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Tyranny of numbers

Goodbye to energy subsidies, hello to price controls?

Posted in General by Djavad on December 19, 2010

Tehran, December 19, 2010.

On what he called “the historic economic night,” President Ahmadinejad appeared on Iranian television to announce the imminent launch of the subsidy reform law, starting with energy prices at midnight (see beloow for new prices). He produced an impressive array of facts and figures from memory hoping to calm fears about the adverse impact of the reform, and showing his government’s command of the situation (“we have carefully thought of every eventuality”). So far he seems to have succeeded: day one of the implementation has gone by without panic buying or a serious incident.

Patience and gradualism seems to have paid off. The plan has been in public view for some time and the money that people call “the subsidy” (but is actually the cash back in lieu of the removal of subsidies!) has been in individual bank accounts for the last few months, though they could not withdraw it (as of this morning they were able to do so). It has also helped to calm nerves that the government extended the low price allocation (1000 rials per liter for 50 liters and good for about 500-1000 kilometers) for an additional month. For most people, this gesture has in effect delayed the start of the price increases by a month. The computerized allocation system using “gasoline cards”, which has been installed in gas stations across the country, is the key instrument that has made gradual and stepwise price increases possible. Reports this evening did not indicate unusually long lines at gas stations today, nor were there panic withdrawals of the “subsidy money” from banks.

Responses of producers to the energy price increases are more difficult to predict. At 7.30 this morning I noticed that the “agence” taxi waiting for me was actually the familiar green colored “line taxi” (cabs that run along a specific route and charge about 30 to 50 cents) rather than the private car I usually expect. The driver had obviously skipped his regular “line” service, where the fees are more tightly controlled, thinking he might have more luck with passengers in an unregulated service. He said other “line taxi” drivers had simply not shown up for work.

Such a supply response is to be expected. The government has been claiming, disingenuously, that there will be no inflation, and called on producers to refrain from raising prices. Going further, President Ahmadinejad even invited people to call in if they see unusual price increases. So, it seems natural for supply to contract, as it seems to have done in the line taxi service based on my single observation!

Some inflation is better than price controls that can disrupt supply of goods and services. Relative prices need to adjust in line with different energy intensity of different products, and to help resources flow to sectors that need to expand in response to higher energy prices, while other sectors contract. Since prices rarely go down, inflation is the only way for this to happen. Costs are increasing for producers across the board; they either have to cut back on supply or raise prices. Finally, the “subsidy money” now in the pockets of consumers is just the additional liquidity that will help producers find customers as they raise prices.

Let’s hope the government is not serious about its “zero inflation” target and will not hassle producers and retailers with harsh price controls. In my view, it would be enough of an achievement for the current plan to succeed and Iran get rid of its vast energy subsidies, even with some inflation. That would prove the critics wrong and become a model for other countries that are looking for a way to wean their citizens off cheap energy.

Footnote: Here are the main price changes: the price of gasoline has gone up from 1000 rials per liter to 4000 (7000 above 60 liters per month, which is close to the world price); diesel, up from 165 rials per liter to 1500 (3500 above quota); and CNG (compressed natural gas for vehicles) from 350 rials to 3000 per cubic meter.