A great deal of our current confusion about inflation, I believe, arises because we do not think about it correctly. We spend most of our time trying to decide whether the main cause of inflation lies in rising oil prices, or burgeoning money supplies, or mushrooming government spending, or declining productivity, and very little time reflecting on the central fact that we live in an inflationary economic environment.
Nowhere is the point clearer than with the case of OPEC, now a prime villain in the conventional analysis of inflation. Oil prices have risen more during the past year, President Carter tells us, than over their entire previous history. The price of crude oil, today roughly $35 a barrel, has been projected to reach outlandish levels—perhaps $90 a barrel—in another few years. There is universal agreement that these oil hikes, past and projected, have been and will be a major cause of inflation.
But suppose we cast our minds back a hundred years to a time when the preponderant source of mineral energy in the country was coal, and imagine that the coal mines formed a cartel as powerful as OPEC and rapidly doubled or quadrupled energy prices in the country. Would that have been inflationary? Would it have touched off a widespread, self-feeding chain reaction of rising prices throughout the economy—first in coal itself, then in steel, then in products made from steel?
I think no one would come to that conclusion. Instead, a coal OPEC would have resulted in the wholesale shutting down of coal mines unable to sell their product; in the drastic curtailment of steel output as plant managers cut back their unprofitable operations; in a decline of purchasing from the businesses and households affected by this turn of events; and thereafter in a fall in “carloadings,” the index of general economic activity we used before GNP was invented.
The contrast between the anticipated effects of an OPEC oil price rise and those of an imagined nineteenth-century OPEC coal price rise sheds important light on the problem of inflation. For it makes clear that the same economic disturbance can produce different results in different settings. In late nineteenth-century capitalism, a sharp increase in energy prices—or in wages or interest rates—would have touched off an economic contraction. In late twentieth-century capitalism they trigger inflation. Thus, as I see it, thinking correctly about inflation means first paying heed to the changes that the economic system has undergone during the last century—changes that make it respond to shocks and internal disturbances in a manner quite different from that of the past.
The Inflationary Structure
What are those changes? There is, to begin with, the radically different relation of government to the rest of the economy. We do not have statistics that enable us to compute exactly the volume of government spending of all kinds—state, local, and federal—in 1880, but it is doubtful that it amounted to as much as a tenth of gross national product. Today it is about a third of GNP if we include spending for “transfer” payments, such as Social Security and welfare. In most European nations the proportion is markedly higher, often over 50 percent of GNP.
It is not merely the economic impetus that is important about this vast change in spending. Equally significant is the enlargement in government responsibilities to which the spending bears partial witness. At the risk of repeating the obvious, I will point out that a century ago there was no “fiscal policy,” no local, state, or federal payments for old-age penury or unemployment, no “disaster relief,” no parity payments to farmers, no Small Business Administration, no federal financing of mortgages or insurance of bank deposits. It was each firm and each household for itself. Dog ate dog.
Thus the first change has been that floors have been placed under a multitude of economic activities, shoring up purchasing power, protecting most households against severe reversal, ensuring a degree of economic safety totally unknown in the era of pregovernmental capitalism.
A second equally striking change is the enlargement of the scale of organization in the private sector. Once again we lack statistics to make exact comparisons, but there is no difficulty in conjuring up the contrast between the two periods. In 1880 the giant corporation was just beginning to emerge. United States Steel had not been formed, the Standard Oil Trust had only just been conceived. The brigade of Generals—General Motors and Electric and Foods—was as yet unformed. Only the railroads were truly national corporations, forerunners of the industrial giants that are the central elements of today’s business system.
Paralleling the emergence of the giant corporation is that of the giant trade union. In 1886 the largest labor organization was the Knights of Labor with 700,000 members scattered among a dozen industries. Today there are six unions with more members than the Knights of Labor. Within the central core of large manufacturing enterprises, about half the work force is organized. In strategic parts of the society, such as municipal services, the building trades, education, and transportation, unions occupy positions of great economic leverage.
