17. The Strike Threat and Inflation

ITIS common to lay part of the blame for inflation on the unreasonable use made of the strike-threat system. The forcing up of wage rates more rapidly than productivity rises is supposed to bring about the “cost-push” as distinct from the “demand-pull” type of inflation. The notion has indirect justification, yet is seriously misleading. I propose to argue that the notions of “price-induced,” or “cost-induced,” or “wage-induced,” or “cost-push,” or “wage-push” inflation have meaning only if they are based on a tacit political assumption.¹

The assumption is that governments must react in a certain way to the fixing of particular prices and wage rates at levels which reduce prospective yields to “investment” (replacement plus net accumulation). That is, the inflation of the contemporary world is a government reaction to the setting of costs and prices at levels which reduce the community’s ability or willingness to purchase previous outputs. But, the pushing up of particular wage rates and prices under duress does not cause inflation. An inflationary monetary reaction may be usual—perhaps almost universal in the present age—but it is not a necessary reaction.

H. G. Johnson, objecting to the suggestion “that in modern economics the wage rate is autonomously determined by collective bargaining and the money supply is automatically adjusted to it,” says that this “would be the case if government were formally committed to the maintenance of full employment, whatever happened. . . . But governments have not,” he maintains, “been prepared to accept this sort of unlimited commitment; they have instead been prepared to tolerate a varying amount of unemployment. . .,”² This not only insists that inflation is not a necessary reaction but implies that too rapid an inflation to offset strike-threat consequences may be as politically disadvantageous as the unemployment caused.

Fruitful study of what we now tend to call “wage-price” policy demands that we be crystal clear on this point. Can the raising of particular prices or costs itself be inflationary? My contention is that it cannot. Whether the prices or costs that are raised are a consequence of factors expressed through free market forces, or due to collusive or political action to create a contrived scarcity is immaterial.³ The real explanation of any labor union responsibility for the inflationary era is simply that strike-threat pressures cause inflation to be politically expedient. Any decline in the real value of the money unit of the kind sometimes termed “wage-inflation” is not caused by duress-imposed wage rates any more than inflation generally is caused by duress-imposed product prices.

Let us suppose that, as the result of a strike threat, wage rates in the footwear industry are raised, or that the price of leather (wholly imported) rises, causing the price of shoes to increase. Then, in the absence of inflation, either some other prices must fall or a cumulative decline in activity (that is, in other outputs) must occur (a) until any price or wage-rate rigidities which prevent other prices from falling are broken, or (b) until wholly new ways of using the displaced labor and other resources—probably ways less subject to value rigidities—have been discovered.⁴ But inflation may “validate” the discoordinative pricing which is causing the decline in activity. Only when one or more of these reactions has followed will the cumulative decline cease. An equilibrium at a lower real income will then have been established unless thrift (possibly aided by current technological progress and managerial ingenuities) happens to have been compensating or bringing forth growth. In other words, every upward pressure on costs in an industry has adverse effects on the magnitude of profitable output; the enhanced costs reduce thereby the possible contribution of that industry to the source of demands for noncompeting outputs; and hence, unless the upward pressure on costs has been caused by an expansion of other outputs, or unless the price-cost effects are “validated” by inflation, it must inevitably set going a cumulative tendency to recession.

Admittedly, the decline in activity caused when certain prices are forced up by private or governmental duress will automatically bring about some inflation if monetary policy is rigid;⁵ just as improved coordination in any society (expressed ceteris paribus in price and cost reductions) will automatically be followed by deflation if monetary policy is rigid. A contraction or expansion of real income requires monetary contraction or expansion if the purchasing power of the money unit is to be maintained constant. Any inflation or deflation which follows individual price changes is fully explained therefore by monetary policy—usually deliberate, even if often reluctant in the present age.

Exactly the opposite idea is reflected in the confusing notion that high economic activity generates inflation. In reality, high activity means high output; and that implies a deflationary outcome (in the sense that deflation will follow under monetary rigidity). The common reversal of cause and effect which I am here trying to expose is one of the most deplorable intellectual consequences bequeathed by the Keynesian ara; and it arises because inflation is (when not fully expected and discounted) a method (albeit a very crude method) of generating activity—that is, of reducing costs relatively to prospective prices; while those responsible for inflation find it expedient to place the blame on the stimulated activity rather than on the stimulant.

Thus, when expectations begin to catch up with the rate of planned inflation, a slowing down of the rate of inflation becomes expedient. The authorities like then to talk euphemistically of aiming at “a slowing down of activity” or “a slowing down of growth. “The absurd implication is, of course, that the discoordination is somehow due to “over-activity,” or “too rapid growth,” or “overheating.” The notions of “over-activity” or “too rapid growth” are meaningless in such context,⁶ as are the even less rigorously conceived ideas of an “overheated” economy or, of a “straining of existing capacity.”⁷ The term “activity,” if rationally used, is synonymous with “output;” and (as was insisted above) an increase in output is the reverse of inflationary. Of course, the tacit (but preposterous) assumption is that aggregate output cannot grow in the absence of inflation, so that any actual growth is proof of inflationary pressures. A phrase of the following kind in a newspaper report illustrates how seriously confused public discussion of the issue has become: “A discouraging development in the inflation fight is the Commerce Department’s report that orders for durable goods . . . are marching again.”⁸ (I return to this subject on pages 255–256.)

The fact that wage-rate increases conceded under strike-threat pressure “require higher payrolls” in particular cases, or cause increases in the money cost of given inventories, or induce investment in labor-saving machinery (all of which require “financing”), does not imply that they have any inflationary effect. If, under such circumstances, borrowing occurs more rapidly than noninflationary monetary policy would permit, it can only be because policy is not noninflationary!

