by JOHN KENNETH GALBRAITH
AFTER surveying the results of the election in the Farm Belt last fall, Secretary of AgriCULTURE Ezra Taft Benson concluded that his policies had been endorsed, admittedly with some reservations, by the farmers. He could have been wrong. An adverse farm vote almost certainly cost the GOP the control of the Congress. And there is a distinct possibility that farmers liked Ike for himself alone and not necessarily for his Secretary of Agriculture. But there is no doubt at all that if farm prices had been better and Mr. Benson more beloved, the Administration would have had to do some fairly serious explaining on another front. For people would have been asking very urgently what had happened to the cost of living.
In recent months, the consumer price index has reached the highest level in history — higher than during the Korean War and very much higher than when the controls came off after World War II. This high level has been the result of an upward movement which began in April of 1956 and which followed four years of seeming stability in the index. But this stability was really yet another example of how we can be misled by averages. Prices were stable only because, from 1951 on, farm prices were going down. Until last spring the 25 per cent fall in these prices was sufficient to conceal the upward movement in nearly everything else, including the costs of handling, packaging, and processing farm products themselves. Foods comprise about 30 per cent by weight of the index of consumer prices. If the underlying farm products, instead of falling, had risen as much as other things, the index would have climbed persistently. W e should have had a nearly unprecedented peacetime inflation.
Early last year farm prices did level off. Soon thereafter the index began to rise. The lesson is clear. Farm prices are unlikely to fall in the future as they have in recent years; price supports will intervene. Henceforth there will be nothing to offset the increasing prices of other things. Those who have been feeling the pinch should brace themselves. Most likely the worst is yet to come.
This —and let me stress the point — is not a prediction but only a reasonable prospect. What is certain is that we are in a very poor position to check any price increases that may occur. We shall, of course, have a massive oral attack on inflation if it continues. There will be promises of action and even promises of drastic action. There will be reassuring and, on occasion, dramatic stories about what the authorities are contemplating. All this will be in very general terms, for if the threat persists we shall discover that the present difficulty in dealing with inflation is a nearly total absence of tools. All the devices for combating inflation — at least all that work — are now under some sort of ideological ban. This isn’t very cheerful, but the prospect doesn’t improve on closer examination.
Prices have been rising in these last years because spending for goods has been pressing on the capacity, including available manpower, to supply them. This is the classic setting for inflation. The spending can come from three (and, apart from comparatively unimportant foreign demand, only three) sources: private consumers, private business, and the government. The active factor in the present inflation is business spending. We are now having a great boom in business investment. At the end of last year, including housing and inventories, these outlays were running at a gross rate of about $64 billion a year. They have doubled in dollar volume since 1949; they are now seven times as great as in 1939.
This investment spending is being augmented by consumer spending from borrowed funds. Consumer credit outstanding has also more than doubled since 1949. Early last year it looked as though the rate of increase (after a phenomenal advance in 1955) were beginning to slow down. But figures for later months seemed to suggest another large increase.
The consequences of high business investment are high employment and high personal incomes. However, consumer spending from t hese high incomes — that is to say, spending from other than borrowed funds —is not out of line. On the contrary, total personal savings increased last year (by about $3 billion), as did the proportion of income saved, and this was on top of a large increase in 1955.
The federal budget is now showing a modest cash surplus. So do the consolidated accounts of federal, state, and local governments. These surpluses indicate that, public bodies, always under suspicion for promoting inflation, are now taking more purchasing power from their taxpayers than they return in income to their employees, pensioners, and suppliers. However, as we shall see presently, these balanced budgets are a limited source of comfort.
Strong demand in relation to the current capacity of the economy furnishes the invariable setting for inflation. On occasion some economists have yielded to the temptation to regard it as the complete explanation. As a result they have succeeded to a surprising degree in not thinking about an even more intractable and unpleasant cause of price increases. This is the wage-price spiral — or perhaps more accurately, the wage-profit-price spiral. Though exceedingly inconvenient, this spiral is one of the facts of modern economic life.
