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Inflation-Unemployment: The Relationship And Its Implications

Proshare

Tuesday, May 9, 2017 / 6:56 PM /FDC 

The Nigerian economy is in turbulent times. A dark cloud hovers with the series of drastic and unwanted changes of the past two years.  

Spikes in inflation, a dramatic increase in unemployment and a substantive decrease in foreign reserves signify economic turmoil.  

The most notable indicator is the exchange rate which spiked to over N500/$ from the N300/$ range in the parallel market. This extreme variance caused pandemonium across the nation, making it the most discussed topic by Nigerians.  

Everyone was concerned, even those who had never travelled abroad nor held a dollar. 

The gap between the official and parallel exchange rates affects everyone because Nigeria is an import-dependent country.  

It results in a substantial increase in the cost of goods, and subsequently, in the rate of inflation.  

Most products used in the country are imported and the desire to purchase foreign goods continues to grow.  

Furniture, clothes, books and even toothpicks - products that can be produced domestically - are all imported and purchased with US currency.  

This causes the demand for the dollar to remain consistently high. The monthly demand for US foreign ex-change (forex) is approximately $4bn a month. When demand exceeds the limited supply, the price of the dollar rises.  

Before mid-2014, the price of a barrel of crude oil comfortably traded above $100/barrel.  

With the boom in the production of US shale oil – a substitute for traditional crude oil - prices fell drastically. Currently, the Brent benchmark trades at about $50.66/barrel while the West Texas Intermediate benchmark trades at $47.87/barrel.  

The Organization of the Petroleum Exporting Countries (OPEC) saw oil prices fall from more than $100/barrel to a staggering low of about $30/barrel in early 2016.  

This drastic price decline, coupled with lower production capacity due to vandalism and leakages, depleted Nigeria’s foreign reserves.  

They stood at about N40bn in 2014 but fell significantly to about N24bn in October 2016. The country simply was not earning as much as it once did. Nigeria started burning through its savings. 

Primarily due to the slump in the oil industry, Nigeria’s highest revenue generating sector, the country slipped into a recession, marked by four consecutive quarters of negative gross domestic product (GDP) growth in 2016: -0.36% in Q1; -2.06% in Q2; -2.24% in Q3; and -1.3% in Q4.  

Accompanying the negative growth was a sharp rise in the general price of goods and ser-vices. Most of the products and capital goods that Nigeria imported had almost doubled in price as a result of the exchange rate spike.  

The increase in inflation led to higher expenses for firms which unfortunately led to mass cost-cutting across the country.  

Companies that were severely affected by the exchange rate spike included Nestle Nigeria Plc, whose net foreign exchange loss increased from N1.7bn in 2015 to N16.2bn in 2016 as the naira lost its value.  

Nigerian Breweries Plc and Transnational Corporation of Nigeria (Transcorp) Plc were also seriously affected as the loss on foreign exchange transactions increased from N752mn to N7bn and N6bn to N18bn, respectively. 

Nigerian Breweries Plc notably laid off more than 100 staff from August to October of 2016.  

The unemployment rate is defined as the percentage of the total labor force that is unemployed but actively seeking employment and willing to work.  

It increased for the seventh straight quarter to 13.9% in Q3 of 2016 from 13.3% in Q2. Banks and telecommunication firms were the largest contributors to the increase.  

FBN Holdings Plc laid off 1,000 workers; Ecobank Nigeria Plc, 1,040; and, Diamond Bank Plc, 200 - all in the span of two months in 2016.  

According to the National Bureau of Statistics, Q2 of 2016 saw an increase in the labor force from 78.5 million to 79.9 million.  

Unemployment was highest for those between the ages of 15 to 24 at 24%, while the underemployment rate for the same group was 34.2% in the Q2 quarter of 2016.  

Within the ages of 15 to 24, 58.2% of Nigerians were either unemployed or underemployed. 2016 saw the worst rise in unemployment as it rose from 9.6% in January to 18.55% in December.  

Inflation is the sustained increase in the general price level of goods and services over a period of time, usually a year.  

The inflation rate fell to 17.78% year-on-year in February 2017 after rising constantly for 12 straight months to 18.72% year-on-year in January 2017, the highest since September 2005.  