Nor are such things as transfer payments (for example, unemployment compensation or relief expenditures), or the reduction of tax payments in developing recession, inflationary or disinflationary in any meaningful sense, although they have been regarded as of a stabilizing nature in such circumstances. Only if inflation maintains a certain money valuation of income (a certain “disposable income” as it is often put) when real income would otherwise fall, can any mitigation of the price discoordination which causes a general decline in activity be brought about by fiscal or monetary means.

It is equally wrong to regard “escalator clauses” as inflationary; for if any inflation ceased, so would the “escalator.” Such clauses do not increase the flow of money wages. If the volume of deposits plus money in circulation is maintained in a more or less constant ratio to real income,⁹ the flow of money wages can rise solely through a rise in output, irrespective of what proportion of those employed are remunerated on an “escalator” basis. In fact, monetary authorities responsible for inflationary policies hate “escalator clauses” (and often dub them “inflationary”) because they destroy the rational purpose of inflation, which is to achieve such coordination of relative prices as results when costs lag in relation to final prices. Universal resort to “escalators” would force abandonment of the inflationary remedy!

But all these factors may be termed “inflationary” if we have previously made it perfectly clear to our students or our readers that all we mean is that the factors concerned are assumed to make it expedient for the monetary authorities to set inflation going or keep it going. If we do so we are, however, under an obligation to emphasize that the inflation is then deliberate and planned, however reluctant. And students and readers should be left under no misconception about the fact that a monetary authority which accepts such an aim must make use of all the difficult and highly expert techniques by means of which the real value of the money unit can be forced to depreciate without causing a general expectation of the speed and duration of the inflation planned. A universal demand for “escalator” valuation or other private action to escape inflationary burdens would defeat the objective.

An equally misleading yet influential idea is that inflation is due to something called the “over-all level of demand” being “in excess.” Such phrases have meaning only when they describe a situation which monetary and fiscal policies have created. But some economists who write in this sort of way do perceive that, if inflation is to be avoided and full employment objectives sought, policy is, in Melvin Rothbaum’s words, forced to “focus on either reducing the power of wage-setters and price-setters or on changing their behavior. . . . [and]. . . .[this] may include attempts to change the structure of business and labor organizations, to devise economic penalties and incentives that will induce the desired wage-price performance, to request voluntary changes in purpose, or to compel the desired performance through a system of controls.”¹⁰ Yes, but if “the structure of business and labor organizations” is changed in the manner required,¹¹ neither “requests” nor “controls” will be necessary; and the “penalties and incentives” to which Rothbaum refers will not need to be devised. They are already there—waiting to be released from the chains in which they have been shackled. They are expressed through the loss-avoidance, profit-seeking discipline which forces entrepreneurial decision-makers constantly to determine the form and use of productive resources through comparison of objective and prospective input values (including interest) with prospective output values, under careful and continuously revised estimates of marginal yields.

A similar notion, also due to a wrong discernment of cause and effect in the interpretation of inflationary experience, has led superficial observers to believe, or careless expositions to assert, that only a state of unemployment is capable of preventing inflation. In my judgment, it has been the present generation’s tolerance of virtually unrestrained resort to the strike-threat system which has been responsible both for this belief and for the corollary that a money unit of defined value is impossible in any society which wants to avoid the curse of chronic unemployment. Hansen expressed the notion in 1949, referring to the United States, in the words, “to secure stable prices it is necessary to have several millions unemployed.”¹² The truth is diametrically opposite. Employment of labor means output, and each output contributes to the source of demands for all other noncompeting outputs. No one would question the possibility that, in a strike-threat era, only unemployment (of men and assets) may be capable of forcing “reasonableness” on the part of unions, and creating an incentive on the part of managements to resist duress-imposed cost increases and so make a slowing down or cessation of inflation politically conceivable.¹³ But this is never said in such simple terms that everyone will understand what is meant. The possibility is the justification of the “Phillips curve.”¹⁴

In my judgment the semantic confusion of “wages” with “wage rates” (that is, of a share in the income flow with the prices of different qualities of labor), in phrases like “high wages make for prosperity,” has had an enormous influence. It is of course true that “prosperity” is characterized by a high flow of wages and other income; but the source of “prosperity” is coordination through the price system, under which the utilization of productive power is adjusted to the magnitude of income and expressed preferences in the market. I forecast that the ultimate verdict of economic historians will be that the most disastrous economic phenomenon of this century, the Great Depression, was due to the pricing of output in the unionized sector at first beyond the reach of uninflated income, later inconsistently with price expectations, and mainly in consequence of strike-threat power in key sectors of the major countries.

The old “classical” teaching pointed to the remedy, namely, the restoration of the flow of wages and income via the repricing of inputs so as to make full potential outputs profitable. But this teaching was spumed through the accelerating influence of Keynesian notions; and those notions were plausible because, even in the 1920s and 1930s, the labor unions stood in the path of the most urgently needed market-selected price and wage-rate adjustments. In the circumstances, unanticipated inflation seemed to have become the only politically acceptable way out and the public was indoctrinated with the idea that the depression had been essentially a monetary phenomenon—as a result of the defects of the supposedly outmoded gold standard system.

