Stagflation. Vol. 1: Wage Fixing 
by James Meade.
Allen and Unwin, 233 pp., £15, January 1982, 0 04 339023 4
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Prices and Quantity 
by Arthur Okun.
Blackwell, 382 pp., £15, August 1981, 0 631 12899 9
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All monopolies work by raising the price per unit sold at the expense of a reduction in volume. Unions are no exception. They are in business to raise the pay of those already employed, even at the expense of fewer jobs. Fear of redundancy is some check, although a limited one where the majority remain at work. Reductions in employment which occur through natural wastage and non-recruitment are much less of an inhibition. Those priced out of work by union activists have the choice between being crowded into inferior jobs in the non-union sector (which is very small for manual workers, and almost non-existent in the public services) or the dole. The effect of union power on employment is thus clearly adverse. But how large a role it has had in producing the current total of three million unemployed is more debatable. James Meade has no doubt that it has played the key role; and he devotes the greater part of the first of his two volumes on Stagflation to an analysis of reforms in wage-fixing methods which would promote rather than destroy employment. The reforms, he believes, must come in the guise of incomes policy.

Although written with the clarity one has come to expect of Meade, there is a certain quality about the book which enables people of different economic persuasions to assess it in very different ways and read into it what they would like to find. One reason for this is that, as in the case of John Stuart Mill, a writer with whom one may notice many parallels, there is something of a conflict between heart and head, and between the intellectual positions which logic forces him to accept and the ones with which he feels most at home. Although union monopoly power plays a key role in his analysis, he is as anxious as Mill was to show that he is not opposed to organised labour. Both writers hope that union leaders and activists will change their attitudes when faced with clear-sighted analysis presented in a benevolent spirit and with a readiness to pursue egalitarian aims by other (in practice, largely fiscal) means. It is nevertheless possible that, for all his desire not to appear antiunion, Meade may exaggerate the role of union wage-fixing in the current stagflation. After all, we did have powerful unions with half a million unemployed and only slow, creeping inflation in the Fifties and early Sixties. What has changed?

Meade cites technological developments which have increased the power of compact groups of workers to push for wage increases, the differentiation of products which is said to make employers less resistant to claims, industry-wide bargaining which guarantees similar cost increases to rival employers, higher rates of unemployment and social-security benefit which have increased ‘workers’ staying power’ – and thus their ability to secure monopolistic pay increases – and the improved legal position of the unions after the legislation of the Seventies, as reasons why union ability to price people out of work has increased. One piece of solid evidence of an increased unionisation effect is the increase in trade-union percentage of the labour force from 43 per cent in 1963 to 56 per cent in 1979. But many of the other forces mentioned by Meade were just as strong in the Fifties and Sixties as they are today. We certainly heard nearly as much about them from the advocates of incomes policy: but at that time union power coexisted with very low unemployment and a moderate and stable inflation rate. There is no doubt that unions, like other monopolistic organisations, have boosted the price of their workers’ services (i.e. their wages) at the expense of volume (i.e. employment). But we are still faced with the awkward fact that unemployment has shot up in countries with widely varying degrees of unionisation, widely varying legal and effective power for unions, and widely varying degrees of ‘responsibility’ in the use of that power. It would be a remarkable coincidence if these influences had increased drastically in nearly all countries at the same time.

Take another favourite explanation: the rise in social benefits relative to normal wages which has created ‘poverty trap’ disincentives to work. The big rise in the ratio of social-security benefits to average post-tax wages took place between the early Sixties and the early Seventies. Since then, it has fluctuated in both directions under the influence of tax and social-security changes. As a result of the reduction in the real value of benefits and the forthcoming taxation of social-security payments, the ‘Why work? syndrome’ is likely to diminish substantially in 1982.

There is, of course, a great deal more to say about the matter, and especially about the cultural changes which have made the drawing of benefit much more widely acceptable (for instance, among middle-class students and young people) than it used to be. But the clinching argument against either a trade union or a ‘poverty trap’ explanation of the rise in unemployment is that the latter is a common international phenomenon. It would be quite remarkable if there had been a crop of tax and social-security disincentives unfavourable to work in all countries simultaneously. Just as remarkable as if there had been a simultaneous increase in union power.

