Inflation In The South African Economy Economics Essay

Inflation is one on the most important features of the South African economy. Basically, if price levels are not kept within control, a whole economy can be destabilized. That’s why most governments favor a low-steady rate of inflation. In May 2010, a strike led by two trade unions of Transnet over poor working conditions led to a sudden increase in wages which was well above the inflation rate of 5.1%. Transnet being South Africa’s largest freight chain that delivers goods all around the country stopped most of the activities due to absence of workers. This strike had some effects on the economy which shall be explained using the AS-AD framework to show that the increase in wages and the impact of the strike will definitely lead to an increase in general price levels.

The initial impact of the strike was a loss of production because workers stopped all activities throughout the country. Transport services were not running during the strike period and as Transnet is ‘the largest and most crucial part of the freight logistics chain that delivers goods to each and every South African’ (Transnet, 2010); coal exports, shipping and fuel distribution all over the country were affected. The main challenge that the South African leading petroleum companies had to face was the distribution of the fuel. Also, the activities of the refineries and depots of petroleum products had been stopped due to the absence of workers to drive the trucks. ‘If prolonged, the strike will create bottlenecks in the industry, with refineries likely to experience an oversupply of petroleum products. Tshifularo said SA’s refineries, which are in Durban, Cape Town and Sasolburg, could be forced to scale down their production.’ (Njobeni, 24 May 2010) http://allafrica.com/stories/201005240034.html. Since aggregate supply is dependent on quantity of labour, the result of the strike caused the Short Run Aggregate Supply curve (SRAS) to shift to the left. A decrease in number of workers means that production levels decreases hence firms have to increase their output costs.

While Transnet agreed on a wage rise of 11%, the workers were demanding a 15% wage increase which is well above the current inflation rate of 5.1%. An increase in wages for the workers would mean an increase in spending power. That would surely allow them to have a more comfortable life but in turns, the company has to provide for this new expense. This additional cost has to either be absorbed by the company itself or be passed on to consumers in the form of higher prices in terms of output goods and services. General price levels will be raised if input prices have been raised, firms will cut back production to their own benefit and this will cause the aggregate supply curve to shift to the left indicating for a given price level, a lower quantity will be allocated. This phenomenon is called cost-push inflation. ‘Cost-push inflation develops because the higher cost of production factors decreases in aggregate supply (the amount of total production) in the economy. Because there are fewer goods being produced (supply weakens) and demand for these goods remains consistent, the prices of finished goods increase (inflation).’ http://www.investopedia.com/terms/c/costpushinflation.asp. Cost-push inflation can be shown using the AS-AD framework. In this case the aggregate demand does not change; it is the aggregate supply curve that shifts to the left, as in the diagram below.

C:UsersRohanDesktopc_push.gif

The aggregate supply in an economy is the total supply of final goods and services in a given time. In other words the AS refers to the GDP of an economy in a given time period. Here, the leftward shift of the AS curve causes the macroeconomic equilibrium to shift hence increasing the general price levels and decreasing GDP.

The trade unions responsible for demanding the wage increase argued for days with Transnet before the latter had to revise their offer. It can be clearly seen that the trade unions have a lot of power in their hands but are they using abusing that power? Trade unions are organisations that look after worker’s right and ensure that employees stick to the law or respectful working conditions. Throughout the strike, there was a decrease in productivity for firms as the workers could not reach their work places or at least get there on time. Increase in wages is very important as if the household’s income remains constant and the price levels increase then the worker’s purchasing power will definitely decrease. This is a wage-price spiral – general price rises will lead to higher wage demands as workers will always try to maintain a real and appropriate standard of living. Firms will have to increase their unit labour costs because of higher wages being paid over any gains in productivity. So for the firms to keep a decent profit margin, they will have to increase the prices of their final goods. This process could repeat itself over and again and cause inflation.