It is truly astonishing how successfully blame for the Great Depression was transferred from defective human organization (in the determination of wage rates and other prices) to the gold standard. For that monetary standard was the foundation of a simple, straightforward system under which—as long as the contract in it was honored—the measuring rod of value had been removed from political tampering. This is not the appropriate context in which to discuss the attributes of the very imperfect credit and currency institutions which had arisen while currencies were fully convertible into gold. But the Keynesian and other attacks on the gold standard were directed as much against the virtues as against the vices of the system. It is obvious that Keynes was, throughout his contributing life, hostile to the notion of any kind of money unit with a defined value. Although he changed fundamentally from” time to time the arguments on which he based his opposition, he wanted the money unit’s value to be a matter of government discretion.¹⁵ But the origin of his position lay in his recognition that, if there is a money unit with the attributes of a satisfactory measuring rod, it bars resort to the process of increasing the money valuation of a given real income; and the latter seemed to him to be necessary in order to enable the community to purchase output without far-reaching reform of the pricing system.

Admittedly, under widespread wage-rate rigidity and price rigidity, the cessation of a period of inflation or even a reduction in its speed, will cause a displacement of labor and wasteful idleness, especially in nonversatile capital resources. The question is, however, are we bound to accept rigidities of this kind as inevitable? A policy which deliberately aimed at preventing any reduction of the wages flow and income while inflation was being gradually but finally brought to an end, could insure continuous normal activity. But any such policy would have to protect managements from the overruling, by strike-threat duress, of social pressures (market forces) in their task of revising wage-rate offers.

If this were understood, it would be perfectly possible, I suggest, to fashion institutions under which there are effective incentives to the pricing of all productive services (of men and assets) so that the full potential flow of output is continuously consumed or utilized, no matter what value for the money unit policy happens to dictate. But the maintenance of some defined value for the unit (such as that of a constant “real value” or a given weight of gold) will assist the coordinative process under which price changes permit not only the uninterrupted use of all productive factors but, what is even more important, their optimal use.

While union spokesmen are unquestionably right, then, in their contention that it is monetary and fiscal policy alone which is responsible for inflation, and not the pressure of their demands on wage rates, when they make this claim they cannot honestly deny their responsibility for the political attractiveness of inflation. Union officials must admit that if inflation does not follow the consequent continuous rise in labor costs from which their profession benefits, cumulative displacement of labor will be unavoidable and multiplied through the decline in the wages flow (and contraction of the income-flow generally) which their policies bring about.

To blame the strike-threat system for increasing the political expediency of inflation is not to deny that inflation itself creates the “need” for upward adjustments of wage rates determined under union “negotiation” if the real value of those wage rates is to be preserved; but as the coordinative effect of inflation depends upon its reducing that real value, through “restorative” increases in end product prices, any policy which allows the restoration of duress-increased real wage-rate levels must be self-defeating.

Whereas the influence of the strike threat is to cause critical money wage rates to be rigid downward during deflations, during inflations it appears to have the opposite effect. It prevents the full benefit which wage-rate inertias can exert in maximizing output and income when inflation tends to rectify duress-imposed price distortions. The “vicious circle” of wage rates chasing prices originates when inflation begins to bring about the intended¹⁶ rise in the cost of living. As soon as the consequences become generally obvious, the policy tends to prompt pressures (first in one occupation and then in another) at least for the restoration of former real wage rates; and if these claims are generally conceded, the whole raison d’être of attempts at inflationary validation of the situation is eradicated. The perception of this has led to some recognition of the folly of the whole process—the purposelessness implied in the term “vicious circle” itself.

Nevertheless, unless the strike threat is continuously exploited, money wage rates which have earlier been determined under that threat will tend to remain relatively undisturbed, while wage rates not fixed under union coercion will tend to rise. The effect will be that customary differentials, based on privilege, will be upset. Should any union then fail to maintain the degree of exploitation from which its members have been profiting, they will lose relatively to other groups, privileged or unprivileged. And as we have seen (in Chapter 13), the feelings of envy or of injustice which are aroused when the comparative earnings of different kinds of workers are changed, bring formidable irrationalities into the wage-rate determination process—a consideration to which we must shortly return.

The discoordination caused by the strike-threat influence in wage-rate determination, and its crude recoordination via “fiscal-monetary” policy (that is, inflationary policy) have created a succession of “short-term” problems. Typical of these are chronic balance of payment deficits, or (when entrepreneurs are trying to assist the avoidance of inflation by avoiding price increases) “shortages” due to inflation-financed demands. Such situations have seemed to call for what it has become usual to term “temporary economic policies,” based on short-term expediency. And most economists would claim, I think, that the policies adopted have not all been altogether ineffectual. When values raised under strike-threat influence have been tending to bring about a slowing down of economic activity, inflationary “validation” in one form or another has always been satisfactory enough, they suggest.

That is one reason why continuous recourse to wholly pragmatic solutions has superficially come to appear inevitable today. Deliberate reform of the pricing system—the only alternative—is ruled out, even by majority opinion among economists, because modern politics demands inhibition of any frank recognition of the strike-threat influence in causing uninflated “aggregate demand” to contract. Economists who have wished their writings or their explicit advice to be regarded as sophisticated or “operational” have mostly felt expected simply to take the strike-threat system for granted. It would be as purposeless, they think, to be critical of that system as to be critical of earthquakes. The world just happens to have both. But the inherent contradictions of inflationary “validation” of duress-imposed wage rates when all come to expect that “validation,” yet some parts of the economy remain free from coercion, have never been solved. And the contradictions are, I maintain confidently, insoluble. All efforts to solve them have failed miserably.

