A LEVEL ECONOMICS 7

Macroeconomic problems

  15.0 Introduction

An economist returns to visit his old school. He's interested in the current exam questions and asks his old professor to show some. To his surprise they are exactly the same ones to which he had answered 10 years ago! When he asks about this the professor answers: "the questions are always the same - only the answers change!"  The same can be said of macroeconomic problems. Over the decades Zimbabwe has faced the same problems of inflation, unemployment and BOP deficits. In this chapter we are going to explore the theoretical underpinnings of these problems as well as the probable macroeconomic policies that can be implemented to curb the problems.

  15.1 Unemployment

An unemployed person is someone who is actively searching for a job but unable to find one within a specified time period. An ‘expanded’ definition of unemployment includes people who have the desire to work but have become too discouraged to actively search for a job.  The rate of unemployment is defined as the number of unemployed job seekers divided by the total number of employed and unemployed persons.

           Unemployment rate      =                                     Unemployed persons    x     100

Labour force In Zimbabwe the level of unemployment is estimated to be over 80%.

15.1.1 Types, causes and remedies for unemployment

Economists distinguish between three major types of unemployment; namely frictional, structural or ‘mismatch’ and cyclical unemployment.  The following table summarises the main causes and remedies for the different types of unemployment.

Table 15.1 Type, causes and remedies of unemployment

Type	Description	Cause	Remedy
FRICTIONAL	-               People voluntarily remain   unemployed while they seek out and weigh up suitable job vacancies.  -               People searching for jobs which exist but where complete information concerning these jobs is lacking	Difficulty        in         matching quickly            workers          with suitable jobs due to :  -               Lack of information concerning jobs.   -               Delays            in            applying, interviewing   and accepting jobs.	Improve the flow of job information to make it easier for job seekers to come into contact with job vacancies -              Advertising in public media e.g. national newspaper -              Establishing employment exchange offices.
STRUCTURAL	Skills profile of unemployed persons does not match the skills demanded by employers	- Declining industries and the immobility of labour. - Workers have the wrong skills in the wrong place	-Subsidise and improve the mobility of labour.   - Change the education curriculum to meet the requirements of industry
TECHNOLOGICAL	With improvement in technology, old skills are no longer required and machines will do the jobs people used to do (labour saving )	-    Technological progress. -     Automation     and information technology	-              Training and retraining the labour force. -               Halt    the            pace     of technological development
CYCLICAL	Workers with skills will be searching for jobs but job vacancies fall short of the number of job seekers	Periodic downswings in the business cycle which lead to an insufficient aggregate demand in the economy	-              Increased           government spending. -               Reduce taxation.   -              Government can spend more money directly on jobs (hiring more civil servants)

15.1.2 Consequences of unemployment

Unemployment affects individuals, society, businesses and the government through the following ways.

a. Loss of output

The opportunity cost of each unemployed person is his or her foregone output. If labour is unemployed the economy is not producing as much output as it could.

b. Loss of human capital

The unemployed labour gradually loses its skills because skills can only be maintained by working. c.Lost tax revenue

Growing unemployment means less direct and indirect tax revenue because unemployed people stop paying income tax and their spending will full considerably.

d. Social Costs

Unemployment brings social problems of personal suffering and distress and possibly also increases in crime such theft and prostitution.

e. Increasing inequalities in the distribution of income

Unemployed people earn less than employed people and so when unemployment is increasing the poor get poorer.

Table 15.2 Employment and training schemes to reduce unemployment in Zimbabwe

Scheme	Description
Restart Programme	Interviews and training for people unemployed for long periods
Community Projects	Local projects for the unemployed
New Workers Scheme	A subsidy to employers taking on the unemployed youth.
Job Search Scheme	Return fare and allowance for job interviews
Job Release Scheme	Early retirement with an allowance
Job Splitting Scheme	A subsidy to encourage job sharing

15.2   Inflation

Inflation refers to a persistent and continuous rise in the general or average price level as reflected in changes in the consumer price index (CPI).  It refers to the rate of increase in the general price level and not a price increase per se or to a one-off increase in the price level.

