When there is too much money in circulation relative to the volume of goods and services available for purchase, you have inflation. In the US, the historical annual inflation rate (measured as the rate of change in the consumer price index) has ranged from 3 to 4%. In the Philippines, it has ranged from 6 to 10%. At this rate, a basket of grocery items bought in a Filipino supermarket will double in price every 7 to 10 years.
This sounds bad enough, but imagine what will happen during hyperinflation, which has been defined as an inflation rate of more than 50% per month. It doesn't take a math genius to see that money will become worthless real fast. This has happened many times in the 20th century: Germany in the 1920s under the Weimar Republic (when prices doubled every 49 hours); Greece during the German occupation of World War 2 (prices doubled every 28 hours); Hungary at the end of World War 2 (prices doubled ever 15 hours); Yugoslavia from 1993-1994 (prices doubled every 16 hours); and the list is not exhaustive.
Hyperwage leads to hyperinflation. The Street Strategist correctly identifies hyperinflation as the greatest nemesis of hyperwage theory. When domestic helpers expect to be paid P20,000 a month, the Central Bank will be forced to print more money to meet the demand for it. The excessive growth in money supply (quantity theory of money), coupled with excessive growth in demand for goods and services (demand-pull inflation), and rapidly rising labor costs (cost-push inflation) will all combine to produce escalating prices. The immediate effect will be the suppression of business activity. What entrepreneur would want to do business in this environment where profit margins are being shaved off by the rising costs? A masochistic entrepreneur, perhaps.
Bentulan counters this argument by saying that the increased purchasing power of domestic helpers will actually stimulate business activity and increase profit margins. The producers of goods and services will supposedly make more money due to the increased demand. Well, this is only correct if the cost of production stays the same while the purchasing power of the consumers goes up. But if the cost of production rises in tandem with or faster than the increase in consumer purchasing power, then what have you really achieved except add a few more zeroes to your currency?
Bentulan also does not take into consideration the fact that there may be a long lag time before production capacity adjusts to the surge in demand. As I said before, goods and services will first have to exist before money can buy them. Just because a domestic helper's wage has been boosted to P20,000 a month does not mean that there has been a corresponding increase in the amount of goods and services she can purhcase. Capital will first have to be invested to build the factories, hire the workers, and deploy the technology needed to manufacture the cell phones and breast implants that the domestic helpers crave.
But since production costs have already escalated due to the prior legislated hyperwage boost, then capital investments have just been made unattractive. This situation will benefit producers who are well positioned to meet the demand. Who are these producers? Likely the deep-pocketed multinational corporations not affected by the hyperwage law who have the means to adjust quickly to the demand surge - since they already have existing factories and the technology in neighboring countries like China where the labor costs are low. This means Filipinos will end up importing these goods and services. Obviously, less capitalized domestic Filipino producers will bear the brunt of hyperwage. They will be decimated.
Hence, the great unintended consequence of hyperwage theory is that it may cause the Philippines' to become a net importer of merchandise. This state of affairs will reduce the country's Gross Domestic Product, given that GDP = consumption + investment + (government spending-taxes) + (exports − imports). Hyperwage may indeed result in a rise in consumption, but if it also reduces investment and causes the net export (gross export minus gross import) to become negative, then it doesn't help overall economic growth.
In summary, Thaddeus Bentulan's Hyperwage Theory was a very entertaining series of articles which forced me to brush up on my economic knowledge. It's a great read even though I have my reservations about it. The biggest objection to it is the threat of hyperinflation that hyperwage will engender, and its detrimental effects on domestic industries which will bear the brunt of high production costs. The much touted economic benefits of increased consumption may only be negated by hyperwage's suppressive effects on investments and its promotion of import dependency.
Bentulan promotes hyperwage as the cure to Philippine poverty. Alas, it is a drug that will kill the patient before its beneficial effects will have a chance to kick in.
¶ 6:43 AM 2 comments
Thaddeus Bentulan aka the Street Strategist shocked his readers when he proposed that the minimum wage of Filipino domestic helpers be turbocharged to P20,000 a month. He laid out this proposal (which he calls Hyperwage Theory) in his 33 week series of articles which appeared on Businessworld in 2005. Bentulan believes that it is the most effective solution to Philippine (and Third World) poverty. The merit of his idea is still being hotly debated in the econ-oriented blogosphere.
