In 1958, economist William Phillips, a New Zealander,
published a paper titled ‘The Relation between Unemployment and the Rate of
Change of Money Wage Rates in the United Kingdom.’ It was an unwieldy title for
a rather simple relationship that he discovered in the economy of the United
Kingdom, and with some more research by Paul Samuelson and Robert Solow, his
discovery eventually became known as the Phillips curve.
What Phillips discovered in his data, it seemed, was an
inverse relationship between inflation and unemployment – higher inflation
resulted in lower unemployment, and vice versa. But while the data did indeed
show this, any student of African economies would by now be able to point out
that this vastly simplifies this relationship, and common sense nowadays shows
this is not true.
It was not even a decade before this ‘Phillips curve myth’
was exposed for what it was. During the 1970’s inflation skyrocketed in
developed nations and unemployment soared, in direct contradiction to what the
Phillips curve predicted. Developed economies entered into a recession, and
economic theories that depended on the Phillips curve could not offer a
solution. But does this not sound eerily familiar?
In South Africa, growth forecasts have been cut time and
time again. The latest by the IMF predicts just a 0.7% growth for the former
regional powerhouse. With strikes increasing in frequency and with electricity
supply issues, industrial development is stalling, and alongside it, employment
opportunities. Coupled with the deteriorating Rand, the South African economy
is again starting to experience strong inflationary pressures, which resulted
in the South African Reserve Bank recently increasing its repo rate to attempt
to head it off.
Luckily, we’re no longer dependent on the ‘Phillips Curve’
economists. Unfortunately, that does not make us as much wiser as we would have
hoped.
Inflation, for instance, generally refers to the increase in
the price of goods. But seen economically, it can also be seen as a reduction
in the purchasing power of currency. There is only X amount of goods that can
be bought with Y amount of money. If the amount of money increases, but the
amount of goods remains the same, you’ll need more money to buy the same amount
of goods.
To control inflation, then, the Reserve Bank needs to reduce
the amount of money – and so, it increases the cost of borrowing money. By
increasing interest rates, money that would instead be used to buy goods and
services, is now used to service debt. Money is taken out of circulation, and
inflation is kept under control.
But economic growth is measured by the amount of goods and
services produced and consumed… So with more money being used to service debt,
and less applied to buying goods and services, economic growth slows – which is
not what we want! Especially not in a potential recession!
The solution to this, naturally, is to substitute private
spending with government spending. Or it would be, were it not for the fact
that government spending is usually funded by issuing debt. And with the
international ratings agencies already concerned with South Africa’s ability to
repay its debt, with a potential ratings downgrade to junk already on the
cards, it is just not possible.
It seems South Africa is suffering from the failure of a
different kind of Phillips Curve. Constrained by previous government policies
is such a way that a fiscal stimulus is impossible, South Africa seems trapped
into either allowing growth and rampant inflation (which will swallow that
growth whole) or containing inflation at the cost of stagnation.
It thus becomes tempting to look back at those developed
economies and try and apply their solution to the stagflation problem here. Unfortunately,
while the inviolability of the Phillip Curve was dealt a critical blow by
stagflation, Phillips did correctly identify a relationship between
unemployment and inflation, albeit only in the short-term.
In the United States, for example, Paul Volcker aggressively
targeted inflation by raising interest rates, which successfully curbed
inflation at the cost of high unemployment rates and a temporarily worsened
recession. While this certainly remain
an option for the South African Reserve Bank, in the current South African
political climate an increase in unemployment would only serve to exacerbate
tensions with the government, and might cost the country what little political
stability it has left.
There might be a different course to recovery though. In
certain cases, growth stagnation can be caused by excessive regulation of
labour and goods markets. It seems reasonable to assume that relaxing a
regulatory regime could do the opposite. With government fiscal stimulus out of
the question, perhaps a private stimulus is needed. Suppose the government of
South Africa instead aggressively cuts the red tape that is strangling its
culture of entrepreneurship, and allows it to blossom. Perhaps South Africa can
kick-start an ‘entrepreneurial’ stimulus to counteract its recessionary
malaise, and lead the BRICS nations into a new golden age. Then perhaps it can
crawl through the jaws of death, back from the mouth of hell…
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