The wage-price spiral affects only a part of the economy—roughly speaking, that part where strong corporations bargain with strong unions. Here, when demand is high, companies have no difficulty in passing the higher costs of wage settlements along to the public. The companies do not need to wait for prices to rise; they can usually raise them. Under these circumstances, while a little ritualistic bickering is still required, there is no real conflict of interest between company and union. It is the public that pays. The price increase that follows a wage increase is often the occasion for gett ing something more for the company. The public will always attribute the whole of the price increase at such a time to the presumed rapacity of the unions. High company earnings then become an invitation to further wage demands. Prices, wages, and profits all shove each other up.
Where there are no unions or where the unions are weak, and where businessmen are small and have no assurance that their prices will rise (or can be raised) to cover higher wage costs, the spiral does not operate. The inflation of recent years has been marked in those parts of the economy that, are subject to the spiral. Thus in the steel industry, where the spiral works relentlessly and where wage advances are invariably the occasion for even larger price increases, the prices of most products are now between 70 and 80 per cent above their 1947-1949 average. At present rates prices of steel products are doubling themselves approximately every len years. To take a random selection of other relatively well-organized industries where prices are also subject to considerable control, machine tools are up about. 60 per cent since 1947-1949; aluminum ingot is up 70 per cent ; bulldozers are up between 50 and 60 per cent; tractor tires are up 61 per cent; mining machinery on the average is up about 75 per cent; internal-combustion engines are up 42 per cent; and farm machinery is up 31 per cent. Building materials are also up about one third.
Where the spiral does not operate, the behavior of prices has been very different. In the cotton textile industry — an industry of weak unions and fairly numerous manufacturers — prices are now on the average between 8 and 9 per cent below the 1947-1949 level. In the apparel industry, where unions are strong but the manufacturers are not, prices are now about the same as in the late forties. Prices of farm products, where there are no unions and where all producers are relatively small, are about 10 per cent below the level of the late forties.
The wage, profit, and price spiral does not explain everything—in economics nothing ever does. The investment boom has increased the demand for capital goods. The pressure of demand has made it easier to raise the prices of metals, machinery, and materials. Consumer goods have gone up less rapidly, in part because demand has increased less rapidly and the danger of customer price resistance has been greater. In numerous industries productivity has gone up more rapidly than wages; to the extent that prices are higher in these industries, producers have simply been taking advantage of a strong market. Nonetheless, the shove of wages on prices and the pull of prices and profits on wages are an inescapable part of the inflationary process. Directly or indirectly, any remedy for inflation must, break this spiral. It is now time to look at these remedies.
THERE are three broad strategies for dealing with inflation, each with a distinct place in the ideological spectrum. On the right and by far the most respectable is monetary policy; this is the higher interest rate and the more reluctant lending that we now celebrate as the “credit squeeze.” In the center with large elements of respectability and some elements of disreputability is fiscal policy. This is the use of the taxing power to curb spending and mop up excessive demand. Far to the left are direct controls on wage and price increases. These in peacetime are not regarded as respectable. Anyone who recommends them does so at considerable risk to his reputation.
Direct controls obviously are not in the cards. One of the first acts of the Eisenhower Administration in early 1953 was to dismantle the price and wage controls which remained from the Korean War. This ev er since has been regarded as an act ion of supreme wisdom and virtue, symbolic of enlightened Republicanism. No one has really disagreed. Not even American radicals these days want it supposed that they harbor secret designs to impose price or wage or rent controls.
However, while direct controls are abhorred, their efficacy, to a marked degree, is conceded. If the danger of inflation were serious enough — in the event, for example, of an old-fashioned mobilization — it is generally agreed that we should have to have them, partly because nothing else comes to grips with the spiral. But in peacetime the right to shove up wages and then increase prices and profits and then raise wages and then start all over again is still one of our liberties. We can reasonably assume it will so remain.
This leaves us with fiscal and monetary policy. An active fiscal policy faces almost equally formidable barriers. The government must raise taxes and cut public spending to the point where the total of all spending, public and private, no longer presses on the capacity of the economy. This policy must be pursued when times are good, incomes are high, sales are large, and when, for these reasons, tax revenues are already high.
