A Tiger by the Tail

V. Wage Rigidities and Inflation

14.   FULL EMPLOYMENT, PLANNING AND INFLATION

Professor Hayek here develops one of his main themes. Save in the exceptional circumstances of the general unemployment of all factors of production, the ‘unemployment’ problem is one of securing the right distribution of labour; monetary expansion along Keynesian lines, by nullifying the effects of relative price movements, exacerbates the situation and makes it impossible to maintain any given volume of employment, except by continued inflation. Considerations such as these are not clearly grasped within the ‘bloc’ thinking of the macro-approach, which may thus serve to conceal important aspects of reality.

In the years that have elapsed since the war, central planning, ‘full employment’, and inflationary pressure have been the three features which have dominated economic policy in the greater part of the world. Of these only full employment can be regarded as desirable in itself. Central planning, direction, or government controls, however we care to call it, is at best a means which must be judged by the results. Inflation, even ‘repressed inflation’, is undoubtedly an evil, though some would say a necessary evil if other desirable aims are to be achieved. It is part of the price we pay for having committed ourselves to a policy of full employment and central planning.

The new fact which has brought about this situation is not a greater desire to avoid unemployment than existed before the war. It is the new belief that a higher level of employment can be permanently maintained by monetary pressure than would be possible without it. The pursuit of a policy based on these beliefs has somewhat unexpectedly shown that inflation and government controls are its necessary accompaniments—unexpected not by all, but by probably the majority of those who advocated those policies.

Full Employment the Main Priority

Full employment policies as now understood are thus the dominant factor of which the other characteristic features of contemporary economic policy are mainly the consequence. Before we can further examine the manner in which central planning, full employment, and inflation interact, we must become clear about what precisely the full employment policies as now practised mean.

Full employment has come to mean that maximum of employment that can be brought about in the short run by monetary pressure. This may not be the original meaning of the theoretical concept, but it was inevitable that it should have come to mean this in practice. Once it was admitted that the momentary state of employment should form the main guide to monetary policy, it was inevitable that any degree of unemployment which might be removed by monetary pressure should be regarded as sufficient justification for applying such pressure. That in most situations employment can be temporarily increased by monetary expansion has long been known. If this possibility has not always been used, this was because it was thought that by such measures not only other dangers were created, but that long-term stability of employment itself might be endangered by them. What is new about present beliefs is that it is now widely held that so long as monetary expansion creates additional employment, it is innocuous or at least will cause more benefit than harm.

Yet while in practice full employment policies merely mean that in the short run employment is kept somewhat higher than it would otherwise be, it is at least doubtful whether over longer periods they will not in fact lower the level of employment which can be permanently maintained without progressive monetary expansion. These policies are, however, constantly represented as if the practical problem were not this, but as if the choice were between full employment thus defined and the lasting mass unemployment of the 1930s.

The habit of thinking in terms of an alternative between ‘full employment’ and a state of affairs in which there are unemployed factors of all kinds available is perhaps the most dangerous legacy which we owe to the great influence of the late Lord Keynes. That so long as a state of general unemployment prevails, in the sense that unused resources of all kinds exist, monetary expansion can be only beneficial, few people will deny. But such a state of general unemployment is something rather exceptional, and it is by no means evident that a policy which will be beneficial in such a state will also always and necessarily be so in the kind of intermediate position in which an economic system finds itself most of the time, when significant unemployment is confined to certain industries, occupations or localities.

Unemployment and Inadequate Demand

Of a system in a state of general unemployment it is roughly true that employment will fluctuate in proportion with money income, and that if we succeed in increasing money income we shall also in the same proportion increase employment. But it is just not true that all unemployment is in this manner due to an insufficiency of aggregate demand and can be lastingly cured by increasing demand. The causal connection between income and employment is not a simple one-way connection so that by raising income by a certain ratio we can always raise employment by the same ratio. It is all too naïve a way of thinking to believe that, since, if all workmen were employed at current wages, total income would reach such and such a figure, therefore, if we can bring income to that figure, we shall also necessarily have full employment. Where unemployment is not evenly spread, there is no certainty that additional expenditure will go where it will create additional employment. At least the amount of extra expenditure which would have to be incurred before the demand for the kind of services is raised which the unemployed offer may have to be of such a magnitude as to produce major inflationary effects before it substantially increases employment.

If expenditure is distributed between industries and occupations in a proportion different from that in which labour is distributed, a mere increase in expenditure need not increase employment. Unemployment can evidently be the consequence of the fact that the distribution of labour is different from the distribution of demand. In this case the low aggregate money income would have to be considered as a consequence rather than as a cause of unemployment. Even though, during the process of increasing incomes, enough expenditure may ‘spill over’ into the depressed sectors temporarily there to cure unemployment, as soon as the expansion comes to an end the discrepancy between the distribution of demand and the distribution of supply will again show itself. Where the cause of unemployment and of low aggregate incomes is such a discrepancy, only a reallocation of labour can lastingly solve the problem in a free economy.

This raises one of the most crucial and most difficult problems in the whole field: is an inappropriate distribution of labour more likely to be corrected under more or less stable or under expanding monetary conditions? This involves in fact two separate problems: the first is whether demand conditions during a process of expansion are such that, if the distribution of labour adjusted itself to the then existing distribution of demand, this would create employment which would continue after expansion has stopped; the second problem is whether the distribution of labour is more likely to adapt itself promptly to any given distribution of demand under stable or under expansionary monetary conditions, or, in other words, whether labour is more mobile under expanding or under stable monetary conditions.

The answer to the first of these questions is fairly clear. During a process of expansion the direction of demand is to some extent necessarily different from what it will be after expansion has stopped. Labour will be attracted to the particular occupations on which the extra expenditure is made in the first instance. So long as expansion lasts, demand there will always run a step ahead of the consequential increases of demand elsewhere. And in so far as this temporary stimulus to demand in particular sectors leads to a movement of labour, it may well become the cause of unemployment as soon as the expansion comes to an end.

Main Cause of Recurrent Unemployment

Some people may feel doubt about the importance of this phenomenon. To the present writer it seems the main cause of the recurrent waves of unemployment. That during every boom period a greater quantity of factors of production is drawn into the capital goods industries than can be permanently employed there, and that as a result we have normally a greater proportion of our resources specialised in the production of capital goods than corresponds to the share of income which, under full employment, will be saved and be available for investment, seems to him the cause of the collapse which has regularly followed a boom. Any attempt to create full employment by drawing labour into occupations where they will remain employed only so long as credit expansion continues creates the dilemma that either credit expansion must be continued indefinitely (which means inflation), or that, when it stops, unemployment will be greater than it would be if the temporary increase in employment had never taken place.

If the real cause of unemployment is that the distribution of labour does not correspond with the distribution of demand, the only way to create stable conditions of high employment which is not dependent on continued inflation (or physical controls) is to bring about a distribution of labour which matches the manner in which a stable money income will be spent. This depends of course not only on whether during the process of adaptation the distribution of demand is approximately what it will remain, but also on whether conditions in general are conducive to easy and rapid movements of labour.

This leads to the second and more difficult part of our question to which, perhaps, no certain answer can be given, though the probability seems to us to point clearly in one direction. This is the question whether workers will on the whole be more willing to move to new occupations or new localities when general demand is rising, or whether mobility is likely to be greater when total demand is approximately constant. The main difference between the two cases is that in the former the inducement to move will be the attraction of a higher wage elsewhere, while in the second case it will be the inability to earn the accustomed wages or to find any employment in the former occupation which will exercise a push. The former method is, of course, the more pleasant, and it is usually also represented as the more effective. It is this latter belief which I am inclined to question.

That the same wage differentials which in the long run would attract the necessary greater number of new recruits to one industry rather than another will not suffice to tempt workers already established in the latter to move is in itself not surprising. As a rule the movement from job to job involves expenditure and sacrifices which may not be justified by a mere increase in wages. So long as the worker can count on his accustomed money wage in his current job, he will be understandably reluctant to move. Even if, as would be inevitable under an expansionist policy which aimed at bringing about the adjustment entirely by raising some wages without allowing others to fall, the constant money wages meant a lower real wage, the habit of thinking in terms of money wages would deprive such a fall of real wages of most of its effectiveness. It is curious that those disciples of Lord Keynes who in other connections make such constant use of this consideration regularly fail to see its significance in this context.

To aim at securing to men who in the social interest ought to move elsewhere the continued receipt of their former wages can only delay movements which ultimately must take place. It should also not be forgotten that in order to give all the men formerly employed continued employment in a relatively declining industry, the general level of wages in that industry will have to fall more than would be necessary if some of the workers moved away from it.

What is so difficult here for the layman to understand is that to protect the individual against the loss of his job may not be a way to decrease unemployment but may over longer periods rather decrease the number which can be employed at given wages. If a policy is pursued over a long period which postpones and delays movements, which keeps people in their old jobs who ought to move elsewhere, the result must be that what ought to have been a gradual process of change becomes in the end a problem of the necessity of mass transfers within a short period. Continued monetary pressure which has helped people to earn an unchanged money wage in jobs which they ought to have left will have created accumulated arrears of necessary changes which, as soon as monetary pressure ceases, will have to be made up in a much shorter space of time and then result in a period of acute mass unemployment which might have been avoided.

Expansion May Hinder Adjustment

All this applies not only to those maldistributions of labour which arise in the course of ordinary industrial fluctuations, but even more to the task of large-scale reallocations of labour such as arise after a great war or as a result of a major change in the channels of international trade. It seems highly doubtful whether the expansionist policies pursued since the war in most countries have helped and not rather hindered that adjustment to radically changed conditions of world trade which have become necessary. Especially in the case of Great Britain the low unemployment figures during recent years may be more a sign of a delay in necessary change than of true economic balance.

The great problem in all those instances is whether such a policy, once it has been pursued for years, can still be reversed without serious political and social disturbances. As a result of these policies, what not very long ago might merely have meant a slightly higher unemployment figure, might now, when the employment of large numbers has become dependent on the continuation of these policies, be indeed an experiment which politically is unbearable.

Full employment policies, as at present practised, attempt the quick and easy way of giving men employment where they happen to be, while the real problem is to bring about a distribution of labour which makes continuous high employment without artificial stimulus possible. What this distribution is we can never know beforehand. The only way to find out is to let the unhampered market act under conditions which will bring about a stable equilibrium between demand and supply. But the very full employment policies make it almost inevitable that we must constantly interfere with the free play of the forces of the market and that the prices which rule during such an expansionary policy, and to which supply will adapt itself, will not represent a lasting condition. These difficulties, as we have seen, arise from the fact that unemployment is never evenly spread throughout the economic system, but that, at the time when there may still be substantial unemployment in some sectors, there may exist acute scarcities in others. The purely fiscal and monetary measures on which current full employment policies rely are, however, by themselves indiscriminate in their effects on the different parts of the economic system. The same monetary pressure which in some parts of the system might merely reduce unemployment will in others produce definite inflationary effects. If not checked by other measures, such monetary pressure might well set up an inflationary spiral of prices and wages long before unemployment has disappeared, and—with present nationwide wage bargaining—the rise of wages may threaten the results of the full employment policy even before it has been achieved.

