Download Since Robert Mugabe took power in 1980, Zimbabwe`s

Zimbabwe:
A Country In Crisis
Public Policy 566: Macroeconomics
Winter 2007
Lisa Lewis
Paige Smyth
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Overview
Since Robert Mugabe took power in 1980, Zimbabwe’s economic state has deteriorated
to the point of collapse. Ranked as Africa’s worst economic performer in a recent United
Nations report, Zimbabwe has experienced a consistent decline in per capita gross
domestic product (GDP) since 1998 and also boasts the world’s worst inflation rate.
Under Mugabe’s control, the country has fallen into a state of dire crisis so extreme that
timely and accurate data fail to keep pace with its demise. In the following paper, we
attempt to present as accurate a description as the data allows, and offer policy
recommendations for what promises to be the very long road to economic recovery.
Economic Performance1
GDP
Zimbabwe experienced overall growth in GDP during the period of 1960 to 1998;
however, from this point forward, GDP fell consistently from approximately $8.3 billion
in 1998 to $5.5 billion in 2005.2 During this same period, population growth exacerbated
the economic hardship felt by individuals. Per capita GDP fell from $675 in 1998 to
$422 in 2005, and is believed to be dropping still.
Inflation
Inflation remains the single biggest problem in Zimbabwe. Although annual percentage
rates have never been particularly low or constant, it was not until 1998 that inflation
began its rapid escalation to today’s levels. Over the last ten years, prices have grown at
an average rate of 132.6 percent, according the World Bank Group. In 2006, prices rose
at an alarming speed to rates well into the 1000s; as recently as last week, rates were
projected to exceed 2500 percent by the end of the month.3 Rapid price changes worsen
conditions for citizens who are already struggling for food and basic necessities.
Money Supply
Zimbabwe’s hyperinflation results from huge increases in the money supply. In order to
meet debt obligations and to finance increases in government spending, the Reserve Bank
of Zimbabwe began printing enormous sums of money. In the last 5 years, money supply
increased by over 820 percent. Demand for foreign currencies is high, as the
Zimbabwean dollar has practically lost all store of value since printing continues without
production increases to back it up.
Debt
Public debt in 2006 was estimated at 108.4 percent of GDP, and external debt, owed in
foreign currencies, was $5.26 billion.4 The Zimbabwean government finances what it
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does repay on these liabilities through issuing new currency to draw down the value of
interest payments. Debt levels are worsened by an accompanying loss of income; tax
revenues have been plummeting due to massive losses in the previously dominant
agricultural sector.
Unemployment
Unemployment in Zimbabwe has reached unprecedented levels since the economic crisis
began. In 2005, unemployment was estimated at 80 percent of the labor force. As a
result, Zimbabwe ranks as the 197th worst country for unemployment out of the 200
countries for which data was available.5 By all accounts, unemployment still hovers near
80 percent and can only increase as the economy grows more unstable.
Interest rates
Zimbabwe’s issues with skyrocketing interest rates are caused by distortionary
macroeconomic policy. Prior to 2004, “legal restrictions… kept interest rates at or below
100 percent”.6 Since inflation had reached over 600 percent by then, keeping the nominal
interest rates around 100 percent led to negative real interest rates of up to 500 percent.
To avoid speculative bubbles caused by these negative real rates, Reserve Bank of
Zimbabwe governor Gideon Gono increased the interest rate to curb inflation, rather than
letting the rate be market determined. The lending rate was set at 500 percent in October
20067; some reports state that it may have been hiked as high as 785 percent 8 in March of
that year. The result is stifled economic growth, since potential domestic investors
cannot afford to borrow funds. In addition, many debtors cannot afford to pay amounts
they already owe, which generates significant losses for banks.
Currency Devaluation
Since Zimbabwe increased their money supply, setting off the exponentially increasing
inflation crisis, the exchange rate has fallen dramatically. In 2003, one could officially
obtain 0.824 Zimbabwean dollars (ZWD) for one US dollar.9 Since July 31, 2006, the
official exchange rate has been pegged to the US dollar at the rate of 250 Zimbabwean
dollars per US dollar.10 However, the non-official exchange rates from the black market
show even greater declines; one US dollar is now worth 5,000 Zimbabwean dollars.11 In
August 2006, the central bank both redenominated and revalued the Zimbabwean dollar.