This change in the texture of the private economy is every bit as important in altering the manner in which the economy works as the more frequently remarked change in its public/private mix. In the private economy dog no longer eats dog. It is an economy of bargaining blocs, of inertial bureaucratic masses, capable of exerting great power to protect and enhance their incomes or prices.
The third factor to which I would draw attention is the consequence of the preceding two. It is a profound change in the expectations with which we face the future and by which we steer our economic course. Filled with anxiety, as many of us are these days, we may forget how much more secure is the outlook of 1980 than that of 1880. Most of us expect, for example, that our pay will be increased each year, whether we work harder or more successfully or not. We expect that the nation’s economic ills will be the object of vigorous government action, not left to work themselves out. We expect that our personal futures will be somehow provided for, so that we can indulge in large consumption spending in good conscience.
These changes in expectations are often the subject of sermons and scoldings. What I find important about them is that they act in concert with the underlying changes in structure, decisively altering the manner in which the economy functions. The placing of government floors, the unification of the corporate economy, the increased leverage of unionism, and the prevailing tenor of expectations—all have worked to transform the depressionary propensities of late nineteenth-century capitalism into the inflationary propensities of late twentieth-century capitalism. As a result, we smile at the old adage that “what goes up must come down”: today we believe that what goes up will continue to go up, and we gear our actions accordingly.
From this point of view, the search for the “cause” of inflation takes on a different aspect. What becomes crucial is to understand that today’s economic structure propagates, magnifies, and sustains increases in costs or demand, instead of blocking, damping, or eliminating them. This is not to wave aside the inflationary stimulus of credit creation, oil hikes, environmental costs, or—to mention the unmentionable—the monstrously cost-pushing, waste-creating defense budget. But we will not get very far if we discuss these causes without constantly referring to the inflation-prone environment in which they operate.
Looking at inflation from this point of view makes it easier to see what must be done to stop it. The system must be altered in ways that will remove, or at least greatly reduce, its inflationary propensities.
In saying this, I take for granted that we cannot undo the structural alterations that have converted the capitalism of 1880 into that of 1980. I assume that, despite the rhetoric of conservative politicians or the efforts of Proposition 13’s backers, we cannot disengage government from our midst. Government will continue to provide pensions and unemployment insurance and welfare and health security, probably on a growing scale. By the end of the century, very likely government in the United States will pay out half of GNP, as it does in Europe. Similarly, I assume that we cannot break up the Fortune 500, returning the business world to the market structures of the past and demoting the brigade of corporate Generals to field and company rank. I assume that we cannot break up our labor unions. And I do not think we will change our basic view of the economic world and the “entitlement” we expect from it.
Because I do not think the structural changes of the last century are reversible, I do not think that the most commonly proposed cure for inflation will work, namely “wringing” inflation out of the system by severely curtailing the ability of the banks to make further loans or by curtailing government spending. The main purposes of severe fiscal and monetary policy are to create sufficient unemployment to temper the appetite of the big unions for higher wages, and to cause enough general hardship to cause entrepreneurs to trim their prices and housewives to trim their spending.
Pursued hard and long enough, such a policy can no doubt achieve its intended results. The question is whether it can do so before the economy is brought to its knees. For example, if unemployment here rose to the levels of unemployment in Switzerland or West Germany under their anti-inflation regimens, 30 percent of the labor force would be without work. The difference is that the Swiss and Germans could ship their unemployed back to their homes in Greece and Turkey and Italy, whereas ours would remain in our midst. My suspicion is that no Congress could long withstand the ensuing mail, the marches, the violence.
How else could we reorganize the economy to remove its inflationary tendencies? The obvious way is to match the floors that have limited its depressionary tendencies with ceilings that would do the same for its upward-moving tendencies. The question is what sort of ceilings would do the trick.
Selective wage and price controls would probably not provide the needed ceilings, although they might be useful as an initial measure to stop the momentum of the inflationary process. The reason is that such wage and price controls cannot be used to spread the inflation-fighting task equitably across the nation. It is impossible to monitor the prices of millions of enterprises or to supervise the wages of 100 million working people. As a result, wage and price controls mean that the wages of a dozen key unions and the prices of perhaps five hundred key companies will be subject to controls, while the wages and prices of the rest of the system will be left free.