15.2.1 Types, causes and remedies for inflation

Economists distinguish between three different three types of inflation namely demand pull, cost push and structural inflation.

The following table summarises the main causes and remedies for different types of inflation

Table 15.3 Type, causes and remedies to inflation

Type	Cause	Remedy
DEMAND - PULL	Demand pull inflation can either be from the real sector or monetary sector - In the real sector keynesians argue that an increase in aggregate demand not being matched sufficiently by increased output usually results in an excess AD which triggers bidding up of prices.	To curb demand pull inflation first identify the source of inflationary pressure -               If it is from the real sector, take steps to reduce demand in the economy through increased taxation, and reduced government expenditure.  -               if it is from the monetary sector reduce growth in money supply through tight monetary policy
	- in the monetary sector monetarists argue that excess supply of money causes too much money to end up chasing too few goods as individuals try to dispose of the excess cash.
COST-PUSH	A firm passes on an increase in production costs to the consumer. The inflationary effect of increased costs can be a result of: -               increased wages leading to a wage-price spiral or wagewage spiral   -               increased import prices (imported inflation) -               unjustified price increases in the case of monopolies	The solutions to cost push inflation resides in  -               de-regulate labour markets  -               encourage greater productivity- apply controls over wage and price rises e.g. price controls -               deduce import prices by removing tariffs.
STRUCTURAL	Production constraints or structural rigidities such as drought cause output to lag behind demand for the goods. The resulting shortage will put an upward pressure on prices.	The solution to structural inflation resides in making supply more responsive to changes in demand through, - the establishment of national reserves e.g. GMB  to minimise adverse effects of events such as droughts.   - improve worker productivity.

15.2.2 Effects of inflation

Not everyone suffers from inflation. Some parts of society actually benefit for example

a.   The government finds that people earn more and so pay more income tax.

b.  Firms are able to increase prices and profits before they pay workers higher wages.

c.   Debtors (borrowers) gain because they have the use of money now when its purchasing power is greater.

On the other hand some parts of society are disadvantage by inflation for example

a.   People on fixed incomes such as pensioners tend to suffer as their incomes are usually not adjusted for inflation.

b.  Creditors lose because the loan will have reduced purchasing power when it is repaid.

c.   Zimbabwean goods may become more expensive than foreign made goods, so the balance of payment suffers.

d.  Industrial disputes may occur if workers are unable to secure wage increases to restore their standard of living.

e.  Investment habits are forced to change from savings to investment in non-monetary assets such as property, which appreciate in value. Monetisation of the economy is reduced.

NB* On the basis of these argument it can be argued that inflation tends to negatively affect living standards of an economy. In the extreme cases of inflation people will loose confidence in the monetary system of the country and resort to barter. Germany is a historical example where the mark lost its value due to hyperinflation which broke the 1000% record to the extent that people resort to using cigarettes as a medium of exchange.

  

15.2.3 Measuring inflation - Calculating the consumer price index (CPI)

CPI is a statistical device that indicates the price level at any given time as compared with the level of prices at some standard time called the base.  CPI looks at how prices are changing in retail shops hence it is also referred to as the Retail Price Index (RPI).  The following procedure is used:

Step 1 A basket of goods and services consumed by the average family is listed.  For example food, clothing and transport are included in the basket.

Step 2 The price of items in the basket in the base year is noted.  The base year is the year in which it is assumed that there were no chronic economic problems, that is, there is no inflation.

Step 3 Each item in the basket is assigned a weight to reflect its relative importance to the average family, in terms of the proportion of income spend on each item.  For example, food has higher weighting than transport.