At the present time this policy would require a general tax increase when the budget is already comfortably balanced. Total spending can be excessive even when the budget is balanced; hence the action is wholly logical. But what seems logical to some people seems like determined masochism to other people, and these include the uniquely strategic George M. Humphrey, the past and (as this is written) the presumptive Secretary of the Treasury. Mr. Humphrey has proudly avowed the oldfashioned view that the single and sufficient goal of fiscal policy is to balance the budget. Since the private spending that brings inflation also brings the revenues that balance the budget, Mr. Humphrey’s position leads not to tax increases but, on the contrary, to tax cuts in times like the present.
In economic affairs necessity is the great evangelist for radical ideas. Conservatives in power must constantly do the things they once excoriated as harebrained. If the present, inflation persists, the Administration may well try to use taxes to cut private spending. A Tory government in Britain has come, though reluctantly, to this policy. And without doubt spending can be cut in this way. But there is another question: whether the policy will work without being impossibly drastic.
Fiscal policy works by squeezing total consumer demand. When this has proceeded to the point where demand no longer presses on capacity, prices no longer rise. Or they are not supposed to.
But where the wage-price spiral is involved things may be less simple. Then costs shove prices up. To halt the spiral the demand for, say, steel would presumably have to be reduced to such a degree that the United States Steel Corporation would fear that it could not pass a price increase along to its customers. This being so, the United Steel Workers Union would know that wage demands that went beyond the gains in productivity portended a serious battle. Perhaps it might be additionally necessary that the union’s hand be weakened by some unemployment. Plainly the policy, to be effective, must be severe. Meanwhile we may well wonder what will be happening to farm prices, and to employment and to prices in other vulnerable industries. For we must remember that the demand squeeze which is stabilizing steel prices will also be common to the whole economy.
Fiscal policy has been ardently discussed by economists for t wenty years. ‘There is a priest hood which is presumed to be deeply accomplished in its rites. But it is a curious fact that it has not yet been put to a test in any serious inflation crisis. In both World War II and the Korean War, direct controls were called into use — the action in both instances was regarded as irregular, unscientific, slightly unAmerican, but also indispensable. And it was the direct controls in each case which halted the spiral. So our knowledge of inflation control by fiscal measures is largely speculative. Since the instrument is one with which experience is so limited, since it would require a disavowal of present policy, since the political resistance would be formidable, and since to be effective it might have to be exceedingly harsh in its effect on prices and employment in some parts of the economy, we should obviously be somewhat skeptical of its present practicability. In fiscal controls we have a gun, but we do not know how heavy a charge it requires or whether it kills first the enemy or the man who fires it.
IN OUR folklore, to possess a full comprehension of monetary policy is to be thought privy to a kind of fiduciary black magic. The facts, perhaps unfortunately, are less romantic. The effect of monetary controls is relatively forthright. By raising interest rates and reducing (or increasing less rapidly) the funds available for lending by the banks, the Federal Reserve discourages borrowing and investment. Investment means spending for capital goods and inventories; less spending for these means less demand and hence less pressure on prices. While, broadly speaking, fiscal policy cuts consumer spending, monetary policy cuts business spending. However, in principle, monetary policy should also reduce consumer spending somewhat by reducing consumer borrowing.
Conservatives applaud a strong monetary policy; it has an unparalleled aspect of sanity and soundness. Liberals once objected but of late they too have acquiesced. They are liberal, but they don’t want to seem irresponsible. The policy is now being pursued with vigor. Interest rates are higher than they have been in twenty years. Anyone who has talked with farmers or smaller businessmen has heard firsthand about the credit squeeze. The policy is meant to squeeze people to make them reduce their borrowing and spending. Accordingly, things seem to be working as they should. Yet in any tolerably detached view monetary policy, at least in its present form, is emerging as the most dubious of all the weapons for attacking inflation.
