11 JANUARY 1957, Page 28

THE COST OF DISINFLATION

By NICHOLAS DAVENPORT THE professional economists are busy conducting the post-mortem on the body economic of 1956. They are pretty well agreed 'that the unhealthy inflation had been driven out of the system even before the unfortunate accident on the Canal. In the Times Review of Industry both Mr. Roy Harrod and Mr. Ronald Brech believe that the curves of unemployment and unfilled vacancies will soon intersect—before the winter is out in Mr.•Harrod's opinion. But while Mr. Brech seems fearful lest the Government should adopt softer policies too early, Mr. Harrod considers that the time is now fully ripe for an easier credit policy. After studying Mr. Brech's statistical diagnosis, which points to the stagnation of 1956 becoming worse in 1957, I fully agree with Mr. Harrod. In an article entitled 'The Year the Economy Stood Still' The Economist puts the cost. of the 1956 disinflation—in terms of unused resources —much higher than does Mr. Brech. It esti- mates the expansion in productive capacity—the first fruits of the investment boom of 1955—as worth about £750 million a year, but believes that only about £50 million of this was actually re- quired and used last year. (This figure is arrived at by a somewhat complicated calculation : briefly, in real terms, an increase of about £50 million in consumption was more than counter- balanced by a decline in public authority spend- ing, while a rise of about £150 million in fixed investment was more than offset by a fall in stock-building. The rate of increase in exports was about £180 million, but allowance must be made for a swing towards us in 'invisibles' and the terms of trade.) Thus, according to The Econo- mist, £700 million or so was the cost of the 1956 disinflation, representing the increase in pro- duction which we could have enjoyed if we had been able to expand output to capacity without bothering about the balance of payments. (Mr. Brech would put it at about £575 million.) It is a sobering thought, especially when one reflects upon the higher output last year of the more dynamic industrial powers—America, Russia and Germany.

*

Production in Great Britain has now been stag- nating for nearly twenty months. Both The Economist and Mr. Brech foresee an actual decline in output over the next six months: neither looks for any upturn before the last quar- ter of the year. As industrial capacity Is still being increased—as a result of the further increase in investment in 1956—the cost of stagnation in 1957 could be twice as high as in 1956. Its cost in business confidence is incalculable. As The, Economist points out, businessmen have as yet tasted none of the fruits of their investment boom; nor has the new equipment they have brought in been given its full chance to cut costs. This is quite enough to cause alarm and despondency in the business world and `the cancellation of

further investment plans. If Mr. Macmillan does not want to see industrial investment actually decline before the year is out he would be wise to restore the investment allowances in his April Budget. And before long, as Mr. Harrod sug- gests, he should follow up the decline in the Treasury bill rate by reducing Bank rate to 5 per cent., even if he still maintains the credit squeeze and the restriction of bank advances. If he leaves these small reliefs till the end of the year he may be courting disaster.

What tends to increase the cost of disinflating a free society is the non-mobility of labour. The

motor industry, for example, which Is the most disinflated in the country, has been hanging on to its labour by working a short week. But there are capital goods industries still short of labour— steel, shipbuilding, aircraft and others. The steel industry needs manpower not only directly but indirectly in the factories making the capital equipment for its expansion. At September last, as compared with September, 1955, the nurribers employed in the restricted trades (wireless, motor- vehicles and other 'consumer durables') were 51,000 fewer, but electrical manufacturing gained only 6,000 and the shipyards only 4,000. Trades which gained labour heavily were building and contracting, distributive and other services— which is hardly what the Government intended. If the shock of the Suez crisis could only speed the flow of labour into the right industries and moderate the pressing wage claims, good may yet come of it. It may succeed in bringing Mr. Mac- millan's disinflation to a quicker end.

Re-expansion waits upon the Chancellor's word. There is enbugh pent-up demand accumu- lating to justify a big expansion of output later in the year. In the normal course of business this will involve a considerable stocking-up and a worsening of the balance of payments in the second half of the year. Let this not deter the Chancellor from giving the signal to re-expand. He has not replenished the gold and dollar re- serves just to please the City of London.