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Blog: 16 May 2016 (South Africa's Phillips Curve)
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In today's blog we take a look at well known economic theory called the Phillips Curve. It was developed by economist A.W.H. Phillips and it states that there is a stable but inverse relationship between the unemployment rate and the inflation rate.
Basically as the one goes up, the other will go down. For example as the unemployment rate falls, more people are employed, so in order for a company to get the best employees they will need to pay more. And this will push up wage price inflation which in turn will push up the general levels of inflation. This theory assumes that the economy is operating at close to full capacity and employment levels. The question is whether the Phillips curve holds true for South Africa? Is there a inverse relationship between South Africa's unemployment rate and inflation rate? We take a look at South Africa's Phillips curve below. |
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The graphic to the right shows a scatter plot (the green dots) of South Africa's unemployment/inflation mix from 2001 to 2016.
The blue line shows what a standard theoretical Phillips curve looks like. As you move up or down the blue line, either inflation or unemployment will increase and the other decrease. The orange dot shows the average level of inflation and unemployment for South Africa from 2001 to 2016 (using the median value between 2000 and 2016). We will call this South Africa's "natural" rate of unemployment and inflation. Placing a linear trend line through the green dots scatter plot, we get the red trend line. This is in stark contrast to the theoretical Phillips curve. Granted most countries unemployment and inflation scatter does not follow Phillips closely but the trend line is negative in most cases. But this is not the case for South Africa. We look into why below. |
So why is it that we show a positive relationship between unemployment rate and inflation rate? When most other countries show a negative relationship between the unemployment rate and the inflation rate?
Well a few possible reasons could be given for this:
Well a few possible reasons could be given for this:
- South Africa's inflation is not driven by wages price increases (this is unlikely as Unions regularly demand above inflation wage increases)
- South Africa's economy is not operating at close to full capacity or employment. This is shown by our manufacturing under utilisation.
- Lack of skilled and experienced labour leads to a high unemployment rate (mostly for unskilled labour) and higher wages for those that are employed (skilled labour)
The linear regression slope tells us that for every 1% increase in the unemployment rate, the inflation rate will increase by 0.24%. While the linear trend line is a very crude estimator (and it's estimates should be read with caution), it does provide a mid point for the scatter plot and shows that in South Africa's case the Phillips curve does not hold true, and that there is no inverse relationship between unemployment and inflation in South Africa. In fact the opposite is true, it seems that in South Africa's case, our high levels of inflation is fueling unemployment.
Perhaps labour unions should demand no pay increases for a few years, but rather demand increasing the number of employed staff? As this would increase number of employed, lowering the unemployment rate, and no wage increases would mean lower wage rate inflation, which in turn would lead to lower levels of inflation. And just like that we will conform to the Phillips curve theory, like most other countries (said tongue in cheek).
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Table:The table to the left shows the average unemployment rate and inflation rate for each year since 2000.
These values were used to create the scatter plot in the graphic above. |