Significant price hikes in the commodity market almost doubled the price of daily goods like bread, eggs and milk.  

The imported demand, due to the depreciating naira, caused this economic low point. The overdependence on crude oil left Nigeria exposed to severe price changes similar to the oil price shock of 2008 (the global recession saw prices fall from the 2008 peak of $147 in July to $32 in December).  

The country has yet to fully recover from the fall in the price of ‘black gold’ and the scarcity of the dollar. Prices continue to sky-rocket and the constant demand for dollars to pay school fees and personal travel allowances has further aggravated the issue.  

Prices are said to be “sticky downward”, meaning once they in-crease they do not easily fall back even though there is an improvement in the general economic condition.  

The exchange rate for instance, went from N275 to N325 when the bankers’ commit-tee recommended that the Central Bank of Nigeria (CBN) remove school fees and medical bills from the interbank forex.  

The recommendation was not implemented at the time with the CBN indicating that they were not setting anything in stone. Their statement was futile as the exchange rate had already sky-rocketed due to supply fears.  

Nine banks were suspended from participating in the foreign exchange market in August 2016. That day the ex-change rate moved from N410 to N430. Within a week it jumped to N490.  

The banks were eventually re-admitted to play in the foreign exchange game but the exchange rate did not fall back.  

This is the current issue with inflation. No matter what the good or service, every seller blames the dollar even if it has nothing to do with it.  

The unemployment rate in Nigeria is not as volatile. While it re-mains problematic and high, it has not risen as fiercely as the inflation rate.  

The issue is that investment, both foreign and domes-tic, is not high enough and with the current economic situation, there is not much incentive to invest in Nigeria.  

Schools produce thousands of graduates a year to a market that is filled to the brim, leading to fierce underemployment and low wages. 

The unemployment and inflation rates are important variables, directly related to the standard and cost of living of citizens in Nigeria.  

The misery index is an economic indicator that helps deter-mine how the average citizen is doing economically.  

It is calculated by adding the seasonally adjusted unemployment rate to the annual inflation rate. It assumes that high unemployment and inflation will lead to social and economic costs for the country.  

The misery index of 2015 in Nigeria was approximately 18.02% but then spiked to about 28.73% in 2016, the highest ever, as inflation and unemployment rose significantly and consistently.  

The misery index, constructed by American economist Arthur Okun for US President Lyndon Johnson, provides an easily adjustable snap-shot of the economy.  

The index measures how miserable or happy people in the economy are. Currently, Venezuela has the highest misery index primarily due to their hyperinflation and very weak currency.  

Food shortages in Venezuela became extremely severe last year and many Venezuelan went weeks without basic items like milk, egg and even toilet paper.  

Their misery index currently stands at 159.7% followed by South Africa which is 32.2%. Argentina stands at third with a misery index of 30.09%.  

The happiest countries – countries with the lowest misery index in 2016 - were Thailand, Singapore and Switzerland with indexes of 1.2%, 1.5% and 2.9% respectively.1 Nigeria’s misery index increased from 18.02% to 28.73% in a year.  

The current index is high and can be seen in the society today. Many people have lost their jobs and basic necessities have increased in price.  

The major driver of the spike was the significant increase in the inflation rate. 

Another theory that relates unemployment with inflation is the Philips curve. It shows the inverse relationship between the level of unemployment and the rate of inflation.  

In simpler terms, a decreasing unemployment rate in an economy is expected to ac-company an increase in inflation.  

However, the 1973-1975 reces-sion was a period of severe economic stagnation in much of the developed nations like the United States and the United Kingdom.  

This period of stagnation was characterized with high unemployment and high inflation.

The Phillips curve came under scrutiny as it could not explain the phenomenon of rising unemployment and rising inflation in the 1970’s recession period.  

The supposed flaw of the Phillips curve can be seen in the Nigerian scenario today as both un-employment and inflation have risen substantially.  

While the Nigerian economy has shown little signs of recovery, the inflation rate dropped for the first time in about a year to 17.78% in February 2017 and the exchange rate at the parallel market has fallen significantly from about N505/$ to N390/$ due to CBN interventions.  