One thousand old Zimbabwean dollars became one new Zimbabwean dollar. In addition,
the bank devalued the foreign exchange rate of the Zimbabwe dollar by 60 percent to the
US dollar.12 While it is more convenient for consumers to carry many fewer pieces of
paper for their transactions, the system of pricing based off the parallel informal market
means these changes in policy will likely have little effect on Zimbabwean citizens.13
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Macroeconomic Vulnerabilities and Failures in Zimbabwe
President Robert Mugabe
Zimbabwean President Robert Mugabe is largely to blame for the country’s dire
economic status and reputation among international powers. He spent hundreds of
millions of Zimbabwe’s money on the war in the Democratic Republic of the Congo, and
his controversial land reform measures forced white commercial farmers off their lands
without compensation, prompting a drop in agricultural production and employment as
well as mass food shortages in the country.14 With the help of Gideon Gono, Governor of
the Reserve Bank of Zimbabwe, Mugabe’s regime continually employed distortionary
regulations, including interest and exchange rate manipulation and price controls. These
policies only served to worsen Zimbabwe’s economic condition.15 Since the beginning
of his leadership, hyperinflation has ravaged the country’s formal markets; it continues to
be the biggest problem in Zimbabwe’s economic future.
Hyperinflation
The quantity theory of money tells us that a certain amount of money growth is needed
for growth in production. Any growth in money beyond this ‘increased transaction’ level
will lead to inflation.
 = (M/M) – (Y/Y)
In Zimbabwe’s case, money supply has been increasing at very high rates because of both
the central bank’s ‘quasi-fiscal operations’ and the growing government deficit due to
unbudgeted spending.16 At the same time, growth in production has been negative,
leading to extremely high levels of inflation.
Making matters worse, the government regulates exchange rates and interest rates within
certain ranges, making it impossible for these values to reach true market values in the
formal market. Price controls and ‘official’ exchange rates cannot keep pace with the
rate at which the Zimbabwean Dollar is devaluing. As a result, informal or black markets
functioning in foreign currencies like the South African Rand, the Euro, and the U.S.
dollar dominate most civilian transactions.17
Hyperinflation amplifies all the customary costs of inflation, including menu costs,
resource allocation inefficiencies, and the general inconvenience and destabilization
caused by constantly changing prices and black market emersion.
Recommendations
The aforementioned series of macroeconomic events has wreaked havoc on the
Zimbabwean economy, and the future looks bleak on every front. All hope is not lost,
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but recovery will require both drastic actions and patience, as it will not be a quick
process.
Recommendation One: Curb Inflation
The biggest obstacle Zimbabwe needs to overcome is hyperinflation. Without
ameliorating this situation, any other attempts at stabilization are likely to be completely
ineffective. Just as increasing the money supply caused the hyperinflation, contracting
the money supply will help alleviate the hyperinflation. In the short run, this contraction
will cause a drop in output, which will be difficult for Zimbabwe since their output levels
are already so low. However, in the long-run, contracting the money supply will
decrease price levels and leave output unchanged. The specific details of these effects
are discussed below.
The Short Term Effects of Contracting the Monetary Supply
Prices are sticky in the short run; thus, contraction of the money supply will manifest
itself through changes in domestic interest rates and output. This can be represented
using the IS-LM model.18
As Zimbabwe takes steps to reduce the amount of currency in the economy, the supply of
real money balances will fall, shifting the money supply curve back and to the left while
holding money demand constant. Both nominal and real interest rates will increase, but
because expectations for inflation will likely remain high at least in the very short run,
nominal rates will likely increase more than real interest rates. At every level of income,
the interest rate for money market equilibrium will be higher; therefore, the LM curve
will shift back and to the left. Holding expenditures constant, this results in lower output
overall. Current real interest rates are well below the world rate. Contraction should be
continued until domestic interest rates equal the world interest rate in order to promote
equilibrium between the current and capital accounts.
Long Term Effects of Contracting the Monetary Supply
For a country already experiencing an economic downturn, the further drop in output
associated with monetary contraction will be painful, but necessary. Unemployment will
likely rise as production decreases; however, both effects are short term. In the long run,
the classical model shows us that output will be restored to pre-contraction levels as price
stabilizes.19
In the long run, output is fixed at a level dictated by the production function and levels of
capital and labor. As money supply decreases, aggregate demand will fall, shifting the
curve down and to the left. The new equilibrium will be established at a lower price
level, where aggregate demand equals long-run supply as dictated by the production
function.
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Recommendation Two: Repair Relationship with the IMF and World Bank
Zimbabwe has been in arrears with the International Monetary Fund (IMF) since early
2001. An IMF review in February 2007 resulted in continued suspension of financial
support and Zimbabwe’s voting rights, but IMF has yet to expel the country entirely. To
get back in the graces of the IMF, Zimbabwe needs to follow these institutions’
comprehensive suggestions for economic stabilization. Furthermore, Zimbabwe will
need the help of the international community during reform times to keep order and to
provide humanitarian aid to its people. The soured relationship between now isolated
Zimbabwe and the international community will need to be repaired if Zimbabwe has any
hope of full and long-term recovery.
Conclusion
Both of these recommendations are likely contingent on a change in political regime.
