Analysis / Stagflation Is Back

The 0.4 percent rise in the Consumer Price Index in September was bad news, proving to all of us that inflation is still alive and kicking. A month ago we hoped that maybe we were heading back to Western normalcy. It seems it was too soon to celebrate.

The 0.4 percent rise in the Consumer Price Index in September was bad news, proving to all of us that inflation is still alive and kicking. A month ago, when the negative August CPI (-0.4 percent) came out, we hoped that maybe we were past the era of rising inflation and were heading back to Western normalcy. It turns out that it was too soon to celebrate.

If inflation continues at its current pace, we will end the year with 9 to 10 percent inflation. That sends us back to the 1990s, when we suffered average inflation of 10 percent a year. The change came in 1999, when inflation declined to 1.3 percent and we joined the list of countries with stable economies. This continued in 2000 (0 percent inflation) and 2001 (1.4 percent).

But now it is 2002 and the proof is in the pudding - we have not yet exorcised the inflation demon. The economy has still not grown used to stable prices, and any crisis, domestic or foreign, results in price increases. This year will be remembered as the great inflation failure.

The first reason for the failure was the drastic 2 percent cut in interest rates in December 2001, when Bank of Israel Governor David Klein believed Prime Minister Ariel Sharon and Finance Minister Silvan Shalom when they promised to cut the deficit. Instead, it grew in the first half of 2002, increasing uncertainty in the market and causing the public to flee to the dollar. The shekel depreciated, and price hikes followed. We are still chewing on the rotten fruits of that policy.

But how do prices go up when unemployment is over 10 percent and wages are falling? One reason is that savings are dropping, as people use them to maintain their standard of living. And there are still people who work and earn a respectable living, so there is still consumer demand, shoppers in the malls and new cars on the roads. The economy is not paralyzed - and that is good.

Another reason is that the dollar is going up - actually, the shekel is falling - and with all imports priced in dollars, this means their prices will go up. And since it is impossible to absorb rising import costs and see their profit margins shrink, the merchants raise prices, especially when they see that people are still buying.

That leads to another important factor: monopolies. Israel does not have a genuinely free market with competition between manufacturers, so it is easier to raise prices. Many branches of the economy have no competition at all, and competition is the best guarantee of efficiency and low inflation.

There are only two banks - Leumi and Hapoalim - and they form a duopoly that controls interest rates and bank fees. They can keep raising their fees even in a recession.

There are only three gas companies, three newspapers, three major supermarket chains, and only one Tnuva, one Osem and one Elite. There is only one electric company, which can raise prices (after getting government approval) and at the same time increase wages. There are monopolies for water, public transport, air transport and the ports. And that is not the entire list. When there is no real competition, the big factories can raise prices, dragging the entire economy along.

That is why we now face threatening stagflation: unemployment, falling wages and rising prices. Clearly, the poor will get poorer, and in the next UN Report on Human Development, our ranking will be even worse. We are already ranked very low with regard to the amount of poverty in the population, and in the coming report, we will be even lower. Let's just hope we do not end up below Russia.