Inflation

Where do we go from here?

D. F. Lomax

A policy against inflation is now one of the central features of any government's pro gramme. Over the last decade various governments have done the best they can in order to cope with this. The results have been unsuccessful, if not positively harmful.

Inflation policy has to take into account the nature of people's behaviour. On the one hand people spend a certain amount of their time competing for or trying to obtain more money, behaving in a thoroughly selfish fashion. On the other hand we also spend a large part of our time, probably the greater part, behaving in ways which accept the interdependence between the various groups of people in the community. In this frame of mind, providing our aspirations are reasonably fulfilled, we are prepared to behave in a manner of live and let live. It is this dichotomy between the two facets of people's behaviour which establishes the conditions for our political as well as our economic system. The balance cannot be upset drastically without fundamental changes being required in the whole way in which we go about our business.

It is now clear, beyond any shadow of doubt, that a formal prices and incomes policy is utterly disastrous in its political, social and economic effects. There can be no complaint whatever about the vigour with which policy was pursued in the past: to take the policy to the extent of a major clash between the government and powerful groups of workers, and of a heavy direct economic cost in temporary loss of production, indicates there was no lack of will on the part of government.

The fault in the policy is that it sets up political and economic forces which create that kind of situation and the other problems which are discussed below. The more vigorously the policy is pursued the stronger these forces.

The effect of a strict incomes policy is to lead in a very short period to the economics of the pig trough. Everybody becomes utterly concerned with their share of the swill, and people concentrate their interest on the precise amount which other groups have compared with their own portion. The inevitable processes of consistent comparison leading to envy, jealousy, and attempts to regain any lost share, lead 'to the breakdown of the co-operative element in people's attitude towards the economy and a focusing almost entirely upon the selfish element.

This focusing on specific incomes immediately raises issues which threaten to undermine the structure of our political economy. This is because public discussion invariably becomes concerned with relative incomes, with inequality of income, and with the justification of differences in income and wealth. This is natural. If people are expected to justify rises of the order of £1 or £2 per week the immediate retort is to question why other people whose social function may not appear to be much more valuable should have substantially greater incomes or even any, capital. In other words, a question mark is raised at what is considered a necessary condition, but not necessarily the most attractive condition, of a liberal democracy — a decentralisation of power and thus private holdings of wealth.

Other political problems arise. Once the government gives itself the power to determine individual incomes it is in principle adopting a posture of dictatorship. The underlying assumption of a democracy is that power is decentralised (including economic power) and that decisions about the bulk of economic and political issues are taken either outside the centre, or at the centre as the result of a multitude of diverse pressures. However, a prices and incomes policy requires that the government lay down the law on these subjects. It is, in principle, a dictatorial attitude and the way in which decisions then have to be concentrated at the centre in order to cope with the consequences of this policy lead to it very soon also being a dictatorship in practice.

In this regard there is a very interesting contrast between public attitudes in the United States and in this country. When I attended a conference of business economists in the United States two years ago the discussion of prices and incomes policy was very sophisticated, and showed full awareness of the political and constitutional implications of such controls. Such discussion has been conspicuous by its absence in the UK. The reason seems to be that the American Constitution is spelt out in detail. It is highly visible. We, on the other hand, take our legal and political framework for granted, and thus abuse it dreadfully without realising what we are doing.

Incomes policy leads also to other problems, perhaps at a slightly lower level of importance, but which nevertheless reflect a deterioration in the quality of our society. There can be no doubt whatever that to provide an excessive expansion of demand but at the same time to control the incomes of some people is to exploit those people in relation to the others.

Restraining the incomes of people working in London at the same time as the financial policy led to a significant inflation of house prices and other costs was a direct cause of the terrific problems faced by the various services in London such as schools and transport, and contributed to the general malaise in the capital.

People in charge of the decentralised organisations who are relied upon for the management of the economy simply abdicate part of their responsibility. The managers of many companies and nationalised industries minimise their own problems by taking the side of their, employees against the government. This reduces the number of internal considerations — checks and balances — which we rely upon for the maintenance of a decentralised

economy.

