A price commission is needed from the government
Finance Minister Asad Umar recently indicated that inflation and fiscal deficit were among the main economic issues being faced by the country. In two of my previous articles here, I had presented arguments in favour of establishing a price commission by the government. This is important, primarily since markets– real and financial–- especially in a developing country context of weak institutional arrangements, presence of cartels, and information asymmetry, among other reasons, require active government involvement for reaching correct price signals.
Both inflation and the two components of fiscal deficit– revenue and expenditure– are influenced directly by the extent to which markets establish prices correctly, and in enhancing the effectiveness of the monetary and fiscal policies. Inflation reflects a rise in the general price level of a basket of goods and services that are both essential to everyday life, and which also feed into the prices of other elements of life. They need price rationalization.
The price of labour– the wage bill– which makes a significant proportion of all production activity in the country, and in that sense affects economic growth rate, employment level, expenditure of the government (one element of the fiscal deficit), and the level of economic activity, in turn generating government revenues (the other element of the fiscal deficit), along with being a significant determinant of how inflation will pan out depending on the growth of wages, requires that both the initial determination of this price of labour, and the price of other goods and services that this wage should be able to pay for the individual to lead a decent life, needs to be reached correctly.
To illustrate somewhat through a recent matter, whereby the members of the Punjab Assembly set out to pass a bill to raise their wage by a lot more (in some instances even by 400 percent), than inflation, which is only eight percent, came under a lot of public discussion. Of course this does not make sense, and any wage raise needs proper justification, yet an argument also holds worth that is an increase of eight percent in wages makes sense when the initial calculation of wages, or the price of labour, is far less than the price needed to earn a decent life for a worker and his dependent family. In that sense, the entire labour market needs to go through this initial correction of the price of labour. At the same time, the price of goods and services that any given wage should be able to buy to lead to a minimum level of decent life, requires also that the prices of goods and services in the economy need to be rationalized on the principle of true market signals of demand and supply, and a socially optimal profit margins.
In that sense, the microeconomic foundations of macroeconomic objectives need correction, and the foremost is the correct pricing of labour in relation with what it should be able to purchase– from a minimum decent life to higher levels of living, given a respective productivity of labour deserves–- and the price of goods and services in both the real and financial markets. This correction in prices would mean that inflation would follow a systematic trajectory at the back of justified levels of prices of labour and of the goods and services it can purchase, and would be more likely to remain stable and low, once market corrections take place though greater price rationalization controls introduced by the government.
On the other hand, government expenditure– the price for establishing public goods and services and for enabling private sector to produce goods and services and live a secure and decent life– will also be rationalized once the prices of all the underlying heads of expenditure, including the wage bill of the labour it employs, and the price of capital or interest rate that it pays on borrowed funds, all stand corrected through the application of price rationalization that the government undertakes through initially setting up a price commission, and in time through improved institutional frameworks of markets that minimize the current high levels of market imperfections; at the back of presence of cartels/collusive practices.
The two main economic challenges of inflation and fiscal deficit could be reined in through a price rationalization effort that the government needs to undertake
At the same time, the revenue side of the fiscal deficit will also benefit from this price rationalization effort. This is because taxes, or the price economic agents pay to the government for consuming public goods and services that it provides, and the taxes or price the agents pay for consuming the private goods and services for which government provides the enabling environment, will in turn be rational and not the ones (that is these taxes) determined on the prices of goods and services that are heavily inflated by the cartels to their benefit. Moreover, the level of tax evasion and tax burden will both reduce, once the magnitude of taxes will fall at the back of deflated prices of goods and service. This will also happen since, under price correction, people will have rationalized price of labour or wages that are commensurate with a level of prices of goods and services that they wish to purchase with these wages, and not the current state of affair where there is a huge mismatch- leaving in turn the right space, capacity, and a better justification of taxes for economic agents to pay willingly. This will also help bring in gains for tax collection at the back of correction in prices across the formal/informal economic divide, leaving in turn a diminishing incentive for economic agents to remain in the fold of informal economy.
Hence, it can be seen that the two main economic challenges of inflation and fiscal deficit could be reined in through a price rationalization effort that the government needs to undertake. Removing market imperfections and price distortions is indeed an important first step that the government needs to take to allow correct and effective implementation of monetary and fiscal policies. Price correction will also help bring in the much needed efficiency and equity gains that the economy needs.