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.

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18 Responses

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  1. Rasool Aslan said, on January 23, 2011 at 3:12 pm

    Dr. Javad I please you to update your blog more commonly. So we can enjoy your comments about our interesting topics in economy related to Iran.

  2. وینچستر سیا said, on January 22, 2011 at 3:26 pm

    ها اکه فارسی بنویسی مشکل پیش میاد ، ملت بیان بخونن ؟؟

    ها؟؟

    • Rasool said, on January 23, 2011 at 3:03 pm

      there is plenty of Farsi website. you can choose and select between them.

  3. Dr. Hamed H. said, on January 2, 2011 at 11:19 pm

    Hi,
    Thanks for another wonderful and insightful article. One surely can not find this kind of analysis in agenda-ful main stream media. Wished it to have been more comprehensive and technical.
    About the “zero inflation” I must say Iranian government is just trying to stop a possible runaway inflation not based in economics but in “appearances” of events which I am sure you are aware of them since in Iran it is not the basics of truth that are important but the appearances which are. I think this is understandable for the government to apply moderate pressure so that certain powerful economic sectors do not abuse the situation to make undue profits. But my guess is that there is not going be zero inflation. Inflation is going to happen. Inevitable. Infact government officials admit to the fact indirectly terming it rationalization of prices. Here is a link: http://www.econews.ir/fa/NewsContent-id_145522.aspx
    So while inflation is already on, officially the inflation is disregarded terming it as rationalization of prices. In fact in their theoretical construct the conventional inflation is only going to take over from the rationalization of prices after market forces come to equilibrium once the reform plan is complete, till then any inflation is going to be termed rationalization. I don’t know if economically it is possible to calculate the real inflation taking out the effect of reforms. But it would be cool, to know that. But I think the situation might be more complex since such a large scale reforms are few in history. All these appearances put up by the government are very important, specially by looking at what happened in Bolivia this week. Though such a thing as Bolivia would not have happened in Iran since Ahmadinejad has a very powerful base and is handling the situation with kid’s gloves, but still economic adjustments always have political consequences whether in Bolivia or Greece.
    As for foreign labors which was mentioned here on the discussion, I beg to differ that they are not entitled unfortunately. Since the rebate (not really a correct word) is actually the money which is coming from the whole sale of Iranian natural resources such as oil, only Iranian citizens would qualify for it. There are some 1.2 million legal refugees in Iran as well some 2 million undocumented refugees as per UN estimates. Most are Afghans living in Iran. The problem is that such a large population would be a significant burden on Iranian finances if they are included in rebate program. Besides it would only encourage more refugees to come to Iran from all over Afghanistan and even other not well off countries. Total Iranian oil and gas reserves are estimated to be worth some 14 trillion dollars for a 75 million Iranian population. Now lets just take the case of only Afghans which are some 25 million. Afghanistan has an estimated 3.5 trillion dollars worth of metal minerals with an additional estimated 1.5 trillion dollars of non-metal reserves. That is 5 trillion dollars which in per capita terms make Afghans richer than Iranians. I am not sure when in future near or far when Afghans start extraction of their resources they would be willing to share it with Iranian citizens. These rebates are not “Manna” which are free and bountiful. We have to be realistic over finances and economics. But ofcourse there are other ways to provide humanitarian aid to Afghans and other refugees which is beyond the point I am trying to make here.
    But I have a more serious question here. I had a hope that the reform of economy is going to be about changing the way wealth is generated in Iran from the current “sell oil, distribute and import” economy to a knowledge based one where local science and technology would generate the bulk of the wealth with natural resources supplementing that. I might be wrong but it seems Ahmadinejad has killed energy subsidies and allocated subsidies in housing sector currently building some 1.8 million housing units. Do you see this technically as a new form of subsidy? And would not distort the housing sector? Do you think this is more important than spending on science and technoloy? I might be wrong but this came to mind.
    At the end I must encourage you to document this important event, I think this has both economical and historical significance. It is much like when Soviet Union collapsed and the Russian economy switched from a subsidy to a market one. Anyways do not get discouraged by few “paranoids” for whom only appearances matter specially the ones mass broadcast to their minds. People who have little understanding of how things work, trying to fish political aims out of every writing and event. People whose political insight do not go beyond personal attacks. The fact is they are the same people who were on the streets in 1953 “protesting” against economic reforms instituted by Mossadeq. We now know who organized and benefited from those “protests”. All the polls conducted show that Ahmadinejad won fair and square. Lies have the tendency to melt. http://payvand.com/blog/blog/2010/12/13/iranian-public-opinion-survey-by-international-peace-institute/
    These two lectures one in Iran and the other in Princeton are eye opening: http://www.youtube.com/watch?v=svZCXUzYXWs&feature=related

