Romania - Current economic position and prospects (Vol. 3 of 3) : Annex B : prices and price policy in Romania

Report No. 492a-RO ALE COPY (Current Economic Position and Prospects of Romania (In Three Volumes)- Volume IIl: Annex B-Prices and Price Policy in Romania October 11, 1974 Europe, Middle East and North Africa Region Not for Public Use Document of the International Bank for Reconstruction and Developmnent This report was prepared for official use only by the Bank Group. It may not be p.,blished, quoted or cited without Bank Group authorization. The Bank Group does not a;"cept responsibility for the accuracy or completeness of the report.  CURRENCY EQUIVALENTS 1. Official Rate lei 4.97 = US$1.00 lei 1 = US$0.20 2. Official Rate With Premium Up to 2 Oct.74: lei 14.38 = US$1.00 After 2 Oct.74 lei 1 = US$0.07 lei 12.00 = US$1.00 lei 1.00 = US$0.08 Conversion Coefficient for Foreign Trade Transactions lei 20 = US$1.00 lei 1 = US$0.05 Fiscal Year -- January 1 - December 31  ANNEX B: PRICES AND PRICE POLICIES Table of Contents Page No. I. INTRODUCTION ........................................................ 1 II. SOCIALIST ECONOMIC CONCEPTS ............................., 1 Value, "Use Value" and Price ............................ 1 Role of Prices in a Socialist Economy .... ............... 1 III. PRICING IN ROMANIA .. ........................... .......... 2 Historical Setting . ..... .... .. ..... ....... ........... . 2 Principal Categories of Prices ......... . ..... ......... .. 4 The Components of Producer Prices ..... .................. 5 Proposals for Producer Price Resetting ................. . 6 The Price Law of 1971 ..................... 7 Stage of Implementation of the 1971 Law ............... . 7 The Price Resetting . .. ................... ......... . 8 Price Administration and Control .................... . 8 Price Regulations in Industry ..9..................... 9 Procurement Prices in Agriculture ....................... 9 Tariffs for Services ........... .......... ................. 10 Tariffs for Electric Power . ...................... 10 Foreign Trade Prices ........................... ........... 11 IV. ANALYTICAL CONSIDERATIONS ............................... 12 Prices and Economic Planning .......................... 12 Prices, Profits, and Material Incentives ............... . 12 Economic Functions of Prices ................. ... 12 Efficiency of the Price System ....... ............ 13 Considerations for Project Appraisal .. ...... ............. 15   ROMANIA PRICES AND PRICE POLICY I. Introduction 1. An understanding of the nature and role of pricing in the Romanian economy is important to the Bank both for country economic analysis and for the economic appraisal of projects. The principal criteria for project ap- praisal currently in use in the Bank have been developed primarily in the context of market economies. The question is whether these techniques are applicable without modification in a planned economy. A case could be made that wholesale prices in the Romanian economy, to the extent that they re- present unit costs plus some average rate of profit, can be used in the Bank's economic appraisal techniques. II. Socialist Economic Concepts Value, "Use Value" and Price 2. In Marxist as in other economic thought, the price of a good is the monetary expression of its value. The value of a good in Marxist economics is seen to have two components, namely its "value" proper (its exchange value) and its "use value." The exchange value of a good is determined by the amount of labor time embodied in its efficient production i.e. in the "socially necessary labor" needed to produce it. Since capital is viewed as cumulated labor this concept equates to the total factor cost of a good. The "use value" of a good is its capacity to satisfy a given need. The "use value" is a function both of the quality of the good, including its technical charac- teristics, durability, etc., and of its social desirability. Since under the system of socialist planning practiced in Romania prices are set by the plan- ning authority, a price will deviate from the exchange value of a good by the central authority's perception of its use value. At the time of setting, therefore, prices reflect social costs and social priorities. Role of Prices in a Socialist Economy 3. Prices in Romania are established by the State according to specific regulations and procedures. The principal functions of prices in the economy are the following: (i) To reflect the social cost of resources and hence to recover the cost of production for the enterprise, including a surplus for re-investment; (ii) To provide economic incentives to enterprises (and collectives); and (iii) To redistribute a part of national income.  The first two functions are fulfilled through the regulation of wholesale prices, while the third is related to retail prices. 4. As there is no private ownership of the means of production, the volume of surplus derived from production in the socialist sector depends on the size and quality of the labor force (including all who work in any capa- city) and the rates of pay and other benefits for various activities. The flow of money demand for goods to be bought by households is determined by the total of money incomes less net private saving. (There is no rentier wealth. Saving is almost entirely saving to spend later; the flow of expendi- ture at any time is reduced by current saving, and swollen by dis-saving of money retained from incomes received in the past. The flow of net saving is the excess of total positive saving over dis-saving). 