Even before the change of government ill March the prices and incomes controls were being criticised by industry as making it impossible for them to plan investment — the severity of the price controls was such as to make it impossible for them to obtain an adequate rate of return to justify investment, taking into account likely costs. Such an outcome is of course inevitable. Any government in a democracy — even one favourable to the market economy — is bound to bias its controls in favour of the short-tarn interests of millions of voters as against the longer term interests of relatively few, companies — and of the community at large, 0, course when, as now, the government is unsympathetic to the private sector the legislation left behind is used with the effect of decapitalising industry systematically and thoroughly. In defence of incomes policy it has been argued that the policy might have worked had it not been for the militant, disruptive, attitude of the unions. Such a view is fundamenta0 naive. Given that there are bound to be dissident, even communist, elements in anY community where does one expect to find such people in the boardrooms of the banks and insurance companies? In fact for a period going back well before 1970, government policY has been in many ways hostile to the trade unions and has presented the dissident elements with a series of excellent banner!, behind which to collect the moderates. The at' of government is to avoid providing opportunities for dissident elements. Incomes policies, however, provide excellent openings for such people. One must remember that not only are the members of trade unions on the same aide, as ourselves, they form a large proportion 01 our own side. It has also been argued that the recent incomes policy would have succeeded had it not been for imported inflation. This opini011,; however, fails to take into account the fu" incomes policy strategy, which incorporated a rapid monetary and fiscal expansion t° encourage growth at the same time as the incomes policy was intended to hold doWn costs. The imported inflation reflected in significant part the depreciation of sterling. which in turn was caused largely by the excessive monetary and fiscal expansion. The imported inflation was thus part and parcel 01 the consequences of the incomes policy. Finally, those who wish to defend incornes policy might point to the fact that such policies have been recommended for a long time by the Treasury and by various macro-economists. As far as the Treasury is concerned one most recognise that, for all its virtues, the TreasurY has shown itself in many ways to have little understanding of, indeed at times little sympathy for, the mechanics of the private sector. The Treasury is far better at running all economy in war than in peace time. For them to recommend an incomes policy is merely a manifestation of the attitude that it would be nice if certain problems would simply go awaY. Similar considerations apply to macro-economists, who regard an incomes policy as a means of fixing a parameter in an equation. A large number of economists practising in govern

Ment and the universities have little experience of the private sector, much less of the political and constitutional repercussions of policy.

, In the light of these arguments it seems that the fault of the incomes policy is in no sense Whatever the consequence of individual Personal failings over the past years, nor of Particular local circumstances. We have now had the opportunity of seeing — as many of us did not recognise beforehand — the disastrous ptical and economic forces generated by a ,aght incomes policy and it is clear that the itself ults are logical consequences of the policy The policy of the present adminstration is to allow the social contract to determine the rate of wage inflation and then for the government, Ihrough its commitment to full employment, to nnance that inflation. The virtue of this policy is that by keeping out of the arena for the time being the government is at least lessening the s°cial and political pressures within the economy and thus allowing the social situation to calm down to a certain extent. However, it is 0‘v clear that trade unions feel unable to notiate wage increases at anything less than e actual rate of inflation. In other words the .ecmseeuence of this form of wage negotiation is

establish perpetual acceleration in inflation.

he government's posture is fundamentally mat they do not care what the rate of inflation /eight be: and the outcome would be Pessimistic. As implemented, however, the ,PblicY is decapitalising industry, since `cm1Panies can obtain nothing like the ecessarY cash flow to compensate for the Increased costs of running their business. It is highly likely, if they were to continue with the relatively tight money policy as has °ccurred over the early part of this year, and Were to continue the squeeze on companies, that the economy would be forced into a ridden deflation which might ultimately have 41e effect of reducing the rate of inflation. owever, if this is the policy it is not one for which the community at large is being PrePared, nor' is it orie which the community 11:°0a€1 find attractive. Allowing inflation to „e reduced by this philosophy of collision "oold certainly do a great deal of harm 4t the time and would lead to unknown ipitical and economic forces being unleashed At the moment, however, we do not know whether the government would, over a period 11everal months more, finance inflation: even ti,'-"eY should introduce a freeze, or should keep money supply down drastically, such a „,t'elleY would have only a temporary effect and "'cold still leave completely open the question

how inflation could be kept under control (luring periods of expansion.

