Must The Price Of Progress Be Lost Jobs
Washington — Inflation and unemployment tend to perform like people at opposite ends of a seesaw. When one goes up, the other goes down.
During the current recession, the US jobless rate has moved to its highest point since 1941, while inflation - though still high by postwar standards - has markedly declined.
Much of the gain against inflation, in other words, has been achieved at the cost of putting the economy through a wringer, inflicting misery on millions of Americans. Businesses are going bankrupt at a pace not seen since the depression years of the early 1930s. Through August 1982, says Dun & Bradstreet, this year's crop of corporate failures totaled about 15,830, up 47 percent from the same period of 1981. More than 12 million Americans are out of work, if one counts the 10.8 million officially unemployed, plus a record 1.5 million ''discouraged'' workers, who have given up looking for jobs.
But equally impressive is progress against inflation. Through the first seven months of 1982 the consumer price index (CPI) climbed only 5.4 percent - a lot less than the 8.9 percent for all of last year, the 12.4 percent of 1980, and the 13.3 percent of 1979. That year marked the highest rate of inflation since 1946, when the economy was adjusting from wartime to peacetime footing.
But the CPI samples a market basket of consumer goods - including volatiles like food and energy, which gyrate up and down. It fails to yield a full measure of inflation. More accurate is what economists call the underlying inflation rate, expressed in the gross national product (GNP) deflator. The GNP deflator measures a complete range of costs throughout the economy. This gauge, analysts agree, has dropped from about 10 percent a couple of years ago to 6 or 7 percent in 1982.
Either of these economic miseries - inflation or unemployment - can wipe out the life savings and retirement hopes and aspirations of individuals and families, depending on the situation in which they find themselves. The tragedy is that progress against one seems to exacerbate the other. From this arise questions:
* Will inflation heat up again, when the current recession ends and the economy picks up steam?
* Must millions of Americans remain jobless to prevent inflation from surging again into double-digits?
* Has the Federal Reserve Board's long fight against inflation been worth the cost?
In coming months the answers to these questions may not be clear, for evidence points to a weak recovery through the remainder of 1982 and into 1983. Unemployment will remain high, while inflation stabilizes around the current level. Sooner or later, however, the questions will reemerge when a full-fledged recovery pits private sector demand for capital against the immense borrowing needs of the US Treasury to finance deficits in excess of $100 billion a year.
Either the Fed will be forced to accommodate that demand by letting the money supply grow, implying renewed inflation, or it will tighten credit, driving up interest rates. In either case the weary cycle would seem to repeat itself.
The Reagan administration had hoped that its combination of huge tax cuts and tight money would break the vicious circle and lead to a new era of economic expansion without inflation. The tax cuts, according to White House supply-siders, would stimulate savings and investment, in turn leading to corporate expansion and more jobs. End result would be a rich harvest of tax revenue, causing deficits to shrink. This would enable President Reagan to boost defense outlays by record amounts and avoid, initially at least, cuts in the growth rate of social security benefits.
Some of the nation's most experienced economists welcomed the President's desire to shrink the government's economic role but punched holes in White House logic.
Under Mr. Reagan's program, said Alice M. Rivlin, director of the Congressional Budget Office, government outlays would rise faster than income. Tax revenues now 21 percent of GNP, would decline to 18 percent by 1987. Over the same period government spending would remain at 23 percent of the GNP. Budget deficits - which amounted to 2 percent of GNP in fiscal 1981 - would grow to 5 percent by 1987.
A budget deficit totaling 2 percent of GNP, said economist Herbert Stein, would require the nation's savings rate to grow by 40 percent to finance the shortfall. There was, he said, no historical precedent to believe that savings would increase by this amount.
Reagan's program, said William J. Fellner of the American Enterprise Institute (AEI), anticipated that the economy would expand by 10 percent a year in nominal terms - that is, in current dollars. Such growth, said Mr. Fellner, always had proved inflationary in the past.
Finally, said Rudolph G. Penner, senior fellow of the AEI, the Reagan budgets included no margin for error - no room to accommodate external shocks, such as sudden rises in the cost of food or oil.