5. If we ignore direct taxes, which are small in comparison to total earnings derived by the state, the whole of the surplus funds required for government expenditure, including investment, are collected by means of profit allocations to the budget and mark-ups contained in the prices of commodities sold to the public. (There is a small and mildly progressive income tax, partly to deal with self-employment). It is essential to set the overall level of prices for the goods sold to households in relation to the level of money incomes, in such a way that the value of sales will yield the necessary surplus over costs of production. 6. Decisions as to how much and what kind of consumption goods to pro- duce are taken before setting prices. These decisions are based on the one hand, on the availability of primary products-food and raw materials-and specialized productive capacity, and on the other hand, on the needs and habits of the population which are to be provided for and the amounts to be exported. There may be a feedback from prices onto decisions about production for the future, but at any time the flow of output of goods of all kinds is already planned. III. Pricing in Romania Historical Setting 7. The present system of prices in Romania dates to 1950, but price resettings occurred in 1954-55 and in 1963. In 1950, with the issue of Decree 142 (1950), the old system of prices set by suppliers, on the basis of self- calculated prices, was abolished. Instead, the responsibility foirestablish- ing planned prices was placed with responsible bodies - The Council of Ministers, relevant Ministries, and People's Councils. The decree also es- tablished three basic principles of pricing, which have governed all subse- quent price regulations: (a) uniformity of prices of similar commodities, throughout the country;  (b) stability of prices, through permanent control; and (c) monitoring of relative prices, with respect to costs, quality of products, and general economic conditions. 8. First catalogues of unique producer (wholesale) and retail prices were published in 1952, to be applicable throughout the economy. During 1950-54, prices of means of production (wholesale prices of raw materials, intermediate, and capital goods) and of consumer goods included the turnover tax. In 1954-55, when prices were revised, the turnover tax was eliminated from wholesale prices, so that average wholesale prices were substantially reduced. Consequently, since 1954-55, two types of wholesale prices have prevailed in the economy: "producer prices" i,e. wholesale prices of enter- prises, (preturi cu ridicata ale intreprinderii) and "delivery prices" (pre- turi de livrare) i.e. prices of goods delivered to retailing or other produc- ing enterprises. As a rule, producer prices were without taxes while delivery prices of goods supplied by the industry to retail trade organizations included a turnover tax. 1/ This dichotomy in wholesale prices prevails even today. Also, under this revision, the prices of similar imported and domestically produced goods were set the same. 9. During 1955 to 1963, average post calculated production costs in several sectors and sub-sectors were significa-..tly reduced, in the wake of expansions in the scale of industry, technological progress, and increases in labor productivity. Consequently, some cost-price relationships became quite distorted, and profitability of different products showed large variations. To remedy the situation, the second revision of wholesale prices took place in 1963. Neither of the price revisions affected retail prices, which are regulated in strict concordance to wage rates, in order to maintain the standard of living of the population. 10. The basic treatment of the system of wholesale prices established in 1963, was not essentially different from the previous one, and reflected mainly a realignment of wholesale prices with production costs. Other features of the 1963 revision included an abolition (as a rule) of budget subsidies to producers; abolishment of compulsory quotas for most of the agricultural pro- ducts (though this began in 1956); and measures concerning the gradual improve- ment of wages. As a result of this revision, producer prices increased in mining, metallurgical industries, and forestry and were reduced for electric and thermal power, machine building, chemicals, pharmaceuticals, soap, cosmetics, tobacco, etc. 1/ In the case where a good is delivered to another producing enterprise there would be no turnover tax but the delivery price would differ trom the producer price by the amount of the transport costs.  11. In 1963, planned alterations were made in retail prices, but were compensated by wage increases to maintain, and continually increase the stand- ard of living. 1/ To a smaller extent, relative international prices (partic- ularly of substitutes, like fuels, natural and synthetic raw materials, etc.) were also considered in establishing domestic prices. This system of prices prevailed until the wholesale price resetting implemented under Law No. 19 of 1971. Principal Categories of Prices 12. The principal categories of prices prevalent in the Romanian economy are: 1. In Industry: a) Retail Price b) Delivery Price c) Producer Price 2. In Agriculture: Procurement Price (i) Contract Price (ii) Acquisition Price (iii) Producer Price 13. Retail prices (also known as "final" or "consumer prices") apply to finished commodities sold by trading units to the population. Means of pro- duction (raw materials, intermediate, and capital goods) are not sold at re- tail prices. Since 1963, retail prices have consisted of the delivery price, plus a markup to cover