6 AUGUST 1977, Page 12

Forward to the crash

Patrick Cosg rave

The reaction to the final collapse of the Government's incomes policy was not as disheartening as one might have expected, given the mindlessness and the folly of so much of the commentary on British economic policy over the last generation. To be sure, much of the press, the CBI, and some other bodies of opinion, foretold disaster. But — helped, no doubt, by Mrs Thatcher and her party's steady and continuing disavowal of the incomes policy instrument in economic management — there were, in addition, plenty of strong voices raised in hearty relief that the fourth successive such experiment had, like its predecessors, ended in failure.

The extraordinary thing is not the failure. It is, rather, the continued support for that general economic policy of which more or less statutory control of incomes is a part, • and which has dominated most government activity in Britain since the war. That whole generation has seen decline, disruption, and repeated demoralisation. What leads otherwise civilised and intelligent politicians and commentators to advocate its continuance? Answering that question is as important a step on the road to economic sanity as advocating the alternative policies which the opposition (most recently in the form of Sir Geoffrey Howe's address to the University of Georgetown last week) have now adopted.

There are, no doubt, many reasons for such attitudes, but I should like to mention only two. First, wehave for a generation been trapped in a vice of economic fashion created by John Maynard Keynes and his followers. The fashion dictates that economic means should be used by governments to achieve social ends (of which full employment is the most important); that governments can use deficit budgeting (i.e. spending more money than they have) with impunity to do this; and that the economic arguments underlying this great consensus are of a very nearly scientific (in the sense of the physical sciences) character. All this is balderdash.

But the second, and perhaps the more important, reason for continuing with what has gone before is an emotional, or psychological, one, based on a generous fear. At its crudest the fear is expressed in the immortal sentence, it's not politically possible', which is meant to convey that alternative policies would be politically intolerable. The generosity in the fear is based on a conviction that to eschew controls on prices and incomes, and to bring the budget into balance, would create both large-scale misery for the needy 'beneficiaries of the Welfare State and incite social and economic dislocation on a large scale. What is, however, becoming increasingly clear is that there is no choice. Matters have now gone so far that even the adoption of such measures as I and the two heroes of this article, F. A. Hayek and Milton Friedman, would consider right and necessary will not save us from severely increased unemployment, a reduced standard of living, and a prolongation of misery. There is, quite simply, no way out other that a painful one.

As several of its members (notably Lord Barber and Mr Heseltine) have testified, the massive increase in the supply of money ordained by the Heath government, and symbolised by the 1972 Industry Act, was above all stimulated by conscience (or panic) in the face of rising unemployment. It had, however, another purpose: it was designed, by injecting capital into the economy at various points, to stimulate economic take-off. Its early period was marked above all by Mr Peter Walker's explaining away the difficulties individuals then faced as 'the problems of success'. In the actions they took Mr Heath and Mr Barber (like Mr Macmillan, Mr Healey and Sir Harold Wilson) were influenced by an essentially Keynesian proposition, and thus by the intellectual economic fashion of the last generation. The proposition was that the best remedy for rising unemployment was an increase in aggregate demand, procured by increased government spending. Empirical experience since the war has shown that this is not the case, but there is nonetheless a very understandable human reason for the continuing attraction of the proposition.

It is this. Economics, for all its pretensions, is not like the physical sciences. Some of its elements are quantifiable and some are not. At the very outset of the Keynesian period economists attempting to devise a theory on which to base policy were attracted by the fact that one could measure both total demand and total employment. A relationship between them was therefore supposed to exist, which only bitter experience has shown to be false. The politicians opted for what it seemed to them could be measured, all the more so because the Keynesian theory relieved them of restraints — such as the taking of the measures required to maintain the stability of the currency.

What happens when governments inject the money they invent into the economy? Well, first of all, money is injected only at particular points: it is impossible to provide a general stimulus. Thus, attempting to establish a relationship between aggregate

demand and aggregate employment is attempting to create a relationship between like and unlike. In the early days of pump-priming what happened was that injections of money produced demand only at those points: when circumstances or policy forced the stoppage of the supply the demand died with it. Today, however, we face something more serious. As unemployment figures (for a great many additional reasons impossible to go into here) prove resistant to inflationary investment it becomes clear that even to maintain the status quo requires not merely a continuing injection of capital, but an accelerating injection, and thus an accelerating inflation. What happens is that demand and employment alike can be sustained only in areas where the market itself (the multiple demands of consumers) would not otherwise create them, and this leads to a systematic and continuing distortion of the economic process. Since we cannot go on creating money for ever, and since the injection of invented money into areas of unemployment feeds on itself rather than creating new wealth and new demand, employment can be sustained only by an accelerating injection and thus by accelerating inflation. When, by whatever means, inflation is made to fall, unemployment must rise. The difference between the existing and the alternative monetarist policies is that the first exacerbates the problem as time goes by, while the second produces transitional unemployment, such as is enforced by a shake-out of labour as the market adjusts to reality. I repeat, however, that in our present position high unemployment levels, at least for a time, are unavoidable.

