Some Reflections on an Incomes Policy

MR. JACKMAN:

It is almost exactly two years since our distinguished guest today spoke to The Empire Club on the difficult problem of inflation. It goes without saying that the intervening period has been a time of great soul searching, not only for our guest but for all of us who are concerned with the stability of our dollar. Circumstances have changed during the last two years--not the least of which has been the decision of the United States to impose a form of wage and price control.

Dr. Young has not made a speech in public for some months now, and the possibility that he might take this opportunity to announce a wage freeze prompted one company executive, who is a member of this Club, to telephone me this morning to ask whether or not he should vote himself his Christmas bonus before 1:00 p.m., this afternoon. I, of course, could not give him a satisfactory answer, except to suggest that if he brought his Board of Directors to this luncheon, and if he was alert and quick enough perhaps he could get his bonus passed before Dr. Young concluded his remarks.

The nature and causes of inflation have, of course, been a subject for considerable discussion among economists over the years. The late George Bernard Shaw once said, that if you put all the economists in the world end to end, they still would not reach a conclusion. In fairness to the late Mr. Shaw, the science of economics has progressed considerably since his time. It is now a far more refined and complex matter. If Shaw were alive today he might say, if you made all the economists in the world stare at the same object they would not even be able to identify the problem.

Whatever the causes of inflation are--most of us agree that the rate of inflation depends on some relationship between the supply of money and the availability of goods and services. Since central governments appear to be the dominant influence in at least one, if not both parts of this equation, our guest will perhaps forgive the feeling on the part of some of our members that his appointment by the central government as Chairman of the Prices and Incomes Commission is something akin to being made director of a hospital for the rehabilitation of narcotic users which is financed by the Mafia.

To assume the difficult task of controlling prices and incomes, Canada is indeed fortunate in having in Dr. Young a man whose credentials are exemplary. He started his career in his native Victoria with the Toronto-Dominion Bank. He served with distinction in the Royal Canadian Air Force during the War, where he finished as a Squadron Leader. After the War, he completed his education receiving a Doctorate at Cambridge in 1951. He has held senior academic positions at Yale and at the University of British Columbia, where he was Dean of the Faculty of Arts. No stranger to government service, he made a significant contribution to our country working with the Royal Commissions on Canada's Economic Prospects, and on Banking and Finance, where he was Assistant Director of Research. These positions he filled with distinction and with a growing awareness on the part of his superiors that he was truly one of Canada's foremost practical economists.

We are, perhaps, living at a time when government initiatives are not always greeted enthusiastically by businessmen. However, it is possible to say without qualification, that in his pursuit of restoring a stable currency to this country, which is so necessary to maintain the confidence that our citizens are entitled to expect, Dr. Young carries the wholehearted support of us all--in what we appreciate must be the most difficult of tasks.

It is, therefore, with great pleasure that I introduce to you, Dr. John Young, Chairman of the Prices and Incomes Commission.

DR. JOHN YOUNG:

This is the second time I have had the pleasure of addressing the Empire Club. In such a situation, there is perhaps a natural tendency for a speaker to look over what was said before to see how far it will be necessary to explain any alteration of views. There was some relief in finding little to change after two years but by that very token I was led to reflect on some of the things we on the Prices and Incomes Commission have learned in the interval. This provides the substance of my remarks today.

Let me begin by reviewing the three topics discussed two years ago under the title, "What Price for Price Stability?" The first point made was that the case for tolerating inflation and learning to live with it was a weak one. The Commission's view on this subject has not changed.

The second point made was that the process of controlling an inflation of the kind existing in 1969 was going to be a long and painful one unless an assist could be given by incomes policy. The events of the last two years have only reinforced this view.

Finally, it was argued that the kind of initiative which we proposed in 1969 could provide help in dealing with the problem.

That initiative had many similarities to the one recently undertaken by the Government of the United States. We sought, as they have, to obtain broad support among the major economic groups for agreed limits on increases in wages and salaries, prices, rents, professional fees and so on. While this was often described as a voluntary scheme, it was envisaged from an early stage that governmental intervention on a significant scale would be required to ensure that the program was sufficiently comprehensive and effectively administered.

The crucial difference between the effort made in this country and the present U.S. program is that the Americans acted at a time of crisis with a strong national consensus and imposed an initial freeze under the force of existing law. Even with all that in their favor, it is evident that the task is not proving to be an easy one.