Assessments by Messrs. Stein, Fellner, and Penner were especially trenchant because all three had served Republican presidents in high advisory posts.
Undeterred, Reagan pushed his program through Congress. The financial markets reacted negatively. Interest rates remained high, as lenders peered into the future to assess what would happen over the life of their loans. Their conclusion: Deficits would grow, putting upward pressure on interest rates; to finance record government debt, the Fed would allow the money supply to grow, unleashing a new bout of inflation.
''Investors made their plans,'' said economist Alan Greenspan, ''on the assumption that the (underlying) inflation rate would be 9 percent over the coming decade.''
The Fed showed no inclination to ease credit as the recession deepened. Corporate demand for capital remained high, as cash-starved companies borrowed short-term money to finance current operations. To loosen the credit reins prematurely, said Fed chairman Paul A. Volcker, would risk giving up hard-won ground in the battle against inflation. He and his fellow Fed governors share the monetarist view that too-rapid growth of the money supply - the classic ''too much money chasing too few goods'' - is a prime cause of inflation.
In October 1979 the Fed began to focus on limiting the money available to commercial banks to lend and available to the economy as a whole. It set annual growth targets for each category of money measurement. In 1982, for example, M-1 - currency in circulation (cash), plus checking accounts of all types - is to rise within a range of 2.5 to 5.5 percent.
Within those limits, according to the Fed, growth of the money supply should not be inflationary. Top Reagan administration officials generally agree. But that policy poured ice-cold water on the economy. Interest rates climbed as the government and the private sector competed to borrow money that no longer was elastic in supply.
Interest-sensitive industries, notably housing and autos, were the first to suffer. Soon the slowdown spread to manufacturers of glass, steel, rubber, furniture, and other industries dependent on vibrant housing and car markets.
Banks scrambled to attract loan capital, offering depositors higher interest rates. Savings and loan associations - stuck with portfolios of old, low-interest mortgages - lost money. So did many farmers, who found they could not earn enough from the sale of their crops to offset their rising costs.
A break came in midsummer. Corporate borrowing declined and interest rates began to drop. In two months the yield on three-month Treasury bills sank from 13.27 to 7.75 percent. The Fed, for its part, nudged the process along by injecting reserves into the banking system and by lowering the discount rate - the rate the Fed charges its member banks - from 12 to 10 percent.
Washington rumor mills began to grind. Volcker and crew, it was said, had yielded to White House pressure and were loosening credit before the November congressional elections. Fed officials denied the charge, noting that slack corporate borrowing had allowed M-1 to sink within its target range. This being so - and concerned that sectors of the economy were slipping into full depression - the Fed felt it safe to let interest rates drop.
Rates were falling, experts agreed, because the economy was weaker than most analysts expected. Forces that normally lead the nation into recovery - notably housing and corporate investment - showed little sign of early growth. Recovery, if there was to be one, would have to come initially from consumers.
Nearly $45 billion in fresh purchasing power at an annual rate had been pumped into the economy by higher social security benefits and a July 1 tax cut. But consumers sat on their hands. The savings rate rose, though not by the margin hoped for by the administration. Retail sales remained sluggish and auto lots were packed with unsold cars.
Against this background, inflation appears to pose little immediate threat. But what happens when real recovery finally comes? To answer this, economists try to disentangle from the causes of inflation the elements that perpetuate the price-wage spiral.
Agreement is general that President Johnson's refusal to raise taxes to pay for the Vietnam war fueled the inflation that gathered momentum during the 1970 s. Government borrowing rose and the money supply expanded. Then came poor harvests. Food prices shot up, prodded by burgeoning foreign demand for US farm exports. Finally, oil prices leaped from $3 a barrel in 1973 to around $34 today.
Analysts, though cautious, foresee few surprises in store for the US economy: Food and energy prices look like they'll remain stable for some time. A possible shock, difficult to assess now, is damage to the world's interlocked banking system if Mexico, Argentina, Poland, or some other debt-burdened nations default on repayment of enormous loans from Western banks.
