CHAPTER 1ONE

INTRODUCTION AND OVERVIEW OF THE STUDY

BACKGROUND AND PROBLEM STATEMENTINTRODUCTION

Labour market economists have frequently focused on the resource market activities to forecast
inflationary pressures among other macroeconomic fundamentals. This is in line with the famous
Phillips curve analysis which uses unemployment to predict price inflation. According to this
analysis, it can be concluded that a low level of unemployment is associated with rising inflation.
The analysis postulates that, if an increase in aggregate demand for goods and services cause
unemployment to fall, below some natural rate, then inflation should accelerate. However,
during periods of high unemployment in Zimbabwe, for example, between 2000 and 2007,
inflation never showed a downward trend. Is this due to the Zimbabwean definition of
unemployment or is because of other factors? Staiger, Stock and Watson (1997), suggests that
unemployment rate is a weak tool for forecasting inflationary trends. With uncertainty about the
unemployment rate’s reliability as an early-warning device for rising inflation, recent attention
has turned to wage growth as labour market predictor of inflation.

G. Lipsey (1960) concluded that buoyant demand reduces unemployment at the expense of
inflationary pressure. When demand for labour is high, firms start bidding against each other.
This will give workers more wage bargaining power for salaries that do not commensurate with
productivity. Awarding workers these higher wages leads to higher prices and this will be
followed by even more higher wages and so on; a phenomenon known as “the wage –price
spiral” in the language of economics. Thus, the theory postulates that, if wage costs rise faster
than productivity, the price level may rise as firms pass forward increased wage costs in the form
of higher product prices. Hence, changes in productivity-adjusted wages are believed to be a
leading indicator of future inflation.

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The intuition behind the view that higher wages cause higher prices is that, since labor costs are a
large fraction of a firm’s total costs of production, an increase in wages puts pressure on firms to
pass the burden to households in form of higher prices. This analysis is incomplete, for it does
not take in cognizance the elasticity of supply. First, an increase in wages will not create
inflationary pressure if the increase is brought about by improved labor productivity. Hence,
controlling for labor productivity in the analysis between wages and prices would seem very
important. Second, an increase in wages will not create inflationary pressure if the increase in
wages leads to a squeeze in a firm’s profits due to their inability to pass along cost increases. No
firm inherits the right to simply ‘mark-up’ the prices of its output as a constant proportion above
their costs, as competitive market pressures provide a strong influence on the pricing decisions of
firms. Finally, the causation could work in the opposite direction; an increase in aggregate
demand may tempt firms to raise the price of their products. The resulting increase in profits
would lead workers to demand a higher wage in future negotiations.

However this cost-push view of the inflation process does not recognize the influences of
Reserve Bank policy and the resulting inflation environment on determining the causal influence
of wage growth on inflation. Kwashirai (1991) blamed money printing in developing countries
to finance huge and unsustainable budget deficits as the main cause of inflation; and Zimbabwe
is no exception. In Zimbabwe the monetary policy can not be ignored in as much as factors
affecting inflation are concerned. Of late the galloping inflation has been blamed on the RBZ for
its policies especially of money printing. This is in line with the Monetarists who view inflation
as a monetary phenomenon. They believe excess money in circulation will see aggregate demand
outstrip supply. According to this view, the causation runs from inflation to wage growth. Firms
raise the price of their products because of excess aggregate demand caused by an expansionary
monetary policy. The resulting increase in prices leads workers to demand higher wages. This
challenges the first proposition which assumes wage inflation granger Granger causes price
inflation.

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BACKGROUND OF THE STUDY

For the past few years, the Zimbabwean economy has deteriorated progressively although it was
once the engine for growth in Africa. Real output has dropped by over one-third cumulatively
since 1995. Inflation reached 269 percent in 2003 and through to by 10452.6 percent by the end
of 2007 (CSO, 2007). To some extent this high inflation has contributed to a continuous
deterioration of social conditions. Severe food shortages have necessitated massive food imports
and donor assistance, as two-thirds of the population required food aid in 2002. The balance of
payments has been under severe pressure since 1999, when Zimbabwe began to accumulate
payments arrears. There is little productive investment in the economy, and there are reports of
significant capital flight and emigration of skilled labor.

The economic crisis in Zimbabwe of late reflects to some extent inappropriate economic policies,
loose fiscal and monetary policies, the maintenance of a fixed exchange rate in an environment
of rising inflation and administrative controls. Increased government intervention have driven
most of economic activities out of the formal sector, and contributed to the chronic shortages of
basic goods and services, and foreign exchange among other things. The severity of Zimbabwean
problems has also been exacerbated by the fast-track land reform program, recurring droughts,
and the HIV/AIDS pandemic. Meanwhile, investor confidence has been eroded by concerns over
political developments, weak governance and corruption, problems related to the implementation
of the government's land reform program, the push for an increased indigenization of the
business sector, and the selective enforcement of regulations. Monetary policy remained
accommodative throughout 2002.

The period before independence in Zimbabwe was associated with income inequalities between
the blacks and whites, the distribution was skewed in favor of the later. For example, according
to ILO, during the pre-independence period an average European was earning 10.4 times as
much as a black Zimbabwean was earning. This was due the oppressive laws that were
prevailing at the moment, besides trade unions for whites were more powerful than those for
blacks. Despite these low wages, unemployment for blacks was higher, for example it was 52 per
cent in 1972 compared to 3% for the whites. According to the Central Statistical Office of

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Zimbabwe the annual inflation was below 10 per cent between 1970 and 1980. After
independence, the government implemented policies whose aim was to reduce income disparities
between blacks and whites. This saw more blacks getting jobs, there was also an improvement is
in salary due to minimum wage policies introduced by the government. Wages in most sectors
surged by between 12 and 34 per cent soon after independence. According to Ncube (1997) the
spectacular economic growth rate of 10.6 per cent in 1980 and 9.7 percent in 1981 also
facilitated to the substantial growth in real wages; it was not only the minimum wage policy by
the government. The increase in wages was also matched my surge in inflation, because the
government did not factor in productivity in setting these minimum wages.