transport and distribution costs plus the retailer's profit. Although a change of retail prices is possible at some future date, following the successful implementation of the wholesale price reform, a sharp distinction is made in the role of the two categories of prices. While the reform of wholesale prices is motivated by considerations of efficiency in production, retail price policies are intimately connected with the distri- bution of output and are coordinated with wages and incomes policies. Of 1/ Retail prices of some industrial products (gas), and some foodstuffs (milk), beef, pork, alcoholic beverages, wine, eggs, etc.) increased. The latter, due to a rise in the state procurement prices of vegetable and animal products, aimed at stimulating agricultural production. At the same time, retail prices of some consumer durables (radios, tele- visions, sewing machines, vacuum cleaners, refrigerators, furniture, some synthetic threads, etc. and some foodstuffs (poultry, eggs, lard, rice, etc.) were reduced in order to stimulate sales and thereby pro- vide incentives for increased production.  - 5 - course, budgetary and financial policies are directly connected with the rela- tionship between wholesale and retail prices; but the practice has been to maintain retail prices constant in the short run, and to be reduced in the long run so far as possible, so as to improve the real standard of living of the population. Planned increases in retail prices, on the other hand, are possible, but are coordinated with wage supplements, unless the intent is to alter the pattern of consumption, away from luxury goods, for instance. The Components of Producer Prices 14. Producer prices consist of planned branch-average unit-cost of produc- tion (or, branch-average cost price), covering all direct and indirect outlays; plus a pre-defined profit (beneficiu, or benefit), which ensures a reasonable profitability for all branches, and for a majority of the enterprises in each branch, and for most products within each enterprise. The components of cost price, established under Law No. 19 (1971), are the following: (a) Raw Materials; (b) Fuel, Energy, and Water; (c) Wages and Wage Contributions (Social Security Contributions); (d) Depreciation of Fixed Assets; (e) Tax on Production Funds (Capital); (f) Land Tax; (g) Research and Development Expenses; (h) Interest, and Other Financial Expenses. 15. For the first time, under this law, explicit charges on total assets are included in cost price, in order to induce a more efficient utilization of resources by the enterprises. Profit is estimated as a norm for branches and sub-branches, and is calculated as a percentage of total assets (fixed assets plus working capital). Permitted profit margins are used to encourage or discourage production of particular goods. The relationship between the various price categories discussed above is illustrated in Figure 1, in relation to tax revenue.  Figure 1 Main Categories of Industrial Prices Retail Priie- Benefit Quota Retained Benefit Delivery Retailer's Cost Price Turnover Tax TAX REVENUE Producer - Price Benefit Quota Retained Benefit Cost Price Cost Price 16. Procurement prices prevail in the agricultural sector, which con- sists mainly of State Farms and Co-operatives, but also include Agricultural Associations and Private Farms. In dealing with the State Farms, the State acquires agricultural products at producer prices, much the same as in the industrial sector. The State and Co-operative trading units negotiate medium and long term supply contracts with cooperatives and Private Farms at contract prices. Due to various quality differentials and other advantages, the use of contract prices is expanding. Finally, cooperatives sell their output in excess of contracted quantities to the State and Cooperative trading organiza- tions at acquisition (or purchase) prices. Acquisition prices are generally lower than contract prices, but it is sometimes possible to specify in the initial contract a provision for obtaining contract prices for production above the contracted amount. Proposals for Producer Price Resetting 17. The 1963 price revision served to align relative wholesale prices, with actual costs reigning at that time. Since then, as a result of techno- logical change and changes in unit productivities, production costs have changed. Since producer prices remained fixed, large differentials resulted in the profit- ability rates of various industries. Consequently, in 1967 the Central Committee of the Romanian Communist Party (RCP) called for appropriate measures to elim- inate the existence of these distortions and both the National Conference of the RCP of December 1967 and the Tenth Congress of the RCP tackled the problems of the price system. After considerable study, the Committee for Prices sub- mitted its proposals for improving wholesale prices.  