Monday, January 16, 2012


Last week the Electricity Regulatory Authority (ERA) announced up to 69% hike in power tariffs.

ERA said the increases were necessary to attract new investment in the sector and to relieve government of the billions of shillings in subsidies it has been doling out to keep power tariffs affordable.

The subsidies were deemed necessary five years ago when we had to resort to costly diesel run generators to bridge the power deficit.

"If ever there was a case study for why subsidies should be frowned on this would be a text book example...

With one fell swoop starting today Monday, manufacturers are going to pay up to 69% more for their power while domestic consumers will pay 38% more.

The unbudgeted for increase in a time of lower than usual economic activity, will lead to two things an increase in commodity prices and a possible slowdown in production. It does not take any advanced powers of prophecy to tell that this increase will be disruptive.

Price should be left to find their own level dictated by the forces of supply and demand, that way prices will move gradually up and down. Attempts to fix prices only create artificial comfort which when lifted can cause price spikes that shake out many economic players.

For instance the 69% increment if it were spread over five years would entail an annual 11% increase that would allow the economy to adjust with time.

There is the experiment where a beaker of water is heated to boiling point and when a frog is thrown in it jumps out immediately however if you put the frog in a beaker of cold water and heat it gradually the frog gets boiled to death because it adjusts to the gradual temperature increase until it’s too late.

"Subsidies are oftentimes motivated by bad politics rather than good economics. The seduction of subsidies for a government is that in the short term they appease certain constituencies in the long term however the costs far outweigh the benefits, by reducing the attractiveness of a particular sector for investors, promoting inefficiency among existing players and therefore sub-par service to consumers...

For instance power use in Uganda is slanted heavily towards personal consumption, used for powering TVs, cooking and ironing rather than industry or the productive sectors of the economy. We use power extravagantly at home because its affordable. And we continue to perpetuate this with the latest tariff hikes by penalizing the producer more than personal consumer.

One positive that is likely to come from this removal of tariffs is that new investment into generation may ensue. Our artificially low tariffs were a disincentive to investment especially in the mini-hydro dams and other alternative energies like solar power.

Hopefully we might see a boom in investment the way we have seen one in the real estate sector.

"Government resisted calls to cap rents in Kampala arguing that supply will rise to meet demand and prices will level off. There still remains a 50,000 housing deficit in Kampala but one can say it would have been worse if government had gone the spineless route of rent controlling....

It’s part of the human condition to desire certainity over uncertainity and hence calls by KACITA last week for government to prevail on banks to lower lending rates.

The raising of lending rates by banks is not to make astronomical profits, but it is in response to the prevailing circumstances.

Inflation hit a 19-year high of 30% at the end of last year. The only commodity banks deal in is money so what makes the traders – many of whom have already raised prices in their shops, think that the cost of money has not risen as well?

The knee jerk reaction is to control lending rates. Controlling lending rates would reduce the incentive for banks to lend, expand or innovate and we would have poorer banking services for it. And when we inevitably have to lift controls – as has happened with the power tariffs, we will be unprepared for the spike in lending rates. And who would be hardest hit? The businessmen.

We are all hurting from the current financial crisis, the immediate pressing need while unbearable now can be made worse in the future if we panic and take short term remedial action that will have long term detrimental damage on the economy.

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