The central bank has made funds available for school fees and personal travel allowances at about 20% above the official rate of about N307/$. This has alleviated the supply problem for people that school abroad.  

Before the intervention, it would take weeks before funds were released by banks for school fees payments and people had to turn to the more expensive parallel market.  

Now the CBN intervention has made funds readily available. Among other new policies, the CBN floods the market with forex on a supposedly weekly basis. This has caused the parallel market rate to drop.  

The government launched its Economic Recovery and Growth Plan (ERGP) on March 7th, 2017 and is adamantly committed to turning around the current economic predicament.  

The ERGP is not a development plan but an economic policy roadmap that encompasses the 2017 appropriation bill and the Medium Term Expenditure Frame-work (MTEF). Among other objectives, the plan aims to achieve:

·         A sustainable and market-determined exchange rate regime, as pressure mounts to let the naira float freely;

·         An inflation rate of 15.74% in 2017, 12.42% in 2018 and single digits inflation by 2020; and,

·         A reduced unemployment rate from 13.9% to 11.23% by 2020 by creating over 15 million direct jobs between 2017 and 2020 or an average of 3.75 million jobs per year.  

The Federal Government, through the Ministry of Agriculture, set up a food task force which aims at improving the logistics and transportation of food across the country. This will enhance the supply of food stuff to places of shortage.  

The goal is to reduce food inflation which rose by 18.5% following 17.8% in January. Serious efforts have been made by the task force and for instance, led to the transportation of tomatoes from Kaduna to Lagos for the first time in 58 years.  

The ERGP expects investment in agriculture will drive food security by achieving self-sufficiency in tomato paste in 2017, rice in 2018 and wheat in 2020.  

By 2020, Nigeria is projected to be-come a net exporter of key agricultural products like rice, ground-nuts, and vegetable oil.  

The government recently commenced the registration of unemployed citizens.  

The National Directorate of Employment con-firmed that the registration was part of the official mandate to obtain and maintain a data bank on unemployment and vacancies in the country.  

This new policy will connect potential employees to employers and loosen the lack of information bottleneck.  

The truth is employment possibilities will increase only if the economy grows. Job creation comes with economic growth and the need to increase output.  

In the ERGP, the government aims to expand the gross domestic product by 2.19% and also projects that GDP will grow by an average of 4.62% annually and reach 7% by 2020.  

Other objectives of the ERGP include various diversification and liberalization policies by the government.  

Crude oil production is also targeted to increase to 2.5 million barrels a day. The diversification policies will increase exports and foreign earnings of the government while the liberalization efforts will let the more efficient market forces prevail.  

In a report recently published by the International Monetary Fund, the Nigerian economy must make some critical reforms urgently if it hopes to recover this year.  

The multiple exchange rate system has to be abolished in order to re-duce the incentive to roundtrip on dollar sales – roundtrip is the practice of selling an asset while agreeing to buy it back for about the same price.  

This has caused serious depreciation to the value of the naira because it increases the chances of people making gains from buying the dollar at a lower rate and selling it at a higher rate.  

The IMF also advocated for structural reforms to re-duce wasteful spending, tighten fiscal and monetary policy and seize corruption. 

In conclusion, unemployment and inflation have been increasing. They translate in a higher cost of living and a reduced standard of living.  

Things have become very difficult for Nigerians but the government seems to be on the right track by making a plan to reduce the misery index.  

Once better management of resources and more efficient policies come in to play the inflation and unemployment rates should slow down and eventually reduce.  

However major incentives to increase the ease of doing business in Nigeria need to be drawn up to encourage both foreign and domestic in-vestment.  

Currently, Nigeria ranks 169th out of 190 countries on the World Bank Doing Business Index.2 On the index, Nigeria ranks one of the lowest particularly in getting electricity, paying taxes, trading across borders and registering property.  

These problems need to be handled by the government in order to con-vince foreign investors to invest in the country.  

Tax holidays, pio-neer status, and land subsidies are good incentives to draw for-eign investment. Foreign investment will create jobs and output, thus leading to more goods being produced with the country.  

This will reduce the overall need to import certain products.  

 

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