CHAPTER 3: THE IMPACT OF INFLATION ON PERFORMANCE

3.1 INTRODUCTION

The preceding chapter discussed the profile of the Zimbabwean construction industry

and reviewed literature on contractor performance. In order to fully satisfy the first

objective on the role of hyper-inflation, this chapter further reviews literature, more

specifically on the phenomenon of hyperinflation and its impact on performance.

3.2 THE PHENOMENON OF HYPERINFLATION

“Inflation is like sin; every government denounces it and every government practices it”

Sir Frederick Keith-Ross

3.2.1 What is hyperinflation?

In economics, hyperinflation is inflation that is "out of control," a condition in which

prices increase rapidly as a currency loses its value. Formal definitions vary from a

cumulative inflation rate over three years approaching 100% to "inflation exceeding

50% a month. (Wikipedia)

While a number of hyperinflation definitions exist, the widely used and most adopted

definition is that of Cagan (1956). Cagan defined “hyperinflation as beginning in the

month the rise in price exceeds 50 percent and as ending in the month before the

monthly rise in prices drops below that amount and stays below for at least a year”

(p.25).

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3.2.2 Causes of hyperinflation

Although there is a great deal of debate about the root causes of hyperinflation, it

becomes visible when there is an unchecked increase in the money supply or drastic

debasement of coinage, and is often associated with wars (or their aftermath),

economic depressions, and political or social upheavals (Makochekanwa ,2007).

Currently, the various hypothesis of hyperinflation have one thing in common, namely

assigning their proximate cause to movements in the money supply .This is generally

known as the quantity theory of money. Thus, the main cause of hyperinflation is a

massive imbalance between the supply and demand of a certain currency or type of

money, usually due to a complete loss of confidence in the currency similar to a bank-

run. This has most often occurred because of excessive money printing, although other

factors may have a reinforcing effect. Often the body responsible for printing the

currency cannot physically print paper currency faster than the rate at which it is

devaluing, thus neutralizing their attempts to stimulate the economy (Wikipedia).

On the other hand cost-push theory underscores the fact that prices rise due to

increasing cost of the factors of production. This theory maintains that prices of goods

and services rise because wages are pushed up by trade unions’ bargaining power, or

by the pricing policies of oligopolistic and monopolistic firms with market power. While

there is a school of thought that wage push inflation is rare in Africa, largely because

wages constitute only a small part of national income, Zimbabwe’s situation since the

new millennium have proved that wage are a force to recon with when analyzing

hyperinflationary trends. Contractors are seriously affected as wages are increased on

a monthly basis while recovering the same cost after 40 days. Further the wage

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increases do not move in tandem with inflation thus, promoting informal trading while

projects are delayed due to inadequate labour.

Demand-Pull Theory postulates that inflationary pressures arise because of excess

demand for goods and services resulting from expansionary monetary and fiscal

policies. Over and above these suggested monetary expansion and fiscal policies, the

Zimbabwean situation has been compounded by shortages of basic commodities (i.e.,

mealie-meal (staple food), cooking oil, flour, fuel, sugar, to mention a few), thus result

in pent-up upward pressure in the overall prices. This means that workers are unable

to feed themselves from their wages thereby prompting the flight of skilled personnel.

For example, Kuchi Construction has lost skilled personnel since 2003 as shown in

figure 3.1.

Staff turnover 2003-2007

20
18
Number of employees

16
14
12
10
8 Series1
6
4
2
0
2003 2004 2005 2006 2007
Year

Figure 3.1 Kuchi Construction Staff turnover 2003-2007

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The mostly affected disciplines include quantity surveyors, site agents, site engineers

and project managers experienced in the construction industry. In absolute terms, the

company lost over 62 personnel in five years.

Literature on recent theories of inflation that have emerged in the past few years

emphasized the role played by political stability, policy credibility and the reputation of

the government and the political cycles in determining or explaining inflation.. These

recent theories have shifted attention away from traditional direct economic causes of

inflation, such as money creation, towards political and institutional determinants of

inflationary pressures. Like most of African countries, Zimbabwe’s political environment

has been typified by severe restrictions on political and civil liberties. Thus the

intensification of political instability and macroeconomic instability following the coming

into fore of resilience opposition political party in 1999, the controversial land reform

since 1999 and most importantly the fact that the country’s been increasingly isolated

from the international community, have resulted in political factors being some of the

major determinants of hyperinflation in the country.

Structural factors are also believed to influence the rate of hyperinflation in

Zimbabwe. Examples include weather conditions and pricing policies of the

government. It can be argued that government’s intention of protecting the general

consumers through controlled market/consumer prices have wreck havoc in most

production industries, especially the production of cement which has led to serious

shortages of the important construction material. This meant that projects were further

delayed as contractors were unable to procure the product. This eventually meant that

certain carrying costs were borne by contractors threatening their viability as the

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Business Herald, Harare 9 April 2003 reported that contractors face imminent closure

as a critical shortage of cement as fuel continue to compound problems.

3.3 HYPERINFLATION AND PERFORMANCE

Zimbabwe has currently the highest rate of inflation in the world (an annual rate of

9,030,000 percent in June, 2008). The high rates of inflation have contributed to the

decline of the Gross Domestic Product by about 43% between 2000 and 2007. Not

surprisingly, every sector of the formerly diverse Zimbabwean economy was affected

(Coltart, 2008). The construction industry was not spared either. In 2007, the

Zimbabwean construction industry operated at 20% capacity. This was a result of the

fact that the Zimbabwean Government which provides 60% of construction contracts is

facing economic and political challenges and is channeling most of its financial

resources to procure essential commodities and utilities (ZCIC annual economic review

on the performance of the construction sector in 2007). The inflationary trend from

2000-2007 is shown in figure 3.2.

