Fighting Inflation: Rethinking People and Profits

Fighting Inflation: Rethinking People and Profits

By Dr Rais Hussin, Dr Margarita Peredaryenko and Ameen Kamal

Economists will typically tell you that inflation results from an increase in production costs or an increase in demand for products and services. Therefore, consumer prices would rise steeply the more a country is exposed to supply chain shocks.

This appears to be true for most countries, but not all.
For example, Japan appears to be an outlier, with an inflation rate of about 2.5 per cent when its Group of Seven (G7) peers are experiencing around 8 to 9 per cent of inflation.
What makes Japan different appears to be its people-centric culture, exhibited in consumer behaviour and businesses that respect it.

This demonstration of the human element in inflation is not often discussed, even though it highlights how the people have such profound power (therefore, impact) on the economy.
It is easier for businesses and regulators to blame market forces or “supply and demand” and point to economic theories and mathematical equations to explain inflation.

Accordingly, some may believe that inflation can only be addressed solely through market forces, monetary policies by regulators, or government interventions.
For example, Malaysia appears to be experiencing very low levels of inflation, putting Malaysia’s inflation rate alongside exemplary advanced economies such as Japan and Switzerland, due to government intervention such as subsidies and other policies or measures.

Although this reduces the impact of inflation, it does not reduce real inflation caused by an actual increase in production costs or prices.
Even when subsidies target input prices, this merely “masks” or “discounts” the costs. The intervention does not actually bring down production costs—unlike what actual efficiencies in production would be able to do. Needless to say, this isn’t sustainable.

Coming back to the human element in Japan’s case, it is said by experts that businesses in Japan are quite reluctant to pass increased costs to the consumers, due to potential backlash from the people. As an explanation of the phenomenon, sources point to deeply-ingrained consumer behaviour of expecting low prices.

Of course, economists and various sources also point to other contributing factors such as an ageing population which causes simultaneous weakening of demand and higher availability of low-cost labour, and historical economic factors where Japan may still be recovering from the economic shock of both the pandemic and its 1989 economic crisis.

Even so, it is unlikely that these would be enough to cause Japan’s very low inflation rate, as the nation is still susceptible to significant external economic shocks that have resulted in increased consumer prices seen among its G7 counterparts.

This is why human behaviour in both the consumer and business end of the equation is often brought up to explain Japan’s unique situation.
In short, Japan has a business ecosystem and culture that respects the impact on the consumer or are concerned about negative public reaction.

Human Behaviour Underlines Inflation

Inflation results from the human desire to reduce losses or maintain the same margins due to an increase in production costs (for example, due to higher input prices and/or weakening currency), or an increase in selling prices as businesses view the increasing demand for their products and services as a cue of higher willingness to pay—irrespective of consumer’s increasing or decreasing ability to pay. The latter requires empathy, which is not taught in traditional economic theories.

In Malaysia, even if people are less willing or less able to pay, the amount of backlash from the people is either insufficient and/or not respected by businesses—a contrasting situation compared to Japan.

Inflation can also be driven by lower production volumes, say, due to scarcity of inputs, which prompts higher selling prices (assuming demand does not drop) in order to maintain the same level of overall profitability despite lowering economies of scale.

In essence, inflation is a function of profits and margins, rather than an automatic reaction between supply and demand, or money supply.
Underlying the action/reaction, supply/demand, and cost-push/demand-pull mechanisms of inflation is human behaviour. That is, consumer behaviour or expectations and human behaviour in businesses responding to consumer behaviour. Of course, this is significantly influenced by the prevailing economic practices.

Relatedly, excess money in circulation is often explained as a contributing factor in inflation. But prices would not rise automatically simply because there is more money in circulation.
The “velocity of money” in the equation of exchange “MV = PY” (money supply, M; velocity of money, V; price level, P; real GDP, Y) refers to how many times the same currency paper or coin exchanges hands in a set amount of time.

But the “Quantity Theory of Money”—which posits that a rapidly increasing money supply results in inflation while a decrease causes deflation—occurs when we assume that velocity V is constant, turning the equation of exchange into the theory.

In reality, V might change exactly because of people’s behaviour.
For example, consumers boycotting price increases (which they would likely do when they have knowledge and options that they could act on) would reduce V. Assuming Y also remains constant or not changed significantly and even when M is constantly growing, V decrease can exert stabilising pressure on P (price levels).

From the human behaviour perspective, what is happening is that businesses perceive higher volumes of money circulating as an indication of consumers’ higher ability to pay higher prices. From the supply-demand viewpoint, there appears to be more money for fewer products and services.

Under free market capitalism, this means businesses should increase prices to maximise profits.
Some companies may even take advantage of the overall inflationary environment to increase prices driven by the desire to compensate for past losses such as those accrued during the pandemic. These companies may not necessarily experience real cost-push inflation, or at least, not in magnitudes that would justify exorbitant prices.

