Abstract
Inflation more often than not is regarded as a bad economic occurrence where prices of commodities and the general cost of living rise. However, inflation also brings positive economic growth and development. Analysts argue that inflation that is regulated presents several benefits for economic growth and development on one hand while on the other factions have refuted claims to the fact that inflation can be utilized to provide any benefits for the economy. Based on an article by Kenneth Rogoff the paper argues for and against the viewpoints of various authors in regard to the benefits visa-vis the disadvantages of inflation on economic growth and development. The analysis relates these benefits and disadvantages on the operations of international business. The findings point to the fact that the benefits and disadvantages of inflation to international business are relative and also that inflation influences are varied as much as its effects are on the development of benefits and or challenges for economic growth and development.
Business in Global Arena – inflation
Kenneth Rogoff in an article titled ‘Inflation is still the lesser evil’ discusses the need to allow for moderate inflation in the economy as it presents various benefits for economic development and economic benefits (Rogoff, 2013). His ideas go against the common belief and the stance on inflation where the term and the situation are associated with an increase in prices of commodities and a decline in money value in terms of purchasing capacity. In such an instance, a lot of money is used to buy very little meaning that money has very little value. This paper examines the validity of this stance by Rogoff in an international framework. It develops an understanding based on the article of the effects of inflation on the operations of businesses in the international arena.
Rogoff in his article presents actions by three central banks in America, Japan and in the European Union that are concerned with controlling inflation rates in their economies. In the case of the USA Quantitative Easing (QE) was used while in Japan, the central bank targeted a 2% annual inflation through the economic policy management of interest rates in Japan. On the other hand the European Central Bank had a different approach altogether in addressing inflation by ensuring that low levels of inflation are attained through bringing down the cost of borrowing. Ultimately, all these measures by the central banks of the USA, Japan and Europe were meant to address inflation by placing measures that encourage inflation at acceptable levels in anticipation of yielding certain benefits for their economies.
Rogoffs ideas are shared by Bajada (2007, p. ii) who notes that the rates of inflation are beneficial to the economic development and sustainability but only if kept at low levels that range between 0 – 5%. Further, according to Bajada distortions arising from inflation are less adverse when inflation levels are kept below 5%. Hence, it is advisable that legislation be tailored in local economies around the encouragement of inflationary conditions that do not surpass the 5% threshold. This is because any inflation that surpasses this limit tends to develop adverse ripple effects on economic development usual presenting detrimental consequences (Bajada, 2007, p. 10).
Similar sentiments by Grimes (1991, p. 631) also point to the fact that inflation can be interpreted to contribute to economic growth in different ways both positively and negatively. Where on one hand inflation can be termed as to raise the rate of nominal tax with effects on raising the value of capital investment such that investments are discouraged; on the other hand, inflation can be seen to increase employment opportunities and raise the nominal value of wages and salaries.
Therefore, there is a level of divisiveness among opinions on the extent to which inflation contributes positively or negatively to economic growth and stability (Grimes, 1991, pp. 631 - 632). This begs the question whether opinions by those noting that low inflationary levels are of beneficial effects in terms of economic growth hold any truth. Rogoff in part in his article develops fault in the move by the American government agencies to bail out individuals from the effects of inflation. He notes that this only serves to derail the economic growth that could be realized from the development that is, as a result, of inflation. The bailout as Rogoff calls it ‘QE’ which stands for quantitative easing is a move by the federal reserve of the USA to cushion individuals from the inflationary effects of the economic downturn. However, as the economy strengthens the need for QE becomes unnecessary (Rogoff, 2013, p. 1).
The focus of this paper is, however, on the effects that inflation has on the operations of international businesses such as MNCs and regional firms. According to Holman & Rioja (1999, p. 22) taxes that cause inflation present various effects on the long run analysis with respect to the effects on international trade and productivity of international businesses. This range of effects is occasioned by the economic reactions in both the country where such taxation is effected as well as in the country that it is engaged in trade or business with.
In the state where taxes are raised the immediate effects are such that there is a reduced expenditure level in regard to investments. The result is a slowdown in economic development that is usually occasioned by the low consumption of goods both locally and abroad. Not even a steady exchange rate system is sufficient enough to insulate the foreign country from the inflation due to taxation. The implication of these on business across the two nations is such that the cost of doing business is heightened due to inflated costs accruing from the taxation. Moreover, a fixed foreign exchange rate causes inflation taxes to have the effect of reducing the rate of consumption locally. The effects of inflation on international business, therefore, are influence by a variety of factors that serve to presents a mixture of benefits and problems for the economy. The positives and negatives of the business are such that their implications have effects that present advantages and disadvantages that are regarded as to be equally impactful on the development and sustainability of the economy (Holman & Rioja, 1999, p. 22).