Unlike inflation, which is widely considered to be normal in a healthy economy,

hyperinflation is always regarded as destructive. It effectively wipes out the purchasing

power of private and public savings, distorts the economy in favour of extreme

consumption and hoarding of real assets, causes the monetary base whether specie or

hard currency to flee the country, and makes the afflicted area anathema to investment

(Wikipedia).

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Zimbabwean inflation trend (2000-2007)

69000

66000

63000

60000

57000

54000

51000

48000

45000

42000

39000
INFLATION %

36000
Series1
33000

30000

27000

24000

21000

18000

15000

12000

9000

6000

3000

0
2000 2001 2002 2003 2004 2005 2006 2007
YEARS

Figure 3.2 Zimbabwe inflation trend

Source: Wikipedia

When operating in a normal environment, the construction industry employs about 6%

of the total formal employment (ZCIC annual economic review on the performance of

the construction sector). Figure 3.3 shows the number of workers employed in the

construction industry from 1996 to 2007. These figures show a downward trend in the

employment levels in the construction industry as a result of the economic environment

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prevailing in Zimbabwe. In March 2007, the Herald reported that one of the largest

construction companies in Zimbabwe was retrenching 150 workers citing a lack of

resources to meet the costs of a large labour force as well as the poor performance of

the construction division. This is a clear indication of how hyperinflation affects

performance.

Construction Workforce

40000
Average workers employed

35000
30000
25000
20000 Series1
15000
10000
5000
0
96

97

98

99

00

01

02

03

04

05

06

07
19

19

19

19

20

20

20

20

20

20

20

20

Year

Figure 3.3: Construction workforce in Zimbabwe

The annual economic review on the performance of the construction sector in

2007(ZCIC) made the following comment, “During the past five years Zimbabwe

experienced a slump in the construction sector mainly as a result of the shortage of

foreign currency and the depreciation of the local currency against major currencies on

the parallel market. The development discouraged the importation of building materials.

The situation was exacerbated by high costs of building materials from the local

market, where prices are pegged using foreign currency rates on parallel market”.

Indeed, as Mbiba, 2006 comments in his paper on decent work in construction that the

construction has been hit hard by the economic problems leading to high construction

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costs. This is further reinforced when one looks at how the construction costs have

increased as shown in table 3.1. The rapid increase in costs can be appreciated if one

looks at the cost index (last column table 3.1) or the detailed price indices for the civil

engineering and building materials as shown in appendix A.

The key component of the construction sector is cement whose production has been

drastically reduced owing to the price controls imposed on the manufacturers. Apart

from price controls, fuel shortages and lack of spare parts has adversely affected the

production capacity of the three cement producing companies in Zimbabwe, namely

Larfage, Unicerm and Sino- Zimbabwe Plant. The cement shortages hit the

construction sector after 2000 and the following media reports indicate how severe the

situation had deteriorated crippling the whole industry.

 For example see “Construction industry appeals for support: Little activity taking
place countrywide –Established companies settling for small jobs” Business
Herald, Harare, 27 January 2000;
 “10 000 likely to lose their jobs in construction” Business Herald, Harare, 11
January 2001;
 “Closures impact on construction industry” The Daily News, Harare, 14th
February 2003.
 Contractors face imminent closure as a critical shortage of cement , fuel
continue to compound problems, Business Herald, Harare 9 April 2003

Under these circumstances, it is clear that performance is greatly affected by

hyperinflation as it creates an environment of shortages, job losses, and flight of skilled

labour thus incapacitating the construction industry.

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Table 3.1: Construction (Building) Cost increases, 1995-2004 (Z$/m2)

Year Standard Standard Standard Arithmetic Index:

House Factory Office Block Mean 1995=100

1995 2,300 1,300 2,500 2,033 100

1996 2,650 1,675 3,000 2,442 120

1997 3,530 2,270 4,750 3,507 172

1998 4,950 3,190 6,620 4,920 242

1999 8,915 5,760 12,040 8,905 438

2000 17,025 10,978 17,275 15,093 742

Mid-2001 29,200 18,000 30,950 16,050 1,281

Mid-2002 56,000 34,000 59,350 49,783 2,448

Mid-2003 800,000 550,000 750,000 700,000 34,426

Feb-2004 1,750,000 1,200,000 1,650,000 1,533,333 75,410

Source: Robertson Economic Information Services, Harare, Zimbabwe

Constructing a favorable business environment by means of a clear industrial policy is

an extremely complex, if not impossible, task under high inflation. In Zimbabwe, this

has severely troubled business operations by means of postponed or unfinished

infrastructural projects and insufficient maintenance of roads and airports. Examples of

unfinished and postponed projects of national importance in Zimbabwe include Joshua

Muqabuko Nkomo international airport, Victoria Falls airport, National University of

Science and Technology building projects, Mortuaries at Harare and Mpilo hospitals,

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Tokwe Mukosi Dam construction, Manyame River Bridge and a host of others. Extreme

and unpredicted government interventions cause uncertainty that harm business

operations. Macroeconomic inflationary problems seem to drive out long-term industrial

policy. In particular, small and medium sized enterprises are not included in any

economic plan. The complexities of the difficulties that arise from high inflation seem

not to allow for striving after long-term industrial goal (Wit and Dyk, 1996).

Indeed, from the above analysis, hyperinflation is inextricably linked to the poor

performance witnessed in the construction industry and the whole Zimbabwean

economy. No major infrastructural developmental projects have taken off or completed

in the last ten years in Zimbabwe.

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