CHAPTER 3: THE IMPACT OF INFLATION ON PERFORMANCE
3.1
INTRODUCTION
The preceding chapter discussed the profile of the Zimbabwean construction industry and reviewed literature on contractor performance. In order to fully satisfy the first objective on the role of hyper-inflation, this chapter further reviews literature, more specifically on the phenomenon of hyperinflation and its impact on performance.
3.2
THE PHENOMENON OF HYPERINFLATION
“Inflation is like sin; every government denounces it and every government practices it”
Sir Frederick Keith-Ross
3.2.1
What is hyperinflation?
In economics, hyperinflation is inflation that inflation that is "out of control," a condition in which prices increase rapidly as a currency loses its value. Formal definitions vary from a cumulative inflation rate over three years approaching 100% to "inflation exceeding 50% a month. (Wikipedia)
While a number of hyperinflation definitions exist, the widely used and most adopted definition is that of Cagan (1956). Cagan defined “hyperinflation as beginning in the month the rise in price exceeds 50 percent and as ending in the month before the monthly rise in prices drops below that amount and stays below for at least a year ” (p.25).
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CHAPTER 3: THE IMPACT OF INFLATION ON PERFORMANCE
3.2.2
Causes of hyperinflation
Although there is a great deal of debate about the root causes of hyperinflation, it becomes visible when there is an unchecked increase in the money supply or drastic debasement of coinage, and is often associated with wars (or their aftermath), economic depressions, and political or social upheavals (Makochekanwa ,2007).
Currently, the various hypothesis of hyperinflation have one thing in common, namely assigning their proximate cause to movements in the money supply .This is generally known as the quantity theory of money. Thus, the main cause of hyperinflation is a massive imbalance between the supply and demand of a certain currency or type of money, usually due to a complete loss of confidence in the currency similar to a bankrun. This has most often occurred because of excessive money printing, although other factors may have a reinforcing effect. Often the body responsible for printing the currency cannot physically print paper currency faster than the rate at which it is devaluing, thus neutralizing their attempts to stimulate the economy (Wikipedia).
On the other hand cost-push theory underscores the fact that prices rise due to increasing cost of the factors of production. This theory maintains that prices of goods and services rise because wages are pushed up by trade unions’ bargaining power, or by the pricing policies of oligopolistic and monopolistic firms with market power. While there is a school of thought thought that wage push inflation inflation is rare in Africa, largely because wages constitute only a small part of national income, Zimbabwe’s situation since the
new millennium have proved that wage are a force to recon with when analyzing hyperinflationary trends. Contractors are seriously affected as wages are increased on a monthly basis while recovering the same cost after 40 days. Further the wage Nilson Biton 18
CHAPTER 3: THE IMPACT OF INFLATION ON PERFORMANCE increases do not move in tandem with inflation thus, promoting informal trading while projects are delayed due to inadequate labour.
Demand-Pull Theory postulates that inflationary pressures arise because of excess demand for goods and services resulting from expansionary monetary and fiscal policies. Over and above these suggested monetary expansion and fiscal policies, the Zimbabwean situation has been compounded by shortages of basic commodities (i.e., mealie-meal (staple food), cooking oil, flour, fuel, sugar, to mention a few), thus result in pent-up upward pressure in the overall prices. This means that workers are unable to feed themselves from their wages thereby prompting the flight of skilled personnel. For example, Kuchi Construction has lost skilled personnel since 2003 as shown in figure 3.1.
Staff turnover turnover 2003-2007 20 03-2007
20 18
N u
16
m
14
o
12
m
10
y
6
e
b r f e p
Series1
8
lo e e s
4 2 0 2003
2004
2005
2006
2007
Year
Figure 3.1 Kuchi Construction Staff turnover 2003-2007
Nilson Biton 19
CHAPTER 3: THE IMPACT OF INFLATION ON PERFORMANCE The mostly affected disciplines include quantity surveyors, site agents, site engineers and project managers experienced in the construction industry. In absolute terms, the company lost over 62 personnel in five years.