In 1990, IMF advocated for ESAP and this saw the government embarking on a liberalization
programme that involved the deregulation of the labour market among other sectors. ESAP
impacted negatively on the labor market through the fall in real wages although nominal average
national wages continued to rise (CSO, 2006). Inflation was also worsened by the tremendous
increase in other macro prices, in particular interest rates, and the depreciation and devaluation of
the Zimbabwean currency. Since the introduction ESAP in 1990, inflation has been on an
upward trend from levels of below 10% to 339.3% in 2004 and 567 % in 2008. For the same
period real wages had been going down, for example, to less than US $10 per month in
December 2008.

1.2 STATEMENT OF PROBLEM

There has been a drastic increase in the Zimbabwean annual inflation during the period under
study (1970-2008). Precisely, for example, the annual inflation has risen from below 10% during
the Colonial Colonial Era Era to 360% in 2003 and more than a billion in 2008. The
unemployment rate has also steadily risen to 90.1% in December 2008, (ILO). Basic
macroeconomic objectives view high inflation (at least more than two digits) and high
unemployment as social ills that must be rectified. According to IMF an average Zimbabwean
has been surviving on less than one American dollar a day. This could be as a result of rising
inflation levels. Bargains for high nominal salaries by labour unions against the background of
declining productivity have worsened the situation in Zimbabwe. Against this background, it is a

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necessary condition the question that comes to the fore are, to empirically determine if there is
causality between inflation and wage growth in a regime of high inflation and associated
question is, what is the direction of causality?. Despite the potential harm the wage-price spiral
pose to the economy, empirical evidence to ascertain the direction of causality for policy
formulation purposes is still scanty in Zimbabwe. Knowing the direction and strength of
causality if any would enable the government to enact policies and implement strategies that
would strike a balance or at least stabilise one of the variables.

1.3 OBJECTIVES OF THE STUDY

The study seeks to establish the direction of causality between inflation and wage growth in
Zimbabwe, in order to better inform the policy debate on how hyperinflation can be tamed.
In particular, the study seeks;The broad objective of the study is to examine the relationship
between wage inflation and consumer price inflation in Zimbabwe. However, the specific
objectives of the study are as follows;

1. To present an overview of the Zimbabwean labour market since ….

2. To establish empirically whether a causality relationship exists between consumer price
inflation and wage growth.
3. To determine empirically the direction of causality between wages and inflation in
Zimbabwe using econometrics techniques.
4. To make recommendations on how inflation can be tamed.based on the findings.

JUSTIFICATION AND SIGNIFICANCE OF THE STUDY

There are several reasons for adopting this study. Rising inflation to a point where prices would
change several times a day for the period under study is a cause of concern. Inflation also causes
low worker morale, which affects productivity, affects the supply of goods and services, retards
economic growth, and imposes a penalty on savers who are a key to any future investment,
growth and development. It is against the background of the above social and economic costs
that inflation has generated widespread debate and controversy in Zimbabwe. Only a low level
of inflation is ideal to stimulate production and not the highly escalating one which reduces

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investor confidence.

Although various studies on causality between price and wage inflation have been done in
developed nations as well as developing countries, generalizations of such results to Zimbabwe
may be inappropriate especially after considering that the Zimbabwean economy has factors
which are peculiar to it.
Also, earlier studies elsewhere on labour market activities used the unemployment rate variable
of the Phillips curve for forecasting inflationary trends. My study will employ wage inflation as
an early warning device for rising inflation. Recent world attention has turned to wages as the
current fashionable labour market indicator for inflation and not the old fashioned
unemployment.

Also Literature on the Zimbabwe labour market is very little. Among these are Ncube (1997),
Kanyenze (1996), Knight (1996) and Fallon and Lucas (1993). Ncube (1997) had focused on the
dynamics of employment while Kanyenze (1996), Knight (1996) and Chitiga (1996) looked at
other various aspects such as the effects of ESAP on the labour market. Of this literature, little
attention has been paid to the causation of wages to inflation,

Despite the potential harm the wage-price spiral pose to the economy, empirical evidence to
ascertain the direction of causality for policy formulation purposes is still scanty in Zimbabwe.
Knowing the direction and strength of causality if any would enable the government to enact
policies and implement strategies that would strike a balance or at least stabilise one of the
variables.

1.5 HYPOTHESIS

The study will test the following hypotheses;

• Ho: Wage growth in Zimbabwe Granger cause consumer price inflation

• H1: ?????

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 • is correlated with price inflation. The study hypothesises that there is an association
between price and wage inflation in Zimbabwe.
• The direction of causality runs from wage inflation to price inflation. The study therefore
test the hypothesis that wage cost push have translated into price inflation under the
period of review. This means that we expect wage inflation to cause price inflation in
Zimbabwe.

1.6 ORGANISATION OF THE STUDY

The study will be organized in six chapters. Following this introductory chapter, chapter two will
give an overview of Zimbabwe’s labour market since the Unilateral Declaration of Independence
(UDI) particularly with regards to wage development and the possible spill over to the price
inflation. Inflation dynamics and trends will also be incorporated in the same chapter. Chapter
three will review the theoretical and the relevant empirical literature on wage determination
theory and inflation theory. The fourth chapter presents the research methodology, outlines the
data sources and discuses variable to be used in the study. Chapter five analyses and interprets
results obtained while chapter six concludes the study, giving key findings, policy
recommendations and suggestions of areas for further studies.