Inflation, Sustainability and Growth: When less is more

Linda Lim & Geh Min, Straits Times 30 Jun 08;

THE current bout of global inflation, mostly but not only in food and fuel prices, may be viewed, like global warming, as a wake-up call that the future of global and local economies cannot be like the past.

Fundamental lifestyle changes may be in store for all of us, particularly those in developed countries, including Singapore.

Today's inflation is symptomatic of substantial long-term world market forces at work, rather than a short-term business cycle or bad government policy. The coincidence of slowing growth with accelerating inflation - popularly known as 'stagflation' - indicates that excess demand resulting from economies operating beyond full-employment levels is not at work here.

Most governments today also understand that excessively 'easy' monetary policy, subsidies or price controls, and undervalued exchange rates all contribute to inflation.

The recent moves by many governments - including those of China, Indonesia and Malaysia - to reduce or remove fuel subsidies are a case in point. Subsidies and government price ceilings make inflation worse because they increase rather than reduce consumption of scarce commodities. Far better for prices to rise to market levels that equate supply and demand.

Consumption of another scarce resource - the natural environment - is also subject to market forces but with a twist: Environmental assets - clean air, water, undisturbed land - are under-priced by the market, regarded as free, and thus are over-consumed.

The market does not capture 'externalities' such as the costs and benefits to the health of human beings, future generations and the earth of exploiting or conserving natural resources.

If externalities were included in market pricing, overuse of scarce natural resources would be limited but they would also be more expensive. Unfortunately, we cannot increase the supply of natural resources. We can only reduce our demand for them.

Governments through regulation can raise the cost to consumers of previously 'free' and thus under-valued and over-exploited resources.

Herein lies the link between inflation and sustainability. The part of today's worldwide inflation which is here to stay is due to long-

term changes in demand and supply. Rising incomes and wealth have created large new consuming populations in emerging markets such as China, India and Russia.

Their consumption adds to global demand, including for scarce resources like fuel. This will only intensify.

On the supply side, land and natural resources are fixed, and have already been fully utilised and exploited throughout most of the world. They are only going to become more scarce, though technological innovation can help us conserve the resources which remain by increasing the amount of output that can be generated with the given resources.

Global warming already signals that we may, according to scientists, be at or close to a 'tipping point' of no return to the balances of the past.

Both inflation and global warming signal a ratcheting upwards of the supply-demand equilibrium for scarce resources to a new and permanently higher level. Market forces will compel us all to consume less of scarce resources because they will become more expensive, properly reflecting their true scarcity value, inclusive of externalities.

In this context, both short- term 'inflation pay-outs' and aggressive long-term GDP growth targets are part of the problem rather than the solution to both inflation and environmental degradation.

'Inflation pay-outs' are simply another version of the 'cost-of-living indices' that perpetuated high inflation in Latin America for decades until the 1990s. By 'cushioning the impact' of inflation, they discourage adjustment to the higher cost of resources.

'Inflation pay-outs' by private companies also increase their costs, reduce their competitiveness, and in Singapore's already high-cost open economy, risk undermining investment and growth.

From a public policy perspective, it may be desirable to subsidise the consumption levels of the poor in a society. But this should be done by taxing those who are richer, who consume more than the poor, and thus contribute more to both inflation and environmental degradation.

Society as a whole needs to consume less. If we do not make that choice ourselves as individuals or governments, the market, nature and society (through political unrest) will do it for us - sooner and with greater force.

The imminent demise of the petrol-guzzling SUV in America, the financial woes of the energy-intensive global airline industry, food riots and protests over high fuel prices in many countries - these are only the first of many examples of lifestyle, business model and even socio-political changes that market prices will impose upon us if regulators will not.

Globally, aggressive GDP growth targets are justifiable for lower-income countries to lift them out of poverty. But they are less justifiable for higher-income countries like Singapore, whose citizens by and large already enjoy a comfortable standard of living.

We are also land- and labour-scarce, bereft of natural resources, already compelled to go further afield to source necessities such as foodstuffs, and vulnerable to supply disruptions.

With our per-capita energy consumption already among the world's highest, policies such as targeting a further 50 per cent increase in our population and resource-wasting practices like the high turnover of buildings - through collective sales, for example - need to be re-thought. We suggest a few simple initial principles.

First, the economic theory of comparative advantage tells us that no country can be internationally competitive in everything, because competition among different sectors for scarce resources will push up resource costs.

As a very small resource- poor country, Singapore cannot expect to be competitive in all of high-value manufacturing, finance, creative industries, life sciences, tourism, education and health services, and so on.

At a minimum, importing the labour and talent to fuel these industries will raise land costs and property prices to a point where the cost-competitiveness of these industries is eroded. Already, Singapore's housing-price inflation last year topped that in other countries by a wide margin.

Second, for both economic and environmental reasons, sustainability should be an important factor in choosing between sectors. This can be achieved by a clear regulatory framework which, for example, encourages energy efficiency in the production of output.

Social cost-benefit analysis techniques can be employed to include the imputed costs of 'externalities' such as pollution and congestion, in project evaluation. Excessively energy-intensive sectors could be penalised through taxes while energy conservation could be encouraged through tax breaks and other investment incentives.

Third, the criteria for measuring successful economic performance should be modified to include sustainability. Some years ago, China required that government agencies be evaluated for their performance on the basis of 'green GDP'. This requires the subtraction of environmental costs from the market value of goods and services produced (or standard GDP).

As a country with a per capita income 10 times China's and per capita carbon emissions about five times China's, Singapore should follow Beijing's lead in this.

It will help us moderate, even if we cannot eliminate, both inflation and environmental degradation as well as contribute to our own present well-being and future sustainability.

Linda Lim is professor of strategy at the Ross School of Business and director of the Centre for South-east Asian Studies, University of Michigan.

Geh Min, an ophthalmic surgeon, is a former president of the Nature Society of Singapore.

CUT CONSUMPTION

Society as a whole needs to consume less. If we do not make that choice ourselves as individuals or governments, the market, nature and society (through political unrest) will do it for us - sooner and with greater force.