Literature on recent theories of inflation that have emerged in the past few years emphasized the role played by political stability, policy credibility and the reputation of the government and the political cycles in determining or explaining inflation.. These recent theories have shifted attention away from traditional direct economic causes of inflation, such as money creation, towards political and institutional determinants of inflationary pressures. Like most of African countries , Zimbabwe’s political environment has been typified by severe restrictions on political and civil liberties. Thus the intensification of political instability and macroeconomic instability following the coming into fore of resilience opposition political party in 1999, the controversial land reform since 1999 and most importantly the fact that the country ’s been increasingly isolated from the international community, have resulted in political factors being some of the major determinants of hyperinflation in the country.
Structural factors are also believed to influence the rate of hyperinflation in Zimbabwe. Examples include weather conditions and pricing policies of the government. It can be argued that government’s intention of protecting the general consumers through controlled market/consumer prices have wreck havoc in most production industries, especially the production of cement which has led to serious shortages of the important construction material. This meant that projects were further delayed as contractors were unable to procure the product. This eventually meant that certain carrying costs were borne by contractors
Nilson Biton 20
threatening their viability as the
CHAPTER 3: THE IMPACT OF INFLATION ON PERFORMANCE Business Herald, Herald, Harare 9 April 2003 reported that that contractors face imminent imminent closure as a critical shortage of cement as fuel continue to compound problems.
3.3
HYPERINFLATION AND PERFORMANCE
Zimbabwe has currently the highest rate of inflation in the world (an annual rate of 9,030,000 percent in June, 2008). The high rates of inflation have contributed to the decline of the Gross Domestic Product by about 43% between 2000 and 2007. Not surprisingly, every sector of the formerly diverse Zimbabwean economy was affected (Coltart, 2008). The construction industry was not spared either.
In 2007, the
Zimbabwean construction industry operated at 20% capacity. This was a result of the fact that the Zimbabwean Government which provides 60% of construction contracts is facing economic and political challenges and is channeling most of its financial resources to procure essential commodities and utilities (ZCIC annual economic review on the performance of the construction sector in 2007). The inflationary trend from 2000-2007 is shown in figure 3.2.
Unlike inflation, which is widely considered to be normal in a healthy economy, hyperinflation is always regarded as destructive. It effectively wipes out the purchasing power of private and public savings, distorts the economy in favour of extreme consumption and hoarding of real assets, causes the monetary base whether specie or hard currency to flee the country, and makes the afflicted area anathema to investment (Wikipedia).
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CHAPTER 3: THE IMPACT OF INFLATION ON PERFORMANCE
Zimbabwean inflation trend (2000-2007)
69000
66000
63000
60000
57000
54000
51000
48000
45000
42000
39000
% N O I 36000 T A L F 33000 N I
Series1
30000
27000
24000
21000
18000
15000
12000
9000
6000
3000
0 2000
2001
2002
2003
2004
2005
2006
2007
YEARS
Figure 3.2 Zimbabwe inflation trend Source: Wikipedia
When operating in a normal environment, the construction industry employs about 6% of the total formal employment (ZCIC annual economic review on the performance of the construction sector). Figure 3.3 shows the number of workers employed in the construction industry industr y from 1996 to 2007. These figures show a downward trend in the employment levels in the construction industry as a result of the economic environment Nilson Biton 22
CHAPTER 3: THE IMPACT OF INFLATION ON PERFORMANCE prevailing in Zimbabwe. In March 2007, the Herald reported that one of the largest construction companies in Zimbabwe was retrenching 150 workers citing a lack of resources to meet the costs of a large labour force as well as the poor performance of the construction division. This is a clear indication of how hyperinflation affects performance.
