The Economy: Between Marx and Milton

The Royal Bank of Scotland has issued a global stock and credit crash alert:

The Royal Bank of Scotland has advised clients to brace for a full-fledged crash in global stock and credit markets over the next three months as inflation paralyses the major central banks.

"A very nasty period is soon to be upon us – be prepared," said Bob Janjuah, the bank’s credit strategist.

A report by the bank’s research team warns that the S&P 500 index of Wall Street equities is likely to fall by more than 300 points to around 1050 by September as "all the chickens come home to roost" from the excesses of the global boom, with contagion spreading across Europe and emerging markets.

Whether this will come to pass, however, depends upon the possibility of inflation.  But Thomas Palley argues that we’re not in the 1970’s and Milton Friedman’s model for an inflation engine no longer holds:

The US Federal Reserve has recently received much criticism from economic conservatives who claim it has ignored inflation, thereby risking a rerun of the inflation show of the 1970s. In response, renowned Princeton economist Paul Krugman has come to the Fed’s defense, arguing today’s inflation is fundamentally different from that of the 1970s.

Krugman is right, but his arguments do more than defend the Fed. They also unintentionally demolish the foundations on which central banks have based monetary policy over the past 25 years. In effect, rethinking the inflation of the 1970s also compels rethinking economic policy.

The essence of Krugman’s argument is that we are not watching a rerun of the 1970s show because this time round there is no mechanism for creating a price-wage spiral. That is because unions are now dead, so that workers are unable to ask for wage increases that match prices. As an example, Krugman contrasts the United Mine Workers contract of 1981, which bargained a three-year 11% annual average wage increase with current conditions. Where now are the unions demanding 11%-a-year increases? Indeed, where are the unions, period?

Those pushes were augmented by cost of living provisions in union contracts, and the effect of those has been mitigated by, if nothing else, the way the cost of living is computed by the government.

But if this is the case, we may be looking at what another economist predicted.  Central to Marxist theory is the condition of later capitalism, where competitive pressures induce capitalists to force wages down, thus impoverishing the whole economy, accelerating the spiral and leading to proletarian revolution.

The occurence of that is not, contrary to Marxist theory, an inevitable result of history.  But it is certainly a plausible scenario, especially given the global nature of the economy and the fact that workers in various parts of the world are competing for similar work with vastly disparate wave levels.  It depends on a number of factors.  But such a course of events shouldn’t be counted out.