7- The Price Law of 1971 18. At the end of 1971 a new law on prices and tariffs was passed (Law No. 19/1971) which provided the legal and analytical framework for a new price policy. The central purpose of the law was to provide for a reconciliation between the need for centrally controlled prices and for greater flexibility in price resetting in order to minimize cost-price distortions. The law pro- vided for the introduction of new cost components in the producer price, notably in the form of a tax on fixed and working capital and land in production, and provisions were made to normalize the average rates of profit in each branch. The law also has specific provisions for increasing the scope for world price changes to have an impact on the domestic costs of Romanian production using imported materials. The role of benefits and profitability, therefore, is to increase under the new law. Stage of Implementation of the 1971 Law 19. While the law on prices was adopted in 1971 its implementation, both in respect of applying new principles of pricing and of the introduction of new competences in the administration of prices, had to be phased over time. The application of new principles of pricing and the introduction of new cost com- ponents necessarily implied the need for general resetting of prices which would take time to complete. Producer prices, last reset in 1963, would probably have been due for revision even in the absence of the new price law. However, a phased resetting of prices, in line with the principles of the law, began in January 1974 and will be completed by the end of 1975, i.e. before the adoption ot the tirst Annual Plan in the next five year plan period. 20. Consequently, as of this time the new cost components contained in the law have been applied to only a limited range of goods, namely those whose prices were subject to revision in the first round of the resetting which was made on January 1, 1974 (see para. 22 below). Full implementation of the principles in the law, as is to be expected, will thus be an evolutionary process over a number of years. 21. An interim step pending the price resetting was the establishment of 'accounting prices' (preturi de calcul) and a 'regularization tax' (taxa de regularizare). 'Accounting prices' are branch average costs of production plus 10 percent admissible profit margin, which may go up to 15 percent for some products. Their main purpose was to cut off exaggerated profit margins of many products whose prices were not covering costs of production, economic units having to surrender the difference between factory wholesale and 'accounting prices.' Moreover, owing to the fact that to measure profitability, profit was previously related to costs of production and not to total capital spent, so that new modern industries were showing high profitability in their products. Thus, 'accounting prices' had to narrow the gap on profit margins among enterprises and products, and to eliminate, as far as possible, the shortcomings of the price system prior to-Law No. 19 (1971), based on free of charge capital.  -8- The Price Resetting 22. In the first round of producer price adjustments implemented on January 1, 1974, prices have been raised for oil (by 449 percent for imported oil, 60 percent for domestic oil), gas (78 percent) for refined products (89 percent on average), for coal extraction (17 percent) and for ferrous minerals (14 percent), among others. On July 1, 1974 prices were raised in the lumber industry (34 percent) and for building materials (16.5 percent). These changes have been made either or both in response to changes in domestic costs or in international prices. Changes in the structure of tariffs (involving increases in some cases, decreases in others) were also made in the transport sector and in electrical energy. A full list of changes is given in Appendix 5, page 2 of the main report. 23. Important producer price changes were also made for some agricul- tural commodities, some of which resulted in changes in the retail price of these commodities. Most notably, the producer prices were increased for beef, pork, tobacco and cotton and in some districts for cereals, with the inten- tion of stimulating production of these commodities. Prices for poultry (in- cluding eggs), on the other hand, were reduced somewhat since profits earned in this branch had been excessive. In response to the increase in producer prices for beef the retail prices were increased while for poultry they were decreased. On balance, however, the consumer benefited more than proportion- ately because to offset the beef price increase (estimated to equal lei 750 million for domestic consumption) an offsetting wage increase (equal to about lei 1,100 million) was granted. Consumers in the peasant sector (where most beef is produced), of course, benefited from the price increase itself. Price Administration and Control 24. Under the law of 1971, the State Council and the Council of Minis- ters are empowered to establish and modify prices, while the State Committee for prices performs the secretarial functions for these two bodies; and in its capacity as a specialized body, it participates fullv in monitoring established prices and initiating proposals for change. There are serious sanctions against violators of the Price Law. 25. The State Committee for Prices, under Article 90 of Law No. 19 (1971), establishes general standards in the price field, and cooperates with other central bodies in improving the price system. In addition to presenting its own proposals to the State Council and the Council of Ministers: the State Committee for Prices also advises on price proposals submitted by Ministries, and controls the manner in which Ministries, centrals, local organs, and enter- prises observe the Price Law. 26. The Ministry of Finance cooperates with the State Committee on Prices in improving the price system, in controlling prices, in resetting prices, as well as in elaborating and setting prices; in order to ensure that price poli- cies are consistent with budgetary requirements.  - 9 - 27. The law contains provisions for some decentralization of price- setting powers. As the economy is getting diversified, there are cases where new products are produced in limited quantities, for which no norms exist. In these few cases, the authority to set producer prices, within limits spe- cified by superior bodies, is delegated to Ministries, centrals, and even enterprises. Nevertheless, as a rule, prices established even under these conditions are unique throughout the economy, and price differences for similar products are exceptional. Price Regulations in Industry 28. The principal regulations in pricing of raw materials, intermediate, and capital goods in industry were summarized in paragraphs 12-15 above. The principal innovative features of the price law are the full costing of capital, inclusion of interest and rent (as tax on land), and the explicit provisions for differential profitability rates allowed, in order to promote technical progress and efficient use of imports. 29. In the construction sector, three types of producer prices prevail under the law: (a) prices on construction projects, or parts of construction projects; (b) unit prices of construction components; (c) estimated prices. 30. In general, there are ceiling prices specified by superior bodies for construction and assembly activities. Where ceiling prices cannot be es- tablished, due to the complexity or other peculiarity of the project, estimated prices may be established on itemized works. Where possible, established norms should be used in establishing estimated prices. Maximum prices cannot be ex- ceeded without approval of superior authorities. Procurement Prices in Agriculture 31. Procurement prices for farm products are particularly important as agriculture continues to occupy a major place in the Romanian economy; such prices are closely related to industrial wholesale prices and to retail prices. The following criteria are employed on establishing wholesale prices for farm products: (a) Geographical differentiation of prices in order to stimulate production of scarce crops and to take account of differential rent. Zonal prices are fixed according to average costs of production on state farms, and in addition bonuses are paid on marginal deliveries beyond the agreed quantity.  - 10 - (b) Differentiation of prices by seasons, to stimulate farms to match the increased demand of industry and consumers for certain products. Seasonal differentiation of prices may not, however, be remunerative enough for producing particular goods if prices do not cover the extra costs of production during that season. (c) Price differentiation by quality standards. Basic wholesale prices for farm products are fixed for given quantities according to defined standard quality; farms may receive 10 percent more or less than a basic price, depending on quality. Higher prices are paid for producing high quality crops or fruits. 32. Procurement prices for farm products are the same for all state farms while there is a price differentiation for cooperative farms. Tariffs For Services 33. In general, service tariffs are set on the same principles as prices in the industrial sector. Tariffs for services consist of the following ele- ments: (a) Cost price, excluding the value of processed materials worked on, if any; (b) Profit; and (c) Turnover tax, depending on the case. Tariffs for Electric Power 34. General delivery prices for electric power are set on the basis of average production cost at the branch level, irrespective of the mode of production (hydro, coal, marsh gas, etc.). Actual delivery prices, however, are differentiated by categories of consumers, and the voltage of electric power supplied. (Production costs vary with the type of supply network). There is also a system of peak-load pricing, and differential tariffs are charged to private consumers, agricultural consumers, public lighting, etc. 35. For agricultural and industrial consumers, irrigation, and oil drilling and exploitation, a "binary" system of prices exists. These con- sumers make a fixed payment for the connected power, in addition to paying at a unit price for the energy consumed. For all other consumers, a single rate prevails. 36. Through the National Energy Distribution system, priority is given to hydro-electric power and to those using solid fuels, so that the consump- tion of oil products and natural gas is saved. Selling prices for thermal power (steam, heat) are set depending on corresponding expenses made for producing it in the same installations producing electric power. To this end conventional keys for incurring expenses are used for by-products. The  - 11 - level of expenses for these products varies depending on the quantity of elec- tric and thermal power obtained in the common installation. For ashes a re- covering price is practiced which represents handling expenses. Foreign Trade Prices 37. Domestic prices of export goods are set according to the same rules as domestic wholesale prices. Prior to price-setting, costs of production are critically reviewed to ensure adequate profitability for exporters as well as to ensure their competitive position in the international market. If, as is usual, export products are specially treated compared to the same product for the domestic market (e.g. weatherproofing, special packaging higher finish, etc.,), then these extra expenses are invoiced separately as special export expenses, and are not treated as part of the export price. Supplementary ex- port expenditures are provided for, where these are necessary to meet the more stringent requirements of international marketing. 