Step 4 The price of goods in the basket is recorded in the current year and compared with base year prices as a percentage (index) using the equation:-

                       Index                          =    Current price            x      100

Base price

Step 5 The index of each item is then multiplied by its weighting to get the weighted index

                     Weighted Index =       Index X Weight

Step 6 The new CPI is found using the equation:

                      CPI                             =      Total Weighted Index

Total Weight

Step 7 The value of the CPI in the base year is always 100.  The rate of inflation is the percentage change in the CPI and is calculated using the equation:

                     Inflation Rate               = Current CPI   -   Base CPI    x     100

Base CPI

The above steps can be illustrated using the follow table

Table 15.4 Calculation of the CPI

Item	Price in Base Year	Price in Current Year	Weight	Index	Weighted Index
Food	300	600	5	200	1000
Clothing	50	250	3	500	1500
Transport	10	5	2	50	100
Total			10		2600

CPI    =       Total Weighted Index	=	2600    =       260
Total Weight		10
The rate of inflation is	=	260 - 100   x   100   =160%
		100

15.2.4 Problems in using the consumer price index

In Zimbabwe people have doubted the authenticity of the CSO published CPI. In most cases they would view the prices as having increased by a greater percentage than the published index. Problem likely to be encountered when computing the CPI may be outlined as follows;

a.   How to define a standard basket, that is, which items should be included in or excluded from the basket of goods?

b.  Different families have different tastes hence different weightings.  How is an average family found?

c.   For a while new products (e.g. mobile phones) may not be included in the basket.

d.  Consumption patterns change overtime, thus weights must be altered to reflect these changes.

e.  The quality of goods changes over time but CPI simply monitors price changes while ignoring quality improvements.

15.3 Balance of Payment (BOP) deficit

BOP deficit refers to a situation on the current account when exports are less than imports.  In the short term, a deficit leads to improved standards of living due to increased consumption of imports but in the long term it may lead to depreciation of the domestic currency thus leading to deterioration in the standard of living.

15.3.1 Correcting a BOP deficit

The correct measures to correct a BOP deficit will depend upon its causes and the exchange rate system. a.Short-term BOP deficit

A short-term BOP deficit may be dealt with by:

i.   Running down foreign currency reserves.

ii.  Borrowing from international institutions such as the IMF. iii.Raising real interest rates in order to attract ‘hot money.’

b. A serious BOP deficit

The measures to correct a serious BOP deficit problem can have two effects. They can either reduce expenditure (cut domestic expenditure on imports) or switch expenditure (switch expenditure from imports to domestic goods). The various policy measures include:

i. Devaluation or depreciation of the domestic currency

Devaluation is a deliberate attempt by the authorities to lower the rate at which the domestic currency exchanges for a unit of foreign currency.  The effect of devaluation is to make our exports cheaper to foreign buyers and holding other things constant, the demand for our exports is expected to rise while demand for imports is expected to decrease since they will become expensive. The success of devaluation in correcting a BOP deficit will depend on:

 Whether the country has the capacity to produce for exports and increased domestic demand. Zimbabwe currently does not have such a capacity.

 The sum of price elasticities of demand for exports and imports must be greater than one (Marshal-Lerner condition). That is devaluation can reduce imports or increase exports if demand for imports or exports is elastic. The demand for imports in Zimbabwe is inelastic because most products produced in Zimbabwe require imported components.

 The J-curve effect, that is, due to the existence of contracts and other factors promoting short run inflexibility, measures taken to remedy a BOP deficit have often led to immediate deterioration of the payment position followed by subsequent recovery.

Fig 15.1 The J-Curve effect

     BOP

                                          +

             

                                          A                       C     

                                                       B     

0

                                          -

ii.     Import controls

Import controls refer to the imposition of direct measures such as tariffs or customs duties.  Such controls tend to discourage imports by either increasing their prices or reducing their volumes.  For example, faced with a BOP deficit a country can impose high tariffs on imports so as to reduce the volume of imports. However import controls conflict with a nation’s treaty obligations, for example, SADC agreement to remove barrier to trade and can be less effective if the other countries retaliate.

iii.    Deflation policy

These are measures aimed at reducing incomes for example, wage freezes or increased taxes on income.  If income is reduced, the ability to import is reduced since imports are an increasing function of income.  However deflation policy is unpopular and can push the economy into other serious problems such as civil unrest.

iv.     Export Promotion

This refers to the carrot and stick methods of increasing export volumes such as:

 Giving export incentives e.g. tax holidays to exporters.

