Increasing the rate of inflation through expansionary fiscal or monetary policies will “certainly not” lead to reduction of high rates of unemployment in South Africa, a Free Market Foundation economist, Jasson Urbach, has argued.
In a paper entitled Is South Africa Headed for a Battle between the Twin Evils? — of high inflation and chronic unemployment — Urbach argues, in contrast to the thinking in leftist circles, that the government should remove artificial constraints on the functioning of the labour market.
He argues that a “one-size-fits-all approach” is “clearly not appropriate” for a developing country such as South Africa. “The solution is not to abandon the market or to dictate to it by setting artificial barriers, but rather to make it more efficient and to remove constraints that have been imposed upon it.”
Rejecting that there is a trade-off between inflation and unemployment — an argument that raged in the 1960s and 1970s — Urbach notes that this idea gained momentum when both inflation and unemployment were generally low and increases in unemployment were often accompanied by decreases in inflation “and vice versa”.
Known as the Phillips curve — after economist William Phillips, who wrote a landmark paper entitled The Relationship between Unemployment and the Rate of Change of Money Wages in the UK 1861 to 1957 — Urbach notes that in the 1970s both inflation and unemployment in Germany and the United Kingdom increased simultaneously, resulting in what became known as stagflation.
“The notion that there was a predictable relationship between unemployment and inflation lost favour amongst most macroeconomists.”
Economist Milton Friedman questioned the curve even before its heyday, arguing that workers would demand higher wages to protect themselves from the rise of inflation.
While Urbach does not mention the government’s alliance partner, the Congress of South African Trade Unions, the union has frequently called for the government’s intervention in the economy, including linking the currency at a set rate to the dollar. It has also questioned the inflation targeting at the expense of job creation.
Urbach says that for a lesson on the consequences of inflation, “we only have to look as far as our neighbour Zimbabwe, where inflation is currently in excess of 1 000%”. This is an extreme case but nevertheless provides “some insight” into inflation’s negative effects.
He notes that under inflationary conditions it becomes impossible to plan and to make any rational economic decisions “as people are more concerned with anticipating inflation than with seeking out profitable new production opportunities”.
In such an environment, “individuals spend almost all their income on consumption and virtually no money is saved”, he notes. Savings are critical as they lead to investment, “which finances the purchase of machinery, equipment and research and development”.
“These types of investments make workers more productive and result in higher wages,” he notes. “In the absence of savings, individuals become worse off and their quality of life declines.”
Inflation also has negative implications for trade because it adversely affects the competitiveness of export industries and import-competing industries. — I-Net Bridge