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.
This is tantamount to designating the union members and corporate managers in selected companies as Inflation Fighters, to use the MIT economist Lester Thurow’s phrase. Let us suppose that we issued them badges in recognition of their patriotic task. If the union members and company managers saw everyone on the street wearing similar badges, there would be a powerful incentive to abide by the limitations of wage and price directives. But if only one worker in ten or one businessman in a thousand were decorated with an Inflation Fighter badge, how long could we expect such an arrangement to last?
The very difficulties of such a system help us to see the nature of the restructuring that would place an effective ceiling on the economy. It is for all of us to become Inflation Fighters, not just the members of a few unions. One way to bring this about would be to impose a very steep tax—say 95 percent—on all income earned in 1980 that was in excess of income earned in 1979. Perhaps for equity’s sake we might exempt low-income earners from the limitation. But for the rest of us, membership in the inflation-fighting brigade would become compulsory. That would bring the upward spiral of income to an immediate slowdown.1
Objections spring instantly to mind. What about the effects of inflation-producing disturbances such as further increases in the price of oil? The answer is not difficult. We would have to decide, given our limited incomes, how much gas and oil to buy at higher prices and what other things to stop buying. Whatever our market behavior, because our household spending power was fixed, the price rise could not set into motion a system-wide rise in prices: our standard of living would fall, but inflation would not rise. Simultaneously we could drastically reduce the impact of an oil price hike by gasoline rationing, by very high taxes on wasteful energy use, by banning energy-squandering products such as useless plastic packaging, and the like.
A far more onerous problem is how to handle increases in income that are not just the result of inflation-induced cost-of-living adjustments. What is to happen to the person who gets a promotion or who switches to a better-paying job, or whose income reflects a successful business venture or an enlarged professional practice? Here is where bureaucracy enters, as it inevitably must when the economy is restricted. There will probably have to be Income Boards to approve job reclassifications or to ask for proof of job changes, just as there were draft boards to approve exemptions from military service. There may have to be exceptions for self-earned incomes; perhaps very large and sudden jumps in such incomes would escape taxation only if sterilized in compulsory savings certificates. Certainly the problem is difficult and cumbersome, but ways could be found, just as ways were found to adjudicate the variety of circumstances under which individuals were eligible for unemployment insurance or for Social Security or government health payments. All these bureaucratic ways will saddle the economy with new costs, will slow down its rate of growth, and will surely become the target of gibes and irritations as well as attempts to evade the rules. But the structural propensity toward inflation of present-day capitalism will be gone or largely curbed, just as the floors that were placed under the economy in the 1930s and 1940s largely curbed the depressionary tendencies of earlier capitalism.
Living with Inflation
It must be evident that there is no possibility of enacting such a program within the near future. I conclude, therefore, that there is no chance of removing the inflationary bias of the system. Chronic and endemic inflation will be our constant companion until we gain the political will, or realize the social fear, needed to institute the kind of structural change I have outlined. It has been said—and the quip illustrates both the difficulty and the gravity of the situation—that the way to stop inflation is to declare war. Short of that it may take a decade to put the new ceilings in place, just as it took a decade to put in place the old floors.
In the meantime we will have to live with inflation. What does that mean? Here it is necessary to distinguish between the actual costs of inflation and its threats and dangers. The costs are much less than we commonly believe. Despite our sense of being impoverished by inflation, the statistics reveal beyond doubt that real incomes—incomes after inflation and taxes are both allowed for—have been rising at virtually the same rate during the inflationary years 1972-1978 as in the previous boom years 1966-1972. Only during 1979 did the curve of real per capita income turn down and that seems to have been the effect of determined efforts to stop economic growth in the name of curbing inflation. Moreover, the official statistics do not show that the relative lot of the poor, the aged, blacks, or other disprivileged groups has worsened, popular beliefs to the contrary notwithstanding. The distribution of the population on the steps of the national escalator has remained about the same, although the escalator itself has been moving faster.2
I know that we feel damaged. But that is largely the consequence of our unequal exposure to the gains and losses of the inflationary process. Inflation brings pay rises as well as price rises, but we are aware of our pay rises only once a year and of price rises 365 times a year. Moreover, if we take advantage of our pay rise to make a big purchase, such as a color TV set, the enjoyment of it every evening is not likely to compensate us for our steadily eroding standard of living when we shop in retail stores every day.
