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"I used to fill the cart with 50 euros, and now..."


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Diario de Navarra

Álvaro Bañón Irujo

Professor of Financial and Investment Management

"How do the measures implemented by governments work? In most cases, as fuel for inflation."

The phrase "I used to fill my shopping cart with fifty euros and now I don't even have enough for half of it" is the best way to express what inflation is. Rising prices. Or, in other words, the worst tax for the poorest classes because it is a consumption tax that applies equally to rich and poor.

Everything on Economics is explained by supply and demand, and inflation in particular. This episode of high inflation has its origin in a spectacular growth of demand (injections of money from central banks, savings saved during the confinement) and a reduction, also considerable, of supply (closures in Asia, bottlenecks in logistics, the war in Ukraine, the drought). result? The seller sees that he can ask for more and asks for it. And he gets paid. And the price goes up and he keeps getting paid.

And how do the measures implemented by governments work? In most cases, as fuel for inflation. If, for example, the government (at a huge cost) subsidizes each liter of gasoline to everyone with 0.2 euros, the only thing that is achieved is that this subsidy goes to the seller or producer.

Why? Because, what will someone who sells gasoline and sees that it is bought at 2.2 euros per liter do if he is subsidized by 0.2 euros per liter? Will he lower it to 2? No. He will keep it at 2.2 and will go to subsidy saying that the price without subsidy would be 2.4. Why? Because the demand supports it.

If the Government leave the VAT on foodstuffs (an excellent measure, but not anti-inflationary), the same thing will happen. If someone who sells oranges at 3.10 euros per kilo (with a VAT of 10%), sees that the VAT leave at 5%, he will continue to sell them at 3.10 euros per kilo as long as the demand endures, adding that 5% to his profit margin. As long as the demand endures, he will not lower the prices, whatever the VAT is.

These measures, besides being useless, are extremely expensive. But they sell well, make polite headlines and make it look like the authorities are taking action.

So, how can we really fight inflation? The question is to decrease demand and increase supply. On the demand side, demand needs to shrink, and that will only happen if we apply measures that are like old-fashioned medicines: unpleasant and with delayed effects.

The rise in interest rates is the most obvious one. When I hear at a dinner party the phrase: "Our mortgage payment has gone up and we will have to take fewer vacation days this year", I immediately think "unfortunately, that's exactly what it's all about".

Spaniards need to demand less leisure, less virgin olive oil (and switch to a cheaper one), less gasoline, less hotel nights. Only then will those who sell to them have to compete for their money. Only then will the price of hotels, apartments, or beer go down (or up less).

The question is, how is the price of olive oil going to go down in the supermarket if it already costs six euros? If the supermarket sees that it has to lower the price to compete because consumers are switching to sunflower oil or because they have less purchasing power, it will have to lower the price. And that drop will go at full speed to the origin of the chain, because the cost of extracting a liter of oil has not gone up 100% for the farmer, as the final price has. The price of a barrel of oil fell to 17 dollars during confinement. Was it cheaper to extract it? No. There was no demand for fuels and the cut went all the way to the source.

There is much less olive oil due to the drought and demand is still strong. If the seller at origin has less product, and sees that demand can withstand price increases, he will raise the price. Whatever his costs are. The price will not go down until he has to sell it in competition (not when his costs go down).

And what about the supply side? Much more skill is needed in all areas. The job of governments should be to remove barriers to entry in many markets. New entrants into a market worry those who are already in the market (and that is why they organize themselves into lobbies) because they will have to lower prices or improve their product or service. But that is the best thing that can happen to consumers. Whether it's new supermarkets, banks or passenger transport services. And whoever is expensive or inefficient will disappear. Not because any "higher power" says so, but because we consumers will decide to stop shopping there.

Therefore, and so that the price of rents, food or transportation does not skyrocket, what is really effective is that barriers to entry are removed and that an increase in supply is allowed and encouraged. More apartments for rent (for example), more skill and new people in the markets.