With every passing year and every new government, the masses are only concerned with ever rising inflation they have had to face over the years which makes the current government worse than the previous one and the previous one worse than the one before and so on. One of pivotal reason for a common man to go and vote for party xyz is because he is in a delusion that party xyz will control pricing which skyrocketed during the reign of party abc. But this common’s man hope sinks in the quicksand with a new wave of inflation brought in by the take over of a party he spent arguing in favor of, all these months before the elections, exhausting all his logics and made up facts about the accomplishments of his heroes and their policies.
It is to solve this dilemma of a common man and his dyeing hope in the government of his country where an economist has to play a responsible role to inform the common man that inflation does not happen because party abc had conspired that once they have the chair, they will sell him the same carton of milk he bought for Rs60 or so a few months back at Rs90 because that is exactly how they can accumulate his wealth in their foreign accounts or that his much cherished heroes in party xyz raised the prices of fruits two fold because that’s exactly what they came in for; to hike prices and as soon as you go away paying Rs140/kg for those mangoes, they send their man to your fruit seller to take away the Rs40 which you thought you paid over and above and hence rant about it all day to your wife.
Phew, so easy. How they earn on our income by first taxing us, then increasing the taxation and then increasing the prices. If that’s what you believe, clearly you are very deprived in terms of ‘economics’. So here’s your catch! inflation does not happen just because a few fat ugly robbers are governing your country, who take a portion of your income in the name of income tax and then some more in the name of sales tax every time you buy any product, be it a detergent or tea and then they increase prices of these goods every month too, because that’s how they do corruption! or so you think. Sadly, you breed much uniformed ideas.
Inflation is an economic phenomenon and this is what you need to know. Inflation is not an increase in prices; it is the rate at which prices increase. But that’s one and the same thing to you, so let’s move on.
There are a number of economic factors which cause inflation. Foremost is the factor of increase in demand. Aggregate demand of an economy is a function of consumption, investment, government spending and net of trade. Due to the trade deficit which Pakistan faces every year when imports exceed exports, the government has to pay from somewhere for these imports. This, the government can do, firstly, by printing money (increasing money supply) which in turn means that where you had Rs100 to buy two goods, now you have Rs200 but same two goods. Hence the price of each will increase.
Secondly, the government can increase taxation (tax being government’s income), increasing tax means the producers/firms will face increasing cost of production and hence pass some of the cost down to the consumers in the form of increased prices. And so you will come across hiked prices of the same quantity and quality of goods.
Moreover, the aggregate demand remains increasing because Pakistan has a weak industry and we hardly manufacture anything which we consume, ourselves. From a bar of soap going up to air planes, everything is imported where as what we export are low priced agricultural goods in return. On top of it, even if our industries do manufacture some items then the inputs for those are in turn imported, a major of them being oil, chemicals etc. This increased demand of goods and the negative trade balance (exports less than imports) are reasons for which the government does taxation or increases money supply, as explained already, to finance the deficit. It can be summarized as simply as this:
1/ demand law: when demand goes up, so does price.
2/ rule of money supply: when you print more money, its value goes down and so prices go up.
3/ tax policy: when prodders (firms) are taxed, they pass on some of this increased cost of production to consumers (common men), and so charge higher prices of goods.
Another major reason for inflation is the devaluation of rupees. Now this common man has much to criticize the government for, one of them being devaluation of rupees, which he again assumes happened just at the will of the same ugly fat bellied men who worship the dollar and keep devaluing rupees because that’s all they do, the money business to sell away their country. Wrong again.
No matter how bad are the men you chose to govern you, point is that the devaluation of rupee is not up to them, it is an economic play. A country has an option to have a fixed exchange rate where it decides what vale to keep its currency relative to dollar or to have floating exchange rate, which values the currency according to its market vis-à-vis the dollar. Back in 1998, Pakistan switched to floating exchange rate, striving to become an open economy.
It is an economic concept that a country with floating exchange rate has to keep reserves in its central bank of all the various currencies it does trade with, so as to pay them. If these reserves go below a certain minimum amount, it has to purchase that currency to bring it back into its reserve and in doing so, its own currency devalues. Hence every time Pakistan has a negative trade balance (more imports than exports), in paying for these imports it exhausts the reserves of dollar in the state bank to pay for those imports, and finally has to purchase the dollar to maintain the reserves, so the rupee devalues This is sometime conditioned by the IMF, adding more burden. But the point is that only a weak economy comes to this point where it has a negative trade balance and so constantly devalued currency. The point to note is that our reduced exports and the exports of low tech and low priced commodities such as cotton, textiles, fruits etc compared to the high tech and high priced imports of machinery, oil, automobiles, plants and non-developing goods of daily use from cosmetics to medicines to everyday grocery items are a cause of the low value of Pakistani Ruppee.
A government cannot control this devaluation much in a floating exchange rate which is determined by the market forces which we, the common men, bring about every time we consume imported goods which our reserves fall short to pay for and hence we face increased prices of those goods to regulate our demand for them and so we see Rs106 equaling a dollar, as of now.
Hence we see that economics does not only control but forms the system we live in, and so it is very necessary that we be informed of its basics. If we belong to a class which is getting the high priced graduate education in Pakistan, we must know a bit about these basics of economics so that next time we blame party abc or favor party xyz, we have a rational choice set and make a fair criticism in the context of the circumstances that were prevalent when a certain party was in governance; because policies are shaped more by the type of times that prevailed than by the type of mind sets of individuals in those times.
( writer: Hira Nisar Khan, the writer is majoring in Economics and is open to all questions related and any disagreements with the argument. Feel free to comment.)
Hira Nisar Khan 