Consider, for example, attempts in recent years to make the working of the price system depend upon “guidelines,” admonitions, exhortations, prayers, entreaties, dissuasions, persuasions, threats, appeals for “moderation,” appeals for “voluntary restraint,” appeals for explicit “voluntary wage freezes,” appeals for “voluntary wage ceilings” or “stops,” appeals for “concern for the public interest” and the like, and ultimately wage and price “freezes” followed by discretionary “controls,” through pay boards, price commissions and cost of living councils. All these things are intended, of course, to weaken the strike-threat factor in price determination. They are apt to be described, however, as “supplements” to or “adjustments” of demand and supply forces! It is, I suggest, obvious why governments were driven first toward rather pathetic pleas, persuasions, half-hearted threats of compulsion, and later to the political determination of wage rates and prices. They were confronted with two causes of unpopularity: the alternatives of recession with unemployment, and increasingly ineffective inflation. They felt bound, therefore, to apply at any rate some curb or discouragement on the activities which precipitated their dilemma.

But what sort of coordinative principle is disclosed in policies so fashioned? And what incentives are favored in such policies? Let us remember that the purpose of “incomes policies,” whether “persuasive” or mandatory, is to mitigate the tendency of wage rates fixed under duress to reduce the current and prospective flow of wages and income. If the labor market can be protected in any measure or for any length of time from strike-threat pressures, it is thought, the speed of the inflation required for crude recoordination of the economy and restoration of the income flow can be reduced and, while the restraint lasts, even brought to an end. Unfortunately, campaigns to obtain general acceptance of voluntary restraints, and threats (in practice, idle threats) of politically unpopular action unless there is “voluntary” submission, seem so far to have been almost completely unsuccessful. Perhaps the most promising attempt was the request for a wage freeze in Britain, tried in 1950. Although accepted by the Trades Union Congress, this initiative lasted a record nine months. Factors which we are about to consider then became too strong and strike-threat demands again became general.

In the United States, an attempt during the Kennedy administration to persuade the unions to limit demands for wage-rate increases to proportions which did not exceed the rate of growth in productivity, tended (in .spite of a few exceptions) to induce unions which might otherwise have hesitated, for fear of adverse reactions, to feel justified in pushing up costs (and managements to feel justified in acquiescing). Provided the proportion of the increase did not exceed the level which had supposedly been officially pronounced as reasonable, there were few inhibitions. Publication of the statistically determined rate of increase in productivity seemed to become an invitation to all and sundry to defeat any hope of achieving real wage rates conducive to non inflationary prosperity. Certainly “guideline” pressures appeared not to slow down the rate of inflation or check the chronic weakening of the dollar (although of course things might have been worse had there been no “guideline” initiative). The hope had been that unions which ignored the government’s exhortations would arouse the disapprobation of the other unions. In fact what happened was rather for them to arouse the envy of the others. Failure to comply provoked no denunciations from the union camp. The complete uselessness of persuasions seemed to become even more obvious as the exceptional union militancy under the Johnson administration developed. And the Nixon administration, probably with less optimism, persevered for two years in attempts to inculcate “reasonableness” in the use of the strike-threat weapon before finally resorting to wage and price restraints.

There are five good reasons for the failure of these and all other experiments in moral suasion, cajolery or compulsion in general wage-rate freezing or imposition of wage-rate ceilings—reasons which explain why governments have acted so hesitatingly, inconsistently and ineffectually.

1. Suppose that all unions decided to behave exactly as governments wished, that a complete wage and price freeze was imposed; and that (a most unrealistic assumption) the freeze was applied with no concern for the vote-controlling power of different groups affected. All that would have been achieved would have been a freezing of one arm of the coordinative process, which depends upon relative prices and relative wage rates continuing to reflect changing relative scarcity. Quantities—outputs—would become the sole variables. “Prices have work to do. Prices should be free to tell the truth,” said Benjamin Anderson. The maxim is as true of the prices of labor’s input as it is of the prices of materials and the prices of final products. And wage freezes have one of the chief defects of inflation as a means of rectifying the tendency to force real wage rates “too high”: They penalize those whose real wage rates are too low precisely because other real wage rates are too high. There is no discrimination between the innocent and the guilty.

2. When the initiatives in question are merely “persuasive,” although the voluntary aspect reflects perhaps some recognition of the absurdity of freezing all wage rates, insufficient account can be taken of the irrationalities and envies which play so important a part in motivating resort to the strike threat. When reliance is placed on “reasonableness,” the members of those unions which regard governmental entreaties seriously or sympathetically must come off worst. Unions which treat appeals for a modicum of altruism with contempt can win larger gains at the expense of the rest. Indeed, do not such appeals offer an exceptional yield to those who cynically but realistically ignore all the exhortations? Are not “voluntary” policies tailor-made to assist those who have no concern whatsoever for the public interest? At their best—that is, in so far as they do succeed in mitigating the lurking influence of strike fears on the coordination of the economy—they permit procrastination in seeking a fundamental solution to the problem of how to protect the flow of wages from depression through strike-threat pressures. At their worst, the policies are an incitement to extortion.

Suppose a great political leader could persuade at least some of the more public-spirited union officials to dissuade their members from insistence upon blindly perpetuating the wage-price spiral. Could that set in motion the dynamic reactions needed to maintain the wages flow during a gradual cessation of inflation? It could not, I suggest, largely because the reasonableness of some must raise the yield to defiant avarice on the part of the rest. In any tendency to recession, as Simons pointed out (apropos the Great Depression):

No single group, able to hold up its own price or wage, could advantage itself by reductions unless other groups acted similarly and simultaneously. Even if general reductions were in prospect, each single group could advantage itself by holding back. . . . They naturally all sat tight, cutting their own throats and all losing absolutely in order to preserve their relative position.¹⁷

3. When the politically necessary condition for the (nominal or genuine) acceptance of reasonableness in strike-threat pressures is that “profits” shall be limited in some manner, the whole purpose of the price-cost coordination sought in that crude manner is defeated. The sole defense of inflation is that it raises predicted yields to replacement and accumulation of capital, and thereby moves forward to greater magnitudes the planned outputs at which marginal prospective yields are equated with the rate of interest (thereby restoring the flow of wages and income). The politicians have no way out of this dilemma. The expediency of an incomes policy (persuasive or mandatory) is due primarily to the scope it gives for misrepresentation of its immediate objective. To the extent to which it is justifiable at all, the aim is, as I have just insisted, to improve profit prospects. But the workers’ leaders could never openly approve of that. It would mean admitting that the larger the profits flow the larger the wages flow; and any such admission would be damaging to their profession. Hence a bluff of limiting profits (as an accompaniment of wage-rate ceilings) may create an aura of justice. The snag is that it is unlikely to remain a bluff and the economic system will find itself enmeshed in totalitarian shackles, with the politically powerful feathering their nests at the expense of the people as a whole.

