The Hyperinflation Hype: What really happened in Zimbabwe?
By Bodh Maathura
“Sri Lanka is on its way to becoming the next Zimbabwe” is a popular conversation starter these days. ‘Zimbabwe’s hyperinflation’ has become an obsession among many opining on money printing. No sooner than there is news about the Central Bank of Sri Lanka printing money, images of people carting money in wheelbarrows in Zimbabwe flood the popular media. Zimbabwe, a country that has earned a reputation for money printing and hyperinflation, is used as ‘evidence’ to tie the two phenomena together, as one causing the other. In other words, the theoretical premise that money printing causes inflation is touted by many as if it is an absolute truth. This is because there is either ignorance or selective amnesia about the objective conditions in Zimbabwe leading up to the hyperinflation crisis.
Economics textbooks explain how money printing causes inflation to rise. This is done using Fisher’s Quantity Theory of Money equation.
M*V = P*T
The theory makes the assumption that velocity of money (V) and the output (T) will remain constant in the short term. As a result, any increase in money supply (M) will directly result in the price (P) to rise. This may be an easy and simple way to explain inflation, however many real-world cases have proved that this does not hold. For example, a simple comparison of the money supply of Japan compared with its inflation (even deflation) data, will show the theory fails. If that does not suffice, countries like China, the US, UK all have been experiencing low levels of inflation with high growth in money supply. This is because these countries have utilized the excess money supply towards production, allowing them to increase output ahead of demand. Maintaining low levels of inflations with high levels of money supply.
Zimbabwe’s inflation skyrocketed in 2007-2008, while large sums of money were printed by the state. However, a deeper look into what really happened in Zimbabwe will show the underlying factors at play that caused hyperinflation.
Zimbabwe’s side of the story
First some context. Zimbabwe gained independence from the British in 1980, which was followed by a period of prosperous growth. The economy grew at an average GDP growth rate of 4.3 percent a year between 1980 and 1998, under the rule of Robert Mugabe the first prime minister of independent Zimbabwe (World Bank). However, by the end of the 1990s, the country’s economic progress came to a halt as the country entered a depression.
As the disparity between the Black Zimbabwean and the ruling elite combined with the land-owning white community began to widen, the Black Zimbabweans turned against the governing regime (Hill, 2003). At the same time, the ZANU-PF loyal war veterans started demanding a larger stake and more compensation. This put the Mugabe regime under stress as it had to secure its popularity among the influential war veterans and the majority population of the country. In response, the Mugabe regime increased pension payments and gave other forms of benefits to the veterans. In 1998, the Mugabe regime, which had vested interests in the Democratic Republic of Congo, deployed the Zimbabwean military to support the Laurent Kabila regime. Both the pensions and the wages of the military were financed through printing money.
A forgotten supply-side disruption
The upheaval of the Black Zimbabweans against the White farmers pressurized the ZANU-PF government led by Robert Mugabe to start acquiring the farms of the white farmers in the mid-1990s. In early 2001 the war veterans mobilized the black Zimbabweans to march on White-owned farmlands and take them over (Coltart, 2008). The state did not intervene to stop this mass seizure of land, but supported it.
Figure 3 depicts Zimbabwe’s agriculture, forestry and fishing output between 1997 and 2008. A clear drop in agricultural output can be observed between 2002 and 2008, due to the sudden switch in management from more experienced commercial White farmers to the Black Zimbabweans who were inexperienced in commercial agriculture. Furthermore, banks did not finance these farms as there was no clear asset ownership to be placed as collateral (Richardson, 2005). The agricultural output declined at an annual average of 15 percent over the 7 years to a low of US$ 0.8 billion in 2008 from US$ 2.9 billion in 2001. Zimbabwe being an agricultural exporter, mainly of tobacco leaf, lost out on a large foreign exchange inflow, which resulted in the currency depreciating over time. Due to the shortage in the food supply, food had to be imported, the combination of the two caused the cost of living to rise. The Mugabe regime addressed this matter by further printing money to finance consumption in Zimbabwe and fighting a war in the DRC which in return devalued the currency and resulted in hyperinflation.