This leads me to the first point I wish to discuss. The difficulty of obtaining a national consensus was the first lesson we were in the process of learning two years ago. Many feel that this is simply a matter of persuasion. If only the public could be made to understand that under certain circumstances the acceptance of a set of rules limiting price and income increases can be helpful in achieving a better economic performance, then a consensus should be relatively easy to obtain. Others are of the view that it is the force of economic events rather than persuasion which makes possible widespread public support for measures of this kind.

The recent experience of the United States provides some support for the latter view. For almost three years leading figures in the U.S. Administration took the position that price and income controls were both ineffective and undesirable, and did their best to persuade the American people of this view. As events developed, with domestic inflation showing few signs of abatement and the international position of the United States worsening rapidly, there was a rising tide of demands for action. In the end, the Administration abandoned its attempts to persuade the public that direct intervention was not required and took steps in the direction of controls which were stronger and more decisive than most of its critics had been demanding.

A second point arising out of our experience in running the price restraint program and in the work we have done on future contingency plans is that there are many difficult issues to resolve in the application of a price and income restraint program to a complex market economy. This came as no surprise to us nor to those in the U.S. Government who have been responsible for setting up their program.

All professional economists are exposed at some time or other to the thoughts of the father of the science, Adam Smith, and many of them share his scepticism about direct governmental intervention. Thus the following comment from the Wealth of Nations, written 200 years ago, often strikes a responsive chord:

"The statesman, who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it."

A copy of this statement should perhaps be included in the training kit of all incomes policy apprentices. The economic system of a modern industrial country is a highly complex organism which at any point of time is responding to past changes in the forces acting upon it, is beginning to respond to new forces and is ready to react in the future to forces which have not yet come into play. Direct intervention in this process through prices and incomes policy cannot be made sufficiently flexible and subtle to reproduce these results. Relative prices and relative incomes move differently under a system of price and income restraint than they would in its absence, and in time the allocation of resources will begin to change accordingly. This will entail some costs in terms of economic efficiency.

These costs would be relatively low when a system of price and income restraint was first introduced but would tend to grow over time as the system failed to reproduce in detail the kind of subtle response induced by the price system. If, however, the program of restraint were not kept in effect for too long, and if it were able to respond at least in part to the economic forces acting on the system, then the costs of such a policy might be fairly low.

These are not the only costs of using incomes policy. A price and income restraint program limits the freedom of employers and employees to set wages either under collective bargaining or under other arrangements. Similarly, it limits the freedom of those making business decisions to determine at what price they will sell the goods and services they have produced. Such an interference with private decision-making imposes political and social costs which are additional to any economic costs.

Given that the past record of incomes policy in a number of countries of the world is to say the least a bit chequered, it is perhaps surprising that incomes policy is kept in the arena. The answer is probably quite simple. Faced with an inflation which has developed considerable momentum and vigor, governments are often confronted by a short-run choice of alternatives: one, to allow the inflation to continue unchecked; two, to have a prolonged period of high unemployment; or three, to try to get some contribution from incomes policy in reducing both inflation and unemployment at the same time.

A third lesson which emerges from our experience over the last two years is that basic differences of view about the causes of the kind of inflation we have been experiencing recently need not lead to differences of view about the usefulness of incomes policy. This is a surprising conclusion which requires some explanation.

First of all, it should be said that there is little difference of view when the inflationary situation is a straightforward one of excess demand pressure on the economy. There may not be any precise agreement on what constitutes over-full employment, but inflations such as those of 1955-57 or 1965-66 do not lead to differing interpretations. When, however, a high level of price and income increases persists over an extended period of economic slack, the arguments begin.

It used to be thought that those who saw the explanation of this phenomenon as basically a problem of excess demand in the past and anticipation of high demand in the future would have a different prescription for dealing with it than those who placed stress on increases in costs and prices brought about through the market power that labor unions and corporations now possess. Those supporting a demand interpretation could be expected to argue in favor of the use of demand policies alone to bring the economy around, while those supporting a cost-push interpretation would, in general, favor direct governmental intervention in one form or another to restrain price and income increases.

As our work progressed and events unfolded, it became increasingly clear to the Commission that in modern economies the decision to use or not to use incomes policy did not depend on holding any special view about the causes of persisting inflation. In particular, we came to the conclusion that it was not necessary to believe that the market power of labor unions and large corporations was a crucial factor in bringing about excessive wage and price increases in order to adopt the position that under some circumstances incomes policy could make a contribution to the control of inflation.

