Monday, March 17, 2008

War on Inflation and Energy Shortages: Substitution Strategy

As South Asians suffer greatly from the twin crises of hyper inflation and prolonged, daily power cuts, the life for them is getting more and more difficult every day. The traditional approaches to solve these problems such as increasing governmental subsidies for food and fuel and building more conventional fossil-fuel based generating capacity are not likely to work cost-effectively and sustain ably in the long run. It is time for South Asians to explore creative options to find workable, long-lasting solutions.

Economists often talk about the impact of supply and demand and consumer behavior on inflation. In fact, the consumer price index calculations in the US rely partly on consumers substituting cheaper alternatives for commodities experiencing higher inflation. For example, it is assumed that when the price of steak goes up, consumers start eating chicken instead. The often-criticized substitution process rationalizes this method to eliminate inflation from the US Bureau of Labor Statistics (BLS) basket of goods and services. Indeed, substitution is proof of inflation. When a product's price rises out of consumers' ability to afford purchasing it, its clearly evidence of inflation.

Unfortunately, this assumption of substitution is not always valid, particularly when a staple food or a common form of energy is involved. For example, the people in Pakistan rely on wheat flour for most of their caloric intake. It is possible but not easy to make a substitution, particularly in a very short time-frame unless it is forced upon them due to complete lack of availability or affordability. Similarly, people are used to getting electricity from the grid or using an existing diesel-based emergency generator.

With continuing and dramatic increases in world-wide food and fuel prices, it is clear that heavy subsidies will only bankrupt the emerging nations' governments and prove ineffective in the long run. Instead, it is incumbent upon all governments, including Pakistan and India, to promote substitutions such as potatoes, rice or other sources of starch for wheat. On the energy front, solar power (roof-installed, local and central generation) or wind power should substitute for fossil-fuel generated electricity grid. Recently, Kyocera has announced production of 1.6MW roof-installed solar panels for homes that can easily supply all the needs of a large home, particularly in mostly sunny South Asia. While expensive upfront, such a strategy would alleviate the widespread power shortages and prove more cost-effective in the long run. It will also help reduce environmental pollution and greenhouse gas emissions.

Substitution should be pursued as a strategy to give incentives to both the private sector and the consumers to produce and use alternatives for commodities experiencing the highest inflation rates. In general, each nation needs to diversify its sources of food and energy by encouraging more production and consumption of such alternatives. The governmental incentives can come in the form of tax credits, partial subsidies, and bringing foreign expertise and capital to help set up production of desirable alternatives. With growing populations and world demand, there will continue to be upward pressure on prices of basic commodities. The strategy of developing alternatives, therefore, needs to be a long term and a sustainable strategy.

The substitution strategy can set the stage for a larger effort to grow the economy and improve the living standards without damaging the environment. It can spur innovation and unleash the creativity of the people in South Asia to deal with the real problems of the day while creating opportunities, jobs and wealth and build a stronger society. It can begin to address the serious environmental issues of the day such as global warming that threatens all life on the planet. It can help South Asians avoid making the mistakes the West has made in its drive to industrialize. It can help Indians and Pakistanis do well and do good at the same time.

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