One of the repeated errors in the evolution of macroeconomic policy-making during the last century has been the emphasis given to what is known as the Aggregate Demand Model (ADM). The Great Depression following the 1929 stock market crash in New York led to a global recession marked by high unemployment levels and deflation. In 1935 John Maynard Keynes published the book, "The general theory of employment, interest and money
". This was taken to represent the basis for a solution to unemployment and growth. Since that time the concept of public government spending by applying tax revenues and raising loans, was accepted as a means of generating demand so as to increase employment. It is paradoxical that during the Golden Age of Keynisianism when the United Kingdom economy grew steadily and kept unemployment at low levels between 1945 and 1965, Keynesian policies were not in fact applied. This growth was the result of reconstruction after a war and largely private sector investment.
In the late 1970s following the international petroleum price hikes the world's growth fell back into a recession marked by slumpflation, the combination of rising unemployment and inflation. The Keynesian policy instruments provide no way to solve slumpflation without severely prejudicing large segments of constituencies. Largely on the basis of assertion as opposed to logic, monetarism rose to the fore largely under the influence of Milton Friedman an American economist from the University of Chicago. The basic problem (elaborated below) was that Keynesianism and Monetarism rely heavily on the ADM and the theory that macroeconomic management needs to
influence aggregate demand. Because inflation was high the monetarist "solution" is to apply high interest rates and sometimes with the help of increased taxes drain "demand" from the economy. When slumpflation had become a serious and growing issues two new approaches to economics began to take shape in the mid-1970s form of Supply Side Economics based on the work of Robert Mundell, a Canadian economist and the American economist Arthur Laffer. The other approach was the Real Incomes Approach which we return to below.
The Reagan Administration in the USA was the first to experiment with a version of Supply Side Economics which was a marginal tax incentive or fiscal policy to reduce marginal tax rates on the theory subsequently explained by the Laffer Curve that purported to explain that lower marginal tax rates increase government revenue. On the other hand Supply Side Economics also assumed that providing executive and business owners marginal tax reduction would encourage investment and the expansion in lower priced output. As can be see this virtuous combination of effects is what gave rise to the notion of "trickle down economics" or "Reagnomics" which initiated an acceleration in inequality in income levels and a massive government deficit and cut back on social programmes.
What undermined this project was the very high interest rates that exceeded 15%, the same model was pursued by the Conservative government in the UK under Margaret Thatcher. In the UK many lost their homes through repossessions and in the US many families lost their farms. As in the case of the Great Depression the "recovery" in the 1980s imposed a massive policy-induced disaster on a large segment of the constituencies concerned. In the UK the inequality of incomes also rose. It was apparent that conventional economic theories did not translate into effective policies. Since were are dealing with wellbeing and livelihoods it was evident that economists needed to stop convincing politicians to impose massive socio-economic experiments on the global population which had weak practical relevance because of the distance between mathematical models and the real economy. A mixture of unethical dealing and weak regulations over financial institutions led to an exposure of the weakness of the so-called Quantity Theory of Money. This came to a head in 2008 with yet another failure in the socio-economic experiment precipitating another major economic crisis. was caused by a poor management of finance by the banks leading, once again, to inappropriate policies in the form of quantitative easing justified as a basis for releasing of "cheap money" for banks to "re-constitute their balance sheets".
On every occasion economists have attempted to suggest that the cause of these economic disasters were different in each case they could not have been anticipated. However, emanating from previous theories and Keynes theory conventional macroeconomic management has increasingly attempted to apply top-down interventions to interfere in the market through changes in interest rates, taxation, public spending, government loans and authorization for banks to issue increasing debt (money volumes) to tackle economic growth and unemployment. The overall long term problem has been that conventional policies have all contributed to a general level of inflation and debasement of the purchasing power of the pound. This has reduced the ability of increasing numbers of people to acquire their basic consumption needs, creating a marginalisation of low income segments.
This bring us to a repeat of economic discussions that raged some 200 years ago. These were shaped by exchanges between Robert Malthus and Jean Baptiste Say. In letters to Robert Malthus, Jean Baptiste Say explained to Malthus why there were periods when lower income groups could not afford to pay for basic needs, as was the case of the English Working class on a repetitive basis linked to tariff on the import of wheat to protect land owner enterprises. Both Malthus and Say clearly felt the contributions of Adam Smith to economics were of great significance so on many areas they were in agreement. However Say, made the point that production generates the opportunity for consumption because monies earned in production can be used to consume the production of others. In a simplistic form many refer to Say's Law as production creates its own demand. But Say didn't say this exactly, rather he clarified the fact that driving up growth is a supply side phenomenon. What escapes many is that this is what Adam Smith explained in each pursuing their own interests in production results in perfection and a generation of a spreading benefit.
It is mentioned above that when Supply Side Economics work was evolving another approach, the Real Incomes Approach was also evolving in an attempt to address slumpflation. However, this developed along the lines of an alternative macroeconomic model, the Production, Accessibility & Consumption Model (PACM), a fundamentally different approach which is entirely supply side in terms of there being no allowance for state impositions in the markets (the basis for ADM policies) to stimulate "demand". The centre for research and development of the Real Incomes Approach to economics is SEEL-Systems Engineering Economics Lab in Hampshire. It is notable that the sub-title to Say's epic work, "A Treatise o Political Economy
" was "or the production, distribution and consumption of wealth
". The Real Incomes programme coordinator, Hector McNeill, explains that the "accessibility" term in the middle of the PACM title in fact refers to three different types of accessibility, including that mentioned by Say (distribution). Accessibility in the Real Incomes school relates to physical accessibility in terms of proximity to a consumer's location, affordability of unit prices and access to adequate information concerning the available goods and services. The second item, affordability, was the topic of exchanges between Malthus and Say where Say's position can be interpreted as stating, if someone is involved in an activity that only pays a low salary, then it is likely that some goods and services will be beyond their ability to consume those products and services. Therefore in order to consume such products it was necessary for the individuals concerned to produce and sell more of value so as to received enough income so as to be in a position of purchase these. In this sense the simplistic version of what if often referred to Say's Law that "production creates it own supply" is an insufficient explanation of what Say's position was.
