Chronic inflation causes and burden

Inflation has been part of the Malawi economy for so long that it can now be described as chronic. But what is inflation and what are its causes?

According to the late Professor Milton Friedman of Chicago University, inflation is always and everywhere a monetary phenomenon. Where there is inflation, money loses its purchasing power. This reminds me of what I read in Paul Samuelson’s famous textbook titled Economics decades ago. Therein he quoted an orator in the southern part of the United States (US) during the civil war. In the past, said the orator, “we went to the market with money in our pockets and brought back food in our baskets. These days we carry money in our baskets and bring back food in our pockets. Everything is scarce except money”.

In this, we see the classic definition of inflation as too much money chasing too few goods. However, abundance of money is not exclusively the cause of inflation. There are other causes but we must begin with the theory of pull inflation. During famines or shortages of food, the demand is greater than the supply. Buyers compete for the scarce food causing prices to shoot up. The rise in prices of food may affect the prices of other goods and services until there is a general rise of price called inflation.

Similarly, petroleum is an input in many business activities. When its price rises because countries producing it have reduced production, the price rise ramifies throughout the economy.

Secondly, there is cost-push inflation. If excess labour is used in the production of a given commodity, its price will be higher than if just enough labour had been used. Businesspeople buying the costly product will also raise prices of their own product or services to try and make profit. Take for example; you want to start a manufacturing business using imported raw materials. If these raw materials cost too much or they are brought into the country through a longer and expensive route, the cost of transportation will affect production in the factory and ultimately this will affect the selling price of the finished product. To keep costs low, a government must invest in improvement of physical infrastructure such as road and railway.

Thirdly, since the 1970s, economists have recognised the existence of what some call inertia inflation and others call stagflation. This inflation is inherited from past inflation which may have been caused by too much money in circulation but even when the excess is reduced through credit squeeze, the inflation does not drop. Previously, demand pull inflation took place during excess economic growth rates, but in the 1970s it was found that even when the economy was no longer growing but was stagnant there was inflation. The inflation taking place during economic stagnation was dubbed stagflation. Its conquest required new weapons.

Fourthly, inflation arises out of conflicts and is known as conflict inflation. Organised bodies compete for the nation cake, each one wanting a bigger slice for itself. When the Teachers Union of Malawi (TUM) learns that the civil servants have compelled government to raise their salaries having staged a strike, it also calls upon its members to go on strike for higher wages.

Inflation tend to persist because of the contracts that economic groups have entered into. A government may appease striking teachers or civil servants by giving them half of what they demand now and promising them the other half in a year’s time. By next year, the economy may have suffered a recession; there is a good deal of employment yet the union demands that government should fulfill what it promised or else they will once more go on strike. Thus increases may be made during stagnant condition and strengthen inflation.

Inflation also resists attempts to push them down because of the existence of cartels in the economy. Cartels are associations of businesspeople in the same industry. They may be bankers, insurers and bus operators.

These agree not to charge less than so much for the services. Whoever wants to raise his prices, will phone the others. “If you raise your price by 20 percent, we shall also raise ours by 20 percent.” In this way, prices which members of the cartel charge are higher than if they operated in isolation, freely competing.

The burdens of inflation are well-known. The main sufferers are those who receive fixed incomes such as pensioners. Interest bearing deposits in banks lose their purchasing power when there is inflation.

Inflation hurts a country’s exports. They cause prices of commodities to rise. When exported, the commodities become more uncompetitive thereby failing to sell.

In condition of ever-rising prices, it is very difficult to enter into reliable contracts. A boarding school may enter into a contract for the supply of food at a certain price. But before the end of the year, prices may have risen thereby upsetting the agreement and the budget wage agreements become worthless within a short period, requiring fresh bargaining. So much time is then wasted in wage wrangles.

How do we solve the inflation problem? Measure of different kinds will have to be tried. If there is excess liquidity in the economy both fiscal and monetary measures should be tried. It will involve taxing corporations more heavily and reducing public expenditure. This is the fiscal approach. It will also involve raising interest rates to curb borrowing. Both measures at a certain level may bring about recession, involving loss of jobs.

Administrative action should be taken against cartels, company takeovers and other activities which stultify competition in the economy.

 

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