There are first of all its side effects. Monetary policy attacks inflation by attacking the volume of investment. When it is effective it cuts down the rate of economic growth. It would be more in accord with our cherished Puritan tradition to cut excessive spending by cutting back consumption, But such austerity has little appeal. Congress has even denied the Federal Reserve the right to regulate consumer credit terms and down payments, which is a way of bringing monetary policy specifically to bear on consumer spending. Thus the professional business statesman who calls for all-out. support of the tight money policy is calling, in effect, for a slower rate of investment and of economic expansion — a less dynamic economy, perish the thought — than if the curbs were placed on consumption. Not infrequently he is contradicting the speech he made just last night about the need to outproduce the Russians. Still, we should keep this issue in perspective. Maybe we are overinvesting. Maybe, too, we exaggerate the importance of growth; or perhaps the emphasis it receives is more liturgical than real. Our need for more automobile capacity is probably not urgent. Additional hotels in Miami Beach probably do not add greatly to our national strength, however agreeable they may be. Moreover, we can afford to view the reduction in growth with equanimity for another reason. The policy isn’t working.
The second side effect of monetary policy is on the competitive balance between large and small business. It would be hard to find a policy better designed to encourage the large and the strong at the expense of the small and the weak. When banks must limit credit, they are impelled to protect their oldest, strongest, and most reliable customers. These, in general, will be t he larger firms. (For one thing, the large lirm has t he st rengt h and reputation to lake itself to another bank if it doesn’t already have multiple banking connections.) As a result the burden of the cut falls on newer, weaker, less reliable
—and smaller—borrowers. There will be many exceptions to this tendency, bul (he tendency is inescapable. In recent months commercial bankers have been sensitive about the suggestion that the smaller and weaker borrowers have been losing out. Some have come perilously close lo claiming that their least valued clients get their first consideration. This is hardly plausible. These are wonderful times, but banks are still not charitable enterprises. Nor, happily, have bankers yet become completely unbusinesslike.
But the larger and stronger firm has other advantages quite apart from its warmer reception at the bank. Its resources may make it more or less independent of loans not only for operations but also for expansion. And the market power of the large firm allows it to pass higher interest costs along to its customers in higher prices. This the farmer and smaller businessman cannot do.
The effects of monetary policy to date have accorded with these expectations. Smaller businessmen and farmers, having failed to experience the privileged treatment they are supposed to receive at the banks, have been complaining bitterly. The big corporations are evincing no similar distress. The failure rate of small business firms is now higher than for years. Earnings of small firms are at best unexceptional. At the other extreme, earnings of very large firms are near record levels, and their share of all corporate assets has been increasing. Curiously enough, despite the squeeze, bank loans outstanding have also been rising steadily. There is at least a possibility that those who have lost their lines of credit in the squeeze have merely given way to larger and stronger borrowers.
While in principle everyone is in favor of the small businessman, it has long been clear that this affection is largely verbal. We grieve terribly over his fate, but not to the point of doing anything about it. And it is true that big business is here to stay and doubtless will get bigger. Nonetheless, we should recognize that monetary policy, as it is now being practiced, is a magnificent instrument for promoting centralization. A move at the present time to repeal the antitrust laws would, without doubt, excite considerable opposition. But it might contribute less markedly to industrial concentration than a long continuation of monetary restraints in their present form. These deny to the smaller and weaker firm the funds on which growth or even survival may depend. The large and the strong tend to get them. The consequences must be clear.
A FINAL difficulty with our present monetary policy is that it probably doesn’t stop inflation. The evidence of the day can hardly be overlooked. The policy of tight money has been applied with increasing severity for many months. And the inflation has marched right along with the policy. Prices are still rising; the pace as this is written is accelerating. The usual t est of a policy is whet her it works.
When we look a little more deeply we are likely to be puzzled most by w hy we are expected to suphighest on record. Why should they be deterred from investing by what, comparatively speaking, are minor increases in interest costs? The prospective returns far exceed the increased costs.
