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Taxing the poor… through inflation

Wolfgang Fengler's picture

Imagine you are spending half of your income on something whose price suddenly increases by a quarter. Seems impossible? This is how in fact inflation has hit the poor in many developing countries, especially Kenya.

This September, overall inflation reached a record high of 17.3 percent. One year ago it was just above 3 percent. Why has it increased so sharply even though Kenya has followed prudent macro policies? The short answer is: food and fuel. In Kenya, food accounts for 36 percent of the average person’s expenditures; energy and transport another 27 percent. The urban poor spend more than 43 percent on food. Since January, food prices have increased by almost 25 percent (see figure), partly as a result of international trends but also due to Kenya’s- agriculture policies. Maize prices tripled between January and June until they retreated a little once the government waived import duties and the 2011 harvest started trickling in. 

Figure – Rising inflation in Kenya

 

 

 

 

 

 

 

 

 So if you are exposed to high inflation, there is no choice but to cut down on food or on other expenses, many of which are vital, such as school fees or health care. This is why inflation is the worst tax on the poor.

Kenya’s National Bureau of Statistics is calculating inflation for different income groups in Kenya and it is interesting –although perhaps not surprising- to see that the rich and the middle class only have a moderate problem. They experience price increases of about 10 percent. But for the poor, those who earn less than Ksh 200 a day, inflation now stands close to 20 percent. The rich can also move their money out of the country if inflation becomes too high – an option the poor don’t have. What about poor farmers? Don’t they benefit from higher food prices? They should but often they don’t. Two thirds of Kenyan farmers are net food consumers and are therefore hurt by rising food prices – although to a lesser extent.

High inflation is also a major headache for Central Banks. The Central Bank’s core mandate is to fight inflation, and there are several tools to do this, such as setting interest rates which will influence the amount of money in the economy. When interest rates go up, then the cost of borrowing money increases as well, discouraging borrowing and subsequent expenditure. This should normally bring inflation down. The Central Bank of Kenya has begun to increase interest rates but inflation is still going up.  How come?

The reason is “supply shocks”: higher import prices that are the result of external factors beyond Kenya’s control. An example was the spike in international oil prices following the “Arab Spring”. The tools available to the Central Bank mainly affect “core inflation” which is all the items beyond food and fuel which people use and consume (phones, rent, cement, etc.). This year, the fuel bill alone will likely be as large as Kenya’s total exports. Investors become wary of investing in countries with high inflation, which is one of the reasons why the exchange rate has been plummeting, and why it is so important for any country, not just Kenya, to focus squarely on fighting inflation.

What will happen in the coming months? There are many reasons to believe that Kenya has reached the peak of inflation and, in the absence of any additional shocks we can expect moderate inflation in the coming months. First, food and fuel prices have started to come down and there is a possibility that global commodity prices will decline further if Europe’s economies enter a full-fledged crisis. Second, the “base effect” will materialize in the first quarter of next year – 12 months after relatively high inflation.  Third, the Central Bank has embarked on tighter monetary policies, increasing the core interest rate to 7 percent.

What can Kenyan policymakers do, especially as they cannot influence the price of several key import prices, especially petroleum? In the short-term, the Central Bank could still tighten monetary policy further to slow down domestic expenditure and avoid price increases of other goods and services.

This is often an unpopular measure because it cools the economy and could lead to increased unemployment. However, such “tough love” measures are often critical to lowering inflation and restoring consumer and investor confidence. In the medium-term, a reform of Kenya’s maize sector would help a lot. Kenya’s traditional high-price policy and inefficient marketing systems are hurting the average Kenyan enormously. If Kenyan maize prices simply came down to international levels, which is in fact what one would expect to see, it would already give the poor and the middle class enormous relief. In the long-term, Kenya will only rid itself from inflation and shocks through growing richer and developing a more robust export sector.

This is easier said than done, but the country’s Vision 2030 agenda provides the right framework and emphasis on clean government and better performing infrastructure, especially the port, rail and energy. Kenya will still not be able to influence international food and fuel prices but higher incomes would protect Kenyans as they would only spend a smaller share of their income to meeting essential needs. High food and fuel prices may still be reason for complaint but not a source of suffering.
 

Comments

Submitted by Anonymous on
Just a few points on the framing of this article. Obviously large price increases in food prices do indeed hit the poor very hard. But overall inflation usually hits the middle classes and wealthy to a greater (proportional) extent than it does for the poor, because the poor have few financial assets whose value is eroded by inflation. Transport can go either way; if it is due to oil price increases, then that often hits the middle classes and wealthier more (particularly in countries with significant diesel generation) because the poor consume little energy (and much of that often comes from wood or charcoal). So it might make more sense to frame this as being an issue about food shocks than an issue about inflation. There are good reasons why central banks typically focus on core inflation (which excludes highly volatile agricultural prices) and don't respond to a one-time commodity supply shock with contractionary policy.

Submitted by Raj Raina on
By referring to inflation as a “tax” the article implies that Kenyan government is at fault. But in this case Kenya's high fuel and food prices as you rightly mention are a result of external shocks. Is there anything the government is doing that is exacerbating the problem? Under “what can Kenyan policymakers do” section of the blog: In the short run, is it possible to compensate the low income groups – those making less than Ksh 200 a day - an amount equal to the inflation of the food and fuel cost through CCT. Is this already being done? If not, why not? On a related but separate question: How independent is the Central Bank to pursue its core mandate of fighting inflation?

Submitted by Anonymous on
Why isn't any body talking about the trade liberalization- removing trade (tariff and non tariff ) barriers on basic food imports. surely if it is a supply shock then the most appropriate way to address it -win win- is to remove the barriers to imports. To what extent do these barriers exaggerate the actual price of food for the poor?

Submitted by Anonymous on
Inflation's root cause is too much government spending. What the world is witnessing is the death of the welfare state. The size of Government and regulation is consuming too much of the world economy and leaves nothing for the poor. What we are witnessing is the collapse of Socialism finally.

Submitted by Anonymous on
what is missing from this aricles is the negative and often disaterous impact of inflation on the social fabric of a given society.i.e,how it erodes the hopes of the young and breaks any dream an aspiring man has.

I agree with the comments that this is some sloppy economics. Total inflation includes changes in the poor's income. Rising food prices that are not compensated by rising incomes hurt the poor more. But if food prices rise by 100% and wages (and other forms of income) rise by 100%, how are they worse off?

Submitted by Wolfgang on
Dear Derrill, I am not sure I understand your point. I thought the chart showed that the price increase the poor are experiencing are higher than for the average person. If a 100% food price increase was being compensated by a 100% wage increase this would mean that core inflation would be much higher than it is now, wouldn't it? The fact that the poor are hit more by inflation has already been well documented for other countries and regions. Even though I like to be novel, I wasn't on this one. Wolfgang

Submitted by Anonymous on
This is not sloppy economics. I think the article clearly states that Kenya is the example here and if you know anything about Kenya, you will not talk about 'rising incomes'.

Submitted by Anonymous on
Kindly comment on the awful inneficiencies in Kenya's transport infrastructure namely;the pipeline and the railway and how they contribute to overall inflation. In doing so I would also like you to address the issue of competition and how the lack of controls on anti-competitive behaviors in markets can contribute to spikes in inflation. I dont't have that much faith in maroeconomic remedies to cure inflation.

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