As is regularly the case in such circumstances, the governments will then find themselves forced to take measures to counteract the effects of their own policy. The effects of the inflation have to be contained or ‘repressed’ by direct controls of prices and of quantities produced and sold: the rise of prices has to be prevented by imposing maximum prices and the resulting scarcities must be met by a system of rationing, priorities and allocations.

The manner in which inflation leads a government into a system of overall controls and central planning is by now too well known to need elaboration. It is usually a particularly pernicious kind of planning, because not thought out beforehand but applied piecemeal as the unwelcome results of inflation manifest themselves. A government which uses inflation as an instrument of policy but wants it to produce only the desired effects is soon driven to control ever increasing parts of the economy.

(Studies in Philosophy, Politics and Economics, pp. 270–76)

15.   INFLATION RESULTING FROM DOWNWARD INFLEXIBILITY OF WAGES

Professor Hayek reiterates the central role of wage rates in determining the volume of employment. Reasoning in terms of wage levels rather than in terms of the structure of wage rates obscures the inflationary implications of refusing to reduce wage rates where necessary. If union-determined wage rates are treated as the datum to which all other economic values must adjust themselves, the monetary consequences of such a course must be clearly recognised. If we wish to avoid the latter, trade unions must treat the flow of money incomes as the final datum to which they must adjust their wage rates. Professor Hayek here explicitly and unambiguously analyses the specific interactions of union wage policy and official monetary policy in creating one of the major dilemmas facing the developed economies.

Contrary to what is widely believed, the crucial result of the ‘Keynesian Revolution’ is the general acceptance of a factual assumption and, what is more, of an assumption which becomes true as a result of its being generally accepted. The Keynesian theory, as it has developed during the last twenty years, has become a formal apparatus which may or may not be more convenient to deal with the facts than classical monetary theory; this is not our concern here. The decisive assumption on which Keynes’s original argument rested and which has since ruled policy is that it is impossible ever to reduce the money wages of a substantial group of workers without causing extensive unemployment. The conclusion which Lord Keynes drew from this, and which the whole of his theoretical system was intended to justify, was that since money wages can in practice not be lowered, the adjustment necessary, whenever wages have become too high to allow ‘full employment’, must be effected by the devious process of reducing the value of money. A society which accepts this is bound for a continuous process of inflation.

Importance of Relative Wages

This consequence is not at once apparent within the Keynesian system because Keynes and most of his followers are arguing in terms of a general wage level while the chief problem appears only if we think in terms of the relative wages of the different (sectional or regional) groups of workers. Relative wages of the different groups are bound to change substantially in the course of economic development. But if the money wage of no important group is to fall, the adjustment of the relative position must be brought about exclusively by raising all other money wages. The effect must be a continuous rise in the level of money wages greater than the rise of real wages, i.e., inflation. One need only consider the normal year-by-year dispersion of wage changes of the different groups in order to realise how important this factor must be.

The twelve years since the end of the war have in fact in the whole Western world been a period of more or less continuous inflation. It does not matter how far this was entirely the result of deliberate policy or the product of the exigencies of government finance. It certainly has been a very popular policy since it has been accompanied by great prosperity over a period of probably unprecedented length. The great problem is whether by the same means prosperity can be maintained indefinitely—or whether an attempt to do so is not bound sooner or later to produce other results which in the end must become unbearable.

The point which tends to be overlooked in current discussion is that inflation acts as a stimulus to business only in so far as it is unforeseen, or greater than expected. Rising prices by themselves, as has often been seen, are not necessarily a guarantee of prosperity. Prices must turn out to be higher than they were expected to be, in order to produce profits larger than normal. Once a further rise of prices is expected with certainty, competition for the factors of production will drive up costs in anticipation. If prices rise no more than expected there will be no extra profits, and if they rise less, the effect will be the same as if prices fell when they had been expected to be stable.

On the whole the post-war inflation has been unexpected or has lasted longer than expected. But the longer inflation lasts, the more it will be generally expected to continue; and the more people count on a continued rise of prices, the more must prices rise in order to secure adequate profits not only to those who would earn them without inflation but also to those who would not. Inflation greater than expected secures general prosperity only because those who without it would make no profit and be forced to turn to something else are enabled to continue with their present activities. A cumulative inflation at a progressive rate will probably secure prosperity for a fairly long time, but not inflation at a constant rate. We need hardly inquire why inflation at a progressive rate cannot be continued indefinitely: long before it becomes so fast as to make any reasonable calculation in the expanding currency impracticable and before it will be spontaneously replaced by some other medium of exchange, the inconvenience and injustice of the rapidly falling value of all fixed payments will produce irresistible demands for a halt—irresistible, at least, when people understand what is happening and realise that a government can always stop inflation. (The hyper-inflations after the First World War were tolerated only because people were deluded into believing that the increase of the quantity of money was not a cause but a necessary consequence of the rise of prices.)

We can therefore not expect inflation-borne prosperity to last indefinitely. We are bound to reach a point at which the source of prosperity which inflation now constitutes will no longer be available. Nobody can predict when this point will be reached, but come it will. Few things should give us greater concern than the need to secure an arrangement of our productive resources which we can hope to maintain at a reasonable level of activity and employment when the stimulus of inflation ceases to operate.

Inflation—A Vicious Circle

Yet the longer we have relied on inflationary expansion to secure prosperity, the more difficult that task will be. We shall be faced not only with an accumulated backlog of delayed adjustments—all those businesses which have been kept above water only by continued inflation. Inflation also becomes the active cause of new ‘misdirections’ of production, i.e., it induces new activities which will continue to be profitable only so long as inflation lasts. Especially when the additional money first becomes available for investment activities, these will be increased to a volume which cannot be maintained once only current savings are available to feed them.

The conception that we can maintain prosperity by keeping final demand always increasing a jump ahead of costs must sooner or later prove an illusion, because costs are not an independent magnitude but are in the long run determined by the expectations of what final demand will be. And to secure ‘full employment’ even an excess of ‘aggregate demand’ over ‘aggregate costs’ may not lastingly be sufficient, since the volume of employment depends largely on the magnitude of investment and beyond a certain point an excessive final demand may act as a deterrent rather than as a stimulus to investment.

I fear that those who believe that we have solved the problem of permanent full employment are in for a serious disillusionment. This is not to say that we need have a major depression. A transition to more stable monetary conditions by gradually slowing down inflation is probably still possible. But it will hardly be possible without a significant decrease of employment of some duration. The difficulty is that in the present state of opinion any noticeable increase of unemployment will at once be met by renewed inflation. Such attempts to cure unemployment by further doses of inflation will probably be temporarily successful and may even succeed several times if the inflationary pressure is massive enough. But this will merely postpone the problem and in the meantime aggravate the inherent instability of the situation.

In a short paper on the twenty years’ outlook there is no space to consider the serious but essentially short-term problem of how to get out of a particular inflationary spell without producing a major depression. The long-term problem is how we are to stop the long-term and periodically accelerated inflationary trend which will again and again raise that problem. The essential point is that it must be once more realised that the employment problem is a wage problem and that the Keynesian device of lowering real wages by reducing the value of money when wages have become too high for full employment will work only so long as the workers let themselves be deceived by it. It was an attempt to get round what is called the ‘rigidity’ of wages which could work for a time but which in the long run has only made this obstacle to a stable monetary system greater than it had been. What is needed is that the responsibility for a wage level which is compatible with a high and stable level of employment should again be squarely placed where it belongs: with the trade unions. The present division of responsibility where each union is concerned only with obtaining the maximum rate of money wages without regard to the effect on employment, and the monetary authorities are expected to supply whatever increases of money income are required to secure full employment at the resulting wage level, must lead to continuous and progressive inflation. We are discovering that by refusing to face the wage problem and temporarily evading the consequences by monetary deception, we have merely made the whole problem much more difficult. The long-run problem remains the restoration of a labour market which will produce wages which are compatible with stable money. This means that the full and exclusive responsibility of the monetary authorities for inflation must once more be recognised. Though it is true that, so long as it is regarded as their duty to supply enough money to secure full employment at any wage level, they have no choice and their role becomes a purely passive one, it is this very conception which is bound to produce continuous inflation. Stable monetary conditions require that the stream of money expenditure is the fixed datum to which prices and wages have to adapt themselves, and not the other way round.

The State of Public Opinion

Such a change of policy as would be required to prevent progressive inflation, and the instability and recurrent crises it is bound to produce, presupposes, however, a change in the still predominant state of opinion. Though a 7 percent Bank rate in the country where they originated and were most consistently practised proclaims loudly the bankruptcy of Keynesian principles, there is yet little sign that they have lost their sway over the generation that grew up in their heyday. But quite apart from this intellectual power they still exercise, they have contributed so much to strengthen the position of one of the politically most powerful elements in the country, that their abandonment is not likely to come without a severe political struggle. The desire to avoid this will probably again and again lead politicians to put off the necessity by resorting once more to the temporary way out which inflation offers as the path of least resistance. It will probably be only when the dangers of this path have become much more obvious than they are now that the fundamental underlying problem of union power will really be faced.

(Studies in Philosophy, Politics and Economics, pp. 295–99)

16.   LABOUR UNIONS AND EMPLOYMENT

Professor Hayek makes two major points in this extract from the Constitution of Liberty. First, it is unwarranted, he says, to identify the interests of union members with the interests of the working class as a whole, since unions are able to obtain higher wage rates for their members only by limiting the supply of unionised labour and thus increasing the supply of non-union labour—i.e., by reducing the wage rates of nonunion workers.

Secondly, the separate attempts of each union to raise real wages by raising the money wages of its members would produce unemployment, unless the monetary authorities inflated the flow of money incomes to compensate for this discoordination; but such an inflation in turn leads to even graver consequences.

Public policy concerning labour unions has, in little more than a century, moved from one extreme to the other. From a state in which little the unions could do was legal if they were not prohibited altogether, we have now reached a state where they have become uniquely privileged institutions to which the general rules of law do not apply. They have become the only important instance in which governments signally fail in their prime function—the prevention of coercion and violence.

This development has been greatly assisted by the fact that unions were at first able to appeal to the general principles of liberty 1 and then retain the support of the liberals long after all discrimination against them had ceased and they had acquired exceptional privileges. In few other areas are progressives so little willing to consider the reasonableness of any particular measure but generally ask only whether it is ‘For or against unions’ or, as it is usually put, ‘For or against labour’.2 Yet the briefest glance at the history of the unions should suggest that the reasonable position must lie somewhere between the extremes which mark their evolution.

Changed Character of the Problem

Most people, however, have so little realisation of what has happened that they still support the aspirations of the unions in the belief that they are struggling for ‘freedom of association’, when this term has in fact lost its meaning and the real issue has become the freedom of the individual to join or not to join a union. The existing confusion is due in part to the rapidity with which the character of the problem has changed; in many countries voluntary associations of workers had only just become legal when they began to use coercion to force unwilling workers into membership and to keep non-members out of employment. Most people probably still believe that a ‘labour dispute’ normally means a disagreement about remuneration and the conditions of employment, while as often as not its sole cause is an attempt on the part of the unions to force unwilling workers to join.