The question then becomes one of determining how much people should be paid and why many, the poor, remain in a situation from which it is difficult to escape. As Say has explained, and as the Real Incomes approach today confirms, unit prices can be reduced if productivity of work is enhanced. However, the Real Incomes approach takes this a few steps further. By 1976 the Real Incomes school had established that inflation is caused by price setting of managers in economic units. It is not related to the volume of money as postulated by the Quantity Theory of Money. Invariably, when Milton Friedman, a leading monetarist, was asked to explain this, he was unable to do this in a convincing fashion. His retort to any insistent questioner on this topic was that this always occurs in the "long run". It is as if there is some osmotic force that relates unit prices to money volumes. McNeill observed the reaction of managers in Brazil during the early 1970s when the international petroleum prices rose several times causing inflation (cost-push) and rising unemployment and, of course, an inability of the poor to access what they needed as a result of rising prices. McNeill observed that managers factored into their pricing a constant rise in nominal unit prices in the expectation of a general rise in prices. They even based this on official inflation indices. They did this in order to maintain their ability to purchase input and to end up with a stable or rising real income. The obvious consequence of this psychological mindset was an accelerating overall rate of inflation which persisted up to 1994 with the introduction of the Real Plan.
By 1976 McNeill had produced his first policy proposal to kill slumpflation and lower unemployment. He called this the "The Real Incomes Approach to Economics". The important contributions to economic theory of this new school was a novel measure of corporate performance. This is the price performance ratio (PPR). The price performance ratio measures the relative movement in unit output prices in response to movements in unit cost changes. McNeill explained in 1976 that no matter which theory of inflation one cares to contemplate the fact of the matter is that rising unit prices are directly related to the pricing decisions taken by the managers of economic units. Therefore a fundamental step in managing inflation is first of all to identify which economic units and sectors are associated with management decisions that sustain or increase inflation. This is important because in many instances the pressure on profits and prices can be radically reduced through economic units taking up and applying state-of-the-art technologies to increase productivity. Along the lines of the notion that by paying workers more, then the economy as a whole can afford to buy more, such as Henry Ford paying production line workers sufficient for them to afford to buy the very cars they were producing - a confirmation of Say's position - it is apparent that productivity is the key factor in being able to pay workers' wages that enable them to access what they need.
McNeill also noted that in order to raise productivity various levels of investment are required which raises corporate costs and, as a result, short term cash flow and profits will decline and, which in an generally inflationary situation, would result also in a decline in real profits. Therefore managers would be reluctant to lower their unit prices having invested in the means of increasing productivity. Invariably investments that raise productivity are reckoned to take time to recoup the investment so the ability to judge the future circumstances in the market, currently subject to inflation, is difficult. This only reduces the confidence of managers to make such investments. McNeill's solution is to apply a price performance levy (PPL) on the output of companies which is correlated to the price performance ratio. The relationship of the PPR to inflation is shown in the table below. If a PPR is greater that unity (>1.00) the company contributes to an increase in inflation. If the PPR is equal to unity (1.00) the company simply passes on input inflation at the same rate. However, in the case of the PPR being less than unity (<1.00), a company helps reduce output inflation to levels below input unit costs inflation.The relationship between the price performance ratio (PPR) and inflation
|Pricing decision performance (PPR) and output inflation|
|PPR||Direction of inflationary pressure|
|>1.00||Increases at higher than input unit cost rate of inflation|
|=1.00||Remains at unit input costs rate of inflation|
|<1.00||Reduces the inflation rate to below unit input costs rate |
McNeill's development of the price performance levy was designed to compensate companies for reducing inflation. Thus a reasonably high levy is applied somewhat like a fixed level tax that would apply to the condition of PPR=1. If a company operated at a PPR in excess of 1.00 then the levy is increased progressively depending on the value of the PPR. In the case of companies achieving a PPR of less than 1.00 the levy is progressively reduced, and eventually to zero. Therefore companies would have a strong incentive to pay more attention to productivity and pricing decisions.
Some have confused this with the marginal tax rate reduction applied under the Supply Side Economics approach. However, McNeill has explained that the levy applied is not a tax and the level of payment can be zero depending on the performance of the company. So in absolute terms the price performance levy is strictly related to corporate inflation performance and good managers can almost always run the levy down to zero. However the condition to pay no levy is that productivity rises to the extent that unit prices are reduced. Under Supply Side Economics the issue is marginal tax rate paid and the already paid is lost to the company.
The net effect of the price performance levy the main policy instrument in one Real Incomes Approach policy, "Price Performance Policy" or PPP, companies receive back in the short term compensation for investment and as the impact of the investment kicks in, they have even more capability to lower their PPRs and unit prices.
Some confuse the price performance levy for a type of investment allowance but it is not related to the amount of investment but rather to the provision of a strong incentive for actual performance based on increasing productivity. McNeill has explained that this to avoid the common practice of companies taking incentives and grants and regarding them as income as opposed to a means towards higher productivity.
The Reagan calamity of "trickle down economics" was an attempt to apply the Supply Side Economic option but income inequality increased and the poor in particular ended up in a worse situation.