In his blog , Thaddeus explains his Theory as follows:
"The minimum wage shall be set to a level that shall give purchasing power to the minimum wage earners, including domestic helpers, unlike current levels wherein the domestic helpers have almost zero purchasing power. A hyperwage resulting in real purchasing power will stimulate domestic demand which in turn will stimulate production which in turn will stimulate employment. This domestic demand, under the power of the economic multiplier will result in increased production of goods or services which in turn will result in more employment in a positive upward spiral. "
Reading this paragraph brought back memories of my econ classes in college. Economics was not my major, but I found it to be interesting....interesting because my college years were bad economic times for the Philippines, and I wanted to understand why that was the case. I thought my Econ 1 course would help me answer my multitude of questions. I believed (naively as it turns out) that poverty can be eradicated simply by giving the poor more money. Why not just print more of the stuff and give them out? After all, when I applied this strategy on myself, it seemed to work. When I ran out of cash, I simply asked my parents for more of it, and that solved my cashlessness. Why can't the government do the same for poor people? Of course I was only 17 years old at that time, and the deeper logic of economic theory eluded my understanding as my powers of concentration were easily overwhelmed by many other distractions, not least of which was this thing called "the opposite sex".
But there is one concept that I did retain from my econ classes which I find very relevant to the discussion of hyperwage theory: inflation. Lay people hear this word often enough through the media that we have formed an opinion about its adverse effects on economic health. Inflation is bad. It is the monster that we must slay if we are to achieve a measure of prosperity. But what is inflation anyway? I can refer you to technical definitions of it, such as this. But I also would just like to define it in my own non-economist's language. Somebody said that if you can't explain a concept in your own words, you don't really understand it.
I understand inflation by imagining myself living in an island in the south Pacific Ocean. The island's chief food source is coconuts. He who has lots of it is considered rich because he can sustain his life for as long as the coconut supply doesn't run out. He who has few or none of it is considered poor. Unfortunately, the supply of coconuts is finite. There is a natural limit to how many coconut trees can grow on this small island. I happen to be one of the poor inhabitants. I own only 2 coconut trees while my neighbor Pablo owns hundreds of them in his plantation.
Despite our islands' backwardness, we do have a market system here where we can buy and sell coconuts using a medium of exchange - the peso. As my bad luck would have it, not only do I have few coconuts to trade, but I also only have five 1-peso bills in my possession. By all measures I am poor. I'd like to buy some of Pablo's coconuts but I can't afford them - I don't have enough pesos.
One day I concoct a plan to obtain more pesos: I decide to manufacture more of them. I own a small printing machine. Heck, I'll just print as many pesos as I want, and then buy out Pablo's coconut trees. That should do it! So I go to Pablo's house, deliver a trunkful of 1 peso bills that I printed, and offer to buy out his trees. There's just one hitch. Pablo won't sell them to me. He says that the actual coconuts are more important to him than the peso bills. Even if I gave him a million pesos he will still not part with his coconuts because he knows that the number of coconut trees the island can grow is finite. He can eat the coconuts but not the peso bills.
The point I am making here is this: money is just a piece of paper. It is worthless unless it can be converted into usable goods. If the amount of goods (and services) available for purchase is limited, then no matter how much money you have in your pocket, you will not necessarily be able to buy these goods and services. You will have to bid higher and higher prices in order to persuade the seller to sell to you. This is what inflation is: too much money chasing too few goods and services. Prices will rise as a result.
This brings me to the relationship betwen money and wealth. Money is not equivalent to wealth. Wealth is everything money can buy (and more). Wealth is the stuff that people use (food, clothing, cars, medicines, land, houses etc) to sustain their lives. These goods and services constitute true wealth. Money is simply a mechanism by which these goods and services are exchanged between those who produce them and those who consume them. Printing more money does not increase the total amount of wealth in a society. It does not increase the number of cars, clothes, or homes that are available for purchase. A country becomes truly wealthy if the aggregate amount of goods and services that it produces goes up, not if the total amount of money in circulation goes up.
This isn't to say that money is unimportant. Money is very important because it makes the trading of goods and services more efficient. But the key point is, these goods and services have to exist in the first place before they can be traded using money as the conduit.
Now that I've given my non-economist's definition of inflation, I will talk about the hyperinflationary effects of hyperwage theory. That's right, hyperwages lead to hyperinflation. The professional economists who criticize Thaddeus' theory understand this. Thaddeus himself acknowledges it. Paying domestic helpers P20,000 a month will cause them to purchase more goods and services. However, if these goods and services are in short supply, their prices will have to go up. Everything from the prices of breast implants, cars, cellphones, clothes, food, TV sets, etc will spiral out of control. That's because the production capacity of the economy is never infinite. We live in a range-bound world. There are just so much raw materials, land, factories, and people available to churn out these goodies.
Next installment: More on Hyperinflation
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¶ 10:37 AM 0 comments