The acquisition of privilege by the unions has nowhere been as spectacular as in Britain, where the Trade Disputes Act of 1906 conferred

upon a trade union a freedom from civil liability for the commission of even the most heinous wrong by the union or its servant, and in short confer[red] upon every trade union a privilege and protection not possessed by any other person or body of persons, whether corporate or incorporate.3

Similar friendly legislation helped the unions in the United States, where first the Clayton Act of 1914 exempted them from the antimonopoly provisions of the Sherman Act; the Norris–La Guardia Act of 1932 ‘went a long way to establish practically complete immunity of labour organisations for torts’;4 and, finally, the Supreme Court in a crucial decision sustained ‘the claim of a union to the right to deny participation in the economic world to an employer’.5 More or less the same situation had gradually come to exist in most European countries by the 1920s, ‘less through explicit legislative permission than by the tacit toleration by authorities and courts’.6 Everywhere the legalisation of unions was interpreted as a legalisation of their main purpose and as recognition of their right to do whatever seemed necessary to achieve this purpose—namely, monopoly. More and more they came to be treated not as a group which was pursuing a legitimate selfish aim and which, like every other interest, must be kept in check by competing interests possessed of equal rights, but as a group whose aim—the exhaustive and comprehensive organisation of all labour—must be supported for the good of the public.7

Although flagrant abuses of their powers by the unions have often shocked public opinion in recent times and uncritical pro-union sentiment is on the wane, the public has certainly not yet become aware that the existing legal position is fundamentally wrong and that the whole basis of our free society is gravely threatened by the powers arrogated by the unions. We shall not be concerned here with those criminal abuses of union power that have lately attracted much attention in the United States, although they are not entirely unconnected with the privileges that unions legally enjoy. Our concern will be solely with those powers that unions today generally possess, either with the explicit permission of the law or at least with the tacit toleration of the law-enforcing authorities. Our argument will not be directed against labour unions as such; nor will it be confined to the practices that are now widely recognised as abuses. But we shall direct our attention to some of their powers which are now widely accepted as legitimate, if not as their ‘sacred rights’. The case against these is strengthened rather than weakened by the fact that unions have often shown much restraint in exercising them. It is precisely because, in the existing legal situation, unions could do infinitely more harm than they do, and because we owe it to the moderation and good sense of many union leaders that the situation is not much worse, that we cannot afford to allow the present state of affairs to continue.8

Union Coercion of Fellow Workers

It cannot be stressed enough that the coercion which unions have been permitted to exercise contrary to all principles of freedom under the law is primarily the coercion of fellow workers. Whatever true coercive power unions may be able to wield over employers is a consequence of this primary power of coercing other workers; the coercion of employers would lose most of its objectionable character if unions were deprived of this power to exact unwilling support. Neither the right of voluntary agreement between workers nor even their right to withhold their services in concert is in question. It should be said, however, that the latter—the right to strike—though a normal right, can hardly be regarded as an inalienable right. There are good reasons why in certain employments it should be part of the terms of employment that the worker should renounce this right; i.e., such employments should involve long-term obligations on the part of the workers, and any concerted attempts to break such contracts should be illegal.

It is true that any union effectively controlling all potential workers of a firm or industry can exercise almost unlimited pressure on the employer and that, particularly where a great amount of capital has been invested in specialised equipment, such a union can practically expropriate the owner and command nearly the whole return of his enterprise.9 The decisive point, however, is that this will never be in the interest of all workers—except in the unlikely case where the total gain from such action is equally shared among them, irrespective of whether they are employed or not—and that, therefore, the union can achieve this only by coercing some workers against their interest to support such a concerted move.

The reason for this is that workers can raise real wages above the level that would prevail on a free market only by limiting the supply, that is, by withholding part of labour. The interest of those who will get employment at the higher wage will therefore always be opposed to the interest of those who, in consequence, will find employment only in the less highly-paid jobs or who will not be employed at all.

The fact that unions will ordinarily first make the employer agree to a certain wage and then see to it that nobody will be employed for less makes little difference. Wage fixing is quite as effective a means as any other of keeping out those who could be employed only at a lower wage. The essential point is that the employer will agree to the wage only when he knows that the union has the power to keep out others.10 As a general rule, wage fixing (whether by unions or by authority) will make wages higher than they would otherwise be only if they are also higher than the wage at which all willing workers can be employed.

Wage Increases at Expense of Others

Though unions may still often act on a contrary belief, there can now be no doubt that they cannot in the long run increase real wages for all wishing to work above the level that would establish itself in a free market—though they may well push up the level of money wages, with consequences that will occupy us later. Their success in raising real wages beyond that point, if it is to be more than temporary, can benefit only a particular group at the expense of others. It will therefore serve only a sectional interest even when it obtains the support of all. This means that strictly voluntary unions, because their wage policy would not be in the interest of all workers, could not long receive the support of all. Unions that had no power to coerce outsiders would thus not be strong enough to force up wages above the level at which all seeking work could be employed, that is, the level that would establish itself in a truly free market for labour in general.

But, while the real wages of all the employed can be raised by union action only at the price of unemployment, unions in particular industries or crafts may well raise the wages of their members by forcing others to stay in less well-paid occupations. How great a distortion of the wage structure this in fact causes is difficult to say. If one remembers, however, that some unions find it expedient to use violence in order to prevent any influx into their trade and that others are able to charge high premiums for admission (or even to reserve jobs in the trade for children of present members), there can be little doubt that this distortion is considerable. It is important to note that such policies can be employed successfully only in relatively prosperous and highly-paid occupations and that they will therefore result in the exploitation of the relatively poor by the better-off. Even though within the scope of any one union its actions may tend to reduce differences in remuneration, there can be little doubt that, so far as relative wages in major industries and trades are concerned, unions today are largely responsible for an inequality which has no function and is entirely the result of privilege.11 This means that their activities necessarily reduce the productivity of labour all around and therefore also the general level of real wages; because, if union action succeeds in reducing the number of workers in the highly-paid jobs and in increasing the number of those who have to stay in the less remunerative ones, the result must be that the overall average will be lower. It is, in fact, more than likely that, in countries where unions are very strong, the general level of real wages is lower than it would otherwise be.12 This is certainly true of most countries of Europe, where union policy is strengthened by the general use of restrictive practices of a ‘make-work’ character.

If many still accept as an obvious and undeniable fact that the general wage level has risen as fast as it has done because of the efforts of the unions, they do so in spite of these unambiguous conclusions of theoretical analysis—and in spite of empirical evidence to the contrary. Real wages have often risen much faster when unions were weak than when they were strong; furthermore, even the rise in particular trades or industries where labour was not organised has frequently been much faster than in highly organised and equally prosperous industries.13 The common impression to the contrary is due partly to the fact that wage gains, which are today mostly obtained in union negotiations, are for that reason regarded as obtainable only in this manner 14 and even more to the fact that, as we shall presently see, union activity does in fact bring about a continuous rise in money wages exceeding the increase in real wages. Such increase in money wages is possible without producing general unemployment only because it is regularly made ineffective by inflation—indeed, it must be if full employment is to be maintained.

Harmful and Dangerous Activities

If unions have in fact achieved much less by their wage policy than is generally believed, their activities in this field are nevertheless economically very harmful and politically exceedingly dangerous. They are using their power in a manner which tends to make the market system ineffective and which, at the same time, gives them a control of the direction of economic activity that would be dangerous in the hands of government but is intolerable if exercised by a particular group. They do so through their influence on the relative wages of different groups of workers and through their constant upward pressure on the level of money wages, with its inevitable inflationary consequences.

The effect on relative wages is usually greater uniformity and rigidity of wages within any one union-controlled group and greater and non-functional differences in wages between different groups. This is accompanied by a restriction of the mobility of labour, of which the former is either an effect or a cause. We need say no more about the fact that this may benefit particular groups but can only lower the productivity and therefore the incomes of the workers in general. Nor need we stress here the fact that the greater stability of the wages of particular groups which unions may secure is likely to involve greater instability of employment. What is important is that the accidental differences in union power of the different trades and industries will produce not only gross inequalities in remuneration among the workers which have no economic justification but uneconomic disparities in the development of different industries. Socially important industries, such as building, will be greatly hampered in their development and will conspicuously fail to satisfy urgent needs simply because their character offers the unions special opportunities for coercive monopolistic practices.15 Because unions are most powerful where capital investments are heaviest, they tend to become a deterrent to investment—at present probably second only to taxation. Finally, it is often union monopoly in collusion with enterprise that becomes one of the chief foundations of monopolistic control of the industry concerned.

The chief danger presented by the current development of unionism is that, by establishing effective monopolies in the supply of the different kinds of labour, the unions will prevent competition from acting as an effective regulator of the allocation of all resources. But if competition becomes ineffective as a means of such regulation, some other means will have to be adopted in its place. The only alternative to the market, however, is direction by authority. Such direction clearly cannot be left in the hands of particular unions with sectional interests, nor can it be adequately performed by a unified organisation of all labour, which would thereby become not merely the strongest power in the state but a power completely controlling the state. Unionism as it is now tends, however, to produce that very system of overall socialist planning which few unions want and which, indeed, it is in their best interest to avoid.

Acting against Members’ Interests

The unions cannot achieve their principal aims unless they obtain complete control of the supply of the type of labour with which they are concerned; and, since it is not in the interest of all workers to submit to such control, some of them must be induced to act against their own interest. This may be done to some extent through merely psychological and moral pressure, encouraging the erroneous belief that the unions benefit all workers. Where they succeed in creating a general feeling that every worker ought, in the interest of his class, to support union action, coercion comes to be accepted as a legitimate means of making a recalcitrant worker do his duty. Here the unions have relied on a most effective tool, namely, the myth that it is due to their efforts that the standard of living of the working class has risen as fast as it has done and that only through their continued efforts will wages continue to increase as fast as possible—a myth in the assiduous cultivation of which the unions have usually been actively assisted by their opponents. A departure from such a condition can only come from a truer insight into the facts, and whether this will be achieved depends on how effectively economists do their job of enlightening public opinion.

But though this kind of moral pressure exerted by the unions may be very powerful, it would scarcely be sufficient to give them the power to do real harm. Union leaders apparently agree with the students of this aspect of unionism that much stronger forms of coercion are needed if the unions are to achieve their aims. It is the techniques of coercion that unions have developed for the purpose of making membership in effect compulsory, what they call their ‘organisational activities’ (or, in the United States, ‘union security’—a curious euphemism) that give them real power. Because the power of truly voluntary unions will be restricted to what are common interests of all workers, they have come to direct their chief efforts to the forcing of dissenters to obey their will.