38. In general, when imported goods are also produced domestically, both have the identical price, irrespective of exchange rate considerations. How- ever, when the difference between the foreign price and internal costs is significant, and internal needs are covered by import, then wholesale prices of imported items may exceed the price of the domestic product. (For instance, oil). Under the foreign trade regime introduced (experimentally) in January 1974, pricing of different categories of imports is as follows: (a) Machines, Equipment, Installations, etc. Wholesale prices of these items are set to equal the (international) import price, converted at 20 Lei/US$1.00, plus the applicable customs duty (30 to 40 percent); (b) Consumer Goods: (i) Luxury Goods - domestic prices are adjusted periodically to reflect international prices, in full. (ii) Other - domestic prices are fixed according to general principles outlined above, except where a large distortion occurs between domestic and international prices, then domestic prices will be revised, although not necessarily in full. (c) Raw Materials: (i) Some raw materials have fixed prices which are not revised frequently; (ii) Other raw materials (e.g. fuel oil, iron, coal, etc) have variable prices, starting 1974, with more frequent adjust- ment, using the conversion rate of 20 lei/US$1.00 plus a tariff (up to 10%). 1/ 1/ This new system of pricing raw material imports was temporarily suspended in April 1974.  - 12 - IV. Analytical Considerations 39. The chief instrument for directing the Romanian economy is the National Comprehensive Plan for Socio-Economic Development. The system of planning is set out in Law No. 8 (1972) on the Planned Economic and Social Development of Romania. The system of planning is discussed in Annex A to this report. Prices and Economic Planning 40. Prices play an important role within the system of Romanian economic planning. As physical production planning is limited to major products only, enterprises and centrals - whose plan targets are expressed in value terms - have considerable scope for determining the actual product mix as well as the type of production factors used. To a large degree enterprises and centrals are therefore responsible to produce such goods and services for which they can find markets within the country and abroad, and to combine production factors in such a way as to minimize costs. In order to ensure that the overall priorities of the plan are reflected in the decisions of enterprises and central-s, prices are used to stimulate or discourage - as the case may be - certain types of production or certain patterns of factor combination. Prices, Profits, and Material Incentives 41. If the use of profits is to function effectively as the principal measure of production efficiency, and if bonuses from profits are to provide sufficient encouragement to enterprises to seek and fulfill production plans advantageous both to themselves ar.d to society, the degree of success that the profit indicator may achieve will depend primarily upon the accuracy with which prices are adjusted to reflect costs. For profit is an integral compo- nent of price, and in percentage and monetary expressions it amounts to the ratio and residual between the selling price of products and their cost. 42. In Romania prices are not the major mechanisms whereby demand and supply conditions are equated because prices are fixed, while resource alloca- tion, production, and consumption are determined in the plan, not in the market. Prices are one of several instruments centrally formulated and manipulated to achieve planned objectives. Economic Functions of Prices 43. Central planners employ prices to effect compliance by plant man- agement with centrally formulated plans and to evaluate managerial performance in executing planned objectives. Although resource allocation is determined in quantitative physical terms, input and output targets for the, enterprise are calculated in value terms both to arrive at common denominators for physically dissimilar units of raw materials, labor, and capital equipment, and to allow the measurement of production efficiency. Production output costs plus payments for the use of operating capital, taxes, and profits, are all  - 13 - expressed in terms of value. In addition, value calculations aid financial authorities to participate in enforcing enterprise compliance with plan ob- jectives. The philosophy in respect to the control and appraisal function of prices has typically been to maintain stable prices over an extended period of time based on a weighted average cost of production of all enterprises producing the product in question. Stable prices facilitate comparisons of output and costs of production; and the "average cost of industry" calculation is intended to provide an "objective" standard by which the costs of a parti- cular enterprise might be compared. 44. Prices serve as a rational guide to resource distribution, and in this sense they exert an influence over resource allocation in different sectors. In the planning sphere, prices aid in national accounting, in deter- mining the national product, and in the selection of technical coefficients for planning in physical terms; at the enterprise level, management is guided by prices in selecting the alternative means of production to meet their as- signed tasks; in agriculture, prices are used to influence the allocation of resources toward one crop genre rather than another. 45. In the area of income distribution, prices are essential in deter- mining the distribution of money income. The distribution of real income, in turn, is achieved primarily by the sale of goods and services to house- holds that are free to spend their income. 