Dr. Kwakye Of IEA Could Be Telling A "True-Lie"

Ghana is an interesting place to be at this time of economic turmoil. I support the view that knowing the problem could be an inch to the solution. Economics as a subjective science therefore means that every man potentially has an answer to the economic crisis of our economy based on their 'understanding' of the problem, which is not politics-blind.

Therefore, I embrace the many proposed untested theories of academics, politicians and the ordinary Ghanaian alike in demonstration that there is no 'black or white' answer to the problem - that is to say events are not independent and mutually exclusive. By this, I mean all these untested theories could be true or a lie at the same time or in varying combinations at different times. However, whether right or wrong, our choice is based on the implicit assumption that there is a standard measure against which these dual mutually exclusive outcomes are derived, which is not likely. The former president's attribution of the economic woes of Ghana to the 2007 redenomination exercise was received less seriously until the learned Dr. Kwakye re-echoed same with some reason unlike the mere and usual roar of the former.

In the midst of varying antithesis of Dr. Kwakye's redenomination-economic crisis argument - referred to in this article as the 'KWAKYE EFFECT' - , I present my views, stemming from my ongoing research on the 'Content of Inflation and the Development Nexus'. I basically explain why I think Dr. Kwakye could be telling a 'true-lie', in other words a half truth. This is because his redenomination argument in my opinion is just one of the 'symptomatic', not a root cause component of inflation and its depreciating effect on the purchasing power of the Cedi.

I therefore propose an alternative framework (model) anchored on 'market failures' and 'value creation' for a superior attribution of the economic performance of the Ghanaian economy. The content of inflation provides us with a robust measuring index of economic performance; that is whether caused by market failures and or as a result of value creation. The lack of such an objective index could be the reason for too many theories of Ghana's woes - some very incredible.

I will proceed by presenting a summary of Dr. Kwakye's argument and complete the presentation with my comments on it. Dr. Kwakye's logic is summarized below:

"If there is an increment in pricing, say something that should be increased from 5 pesewas to 7 pesewas, it automatically jumps to 10 pesewas because of the absence of lesser denomination. A continuous repeat of this in no time certainly will have adverse effects on the economy or to limit it people's economies and the nation's economy on a large scale".

Analysis of the Kwakye Effect
Basically, Dr. Kwakye is simply saying in other words that the HIGH INFLATION or simply inflation is the cause of the current economic quagmire, resulting from the 2007 redenomination exercise. It is difficult to agree with him on the basis because smaller currency denominations including 1pesewa coins were provided for trading purposes.

Therefore, price increments from 5pesewas to 7pesewas will not automatically jump to 10pesewas because two of the 1pesewa coins could be added to the 5pesewas to make 7pesewas. However, the logic of the redenomination as the cause of high inflation 'could hold true' because the 1pesewa coin is practically not in use. This doesn't mean that high inflation is the problem, rather the causes of high inflation should be our necessary examination. I perceive that Dr. Kwakye's has lump two arguments into one argument. I present these two arguments as H1 and H2 and H3 as his conclusion below:

H1: Redenomination is the cause of high inflation
H2: High inflation is the cause of the current economic crisis

H3: Therefore, redenomination is the cause of the current economic crisis

This kind of logic is pretty simple (for this high level of economic analysis) and assumes a linear function but creates an implicit impression that any event which could creates inflation could be the cause of the economic crisis - that could also be true. Therefore, judging by Dr. Kwakye's own logic, the profligate spending of the NDC government during the erstwhile 2012 election period could also be the cause of the problem. In fact, this logic by extension also means that all the triggers of inflation, including the redenomination, profligate spending, import-export imbalances, high cost of production, inefficient economy, bla bla bla beside others could at the same time be the reason for this problem. Hence, the cause of the problem in my opinion is not a 'black or white' answer (define above) at this stage, but of multiple continuous accumulative causation.