The enormous political advantage of the original Keynesian proposition was that a trade-off was possible between inflation and unemployment, and that one could thus choose X rate of inflation in order to get 1' level of employment. Provided A' was not too intolerable, therefore, one could choose any that was politically attractive. For a variety of reasons this simple equation has been discredited. Among the reasons are the much stronger social security net underlying modern unemployment which makes the condition more tolerable; the movement of women and teenagers in and out of jobs; the inhibition council housing imposes on mobility of labour; and the effect of inflation on people's attitudes to the traditional moralities of a high employment society — for inflation weakens both the desire to work and the desire to save. In consequence, the belief has grown in a natural rate of unemployment — a rate which could not be made to fall however much was spent. We have now — at any rate in monetarist thinking — arrived at the proposition that higher inflation brings about higher unemployment.

Here we reach the vital question of politicians have only slowly become aware. dangers of controls. The level of unemployment if we use traditional evil on which politicians most readily fixed, and for which they sought a solution most assiduously. Expenditure cuts which seemed likely to increase it were most sternly resisted. There have been good and bad reasons for this. Among the good was the sheer horror of unemployment as manifested in memories of the 'thirties. Among the bad was the brutal fact that, if money had to be trimmed back, it was most easily trimmed back by cutting spending in purely social fields, like social security and education, where the clients were least able to fight back, rather than in employment subsidy, where powerful trade unions posed a threat. That really large amounts of money can be saved only by cutting industrial subsidisation is a fact of which politicians have only slowly become aware. However, as inflation and unemployment both rose, and the electoral threat they posed became manifest, politicians had to do something, so they sought to control the symptoms of inflation, of which booming money wages and booming money prices are the most obvious. The trouble is that both wage and price controls further distort the economic process, already badly out of shape after years of inflationary spending. More: the present Labour Government in particular, in a pathetic attempt to buy wage controls, undertook large public spending programmes (in nationalisation and employment controls particularly) which Increased the deficit.

Wage and price controls are thus the outward signs of an inflationary policy, all the more so in that in the recent past their complete failure to win for workers and consumers a reduction in inflation as they see it in their daily lives has built up enormous pressure against continuance of the controls — pressures such as we are now seeing in the Stage Three negotiations — and, when the dam bursts, there is an immediate and destructive jump in wages and prices. Such a jump is absolutely inevitable in Britain in the next year.

Which brings me to F. A. Hayek and Milton Friedman. In the last few years the names of both men — Hayek, the austere Austrian philosopher, Friedman the ebullient and diminutive American economist — have• become increasingly familiar. Their influence has, without becoming anything like preponderant, increased; and their achievement has been rewarded by Nobel prizes in successive years. Both men have an enormous amount of writing to their credit but, thanks to the Institute of Economic Affairs, we now have available succinct summaries of their thought in the form of their Nobel lectures."

There are important differences between the two men — Hayek believes in the

restraining effect on government profligacy of such institutions as fixed exchange rates; Friedman does not; Hayek is much more hostile to trade unions than Friedman; and *Full Employment at Any Price? F. A. Hayek (LEA f1.00). Inflation and Unemployment Milton Friedman (IEA £1.00) .

Hayek believes that Inflation ends in totalitarianism, while Friedman does not think this necessarily so.

I should like first to dispose of the commonest accusation made against Hayek, Friedman, and their followers (usually called monetarists, because of the emphasis they place on the role of money in the causation of inflation, though Hayek is sharply critical of strict monetarism). The accusation is that they would — heartlessly or naively, according to the inclination of the critic — use unemployment deliberately as a weapon against inflation. The point ought to be put in a very different way. Both believe that inflation has always, in the long run, caused unemployment. They believe that monetary measures to reduce inflation will cause some unemployment in the short run. In recent years, however, they have come to the conclusion that, given the acceleration of inflation throughout the western world (there have been ups and downs, to be sure, but since the war all of us except the Swiss and to a lesser extent the Germans have been living in an inflationary world, with Britain and Italy suffering most) and the increasing failure of the unemployment figures to respond to injections of cash by the state, we face a choice between long-term large-scale methods, and short-term large-scale unemployment if we employ the monetary weapon. Whatever the correctness of the reasoning, therefore, the policies advocated are in theory more humane that the present ones.

