Why the UAE will have to learn to live with inflation

 

Members of the UAE Federal Natio-nal Council have taken ministers to task over mounting inflation, criticising them for token measures that achieve little, such as forcing down the price of bottled water. It is also true that government salary rises are not a solution. But much of the inflation the UAE is now facing cannot be controlled and we are just going to have to learn to live with it.


Consider supermarket prices of food. Who sets these prices: global market forces or Spinneys and Choitrams? It is the poor harvest in the United States and Australia that is forcing up the price of wheat and wheat products such as pasta. The supermarket is just the middleman in this process, and given rising staff costs may even find its profit margins under pressure. And the same could be said for many businesses in the Emirates that find their raw material costs spiralling upwards.


Better perhaps for the government to look at areas where it can make a difference. The bulk buying and storage of certain construction materials, for example, is one way to keep cost increases under control, for a while.


However, if you want the root cause of the inflation now menacing the UAE – estimates of local inflation range from a little under 10 to more than 20 per cent – then you need to look overseas.


It is the giant money supply expansion engineered by the US Federal Reserve since the dotcom bust in 2000-01 that is to blame. For if you increase the supply of money in the world faster than the amount of goods and services available then that is bound to cause inflation.

The Fed took this path – which led directly to the US housing boom, sub-prime loans and the subsequent housing crash – because the alternative was too horrible to contemplate. That alternative would have meant a long and deep recession or worse in the world’s biggest economy.


The US is not likely to want one now either, and so we should expect more of the same medicine in 2008 to offset the impact of the credit crunch and most probably also a big decline in equity prices and further falls in the value of US real estate.


Therefore, the primary cause of inflation in the UAE is well beyond the control of the federal government. All the same, the government can take certain measures to lessen the impact of US-driven inflation on the local economy.


Top of the list is a revaluation of the dirham. This would ease price rise pressures from Europe and the United Kingdom, which together form the main source of local imports. It would also improve the international competitive advantage of local business by boosting the value of expatriate salaries in foreign currencies.


How far price controls actually work, and how far they merely artificially distort economies is a matter of debate. Most countries around the world have spent the last couple of decades dismantling price controls and allowing the free market to function.


Certainly hitting a few unfortunate companies for raising prices while allowing prices to surge elsewhere in an economy is not fair or effective; the main area the government can take action is in attempting to cap rental increases.


However, rent controls tend to dissuade investment in property, and that is what is needed to bring rentals down in the longer term, and to moderate house price inflation. So what appears an easy choice for the government is not that simple: do you go for the short-term inflation fix or take the longer view?


On the other hand, very high wage settlements such as the 70 per cent rise given to 60,000 federal staff for 2008 are inflationary. If you put more money in people’s pockets they have more to spend on goods and services and that chases the price up.


There is perhaps a good argument that federal salaries have lagged along way behind inflation and thus merited a one-time realignment. But in future this kind of huge increase ought to be avoided, and the idea that raising salaries tackles inflation is ludicrous, it can only make things worse.

But maybe the UAE is just going to have to get used to a period of high inflation and high growth, which is largely due to problems in America and not something that the local government can do much about apart from adopting policies to avoid making it worse.

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