There have of course been losers in recent years. The take-home pay of factory workers has been lagging behind inflation, but not because hourly wage rates are lagging so much as because part-time work (largely female) has been growing in the factories. So, too, the real pay of college professors has been falling behind in recent years, but this is the consequence of a bad supply-and-demand situation for college teachers. Unquestionably some families have directly suffered from inflation, especially in the value of their savings accounts or life insurance (but not their real estate!). Yet, as we look in horror at the prices in the shopping centers and department stores we can also see a great many people buying those inflated wares. Has our actual national standard of well-being and comfort been substantially affected by inflation? Cries and groans and headshaking to the contrary, I do not think so.3
What is really serious about inflation are two threats that it holds over our heads. The first threat has to do with the strains that inflation imposes on our creditworthiness. Everyone has become aware of the extraordinary surge of consumer credit buying, a phenomenon that President Carter will try to arrest by tightening the rules under which the credit card economy works. Perhaps more serious, although less widely noticed, is the tendency of an inflation-ridden economy to pile up short-term rather than long-term debt. Banks and other financial institutions will not lend money for long periods of time, knowing that they will be repaid in shrunken dollars. Thus debt gets shorter and shorter, and finally the banking system ends up (as it is today) with a great deal of short debt and virtually no new long debt.
The difficulty comes if a borrower such as Chrysler Corporation or New York City gets in trouble. If a big borrower is unable to meet its obligations, there is no time for working out the terms of a new deal or for allowing credit markets to improve. As a result, banks and credit institutions become extremely vulnerable to untoward events. The financial community has been holding its breath and crossing its fingers for a long time now.
A credit collapse could cause widespread business wreckage. But inflation poses a second, far graver threat, even if the banks stand firm. This is the threat that our present rate of inflation will quicken, first into the “Latin American” range of 50 to 150 percent a year, finally into the incalculable rates of Weimar Germany or the American Confederacy.
Is such a progression likely? Considerations of both logic and experience make us fear it might be. The logic is that inflation feeds upon itself because everyone tries to get ahead of everyone else. If we expect prices to rise 10 percent, we try to secure increases in pay for ourselves of more than that, say 15 percent. If everyone succeeds at this, inflation itself rises to 15 percent, and our income objectives accordingly rise to 20 percent. Thus what begins as an orderly parade becomes a wild rush, as everyone tries to move up to the front rank.
Recent history proves some unwelcome confirmation of this logic. In the decade of the 1950s our yearly inflation rate averaged 1.4 percent. In the decade of the 1960s it rose to 2.8 percent. During the 1970s it was just under 7 percent until 1979, when it broke through the double digit barrier. Today it is pressing toward 20 percent.
Do these disquieting considerations mean that inflation must develop a fatal runaway momentum? Our present anti-inflation policy is based on the hope that this is not the case. Economists in the Carter administration maintain that their suggested remedies—mainly less government spending, some credit controls, and a small tax on oil—will reduce the inflationary trend. No doubt they rest their case on the fact that we had a touch of double digit inflation in 1974, but cut it substantially by 1976; that England had 25 percent inflation in 1975 but lowered it by more than half within two years; that Japan had a ferocious inflation in the early 1970s, but has managed to curb it remarkably well in recent years.
We do not yet know whether the Carter program will succeed in halving the inflation rate to “only” ten percent. But there seems absolutely no chance that it will succeed in removing the tension gathered within the system. The inflationary spring remains coiled and ready to exert its pressure the moment that anti-inflationary measures are relaxed. Tight money, burgeoning unemployment, and declining government spending will all exert some effect as long as they are applied. But once removed, the latent inflationary bias of the system seems certain to assert itself again, whether touched off by another buffet from OPEC, another round of wage increases, another wave of speculative fever. And the danger is that each time we find ourselves closer to Latin America.
Could we live with inflation rates of 50 to 100 percent a year? For a while, perhaps. There is a tremendous desire to cling to one’s faith in money, for the alternative is a terrifying descent into a Hobbesian chaos. People learn to adapt, even to the most frightening circumstances. Nonetheless, such an inflation seems to me to be intolerable if endured very long. It will bring morale-destroying rumors, wracking social fears, and, worst of all, a setting for wild political movements. Under such conditions, I believe we will move in the direction of a restructured capitalism along the general lines I have suggested. An economy with ceilings as well as floors, encumbered though it may be with another layer of bureaucracy, will then appear to be not an unthinkable, but an inescapable, indeed, a welcome haven.
May 1, 1980
I should add that income ceilings would need to be backed by an appropriate monetary and fiscal policy, designed to keep both public and private spending within the bounds of realism. This would mean less public spending for wasteful projects and less credit card living-it-up. In addition, a serious anti-inflation policy would try to reverse the falling trend of US productivity, probably by encourging research, investment, and competition. ↩
Official statistics are always behind the times and suffer from various biases and distortions. It is possible that low-income groups have been disproportionately affected during recent years because the costs of food, health care, housing, and energy (gas and heating) have risen faster than those of other consumer items. These basic necessities bulk larger in low-income than in upper-income budgets. Even if these contentions prove to be true, however, nothing like a large-scale redistribution of income has taken place as a consequence of inflation. ↩
True, our savings rate has declined, which may affect our future level of well-being. But current consumption is raised, not lowered, by this inflation-induced change. ↩