4. The insistence as a parallel condition for “wage restraints” or “wage ceilings” that the prices of final products shall not rise has a further defect in that it fails to take into account the reality that wage rates already conceded under strike-threat pressures have been conditioned by the expectation of both managements and union leaders that the wage rates established will be gradually “validated” by subsequent inflation. The awkward truth is that any really effective correction of the situation must appear to be grossly unfair to labor. Logically, even if wage rates are frozen or wage ceilings imposed, final prices have to be left to determination under market discipline if the crudely coordinative reactions are to be realized.

The inclusion of dividends and product prices in guideline persuasions has probably always been pragmatic—to provide an apparently satisfactory answer to those who would otherwise shout that not to include prices and profits would be unfair to labor.¹⁸ But if policy is sincerely aiming at wages equity and wages-maximization, booming profits ought to be encouraged, never restrained or exploited. Accelerating demands for labor, of which rising prospective yields to replacement and growth (that is, rising dividend forecasts) are the manifestation, should surely never to be curbed as a quid pro quo to satisfy the rank and file of unions whose rulers who shrink from the task of leadership.¹⁹

5. Probably most important of all, the officials of the labor union movement have correctly felt that the very purpose of the “voluntary restraints” arises from the dawn of an understanding of the indefensibility of strike-threat pressures as such. Under a Labor Government in Britain, when the alternative was a government likely to be even more critical of the system, it was expedient for the Trades Union Congress to be cooperative, even to recommend “no-strike bargaining” and exhort its members to think in terms of real wage rates. But for the logic of “wage persuasion” to be explained, an important concession toward the principle of free market determination of wage rates would have had to be made. It is unthinkable that union officials would be capable psychologically, even if intellectually, of communicating such a notion to their members. This, together with the influence of the other factors mentioned above, appears to have caused all attempts at wage rate “restraint” to have been of little or no effect. And when resort is finally had to compulsion, it remains “politically impossible” to use the “controls” effectively.

From the standpoint of the politicians, the press and other makers or leaders of public opinion, there has never been anything more than a groping toward an understanding. The issues which have activated appeals to the unions for “wage reasonableness” have often been described as “political dynamite;” governments and their spokesmen have undoubtedly fought shy of discussing them with the clarity which candor could have thrown upon the subject; and the terms we discussed above, like “wage-push” or “wage-induced” inflation, seem to have been coined by “sophisticated” economists—experts in semantics—to serve as the politicians’ currency. At any rate, those terms have been eagerly borrowed by politicians and political journalists, and they have been, I think, largely responsible for the survival of the idea that inflation can be held in check in spite of an increasing volume of bank deposits and currency in circulation relative to aggregate output.

In a sense, the object of an incomes policy may be said to be that of superseding the chaos and arbitrariness of political or private restraints on the competitive mechanism. The method is, as has been suggested, the enactment of values—directly or via ceilings and floors—which the executives entrusted with the policy judge would have been established under unhindered competition. But it is extraordinarily difficult, even for experts, to guess what the valuation results of the unhampered pricing mechanism would have been. All that any controlling authority could know with any certainty is that, in the presence of abnormal unemployment, wage rates as a whole fixed under duress are too high for the achievement of the maximum wages flow. But if some wage rates are too high, that means that certain other wage rates will be too low. For as we have seen (pages 92–93) every “contrived scarcity” involves an “incidental plenitude.” Even wage rates determined under strike-threat influences may be too low. Workers excluded from more profitable employments may themselves be exploiting other, even less privileged workers. Any rectification under an incomes policy is likely to be just as arbitrary as the confiscation of increases in real wage rates by means of rising prices, which is the “full employment” policy that it is the purpose of an incomes policy to supplant. Worse still, in practice vote-procurement incentives will almost inevitably come to dominate the administration. Henceforth, wage rates will be politically determined.

Moreover, because the objective is enhanced realized outputs, downward adjustment of certain product prices initially may be essential. Hence it might seem that there could be no harm in guaranteeing this outcome (via price controls) in order to overcome opposition. Even so, it is difficult to imagine the officials entrusted with the task of insuring that wage-rate cuts are accompanied by cuts in end-product prices understanding the raison d’être, as I have explained it. But an incomes policy having been adopted, it is incomparably better to be perfectly frank about the purpose—restoration of profit prospects by the cheapening of such labor as has been priced to cause its prospective profitable output to be beyond the reach of uninflated income. That will reduce, but certainly not eliminate, the political dangers to which I have just referred.

Naturally the union officials and their spokesmen make casuistic use of the argument which the Keynesians once gave them. They are apt to argue, with apparent authority (for effective answers from press, radio, television, pulpit, statesmen, and other opinion-makers are lacking), that the forcing up of costs is the path to economic growth. “Higher wages increase consumption and aggregate demand,” they echo. And reasoning from this major premise of what was once confidently asserted to be “the new economics,” they claim that acquiescence in “guideline” limits, for example, can be the cause of a slowdown and recession. The fact that most of the economists who once used this argument would now like to forget that they ever gave it any support, does not prevent union spokesmen from continuing to rely upon it. (See p. 256.)

