The Harm of Artificially Restraining Monopoly Tariffs
Translated from Russian with the help of AI. Original: Russian version
Underestimating depreciation in monopoly tariffs leads to deteriorating networks and higher inflation down the road. Hiding the problem for the sake of apparent stability has produced today's shortages and unpopular price hikes.
To be, not to seem: that should be the motto in the fight against inflation. Showing stability by any means, even knowing that it is only window dressing that will make the problem still more acute in the future, has led to colossal imbalances. We are now reaping the fruits of this policy of past years. Worn-out networks, fuel shortages, a lack of electricity, shortages of food: all of these are consequences of an artificial fight against inflation, of holding prices down, freezing them, and controlling them by hand through every possible agency, of a perpetual war on intermediaries, and so on.
When the task is to keep inflation within a certain range and market mechanisms are no longer available, the authorities start inventing options such as freezing tariffs and fuel prices. Instead of showing reality now, they should be fighting future inflation with the right methods.
When depreciation accounts for a large share of the cost of a tariff, the temptation to cut the price by the amount of depreciation is always great. Yet depreciation is the classic source of investment for the reconstruction and major overhaul of networks and other infrastructure.
Take, for example, a pipeline network built for, say, KZT 100 billion with a service life of 20 years. In 20 years, it will need to be replaced. Every year, depreciation will account for KZT 5 billion of the cost base. That portion of the cost in the tariff arrives as free cash flow that the company does not need right now. It should accumulate this money and invest it in income-generating instruments to offset the time value of money. After 20 years, the company should hold these funds as savings and put them toward the replacement. This is the classic system of financial management in a company.
When such companies are under government influence, then to avoid raising tariffs, the growth in costs (for example, by the rate of inflation) is offset by cutting depreciation. In the short term, the tariff seemingly does not rise, but in fact a problem is building up, because in 20 years there will be no money to replace the pipes.
Tariffs cannot fail to rise when a country has inflation. The economy is structured so that, over the long term, all goods and services grow in price by roughly the same amount, because the production of goods and services depends on other goods and services. If some goods and services become more expensive, this affects all the others down the chain.
Therefore, the cost of producing monopoly services keeps rising while the tariff does not. As a result, after a few years tariffs have to be raised all at once, which in turn feeds through to inflation further and more strongly.
Only growth in labor productivity and an expansion of supply through production can reduce inflation. Everything else can have only temporary effects.
Far worse, however, are illogical pro-inflationary actions that push inflation up. These must also be fought, since they keep inflation from falling. Examples include a sharp rise in wages in unproductive public-sector organizations, which on the one hand increases consumption and on the other draws labor away from the market, pushing up wages across the whole market, and wages are a cost. Others are the handing out of pension savings, cheap consumer loans, and the construction of unproductive showcase projects such as EXPO.
Today the government essentially has to take extremely unpopular measures that can no longer be avoided, because the damage has already been done. Hence the increases in tariffs, in fuel prices, and in electricity prices are all the result of mistaken decisions made by previous governments.
And why did this happen? Because in the past the main thing was to appear stable rather than to be stable.
The rise in tariffs is inevitable, and inflation in this segment has to be caught up with. But we also need programs for the rational use of our resources. That is a separate program. It is only in post-Soviet countries that people wash their cars with drinking water.