Removing Price Discrepancies

The Serbian Government has decided to gradually remove price disparities in public enterprises while preserving the price stability as a whole. Prices and wages in infrastructure should be kept within the general framework of the economic policy laid down by the Monetary Reconstruction Program. Since nothing was said as to how they would go about it, we shall try here to outline two possible scenarios. It goes without saying that it concerns not only the price of electricity as there was a recent corrective increase there, but also the prices of other public utilities. As it can hardly be assumed that price increases will be permitted to some, and denied to other public enterprises, it is necessary to consider this whole area of activity together.

The immediate cause of the disrupted price parity is the factual devaluation which brought about the increase of import prices and a general upward price movement. Here we shall not go deeper into the causes of the devaluation; it suffices to note that within the general price increase context, their ratios suffered a change because the prices of infrastructural goods and services rose slower than the prices of imported goods.

The whole problem needs to be viewed from the standpoint of foreign trade because the balance-of-payments constraints are the major hindrance to domestic production at the moment. From this standpoint, the infrastructure produces non-exchangeable goods and services whereas imported goods are exchangeable.

The first scenario derives from the hypothesis that the rising prices of infrastructural goods and services result in an increase of domestic prices compared to foreign prices.

In other words, if the overall supply does not grow and the quantities are adjusted to prices, a new balance presumes larger imports and lesser domestic production. However, the balance-of-payments constraints will not allow to increase the imports so that one cannot count on the quantitative adjustment.

Prices, rather than quantities, will thus undergo another change, which means that the prices of imported goods will rise causing thereby another factual devaluation. In other words, the initial increase of the domestic prices is untenable unless the overall supply changes, that is if imports are more-or less fixed.

According to the second scenario, price increases in the field of infrastructure do not lead to the overall price increase of domestic goods. This will be achieved through dual prices: the households will pay one price of electricity,

the industries another. In that case, the electricity price increase for households will not cause the growth of production costs and a general price increase as long as nominal wages are kept at the same level. The only change will occur in the consumption structure. In view of the relatively inflexible demand for infrastructural goods and services, their higher prices will lead to a lower demand for other consumer goods. In its turn, this should result in a decrease of their prices so that the overall price index of the domestic goods would not change.

According to these hypotheses the domestic prices would remain the same but the production would decline due to the lower consumer demand. Since this decline cannot be compensated by way of exports because these are domestic non-exchangeable goods and services accounting generally for the largest share of household consumption, the overall production drop is inevitable. At the same time, however, the relative rigidity of the domestic prices gives rise to another problem. If other prices do not drop due to the lower consumer demand and the changed personal consumption structure, the domestic price index cannot remain stable. Due to the price rigidity, the new infrastructure pricing policy ought to think about some form of control over

other prices.

If between July 24 and this day the prices generally rose by some 40% and if the prices of services approximate those of the domestic goods with an increase of about 30%, and if it is borne in mind that the share of imports in the aggregate supply is about 15 per cent, then the result is a 100 per cent increase of import prices. This tallies with the increase of the black market exchange rate from 1 dinar to 2 dinars for l German mark. In this regard, the black market rate of exchange is close to its balance level.

Any further change in the parity between the domestic and foreign prices, regardless of why it occurred, cannot but find its reflection in the black market rate of exchange.

The reason for the intimated change of the infrastructure prices should be sought in the need to provide the working capital for the current repairs of the relevant plants.The basic question is: is the formation of the working capital

through price increases the cheapest way of ensuring the normal functioning of the public utilities. Two alternative proposals are worth serious consideration. The first says that the necessary resources could be provided through the re-allocation of budgetary expenditures without a general tax increase. The second claims that this can be done on the capital market through the issue of shares. The price increase would be compensated through the issue of shares so that the real decline of the personal consumption would be a kind of enforced real savings by the population. The

citizenry could, of course, sell those shares in the stock-market at a freely-formed price there and then immediately try, if they so wish, to convert a part of such forced savings into current income.

(This is an abridged version of the text originally featured in the latest issue of the monthly Konjunkturni Barometer published by the Institute of Economics in Belgrade)