Construction Workforce 40000
d e 35000 y o l p 30000 m e 25000 s r e 20000 k r o 15000 w e g 10000 a r e 5000 v A
Series1
0
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
Year
Figure 3.3: Construction workforce in Zimbabwe
The annual economic review on the performance of the construction sector in 2007(ZCIC) made the following comment, “ During the past five years Zimbabwe
experienced a slump in the construction sector mainly as a result of the shortage of foreign currency and the depreciation of the local currency against major currencies on the parallel market. The development discouraged the importation of building materials. The situation was exacerbated by high costs of building materials from the local market, where prices are pegged using fo reign currency rates on parallel market”. Indeed, as Mbiba, 2006 comments in his paper on decent work in construction that the construction has been hit hard by the economic problems leading to high construction Nilson Biton 23
CHAPTER 3: THE IMPACT OF INFLATION ON PERFORMANCE costs. This is further reinforced when one looks at how the construction costs have increased as shown in table 3.1. The rapid increase in costs can be appreciated if one looks at the cost index (last column table 3.1) or the detailed price indices for the civil engineering and building materials as shown in appendix A.
The key component of the construction sector is cement whose production has been drastically reduced owing to the price controls imposed on the manufacturers. Apart from price controls, fuel shortages and lack of spare parts has adversely affected the production capacity of the three cement producing companies in Zimbabwe, namely Larfage, Unicerm and Sino- Zimbabwe Plant. The cement shortages hit the construction sector after 2000 and the following media reports indicate how severe the situation had deteriorated crippling the whole industry.
For example see “Construction “Construction industry appeals for support: Little activity taking place countrywide –Established companies settling for small jobs” Business Herald, Harare, 27 January 2000;
“10 000 likely to lose their jobs in construction” Business Herald, Harare, 11
January 2001;
“Closures impact on construction industry” The Daily News, Harare, 14th
February 2003.
Contractors face imminent closure as a critical shortage of cement , fuel continue to compound problems, Business Herald, Harare 9 April 2003
Under these circumstances, it is clear that performance is greatly affected by hyperinflation as it creates an environment of shortages, job losses, and flight of skilled labour thus incapacitating the construction industry.
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CHAPTER 3: THE IMPACT OF INFLATION ON PERFORMANCE
Table 3.1: Construction (Building) Cost increases, 1995-2004 (Z$/m2) Year
Standard
Standard
Standard
Arithmetic
Index:
House
Factory
Office Block
Mean
1995=100
1995
2,300
1,300
2,500
2,033
100
1996
2,650
1,675
3,000
2,442
120
1997
3,530
2,270
4,750
3,507
172
1998
4,950
3,190
6,620
4,920
242
1999
8,915
5,760
12,040
8,905
438
2000
17,025
10,978
17,275
15,093
742
Mid-2001
29,200
18,000
30,950
16,050
1,281
Mid-2002
56,000
34,000
59,350
49,783
2,448
Mid-2003
800,000
550,000
750,000
700,000
34,426
Feb-2004
1,750,000
1,200,000
1,650,000
1,533,333
75,410
Source: Robertson Economic Information Services, Harare, Zimbabwe
Constructing a favorable business environment by means of a clear industrial policy is an extremely complex, if not impossible, task under high inflation. In Zimbabwe, this has severely troubled business operations by means of postponed or unfinished infrastructural projects and insufficient maintenance of roads and airports. Examples of unfinished and postponed projects of national importance in Zimbabwe include Joshua Muqabuko Nkomo international airport, Victoria Falls airport, National University of Science and Technology building projects, Mortuaries at Harare and Mpilo hospitals, Nilson Biton 25
CHAPTER 3: THE IMPACT OF INFLATION ON PERFORMANCE Tokwe Mukosi Dam construction, Manyame River Bridge and a host of others. Extreme and unpredicted government interventions cause uncertainty that harm business operations. operations. Macroeconomic inflationary problems seem to drive out long-term industrial policy. In particular, small and medium sized enterprises are not included in any economic plan. The complexities of the difficulties that arise from high inflation seem not to allow for striving after long-term industrial goal (Wit and Dyk, 1996).
Indeed, from the above analysis, hyperinflation is inextricably linked to the poor performance witnessed in the construction industry and the whole Zimbabwean economy. No major infrastructural developmental projects have taken off or completed in the last ten years in Zimbabwe.
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