WHY INFLATION IS A BIG PROBLEM FOR PAPUA NEW GUINEANS

What is Inflation?

According to the IMF inflation “is the rate of increase in prices over a given period of time”. Although inflation can refer to prices of specific products or services such as rice, petrol or airline tickets, it is typically referred to and discussed in public as a broad measure of the overall increase in prices that reflects the increase in the cost of living in a city, region or country. Inflation represents how much more expensive the goods and/or services on average have become over a certain period. Usually when the experts or government refer to inflation they talk about inflation from year to year, that is, how much prices increased in one year compared to the previous year. This is usually expressed as the percentage (%) increase in prices for a country as a whole.

How is inflation measured?

Inflation is commonly measured by regular periodic consumer price surveys, eg. every month or every 3 months, of a basket of goods and services that has been carefully selected by the measuring institution. This basket of goods and services is used to calculate what is referred to as the consumer price index or CPI from which inflation is derived. The cost of this basket at a given time expressed relative to a base year is the CPI, and the percentage change in the CPI over a certain period is consumer price inflation, the most widely used measure of inflation. In Papua New Guinea the CPI is measured and calculated by the National Statistics Office.

Why does inflation matter to everyday Papua New Guineans?

Inflation matters to Papua New Guinean’s because it reflects the increase in prices of items such as Ox & Palm corned beef, Kwik Kai chicken, Dolly tinned tuna, Panadol, Toyota Hilux vehicles, legal fees, accountant fees etc. Inflation represents how expensive goods and services are becoming compared to a person’s pay or income. For example, if Kila pays K10,000 per year on goods and services and inflation is 10% per year, that means the items that Kila could afford at K10,000 per year will now cost K11,000 so Kila will have to increase his expense by K1,000, or reduce consumption, or find alternatives, or seek an increase in pay. In this way Kila’s (and most other Papua New Guinean’s) money has lost value because of inflation.

What is PNG’s level of inflation now and in the past?

PNG’s inflation rate as measured by the CPI has averaged 5% over the last 10 years from 2011 to 2021 with forecast inflation rate for the full year 2022 of 6%. An inflation rate of above 4% for a rapidly growing developing economy is not an unexpected occurance with rapid economic growth placing pressure on the country’s social and business infrastructure to handle the increased demand efficiently.  On the other hand developed and well managed economies generally target lower inflation rates below 4% as these countries generally have higher capacity to abosorb demand and more efficient infrastructure. This is demonstrated below with Australia’s inflation rate averaging 2% over the same period. The Australian government has tended to target an inflation rate between 2% and 3%.

A more instructive way to view inflation and it’s significant impact over time is illustrated by the graph below which shows the cumulative inflation since the 4% rate of 2011. From 2011 to 2021 the inflation rate increased by 51%, that is, the cost of goods and services increased by 51% from 2011 to 2021.

Another perhaps more real demonstration of the impact of inflation is to look at the price of a specific good or service over time. The graph below demonstrates how the price of the popular Ox & Palm corned beef 340 gram can has changed over time using the inflation rate. Current price of Ox & Palm corned beef 340 gram can is around K15.30 compared to K8.70 back in 2011, an increase of K6.60 per can or 76% increase!

What creates the inflation we see in PNG?

Some economists believe that the level of inflation is directly related to the supply of money in the economy under a theory called the quantity theory of money. If the money supply grows too big relative to the size of the economy, there will be a scenario whereby you have more money chasing limited or finite economic opportunities, i.e. fewer goods and services, resulting in prices increasing to compensate for this lack of opportunities. With a heavily resources reliant economy combined with severely limited social and physical infrastructure as well as very small labour force relative to the total population, one can see Papua New Guinea as an ideal environment for the quantity theory of money to play out. Indeed one of the significant concerns of the PNG LNG project was the potential of the project’s revenues to be brought into country and significantly increasing the amount of money in the economy with no real productive purpose and thereby resulting in inflation as the money is used for increasingly unproductive purposes such as spending on unproductive consumer items, needless real estate developments, needless roads, unjustified sports events etc.

Other economists view inflation as being driven by factors affecting the supply of goods and services or the demand for goods and services.

Supply shocks that affect production, such as natural disasters, or higher costs, such as high oil prices, can push the cost of producing goods and services up thereby increasing prices offered by producers and leading to “cost-push” inflation. PMV fares on highways are good example of how cost push inflation occurs as PMV owners have continued to increase PMV fares as the cost of vehicles, repairs and maintenance, and fuel have increased.

