Unpacking the deflation debate

By IAfrica
In Zimbabwe
Jul 28th, 2014
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Massive imports of basic commodities have triggered deflation in an economy that has no significant export receipts to balance external outflow of funds

Massive imports of basic commodities have triggered deflation in an economy that has no significant export receipts to balance external outflow of funds

Ngoni Nhamo Chivizhe Correspondent

Hence, it is now very obvious that deflation has nothing to do with cost structure, indigenisation or the US dollar.
The cause of deflation is money that firms pay out as salaries, but the money does not return to firms because people do not buy goods produced by local firms, but choose to buy from other countries.

Daily, Zimbabwean media never run short of someone who purports to be giving an impeccable explanation of the causes of the deflation that the Zimbabwean economy is experiencing.

Some blame the US dollar, some blame indigenisation, and some even think price competition is causing prices to go down. I will try to show that neither the use of US dollar, cost structure, price competition, nor indigenisation policy has caused the deflationary process.

I will demonstrate that it is the haemorrhage of our money through massive imports that has triggered deflation in an economy that has no significant exports receipts to balance external outflow of funds.

Deflation is a self-sustaining process where the average price of goods in a country decreases as a sign that the amount of spendable money that people have is less than the amount of money required to buy all the goods produced by firms in that country.

Otherwise deflation occurs when the money in the country is not enough to buy all the goods that have been produced by the firms. Goods produced by all firms in a country in a given period are known as aggregate supply.

The spendable money in a country is known as aggregate demand. The following is a simplified process explanation of what caused deflation in the Zimbabwean case.
Let’s think of a very small country where there are only three people, A, B and C, who are employed by only one firm that produces bread. At work each person produces one loaf per month at the firm, and is paid one dollar as a monthly salary.

And so the selling price of the loaf of bread is also one dollar, just to recover costs. So the firm produces only three loaves per month, with three workers, and pays three dollars as salary to the three workers.

But once the firm has paid the workers, the workers must come back and use their salary money to buy the bread from the firm. Hence, soon after month end, the three dollars paid to workers must return back to the firm when these three people buy bread for them to survive.

Once all the workers have come back to buy the bread, it means the firm will then have the money (three dollars) to pay salaries for the three workers in the next month.

Now, deflation sets in when one of the three people decides to use salary money to buy bread from South Africa. For it means the firm in Zimbabwe will only get back two dollars, and only two loaves will be bought.

The dollar that would have bought the third loaf of bread has gone to South Africa, and never to come back. And so the firm has a loaf on its shelf that has no purchaser.

The country no longer has money to buy the third loaf. The firm will try to reduce the price hoping that the bread will be bought – deflation, but the truth is that the money that should have bought the bread has gone to South Africa.

And so the money remaining in the country (two dollars) is no longer adequate to buy all the goods (three loaves) produced by the firm. The effect goes further. Since the firm has received only two dollars back, it means the firm has salary money for only two people, come next month-end.

One of the three people must be retrenched, for the firm has no money to pay his salary. The money has gone to South Africa where it has imported a TV, radio, etc. Hence, it is now very obvious that deflation has nothing to do with cost structure, indigenisation or the US dollar.

The cause of deflation is money that firms pay out as salaries, but the money does not return to the firms because people do not buy goods produced by local firms, but choose to buy from other countries.

That is why you see firms being unable to pay salaries.
The money firms would have used to pay salaries is now in other countries because of imports. Instead of money, firms have unsold goods in their shelves. Unsold goods cannot be used to pay salaries.

There would not have been deflation if foreigners were also coming in to buy Zimbabwean goods, as this would then bring back the money that has been channelled out by Zimbabweans.

However, our industries are producing very little to export because they do not have machinery or are using antiquated machinery which is costly and has low productivity.

We would have hoped that the export of our diamonds and tobacco would probably abate the deflationary process by returning the monies that our people have taken to other countries to import cars and even food items. But we all know how hazy the accountability of diamond sales proceeds has been.

Ngoni Nhamo Chivizhe is a local economics lecturer and commentator. He writes in his personal capacity.


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