During the prosperous decades after World War II, meanwhile, many Americans came to expect, as a kind of right, a 3 percent yearly increase in their real standard of living. These rising expectations were reflected in myriad union contracts, calling for cost-of-living adjustments (COLAs) over and above annual wage boosts.
When COLA agreements began to flourish, the nation's inflation rate was roughly 2 percent. As the CPI climbed and finally broke into double-digits, wage costs - linked to inflation - became an extraordinary burden on employers, who passed along added labor costs in the form of higher prices for their goods.
So long as productivity grew at roughly 3 percent a year, says the Fed's Volcker, inflationary damage could be contained. When US productivity dwindled almost to the vanishing point, COLAs - pegged to the CPI - contributed directly to inflation.
Nearly 60 percent of unionized workers now benefit from COLA clauses. Many nonunion employees receive some form of cost-of-living adjustment. Government adds to the wage-price spiral by indexing social security and other entitlement programs to the CPI.
Real progress against inflation presupposes that rising labor costs can be kept within the bounds of productivity growth. At this writing productivity - or output per manhour of work - is rising slightly. This is normal during the tail end of a recession and the early phases of a recovery. Employers, anxious to recoup some of their recession losses, try to get more production out of a reduced labor force before rehiring laid-off workers. That appears to be happening now.
Changes in the economy, experts warn, may limit productivity increases over the next few years. The number of manufacturing jobs, where the potential for productivity improvement is greatest, is shrinking and the number of service jobs grows, as the economy becomes more service-oriented.
''In 1981,'' reports the American Retail Federation, ''of 91.5 million persons employed in nonagricultural work, only 25.6 million worked in goods-producing (manufacturing, construction, and mining) industries, while 65.8 million worked in service-producing activity, including wholesale and retail trade.''
It is harder to devise ways to raise the output of a schoolteacher, automobile mechanic, or government employee than of an assembly-line worker.
The other essential part of the equation - moderation of wage demands - has been increasingly evident during this recession. Auto workers led the way last year by accepting lower wage and benefit boosts - and in some cases rollbacks - to keep plants open. Workers in a number of other industries followed.
All told, according to the US Labor Department, wages, salaries, and benefits , including COLA, make up about three-fourths of the entire US economy. Inflation is bound to occur if labor costs rise faster than the nation's output of goods and services. Assuming labor costs continue to rise in moderation, and that productivity continues to grow - and assuming that food, oil, and other commodity prices remain stable - the trend toward a lower inflation rate may persist.
Many businessmen are guardedly optimistic about future inflation, says John M. Albertine, president of the American Business Conference (ABC), representing middle-sized American firms. Why? ''They regard food and oil crises as unlikely to recur. They interpret wage settlements so far this year to mean that future labor costs will rise less quickly than before,'' he says.
On the basis of this assessment, said Albertine - both inflation and interest rates below 10 percent - many medium-sized companies are making investment and production plans for the next five years.
To sustain this relatively optimistic outlook, he says, four things are needed:
* A slower increase in defense spending.
* Cuts in the growth rate of benefits under social security and other entitlement programs.
* Continued efforts by Congress and White House to lower deficits in the years ahead.
* Scrapping of tax indexation, now due to begin in 1985.
Under indexation, income tax brackets will be indexed to the CPI to prevent inflation from pushing taxpayers into higher brackets. One result is that US government tax receipts will be significantly less. This will make it much harder for Congress to narrow the budget gap, because smaller tax revenues will offset cuts in spending. This is one indication that disinflation - the process of reducing the inflation rate - is not without cost.
Jerry J. Jasinowski, senior vice-president and chief economist of the National Association of Manufacturers (NAM), says firms that borrowed heavily at high interest ''are paying a higher adjustment cost than they expected,'' because their managers can no longer count on repaying debts with cheaper dollars. The same is true of individuals who took on long-term debt at high interest, in the expectation that inflation was here to stay.
Many NAM executives, says Mr. Jasinowski, expect inflation ''will be 6 percent or less over the next 18 months or so.''