Therefore, for Dr. Kwakye to assert that the 2007 redenomination exercise is 'THE' cause of the current economic crisis in Ghana, he implicitly assumes that among all the causes of inflation (some listed above), the redenomination exercise is the most significant (Relatively important) force in causing the problem; although, he did not originally recognize that all these factors are in the vending machine. Without a robust evidence-based indicating these parameters of relative importance of the causes of inflation and their linkages to the current economic crisis (which I think is the crux of the debate), the' Kwakye Effect' which appears to be based on a careful conjecture is not a very useful model for to warrant our considerable time.

Moreover, the 'Kwakye Effect' is a second-level argument which ignores the (root) primary causes of inflation. Inflation doesn't cause itself, so whether prices jumps from 5pesewas to 10pesewas instead of 7pesewas, there are fundamental causes which must be dealt with. Hence, the 'Kwakye Effect' will actually be a 'mirage' in a well-managed or deflationary economy, although such an economy like Japan comes with its own challenges.

Market Failures and Value Creation: An Inflation Framework for Economic Performance Attribution

I will attempt to explain from a classical economics point of view of inflation and latter introduce my perception of inflation with a revelation of an element of inflation -i.e. value creation - which is barely spoken about in the inflation debate by the many street economists in Ghana, and sometimes omitted by certified economists. I will create a model of inflation and explain the relationship between the elements of inflations as my view for better attribution of the economic crisis, not the 'Kwakye Effect' above.

In economics, inflation is accepted as a sustained increase in the general price level of goods and services in an economy over a period of time (Blanchard, 2000; Wyplosz & Burda, 1997; Barro, 1997; Abel & Bernanke 1995). When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation reflects a reduction in the purchasing power per unit of money - a loss of real value in the medium of exchange and unit of account within the economy. Economists generally believe that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply (Barro and Grilli, 1994). However, money supply growth does not necessarily cause inflation.

Some economists maintain that under the conditions of a liquidity trap, large monetary injections are like "pushing on a string" (John Makin, 2010; Paul Krugman; Gauti Eggertsson). A liquidity trap is a situation, described in Keynesian economics, in which injections of cash into the private banking system by a central bank fail to decrease interest rates and hence make monetary policy ineffective. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war (Krugman, 2008). Notwithstanding, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth (Mankiw 2002, pp. 81-107 and Abel & Bernanke 2005, pp. 266-269).

In my view as earlier deducted from the Kwakye Effect, inflation is multi-dimensional; hence, I contend that the notion of redenomination (one-dimensional) as the sole cause of the current economic mess is preposterous and an over-simplification of the problem. In my opinion, the causes of inflation (I) can be classified under two broad categories: (1) market failures (MF) and (2) value creation (VC). Any measure of inflation in any economy at any point in time is a combination of these two factors. This is represented mathematically as:

A market failure is a situation where the market fails to allocate resources (goods and services) efficiently or fairly - in the right quantities to the people who need it most. Market failures are often associated with 'time-inconsistent preferences', 'information asymmetries', 'non-competitive markets', 'principal-agent problems', 'externalities', or 'public goods' (Stiglitz, 1989, Palacios-Huerta, 2003; Wilson, 2008; Stiglitz, 1998; Laffont, 2008). The existence of a market failure is often the reason why self-regulatory organizations, governments or supra-national institutions intervene in a particular market (Arrow, 1969; Gravelle, Hugh; Ray Rees, 2004).

However, government policy interventions, such as taxes, subsidies, bailouts, wage and price controls, and regulations (including poorly implemented attempts to correct market failure), may also lead to an inefficient allocation of resources, sometimes called 'GOVERNMENT FAILURE' (Weimer, David; Vining, 2004).

Value on the other hand is basically the ability to satisfy wants, which could be economic, social, political etc, achieved at a cost. Value therefore becomes a fundamental relationship between function (what the goods and services produced in an economy must do - benefits) and cost. In a businesS sense then, value creation is the performance of actions that increase the worth of goods, services or even a business. Many business operators now focus on value creation both in the context of creating better value for customers purchasing its products and services, as well as for shareholders in the business who want to see their stake appreciate in value. From a financial perspective, value is said to be created when a business earns revenue (or a return on capital) that exceeds expenses (or cost of capital).