They could never have been successful in this without the support of a misguided public opinion and the active aid of government. Unfortunately, they have to a large extent succeeded in persuading the public that complete unionisation is not only legitimate but important to public policy. To say that the workers have a right to form unions, however, is not to say that the unions have a right to exist independently of the will of the individual workers. Far from being a public calamity, it would indeed be a highly desirable state of affairs if the workers should not feel it necessary to form unions. Yet the fact that it is a natural aim of the unions to induce all workers to join them has been so interpreted as to mean that the unions ought to be entitled to do whatever seems necessary to achieve this aim. Similarly, the fact that it is legitimate for unions to try to secure higher wages has been interpreted to mean that they must also be allowed to do whatever seems necessary to succeed in their effort. In particular, because striking has been accepted as a legitimate weapon of unions, it has come to be believed that they must be allowed to do whatever seems necessary to make a strike successful. In general, the legalisation of unions has come to mean that whatever methods they regard as indispensable for their purposes are also to be treated as legal.

The present coercive powers of unions thus rest chiefly on the use of methods which would not be tolerated for any other purpose and which are opposed to the protection of the individual’s private sphere. In the first place, the unions rely—to a much greater extent than is commonly recognised—on the use of the picket line as an instrument of intimidation. That even so-called ‘peaceful’ picketing in numbers is severely coercive and the condoning of it constitutes a privilege conceded because of its presumed legitimate aim is shown by the fact that it can be and is used by persons who themselves are not workers to force others to form a union which they will control, and that it can also be used for purely political purposes or to give vent to animosity against an unpopular person. The aura of legitimacy conferred upon it because the aims are often approved cannot alter the fact that it represents a kind of organised pressure upon individuals which in a free society no private agency should be permitted to exercise.

Next to the toleration of picketing, the chief factor which enables unions to coerce individual workers is the sanction by both legislation and jurisdiction of the closed or union shop and its varieties. These constitute contracts in restraint of trade, and only their exemption from the ordinary rules of law has made them legitimate objects of the ‘organisational activities’ of the unions. Legislation has frequently gone so far as to require not only that a contract concluded by the representatives of the majority of the workers of a plant or industry be available to any worker who wishes to take advantage of it, but that it apply to all employees, even if they should individually wish and be able to obtain a different combination of advantages.16 We must also regard as inadmissible methods of coercion all secondary strikes and boycotts which are used not as an instrument of wage bargaining but solely as a means of forcing other workers to fall in with union policies.

Most of these coercive tactics of the unions can be practised, moreover, only because the law has exempted groups of workers from the ordinary responsibility of joint action, either by allowing them to avoid formal incorporation or by explicitly exempting their organisations from the general rules applying to corporate bodies. There is no need to consider separately various other aspects of con-temporary union policies such as, to mention one, industry-wide or nation-wide bargaining. Their practicability rests on the practices already mentioned, and they would almost certainly disappear if the basic coercive power of the unions were removed.17

A Non-coercive Role

It can hardly be denied that raising wages by the use of coercion is today the main aim of unions. Even if this were their sole aim, legal prohibition of unions would, however, not be justifiable. In a free society much that is undesirable has to be tolerated if it cannot be prevented without discriminatory legislation. But the control of wages is even now not the only function of the unions; and they are undoubtedly capable of rendering services which are not only unobjectionable but definitely useful. If their only purpose were to force up wages by coercive action, they would probably disappear if deprived of coercive power. But unions have other useful functions to perform, and, though it would be contrary to all our principles even to consider the possibility of prohibiting them altogether, it is desirable to show explicitly why there is no economic ground for such action and why, as truly voluntary and non-coercive organizations, they may have important services to render. It is in fact more than probable that unions will fully develop their potential usefulness only after they have been diverted from their present anti-social aims by an effective prevention of the use of coercion.18

Unions without coercive powers would probably play a useful and important role even in the process of wage determination. In the first place, there is often a choice to be made between wage increases, on the one hand, and, on the other, alternative benefits which the employer could provide at the same cost but which he can provide only if all or most of the workers are willing to accept them in preference to additional pay. There is also the fact that the relative position of the individual on the wage scale is often nearly as important to him as his absolute position. In any hierarchical organisation it is important that the differentials between the remuneration for the different jobs and the rules of promotion are felt to be just by the majority.19 The most effective way of securing consent is probably to have the general scheme agreed to in collective negotiations in which all the different interests are represented. Even from the employer’s point of view it would be difficult to conceive of any other way of reconciling all the different considerations that in a large organisation have to be taken into account in arriving at a satisfactory wage structure. An agreed set of standard terms, available to all who wish to take advantage of them, though not excluding special arrangements in individual cases, seems to be required by the needs of large-scale organisations.

The same is true to an even greater extent of all the general problems relating to conditions of work other than individual remuneration, those problems which truly concern all employees and which, in the mutual interest of workers and employers, should be regulated in a manner that takes account of as many desires as possible. A large organisation must in a great measure be governed by rules, and such rules are likely to operate most effectively if drawn up with the participation of the workers.20 Because a contract between employers and employees regulates not only relations between them but also relations between the various groups of employees, it is often expedient to give it the character of a multilateral agreement and to provide in certain respects, as in grievance procedure, for a degree of self-government among the employees.

There is, finally, the oldest and most beneficial activity of the unions, in which as ‘friendly societies’ they undertake to assist members in providing against the peculiar risks of their trade. This is a function which must in every respect be regarded as a highly desirable form of self-help, albeit one which is gradually being taken over by the state. We shall leave the question open, however, as to whether any of the above arguments justify unions of a larger scale than that of the plant or corporation.

An entirely different matter, which we can mention here only in passing, is the claim of unions to participation in the conduct of business. Under the name of ‘industrial democracy’ or, more recently, under that of ‘codetermination’, this has acquired considerable popularity, especially in Germany and to a lesser degree in Britain. It represents a curious recrudescence of the ideas of the syndicalist branch of nineteenth-century socialism, the least thought-out and most impractical form of that doctrine. Though these ideas have a certain superficial appeal, they reveal inherent contradictions when examined. A plant or industry cannot be conducted in the interest of some permanent distinct body of workers if it is at the same time to serve the interests of the consumers. Moreover, effective participation in the direction of an enterprise is a full-time job, and anybody so engaged soon ceases to have the outlook and interest of an employee. It is not only from the point of view of the employers, therefore, that such a plan should be rejected; there are very good reasons why in the United States union leaders have emphatically refused to assume any responsibility in the conduct of business. For a fuller examination of this problem we must, however, refer the reader to the careful studies, now available, of all its implications.21

Minor Changes in the Law

Though it may be impossible to protect the individual against all union coercion so long as general opinion regards it as legitimate, most students of the subject agree that comparatively few and, as they may seem at first, minor changes in law and jurisdiction would suffice to produce far-reaching and probably decisive changes in the existing situation.22 The mere withdrawal of the special privileges either explicitly granted to the unions or arrogated by them with the toleration of the courts would seem enough to deprive them of the more serious coercive powers which they now exercise and to channel their legitimate selfish interests so that they would be socially beneficial.

The essential requirement is that true freedom of association be assured and that coercion be treated as equally illegitimate whether employed for or against organisation, by the employer or by the employees. The principle that the end does not justify the means and that the aims of the unions do not justify their exemption from the general rules of law should be strictly applied. Today this means, in the first place, that all picketing in numbers should be prohibited, since it is not only the chief and regular cause of violence but even in its most peaceful forms is a means of coercion. Next, the unions should not be permitted to keep non-members out of any employment. This means that closed- and union-shop contracts (including such varieties as the ‘maintenance of membership’ and ‘preferential hiring’ clauses) must be treated as contracts in restraint of trade and denied the protection of the law. They differ in no respect from the ‘yellow-dog contract’ which prohibits the individual worker from joining a union and which is commonly prohibited by the law.

The invalidating of all such contracts would, by removing the chief objects of secondary strikes and boycotts, make these and similar forms of pressure largely ineffective. It would be necessary, however, also to rescind all legal provisions which make contracts concluded with the representatives of the majority of workers of a plant or industry binding on all employees and to deprive all organised groups of any right of concluding contracts binding on men who have not voluntarily delegated this authority to them.23 Finally, the responsibility for organised and concerted action in conflict with contractual obligations or the general law must be firmly placed on those in whose hands the decision lies, irrespective of the particular form of organized action adopted.

It would not be a valid objection to maintain that any legislation making certain types of contracts invalid would be contrary to the principle of freedom of contract. We have seen before (in Chap. xv) that this principle can never mean that all contracts will be legally binding and enforceable. It means merely that all contracts must be judged according to the same general rules and that no authority should be given discretionary power to allow or disallow particular contracts. Among the contracts to which the law ought to deny validity are contracts in restraint of trade. Closed- and union-shop contracts fall clearly into this category. If legislation, jurisdiction, and the tolerance of executive agencies had not created privileges for the unions, the need for special legislation concerning them would probably not have arisen in common-law countries. That there is such a need is a matter for regret, and the believer in liberty will regard any legislation of this kind with misgivings. But, once special privileges have become part of the law of the land, they can be removed only by special legislation. Though there ought to be no need for special ‘right-to-work laws’, it is difficult to deny that the situation created in the United States by legislation and by the decisions of the Supreme Court may make special legislation the only practicable way of restoring the principles of freedom.24

The specific measures which would be required in any given country to reinstate the principles of free association in the field of labour will depend on the situation created by its individual development. The situation in the United States is of special interest, for here legislation and the decisions of the Supreme Court have probably gone further than elsewhere25 in legalising union coercion and very far in conferring discretionary and essentially irresponsible powers on administrative authority. But for further details we must refer the reader to the important study by Professor Petro on The Labor Policy of the Free Society,26 in which the reforms required are fully described.

Though all the changes needed to restrain the harmful powers of the unions involve no more than that they be made to submit to the same general principles of law that apply to everybody else, there can be no doubt that the existing unions will resist them with all their power. They know that the achievement of what they at present desire depends on that very coercive power which will have to be restrained if a free society is to be preserved. Yet the situation is not hopeless. There are developments under way which sooner or later will prove to the unions that the existing state cannot last. They will find that, of the alternative courses of further development open to them, submitting to the general principle that prevents all coercion will be greatly preferable in the long run to continuing their present policy; for the latter is bound to lead to one of two unfortunate consequences.

Responsibility for Unemployment

While labour unions cannot in the long run substantially alter the level of real wages that all workers can earn and are, in fact, more likely to lower than to raise them, the same is not true of the level of money wages. With respect to them, the effect of union action will depend on the principles governing monetary policy. What with the doctrines that are now widely accepted and the policies accordingly expected from the monetary authorities, there can be little doubt that current union policies must lead to continuous and progressive inflation. The chief reason for this is that the dominant ‘full-employment’ doctrines explicitly relieve the unions of the responsibility for any unemployment and place the duty of preserving full employment on the monetary and fiscal authorities. The only way in which the latter can prevent union policy from producing unemployment is, however, to counter through inflation whatever excessive rises in real wages unions tend to cause.