Pearce (1982, p.1) also argues that international businesses are influenced in terms of their productivity and profitability majorly from the stock prices of commodities in the market. Inflation only serves to make the situation worse since the resultant effect is such that the value of stocks falls below 50%. Due to inflation international businesses, therefore, lose out tremendously in the value of their stocks that depreciates.
Blaming inflation for reduced value of stocks has the implication that inflation either has the effect of raising the required rate of return on the stock. This in effect develops several ripple effects, for instance, it results in the reduction of expected profits by raising the real tax burden on corporate earnings. This raise in taxation of corporate earnings is usually done through the non-indexation of inventory and depreciation charges (Pearce, 1982, p. 17).
International businesses are as well affected by inflation where the value of stocks are devalued resulting from confusion among investors that essentially makes most investors undervalue corporate profits. The undervaluing of corporate profits is caused in most situations by the investors’ failure to take notice of the inflation induced fall in stock prices and hence the fall in the value of profits realized by their businesses. As a result, investors make poor investment decisions that end in the failure of their international businesses (Pearce, 1982, p. 17).
Much of the evidence, therefore, points to the fact that inflation has the effect of increasing the perceived risk on stock ownership that in turn deceives investors regarding the decisions they make on their investments. A definite fact is however that inflation has the effect of generating a decline in the prices of stocks that destabilize the market in terms of investments made. Consequently, the result is such that international business operations that rely on stock prices find it quite tasky to manage its operations (Pearce, 1982, p. 18).
In a study to investigate the impact of the Chinese economy of gross domestic product (GDP) in the industrial countries, Dreger and Zhang (2011, p. iii) observe that international businesses that have connections with china also suffer and gain from the effects of inflation in the Chinese economy. In essence, benefits that are, as a result, of inflationary occurrences in the Chinese economy spill over to the businesses that are directly engaged with the Chinese market and industries. The same situation replicates when the Chinese economy due to inflation presents several challenges that are shared among industries in the Chinese market and their international affiliates.
Hence, the linkage that an international business has with the economy that is experiencing inflation greatly influences the magnitude of the effects that it can undergo from ripples in the Chinese economy which it is highly linked to. On the contrary, the same business which is minimally linked to other economies of the world such as the US or India does not in effect portray any significant ripple effects of inflation in such countries. Therefore, international businesses cannot be affected greatly with inflation that occurs in a country or an economy where their operations are minimal or nonexistent (Dreger & Zhang, 2011, p. 14).
Mwakanemela & Kasidi (2013, p. 363) developed a study that was concerned about the ongoing debate whether inflation had the effect of generating economic growth particularly in the country of Tanzania. Their investigation employed various variables that measured both the effects on inflation in the long run and over a considerable shorter period. This evaluation examined Characteristics that could be observed in the performance of the Tanzanian economy over a period of ten years. The decade running from 1990 through to 2011 was one characteristic of many occurrences that served to shape the manner in which inflation influenced economic growth in the country.
The outcome of the research was such that a conclusive deduction was made regarding the influence of inflation on the performance of the Tanzanian economy in general. According to the research results, there were relationships that could be inferred between inflation and GDP, as well as inflation and the rate of investment in the country. Primarily, on both premise in regard to the relationships that inflation has on both the GDP and the relationship between inflation and investment in the country. The relationship in both instances was negative where inflation was found to negatively impact economic growth in either case. A comparison of the long term and short term effects of inflation on both instances did not find any different results. The study found that inflation has negative implications on economic growth on the Tanzanian economy whether in the short run or the long term basis (Mwakanemela & Kasidi, 2013, p. 363).
This, therefore, implies that for the case of Tanzania businesses whether local or international suffered negative implications of inflation during the period the study was conducted (Mwakanemela & Kasidi, 2013, p. 377). This is contrary to the opinion of some authors and especially the opinion held by Bajada (2007, p. 1) who holds that the short term effects of inflationary conditions are beneficial to the economic growth and development. Taking cognizance of the fact that the authors holding the two opposite view point’s base their literature in the USA and Tanzania i.e. Bajada (2007) and Mwakanemela & Kasisdi (2013) respectively, the question that begs are whether the size of the economy matters when it comes to the realization of economic benefits of inflation.
