The government is serious about bringing down the cost of essential items before the prices of essential items bring the government down. A war on prices has become as important as ending the other war. Recent measures to bring down the prices of petroleum products, electricity, wheat flour and bread, among others, were imperative in a situation where the cost of living was rising daily. Whether these reductions would make significant dents on the cost of living is to be seen. The reduction in taxes by a reduced VAT replacing a higher BTT would of course result in a marginal decrease in prices of many commodities. Lower electricity bills on domestic use would also bring down the cost of living.

These would indeed have some direct impact, but the expectation of the government is that the reduction in prices of many of these items would reduce other prices as well and that therefore the general level of prices would be brought down. The usual experience is that when prices of items like petroleum products go up, other prices rise on the grounds that the costs of transport is higher. The logic does necessarily work in a similar manner downwards. There is what economists call a "ratchet effect"; a tendency for prices to get stuck at the higher level.

This internationally observed phenomenon seems to be even more so here. The cost of living is an intractable one for many reasons.

What the government has attempted to do is to reduce the prices of several imported items or prices of goods dependent on import costs. The reduction in petrol and diesel prices is expected to reduce transport costs of passengers as well as produce. There is an expectation that besides the reduction in passenger transport fares that the reduced prices of fuel would bring down the costs of many basic items. This argument is based on two premises. One, that transport costs are significant components in other costs and two, that merchants would pass on the benefit of any reductions in their costs to the consumer. The latter factor is very much dependent on the extent of competition in the market. There are several other pertinent issues that this strategy to bring down prices poses. Many of the price reductions are of imported items or items heavily dependent on imports, such as electricity. What the trade deficit, the balance of payments and the dire straits of the state of the economy should dictate is a reduction in imports. One of the mechanisms by which this is achieved is through a rise in prices.

Earlier the government adopted a price fixing mechanism for petroleum products that was based on international prices. This had merits on two counts, local prices would be geared to movements in international prices and the rate of exchange and price changes would be gradual. The most important effect of such pricing is that domestic demand would be made to respond to international price changes. The current pricing policy has suddenly jettisoned this approach, in fact it is a U turn in pricing policy. The new pricing policy would have the effect of increasing imports of many items, especially crude oil imports. It will have an adverse impact on the trade balance and would exert pressures for further depreciation. This in turn would result in higher prices. To the extent that the price reductions would necessitate subsidies, the budget deficit would increase and once again assert pressures on prices. The price of politics is the politics of prices. A stable cost of living is not likely to be achieved when politics dictate prices.

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