Wars aren’t won with peacetime economies

Source: The post is based on an article “Wars aren’t won with peacetime economies” published in Business Standard on 22nd October 2022. 

Syllabus: GS 3 – Economy 

Relevance: measures that can be taken by the US and Europe to improve their economic condition at the time of war. 

News: Russia-Ukraine war has caused concerns towards the economies around the world as it has led to the increase in energy prices along with others. 

Even though Europe and America have provided economic and military assistance to Ukraine they are facing effect of the war along with other countries.  

However, it is a mistake to think that the war can be won with a peacetime economy as no country has ever prevailed in a serious war by leaving markets alone.  

So, efforts such as imposing windfall tax are required from the US and European countries to better their economic conditions to support Ukraine. 

How does not imposing the windfall tax create impacts on the economy? 

War caused shortages, but it leads to windfall gains for some companies. Therefore, there is a need for the country to enforce windfall profit tax on the companies making windfall gains. 

The EU and the US have failed to come up with a windfall tax on the companies due to the concerns of appearing antibusiness. 

However, taxing windfall profits and using the proceeds to finance the necessary war spending and support for those hurt by high prices is not anti-business.  

But it is responsible wartime governance which is necessary to maintain popular support for the war. 

These temporary taxes neither hurt investments nor employment and there is nothing wrong to tax exceptional gains. 

Moreover, the prices of electricity and food are also increasing which has affected the consumers and raised concerns for the government. 

How marginal-cost pricing is impacting Europe? 

Europe needs more comprehensive effort as its market structure was not designed to deal with wartime conditions. It follows the principle of marginal-cost pricing. 

The marginal cost pricing means the extra price required for the production to meet the demand.  

Therefore, with the increase in gas prices, the marginal costs have risen above average costs and this acts as a burden on the consumers of electricity in Europe.  

Moreover, economists love marginal-cost pricing because it attracts incentives and its distributive consequences on consumers is small and manageable.  

However, looking at the present condition of the increase in global prices there are low incentives available and distributive effects are huge on consumers. 

Therefore, there is another simpler system in the discussion that would retain most of the marginal-cost pricing’s incentive effects without the distributive effects.  

It is a non-linear pricing framework and this can be adopted by the European countries. 

What is a non-linear pricing framework? 

The non-linear pricing framework works on the principle where the total charges payable by customers are not proportional to the number of their consumed services. 

Therefore, it is better to fix a certain amount of prices for the consumer based on non-linear pricing framework and the rest amount should be based on marginal-cost price. 

Further, the non-linear pricing framework cannot be used in all the markets but it can be used in electricity and it is an important framework that can be followed by the government during the wartime. 

Therefore, countries in Europe and the West require more efforts like windfall profit taxes, controlling prices of food and electricity and encouraging necessary government interventions to generate more gains to support Ukraine.