In an economy, the interplay of market failures and value creation determines the rate of inflation in my opinion. The size of the rate of inflation is however dependent on the stage of a country in the development Life cycle, that is, Birth or Growth or Maturity or Decline. At the growth stage where Ghana seems to be, the potential for value creation is very high unlike an already developed economy like the US and the UK. Pursuing value creation at a growth stage in the development cycle could actually create inflation. In the maturity stage of development as experienced by the US and UK, value creation has limits and is more likely to fall unless supported by extreme innovation, which is also scarce and expensive.

Low rates of inflation in the US and UK is therefore as a result of optimum value creation over less market failures. That is, while there is an inverse relationship between inflation and 'optimum' value creation (time constrained), inflation relates positively to market failures at all times. Thus, the high potential for value creation in the Ghanaian economy at this stage could lead to increases in price of goods and services. But, potential is not the same as actual, because value creation in Ghana is practically meagre. Further, the likelihood of market failures is as high as the prevalence of the causes of market failure including government failure as highlighted above. Value creation is positive and over a sustained period in the maturity stage of the development life cycle stagnates and subsequently falls; thus, reducing its contribution to inflation. Market failures on the other hand are continuously negative and prudent economic management is the only way for reducing its contribution to inflation.

Per this nominal reasoning, the high incidence of sustained market failures and the high potential for value creation could constitute the first level root causes of high inflation regime in Ghana and the seeming economic crisis. However, in Ghana, it is clear that the contribution of market failures to inflation is higher than value creation. For instance, increases in prices of utilities like electricity and water is as a result of inefficiencies in the production process which normally comes at a high cost compared to improvement (value created) in the services provided. Another example is the case of excess supply and excess demand of goods and service.

This could lead to over-consumption or under-consumption of goods and services, which is a clear case of an inefficient market. For instance, fuel shortages lead to under-consumption of fuel and price hikes transmitted across the real economy: agriculture, industry and services. Another example is the oversupply of money during the 2012 election period and the persistent corruption in our economy. This increased the purchasing power of beneficiaries leading to over-consumption of goods and services in the economy.

It should be noted in our explanation of inflation above, that oversupply of money in an economy not accompanied by an equal measure of economic growth causes inflation. Economic growth is the sustained increase in the market value of the goods and services produced by an economy over time. This results from value creation due to a more efficient use of the nations resources according to economic growth theory. Thus, inefficient use of national resources leads to less value creation and subsequently less economic growth and vice versa. In the last two years, unproductive spending could therefore be blamed for the dwindle fortunes of Ghana's economic growth potential. This evidence supports my opinion that among the two causes of inflation in Ghana and the consequent economic hardship, market failures due to bad economic management is RELATIVELY IMPORTANT than value creation (from efficient use of resource) in explaining the current economic turmoil.

From this framework, Dr. Kwakye's redenomination argument fits into the typical case of a market failure when inefficiencies in the production process results in high inflation. But the redenomination phenomenon is only a symptom of a real underlying cause of inflation, which the 'Kwakye Effect' fails to explain. I must admit that the 'Kwakye Effect' could be created by excessive value creation but that is far remote and not the case in the Ghanaian economy, making his argument subprime in attributing the current economic crisis. His argument is just a component of the bigger problem.

Conclusion
Summarily, I have demonstrated through economic reasoning that Dr. Kwakye's attribution of the economic woes of Ghana to the redenomination is an over-simplification of the problem, a second-level argument which ignores the first level primary causes of inflation in the Ghanaian economy in the first place. However, the persistence of market failure and the potential for high value creation associated with Ghana's stage in the development life cycle in my opinion presents a stronger, complete and a more robust model for attributing the problem at hand. Ghana deserves better.

Kenneth A. Donkor-Hyiaman
Department of Land Economy
University of Cambridge
United Kingdom
[email protected]