In order to understand the situation into which we have been led, it will be necessary to take a brief look at the intellectual sources of the full-employment policy of the ‘Keynesian’ type. The development of Lord Keynes’s theories started from the correct insight that the regular cause of extensive unemployment is real wages that are too high. The next step consisted in the proposition that a direct lowering of money wages could be brought about only by a struggle so painful and prolonged that it could not be contemplated. Hence he concluded that real wages must be lowered by the process of lowering the value of money. This is really the reasoning underlying the whole ‘full-employment’ policy, now so widely accepted.27 If labour insists on a level of money wages too high to allow of full employment, the supply of money must be so increased as to raise prices to a level where the real value of the prevailing money wages is no longer greater than the productivity of the workers seeking employment. In practice, this necessarily means that each separate union, in its attempt to overtake the value of money, will never cease to insist on further increases in money wages and that the aggregate effort of the unions will thus bring about progressive inflation.

This would follow even if individual unions did no more than prevent any reduction in the money wages of any particular group. Where unions make such wage reductions impracticable and wages have generally become, as the economists put it, ‘rigid downward’, all the changes in relative wages of the different groups made necessary by the constantly changing conditions must be brought about by raising all money wages except those of the group whose relative real wages must fall. Moreover, the general rise in money wages and the resulting increase in the cost of living will generally lead to attempts, even on the part of the latter group, to push up money wages, and several rounds of successive wage increases will be required before any readjustment of relative wages is produced. Since the need for adjustment of relative wages occurs all the time, this process alone produces the wage-price spiral that has prevailed since the second World War, that is, since full-employment policies became generally accepted.28

The process is sometimes described as though wage increases directly produced inflation. This is not correct. If the supply of money and credit were not expanded, the wage increases would rapidly lead to unemployment. But under the influence of a doctrine that represents it as the duty of the monetary authorities to provide enough money to secure full employment at any given wage level, it is politically inevitable that each round of wage increases should lead to further inflation.29 Or it is inevitable until the rise of prices becomes sufficiently marked and prolonged to cause serious public alarm. Efforts will then be made to apply the monetary brakes. But, because by that time the economy will have become geared to the expectation of further inflation and much of the existing employment will depend on continued monetary expansion, the attempt to stop it will rapidly produce substantial unemployment. This will bring a renewed and irresistible pressure for more inflation. And, with ever bigger doses of inflation, it may be possible for quite a long time to prevent the appearance of the unemployment which the wage pressure would otherwise cause. To the public at large it will seem as if progressive inflation were the direct consequence of union wage policy rather than of an attempt to cure its consequences.

Though this race between wages and inflation is likely to go on for some time, it cannot go on indefinitely without people coming to realise that it must somehow be stopped. A monetary policy that would break the coercive powers of the unions by producing extensive and protracted unemployment must be excluded, for it would be politically and socially fatal. But if we do not succeed in time in curbing union power at its source, the unions will soon be faced with a demand for measures that will be much more distasteful to the individual workers, if not the union leaders, than the submission of the unions to the rule of law: the clamour will soon be either for the fixing of wages by government or for the complete abolition of the unions.

Progression to Central Control

In the field of labour, as in any other field, the elimination of the market as a steering mechanism would necessitate the replacement of it by a system of administrative direction. In order to approach even remotely the ordering function of the market, such direction would have to coordinate the whole economy and therefore, in the last resort, have to come from a single central authority. And though such an authority might at first concern itself only with the allocation and remuneration of labour, its policy would necessarily lead to the transformation of the whole of society into a centrally planned and administered system, with all its economic and political consequences.

In those countries in which inflationary tendencies have operated for some time, we can observe increasingly frequent demands for an ‘overall wage policy’. In the countries where these tendencies have been most pronounced, notably in Great Britain, it appears to have become accepted doctrine among the intellectual leaders of the Left that wages should generally be determined by a ‘unified policy’, which ultimately means that government must do the determining.30 If the market were thus irretrievably deprived of its function, there would be no efficient way of distributing labour throughout the industries, regions, and trades, other than having wages determined by authority. Step by step, through setting up an official conciliation and arbitration machinery with compulsory powers, and through the creation of wage boards, we are moving towards a situation in which wages will be determined by what must be essentially arbitrary decisions of authority.

All this is no more than the inevitable outcome of the present policies of labour unions, who are led by the desire to see wages determined by some conception of ‘justice’ rather than by the forces of the market. But in no workable system could any group of people be allowed to enforce by the threat of violence what it believes it should have. And when not merely a few privileged groups but most of the important sections of labour have become effectively organised for coercive action, to allow each to act independently would not only produce the opposite of justice but result in economic chaos. When we can no longer depend on the impersonal determination of wages by the market, the only way we can retain a viable economic system is to have them determined authoritatively by government. Such determination must be arbitrary, because there are no objective standards of justice that could be applied.31 As is true of all other prices or services, the wage rates that are compatible with an open opportunity for all to seek employment do not correspond to any assessable merit or any independent standard of justice but must depend on conditions which nobody can control.

Once government undertakes to determine the whole wage structure and is thereby forced to control employment and production, there will be a far greater destruction of the present powers of the unions than their submission to the rule of equal law would involve. Under such a system the unions will have only the choice between becoming the willing instrument of governmental policy and being incorporated into the machinery of government, on the one hand, and being totally abolished, on the other. The former alternative is more likely to be chosen, since it would enable the existing union bureaucracy to retain their position and some of their personal power. But to the workers it would mean complete subjection to the control by a corporative state. The situation in most countries leaves us no choice but to await some such outcome or to retrace our steps. The present position of the unions cannot last, for they can function only in a market economy which they are doing their best to destroy.

‘Unassailable’ Union Powers

The problem of labour unions constitutes both a good test of our principles and an instructive illustration of the consequences if they are infringed. Having failed in their duty of preventing private coercion, governments are now driven everywhere to exceed their proper function in order to correct the results of that failure and are thereby led into tasks which they can perform only by being as arbitrary as the unions. So long as the powers that the unions have been allowed to acquire are regarded as unassailable, there is no way to correct the harm done by them but to give the state even greater arbitrary power of coercion. We are indeed already experiencing a pronounced decline of the rule of law in the field of labour.32 Yet all that is really needed to remedy the situation is a return to the principles of the rule of law and to their consistent application by legislative and executive authorities.

This path is still blocked, however, by the most fatuous of all fashionable arguments, namely, that ‘we cannot turn the clock back’. One cannot help wondering whether those who habitually use this cliché are aware that it expresses the fatalistic belief that we cannot learn from our mistakes, the most abject admission that we are incapable of using our intelligence. I doubt whether anybody who takes a long-range view believes that there is another satisfactory solution which the majority would deliberately choose if they fully understood where the present developments were leading. There are some signs that farsighted union leaders are also beginning to recognise that, unless we are to resign ourselves to the progressive extinction of freedom, we must reverse that trend and resolve to restore the rule of law and that, in order to save what is valuable in their movement, they must abandon the illusions which have guided it for so long.33

Nothing less than a rededication of current policy to principles already abandoned will enable us to avert the threatening danger to freedom. What is required is a change in economic policy, for in the present situation the tactical decisions which will seem to be required by the short-term needs of government in successive emergencies will merely lead us further into the thicket of arbitrary controls. The cumulative effects of those palliatives which the pursuit of contradictory aims makes necessary must prove strategically fatal. As is true of all problems of economic policy, the problem of labour unions cannot be satisfactorily solved by ad hoc decisions on particular questions but only by the consistent application of a principle that is uniformly adhered to in all fields. There is only one such principle that can preserve a free society: namely, the strict prevention of all coercion except in the enforcement of general abstract rules equally applicable to all.

(The Constitution of Liberty, extracts from Chap. 18)

17. (a) INFLATION—A SHORT-TERM EXPEDIENT

 (b) INFLATION—THE DECEIT IS SHORT-LIVED

In the first of these two extracts, Professor Hayek points out that one effect of inflation in its initial stages is to keep afloat businesses that would otherwise suffer losses. But as inflation proceeds and comes to be expected, costs are bid up in anticipation, profits shrink back to non-inflationary levels (in real terms), and apparently deflationary symptoms begin to appear.

In the second extract he outlines a non-inflationary criterion for monetary stability in line with currently unchangeable historical circumstances, viz. maintaining the stability of a comprehensive price index. Given the change in union wage-rate policy outlined in earlier extracts, such a monetary policy would also produce stability in total employment.

Professor Hayek emphasises two social dangers of inflation. First, by destroying the value of savings and of fixed incomes it creates the problem of poverty in old age, as well as a dangerous gap between the wealthy minority and the propertyless majority. Second, it reinforces the disinclination to take long-term effects into account when determining policy.

17.   (a) Inflation—A Short-term Expedient

Although there are a few people who deliberately advocate a continuous upward movement of prices, the chief source of the existing inflationary bias is the general belief that deflation, the opposite of inflation, is so much more to be feared that, in order to keep on the safe side, a persistent error in the direction of inflation is preferable. But, as we do not know how to keep prices completely stable and can achieve stability only by correcting any small movement in either direction, the determination to avoid deflation at any cost must result in cumulative inflation. Also, the fact that inflation and deflation will often be local or sectional phenomena which must occur necessarily as part of the mechanism redistributing the resources of the economy means that attempts to prevent any deflation affecting a major area of the economy must result in overall inflation.

Inflation Similar to Drug-taking

It is, however, rather doubtful whether, from a long-term point of view, deflation is really more harmful than inflation. Indeed, there is a sense in which inflation is infinitely more dangerous and needs to be more carefully guarded against. Of the two errors, it is the one much more likely to be committed. The reason for this is that moderate inflation is generally pleasant while it proceeds, whereas deflation is immediately and acutely painful.34 There is little need to take precautions against any practice the bad effects of which will be immediately and strongly felt; but there is need for precautions wherever action which is immediately pleasant or relieves temporary difficulties involves much greater harm that will be felt only later. There is, indeed, more than a mere superficial similarity between inflation and drug-taking, a comparison which has often been made.

Inflation and deflation both produce their peculiar effects by causing unexpected price changes, and both are bound to disappoint expectations twice. The first time is when prices prove to be higher or lower than they were expected to be and the second when, as must sooner or later happen, these price changes come to be expected and cease to have the effect which their unforeseen occurrence had. The difference between inflation and deflation is that, with the former, the pleasant surprise comes first and the reaction later, while, with the latter, the first effect on business is depressing. The effects of both, however, are self-reversing. For a time the forces which bring about either tend to feed on themselves, and the period during which prices move faster than expected may thus be prolonged. But unless price movements continue in the same direction at an ever accelerating rate, expectations must catch up with them. As soon as this happens, the character of the effects changes.

Inflation at first merely produces conditions in which more people make profits and in which profits are generally larger than usual. Almost everything succeeds, there are hardly any failures. The fact that profits again and again prove to be greater than had been expected and that an unusual number of ventures turn out to be successful produces a general atmosphere favourable to risk-taking. Even those who would have been driven out of business without the windfalls caused by the unexpected general rise in prices are able to hold on and to keep their employees in the expectation that they will soon share in the general prosperity. This situation will last, however, only until people begin to expect prices to continue to rise at the same rate. Once they begin to count on prices being so many percent higher in so many months’ time, they will bid up the prices of the factors of production which determine the costs to a level corresponding to the future prices they expect. If prices then rise no more than had been expected, profits will return to normal, and the proportion of those making a profit also will fall; and since, during the period of exceptionally large profits, many have held on who would otherwise have been forced to change the direction of their efforts, a higher proportion than usual will suffer losses.