 Establishing Export Processing Zones (EPZ).

 Allowing exporters to retain a percentage of their foreign currency earnings.

 Trade exhibitions such as the ZITF and Travel Expo.

v.      Import substitution

To reduce the volume of imports the country can produce goods that are close substitutes of the imported goods.

  

15.4 ECONOMIC PROGRAMMES IN ZIMBABWE

The country is best known for the numerous unsuccessful economic reform programmes most of which were never implemented. Of those implemented, they were never fully implemented rendering them all ineffective in addressing the economic problems facing the country.

15.4.1 The Economic Structural Adjustment Programme (ESAP)

Independence in Zimbabwe coincided with the start of the first decade of structural adjustment in Africa. The economy that we inherited from the colonial government was highly regulated and inward looking, that is, it had adopted an import substitution strategy as a way of overcoming the shortages caused by sanctions. The new government needed to redress the imbalances caused by the colonial past and this could not be accomplished through market forces. As a result the government adopted a socialist stance through the Five -Year Developmental Plans.

Zimbabwe became a member of the IMF and the World Bank in 1980. These two institutions and the donor community exerted pressure on the country to adopt a reform program from the IMF in return for a stand by finance package.

a. Economy under ESAP (1991-5): Economic Policy Statement (1990) and the Framework for Economic Reform (1991)

The main targets as outlined in the framework for economic reform document include; 1.   A reduction of the budget deficit from about 10% of the GDP in 1990 to 5% by 1995.

2.      Complete liberalization of the foreign exchange and trade regime in 1995.

3.      Elimination of subsidies, reduction of social expenditure and levying of cost recovery rates on social services.

4.      Rationalization of some public enterprises and privatization of others.

5.      Liberalization of prices, interest rates and the exchange rate by 1995.

6.      Deregulation of the economy.

7.      Liberalization of foreign investment regulations and,

8.      Deregulation of the labor market by allowing for free collective bargaining wage flexibility and abolishing certain restrictions on retrenchments.

b. The outcomes of ESAP

As a result of ESAP the country’s economy was opened to competition, trade was liberalized, controls on prices were removed and economic growth was promoted. On the other hand, companies closed, workers were retrenched, the removal of price controls witnessed an increase in the rate of inflation, the economy’s capacity to grow was greatly reduced and the overall standards of living deteriorated. Uncertainties, drought and the increasing budget deficit sometimes hampered the promotion of investment, both local and foreign. Retrenchments led to reduced incomes for households and this has increased poverty. ESAP brought more suffering than help.

c. Why ESAP failed

ESAP did not derive from the prevailing conditions in Zimbabwe. ESAP failed in Zimbabwe (and elsewhere) partly because it was an externally designed economic program, which did not suit our local realities. In addition, it failed because of its total reliance on market forces and its bias towards the formal sector at the expense of the informal sector of the economy. However, ESAP gave us a framework upon which our domestically designed policies can be built such ZIMPREST.

15.4.2 ZIMPREST

a. Main components

1.               Urgent  restoration of macroeconomic stability

2.              Facilitation of public and private sector saving and investment needed to attain growth.

3.              Pursuing economic empowerment and poverty alleviation by generating opportunities for employment and encouraging entrepreneurial initiative.

4.              Investing in human resource development

5.              Providing a safety net for the disadvantaged.

b. Comment

The program was not successful. The main problem was that the macroeconomic fundamentals (particularly the budget deficit, inflation and foreign currency) were not right. Economic empowerment was hampered by lack of credit and high interest rates.

Debt repayments are taxing on the economy and this has meant reduction in expenditure on other more fundamental areas.