Faced with the unsatisfactoriness of purely union-based explanations of stagflation, one is tempted to refer to a book by a distinguished US economist, the late Arthur Okun: Prices and Quantity, published a little before the Meade volume. Okun shares Meade’s preoccupation with the diversion of nominal demand into price and wages increases at the expense of output and employment, but his explanation deliberately hardly mentions unions at all. Okun argues that in a world where the performance of individual workers is variable and unpredictable but responsive to on-the-job training, it is rational for employers to maintain a given wage structure and to respond to changes in demand by adjusting hiring rates rather than moving wages sharply up or down to market-clearing levels. Moreover, when adjustments are required, it is sensible to make use of various rules of thumb, such as ‘consensus’ perceptions of the inflation rate and ‘relativity’ comparisons with other groups of workers. These administrative devices depend neither on irrationality nor on union monopoly.

The net result is that the short-term trade-off between inflation and unemployment is very unfavourable. If something like an oil price shock (or a rise in indirect taxes such as the 7 per cent increase in VAT in Sir Geoffrey Howe’s 1979 Budget) shifts the price level upwards, transitional unemployment will have to be long and severe before wages and finished-product prices are marked down enough to return to the original inflation rate. At an international level, the 1973-74 oil price explosion raised the short-term average inflation rate in the main industrial countries from about 5½ per cent to nearly 13½ per cent. Before either inflation or unemployment could fall back to earlier rates, there followed the second oil price explosion of 1979-80, associated with the removal of the Shah. As a result, it has required a further severe recession and still more unemployment to hold inflation at 10 or 11 per cent. Despite this gloomy history, the Okun theory is ultimately an optimistic theory, perhaps too much so. For by implication it attributes the rise in unemployment to the transitional costs of reducing inflation after two painful but chance events. It follows from the Okun model that a favourable shock – such as the collapse of the world oil price – would set the whole process going in reverse, though not at the same speed.

Professor Meade’s book is more prescription than diagnosis. Given the mystery about exactly why unemployment has risen, this is perfectly justifiable. In economics as in medicine, a physician often has to prescribe for a disease which he has not fully diagnosed. Even if union wage-fixing is not the main cause of our present discontent, it may well be a main obstacle to its removal. A harsher economic climate, brought on by whatever cause, requires more flexibility in labour markets and more willingness to price people into jobs than were needed when the environment was kinder. A degree of union power – or of conventional wage-fixing à la Okun – which we could afford in smoother times, is something we cease to be able to afford when the going gets tough, for it then becomes incompatible with the goal of full employment, apart from any other damage it may inflict.

Meade’s type of incomes policy is totally different from anything which has gone under this name before – a point which he might have emphasised more. Like Mrs Thatcher, he would assign to fiscal and monetary policy the job of reducing inflation and keeping it low and stable; and he would use incomes policy to promote employment – that is, to price people into jobs. If politicians are determined to go for something called incomes policy, or feel they are committed to going for one, the Meade version is the least dangerous, and readers who remain sceptical will still learn a great deal about the relation between wages, prices, profits and employment by following through his analysis. Meade does not favour the traditional British-type centralised incomes policy, enforced either by a pact with the unions or by some body which would have the power to enforce a ‘norm’ – and exceptions to the ‘norm’. He argues for what has been called a market-based or decentralised incomes policy: he calls it ‘Not Quite Compulsory Arbitration’. The idea is that freely agreed bargains would go ahead as at present: but a dissatisfied employer or union could take the dispute to a central arbitration body. This body – in complete contrast to the way such bodies have hitherto operated – would seek settlements which would promote employment in the sector concerned. It would not be able to enforce its award directly on unions, but would be able to exert powerful sanctions, such as wholesale withdrawal of legal immunities, if its guidance were disregarded.

One would have liked more detail on the economic criteria according to which the tribunal would work. If it were to follow Meade literally, virtually all wage claims would be ruled out of court while there are three million unemployed; and the distinction between the Meade plan and union-bashing would look very thin. If the tribunal had to soft-pedal, it would have to decide how much loss of employment it would have to accept for every 1 per cent of wage increase it allowed. The elasticity of demand for labour in any particular case is a matter of conjecture and the tribunal would have to decide whose estimates to take. It would also have to decide what allowances to make for indirect effects – for instance, the effects of high wage settlements in components manufacture in reducing the demand for motor-cars. The lawyers and industrial relations experts who normally staff such tribunals have little background in market economics; and one does not have to be very cynical to see them escaping from these conundrums by reverting to the old bad habit of trying to apply a national norm, with the exceptions determined by political pressures and strike threats rather than the need to promote fuller employment. The right of referral to the tribunal would clearly have to be given to the government as well as to employers and unions. In the UK economy the heart of the stagflation is in the public sector and in highly concentrated industries, where the pressure for higher wages at the expense of employment is at its most severe. There is no guarantee, however, that even private-sector employers would refer to the tribunal wage claims which threatened employment. They will often have a common interest with the unions in settling for high wages and a quiet life at the expense of low recruitment and excessive mechanisation. The supine attitude of many employers’ bodies to the closed shop is evidence enough for these tendencies.

