Combating stagflation

"WHEN the United States sneezes, the rest of the world gets a cold, which affects investments," said J.P. Morgan Chase's 1973, Johannesburg office managing director, Ronald Gault. The observation is astute and incisive, given that the $14 trillion US economy accounts for nearly 30% of global GDP with its boisterous $57 trillion ($57,000,000,000,000) financial system.
My piece on January 24, "US recession and global woes," delved into the ongoing and progressive ailments of the US economy with its possible global implications.
Andrew Burns, author of the World Bank report, Global Economic Prospects 2008: Technology Diffusion in the Developing World, believes that "even if the recession were to happen, we believe growth in developing economies will slow down only modestly over the coming two years."
However, any potential spillover effects of a US recession on Bangladesh economy would be in the apparel sector, given that US markets account for nearly 30% of Bangladesh's entire apparel export earnings (approx $3 billion).
Bangladesh exporters, already losing market shares to Chinese and Vietnamese exports, will get hit hard depending on the severity of the US recession. Any strikes and lockouts must be averted; for saving factories from shutting down and, thus, saving jobs.
Before the US recession takes its toll on developing economies, Bangladesh has much too worry about its ongoing internal economic predicaments.
The country's development partners, including the WB, ADB, and IMF, have forecasted a lower economic growth of around 5.5% for the fiscal year 2008. On January 10, Bangladesh Bank differed with that estimate and revised its projection of GDP growth from the previous 7.0% to about 6%.
Achieving a growth rate of 5.5% or so will be quite laudable, given that the country had to withstand two natural disasters only months ago, whose ripple effects will reverberate for a long time.
The problem isn't GDP growth per se -- it's the virulent inflation and the continued loss of purchasing power of all groups; especially hard hit are the fixed income public servants, factory workers, and daily wage earners in farm lands. Loss of consumer confidence is a serious drag on the economy as well.
Many academic and "over the counter" economists (generalists) claim that the economy has become stagnant under the present regime. For example, Professor Kholiquzzaman Ahmed blamed the interim government for failing to institute proper market monitoring mechanisms to respond to commodity supply to contain the price spiral.
While addressing a seminar on January 19 on the "State of the economy and the way forward," Regulatory Reforms Commission Chairman (an economist), Akbar Ali Khan said, "Food price inflation had been lower during the last 15 years of corrupt political governments, as they were careful and serious about arresting food price hikes."
Defending the government, Economic Adviser Mirza Azizul claimed that all economic indicators, except inflation, are doing well. He, however, acknowledged the government's lack of success in reversing the course of soaring inflation, which reached 11.21% on a point-to-point basis in November.
All three economists are in my short list of people to whom I look up to for their acuities in various aspects of the country's politics and economics. However, the suggestion by Akbar that "food price inflation had been lower during the last 15 years of corrupt political governments as they were careful and serious about arresting food price hikes" cannot be backed by facts. The facts are:

• "Price spirals have been a cri de coeur from all quarters for over two years now [prior to 1/11]. The corrupt alliance government had ignored it the same way it dumped the terrorist menace and endemic corruption as the creation of the media and the opposition (DS: March 25, 2007 "Market failure and price spirals")."
• The interim government took over at a time when everything had come to a near standstill -- a civil war like commotion, with an economy flashing all the signs and symptoms of "market failure."
• No market monitoring of price movements existed until BDR started its retail sales centers -- an observation made by BDR's Col. Mujibul Huq who is heading the operation.
• Two unanticipated back-to-back natural disasters -- flood and Cyclone Sidr -- would pose challenges to any government, elected or unelected.
• Any suggestion that an elected government would have brought faster relief and efficient operations in procuring food from international market, securing food aid from donors, ensuring proper distribution, and managing the market distorted by soaring price all at the same time is not defensible -- looking at past records.
• The domestic food shortages and high prices arose partly due to natural disasters that occurred at a time when the world food supply was on the decline and food prices were spiraling at a record pace. The Food and Agriculture Organisation's food price index rose more than 40% in 2007, compared with 9% the year before.
• Inflation induced increased expenditure on food has forced a reduction in the consumption of other products. This is bound to contribute to the sluggishness in the production of industrial goods.

Economists, instead of identifying the confluence of slow growth and high inflation as stagflation, call it stagnant. As the old saw has it, if it looks like a duck, walks like a duck, and talks like a duck, then one might as well call it a duck.
The phenomenon of "stagflation" conjures up some puzzling combination of high inflation, high unemployment, and sluggish growth -- all occurring in tandem -- that poses a question to the policy makers as to what to do next.
In Keynesian theory, recessions (and implied unemployment) are tackled by inflation (stimulating aggregate demand), while inflations are derailed by recessions (raising interest rates). When stagflation is diagnosed, the theory is not only helpless, but fiscal and monetary authorities are also thrown into a conundrum as to what to do next.
If the country's growth recession is due to rising prices and loss of purchasing power, then it is prudent to identify the sources of inflation. In two of my recent articles (March 25, "Market failure …" and July 25, "Stagflation …)" I argued that non-monetary influences such as food and energy prices have largely contributed to price spirals. Add to that the shortages of agricultural inputs and the back-to-back devastating natural disasters.
Commenting on the dilemmas of the economy, CPD's Mustafizur Rahman has said that there is no magic wand to derail the accelerating inflation train, and recommended against using contractionary monetary policy to combat inflation. Obviously, this article embraces such views.
This article also embraces Akbar's suggestion that "we have no alternative but to invest more in agriculture to grow sufficient foods to contain food price inflation."
By reversing the price spiral through improving production conditions in the sectors in which prices are rising faster seems to be plausible recourse out of a nasty stagflation.

Dr. Abdullah A. Dewan is Professor of Economics at Eastern Michigan University.