The stimulating effect of inflation will thus operate only so long as it has not been foreseen; as soon as it comes to be foreseen, only its continuation at an increased rate will maintain the same degree of prosperity. If in such a situation prices rose less than expected, the effect would be the same as that of unforeseen deflation. Even if they rose only as much as was generally expected, this would no longer provide the exceptional stimulus but would lay bare the whole backlog of adjustments that had been postponed while the temporary stimulus lasted. In order for inflation to retain its initial stimulating effect, it would have to continue at a rate always faster than expected.

Accelerating Inflation

We cannot consider here all the complications which make it impossible for adaptations to an expected change in prices ever to become perfect, and especially for long-term and short-term expectations to become equally adjusted; nor can we go into the different effects on current production and on investment which are so important in any full examination of industrial fluctuations. It is enough for our purpose to know that the stimulating effects of inflation must cease to operate unless its rate is progressively accelerated and that, as it proceeds, certain unfavourable consequences of the fact that complete adaptation is impossible become more and more serious. The most important of these is that the methods of accounting on which all business decisions rest make sense only so long as the value of money is tolerably stable. With prices rising at an accelerating rate, the techniques of capital and cost accounting that provide the basis for all business planning would soon lose all meaning. Real costs, profits, or income would soon cease to be ascertainable by any conventional or generally acceptable method. And, with the principles of taxation being what they are, more and more would be taken in taxes as profits that in fact should be reinvested merely to maintain capital.

Inflation thus can never be more than a temporary fillip, and even this beneficial effect can last only as long as somebody continues to be cheated and the expectations of some people unnecessarily disappointed. Its stimulus is due to the errors which it produces. It is particularly dangerous because the harmful after-effects of even small doses of inflation can be staved off only by larger doses of inflation. Once it has continued for some time, even the prevention of further acceleration will create a situation in which it will be very difficult to avoid a spontaneous deflation. Once certain activities that have become extended can be maintained only by continued inflation, their simultaneous discontinuation, may well produce that vicious and rightly feared process in which the decline of some incomes leads to the decline of other incomes, and so forth. From what we know, it still seems probable that we should be able to prevent serious depressions by preventing the inflations which regularly precede them, but that there is little we can do to cure them, once they have set in. The time to worry about depressions is, unfortunately, when they are furthest from the minds of most people.

The Path of Least Resistance

The manner in which inflation operates explains why it is so difficult to resist when policy mainly concerns itself with particular situations rather than with general conditions and with short-term rather than with long-term problems. It is usually the easy way out of any temporary difficulties for both government and private business—the path of least resistance and sometimes also the easiest way to help the economy get over all the obstacles that government policy has placed in its way.35 It is the inevitable result of a policy which regards all the other decisions as data to which the supply of money must be adapted so that the damage done by other measures will be as little noticed as possible. In the long run, however, such a policy makes governments the captives of their own earlier decisions, which often force them to adopt measures that they know to be harmful. It is no accident that the author whose views, perhaps mistakenly interpreted, have given more encouragement to these inflationary propensities than any other man’s is also responsible for the fundamentally anti-liberal aphorism, ‘in the long run we are all dead’.36 The inflationary bias of our day is largely the result of the prevalence of the short-term view, which in turn stems from the great difficulty of recognising the more remote consequences of current measures, and from the inevitable preoccupation of practical men, and particularly politicians, with the immediate problems and the achievement of near goals.

Because inflation is psychologically and politically so much more difficult to prevent than deflation and because it is, at the same time, technically so much more easily prevented, the economist should always stress the dangers of inflation. As soon as deflation makes itself felt, there will be immediate attempts to combat it—often when it is only a local and necessary process that should not be prevented. There is more danger in untimely fears of deflation than in the possibility of our not taking necessary counter-measures. While nobody is likely to mistake local or sectional prosperity for inflation, people often demand wholly inappropriate monetary counter-measures when there is a local or sectional depression.

These considerations would seem to suggest that, on balance, probably some mechanical rule which aims at what is desirable in the long run and ties the hands of authority in its short-term decisions is likely to produce a better monetary policy than principles which give to the authorities more power and discretion and thereby make them more subject to both political pressure and their own inclination to overestimate the urgency of the circumstances of the moment. This, however, raises issues which we must approach more systematically.

17.   (b) Inflation—The Deceit is Short-lived

I certainly have no wish to weaken the case for any arrangement that will force the authorities to do the right thing. The case for such a mechanism becomes stronger as the likelihood of the monetary policy’s being affected by considerations of public finance becomes greater; but it would weaken, rather than strengthen, the argument if we exaggerated what can be achieved by it. It is probably undeniable that, though we can limit discretion in this field, we never can eliminate it; in consequence, what can be done within the unavoidable range of discretion not only is very important but is likely in practice to determine even whether or not the mechanism will ever be allowed to operate.

Limited Central Bank Influence

There is one basic dilemma, which all central banks face, which makes it inevitable that their policy must involve much discretion. A central bank can exercise only an indirect and therefore limited control over all the circulating media. Its power is based chiefly on the threat of not supplying cash when it is needed. Yet at the same time it is considered to be its duty never to refuse to supply this cash at a price when needed. It is this problem, rather than the general effects of policy on prices or the value of money, that necessarily preoccupies the central banker in his day-to-day actions. It is a task which makes it necessary for the central bank constantly to forestall or counteract developments in the realm of credit, for which no simple rules can provide sufficient guidance.37

The same is nearly as true of the measures intended to affect prices and employment. They must be directed more at forestalling changes before they occur than at correcting them after they have occurred. If a central bank always waited until rule or mechanism forced it to take action, the resulting fluctuations would be much greater than they need be. And if, within the range of its discretion, it takes measures in a direction opposite to those which mechanism or rule will later impose upon it, it will probably create a situation in which the mechanism will not long be allowed to operate. In the last resort, therefore, even where the discretion of the authority is greatly restricted, the outcome is likely to depend on what the authority does within the limits of its discretion.

This means in practice that under present conditions we have little choice but to limit monetary policy by prescribing its goals rather than its specific actions. The concrete issue today is whether it ought to keep stable some level of employment or some level of prices. Reasonably interpreted and with due allowance made for the inevitability of minor fluctuations around a given level, these two aims are not necessarily in conflict, provided that the requirements for monetary stability are given first place and the rest of economic policy is adapted to them. A conflict arises, however, if ‘full employment’ is made the chief objective and this is interpreted, as it sometimes is, as that maximum of employment which can be produced by monetary means in the short run. That way lies progressive inflation.

The reasonable goal of a high and stable level of employment can probably be secured as well as we know how while aiming at the stability of some comprehensive price level. For practical purposes, it probably does not greatly matter precisely how this price level is defined, except that it should not refer exclusively to final products (for if it did, it might in times of rapid technological advance still produce a significant inflationary tendency), and that it should be based as much as possible on international rather than local prices. Such a policy, if pursued simultaneously by two or three of the major countries, should also be reconcilable with stability of exchange rates. The important point is that there will be definite known limits which the monetary authorities will not allow price movements to exceed—or even to approach to the point of making drastic reversals of policy necessary.

Weak Opposition to Inflation

Though there may be some people who explicitly advocate continuous inflation, it is certainly not because the majority wants it that we are likely to get it. Few people would be willing to accept it when it is pointed out that even such a seemingly moderate increase in prices as 3 percent per annum means that the price level will double every twenty-three and a half years and that it will nearly quadruple over the normal span of a man’s working life. The danger that inflation will continue is not so much due to the strength of those who deliberately advocate it as to the weakness of the opposition. In order to prevent it, it is necessary for the public to become clearly aware of the things we can do and of the consequences of not doing them. Most competent students agree that the difficulty of preventing inflation is only political and not economic. Yet almost no one seems to believe that the monetary authorities have the power to prevent it and will exercise it. The greatest optimism about the short-term miracles that monetary policy will achieve is accompanied by a complete fatalism about what it will produce in the long run.

There are two points which cannot be stressed enough: first, it seems certain that we shall not stop the drift toward more and more state control unless we stop the inflationary trend; and, second, any continued rise in prices is dangerous because, once we begin to rely on its stimulating effect, we shall be committed to a course that will leave us no choice but that between more inflation, on the one hand, and paying for our mistake by a recession or depression, on the other. Even a very moderate degree of inflation is dangerous because it ties the hands of those responsible for policy by creating a situation in which, every time a problem arises, a little more inflation seems the only easy way out.

We have not had space to touch on the various ways in which the efforts of individuals to protect themselves against inflation, such as sliding-scale contracts, not only tend to make the process self-accelerating but also increase the rate of inflation necessary to maintain its stimulating effect. Let us simply note, then, that inflation makes it more and more impossible for people of moderate means to provide for their old age themselves; that it discourages saving and encourages running into debt; and that, by destroying the middle class, it creates that dangerous gap between the completely propertyless and the wealthy that is so characteristic of societies which have gone through prolonged inflations and which is the source of so much tension in those societies. Perhaps even more ominous is the wider psychological effect, the spreading among the population at large of that disregard of long-range views and exclusive concern with immediate advantages which already dominate public policy.

It is no accident that inflationary policies are generally advocated by those who want more government control—though, unfortunately, not by them alone. The increased dependence of the individual upon government which inflation produces and the demand for more government action to which this leads may for the socialist be an argument in its favour. Those who wish to preserve freedom should recognise, however, that inflation is probably the most important single factor in that vicious circle wherein one kind of government action makes more and more government control necessary. For this reason all those who wish to stop the drift toward increasing government control should concentrate their efforts on monetary policy. There is perhaps nothing more disheartening than the fact that there are still so many intelligent and informed people who in most other respects will defend freedom and yet are induced by the immediate benefits of an expansionist policy to support what, in the long run, must destroy the foundations of a free society.

(The Constitution of Liberty, pp. 330–33, 336–39)

 

_______________

38Including the most ‘orthodox’ political economists, who invariably supported freedom of association. See particularly the discussion in J.R. McCulloch, Treatise on the Circumstances Which Determine the Rate of Wages and the Condition of the Labouring Classes (London, 1851), pp. 79–89, with its stress on voluntary association. For a comprehensive statement of the classical liberal attitude toward the legal problems involved see Ludwig Bamberger, Die Arbeiterfrage unter dem Gesichtspunkte des Vereinsrechtes (Stuttgart, 1873).

39Characteristic is the description of the ‘liberal’ attitude to unions in C.W. Mills, The New Men of Power (New York: Harcourt Brace, 1948), p. 21:

‘In many liberal minds there seems to be an undercurrent that whispers: “I will not criticise the unions and their leaders. There I draw the line.” This, they must feel, distinguishes them from the bulk of the Republican Party and the right-wing Democrats, this keeps them leftward and socially pure.’