While political analysis is beyond the scope of this macroeconomic paper, it must be
mentioned that the crisis in large part originated, and continues, because of poor
leadership. President Mugabe has made clear that Zimbabwe does not need outside help,
especially from the World Bank or IMF. Furthermore, he blames Zimbabwe’s crisis not
on poor macroeconomic decisions, but on the lack of support provided by the
international community in response to his land reform policies. He continues to make
poor economic decisions despite the overwhelming evidence of Zimbabwe’s crisis.
Thus, both of the aforementioned recommendations will probably require Mugabe’s
ouster. Whether this is politically feasible or not remains to be seen, but transfer of
power and new, more effective and responsible leadership seems necessary for
Zimbabwe to take the first steps to recovery.
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Graphs
Money Supply in Zimbabwe, 1975 - 2005
50,000,000
Money Supply (Millions ZWD)
45,000,000
40,000,000
35,000,000
30,000,000
25,000,000
20,000,000
15,000,000
10,000,000
5,000,000
0
1970
1975
1980
1985
1990
Year
Source: World Development Indicators 2006
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1995
2000
2005
2010
Inflation in Zimbabwe, 1960 - 2005
400
Percent Inflation (with GDP Deflator)
350
300
250
200
150
100
50
0
-50
1960
1965
1970
1975
1980
1985
Year
Source: World Development Indicators 2006
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1990
1995
2000
2005
GDP in Zimbabwe, 1960 - 2005
9,000,000,000
Gross Domestic Product
(adjusted to USD in year 2000)
8,000,000,000
7,000,000,000
6,000,000,000
5,000,000,000
4,000,000,000
3,000,000,000
2,000,000,000
1,000,000,000
0
1955
1960
1965
1970
1975
1980
1985
Year
Source: World Development Indicators 2006
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1990
1995
2000
2005
2010
IS-LM Model
LM2
LM1
R*
r1
IS
Y2
Y1
Long Run Aggregate Supply Model
LRAS
P1
AD1
P2
AD2
Y
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End Notes
1
See appendix for graphs.
World Bank Group. World Development Indicators. Constant 2000 U.S. Dollars.
3
“Zimbabwe Inflation to Explode.” Cape Times: Business Report. April 4, 2007.
4
"Zimbabwe." The World Factbook. 15 Mar. 2007. CIA. 3 Apr. 2007
<https://www.cia.gov/cia/publications/factbook/geos/zi.html>.
5
"Rank Order - Unemployment Rate." The World Factbook. 15 Mar. 2007. CIA. 5 Apr. 2007
<https://www.cia.gov/cia/publications/factbook/rankorder/2129rank.html>.
6
"Cash Shortage for Zimbabwe Banks." BBC News 12 Jan. 2004. 6 Apr. 2007
<http://news.bbc.co.uk/2/hi/business/3389581.stm>.
7
"Zim Interest Rates Up to 500%." News24.Com 9 Oct. 2006. 6 Apr. 2007
<http://www.news24.com/News24/Africa/Zimbabwe/0,,2-11-1662_2010493,00.html>.
8
"Zim Hikes Rates to 785%." News24.Com 16 Mar. 2006. 6 Apr. 2007
<http://www.news24.com/News24/Africa/Zimbabwe/0,,2-11-1662_1899624,00.html>.
9
"Zimbabwe." The World Factbook. 15 Mar. 2007. CIA. 3 Apr. 2007
<https://www.cia.gov/cia/publications/factbook/geos/zi.html>.
10
"Zim Economy to Sink Further Into Mire." ZimOnline 24 Nov. 2006. 8 Apr. 2007
<http://www.zimonline.co.za/Article.aspx?ArticleId=513>.
11
Biles, Peter. "Zimbabwe Devaluation is Ruled Out." BBC News 31 Jan. 2007. 8 Apr. 2007
<http://news.bbc.co.uk/2/hi/business/6319265.stm>.
12
Mugari, Shakeman. "What Zimbabwe's Currency Reform Means." BBC News 29 Aug.
2006. 8 Apr. 2007 <http://news.bbc.co.uk/2/hi/africa/5296192.stm>.
13
Zimbabwe. Reserve Bank of Zimbabwe. 3 Apr. 2007 <www.zimdollar.co.zw>.
14
Rawlins, Rachel. "Zimbabwe: Economic Melt-Down." BBC News 18 Oct. 2000. 8 Apr.
2007 <http://news.bbc.co.uk/2/hi/africa/978768.stm>.
15
International Monetary Fund. Public Information Notice PIN No. 04/104. September 17,
2004.
16
International Monetary Fund. Public Information Notice PIN No. 05/189. October 4, 2005.
17
Thornycroft, Peta. "Inflation Forces Citizens Into Mafia Economy." The Sunday
Independent (South Africa) 11 Mar. 2007. 8 Apr. 2007
<http://www.int.iol.co.za/index.php?art_id=vn20070311085626429C172551>.
18
See appendix for model graph
19
See appendix for model graph
2
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