Those who hold the market power view of inflation believe that if the economy were made up of competitive firms and competitive markets for labor, then once the pressure of demand was removed, prices and incomes would stop rising and the inflation would come under control. This has not happened. It follows that it is the absence of competition, i.e., the market power of unions and corporations, which enables them to avoid reacting to changes in market conditions. For the sake of brevity I have caricatured this line of reasoning, but this is the bare bones of it.

Now, if one has in one's mind the most simple example of the traditional competitive firm--a relatively self-sufficient family farm--it is clear that the reaction to a change in demand is as straightforward as an over-simplified demand-pull theory of inflation implies. A fall in demand on a competitive market for farm products would lead to a fall in prices. A farmer who owns his farm and operates with family labor and few non-farm costs might just as well keep producing since it is better to earn something than nothing. Thus output would remain high, but prices would fall and the income of the farmer and his family would fall at the same time. In short, a reduction in demand would lead to a sharp response in the rate of increase of money prices and money incomes. There would be complaints about the instability of prices and incomes, but there would be no unemployment or significant loss of output as a result of bringing the inflation under control.

Once the enterprise becomes more complex, however, with inputs coming from several independent quarters, the reaction to a fall in demand after several years of inflation is quite different. Instead of prices falling sharply in the face of a decline in demand, and production being maintained by an equally strong fall in the incomes of those working, there is a tendency for prices to be maintained or increased while wages and salaries continue to rise. The result is a decline in the growth of output and a rise in unemployment.

It might be thought that this loss of output and rise in unemployment would not last long. After all, once it is clear that there are more people available for jobs than jobs available, it might be expected that competition among wage and salary earners for the existing jobs would lead to sharp downward adjustments, thus reinforcing the effect on prices of competition among firms to protect their share of a contracting market.

In fact, however, these adjustments do not occur at all quickly and smoothly in an economy which has developed considerable inflationary momentum. There are particular cases where the change in circumstances is sufficiently drastic to lead to major price and income adjustments. In general, however, even in those areas directly exposed to market forces, the response is much more sluggish, while in those sectors of the economy more insulated from the market, prices and incomes in many cases show even less response.

When people seen an entrenched inflation persisting in this way well into a period of slack demand they are inclined to focus their attention on some well-publicized union wage settlements, or on the more noticeable increases in the prices of major firms, and to describe the process as one of cost-push resulting from the market power of major unions and corporations.

An alternative explanation of what we have been observing in the last two years or so puts much greater emphasis on the part played by institutional lags in the process of adjustment and by persistent expectations of continuing inflation. In 1969, after a period of over 35 years in which the price level has been moving in an upward direction, a period of nine years of uninterrupted economic expansion and more than four years of rapid inflation, it was not to be expected that it would be easy to change people's view about the likelihood of future inflation.

The fact that you do not have to accept market power as the main explanation of continuing inflation to see a useful role for incomes policy is well illustrated by recent events in the United States. Prior to the decision of August 15th, one of the most forceful advocates of the market power diagnosis was our famous expatriate, the president-elect of the American Economic Association, John Kenneth Galbraith. As I am sure you all know, Professor Galbraith believes quite strongly that recent inflation is particularly associated with the price-raising activities of corporations and to a lesser extent unions. Over many months this view of the economy was rejected by the Nixon Administration and as recently as July 1971, a newspaper article by Paul McCracken, Chairman of the Council of Economic Advisers, described Galbraith's view of the nature of the price system as one still common among uneducated people and unusual only in being held by the President of the American Economic Association and in being described by him as new. Within a matter of weeks, however, the U.S. Government appeared to adopt Galbraith's policy prescription of wage and price control. Was this the result of an overnight conversion to a Galbraithean interpretation of the economy? The answer is clearly no.

The scheme introduced in the United States is a temporary one aimed in principle at virtually all wages and prices, with a degree of selectivity of control being dictated by administrative considerations. The predominant view held in Washington does not seem to have changed greatly, namely that recent inflation is primarily a reflection of continuing expectations of rapid wage and price increase drawn from past experience and only to a limited extent influenced by institutional developments.