40A.V. Dicey, ‘Introduction’ to the second edition of his Law and Opinion (London: Macmillan, 1914), pp. xlv–xlvi. He continues to say that the law

makes a trade union a privileged body exempted from the ordinary law of the land. No such privileged body has ever before been deliberately created by an English Parliament [and that] it stimulates among workmen the fatal delusion that workmen should aim at the attainment, not of equality, but of privilege.

Cf. also the comment on the same law thirty years later, by J.A. Schumpeter, Capitalism, Socialism, and Democracy (New York: Harper & Row, 1942), p. 321:

It is diffcult, at the present time, to realise how this measure must have struck people who still believed in a state and in a legal system that centred in the institution of private property. For in relaxing the law of conspiracy in respect to peaceful picketing—which practically amounted to legalisation of trade-union action implying the threat of force—and in exempting trade-union funds from liability in action for damages for torts—which practically amounted to enacting that trade unions could do no wrong—this measure in fact resigned to the trade unions part of the authority of the state and granted to them a position of privilege which the formal extension of the exemption to employers’ unions was powerless to affect.

still more recently the Lord Chief Justice of Northern Ireland said of the same act (Lord MacDermott, Protection from Power under English Law , p. 174) : ‘In short, it put trade unionism in the same privileged position which the Crown enjoyed until ten years ago in respect of wrongful acts committed on its behalf’.

41Roscoe Pound, Legal Immunities of Labor Unions (Washington, D.C.: American Enterprise Association, 1957), p. 23, reprinted in E.H. Chamberlin, and others, Labor Unions and Public Policy (Washington, D.C.: American Enterprise Association, 1958).

42Justice Jackson dissenting in Hunt v. Crumboch, 325 US 831 (1946).

43Ludwig von Mises, Die Gemeinwirtschaft (2nd ed.; Jena: Gustav Fischer, 1932), p. 447.

44Few liberal sympathisers of the trade unions would dare to express the obvious truth which a courageous woman from within the British labour movement frankly stated, namely, that ‘it is in fact the business of a Union to be anti-social; the members would have a just grievance if their officials and committees ceased to put sectional interests first’ (Barbara Wootton, Freedom under Planning , p. 97). On the flagrant abuses of union power in the United States, which I shall not further consider here, see Sylvester Petro, Power Unlimited: The Corruption of Union Leadership (New York: The Ronald Press Company, 1959).

45In this chapter, more than in almost any other, I shall be able to draw upon a body of opinion that is gradually forming among an increasing number of thoughtful students of these matters—men who in background and interest are at least as sympathetic to the true concerns of the workers as those who in the past have been championing the privileges of the unions. See particularly W.H. Hutt, The Theory of Collective Bargaining (London: P.S. King, 1930), and Economists and the Public (London: Jonathan Cape, 1936); H.C. Simons, ‘Some Reflections on Syndicalism’, Journal of Political Economy LII (1944), reprinted in Economic Policy for a Free Society (Chicago: University Chicago Press, 1948); J.T. Dunlop, Wage Determination under Trade Unions (New York: Macmillan, 1944); Economic Institute on Wage Determination and the Economics of Liberalism (Washington, D.C.: Chamber of Commerce of the United States, 1947) (especially the contributions ‘Wage Determination as a Part of the General Problem of Monopoly’, by Jacob Viner and ‘Monopolistic Wage Determination as a Part of the General Problem of Monopoly’, by Fritz Machlup); Leo Wolman, Industry-wide Bargaining (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1948); C.E. Lindblom, Unions and Capitalism (New Haven, Conn.: Yale University Press, 1949) (cf. the reviews of this book by A. Director, University of Chicago Law Review XVIII [1950]; by J.T. Dunlop in American Economic Review XL [1950]; and by Albert Rees in Journal of Political Economy LVIII [1950]); The Impact of the Union, ed. David McCord Wright (New York: Harcourt Brace, 1951 [especially the contributions ‘Some Comments on the Significance of Labor Unions for Economic Policy’, by M. Friedman and ‘Wage Policy, Employment, and Economic Stability ’, by G. Haberler]); Fritz Machlup, The Political Economy of Monopoly (Baltimore: Johns Hopkins Press, 1952); D.R. Richberg, Labor Union Monopoly (Chicago: Henry Regnery, 1957) ; Sylvester Petro, The Labor Policy of the Free Society (New York: The Ronald Press Company, 1957); E.H. Chamberlin, The Economic Analysis of Labor Power (1958), P.D. Bradley, Involuntary Participation in Unionism (1956), and G.D. Reilly, State Rights and the Law of Labor Relations (1955), all three published by the American Enterprise Association (Washington, D.C.) and reprinted together with the pamphlet by Roscoe Pound (LegalImmunities of Labor Unions; B.C. Roberts, Trade Unions in a Free Society (London: Institute of Economic Affairs, 1959); and John Davenport, ‘Labor Unions in the Free Society ’, Fortune (April, 1959), and ‘Labor and the Law ’, Fortune (May, 1959). On general wage theory and the limits of the powers of the unions see also J.R. Hicks, The Theory of Wages (London: Macmillan, 1932); R. Strigl, Angewandte Lohntheorie (Leipzig and Vienna: Franz Deuticke, 1926); and The Theory of Wage Determination, ed. J.T. Dunlop (London: Macmillan, 1957).

46See particularly the works by H. C. simons and W. H. Hutt cited in the preceding note. Whatever limited validity the old argument about the necessity of ‘equalising bargaining power’ by the formation of unions may ever have had, has certainly been destroyed by the modern development of the increasing size and specificity of the employers’ investment, on the one hand, and the increasing mobility of labour (made possible by the automobile), on the other.

47This must be emphasised especially against the argument of Lindblom in Unions and Capitalism.

48Chamberlin, The Economic Analysis of Labor Power, pp. 4–5, rightly stresses that ‘there can be no doubt that one effect of trade union policy . . . is to diminish still further the real income of the really low income groups, including not only the low income wage receivers but also such other elements of society as “self-employed” and small business men’.

49Cf. F. Machlup in these two studies: ‘Monopolistic Wage Determination as a Part of the General Problem of Monopoly’ and The Political Economy of Monopoly.

50A conspicuous example of this in recent times is the case of the notoriously unorganised domestic servants whose average annual wages (as pointed out by M. Friedman in D. Wright’s The Impact of the Union, p. 224) in the United States in 1947 were 2.72 times as high as they had been in 1939, while at the end of the same period the wages of the comprehensively organised steel workers had risen only to 1.98 times the initial level.

51Cf. Bradley, Involuntary Participation in Unionism.

52Cf. S.P. Sobotka, ‘Union Influence on Wages: The Construction Industry’, Journal of Political Economy LXI (1953).

53It would be difficult to exaggerate the extent to which unions prevent the experimentation with, and gradual introduction of, new arrangements that might be in the mutual interest of employers and employees. For example, it is not at all unlikely that in some industries it would be in the interest of both to agree on ‘guaranteed annual wages’ if unions permitted individuals to make a sacrifice in the amount of wages in return for a greater degree of security.

54To illustrate the nature of much contemporary wage bargaining in the United States, E.H. Chamberlin, in The Economic Analysis of Labor Power, uses an analogy which I cannot better:

Some perspective may be had on what is involved by imagining an application of the techniques of the labour market in some other field. If A is bargaining with B over the sale of his house, and if A were given the privileges of a modern labour union, he would be able (1) to conspire with all other owners of houses not to make any alternative offers to B, using violence or the threat of violence if necessary to prevent them, (2) to deprive B himself of access to any alternative offers, (3) to surround the house of B and cut off all deliveries of food (except by parcel post), (4) to stop all movement from B’s house, so that if he were for instance a doctor he could not sell his services and make a living, and (5) to institute a boycott of B’s business. All of these privileges, if he were capable of carrying them out, would no doubt strengthen A’s position. But they would not be regarded by anyone as part of ‘bargaining’—unless A were a labour union.

55Cf. Petro, The Labor Policy of the Free Society, p. 51:

Unions can and do serve useful purposes, and they have only barely scratched the surface of their potential utility to employees. When they really get to work on the job of serving employees instead of making such bad names for themselves as they do in coercing and abusing employers, they will have much less difficulty than they presently have in securing and keeping new members. As matters now stand, union insistence upon the closed shop amounts to an admission that unions are really not performing their functions very well.

56Cf. C.I. Barnard, ‘Functions and Pathology of Status Systems in Formal Organizations’, in Industry and Society, ed. W.F. Whyte (New York: McGraw-Hill 1946), reprinted in Barnard’s Organization and Management (Cambridge, Mass.: Harvard University Press, 1949).

57Cf. Sumner Slichter, Trade Unions in a Free Society (Cambridge, Mass: Harvard University Press, 1947), p. 12, where it is argued that such rules ‘introduce into industry the equivalent of civil rights, and they greatly enlarge the range of human activities which are governed by rule of law rather than by whim or caprice.’ See also A.W. Gouldner, Patterns of Industrial Bureaucracy (Glencoe, Ill.: The Free Press, 1954), especially the discussion of ‘rule by rule’.

58See particularly Franz Böhm, ‘Das wirtschaftliche Mitbestimmungsrecht der Arbeiter im Betrieb’, Ordo IV (1951); and Götz Briefs, Zwischen Kapitalismus und Syndikalismus (Bern: Francke, 1952).

59See the essays ‘Wage Determination as a Part of the General Problem of Monopoly’, by Viner and ‘Wage Policy, Employment, and Economic Stability’, by Haberler; ‘Some Comments on the Significance of Labor Unions for Economic Policy’, by Friedman; and the book The Labor Policy of the Free Society by Petro.

60Such contracts binding on third parties are equally as objectionable in this field as is the forcing of price-maintenance agreements on non-signers by ‘fair-trade’ laws.

61Such legislation, to be consistent with our principles, should not go beyond declaring certain contracts invalid, which is sufficient for removing all pretext for action to obtain them. It should not, as the title of the ‘right-to-work laws’ may suggest, give individuals a claim to a particular job, or even (as some of the laws in force in certain American states do) confer a right to damages for having been denied a particular job, when the denial is not illegal on other grounds. The objections against such provisions are the same as those which apply to ‘fair employment practices’ laws.

62See A. Lenhoff, ‘The Problem of Compulsory Unionism in Europe’, American Journal of Comparative Law V (1956).

63See Petro, Power Unlimited: The Corruption of Union Leadership, esp. pp. 235ff. and 282.

64See the articles by G. Haberler and myself in Problems of United States Economic Development, ed. by the Committee for Economic Development, Vol. I (New York, 1958).

65Cf. Arthur J Brown, The Great Inflation, 1939–1951 (London: Oxford University Press, 1955).

