Blame for petrol price, VAT hike at government’s door?

Earlier this month, President Cyril Ramaphosa expressed concern on an eNCA newscast about the likely rise in the cost of food and other basic products following the recent increases in the price of fuel. During the newscast the president blamed a weak currency and rising oil prices for the hikes. President Ramaphosa requested retailers and food producers to, “hold back and not increase prices of foodstuffs and basic products people use.” The crux of the matter is that President Ramaphosa requested that businesses should absorb the additional supply-side costs associated with the recent increases.

Concerning pronouncements

It is extremely concerning though perhaps not surprising that President Ramaphosa, who is widely described as a successful businessman, regards such a request as reasonable.

One should view such pronouncements and appeals from prominent politicians with caution. Historically, political appeals for businesses to refrain from increasing prices have often been quickly followed by price controls and regulations prohibiting “price gouging”, “profiteering” and “damaging speculation” – all euphemisms for peaceful business activity the state does not approve of.

Failing governments very often try to hide their failures by blaming private sector scapegoats for the problems that stem from overregulation and misregulation. Once scapegoats are established, appeals not to raise prices quite easily shift to the implementation of coercive price controls. Zimbabwe, Venezuela, and many other countries have proved such policies to be absolutely disastrous.

Large South African retailers generally operate on thin profit margins. South African consumers currently do not have strong purchasing power. As a result, supply-side price increases would take a significant toll on business margins and household finances.

Among many concerning indicators, the BER’s survey of retailers stands out and strongly points to weak retail profitability. Furthermore, when one considers poor net fixed investment growth it stands to reason that productivity and therefore the strength of demand is in danger of declining. Declining productivity would mean further pressure on the retail sector.

BER surveys also point to low business confidence among retailers in the second quarter of 2018, at levels last seen in the early 2000s.

Just pass it on?

Against this backdrop, the assumption that retailers could simply absorb higher costs is clearly problematic. But it is also not clear that retailers simply have a choice to “pass on costs” to consumers.

Most businesses certainly would like to pass on costs, but this is just another way of saying businesses would like to charge more, or even as much as possible, for their products and services. This raises a question: if it is as simple as raising prices at will, why would these companies not have done so already?

In reality, the sensitivity of many consumers toward price increases, what economists explain in terms of elasticity, means many retailers won’t be able to successfully pass on fuel costs and VAT hikes to consumers in any case. They may initially try to increase prices, but, facing weak consumer demand, are at risk of suffering sharply declining sales volumes and earnings.

Companies must either try to raise prices or to protect margins by incurring fewer costs by for example cutting labour costs or reducing the quality of inputs.

Marginally profitable enterprises unable to pass on higher prices or to cut costs will be forced to close down, while more efficient firms survive. Lower profitability of firms means less saving and reinvestment and therefore less productivity growth. In the long run this raises the real cost of living for households and diminishes employment opportunities.

It’s not just the rand

As noted above President Ramaphosa blamed the higher price of petrol on the weaker currency and rising oil prices. While these factors do play a role, it is perhaps also too simplistic to blame only these elements. It creates an apparent impression that South Africa is merely a victim of external factors.

However, much of the present peril, can actually be attributed to a mismanagement of South African economic policy in general. A sluggish economy owes to mounting counterproductive government policies over which President Ramaphosa finally resides. In reality President Ramaphosa’s cabinet has not made South Africa any friendlier to business or moved it closer toward much needed structural reforms in the direction of freer markets.

Under President Ramaphosa’s guidance we’ve rather seen a continuation of the ANC’s anti-market interventionism. This includes the minimum wage bill deemed to become law, the NHI and medical schemes bills, and a still very problematic mining charter.

Not only that, but the Ramaphosa cabinet also presided over the devastating push for expropriation without compensation. To say the least, these clearly aren’t moves toward deregulation, positive reforms or freer markets.

One way of strengthening the rand is to attract foreign investment which requires foreigners on net to buy more rands (raise demand). Rands are then spent on local investment opportunities. These investments raise productivity levels which can strengthen the currency further in the long run.

However, to invest in fixed projects, say to start a new mine or a new factory, foreigners would have to weigh the risks and costs relative to other countries. In South Africa such investors face overregulated, militantly unionized and relatively expensive labour, racialized employment policies, dictates on ownership structures and difficult rules for doing business with government among other things - all things flowing from policies directly under the control of government.

Predictably, in facing an onslaught of expensive regulation and looming private property encroachments, organic private fixed investment remains weak and elusive, which is likely playing a part in the relative weakened demand for the rand on the currency exchanges.

Government’s dirty little “fuel secret”

Not mentioned by President Ramaphosa is that the petrol price is actually administered by government, which means the fuel market is not allowed to function in the true free market sense of the word.

Government determines the wholesale and retail margins and imposes a whole range of taxes on fuel. We don’t really have an idea what a market price for fuel would look like. However, we have to consider that continual increases of the fuel and road accident fund levies means these taxes now amount to R5,30 per litre of petrol, or around 37% of the retail price of petrol in July.

Fuel vendors are not permitted to compete with each other on price or offer customers special deals. Prices are ‘fixed’ and yet you won’t hear the Competition Commission complaining about this particular market manipulation.

The core of the matter

The South African government continues to spend much more than it taxes and where it spends, it spends very poorly. Even disregarding the opportunity costs associated with vast amounts of taxes levied from the private sector to prop up dysfunctional and irresponsible municipalities, imperilled state institutions and a bulging public sector wage bill, government maintains budget deficits, sinking the taxpayer into more and more debt.

It is government’s spending, including the proposed new spending on gratis, not “free”, higher education that actually demands more taxes, such as the increased VAT.

Perhaps then, it would be best for President Ramaphosa to evaluate the cumulative impact of counterproductive regulation, policies and taxes instead of now implicitly scapegoating the private sector with unworkable requests, which may serve to create an atmosphere for even more detrimental policies, such as price controls.