The Indian politician has never been the symbol of economic wisdom. I am truly privileged (/sarcasm) to live in a part of India where politicians never cease to be funny and do hilariously stupid things. The latest in the line of economic foolishness is this
No matter what economic theory says, politicians will play politics and this is just one more example.
First, prices of goods are determined by the forces of demand and supply. Demand and supply, in turn, are determined by the subjective preferences of all the individuals who constitute the market. No one’s whim can supplant the will of the market as a whole.
Second, every unit of every factor employed in the production of a good will be paid its Marginal Value Product. In simple terms, if an additional unit of a factor earns a firm Rs. 5000 per month, Rs. 5000 per month (or a suitably discounted amount to account for the time difference) is what will be paid to the factor. Employers do not whimsically decide what they wish to pay any factor, be it land or labour. In the long run, those who decide on whim will either be put out of business or be taught a lesson by the market.
Third, in the long run, there is no such thing as profit except for the entrepreneur’s act of wisdom in identifying underpricing of factors in the market. Even such profits are short-lived because they attract capital into that line of production leading to falling price spreads and the eventual elimination of profit. All that capitalists earn, in the long run, is the interest income for waiting to consume.
Finally, the real cause of steadily rising prices is government and the politicians themselves. It is government that is responsible for steadily increasing money supply sending prices of all goods and services perpetually upward except for occasional blips. If a politician really wants to address the burning issue of rising prices making essential commodities unaffordable to the poor, he needs to make difficult political decisions and bring government expenditure to the bare minimum, if not to zero. All subsidies and other forms of welfare have to be stopped. Government should, at the worst, limit itself to policing, national defence and judicial services (Frankly, there is no argument for government having a monopoly on these as well, but let me rest that argument for another day).
If idlis currently cost Rs. 3 apiece even at the road-side eateries, that means that no one can afford to sell them at a price below that and hope to stay in business for long. Government may think it is beyond the laws of scarcity, supply and demand but in reality, it is not. Someone will have to bear the cost of these cheap idlis and who better than the tax payer. As the government creates a deep hole in its pockets, what else will it do but dig deep into the pockets of ordinary, hard-working, honestly earning citizens. More taxes are on the way!
And taxes mean that we all pay the price in more ways than one. First, we consume less today than we would if we weren’t taxed. Second, we save and invest less. Therefore, production in the private sector suffers in the long-run. So through a relative shrinking of the production structure resulting in lower supply of goods and services and lowered employment of factors, we all suffer a lower standard of living.
If governments do not explicitly tax citizens to make up the additional deficit, they will have to implicitly tax them by inflating money supply. The consequence of this is the very price rise that politicians seek to contain by subsidising idlis.
The simple lesson that we have to learn and throw at our politicians is this – Prices are a market phenomenon that no politician can hope to control. Rather than engage in futile attempts to control prices, politicians should work towards shrinking government to the point where its existence does not impoverish ordinary people to enrich those in and connected to government.