whythawk ratings: measuring effective development

When planned economies fail

In the smouldering aftermath of the violence of the past few weeks, politicians and apologists are looking for excuses and reasons. The structure of the economy is being blamed and the debate about the way in which to promote economic growth is taking on new urgency.

The first option is to embark on a period of state-led intervention; where government-owned businesses create new industries or extend existing ones. The alternative is to promote private endeavour and encourage investment by businesses and corporations.

All businesses require an upfront investment in infrastructure and capacity prior to being able to deliver their products. This is true for both start-up concerns, as well as for the expansion of existing businesses.

A business looking to raise the capital to invest in productive capacity can do two things: they can go to their shareholders or creditors and ask them for more money, or they can raise the prices on their existing products to cover the cost.

Eskom would like to raise the price of electricity to cover their expansion. Normally, in a competitive environment, one company cannot raise prices significantly without handing a decisive competitive advantage to others. If Pick 'n Pay wants to build a major new shopping centre, they can't raise bread prices for fear that Shoprite, Checkers, Spar, Woolworths and a whole host of others will simply take their customers away.

In Eskom's case, the rise is unlikely because the government fears the impact it will have on the poor.

This is why most business expansion is usually covered through debt and shareholder investment. MTN, Cell C and Vodacom have invested vast amounts of cash in creating infrastructure to offer their services. They had to do this up-front and with no guarantees that we, the public, would buy sufficient services from them to pay back that investment. And, since these companies paid licence-fees to government and bought components from other companies prior to launching their products, the nation benefited from increased investment before we even had to buy anything.

The same is true for all private businesses. That some of them become supremely wealthy afterwards is unimportant. Private companies in a competitive environment will have to compete with each other on price and service to attract customers. If their product isn't available, they can't make money. If they need to invest in major new capacity, they have to cover it themselves in advance.

Not so with Eskom or any other state-owned enterprise. The shareholder here is the taxpayer. Government must pay money derived from the earnings of South Africans to cover the cost of the investment in state-owned firms.

If government increases company tax, businesses must raise their prices to cover the additional costs. If government increases employees tax, then pressure will be put on wage negotiations to increase employee pay, which businesses have to cover by increasing prices.

Either way, tax increases cause prices to rise and this effects the poor more than anyone else.

In order to finance state-owned businesses, government needs to raise money from taxpayers just as the economy takes a dive and puts pressure on salaries. There will be less tax, and capital-gains-derived revenues, to pay for all these new promises.

Even worse is that, as government nationalises industries, they undermine the entire economy. Already medical device and pharmaceutical manufacturers are cutting their investments and moving elsewhere as government threatens the private health sector. These retrenchments further reduce the tax base and make government investment even more difficult.

The argument that state-owned products can be priced below cost is spurious since any losses will have to be covered by taxpayers causing price rises in other industries.

In other words, there is no way that state-owned enterprises can protect the poor from high prices. Whether Eskom increases their prices, or the government leans more heavily on taxpayers to finance Eskom, the poor will take it in the neck.

Keywords : South Africa, planned economy, subsidy, energy, electricity, Eskom, power, pricing