And the investment boom has continued. With one qualification, as this is written, there is no sign of the tapering off which would signify that the policy was succeeding. The exception was the leveling off last year in residential housing. This is partly because buyers were discouraged by the stiffer terms. But partly it was because housing is pre-eminently a field of the small businessman. As a result t he credit squeeze was effective for builders. General business investment, where the influence of the large firms is dominant, showed one of the largest increases ever. At the moment the hope for 1957 is only t hat the rate of increase will be smaller.
Monetary policy is dubious for another reason.
It makes no contact with the wage-price spiral. No one supposes that the steel industry was much deterred last summer in reaching a wage settlement and raising its prices because money was tight. Nor can anyone doubt that the higher wages and prices (prices that became costs to steel users) were inflationary. The spiral could be checked if investment spending were so severely curtailed that the total demand for steel became soft. Then the steel firms would be cautious about wage settlements that involved price advances. And the union would be cautious about demands that meant a long battle or which might, if granted, mean unemployment. But to say what, would be needed is to make clear by what a vast margin the present policy fails to make contact with the problem. The present policy, even though ineffective, is sufficient to bring cries of anguish from weaker borrowers. Plainly a policy so astringent as to reduce investment by the big firms would mean euthanasia for the smaller businessmen and the farmers. This, one supposes, might eventually become socially and politically unacceptable not only in principle but in practice.
As noted, the central fact in the present inflation is the big boom in business investment and therewith in business spending. This investment could begin to taper off for reasons that have nothing to do with the control of inflation. And it might suffer a traumatic reduction which would promptly set us worrying, not about the wage-price spiral, but about depression and unemployment. There are elements of imbalance in the present prosperity — the heavy consumer borrowing, high profits, lowfarm income, the investment boom itself—which are not reassuring. (We should also be terrified by the number of people who are looking at our present prosperity and solemnly proclaiming it to be sound.) But nothing is so unrewarding as economic prediction. There is an opposite chance t hat demand will continue strong and wages, profits, and prices will continue to push and to pull each other up.
If so, we will continue to have inflation, and in face of that our situation could scarcely be worse. Monetary policy in its present form, the one measure we are presently prepared to use, is almost certainly ineffective unless applied with intolerableseverity. So applied, the social consequences — at least as seen by the farmer and smaller businessman — would be most disenchanting.
Inflation — progressive, unremitting, and unending inflation— is not a pleasant prospect. It undermines all the arrangements that civilized man makes and maintains with the greatest difficulty. Schools, hospitals, churches, public services, law and order, care of the sick and the aged, all suffer. By contrast, speculators, promoters, all who are knowledgeable about making money, do well. As things now stand, their future looks bright.
Inflation can be controlled. It will require, however, a willingness to do the things that work. The problem is one of economics, not theology. And all the effective remedies hurt. That is because they deny to someone an increase in prices or profits or wages which he otherwise would have had. To illustrate: a convention, somehow reinforced by law, which proscribed any general price increase for at least six months following the negotiation of a new collective bargaining contract would do wonders to stop soft wage settlements that are automatically passed along to the consumers. It would require that wage increases be paid out of profits or productivity increases — which is where they should come from. Yet one can imagine the cries of out rage were this seriously proposed.
Such a measure would have to be reinforced by fiscal and monetary controls equipped, where necessary, with new teeth. The difficulties in bringing taxation to bear on consumption have already been told. If we are to continue to use monetary policy, ceilings will have to be placed on the credit lines of larger borrowers. This action would prevent them from using the credit denied to weaker borrowers and it would make them share equitably in any reduction. Large enterprises will certainly object bitterly to such limitations. (The smaller and weaker firms that now get no credit at all are expected to view their privation with more nobility of character.) And numerous small businessmen would themselves stage a bitter-end fight against consumer credit controls. These are a necessary adjunct to other weapons for attacking inflation. A change in farm policy from the system of pegging farm prices to one of allowing them to find their own level, with the farmer’s income protected by direct payments, would be immensely useful. This, too, would be opposed.
So it goes. Inflation control is the ultimate test of the power of the general interest against the special interest. For the moment, at least, the position of the special interest could scarcely be stronger. It has managed to ban all the weapons by which inflation might successfully be attacked.