Governments and consumers must learn a new lesson: price rises are no longer automatic, thanks to technological advances and global integration. Roger Bootle discusses his theory with Madeleine Wackernagel
Inflation is dead, RIP. At least in the industrialised world. South Africans may not be immediately convinced, but if Roger Bootle’s thesis is valid, we may have no option but to follow suit.
South Africa is loosely classified as being part of the “east”, and the contrast between the inflation rates of the dynamic economies of the east and the established countries of the West is considerable. But if inflation continues on its negative path in the west, the pressure for the rest of the world to conform will be profound.
Before World War II, inflation was not inevitable; then came 50 years of perpetually rising prices, changing our expectations.
“It is natural for people to assume that the future is going to be similar to the recent past,” writes Bootle, chief economist of the HSBC Group, parent of Midland Bank, one of Britain’s biggest, in The Death of Inflation. “Sometimes, though, this assumption can be dangerously off beam … Sometimes history reaches a breakpoint. It is at a breakpoint now.”
The change in the inflationary environment is most obvious in Japan: in November 1995, wholesale prices were 7% lower than in 1990; consumer price inflation was minus 0,5%. And while the turnaround has not been quite as dramatic in the Organisation for Economic Co-operation and Development (OECD) countries, it has nonetheless been significant.
Bootle’s thesis has been greeted with scepticism by central bankers. “Eddie George, governor of the Bank of England, as well as Hans Tietmeyer of the German Bundesbank, publicly criticised my book,” he told the Mail & Guardian this week. “But this reaction was predictable. The raison d’tre of central bankers has been to combat inflation, the scourge of the post-war era. If there is no inflation, they will have to find something else to do!”
Indeed, it has been very difficult for policy-makers and economic commentators to concede that the next 50 years may present a very different danger — deflation — requiring a sea-change in policy emphasis, from monetary to fiscal.
Even in South Africa, hardly had inflation fallen to a surprise low of 5,5% for April, than the pundits were predicting an increase. The argument was valid, in terms of the collapse in the rand, but the extent of the scepticism threatens the hard-won reversal in inflation expectations. The Reserve Bank has fought long and valiantly to change the attitudes of consumers and producers — a much more difficult task in a country with a history of high inflation such as ours, than in Germany, for instance.
But there is more to changing an inflation culture than periods of low and falling prices. The defining factor in the 1990s has been the structural changes wrought by decades of tough anti-inflationary policies in the west. The growth in technology and the rapid increase in global integration have dampened inflationary pressures as Eastern producers are able to supply goods to western markets at much lower cost.
“The result,” says Bootle, “is to put massive competitive pressure on western producers and to undermine established oligopolies in the west.
“As they find they cannot compete on price, they either have to abandon whole areas of production, source most of the product from the dynamic countries, withdraw into higher value-added, niche areas, or make a determined effort to match the competition on price through substantial cost savings, including demanning and wage freezes and/or investing in cost-saving technology.”
Alternatively, they can move their operations eastwards — a growing trend among conglomerates — to capitalise on low-cost labour and in turn pressurise the home labour market to accept wage concessions. Bootle cites the example of Daimler- Benz, which was considering building a new plant outside Germany until the workers agreed to wages below the national level.
Advances in technology mean that high-tech goods — – mobile phones, video recorders, compact disc players and computers — have become cheaper. And consumers expect prices of such products to drop, giving added impetus to expectations of low inflation.
There is always the threat of imported inflation. But Bootle argues that if the west concentrates on manufacturing goods where it has a comparative advantage, such as heavy machinery, aircraft and pharmaceuticals, then specialisation would lower the average costs of production.
The dynamic economies of the East have some way to go, although the situation is improving: inflation in the Czech Republic was below 10% last year, against 20% in 1993; Brazil was at 20%, having been 1 000% in 1994, while Argentina was down to 1,5% after a history of hyper-inflation in the 1980s.
Bootle is confident the twin forces of international financial market pressure on governments to enforce fiscal and monetary discipline, and more open trade policies will see the eastern economies right before too long.
But not everyone will hail the new low-inflation era — annual pay increases will no longer be automatic, and house prices will fall. An immediate benefit should be lower interest rates, but unless the financial markets react, quickly, to the new order, interest rates and yields will continue to be out of kilter, risking recession and at the extreme, financial crisis.
Governments borrow at the long end; if these rates don’t follow short-term levels downwards, the result could be catastrophic for the national debt as interest payments pile up inexorably.
The only solution, says Bootle, is tighter fiscal policy and easier monetary policy — completely apposite to conventional economic wisdom in the past 30 years. There are signs of such a sea-change already in the European Union and United States. If nothing else, the sheer force of demographics will restrict governments’ spending power.
“Such a change will not happen overnight; it is a very slow process. And it may even take a financial disaster in one country to force the others to realise that they must cut interest rates while cutting spending,” says Bootle.
The spectre of resurging inflation is proving difficult to dispel. Only last week the US financial markets reacted wildly to strong employment data for June as some players believe the prospect of full employment and strong economic growth — but without inflation — will remain the stuff of economic fantasy.
Bootle admits there may be hiccups, but the prospect of a “rip-roaring boom” is slim, particularly in Japan and continental Europe. “The foundations have been laid; a period of great promise lies before us,” says Bootle. “Now it’s up to the policy-makers to ensure that promise is fulfilled.”
l The Death of Inflation: Surviving and Thriving in the Zero Era by Roger Bootle