The main problem of incomes policy is more fundamental than the particular defects of particular schemes. There is a fundamental conflict between Meade’s analysis, which shows union power to be employment-destroying, and the practical requirements of incomes policy, which involve a strengthening of that power. To be implemented, incomes policy – more than any other kind of policy – requires the consent or at least the acquiescence of unions. Union good-will is purchased by measures which augment union monopoly power and thus in the long run increase rather than diminish unemployment. When a ‘social contract’ is in operation, not only is the law changed to promote unionisation, but in every sphere of policy, the union interest would be (and indeed was) exercised in favour of the status quo and against any kind of competition or undercutting. If workers are to be priced into jobs, labour markets have to be more flexible and wages more – not less – sensitive to demand-and-supply conditions in different localities and occupations. In pay-policy periods union influence extends in other pernicious directions – from the maintenance of price controls, when serious economists of all persuasions are worried that profit margins are too low rather than too high, to tax and exchange control policies. Meade’s logic points, not to incomes policy, but to an anti-monopoly approach to union wage-fixing powers, frankly designed to weaken them wherever possible. There is a very long way to go in weakening union power before the balance is tilted so far that wages fall below the competitive level. A tribunal might have a peripheral and educational part to play in examining the more blatantly employment-destroying wage claims or settlements. It might affect public attitudes a little if it were shown that the adverse effects of some public-sector union claims on unemployment were not simply the invention of the Chancellor of the day, but were accepted by a body of the ‘great and the good’ at some distance from the political fray. Such a tribunal could also look at employer abuses, but to rely on it for the thrust of economic policy would be unrealistic.

Professor Meade is much more aware than most British economists of the danger that pay and price controls will tempt governments into inflationary monetary and fiscal policies. Unlike many of the present government’s economic critics, he sees that demand-management policies designed to secure a full employment target can lead, not merely to inflation, but to accelerating inflation. Let us assume that total spending (which economists call ‘monetary demand’ and statisticians measure as ‘Money GDP’) is raised in pursuit of a full employment goal. The result is likely to be a rise in wages and prices. But the process cannot end there. For unless unions are indefinitely fooled by inflation, there will be a second round in which they will ask for still larger wage increases to catch up with inflation, followed by a third, a fourth and so on. The result will be ever-accelerating inflation, which any government will have to halt by stepping on the brakes.

In common with Friedman and the recently reborn classical school, Meade sees that the lowest rate of unemployment which can be achieved by what Chancellors of the Exchequer call demand management (and the sophisticated man in the street sees as financial policy) is that at which the rate of inflation neither rises nor falls. This was originally christened by Friedman the ‘natural rate’: but as there is nothing natural about it, the colourless but accurate label NAIRU – ‘non-accelerating inflation rate of unemployment’ – has come into use instead. It is sometimes possible to reduce unemployment temporarily below the NAIRU by injecting more money into the economy, at the expense of rising inflation. Similarly, a monetary squeeze imposed to reduce inflation will raise unemployment above the NAIRU. Both these effects are, however long-drawn-out, transitional. If the NAIRU – that is, the minimum sustainable unemployment rate – is too high, both causes and remedies must be sought outside the financial policy. Unlike most of his British confrères, who behave as if events both in the world economy and in the sphere of ideas had stood still since the early Sixties, Meade accepts and sets forth the NAIRU concept. He prefers, however, to call his doctrine ‘New Keynesian’ rather than ‘New Classical’, which would fit in nearly as well. ‘New Keynesian’ has the merit of avoiding a fruitless argument about what Keynes would have said if he had lived beyond 1946; and it leaves the label ‘Old Keynesian’ for the conventional post-war type of demand stimulation for which most of the Government’s critics are now calling.