It is essential also to reject the notion (also a consequence of Keynesian influence) that “demand in general” (“the overall level of demand,” “aggregate demand,” etc.) can become “unbalanced,” or that one or other influence held responsible for inflationary or deflationary tendencies needs “moderating” or “adjusting” by order of a government official who can somehow perceive just what is wrong. The only magnitude which can be said to be “too great” in an inflationary condition is the number of money units²⁰ in relation to the demand for monetary services. But that is, as we have seen, wholly a matter of monetary policy. And properly the “policy” in this case ought to be purely interpretative—the choice of the least-cost method for adhering to some monetary contract with the world or some acceptable real value of the money unit: for example, the maintenance of the value of the money unit in terms of gold, or in terms of foreign currencies, or in terms of a price index (as when a government claims to be “fighting inflation” although wanting the monetary freedom permitted under floating exchange rates). There is no country in the world in which the treasury and central bank between them cannot cause the volume of deposits plus currency in circulation to change in any direction they wish.²¹ When inflation occurs, then, it is because it is the duty of these agencies to bring it about—sufficient of it to achieve some objective like full employment or full activity (with no explicitly enacted or enforced restraint on collusive action to raise particular wage rates or prices, which will set the whole “vicious circle” going again).

The suggestion that strike-threat pressures divert income from “saving” to “spending,” thereby ensuring prosperity, because the poor are less provident than the rich, is based on the same invalid assumption. There is, as we have seen, no net redistribution in favor of the poor so caused. But through the inflation which the tolerance of strike-threat anarchy makes politically expedient, together with the differential taxation which usually accompanies it, there may be a short-run redistributive effect. Even so, there is no stimulus to the economy due to this redistribution (as there is from the consequences of inflation upon prospective cost-price ratios). I have dealt elsewhere with the Keynesian notion which suggests that there can be such a stimulus.²² The fallacy lurks in the idea that consumption is a source of people’s demands (as distinct from the ultimate purpose of their demands) whereas the real source of demands lies in production to replace consumption or to add to the stock of assets. If, however, such a redistribution does cause the consumption of a bigger proportion of an income which has been rising at a given rate, it reduces any rate of increase in the volume of assets; and assets are, in general, wage-multiplying. The confusion of the stimulus of rising prospective yields, due to an accompanying inflation with the supposed stimulus of increasing consumption has been disastrous to clarity of thought.

I sometimes think that the tendency for official pronouncements to attribute the blame for inflation to “cost-push” influences (via strike-threat pressure on wage rates) is due to a mistaken judgment that it is the most tactful way—perhaps the only politically feasible way—in which to draw the attention of the public to the persistently discoordinative pressures the unions impose on the economy. The aim has certainly been to bring public opinion into operation as a dissuasive factor. But the weakness of such an “anti-inflationary” strategy lies partly in the plausible fallacy on which it relies. A cumulative decline in output—due to worsening unemployment, or to capacity diverted to less productive uses—and not inflation could conceivably be the politically preferred alternative following the forcing up of costs, as we noticed on pages 000–000. It could be preferred because it would focus the blame for discoordination and unemployment upon those responsible for it. Fundamental reform would then cease to be politically inconceivable. Blaming strike-threat pressure for inflation merely diverts attention from the fundamental causes of discoordination. The cumulative withholding of productive capacity which becomes profitable (“profitable” in the sense of minimizing losses), when one wage rate is forced up by the strike threat in the presence of general price rigidity, itself creates pressures toward coordinative adjustments; and if governments resumed their “classical” planning and coordinative functions (and such a step would constitute the fundamental reform needed), these pressures could select the particular adjustments needed.

The only remaining justification for the belief that market-selected wage-rate reductions may fail to restore employment and the full wages flow in incipient recession arises from the possibility that the initial adjustments may be too small to bring wage rates and prices into harmony with expectations. This brings up the general problem which can arise under what I have called (in another work) “unstable price rigidities.”²³ Thus, if reductions are made in certain long-term wage agreements, entrepreneurs may feel that subsequent agreements are likely to facilitate planning at even lower labor costs. In the meantime, then, they will tend to invest to an abnormal degree in liquid assets. They may indeed judge that even normal replacement, let alone net accumulation, of fixed assets and inventories (of materials, work in progress and stocks of end products), is likely to prove unprofitable until further cuts in wage costs have been secured.

Such a reaction will, some economists fear, reduce the money valuation of a given real income and hence cause another round of downward price and wage-rate adjustments to be necessary for recovery. But the monetary deflation implied need not follow. It is solely a question of monetary policy; and that policy, if correctly discerned by entrepreneurs, is assisted by their speculative activity.²⁴ Hence, unless deflation is purposeful, to rectify a previous inadvertent period of inflation, or adopted as a collective objective,²⁵ it is impossible to contemplate its ever being deliberately adopted. Thus, we can assume the absence of any deflationary effect and eliminate it as a causal influence in respect of unemployment or underemployment of resources. This implies that any idleness of labor or capital assets will be due to particular wage rates and/or particular prices being too high, and possibly too high in the sense that certain wage rates or prices, even if they have been reduced, are still too high in relation to expected wage rates and prices.

