Why does inflation worry the right so much?

Conservative rhetoric warning of wage-price spirals is disingenuous

Last modified on Thu 15 Jul 2021 06.01 EDT

Thirty years ago, Albert O Hirschman published a short book that infuriated conservatives called The Rhetoric of Reaction. The book showed how conservative arguments across time and space fell into three rhetorical buckets: perversity – raising taxes means less revenue; futility – voting changes nothing; and jeopardy – if you give the vote to poor people, you get revolution (the opposite of futility, but who cares about consistency). As well as being a great summer read, Hirschman’s rhetoric continues to shed a useful light on the present conservative obsession (apart from critical race theory) with inflation.

Whenever inflation threatens, two versions of the perversity thesis are deployed. The first, usually opined by members of the investor class, argues that inflation mainly hits those on fixed incomes, older and poorer people, thereby proving their concern is born from a sense of care for society’s weakest. Oddly, that same class of folks seem utterly indifferent to older and poorer people until inflation threatens to either reduce their expected investment returns, or impact their leveraged financial strategies, as interest rates rise.

The second rhetorical deployment, found mainly in mainstream media and amplified from there, reaches back to that “terrible time” called the 1970s (Labour voters will know this one well) to warn about wage increases causing price increases causing inflation – the classic wage-price spiral argument. You might think giving poorer people more money helps, but it doesn’t. It only makes things worse by pushing up prices.

The success of such rhetoric seems strange in a world where wage stagnation and inequality have become top political issues in countries as diverse as the US, the UK and Germany – and yet it persists. And it persists, in part, because of the slippage between two types of economic models we find in the world: formal and folk.

Formal models are the mathematical workhorses of governments and businesses. They are to be used rather than to be believed, and they tend to blow up once the world they model changes in unanticipated ways. Folk models are the ones that get stuck in our head as a usually pernicious form of common sense. Examples include the “national credit card being maxed out” (there is no such thing) and Angela Merkel’s “Swabian housewife” as policy guide. Folk models are believed rather than used, and no amount of disconfirming evidence blows them up. How we think about wages and inflation, and what the perversity thesis pulls on, is a folk model descended from a formal model.

The formal model is called the Nairu (the non-accelerating inflation rate of unemployment), the intuition behind which is simple. An economy is simply the number of workers times the number of hours worked times the amount and quality of capital that they work with. In such a world, pouring money into the system can only push up prices since the “supply side” (everything else) is fixed at the “natural rate” – the highest rate of employment the economy can sustain without inflation. If prices go up and wages go up to match, it’s a wash. But if people then begin to expect prices to keep going up (in the lingo – inflation expectations become “un-anchored”) then you get an inflation in the general level of prices that undermines purchasing power.

Given all this, the only way workers can get sustainable wage rises is if we increase productivity. Governments should therefore not try to spend their way to prosperity by pushing up wages, as Joe Biden is trying to do now. They should instead liberalise their labour and product markets to capture the efficiency gains that would make wage increases sustainable.

The problem with this argument was that not only did the so-called “natural rate” jump around a lot (the UK has had everything from 10% unemployment to 4% unemployment over the past three decades with an inflation rate of 2%) but wages also stubbornly refused to rise for most wage earners despite decades of such reforms and long periods of full employment. Add to this the fact of inflation being “too low” rather than “too high” for many countries since at least 2008, and you must conclude that this model has probably passed its sell-by date.

But even if you do, the folk model that we derived from 30 years of thinking this way is sticky, which is why this rhetoric works. Follow its logic through and it means that the only way wages can rise is through the generosity of employers. Trade unions will only bid up wages for their members at the expense of employment for everyone else. Pay rises must be limited to what productivity can support, and if we go beyond that, inflation must result. How then do we shake the folk model out of our heads? Josh Bivens, at the Economic Policy Institute, has written a piece that seeks to do just that.

Let’s start with the old “fixed income/I care a lot” argument. The imagined poor here are low-income retirees. However, in the US, social security provides most of the income for this group, and like state pensions in the UK, such payments are indexed to inflation.

As for the productivity limit on wage growth, when pay and productivity become decoupled, as they have been in the US since 1973 and in the UK since the early 1990s, there is considerable room for wages to grow in a non-inflationary manner. What really matters here is that the legal and institutional mechanisms that workers used to claim their share of productivity gains have been systematically targeted by those “efficiency-enhancing” reforms that, on net, simply hand all the productivity gains to employers in the form of higher profits and greater returns to shareholders.

Indeed, as Bivens argues, it’s far from clear that wage earners actually lose from inflation. There is no one-to-one relationship between inflation and consumption. As he puts it: “If it is wage increases that lead to price growth, then these increases will not reduce living standards.” In other words, yes, prices are up, but so are wages. And depending on what you consume, and how much debt you carry, that can be a net positive since inflation erodes the real value of debts. (Spoiler alert – that’s why finance hates it, really.)

Finally, even if it was a wage-price spiral that ignited the inflation of the 1970s, that simply couldn’t happen now. Forty years of labour market and product market reforms have, outside of a handful of monopoly firms, killed the ability of both to push on prices without losing market share. Chuck in the effects of adding 600 million people to the global labour pool over the past 30 years and we can see why deflation, rather than inflation, has been the lot of the world since at least 2008.

In short, beware the rhetoric of inflationary reaction. A perversity thesis joined to naked self-interest should not guide policy, no matter how hard it is to get that folk model out of our heads.

Mark Blyth is professor of international economics at Brown University

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