APRIL 01, 1971 by GEORGE HAGEDORN
Mr. Hagedorn is Vice-President and Chief Economist of the National Association of Manufacturers. This column appeared in
If, as of on a certain date, every dollar were to count as two dollars, and every price, wage rate, etc. were doubled, the resulting "inflation" would make absolutely no difference to anybody. The only problem might be to adjust our financial arithmetic.
In practice, inflation does not, and cannot, ever happen that way. It occurs as a process spread out over time. And it affects incomes, prices, and the value of assets unevenly over the time scale. At any given stage of the process, some people are ahead of the game and some are behind. Even when the process is all over, some will still be behind and others still ahead.
This is an elementary and perhaps a rather pedantic line of thought. But it is often ignored in practice. Inflation is discussed as though its chief evil lay in the general rise in prices and incomes.
The real evil of inflation lies in the fact that it is not general enough. The uneven response of various prices and incomes introduces distortions and inequities into the economy. The position of various sectors of the economy relative to each other is changed. As the process proceeds the relative position of the goods sector vs. the service sector, of employers vs. employees, of organized labor vs. unorganized labor, of borrowers vs. lenders, of pensioners vs. active workers, etc., etc., keeps changing.
Naturally, as this goes on, it provokes strong feelings among those affected. The groups that fall behind, relatively, are embittered. But those who have gained ground are not likely to feel especially favored—they are more likely to conclude simply that at last they have got their due. Thus, the balance between satisfaction and dissatisfaction with the inflationary developments is not an even one.
The Function of Prices
But the effect of the inflation on intergroup equity, or subjective feelings of equity, is not the only problem involved. The relationship among various incomes and prices is the mechanism which keeps our economy going as an efficient producer of goods and services. Goods can’t be produced if their costs exceed their market price. And if costs and prices are so related that a profit can be made on almost anything, no matter how inefficiently it is produced, manpower and capital are not allocated to the most useful purposes. The relationships among prices (in the broadest sense of the word) are more important in maintaining a workable economy than the absolute level of prices.
Thus, during the inflationary process, patterns of economic activity are distorted. This might not be too bad, but the temporary effect of changed price-income relationships is often interpreted as a permanent change in demand patterns. Capital is invested to supply goods that may not be wanted later—and is not invested where it will be needed. Workers are hired and trained for jobs that may not exist beyond the inflationary period.
This is not anyone’s fault in particular. The price-income signal system which we rely on to control the economic traffic is thrown out of kilter by the uneven inflationary process.
When the inflation ends—as all inflations must—the process is thrown into reverse. Not that prices and incomes generally go down, but those which have been behind tend to catch up. This process, too, is a slow and uneven one. At the end it is usually incomplete.
Malinvestments During Boom
The process of "disinflation" is even more painful than the slow and uneven process of inflation. Those who may be catching up are still bitter because they were behind so long. Those who had gained ground begin to feel a vested right in their new position, and will resent losing their temporary relative advantage.
But the most unpleasant aspect of a disinflation period is that we are left with a heritage of the misdirected investment and manpower from the preceding inflation. It remains to be seen just how serious a problem this will be if, and as, we liquidate the inflation of the late 1960′s. In the opinion of this writer it will not be catastrophic (although it could become so if the inflation is reactivated). But it is already a painful problem and we should not deceive ourselves on that score. The nation took an inflation "trip" and we are only now learning how bad a trip it was.
In pointing out that the real problem of inflation is not the general price-income increase, but its unevenness, we hope it is clear that we are not advocating an attitude of complacency toward inflation. We are not suggesting that inflation should be tolerated, and our efforts should be merely to insure that everything responds simultaneously and proportionately to it. Our economic institutions are not geared to perform in that way and it is hard to conceive of any set of institutions that would. Universal automatic escalation, if it were possible, would destroy the meaningfulness of our most basic institution—money. The only way to avoid the kind of distortions and inequities we have described is to avoid inflation.
Price Controls Assure "Worst of Both Worlds"
Our theme does, however, have a bearing on an important national question. Those who believe that the evil of inflation lies in the general rise of prices and incomes have a simple solution. All you have to do, they say, is freeze all prices and incomes at their present levels by government decree.
The effect would be to freeze all the distortions and inequities produced by inflation permanently into the system. The temporary advantages of some groups over others would be preserved as long as the freeze endures. The process of unwinding the inflation, and restoring a more rational pattern of price and income relationships, would be stopped dead.
A price level which is kept from rising by jamming the internal mechanism of our economy is the real "worst of both worlds."
To enact stand-by controls would mean putting into the law of the land a permanent endorsement of a basic tenet of socialism—the principle that control of the vital mainstreams of commerce and confiscation of the rights of private property are sound and just practices.
F. A. HARPER