This may be the position, as I have just suggested, when there are unstable rigidities present in the pricing mechanism. It is the belief that these rigidities will eventually break down which temporarily causes the prospective yield from money to increase relatively to the prospective yield from nonmoney, and hence the aggregate real value of money to rise. Under a flexible but non inflationary monetary policy this will call forth monetary expansion. But if outputs generally are declining in consequence of duress-imposed labor costs, a recessionary effect must emerge through the real income contraction. At the same time, of course, the recession itself—manifested in the slowing down of activity—will be creating powerful incentives for coordination, that is, for the rigidities to be overcome and the flow of income to be restored. Unfortunately the incentives, in spite of their strength, may be frustrated.

In the circumstances just discussed, if the unions acted as entrepreneurs on behalf of their members, they would at once approach any corporations which were working at below full capacity to bargain for the reemployment of all their members who did not have better openings at the full employment wage rate. They could do so by agreeing to accept wage costs judged to be sufficiently low in relation to expected wage costs. If such a policy were generally followed, very small wage-rate reductions would be necessary in most cases. Through the operation of Say’s law, the point would soon be reached at which labor shortage began to create pressures for the restoration of former real wage rates. The increased outputs in any one industry would be adding to the source of uninflated demands for the outputs of noncompeting industries. And if, at any time, the required fall in labor costs had not been achieved in any industry, enlightened unions would bargain further for the full employment of their members.

It seems to me that, in the psychological atmosphere created by prolonged depression in the 1930s, when entrepreneurs had again and again been disappointed, incurring losses through wage contracts influenced by unfounded expectations of recovery, it was essential (in the interests of full and optimal employment) that they should have had iron-clad guarantees of freedom at any time to reduce, if necessary, their wage-rate offers. It was, in my judgment, because such guarantees could not be given that the Great Depression of the 1930s was so prolonged. But the power to reduce wage rates would have been limited, of course, by what I have called “market-established minima”—the wage rates at which firms would lose essential labor, not through strikes, but through their workers leaving for better paid employments (see pp. 188–190).

The vital condition for optimal employment is that managements, as representatives of the residual claimants—the providers of the assets—should be allowed untrammeled discretion in their interpretation of market commands and hence in making wage offers. We should remember that the result would be not merely to restore the flow of wages and full employment; it would set in motion a trend toward the maximization of the wages flow, and the minimization of inequality in the distribution of that flow.²⁶ It would draw people from the unskilled ranks for training in semiskilled or skilled work, as well as promote a fructifying net accumulation of wage-multiplying assets.

I conclude that incipient depression caused by duress-imposed labor costs and expressed as the depletion of wages and income generally, is incapable of being held off except by inflation. And ultimately it is due to the fact that union officials have been allowed to acquire immense political power. The textbooks of labor economics ought to be drawing the students’ attention to this reality. But because rising prices are now universally expected and hence bereft of their former coordinative ability, the sole purpose of inflation has become political—to satisfy the many vested interests which have come to depend upon it. The profession of union officials may well be the most important. But all those organizations of persons who have used the remnants of the market system to protect themselves from the policy will now be confronted with serious difficulties if inflation really threatens to come to an end; and they will constitute a formidable obstacle to the emergence of any noninflationary era. They have been forced to gamble and they have—so far—forecast the continuance of inflation. They will have lost if inflation comes to be recognized as economically purposeless simply because everybody expects it to continue.²⁷ Yet all great steps in the progress of mankind have created difficulties—especially problems arising from disappointed expectations and requiring drastic readjustments.

Today’s problem of inflation is, however, unique in history in some of its aspects. Unless it can be solved, the survival of the freedom which the West has enjoyed in increasing measure is in jeopardy. And the solution is not to be found in monetary policy alone but in the reform of a chaotic, private pricing policy which—until the present, emerging era—has made inflation inevitable for any government which has wished to remain in power, but at the cost of increasing instability, perpetuated inequality, social injustice, and worsening chaos in the international monetary sphere.

We must be clear on two important practical points. First, the difficulties created by the abandonment of inflation are less likely to promote civil strife than inflation itself. The inflationary policy of the period 1960 to 1971 in the United States was accompanied by growing and successful incitement to disorder—a phenomenon which, I think, no recession period has witnessed. Secondly, while recession can act as a harsh discipline forcing the unions to make the concessions needed to raise the wages flow, wise policy would make it clear to the unions and the community that the pains of that type of adjustment are avoidable. Policymakers could tactfully explain that if strike-threat entrenchments against the maximization of the average wage and the minimization of inequalities in the distribution of the wages flow were abandoned, a stable money unit would not only be compatible with, but conducive to, “full employment,” higher wages and greater security than have ever been realized in the past.

Inflation was the scourge of the masses under the monarchies. The invisible taxes it levied accorded the princes resources which they could never have obtained openly without violent opposition. That it has survived in the world’s totalitarian countries is not surprising. It helps to finance the ruling groups in dictatorial regimes as it formerly helped to finance royalty and the court. But its survival under representative government is something of a mystery, despite the inconspicuous way in which—for long periods of time—it takes its toll. Public tolerance of inflation under democracy is paradoxical because of its blatant regressiveness, the distortions of the production structure for which it is responsible, and the sapping of incentives (for enterprise and for thrift)—vices which seem to be its necessary concomitants. Admittedly, inflation remains a device through which elected governments can raise funds without parliamentary authorization. But that alone would not account for its survival, I venture the following diagnosis.