h We thus see that past and present policies aye simply failed, have created threats to the economic and political structure of this society, Md have caused considerable social discontent. Any long-term policy should aim at restoring the situation in these areas as far as OcIssible and should attempt to maintain the aceePtance of interdependence within the e„°nIrnunity and avoid pushing people towards ncentration on divisive selfishness.

At this stage we must accept that "Insiderable damage has been done to the Political and social structure of this country 4nd it is by no means certain that one can restore the attitudes necessary for the smooth .‘1,v2rking of our parliamentary democracy. ,'ere seems no alternative, however, to atterrip

ting to formulate the policies consistent

With it. One does not know of any satisfactory Tternative structure of government. If one ces not attempt to formulate the policies to sustain democracy one is implicitly reducing Politics to the single question of which political 13arty will be in a position to call in the troops. „,9ne way of increasing one's chances of 'uccess against inflation would be for the rernment to announce its policy roughly in

e form of saying that it intended to create the expansion of monetary demand to accommodate in a particular year growth in the nominal GNP of a certain figure — say, 12 per cent, for the purposes of discussion. It would also make it cleaar that its desire would be for the maximum proportion of this 12 per cent to be in the form of an increase in real income and the minimum proportion in the form of inflation. However, the final balance between the two would have to depend upon the way in which people behaved. Excessive inflation would lead to lower real growth and vice versa.

There are various objections to this policy. It would be difficult technically to carry this out and to control the growth of money incomes so precisely. It would, of course, risk being challenged in a brutal sense. On the other hand,

such a policy is certainly less of a specific•challenge to certain sectors of the community

than is a specific incomes policy. It has the effect of forcing decision out of government on to the community at large and presenting paople with clear and reasonable choices which reflect the true nature of our society. It also gives people something to do. One of the harmful effects of specific incomes policies or hard squeezes is that they give people no incentive whatever to do anything.

However, a policy as outlined would give people plentiful opportunities to engage in economic activity as fully as they liked. At the same time the way would be open to the government to use whatever other policies it could, management of indirect taxes, the control of interest rates, movement of the exchange rate, to help keep inflation down. Such a policy also is broadly consistent with other measures which could well be introduced as a means of restoring or maintaining the market economy.

The question still arises as to how we handle the next few months. A new policy could not be introduced until people's expectations were under control, the social situation was relatively calm, and the public had been prepared for it. One would expect, however, that by the end of this year people's expectations about real growth would be fairly well down, and they might also be expecting somewhat reduced inflation, To be effective, this anti-inflationary policy would also require other measures which helped restore confidence in the mixed economy. A longer-term commitment on the part of government to such an end would at least be a start. Industry will need to have assurances regarding the fiscal environment it will face. There are a multitude of detailed policies which need to be considered when one is putting together the entire package of government policy. One point which seems worth emphasising, however, is that it seems that the political forces now in existence are such that unless industry is able to put itself across in a politically effective way it will simply go under. A politically effective stance would seem to require a full-blooded commitment to play the necessary part in economic growth provided government does not make it impossible for it to do so. Unless industry can put itself across in such terms the political parties devoted to the mixed economy may well be unable to save it.

As far as the present government is concerned their existing policy can certainly be criticised. as being no policy, merely the acceptance of any rate of inflation determined by wage bargaining, probably to be followed by a recession. There is every reason why what is broadly a monetarist approach to this problem should be aired and developed. Monetarism does not mean recession. There is also every reason to concentrate discussion away from the specific incomes policies which, we now learn by experience, have done so much harm.

D. F. Lomax, formerly of the Department of Economic Affairs at the Foreign Office, is now an analytical economist with one of our major clearing banks