Though cost-push inflation can be driven by the desire to maintain margins and therefore maintain overall profitability, demand-pull inflation is mainly driven by the desire to maximise profits, capitalising on circumstances that could push consumers’ willingness to pay higher prices.

Thus, economic theories and their mathematical equations do not dictate human behaviour, but rather, human behaviour dictates what the mathematical equation would be.
The good news is that unlike the physical laws of nature, there is still room for change.

A People-centric Societal Model Is Needed

As explained above, the dynamic between human behaviour in businesses and consumers underline economic phenomenon such as inflation. Thus, breaking this would require consumers and businesses to behave differently.

Instead of a business-centric or money-driven ecosystem, we need a people-centric societal model.
Of course, rethinking economic practices will take years of conditioning and setting up a new culture is a long-term struggle. But we know the steps to get there—a deeply-integrated society with technology, governed by inclusive and equitable principles and practices.

Japan’s “Society 5.0” vision is a good futuristic societal model that puts the people at the heart of inter-connected Fourth-Industrial Revolution (4IR) technologies and through what Japan refers to as a ‘super-smart’ society, people’s problems can be addressed.

Japan’s cabinet office defines its Society 5.0 initiative as follows: “A human-centered society that balances economic advancement with the resolution of social problems by a system that highly integrates cyberspace and physical space.”

This is a paradigm shift from standard free-market capitalism. As mentioned in an International Monetary Fund article, “The essential feature of capitalism is the motive to make a profit”.
Therefore, thinking of the consumer, or worrying about consumer backlash (as what appears to be happening in Japan) instead of just how to capitalise on the consumer or market forces is revolutionary, and a much-needed change in human behaviour.

It embodies the concept of “Economics of Empathy” as EMIR Research coined before.
Transformations solely led by technological innovations such as digitisation, automation, high-tech surveillance and artificial intelligence (AI) hold the promise to be highly efficient at minimising costs.

However, in the absence of a policy or societal model (widespread, deep, transparent and fair implementation, a people-centric culture, effective legislation and enforcement) that puts the well-being of the people first, such a system would do little to improve people’s lives, if not make it worse, as businesses would only use technology to further maximise profits.

This consideration forms the basis for the development of the “Malaysia 5.0” national strategy vision, which takes inspiration from Society 5.0 and integrates Malaysia-specific circumstances and goals (such as those outlined under Shared Prosperity Vision 2030).

It is important to clarify that Malaysia 5.0 isn’t a radical swap from extreme capitalism to extreme socialism. Instead, what is proposed is simply a structure/framework that promotes and enforces a fairer, more empathetic version of economic practice where the beneficiary of the technological revolution is the people – not just businesses or the elites.

Though this is obviously a long-term vision, we can start with a few “quick wins”.

For example, for food items such as chicken, we should consider official online portals which show the list of all registered chicken meat retailers/sellers publishing up-to-date respective selling prices which would increase visibility and therefore, competition and consumer options.

Any sellers using exorbitant prices will be quickly reported by other users for authorities to take action. This can be further enhanced with consumer ratings and reviews.
Significant buyer resistance and the ability to act on increased availability of choices (e.g., innovative transport/delivery services regardless of distance) will force sellers to minimise selling price, instead of maximising it. Competition among sellers and the ability of consumers to exercise their choices will be key to bringing prices down.

Moving Forward

As the consumers are more empowered, the backward pressure would impose increased competition throughout the supply chain, further reducing costs. This will promote better uptake of digital transformation in supply chains as businesses will seek to reduce costs through improving efficiencies.

A widespread digital transformation and competition set the opportunity for technology legislation to enforce increased transparency—minimising the ability of companies who are taking advantage of the overall high inflation environment even though they may not necessarily experience real cost-push inflation.

Big Data generated throughout the supply chain (enabled through Internet-of-Things; IoT technologies) should be fed to and analysed by AI for supply chain and logistics optimisation, which includes real-time decision-making and forecasting.

Such a technologically transformed supply chain may benefit in helping reduce inflation due to increasing energy/fuel costs, which is one of the biggest cost-push contributors.
The digitally-transformed and radically-transparent supply chains would see significantly increased competition throughout the supply chain of goods and services, resulting in lower prices for the consumer.

Evidently, the concepts of self-sufficiency, localisation of supply chains, and buy-in of the people-centric framework at a global scale are critical in ensuring a more sustainable economy, and in fighting inflation.

(Rais Hussin, Margarita Peredaryenko and Ameen Kamal are part of the research team at EMIR Research, an independent think tank focused on strategic policy recommendations based on rigorous research.)

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