46. Prices are used to some extent to influence demand to meet supply. This occurs, for example, with luxury goods which generally carry a high rate of turnover tax. It also applies to the instances where goods cannot be sold and inventories accumulate. In this situation retail prices may be reduced to clear the goods. In general, however, demand and supply are equated in the plan of production and incomes, and not through price adjustment. Efficiency of the Price System 47. All discussions of pricing in Romania have been intimately linked with the relationship between the plan and the market. After successive price resettings, it seems that the current thinking in Romania is clear on the ne- cessity of taking demand and supply conditions into account in fixing prices, as long as it is realized that policy changes in recognition of market condi- tions, will always be subserviant to considerations of the overall socio- economic plan for development. Thus the role of the market, albeit subserviant to the plan, has been clearly established in Romania; 1/ and increasing efforts are being made to move speedily toward a system of wholesale prices which re- flect the scarcities of resources. 1/ See Annex A, Chapter II of the present report.  - 14 - 48. The price system currently under implementation, has five basic tasks: to fix standards, organize production, distribute output, provide for mainten- ance and progress, and adjust consumption to production in the short-run, in the light of domestic and foreign resource costs. 49. Fixing of Standards. Article 1 of Law No. 19 (1971) states that: "... prices and tariffs must reflect the social cost of production, take in account the use-value of (or demand for) products, and con- tribute to... a rational utilization of material and labor resources,..." Current efforts in implementing the Price Law are clearly designed to provide enterprises with more rational prices of inputs and outputs. No doubt, ini- tially prices may not reflect scarcities; but as the system is implemented, enterprises will be guided in their factor and product-mix policies by ra- tional economic constraints: selling prices must clear the market. Under these conditions, irrespective of the initial starting prices, approximate marginal cost pricing is bound to follow from the Romanian practice, of setting prices on an average cost-plus basis. 50. Organizing Production. Given rational standards - rational relative prices - a rational organization of production should be expected if: (a) enterprises are permitted to change their factor-mix and output-mix, and are given incentives to do so; and (b) are blocked from maximizing merely profits by artificially restricting output. The main body of this report (Chapter I) has discussed the institutional changes designed to increase the efficiency of decision-making. 51. Distribution of Output. The main report has discussed the success in achieving an equitable distribution of income. 52. Provision for Maintenance and Progress. The system of providing for maintenance has been considerably improved. The Price Law also recognizes the need for technological change, and provides for movement towards more and more rational allocation of resources. 53. Short-Run Market Equilibrium. The last task of the economic system, is to clear the markets in the short run. It has been noted above that planners are committed to-clearing the market in the medium- and long-term, which is bound to lead to approximate short-run market equilibrium. In any case, no economy, in practice, achieves exact short-run equilibrium; and consumers are accustomed everywhere for delivery periods, advance bookings, etc. 54. From this brief review, it would appear that while the present sys- tem may suffer from distortions where prices do not adequately reflect costs, the revised system of prices, to be implemented by the end of 1975 under the Price Law, should result in less distortion and greater economic efficiency.  - 15 - Considerations for Project Appraisal 55. Given the fact that prices in Romania are set in relation to both production costs and social priorities, it can be argued in principle that producer prices be used in the economic analysis of projects. Certainly this would seem valid in periods soon after price-cost alignments had been reset. Of course where domestic price distortions exist, these would be handled by the use of shadow prices, or other techniques used in the context of other economies. Under the 1971 price law adjustments will be made more frequently than before and will not necessarily involve a global resetting but can be made with individual categories of prices as the need arises. 56. One important feature in the Romanian economy, which has to be borne in mind when analyzing projects, is that there is no relation between rates of interest and the price system because capital is not bought and sold at a 'price' in a free market. There are interest rates and there is, indeed, a notion of the economic cost of capital. The latter, however, is not necessarily reflected in the interest rate. 59. With regard to the pricing of labor costs in project analysis there may be grounds to suppose (depending on the case) that the economic cost of labor is less than measured by the actual wages paid. This is so because, while there is no unemployment in Romania, there is a significant labor re- serve in agriculture where the marginal loss of output due to a worker trans- ferring into industry is probably neglible. Since the provision of social services and public amenities has already been well developed in rural as well as urban areas the 'urban infrastructure' component of the shadow wage is not a function of industrial employment and does not therefore enter the economic cost of industrial employment.