Demand shocks occur due to factors such as when large injections of cash are absorbed into the economy. For example when drawdowns on large loans are made by Government or when big royalty payments are made, or if the cost of borrowing money becomes very low, which results in more cash available to people and businesses to spend or increase their demand of goods and services. This increase in demand will challenge the economy’s production capacity to absorb the money, that is it challenges the production of goods and services to keep up with increase in demand so that no one who wants a good or a service misses out at the market price. If people start missing out on goods and services they will bid up the price resulting in “demand-pull” inflation. The prices of pigs during election time is a clear example of how demand shock due to the increased money flow in the elections results in prices being accepted by competing buyers going higher and higher.

Another more recently accepted cause of inflation is the expectations of people and businesses on future levels of inflation. If people or businesses anticipate higher prices, they build these expectations into wage negotiations and contractual price adjustments for CPI increases. This behavior by suppliers and consumers partly contributes to the next period’s inflation; once the contracts are signed and wages or prices rise as agreed, the expectations become self-fulfilling.

In PNG all the causes of inflation can be observed from rising prices due to increased transport costs to rising prices as government deficits have increased money supply in the economy without a matching increase in productivity. Inflation driven by expectations has also become a self-fulfilling scenario with many unions fighting for CPI increases and salaried staff including CPI increases in their contracts of employment.

Should Papua New Guineans be concerned about inflation?

In short, Yes. Papua New Guineans should be very very concerned about the inflation rates that affect their cost of living. Inflation reflects the rising cost of essential items such as food and medicines. Inflation is why the items that you could buy for K1 in 2011 will now cost K1.80. It is the reason why people think about the good old days when things were ‘cheaper’.

Inflation should be a key issue that people discuss with their government representatives at all levels. What are their representatives doing about the cost of living for ordinary people who are not privileged enough to influence their income levels to match inflation?

 What can Papua New Guinea do about inflation?

The underlying issue that enables inflation rate to become too high in Papua New Guinea is the lack of productive infrastructure that allows for more efficient and low cost production of goods and services, that is, the productive capacity of Papua New Guinea economy is low. Infrastructure can be physical infrastructure such as roads, bridges, wharves, airports, telephone lines, power lines, water supply or social infrastructure such as an appropriate education system, law and order, health services etc. These are fundamental development challenges faced by Papua New Guinea since independence that form a baseline for government and the people to respond to. It is nothing new but it explains inflation in this country.

However the response to inflation in this country has left much to be desired as numerous governments have talked about inflation without really focusing on it as a policy priority. There is no inflation targeting in PNG like they have in Australia and other economies. This has been a real loss to the people of Papua New Guinea because focusing on and addressing inflation will result in many of the development issues people raise in public discussion being addressed. Some of the topical issues that have a real impact on inflation include:

• SOE reform – the expensive, inefficient and unreliable delivery of services by the state owned enterprises such as PNG Power, Water PNG etc. has resulted in significant cost push inflation in the economy as businesses are forced increase prices to cover for the impact of unreliable and costly services while households experience real declines in their standard of living, eg. food in the fridge going bad as a result of blackouts.

•  Under-developed transport infrastructure – PNG has been handicapped by insufficient transport infrastructure since independence. Numerous governments have come and gone without ever recognizing the urgency of transport infrastructure as the backbone of development in this country. Well planned transport infrastructure built cost effectively in strategic locations will allow lower cost logistics that translates to lower inflation and an improvement in the cost of living for Papua New Guineans.

• Government borrowing – The Government’s use of borrowing is an acceptable way to fund it’s budget however it must ensure that the use of these borrowed funds are put to productive use. In PNG where the country has such a small economic production capacity, the Government’s borrowed funds must be used to fund required infrastructure that stimulates economic activity and increases this productive capacity. If a government borrows to fund non-productive consumption, eg. salary and wages, then this directly leads to demand pull inflation.   

• Sovereign wealth fund – As a resource rich country with limited productive capacity there is real danger of increase money supply driving prices and inflation up when resource revenues, especially windfall revenues from high commodity prices, are brought into country and spent by government. That is why over 10 years ago the Treasury Department and Bank of PNG led efforts to set up a Sovereign Wealth Fund to soak up this money and keep it out of the system to only release it through support for the national budget. In that way inflation can be minimized while the Government has a controlled long-term income stream to supplement it’s budget. However three governments have so far failed to establish the Sovereign Wealth Fund while Papua New Guinea continues experience significant out of control government spending funded by resource revenues.

It is worth noting that with the Governments earnest efforts to start-up resource projects (P'nyang, Papua LNG, Pasca, Wafi Golpu, Porgera 2.0) and the talk of the PNG economy becoming a K200 billion economy in the next decade by the Prime Minister Hon. James Marape as a result of all this activity, there is a potential inflationary impact due to the potentially massive demand placed on the economy and the resulting increase in inflation as prices for rent, food, building materials etc. increase significantly as too much cash chases too few goods and services. We have seen it before during the PNG LNG construction phase.