Bail out No. 2

Hold your horses. It’s not what you think it is. This time it’s for the airlines. The CBN announced a 500bn naira bail-out package for the airline industry. The rationale of the CBN is a default by airlines will put more pressure on the banks and could put the banks under even more stress (I think).

Why are airlines failing? The bottom line is that current prices charged by airlines are too low to sustain the rising costs of operating an airline. Those 5000 naira flights to Lagos come to mind. In the short run this problem should be resolved by some airlines shutting down or at least scaling back activity. This should lead to an increase in the price of air travel and should put the airlines back in some decent shape. However if you throw in the fact that an airline that cannot break even can borrow from a bank then this would delay the process. Maybe even make it worse. The airlines that take loans to sustain their airline will force prices to remain at that low level  and force other airlines who previously were not willing to run at loss engage in this practice of using loans too. However this cannot go on forever. Sooner or later loans have to be repaid which brings us to where we are today.

A 500bn naira bailout has the same effect as loans. It keeps the prices in the airline industry artificially low by allowing airlines who should shut down or at least scale back activities remain in business. In a sense it only postpones the inevitable. Then again that might be one of the incentives behind the CBN’s actions. Just make sure it doesn’t go down during my tenure right?

Why should we care? Well economics tells us that if for some reason prices are artificially low, we could improve social welfare by allowing prices to “get back to equilibrium”. Some people will gain and some will lose but we will be better off as a whole. More worrying however is the CBN’s intervention in the real economy. History and theory tell us that it usually ends with no feasible impact on the economy and higher inflation. Something we should be very worried about.

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