The fact that the American program is temporary indicates the difference in interpretation. If one supports the market power view of inflation, then the problem can only be met on a continuing basis by a permanent system of controls, or by fundamental institutional changes which reduce the power of unions, corporations, professional associations and other groups to influence the determination of their prices or incomes. Such institutional changes may well be desirable on other grounds, but given the difficulty of altering the whole structure of our economy, are not likely to provide an answer in the near future. A Galbraithean view of the economy tends to lead, therefore, to a permanent system of controls, while the analysis of inflation of the U.S. Administration leads to a temporary program.

The difficulty of keeping these distinctions clear is well illustrated by the recent report of the Senate Committee on National Finance. There is much in this well-written report with which one can agree, including the Committee's view that given the present structure of the Canadian economy, there is need for greater realism about the level of unemployment consistent with economic stability. Their emphasis on the importance of recognizing lags in the response of the economy to changes in economic policy is also a lesson which bears repeating. My colleagues and I found the discussion of incomes policy much less satisfactory. While the Committee saw some possibilities for the limited use of incomes policy, on the whole they took a negative position towards guidelines and controls. This negative position was in part based on a strong dislike for direct interference in the economy but also in part on the mistaken view that "one basic condition for the use of peacetime controls would be the acceptance by the authorities of a cost-push inflationary diagnosis strongly related to the exercise of market power". Since the Senators are dubious about this explanation and instead stress lags, expectations and international influences in explaining the persistence of inflation, they conclude that there can be no strong case for controls. It will be apparent from my earlier remarks that the view of the inflationary process held by the Senate Committee does not necessarily lead to the Committee's negative conclusions on incomes policy.

Even if one takes the view that, with some exceptions, unions and major corporations are no more responsible for inflation than the rest of us, does it follow that their cooperation is unimportant in helping to make an incomes policy a success if a decision is taken to use it? The answer to that question is clearly no. Those who make decisions affecting a large number of prices and a wide range of wages and salaries are obviously in a crucial position to help or hinder the success of a program of direct intervention. We are seeing a striking demonstration of that in the United States.

When we met with business leaders at the end of 1969 and early 1970 to see whether they would support a program to restrain prices, even in the absence of comparable restraints on wage and salary increases, some of them said that this would be interpreted by the public as an admission of guilt on the part of the business community. These views did not prevail and we went ahead. I think it is a fair statement to say that the public did not in fact put this interpretation on business support for the program. They expected a measure of leadership from those in the community who were in a position to give it. While there was widespread disappointment that this initiative did not lead to a more comprehensive and effective set of arrangements, it was recognized that a genuine attempt had been made to contribute to the solution of the problem.

The aim was to help reduce the loss of jobs and output involved in getting the country out of a severe inflation. If the occasion should arise again, it is to be hoped that the lessons drawn from this previous experience and the renewed and expanded support of all groups in the community will lead to a more effective program for achieving this result.

Dr. Young was thanked on behalf of the Empire Club of Canada by Mr. Charles C. Hoffman.

EDITOR'S NOTE: Since 1965, the cost of living in both Canada and the United States had been rising at what was generally considered to be unacceptable levels. The problem was compounded in 1970 and 1971 when substantial unemployment and unused industrial capacity did little to restrain the rise in both incomes and prices.

This speech by Dr. Young was given only two weeks after the implementation of Phase Two of the U.S. Government's comprehensive experiment in mandatory wage and price controls. There was considerable speculation as to whether Dr. Young might give an indication whether controls would be imposed in Canada. Although this question was not answered directly, this address, particularly when read in connection with his speech to the Empire Club on October 30th, 1969, gives an interesting analysis of the evolution of a Canadian incomes policy contrasting it with comparable developments in the U.S.A.

The Prices and Incomes Commission was disbanded on August 30, 1972 and in his valedictory report, Dr. Young warned that if Canada's performance in fighting inflation and high unemployment grew markedly worse than that of the United States, Canada would have to resort to price and wage controls.

Dr. Young repeated his frequently expressed view that an incomes policy could work only if there was a widespread concensus in support of such a program. However he said that "a significant divergence between Canada and the U.S., which looked as though it was going to persist might prompt widespread public support for direct government intervention in the free market economy." According to Dr. Young, these factors could only be judged after the U.S. elections in November (and Canadian general elections called for October 30, 1972) when it would be known whether the U.S. Administration intended to continue with its own system of controls.