  4. رضا said, on December 24, 2010 at 10:54 am

    آقای دکتر، تا آنجا که من می دانم شما اقتصاددان طرفدار بازار آزاد هستید. درست می گوییم؟ معمولا اقتصاددانان طرفدار بازار ادعا می کنند که بازار های آزاد سنگ زیر بنای دموکراسی هستند. سئوال من این است که اگر طرح هدفمند سازی یارانه ها به اعتراض های مدنی، اعتصاب و یا حتی شورش های شهری منجر شود و حکومت برای سرکوب و مهار اعتراضات و اعتصاب ها و احتمالا شورش ها به خشونت هر چه بیشتر رو آورد، آیا شما طرف دمکراسی و آزادی را خواهید گرفت یا طرف بازار آزاد را. بعبارتی، اگر مردم به این طرح رای منفی دادند، آیا همچنان از این طرح دفاع خواهید کرد؟ این سئوال از آنجا به ذهن من خطور کرد که در وبلاگ یکی از همفکران شما خواندم که مردمی که به این طرح اعتراض کنند دچار توهم هستند (نقل به مضمون). منتظر پاسخ شما هستم. رضا

    • Djavad said, on December 30, 2010 at 11:32 pm

      Your comment makes a couple of assumptions that I feel I should correct before I can asnwer your question –how I would think of subsidy reform “if people reject it”.
      First, I do not think of myself as a supporter of free markets. Here is what I do believe. I believe that markets are important and even indispensible in a modern economy, but their efficiency depends on the rules that govern their operation. Markets from health and education to credit and labor require an institutional set up which is defined by laws and regulation agreed upon in any society.
      Second, I do believe that democracy without free exchange (under a sound institutional set up) is not possible. But this is a very complicated issue, and I therefore try hard not to form beliefs about cause and effect here.
      Now, to your question. My purpose in this weblog is not to promote this or that cause. I have a much more modest aim of throwing light on economic issues of importance for Iran. I do hope that Iranians will find a way to live with a market economy and to deal with the challenges they face peacefully. So far, on this particular issue of paying for the energy they use, this seems to be coming true. I know that some people are always hoping for resistance to government initiatives no matter the policy, which I find very sad.

      • Karl said, on December 31, 2010 at 9:33 am

        سلام

        گمان میکنم به نحوی از انحا از پتسخ به این پرسش طفره رفته اید. برای من نیز جالب است بدانم اگر مردم به هر دلیل موجه یا غیرموجهی اجرای این طرح را نپذیرفتند و راه های صلح آمیزی نیز پیدا نکردند تا با این موضوع کنار بیایند و ازاین رو سر به شورش گذاشتند، شما کدان طرف خواهید ایستاد؟ طرف مردم یا طرف دولت کودتا؟ با تشکر

  5. یاسر said, on December 22, 2010 at 2:43 pm

    I think, hard price control was necessary in first days and helped to keep the government credible and powerful in the eyes of public. This show, was the key factor in keeping the market and society calm in first days and gradually, they would relax prices.
    Well, I see a great success; something over expectations. And for the next year, Ahmadinejad has promised a “free price” for gasoline.

  6. Hossein said, on December 21, 2010 at 8:30 am

    Many thanks for the above post. What interests me most is that the Administration and the state controlled media too refuse to tell people the harsh truth that in lieu payments for the first stage of the reform plan will stop in a few months (between 4 to 6 months) and then people have to live with the new market status. New payments can be made only if Majlis gives another go ahead for slashing of subsidies which can hardly make people happy. The deluded wisdom among people is that payments will continue for years to come and Ahamdinejad only deceitfully confirmed it the other night.

    Also one area worth studying is impact of the plan on livelihood of foreign labor force. Only around 1.2 million Afghans work in housing sector and subsidies cut can seriously affect wages, hence end price of housing.

    • Djavad said, on December 30, 2010 at 11:17 pm

      The economy will adjust to the new prices and payments may be unnecessary. But, the government will be saving money/collecting new revenue, which could be allocated to this rebate program.

      You have a good point about foreing labor in Iran, who do not qualify for the rebate. In general, watching construction wages is very informative, as the inflationary effects will be first reflected there. I hope to hear from readers about daily construction wages in the coming weeks!

  7. Karl said, on December 20, 2010 at 9:14 pm

    In response to Mohammad, you wrote: “Chance indeed! I am usually here for breaks to visit family and for my research.”

    Really? Does it mean you are not there as a consaltant in the Ahmadinejad coup government?

  8. N. R. Arghami said, on December 20, 2010 at 1:52 am

    I expected more from this article. I could say as much just by having an old BSc in economics. I shall expect some predicttons, at least on the rate of inflation, in the follow up.

  9. جعفر خیرخواهان said, on December 20, 2010 at 12:18 am

    Here is a valuable opportunity to see politicians’ actions and market reactions from the eyes of a sagacious observer and patriot veteran.

  10. […] در ادامه داستان یارانه ها مقاله دکتر جواد صالحی را که گویا در ایران هستند را اینجا بخوانید. […]

  11. Mohammad said, on December 19, 2010 at 4:38 pm

    Interesting to learn that you are in Iran at this particularly attractive time regarding your research interests. Is it a chance or your decision? Does being in Iran at this time really help understand the dynamics of subsidy cuts better?

    • Djavad said, on December 19, 2010 at 11:43 pm

      Chance indeed! I am usually here for breaks to visit family and for my research (which, by the way, does not include subsidy reform!). It is always good to be here to get ideas for research. It also helps one understand the dynamics, as you said, and get a feel for how people deal with a shock of this kind.

  12. پرستو said, on December 19, 2010 at 3:49 pm

    “diesel, … (350 above 60 liters per month)”
    It should be 3500.


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