Rising Costs of Living: Which Way to Go?

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By Klaus Schade

FOOD prices increased on average by 40 percent worldwide during last year and continue to rise. Crude oil prices almost doubled between May last year (US$67 per barrel) and last month exceeding US$130 per barrel. The price of US$150 per barrel is within reach during the second half this year. Interest rates rose by 3.5 percentage points over the past two years while an electricity price hike is due in July. The list goes on.

These price hikes have resulted in calls for government to intervene. This piece intends to make an informed contribution to debate about the various options suggested in the public debate and further alternative interventions.

Generalisations are unavoidable in order to make the point. However, before we discuss interventions we need to reach consensus on who is in need of assistance by government, hence this will have a bearing on possible measures. Although we are all affected as consumers, the degree differs widely as well as our own means to cope with the situation.

The gini-coefficient measured at 0.6 and hence one of the highest measured in the world clearly illustrates the huge disparities in income and wealth in Namibia. According to the Report on the National Household Income and Expenditure Survey (NHIES) the wealthiest 2 percent of households account for 15.3 percent of total consumption in the country while the poorest 25 percent account for a meagre 6.4 percent.

These figures lead to two conclusions: First, the groups in society who have the means to consume more, most likely benefit more from any interventions that affect consumer prices than those who live in poverty.

Second, the wealthier households are in a better position to adjust their expenditure patterns in order to cope with price increases than the poorer households that live at the bare minimum. Obviously, any interventions should be directed towards the most vulnerable members of society who are in need of assistance. Again, based on the NHIES the poor reside mainly in rural areas (42 percent of households are considered being poor or severely poor) compared to 7 percent in urban areas. However, usually the wealthier, urban groups in society have a stronger influence on governments and their policies than the often-voiceless poor in rural areas.

Government has expanded the social safety net that attempts to assist the neediest in society, namely the elderly, people living with disabilities, orphans and vulnerable children as well as foster parents. The provision of grants has contributed to poverty alleviation and a reduction in income inequality. Admittedly, there are other groups in society that do not yet benefit from the social safety net, for instance the unskilled unemployed who find it difficult to find jobs as well as low-paid workers in particular in the informal sector whose wages are hardly adjusted to inflationary pressure.

These are the people who are hardest hit by price increases and should therefore be the beneficiaries of government interventions.

Mainly two interventions are proposed in the public debate, namely tax relief (VAT exemption) and subsidies, in order to reduce prices.

In general, prices set by the market are an indication of relative or absolute scarcity that could be caused by actual or artificial (through speculation for example) supply constraints or of abundance of goods, services and factors of production (such as labour). Thus, prices direct the demand for goods and services by producers and consumers to the relatively less expensive goods and direct investment to the most lucrative sector. Subsequently, any interference in this market mechanism could distort the market and result in less efficient allocation of resources.

Keeping these admittedly simplified fundamentals in mind let us have a look at the merits of the suggested interventions – VAT exemption and subsidies:

With the exception of maize and mahangu (corn as well as flour) all other food items are subject to a 15 percent Value Added Tax (VAT), meaning that 15 percent is added to the final price. The final consumer has to bear the tax, while producers can reclaim VAT paid on inputs from the Receiver of Revenue. Adding a number of other food products to the list of VAT exempted goods implies that the price would drop by 15 percent – in theory.

However, in practice there are always leakages along the whole value adding chain, since suppliers could try to increase their profit margin, so that the final consumer benefits usually by less than 15 percent if at all. Moreover, government would need to decide which food products to exempt from VAT.

It would be possible to identify products that account for a larger proportion of food expenditure of the poor by analysing the National Household Income and Expenditure Survey data.

However, whatever products are selected, the beneficiaries of this tax relief are the people who account for most of the consumption and these are the people who can afford to buy these products. Hence, these are usually the better off. Undoubtedly, at least some of the vulnerable households will also benefit but to a far lesser extent depending on their consumption basket.

Furthermore, tax exemption is a once-off measure and does not protect consumers from further price increases.

Subsidies do not have a reputation for being an efficient intervention measure in terms of achieving the intended objective, in our case assisting vulnerable households in their efforts to cope with price increases. Subsidies result in market distortions and lead to less efficient allocation of resources. Again, it is doubtful that the consumer will benefit to the full extent from subsidies provided to producers and/or retailers. Moreover, artificially low prices through subsidies on some products in Namibia can well result in these products being sold on neighbouring markets because of a high profit margin. In addition, government would need to decide whether to provide a fixed amount as subsidy for a certain product – which would provide only for a once-off relief to the consumer – or to set a price limit and subsidise the difference between the set price and the actual market price. In the first instance, it remains doubtful to which extent consumers will benefit, while the second intervention bears substantial financial risks since future price trends are very difficult to predict. As with tax exemption the beneficiaries are not necessarily the neediest but the ones who consume most of these products.

Furthermore, any intervention affecting the price of a certain product does not only affect the nominal price but also the relative price of this product – namely the price in relation to other products. If some products benefit from tax exemption or subsidies the demand for these products could increase while the demand for products that fulfil the same purpose but are not VAT exempted or subsidised could decline resulting in upward price pressure for the subsidised products.

Finally, tax exemption and subsidies are usually not temporary measures but are here to stay because it would be very unpopular for any Finance Minister and Government to remove them. Since it is not expected that price levels will drop significantly in the short to medium term it would be difficult to find a justification for the removal of these interventions. Hence, while the impact of these interventions on consumer prices is at least uncertain and while the interventions would most likely benefit the better off to a larger extent than vulnerable households, and since these interventions bear considerable fiscal risks alternative, better targeted measures could be considered. They exist and some could be implemented without administrative burden in the short term, while others might bear fruits only in the medium term. The following list is certainly not exhaustive but provides some ideas of possible interventions:

– Increase social grants for the elderly, people living with disabilities, orphans and vulnerable children in order to enable them to maintain their standard of living;

– Increase the coverage of these grants in order to reach more of or even all of the intended beneficiaries – namely the vulnerable households;

– Strengthen the school feeding programme in poor communities in order to provide children of poor households with a proper meal;

– Increase the ceiling for contributions to the Social Security Commission further in order to generate additional revenue that could be used for instance to introduce some kind of unemployment benefits;

– Increase the tax threshold in order to avoid that households exceed the tax threshold because of inflation-adjusted salaries;

– Create incentives for informal businesses to join the formal sector in order to increase the social protection of employees working in these businesses;

– Expedite the implementation of labour-intensive capital projects in order to create jobs and income for the unemployed as well as to stimulate economic growth;

– Remove red tape that hinders the creation of decent jobs and income opportunities; and

– Enhance the income generating capacity of vulnerable households.

These interventions bear the advantage that they target the most vulnerable households and benefit households irrespective of their consumption pattern in the sense that they mitigate the impact of price increases also for those goods and services that are not mentioned in the debate of VAT exemption and or subsidies.

There is no quick fix to the situation and any intervention needs careful consideration in order not to jeopardise macro-economic stability, since most of these price increases are not of a short-term nature but indicative of a relative scarcity of goods. Whatever measures are taken, someone is going to pay for it, be it in form of higher or additional taxes and fees for government services or in form of reduced levels of public services. It is necessary to design strategies that are sustainable in the medium to long term and are supportive of the main objectives of our National Development Plans, namely poverty alleviation, reduction in income inequality, sustainable economic growth and job creation.

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