Petursson (2009, p. i) conducted a study in this respect concerned with the disparity between different countries especially in regard to levels of inflation in the developed and developing countries. The study developed insight that helps in understanding the influence that inflation has on businesses that are international in scale especially in the instance that their operations vary between countries in the developed and developing the world as well as in the emerging economies.
According to the study volatility to inflation is more rampant and evident in emerging world economies and the developing world. The latter bares the greater brunt of the two as inflationary effects have far devastating implications that usually stretch into affecting basic commodities such as food, housing, insurance etcetera making living conditions very poor and difficult in third world countries. A comparison of this performance to that of the developed countries reveals that the volatility of 1st world countries’ economies to the effects of inflation have very little impact in terms of the negative effects that inflation presents to the developed world’s economies in comparison to the third world and the developing world. However, this is to imply that the effects of inflation in the developed world are of no impact to their economies but rather, it means that the impact on the first world economies fairs better compared to that experienced in the third world or the emerging economy countries (PÈtursson, 2009, p. i).
Therefore, that question that lingers are concerned with what exactly is to blame for this disparity between first world economies, emerging economies, and third world economies. As Petursson (2009, p. i) explains the disparity is occasioned by the risk of premium in multi-lateral exchange rates. Hence, the greater the degree of influence of inflation on the exchange rate the greater the implications of the inflation that tends to make inflation in third world countries harder to bear with than in the developed world.
Dotsey (2006, p. 10) advances a different view in explaining exactly why first world countries such as the USA, Canada and Australia among others have remained at the top in effectively cushioning the effects of inflation on their economies. He attributes this to Inflation Targeting, which he terms or defines as setting targets on the limits of inflation that the country can endure. Inflation targeting in this case is guided by the fact that low levels of inflation result in positive impacts on economic development. Thus, placing a cap on the level of inflation that is acceptable or unacceptable in the country ensures that the economy can gain in growth and development realizable from targeting inflation rates.
Inflation targeting can effectively be achieved through the drafting of legislation that ensures that the levels of inflation remain low or that they do not exceed certain levels. It presents various benefits among which is enhancing credibility of the strength of the economy in the eyes of investors and also making the economy flexible in the form of growth capacity. The implications for this on businesses in the developed country are such that international investors develop confidence in the economy to sustain their businesses. As a result, the economy benefits from low levels of inflation through inflation targeting to realize economic growth and development (Dotsey, 2006, p. 10).
Kenneth Rogoff’s ideas resonate in many writings of authors reviewed in this paper. Fundamentally, popular opinion points to the fact that inflation is an occurrence that presents negative implications on the growth of the economy (Mwakanemela & Kasidi, 2013; Holman & Rioja, 1999). The implications of inflation have also been compared on a number of situations and conditions which are both differentiated and unique in terms of their impact and influences on the performance of the economy.
Whereas in some instances inflation is found to have grave effects on the economy, in other situations the effects don’t serve to be as grave. For instance, a comparison between the effects of inflation on the performance of the economies of third world countries, emerging economy countries and the developed world economies reveals very marginal disparities. Central to the discussion though are the implications of inflation on the performance of international businesses.
Policies have also been found to have a great impact on control of inflation. As Dotsey (2006, p. 10) explains inflation targeting is one way of developing legislation that can result in the realization of economic benefits from inflation. These sentiments resound the sentiments of the article by Rogoff that informed the purpose of this paper. The paper finds that debate on whether inflation in the short run and low levels presents benefits for economic growth and development can neither be refuted nor accepted fully in the light of the evidence presented. This is majorly because the topic on inflation usually is marred by a myriad of influencing factors that cannot blankly be harmonized to come up with objective and accurate generalizations or conclusions. Hence, the implications of inflation on international business enterprises are relative in line with the findings and evidences discussed.
References
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Dotsey, M., 2006. A Review of Inflation Targeting in Developed Countries. Business Review, Volume 03.
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Mwakanemela , K. & Kasidi , F., 2013. Impact of Inflation on Economic Growth: A Case Study of Tanzania. Asian journal of Empirical Research, 3(4), pp. 363 - 380.
Pearce, D. K., 1982. The Impact of Inflation on Stock Prices. Economic Review, pp. 1 - 18.
PÈtursson, T. G., 2009. Infaltion Control Around the World: Why are Some COuntries More Successful than others?, Hong Kong: Malta.
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