A reader recently asked for more explanation on the precise challenges facing Zambia. This is a huge question! We have already said much about this subject through many posts, especially on our Facebook page. But we appreciate that there is a lot more to be said than we have said.
Simply put, the situation facing Zambia is one of having many policy objectives (problems) but insufficient policy instruments (solutions), in face of serious external supply shocks. Zambia is failing the "Tinbergen Rule".
The rule reminds us that the number of policy targets (objectives) demands at least the same number of policy instruments. In simple english, you can't solve three problems with one or two solutions! You need at least three solutions.
Let us explain this conundrum in our context. Zambia currently has three major supply shocks. Electricity supply has substantially reduced due to load shedding. This has increased the cost of doing business in Zambia. The result is higher prices and lower output.
The other supply shock we are currently seeing is reduced agriculture output. Poor rains and load shedding, coupled with higher costs of inputs (due to weak exchange rate) means agriculture output will continue to struggle going forward. The result is higher prices and lower output. On top of the usual institutional and microeconomic challenges facing mealie meal.
The largest supply shock is in the mining sector. Lower external demand for minerals coupled with lower electricity output has translated in lower copper production. This has in turn led to weak dollar receipts and substantially depreciating exchange rate. The result again is higher prices (more expensive imports) and lower output (because some production inputs are more expensive, and obviously because copper production itself is down).
Now let us throw in the mix other challenges. Price expectations have been revised upwards! Everyone is now asking for higher wages because the cost of living is very high. This threatens even higher inflation going forward. Given the rising cost of production, such demands can only be met at the expense of less hiring of new workers and reduced capital investment in the short term.
So to sum up the three policy challenges facing Zambia are : lower national output; high inflation; and, high unemployment especially in urban areas. The challenge for Government is how to deal with all these three problems! This is where the Tinbergen Rule has become important.
The government has so far relied solely on monetary policy. The Bank of Zambia increased interest rates (the price of money) substantially in order to reduce spending as a way of controlling inflation. It has also undertaken other liquidity tightening measures.
Hopefully we can now already see why this is a big challenge. Higher interest rates reduce spending, which is okay if you are facing a demand shock. But Zambia is facing supply shocks. So higher interest will now lead to even more reduced output.
Now remember that unemployment is high and output is already falling! So in the short term the BOZ policy may achieve some price stability, but it will also substantially reduce output. The result may be even greater inflation at even lower levels of output in the medium term, if it chokes output too much! Incidentally, we must remember that inflation reduces real wages further curtailing people's spending power.
What we need therefore is a combination of fiscal and monetary policy. Higher interest rates should ideally be accompanied by greater fiscal SPENDING on the PRODUCTION side to stabilise output. If this does not happen the economy could become like Venezuela, with higher prices (hyper inflation) and ever shrinking output.
The problem is that Zambia has a serious fiscal deficit problem. Simply put it has no money to stabilise the production side unless it substantially rebalanced its spending. It is not austerity it needs, it needs to REPRIORITISE it's spending, away from consumption and focus urgently on productive sectors. This means a complete rethinking of the role of government going forward.
Above all there is need now to restore policy credibility. As we have repeatedly noted, a big problem at the moment is that Zambia has missed its budget spending targets year or year. This is as a result of poor management of the economy by the Finance Minister. This has reduced money market investment and helped weaken the exchange rate.
Although the credibility of the Bank of Zambia is also being restored after the failures of Gondwe, we are suffering from poor credibility on the fiscal side. It is not about cutting the number of embassies abroad or stopping new projects, what markets want is a step change in fiscal competence. Markets need someone they will immediately recognise as a credible finance minister. We don't have one at present.
We have already note that we think N'gandu Magande is the best candidate at present because his reputation is well established. His appointment would send a powerful signal to the markets, especially if the President explained publicly his appointment. We would of course need new economists to steer the Ministry of Finance (MoF) in the right direction. We must clear all the decks at MoF.
A lot of Zambian economists at home and many abroad are willing to help at this critical hour to help the government come up with policies that would make Tinbergen proud. We need policy solutions whose number match policy objectives. But it needs humbleness by those with the power to act - to reach out for help! You can take a camel by an oasis, but you can't make it drink water!
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