challenged!)
It's quite a pain to re-write but I guess I'll start trying!

error said...

WHATS YOUR INFLATION RATE?

LuLu said...

error our inflation rate is a joke.. the Central Informatics Organization (CIO) publishes an official rate of around 2-3%, but anyone who lives in Bahrain will tell you that has no relation what so ever with reality. I really think the CIO should revise its goods basket and methodology. Oh I forgot, the last calculation they published was for 2004 then they somehow just... stopped.

isagreatphilosopher said...

"When I ask two economists a question I get two different answers, unless one of them is Lord Keynes, in which case I get three" - Winston Churchill

As another self proclaimed economist, I wanted to bring a few matters to your attention.

Firstly, you criticize a wage rise as a solution to inflation, and rightly so, yet you seem to ignore the same inflationary pressure that would arise as a result of indirect subsidies.

If goods are overpriced due to lack of competition then sorting that would be the direct solution.

With regards to the difference between targeted subsidies and "blanket" subsidies, I do agree that, at least in theory, the latter are a better solution in Bahrain's case at least, simply due to the redistributive effect that is brought about, a better solution in terms of welfare and no way a solution for inflation that is.

It is true that such targeted subsidies may be hard to apply as result of the costs of screening people whom are entitled of such subsidies from those who are not, the latter of course would have the incentive to cheat the system and benefit. If there was any record of income, like there is in economies with tax/welfare systems, then this should not be much of an obstacle.

Having ruled out both fiscal and monetary, which is impossible given the structure of our economy, you offer no solution to inflation, your suggestions seem to only tackle the harms that come about as a result.
The only solution in theory is contractionary fiscal policy. This may seem odd, as fiscal policy has pretty much fallen out of favor as a tool of macro-policy over the past few decades. The lack of alternatives in Bahrain's case, unless we suddenly decide our willingness to manipulate the interest/exchange rate, renders fiscal policy necessary to tackle inflation, so long as it is not a result of monopolistic market structures.
Ofcourse this is not attractive. Any modern day econ textbook will tell you that there is a tradeoff between unemployment and output in the short run. Thus, a decrease of government spending, or an increase in taxation (!), will result in higher unemployment in that time period.
Modern day macroeconomics will also tell you that inflation should take priority over unemployment, simple because economies are always moving back to their "full employment/ natural rate of unemployment" level in the long run, whilst inflation presists in the long run, hence sustaining our monetary anchor, fighting inflation, should be given more weight in macro decisions than unemployment.
Our long term unempolyment level can be lowered through the use of policies that enhance the flexibility of our job market, mobility of labour and their skills.
In conclusion thus, if I ran our government budget, I would spend even less - rather than subsidize, and encourage job market reforms.

I sincerely believe that I am a better economist than a philosopher. I hope you would agree.

LuLu said...

Well I don't remember having a philosophical discussion with you so I can't compare, but you do making an outstanding economist, no doubt! I guess what struck me in your post is that you are asking the government, instead of merely treating the impact of inflation, to implement structural policy changes that will treat inflation "itself." I think you're probably for the first time over-estimating the intelligence of the people in charge. I know I'm not speaking as a self-proclaimed economist now but as a realist who had just spoke with a number of people (I snoop) and really found out that the Ministry in charge of inflation, exactly as I thought, had not even one economist on sight. I won't be ambitious and say at least put the EDB in charge because I don't even know if they have anyone (I won't be shocked if they didnt)... Now I'm thinking maybe we're actually doing well, for an economy that is just left to manage its own self with no adult supervision.

isagreatphilosopher said...

Lulu, I am merely providing what I think is the answer closest to being right.
What the government will or won't do is another matter. Funny enough, if you have done any game theory, you realize one of the central assumption of rationality of agents. Without it, economists have very little to work with.
To be honest with you, not many countries in the world manage the role of fiscal policy well.
I think if we manage to structure our economy around a discretionary fiscal policy as the main tool for economic policy, ran through a board of economists(!), then we will be setting world wide precedent.
Can we find ten Bahrainis with PhD's in economics welling to sacrifice their intellectual journey or triple figure salaries in western countries in return with working for/with a bunch of morons?

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