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Corruption driving Zimbabwe's inflation
Gilbert Muponda, New Zimbabwe
January 16, 2008

http://www.newzimbabwe.com/pages/inflation181.17413.html

Writing last week, I gave a quick comparison of Zimbabwe's high inflation at 24 000% compared to the next highest which was Burma/Myanmar at 40%.

Zimbabwe and Burma are both under sanctions. The two countries are also very close allies of China. They both possess massive natural resources. And the Chinese have been keen to maintain the relationships so as to access Rubber, Oil, Steel, Gold, Copper, Nickel, Timber and other natural resources.

So the question that comes to mind is: if these two nations share such similarities, how come Zimbabwe's inflation is so high at 24 000% and Burma is only at 40%?

Part of the answer lies in corruption, so in this article, I seek to establish the link between inflation and corruption. Corruption in finance and economics is at times called rent seeking. Inflation is correlated with corruption.

A resource-rich country, Burma, like Zimbabwe, suffers from pervasive government controls, inefficient economic policies, and rural poverty. Lacking monetary or fiscal stability, the economy suffers from serious macroeconomic imbalances - including rising inflation, fiscal deficits, multiple official exchange rates that overvalue the Burmese kyat, a distorted interest rate regime, unreliable statistics, and an inability to reconcile national accounts to determine a realistic GDP figure.

It's clear that Zimbabwe and Burma have a lot in common and their high inflation is partly due to similar policies. Burma is rated the most corrupt country in the world. And its inflation is the second highest in the world after Zimbabwe.

Corruption is a general concept describing any organised, interdependent system in which part of the system is either not performing duties it was originally intended to, or performing them in an improper way, to the detriment of the system's original purpose. Political corruption, meanwhile, refers to dysfunctions of a political system or institution in which politically elected officials seek illegitimate personal gain through actions such as bribery, extortion, cronyism, nepotism, patronage, graft, and embezzlement.

"Rent seeking" is a closely related term in economics. In some nations, corruption is so common that it is expected when ordinary businesses or citizens interact with government officials (for example someone selling a passport form). The end-point of political corruption is a kleptocracy, literally meaning the "rule by thieves". It should be noted that a government is not and cannot be corrupt. It is only the individuals who may become corrupted.

Monetary policy rests on the relationship between the rates of interest in an economy; that is the price at which money can be borrowed, the total supply of money and inflation. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment. Once one of these components is corrupted through any manipulation, such as the direct release of funds from the issuing authority to the public such as black market forex runners, then the system becomes corrupt and feeds directly into inflation. This is so because of the general market's lack of confidence in the currency, which loses value at any alarming rate.

In economics, rent seeking occurs when an individual, organisation, or firm seeks to make money by manipulating the economic and or legal environment rather than by making a profit through trade and production of wealth. The term comes from the notion of economic rent, but in modern use of the term, rent seeking is more often associated with government regulation and misuse of governmental authority than with land rents.

Rent seeking generally implies the extraction of uncompensated value from others without making any contribution to productivity, such as by gaining control of land and other pre-existing natural resources, or by imposing burdensome regulations or other government decisions that may affect consumers or businesses. While there may be few people in modern industrialised countries who do not gain something, directly or indirectly, through some form or another of rent seeking, rent seeking in the aggregate may impose substantial losses on society.

Most studies of rent seeking focus on efforts to capture special monopoly privileges, such as government regulation of free enterprise competition (like fixing exchange rates as in Zimbabwe). Other rent seeking is held to be associated with efforts to cause a redistribution of wealth by, for example, shifting the government tax burden or government spending allocation.

If the international markets regard a domestic government as conducting an irresponsible monetary policy, such as excessive growth in the money supply or unduly low interest rates (Bacossi), then there will be capital flight from that market. Other central banks will not help when called upon to.

The reported release of $2.1 trillion to a private firm on the basis of a verbal agreement undermines the credibility of the RBZ. The reported relationship between the RBZ and individual money changers would appear to be generally corrupt, and must be investigated further as it undermines the RBZ's reputation. Once the RBZ becomes involved in such corrupt practices, then there is need to provide more checks and balances to ensure the national purse does not becomes someone's back pocket.

Zimbabwe's fixed and unsound foreign exchange rate policy aids corruption and in turn feeds the hyperinflation. A simple example will clarify the point. Assuming one approaches the RBZ and accesses US$1000 at the official rate of US$1: Z$30,000, it means you pay the RBZ Z$30 million. Then you walk across the city to Fourth Street or take the US$1,000 to Road Port and you meet one of the RBZ's runners who offers you a rate of US$1: Z$4,000,000.

So, for your RBZ-sourced US$1,000 you get a whooping Z$4 billion. Magic! So within one morning, Z$30 million becomes Z$4 billion. Since this is a sweeter than honey, at around 2PM you rush back your suitcases of bearer (or is it burial?) cheques to the RBZ and buy more forex. This time around, you are loaded with Z$4 billion, which can buy you a massive US$133,000. And by now, from a mere millionaire in the morning, you are now in a respectable neighbourhood with Z$533 billion (US$133, 000 times Z$ 4,000,000).