Inflation is essentially an ovqrall, steady, and perhaps precipitous increase in the general level of prices. Market conditions, failure of crops, natural disasters, such events as the Middle Eastern war of 1973, among other phenomena, may cause increases, even sharp and dislocating ones, in particular prices, but to thee a healthy economy can fairly quickly adjust, as has the Japanese since 1973. The problem of dealing with a general increase, and the concomitant decline in the value of money, is of a different order. Common sense —and, for that matter, daily experience — indicates that the greater the supply of a commodity, the lower the value of its individual units. Thus, the more money is made.available in a society the less the individual unit of currency will purchase, particularly when this money is not real. When the public sector spending deficit is large, therefore — as it has been in Britain for many years — and the difference between government income and government outgoings is made up either by borrowing or by the extension of credit (printing money) the decline in its value will be precipitate. $o, although the present government has taken a number of measures (some of which are more artificial than real) to reduce spending in the last couple of years, the deficit remains large, and it is the size of the deficit that, more than anything else, conditions the rate of inflation. I would estimate that the last Budget strategy outlined by the Chancellor locks us into an inflation rate of about 16 or 17 per cent. If, as he now threatens,' the Chancellor reflates in the autumn (eitheriby cutting taxes or by increasing credit) the figure for inflation will rise. There is no present prospect of our rate of inflation declining below 15 per cent.

Now, the present policy depends on a continued high, even if reduced, deficit. This deficit has been maintained above all for social reasons, and particularly to keep unemployment figures down. Essentially, this is exactly similar to all post-war economic policies, though we must take account of the fact that the continuance of the same bad policy increases the problem progressively year by year. Mr Harold Macmillan, for instance, frequently prides himself on the fact that inflation was much lower when he was Prime Minister. But the fact of the matter is that his was merely an earlier stage in the process, and the economic system in the 'fifties was much better able to bear government profligacy than it is in the 'seventies. That is why our situation had become steadily worse, and will continue to do so. We are becoming progressively weaker.

Those who argue, therefore, for a tight Stage Three would, even if they had their wish, achieve nothing except a brief postponement of the inevitable. Indeed, there is much to be said for getting the whole business over quickly, and it is therefore probably better that the present government should preside over the disaster at whatever cost to themselves electorally, rather than that a new government should have to bear the liurden of their folly. What will happen when the dam breaks, of course, is that both wages and prices will rise fast and steeply. If government behaves responsibly in moving towards a balanced budget, then, if the trade unions maintain their pressure on wages there will be much higher unemployment immediately: the unions will be demonstrating their only real power, that of pricing people out of work. But I must stress that there is nothing political tacticians — the authors of theories about what is politically possible, or what one can and cannot do about the unions and their power — can do about it. Whatever policies are adopted, the post-inflation crash cannot be avoided.

There are two final points of importanceBecause Conservatives have been most receptive to Hayek and Friedman and their thinking, it is assumed that the monetarist policy I have outlined is necessarily a Tory one. That is not so. True, there-are inherent characteristics of the Labour Party which make it difficult for that party to survive electorally without a high spending programme. True, too, there are further extensions of monetarism — and notably of Hayekian thinking — Which are particularly palatable to Conservatives, notably the argument for massive cuts in the amount of GNP consumed by the state in order to enhance individual freedom. But these, as I know Mr Benn has grasped, are extraneous to the argument as I have advanced it here. No government of whatever colour can survive or save Britain with anything like the Present policies.

When inflation has been stopped, it is Possible to balance the budget with either a high or a low level of taxation, Given that a Socialist government would still have many more activist aims to fulfil than a Conservative one, it would have a high taxation system. It is true too, in my Opinion, that a non-inflationary socialist economic system would continue to inhibit the creation of wealth: we would, under them, be poorer, but we would be much more equal (and egalitarianism is a great socialist aim) and our economy would be stable.

For — and this is my second point — there IS nothing inherently wealth-generating about the alternative policy I have outlined. What is being sought is an equilibrium between demand and employment. What is being argued is the conviction that that equilibrium can be created only if the millions and billions of demands of consumers are expressed freely and fully through the market and therefore attract to themselves the hands and brains of all who are employable and who are willing to work. This and this ,alone can end inflation and achieve as much employment as is Possible. How to make ourselves rich, and to ensure a rising standard of living, is a much more contentious argument. All I say now is that stability and relatively full employment can be achieved, but that to achieve them would require a wholesale abandonment of fashionable policies.

Is it politically possible? The Pusillanimity of politicians perhaps even More than the arrogance of economists who thought they were scientists has brought us to our present pass. The conviction is Widespread that a democratic electorate is

t°0 selfish or .materialist or uncomprehending to tolerate the shock that a stiff dose of monetarism would produce. The immediate consequence of a switch of authority from the state to the market Tay, however, be exaggerated. In Germany ur Erhard achieved it without much pain .and to the great benefit of his countrymen pecause they understood the alternative. I `A',ould, however, be vastly preferable (and nere I am with Hayek rather than Friedman) to make the first step a massive and fundamental immediate cut in sPending, To do the job gradually would rU n even a fresh government into constant

pressures and weaken its resolution as the

next election approaches: its best prospect , ermomically and politically would be to act immediately, and trust to its own persuasive Powers and the understanding of the people Flo see it through. But, I stress again and 1.1114111Y, there is no choice between pain as a esuit of new policies and calamity with the Present ones, including those advocated at Present by Messrs Healey, Grigg, Maudling and Callaghan.