Why+emergency+plan+is+no+way+to+limit+pain,+Roodt,+B+Day



=Why emergency plan is no way to limit nation’s pain=


 * Dawie Roodt, Business Day, Johannesburg, 31 January 2008**

Pointing fingers and calling for heads to roll are all valid and appropriate responses to the electricity fiasco. The obvious medium- to long-term solution is to invest in more power generation, to improve the efficiency of our electricity consumption, and to break the stranglehold of yet another monopoly. All this is obvious. However, the immediate problem is to allocate the existing scarce resource, electricity, as efficiently as possible. The authorities did put an emergency plan on the table; a plan that is fundamentally flawed. But before we get to the plan, and the superior alternative, SA faces a serious economic calamity.

The potential effect on the economy is impossible to determine but estimates vary from a best-case scenario of 0,5% lower growth to a full-blown recession.

Inflationary pressures will increase, interest rates will remain high and job creation will be affected. The question is how to manage the situation and how to soften this imminent hardship. Medium- and long-term strategies need to be drawn up, but it is the here and now that requires our immediate attention.

The suggested plan, the national electricity emergency programme, emphasises increased energy efficiency with the immediate priority to reduce demand 15%- 20%. This is obvious.

However, the way this is supposed to be achieved is highly impractical and will lead to an increase in all kinds of costs, corruption, and, most important, to a further misallocation of resources. The programme can be summarised as follows:

In evaluating the core of the proposed programme, it is clear that it is likely to add to our misery.
 * Evaluation of future projects;
 * Electricity price increases (but not too much);
 * Implement “emergency measures” to ensure power stations get enough and the correct quality coal;
 * Embark on a power-rationing programme (quotas: cut industrial usage 10%, commercial usage 15%, hotels, resorts, retail and conferences 20%, large offices, government, municipalities 15%, agriculture 5% and residences 10%, with a penalty and incentive system); and
 * Specific measures (such as the roll-out of compact fluorescent lights and restricting the manufacturing of incandescent light bulbs, the installation of subsidised solar heaters, changes to building standards and legislation, the conversion of traffic lights to solar power, etc).

It appears that future projects will now be evaluated to determine their likely effect on electricity demand.

Apparently, in the future, bureaucratic consent will “guide” investment decisions, creating the inevitable opportunities for corruption and investment decisions based on political considerations and not on the basis of financial and economic realities.

Electricity prices will be increased, but the authorities are quick to assure us that SA’s electricity prices will remain lower than most. This obviously assumes that the authorities know what the “correct” price of electricity should be — information that is simply not available. In the meantime, SA’s electricity prices are among the lowest in the world.

The comment regarding the provision of coal to the power stations is of particular concern. By threatening to “evoke emergency powers”, Public Enterprises Minister Alec Erwin concedes, by implication, that whoever is in control of buying coal at Eskom has done a lousy job.

More worrying, if Eskom does not get the required quality and quantity coal, producers will simply be forced to sell to Eskom. Economists call this nationalisation.

The proposed rationing system is particularly absurd. Different consumers are required to reduce their consumption by a certain percentage.

Who calculated these percentages and why should commercial users reduce their consumption 15% while industrial consumers only 10%? Shouldn’t it perhaps be 9% and 16%? Which central planner has all the relevant information to decide who should get how much? What system will be implemented to change these quotas? Will households get more in winter or gold mines less when the gold price declines?

The inevitable result will be that a scarce resource will be misallocated, which will lead to wastage.

The specific measures are equally silly. Bureaucrats decided that certain kinds of products will now be off limits (incandescent lights, for example), which means that legislation will have to be prepared and implemented to prohibit the manufacturing of these products.

Laws add to all sorts of costs and laws need to be policed, which requires manpower, which costs money. Can we expect an army of light-bulb inspectors or geyser police in future?

Furthermore, subsidies and the systems required to run them create a fertile ground for corruption and a further misallocation of resources. In any event, this “subsidy” will be for the account of the electricity user or the taxpayer.

In summary, the national electricity emergency programme is a plan that will require bureaucratic approval for investments, new rules and regulations that need to be policed, threats against those who do not comply and, most important, supply and demand forces will be replaced by committees and task teams, which could ultimately result in the misallocation of a scarce resource. It sounds pretty much like a centrally controlled system.

Instead, market forces should be trusted. Nobody but the market has enough information to decide how resources should be allocated. We have to reduce consumption 15%-20% in the short term. That means electricity prices must be increased until demand falls by the required percentage.

Based on international studies on the elasticity of electricity demand, an increase of 1% in the price of electricity will lead to a fall of more or less 0,2% in demand. A quick calculation suggests that an increase of about 75% in electricity prices should lead to a fall of approximately 15% in demand.

Such an increase will bring SA’s electricity prices to more or less on a par with the international average.

Be assured, the effect on the economy will be severe. The first-round effect on inflation, for example, will “add” approximately 2% to inflation.

Economic growth will be affected and, as usual, the poor will suffer the most. The advantage is that the implementation of electricity efficiency will be an automatic result of the market, additional legislation will not be required, red tape and electricity policing will be unnecessary and, most important, there will be no committees, task forces and political meddling.

Rest assured, the South African economy is heading for a serious bout of pain. This is simply inevitable.

Following the authorities’ emergency plan will result in inflation, low growth and job losses, and pain for the poor, but with the additional costs of a misallocation of a scarce resource and political interference.

Doing the obvious and letting the market determine the correct allocation is the clear solution.

I propose an immediate sharp increase of the price of electricity, with no preferences to any consumer.

This can be phased in over a period to get a better idea of the elasticity of SA’s electricity demand. Measures are already in place to help the poor with “free” electricity. However, should a special case be made for help, it must be budgeted for.

The effect can be softened by cutting taxes. Unfortunately, monetary policy is currently not an available instrument.

Finally, Eskom’s management has been given rewards on Eskom’s profits in the past. This must be stopped and competition must be introduced in the market to assure that Eskom does not fail SA again.

And, of course, heads must roll.


 * Roodt is chief economist at Efficient Group


 * From: http://www.businessday.co.za/articles/opinion.aspx?ID=BD4A695547**

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