A production economy left behind
The Zimbabwe story does highlight that hyperinflation was made possible by printing money, however, there were a few underlying causes that facilitated the crisis. Figure 4. compares the gross domestic output of Zimbabwe against the annual inflation rate, the two have a negative correlation, emphasizing that as output decreased inflation rose. However, a comparison of broad money and inflation will show that as money printing increases, inflation has risen. It is important to identify where this printed money was used. The capital formation of Zimbabwe as a percentage of GDP (Figure 5) shows that the money printed was not used for capital investment into the economy. The rate of capital formation declined from 20% of GDP in 1998, to 1.5% of GDP in 2005. In contrast, Sri Lanka maintained an annual average capital formation of 25% of GDP, between 1998 and 2005. It becomes clear by the decline in capital formation that there was a lack of investment into production in Zimbabwe leading up to 2008. The disruption in the agricultural sector, lack of investment into production and the printing of money to finance consumption created the underlying setting for Zimbabwe to enter a hyperinflationary crisis which further disrupted the economy.
Is Sri Lanka the next Zimbabwe?
Sri Lanka too is printing money, and there is a lot of criticism surrounding this. But the key question is what the printed money is being used for. In the latter part of 2019, the state announced a looser fiscal policy, by lowering taxes on businesses and investment. It also gave out many tax breaks for businesses to encourage expansion into the global markets through exporting. Such a measure reduces government tax income in the short run. However, the expectation that firms would set up production plants to expand output, taking advantage of the tax relief, was somewhat thwarted in the face of the COVID-19 pandemic which in turn exacerbated the global economic slowdown that was already in motion.
The economic effects of the pandemic further reduced tax income, while also increasing public health expenditure. The decline in transactions of goods and services during the lockdown period, resulted in the direct and indirect tax income to decline in 2020. This mismatch between government tax income and government expenditure has been financed by the printing of money to maintain the level of public spending needed for the country. This is the funding mechanism set in place in countries that run a budget deficit. It is good to remind ourselves that Sri Lanka has large public, health, education and energy sectors, which are cherished continuities of our welfare state. These sectors provide services at highly subsidized rates, and are able to do so because the state finances these institutions. Furthermore, the Central Bank has aligned the monetary policy with the country’s expansionary fiscal policy, mandating a single-digit interest rate policy. Both the fiscal and monetary policy is in line to create an investment-friendly, pro-production economy, whilst maintaining welfare provisions.
Sri Lanka has printed money to facilitate the expansion of production and capital formation, by giving out tax breaks and tax incentives to firms. The printed money finances the public sector, providing the businesses and people healthcare, education, electricity, water and even fuel at a subsidized rate. This has reduced the cost of living for people and lowered the cost of production for businesses, making the price of Sri Lankan products competitive in the global market. The money printed has been used to incentivize production and expand output in the economy, which in return brings down inflationary pressure in the long run. In contrast, Zimbabwe used its printed money to fund consumption, through the pensions of its veterans and funding for its war efforts. Further as a result of the land seizure, the country experienced a sharp fall in its agricultural production. All three acts did not incentivize production, the latter in fact disrupted it. In conclusion, the underlying conditions of Sri Lanka’s money printing remain vastly different from the conditions and reasons as to why Zimbabwe printed money. Hence comparing the two countries is grossly misleading, as one printed money for consumption and the other to finance a production economy with a strong welfare state.
Coltart, D. (2008). A Decade of Suffering in Zimbabwe. Economic Collapse and Political Repression under Robert Mugabe. Economic Development Bulletin, March 24th.
Hill, G. (2003). The Battle for Zimbabwe. Cape Town: Zebra.
Richardson, C. (2005), How the Loss of Property Rights Caused Zimbabwe’s Collapse. Economic Development Bulletin, November 14th 2005.