From the above analysis, it's clear the fixed exchange rate accompanied by corruption feeds the hyperinflation cycle. There has to be corruption for you to access the US$1000. And once you have this money, even if you are a very serious business, you would be very foolish to try and buy equipment, stocks or whatever it is you said you were going to buy! You simply take the US$ to the RBZ runners at Road Port, then sell it to them at Z$4,000,000 and go back to the RBZ and buy some more US$ at Z$30,000. So for each US$, you make a profit of Z$3,970,000.

As a result, you keep doing this and why would you bother to go and open a proper business which produces bread, soap and candles when you clearly know once operation Dzikisa Mutengo comes, you can lose all your "hard earned" profits. This trend is highly inflationary which explains why it's not advisable to fix the currency especially if there is no other major source of forex.

As can be seen above, our enterprising friend turned Z$30,000,000 into Z$533 billion within a day. There was no production involved; yet he had a ready buyer for the forex (RBZ runner). This is how inflation gets out of hand. No matter what policing you do, as long as such loopholes exist, then you have to keep running to stay at the same place.

This vicious cycle is further enhanced by other not-so-properly-structured facilities such as Baccossi, which lends money at 25%. One wonders why 25%? Why not 15% or 300%? These cheap funds are disastrously inflationary. Assuming Cde Cell-Phone Farmer gets a Baccossi facility of Z$1 billion, it is clear there is an incentive to take it or some of it to Road Port. But if he is more daring, then he could simply get the 'burial cheques' to the RBZ and buy say US$1000 at US$1: Z$30,000. Once he disposes the US$1000 to an RBZ runner at Road Port, then he instantly becomes a billionaire.

With his new found wealth, the next week he can go back to the RBZ and pay off the Z$1 billion loan and remain with Z$3 billion profit before he even starts any production. But since the money is almost free at 25%, when inflation is at 24,000%, he is better off holding on to the money and spinning it more. Or just lend it to the RBZ by buying treasury bills, which yield more than 300% with your cost being only 25%.

I hope this clearly explains why we end up with a trillion-dollar house, billion-dollar car, million-dollar bed and a thousand-dollar box of matches. Cde Cell-Phone Farmer would be a trillionaire or is it a quadrillionaire without any production whatsoever at his farm, thanks to facilities like Baccossi and fixed exchange rates. Please note nobody really knows why we have an exchange rate of US$1: Z$30,000 and Baccossi interest of 25%. Why not lower, and why not higher? Hopefully someone didn't consult the infamous 'diesel mystic' to come up with the interest rate or fixed exchange rate! These rates can't be so divorced from reality as in inflation and trade deficit. Should this happen, the 'mazhero' will be back with a vengeance!

From a theoretical standpoint, the moral hazard of rent seeking can be considerable. If "buying" a favourable regulatory environment is cheaper than building more efficient production, a firm will choose the former option, reaping incomes entirely unrelated to any contribution to total wealth or well being. This results in a sub-optimal allocation of resources - money spent on lobbyists and counter-lobbyists rather than on research and development, improved business practices, employee training, or additional capital goods - which retards economic growth. Claims that a firm is rent seeking, therefore, often accompany allegations of government corruption, or the undue influence of special interests. This affects inflation since money will exchange hands without any production or value addition.

Rent seeking may be initiated by government agents, such agents soliciting bribes or other favours from the individuals or firms that stand to gain from having special economic privileges, which opens up the possibility of exploitation of the consumer. It has been shown that rent seeking by bureaucracy can push up the cost of production of public goods. It has also been shown that rent seeking by tax officials may cause loss in revenue to the national purse (Zimra).

Corruption also undermines economic development by generating distortions and inefficiency. In the private sector, corruption increases the cost of business through the price of illicit payments themselves, the management cost of negotiating with officials, and the risk of breached agreements or detection. Although some claim corruption reduces costs by cutting red tape, the availability of bribes can also induce officials to contrive new rules and delays. Openly removing costly and lengthy regulations is better than covertly allowing them to be bypassed by using bribes.

Where corruption inflates the cost of business, it also distorts the playing field, shielding firms with connections from competition and thereby sustaining inefficient firms, which fail to produce to meet demand. And the shortage of goods will result in inflation as all the money available chases after the little that's available.

Besides pushing inflation, corruption also generates economic distortions in the public sector by diverting public investment into capital projects where bribes and kickbacks are more plentiful. Officials may increase the technical complexity of public sector projects to conceal or pave way for such dealings, thus further distorting investment. Corruption also lowers compliance with construction, environmental or other regulations, reduces the quality of government services and infrastructure, and increases budgetary pressures on government.

University of Massachusetts researchers estimated that from 1970 to 1996, capital flight from 30 sub-Saharan countries totalled US$187bn, exceeding those nations' external debts. In the case of Africa, one of the factors for this behaviour was political instability and corruption, and the fact that new governments often confiscated previous governments' corruptly obtained assets. This encouraged officials to stash their wealth abroad, out of reach of any future expropriation.

In contrast, corrupt administrations in Asia like Suharto's have often taken a cut on everything (requiring bribes), but otherwise provided more conditions for development, through infrastructure investment, law and order.

Gilbert Muponda is a Zimbabwe-born entrepreneur, living in exile. He can be contacted at gilbert@gilbertmuponda.com

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