To forestall the danger of a well-meaning attempt to spend ourselves into full employment, leading indeed to runaway inflation, Meade has a clear and definite proposal. He proposes a demand-management policy expressly designed to keep total money expenditure rising at a steady and moderate rate of 5 per cent per annum. This will be shown statistically by a growth of money national income or Money GDP of around that rate. Such a target would mean that although the immediate impact on the price level of an outside shock such as an OPEC price increase would be accepted, it would have no further consequences. Any attempt by producers to obtain pay and price increases to restore their living standards would come up against the wall of a national spending limit.

It has been unfortunate (but predictable) that so much of the discussion of Meade’s book should have centred on the incomes policy side as distinct from his demand-management proposal. A 5 per cent growth in total spending – or in the demand for the products of labour – will, in Meade’s words, provide sufficient restraint to ‘rid ourselves of the idea that whatever may happen to the rate of rise of money wages, spenders will always be supplied with sufficient confetti money to cover the resulting costs of production.’ On the other hand, wage-earners will know that if they refrain from overpricing there will normally be a sufficient market for their labour. The move down to 5 per cent from recent high levels of inflation would, of course, have to be gradual. Such a target could be easily popularised as a ‘national cash limit’ or ‘national cash objective’.

The resemblance between the Meade prescription and the Friedmanite rule of a gradual reduction in the growth of money supply, followed by steady growth at a modest rate, is no accident. The main technical distinction is that Meade doubts whether controlling the stock of monetary assets is enough to control the flow of total spending and his emphasis is on fiscal rather than monetary policy. Such differences between Meade’s ‘New Keynesians’ and the pure monetarists are important mainly for those concerned with drawing up (or appraising) the detailed control mechanism (and will be explained in Meade’s second volume). It is a feature of his book, however, that differences between its approach and the New Classical (or so-called ‘monetarist’) one are exaggerated, while the very obvious common ground is treated with some embarrassment. Indeed, Meade’s financial policy could be headlined ‘Monetarism without Mumbo Jumbo’. The aims of the Meade demand-management strategy are very similar to the present government’s Medium-Term Financial Strategy – or to what that strategy would look like if ministers could bring themselves to state it coherently. The main non-technical reason Meade is so anxious to put a distance between himself and both Friedman and the Medium-Term Strategy lies in his stress on wage-fixing. Unless wage-fixing institutions are reformed in an employment-creating manner, so that a given Money GDP gain is channelled into output and employment instead of being dissipated in wage and price increases, Meade is unwilling to lay down or endorse any financial strategy at all. He is, however, too quick in identifying such reforms with incomes policy. ‘Labour market policies’ would be a more comprehensive label which forced attention on a much wider range of possibilities.

Meade’s insistence on incomes policy has in no way mollified the ‘Old Keynesians’, who have clearly been highly irritated by the national cash target aspect of the book. So far they have written more in sorrow than in anger, suggesting that Meade must have slipped up and could not mean anything so similar to what the dreadful monetarists have in mind. But the distinction Meade draws between his own approach and that of the so-called monetarists is not in the last resort sustainable (except in technical and operational detail). For the more one thinks about it, the clearer it becomes that even if one accepts the Meade incomes policy without reservation, there will be no Day One on which it can be announced that wage-fixing institutions have been reformed sufficiently for the financial side of the Meade strategy to go ahead. The erosion of wage-fixing practices detrimental to full employment will be a long and gradual process of attrition, whatever the route chosen.

This attrition has already begun, even in the absence of incomes policy. Both outside and inside the unionised sector more realistic attitudes to available real wages are spreading, and may, in part, survive the recession. The shift from old-established manufacturing to light industry and services, and the shift in fashion from large to small-scale establishments, should weaken the influence of industry-wide collective bargaining where most of the ‘pricing out of work’ takes place. As a result of recent changes, strikers and unemployed are now much less likely to be ‘nearly as well off as when at work’. On the union side, the zenith of legal privilege was probably reached with the Foot legislation of the mid-Seventies, and the 1980 Act and the present Tebbitt Bill mark a modest turning of the tide. The main redoubt of unionised pricing out of work is in the public sector. A reduction of monopoly power here need not mean merely old-fashioned denationalisation. A variety of approaches, ranging from geographical decentralisation to management buy-out, workers’ co-ops or the vesting of ownership in people’s shares, may have a part to play. In the meanwhile, the proposed ‘national cash target’ should itself contribute to the greater awareness of the link between pay and jobs which Meade would like to see, and thus help gradually to reduce unemployment. The national cash target idea would be especially helpful if it could become part of the language of political debate, so that argument centred on the size of that target instead of on whether it should exist or not.

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