While (as I have insisted) the strike-threat system does not directly cause prolonged inflation, the link between them is close. Governments have accepted responsibility for the maintenance of prosperity but have abdicated from their duty to remove observable obstacles to prosperity when those obstacles have been erected by groups with great voting strength. Inflation has become chronic because, when not fully discounted, it works as an antibody to duress-imposed costs. In other words, it acts as a continuous (although partial) rectifier of the discoordination which the overruling of the market mechanism persistently causes. But what is so worrying today is that “the antibody” is losing its ability to preserve the apparent health of the body economic. For creeping inflation is being more and more expected and more fully discounted. As I write, the advisers of governments do not appear anywhere to have drawn the attention of politicians effectively to this disconcerting and worsening phenomenon. Perhaps the almost anarchical relations between the world’s currencies which have been created, despite the cold-shouldering of the IMF through the ill-fated “Smithsonian” initiative, may bring opinion-makers in the “democracies” to their senses.²⁸

NOTES

¹ This thesis is developed at greater length in my Politically Impossible. . .?, already cited.

² H, G. Johnson, “The Determination of the General Level of Wage Rates,” in J. T. Dunlop, ed., The Theory of Wage Determination (London: Macmillan, Ltd., 1957), p. 37.

³ Defining inflation as the loss of value in some defined sense in a money unit, and illustrating by the case in which value is measured in abstractly conceived “real terms,” we can say that inflation occurs when monetary policy allows the aggregate value of money in actual money units (that is, in dollars, pounds, francs or marks) to increase more rapidly than the same aggregate value in real terms. We are concerned in the text with how autonomous changes in particular prices affect this relationship.

⁴ Under minimum wage legislation, this last way of mitigating the discoordination may be seriously restrained.

⁵ Monetary policy may be defined as “rigid” when, in terms of the “quantity theory identity,” MV ≡ PT, M does not rise or fall in proportion to changes in aggregate demand for monetary services (which demand changes in proportion to changes in T and/or in 1/v.

⁶ The notion of wrong activity is not meaningless. An activity which yields the largest flow of final products in the short run may be “wrong” in the sense that it is being achieved through a sacrifice of the rate of replacement or net accumulation of productive capacity—that is, because there may be unobserved consumption. But aggregate thrift—the net accumulation of income-yielding assets—can never be “too great” except insofar as any preference can be judged on purely ethical grounds.

⁷ Unless what is meant is the condition referred to in the above footnote, and I do not think that is ever what is intended by the phrase.

⁸ Report in San Francisco Examiner, October 26, 1969.

⁹ I say “more or less” in order to envisage monetary policy as reacting to those sources of demand for the services of money which are not correlated with the magnitude of output (i.e., not correlated with T in the quantity theory identity).

¹⁰ Melvin Rothbaum, “Wage-Price Policy and Alternatives,” in Lloyd Ulman, ed., Challenges to Collective Bargaining (Englewood Cliffs, N. J.: Prentice-Hall, Spectrum Books, 1967), pp. 135-136.

¹¹ That is, so as to exclude the power to fix wage rates and prices above the free market level and thereby reduce the flow of uninflated wages and income.

¹² A. H. Hansen, Monetary Theory and Fiscal Policy (Norton, 1941), p. 101.

¹³ It can create also a collective incentive to eliminate by taw the strike-threat in the interests of a stable, well-coordinated economy with full employment.

¹⁴ The “Phillips curve” is designed to represent the empirically established relationship between the magnitude of “unemployment” and the rate of inflation.

¹⁵ His position may have seemed rather equivocal until 1936. It became most explicit in his controversy with F, D. Graham and F. A. Hayek (Economic Journal. 1943, pp. 185-7, and 1944, pp. 429-30). See W. H. Hutt, Keynesian-ism, Retrospect and Prospect (Chicago: Henry Regnery Co., 1963), pp. 95-105; Politically Impossible . . .?, Part V.

¹⁶ “Intended” because no one really doubts that monetary and fiscal policies aimed at “maintaining aggregate demand” cause the money valuation of income to rise more rapidly than its real value increases.

¹⁷ H. C. Simons, Economic Policy for a Free Society (Chicago: University of Chicago Press, 1948), p. 128.

¹⁸ It has no other justification unless there has been a failure to use antitrust (or similar) initiative against contrived scarcities achieved through managerial collusion.

¹⁹ It should be noticed that if policy is framed with main focus upon the greatest advantage of wage earners collectively, the benefits which accompany the general increase of profits in a coordinated economy are likely to be enjoyed by labor as much through a shift in employment from low-paid to high-paid categories of work as through increases in the real remuneration of different kinds of work. Free market influences are, as I have several times insisted, intensively egalitarian.

²⁰ The “number of money units” may be taken to mean, for this purpose, the volume of demand deposits plus currency in circulation. For full accuracy, the “pure money equivalent” of “money substitutes” or “near money” would have to be included. See W. H. Hutt, Keynesianism. pp. 90, 92, 96, 417.

²¹ This does ṅot mean that such changes in demand for the services of money as some economists envisage under the misleading term “velocity of circulation” can be ignored in attempts to maintain money income in a planned proportion to real income.

²² See Ibid., Chapter 10 to 12 and especially pp. 195, 233-240, 250-51, 256-59, 295-96.

²³ See Ibid., pp. 25, 64, 170-76, 242.

²⁴ See Ibid., pp. 40, 100-101, 106, 169-70.

²⁵ As it was by Britain after 1920, as a means of keeping faith with the world from whom she had borrowed cheaply during World War I through her promise to return to and maintain the gold standard at the 1914 parity.

²⁶ For any such policy of maximizing the wages-flow to succeed, however, it would be essential that unemployment compensation should not be allowed to sabotage it.

²⁷ On the difficulties which long perseverence with Keynesian-type policies has created for governments, see F. A. Hayek and Sudha Shenoy, A Tiger by the Tail (London: Institute of Economic Affairs, 1972).

²⁸ On the general subject of strike-threat power in relation to inflation, see Inflation and the Unions, by G. Haberler. M. Parkin, and H, Smith (London: Institute of Economic Affairs, 1972).