Petrol Price and the Soulful Science

Wrote this comment on Nat's blog. Thought that it might be relevant to the previous post, so I am reproducing it here:

But Nat, economics IS humane. As humane as any discipline could get. Some argue it is a soulful science. One even wrote a book with that title. What it could do is to have better public intellectuals to do some good PR job for some of the explanations and reasonings.

In the context of your post, I think a true economist (ie, not the talking heads on Bloomberg, or your local financial analysts) would be deeply misguided if 'efficiency' is regarded as an ultimate goal. In all reasonable considerations, efficiency is at most a proximate goal, with the ultimate goal being the wellbeing everyone. No one should really argue for efficiency just for efficiency sake. For eg, if you truly embrace and understand the purpose of central banks, the ultimate goal of all central bankers is to maintain and improve a sustainable level of living standard - inflation stability and economic growth are proximate objectives.

So when a clear headed economist argue that the fuel price increase is good, it is not because she is making a case of efficiency is more important than the rakyat. On the contrary, it is because the fuel increase is good for the rakyat ultimately. The problem is that the reason why this is good is so against intuition and conventional wisdom, that most economists making a non-apologetic case for it sound like bitches.

And now moving on to be even more specific, I disagree with phased increase in fuel price. If we agree that removal of fuel subsidy is inevitable, and that the main problem with removal of subsidy is hardship for the people due to inflation, then phased increase in price will ultimately hurt the people more, not less. And no, it is not hoarding and the sorts, but through the main determinant of inflation - inflation expectation. A one time increase limits the expectation of future inflation, but a staggered increase embeds the expectation. A phased increase in fuel price will most probably lead to much higher overall inflation than a one time increase. And when that happens, the hardship of the rakyat will be greater, not less. One can take a corollary of this argument in central banks raising interest rates, either one time or in a staggered manner. If the central bank is worried about inflation expectation (as compared to being worried about a financial market meltdown), you would expect it to raise rates over a period of time, multiple times in a staggered manner. This embeds expectation. In the reverse, if you do not want to embed expectation as in the case of raising fuel price, you should want to do it in one go. I am doing a bad job in explaning this, but Paul Krugman wrote briefly on this matter not so long ago - google "Krugman + embedded inflation".

This doesn't mean we should ignore those who are badly hit by this one time increase. It is just that there would be more badly hit people if it is phased. One way to alleviate the hardship of the poor is to have direct transfer to them, and the road-tax rebate does this. It is imperfect yes; no tool is perfect, but it is important that it reaches the intended target most of the time (for eg, a blanket fuel subsidy for everyone is NOT a good tool to help the poor). Yes, you can argue that it is unfair that some Beemer and Merc owners get the rebate too, but how many of these cases are there anyway, compared to the rest of the population? 5% to 95%?

But of course, more could be done. Income-based, mean tested transfer perhaps. If the Government is wise, this should be in the planning process for the next Budget.

Man, I post the longest comments on your blog, haha.

Noticed the alliterating title?

Teehee.