66See J.R. Hicks, ‘Economic Foundations of Wage Policy’, Economic Journal LXV (1955), esp. p. 391:

The world we now live in is one in which the monetary system has become relatively elastic, so that it can accommodate itself to changes in wages, rather than the other way about. Instead of actual wages having to adjust themselves to an equilibrium level, monetary policy adjusts the equilibrium level of money wages so as to make it conform to the actual level. It is hardly an exaggeration to say that instead of being on a Gold Standard, we are on a Labour Standard.

But see also the same author’s later article, ‘The Instability of Wages’, Three Banks Review, no. 31 (September, 1956).

67See W. Beveridge, Full Employment in a Free Society (London: George Allen & Unwin, 1944); M. Joseph and N. Kaldor, Economic Reconstruction after the War (handbooks published for the Association for Education in Citizenship [London, n.d.]); Barbara Wootton, The Social Foundations of Wage Policy (London: George Allen & Unwin, 1955); and, on the present state of the discussion, D.T. Jack, ‘Is a Wage Policy Desirable and Practicable?’, Economic Journal LXVII (1957). It seems that some of the supporters of this development imagine that this wage policy will be conducted by ‘labour’, which presumably means by joint action of all unions. This seems neither a probable nor a practicable arrangement. Many groups of workers would rightly object to their relative wages being determined by a majority vote of all workers, and a government permitting such an arrangement would in effect transfer all control of economic policy to the labour unions.

68See, e.g., Barbara Wootton, Freedom under Planning, p. 101:

The continual use of terms like ‘fair’, however, is quite subjective: no commonly accepted ethical pattern can be implied. The wretched arbitrator, who is charged with the duty of acting ‘fairly and impartially’, is thus required to show these qualities in circumstances in which they have no meaning; for there can be no such thing as fairness or impartiality except in terms of an accepted code. No one can be impartial in a vacuum. One can only umpire at cricket because there are rules, or at a boxing match so long as certain blows, like those below the belt, are forbidden. Where, therefore, as in wage determinations, there are no rules and no code, the only possible interpretation of impartiality is conservatism.

Also Kenneth F. Walker, Industrial Relations in Australia (Cambridge, Mass.: Harvard University Press, 1956), p. 362: ‘Industrial tribunals, in contrast with ordinary courts, are called upon to decide issues upon which there is not only no defined law, but not even any commonly accepted standards of fairness or justice.’ Cf. also Gertrud Williams [Lady Williams], ‘The Myth of “Fair” Wages’, Economic Journal LXVI (1956).

69See Petro, The Labor Policy of the Free Society, pp. 262ff., esp. p. 264: ‘I shall show in this chapter that the rule of law does not exist in labour relations; that there a man is entitled in only exceptional cases to a day in court, no matter how unlawfully he has been harmed’; and p. 272:

Congress has given the NLRB [National Labor Relations Board] and its General Counsel arbitrary power to deny an injured person a hearing, Congress has closed the federal courts to persons injured by conduct forbidden under federal law. Congress did not, however, prevent unlawfully harmed persons from seeking whatever remedies they might find in state courts. That blow to the ideal that every man is entitled to his day in court was struck by the Supreme Court.

70The Chairman of the English Trade Union Congress, Mr. Charles Geddes, was reported in 1955 to have said:

I do not believe that the trade union movement of Great Britain can live for very much longer on the basis of compulsion. Must people belong to us or starve, whether they like our policies or not? No. I believe the trade union card is an honour to be conferred, not a badge which signifies that you have got to do something, whether you like it or not. We want the right to exclude people from our union if necessary and we cannot do that on the basis of ‘Belong or starve’.

71Cf. W. Röpke, Welfare, Freedom, and Inflation (London: Pall Mall Press, 1957).

72Cf. my essay ‘Full Employment, Planning, and Inflation’, Review of the Institute of Public Affairs IV (Melbourne, Victoria, Australia, 1950); and the German version in Vollbeschäftigung, Inflation und Planwirtschaft, ed. A. Hunold (Zurich, 1951); and F.A. Lutz, ‘Inflationsgefahr und Konjunkturpolitik’, Schweizerische Zeitschrift fur Volkswirtschafi und Statistik XCIII (1957), and ‘Cost- and Demand-Induced Inflation’, Banca Nazionale de Lavoro Quarterly Review XLIV (1958).

73J.M. Keynes, A Tract on Monetary Reform (London: Macmillan, 1923), p. 80.

74See my essay ‘Monetary Nationalism and International Stability’.

• 1Charles Gascom, “The Current Recession: How Bad Is It?” Federal Reserve Bank of St. Louis Economic Synopses 4 (January 8, 2009): 2, available at http://research.stlouisfed.org/publications/es/09/ES0904.pdf.
• 2It should be briefly noted that this was the same cheap money policy that ignited and stoked the unsustainable real estate boom in the first place. Thus from December 1999 through December 2005, the Fed increased the money supply as measured by MZM by about $2.5 trillion, or 57 percent, which works out to an uncompounded annual rate of 9.5 percent. During the same time period another Fed monetary aggregate, M2, registered an increase of $2 trillion, or about 44 percent, which yields an uncompounded annual rate of 7.3 percent. This massive monetary inflation was naturally accompanied by a precipitous decline in interest rates, with the target Fed Funds rate plunging from 6.5 percent in late 2000 to 1.0 percent in mid-2003 and being pegged at that level for nearly a year and then remaining below 3.0 percent for almost another year. Mortgages rates followed this sharp downward movement, with the rate on 30-year conventional fixed mortgages dropping 3 percentage points, from 8.52 percent in mid-2000 to 5.58 percent in mid-2005. But this understates the looseness in the home loan markets generated by the monetary inflation, which also induced the development of a remarkable laxity in credit standards. The statistics in this footnote and in the associated paragraph in the text are based on data from The Federal Reserve Bank of St. Louis Economic Research available at http://research.stlouisfed.org/).
• 3The Pure Theory of Capital (London: Routledge and Kegan Paul, 1953), p. 409; p. 29 in this volume.
• 4Professor T.W. Hutchison, Markets and the Franchise, Occasional Paper 10 (London: IEA, 1966).
• 5The Times, 4 January, 1975.
• 6Economists and the Public (London: Jonathan Cape, 1936). Professor Hutt published a brief analysis of the central issues in his Theory of Idle Resources (London: Jonathan Cape, 1939); his earlier work on the Theory of Collective Bargaining (1930; new edition, Glencoe, Ill.: The Free Press, 1954; 2nd British edition published as The Theory of Collective Bargaining 1930–1975G, Hobart Paperback No. 8 ) analysed the position of the Classical economists on the relation between unions and wage determination.
• 7F. Machlup, ‘Another view of cost push and demand pull inflation’, Review of Economics and Statistics (1960).
• 8P.P. Streeten, ‘Wages, prices and productivity’, Kyklos (1962).
• 9D.J. Robertson, ‘Guideposts and Norms: Contrasts in US and UK Wage Policy’, Three Banks Review (December 1966) ; D.C. Smith, ‘Income Policy’, in R.E. Caves and Associates (eds.), Britain’s Economic Prospects (London: Allen & Unwin, 1968).
• 10W.H. Beveridge, Full Employment in a Free Society (London: Allen and Unwin, 1944, pp. 198–201, esp. p. 201: ‘Adoption by the State of a price policy is a natural and probably an inevitable consequence of a full employment policy’.
• 11Lord Robbins, ‘Inflation: The Position Now’, Financial Times, 23 June, 1971; J.E. Meade, Wages and Prices in a Mixed Economy, Occasional Paper 35 (London: IEA for Wincott Foundation, 1971); F.W. Paish, Rise and Fall of Incomes Policy, Hobart Paper 47 (London: IEA, second edition, 1971); S. Brittan, Government and the Market Economy, Hobart Paperback 2 (London: IEA, 1971); E. Victor Morgan, ‘Is Inflation Inevitable?’, Economic Journal (March 1966).
• 12T. Balogh, Labour and Inflation, Fabian Tract 403 (Fabian Society, 1970); Streeten, ‘Wages, prices and productivity’; R.G. Opie, ‘Inflation’ in P.D. Henderson (ed.), Economic Growth in Britain (London: Weidenfeld & Nicolson, 1966).
• 13Robbins, ‘Full Employment as an Objective’, in The Economist in the Twentieth Century (London: Macmillan, 1954); italics in original.
• 14Robbins, Inflation’, pp. 35–36.
• 15Financial Times, 23 June, 1971.
• 16Morgan, ‘Is Inflation Inevitable’, p. 14; Paish, Rise and Fall of Incomes Policy, Postscript; S. Weintraub, ‘An Incomes Policy to Stop Inflation’, Lloyds Bank Review (January 1971).
• 17Brittan, Government and the Market Economy, pp. 48–56.
• 18Professor W.B. Reddaway (‘Wage Flexibility and the Distribution of Labour’, Lloyds Bank Review [April 1959]) has suggested, on empirical investigations, that relative wage-rate movements have little allocative significance today: labour reallocation among industries and firms is achieved by changes in job offers. Given union-determined wage-rate structure, this is perhaps to be expected; but it is not incompatible with the basic proposition that prices are capable of performing allocative functions—if the institutional framework is designed to this end.
• 19Suggestions that wage increases be linked to productivity are clearly attempts to offer some coordinative criterion, in this discoordinated situation.
• 20F.A. Hayek, ‘Economics and Knowledge’, ‘The Use of Knowledge in Society’ and the three chapters on ‘Socialist Calculation’ in Individualism and Economic Order(London: Routledge, 1948).
• 21Routledge and Kegan Paul, 1931 and 1933. A scheme which confines itself to contrasting ‘the “Classical” model’ (i.e., the conceptual framework used by the English economists contemporary with Keynes) and ‘the Keynesian (and/or post-Keynesian) model’ may therefore be incomplete. H.G. Johnson, ‘Monetary Theory and Keynesian Economies’; ‘Introduction’, in Ball and Doyle (eds.); and the ‘Introduction’ to R.W. Clower (ed.), Monetary Theory (Harmondsworth, U.K.: Penguin Books, 1969) are instances of such schemes.
• 22Professor Clower’s stricture that ‘at no stage in pre-Keynesian economics was any serious attempt made to build peculiarly monetary assumptions into the micro-foundations of economic analysis’ (Monetary Theory, p. 19) is not accurate.
• 23Prices and Production (London: Routledge, 2nd ed., 1935), pp. 161–62.
• 24‘Reflections on the Pure Theory of Money of Mr. J.M. Keynes’, Economica (August 1931 and February 1932); J.M. Keynes, ‘The Pure Theory of Money—A Reply to Dr. Hayek’; F.A. Hayek, ‘A Rejoinder to Mr. Keynes’, Economica (November 1931).
• 25Incomes policy advocates implicitly assume that ‘full employment’ relative price and wage interrelationships once established can be maintained indefinitely; their implicit ‘model’ is that of a rigid real structure of outputs and prices on which a varying monetary stream impinges (see esp. Meade, Wages and Prices in a Mixed Economy, pp. 11–12; Morgan, ‘Monetary Theory and Keynesian Economies’; Brittan, Government and the Market Economy. Hayek has characterised such a mode of thinking as belonging essentially to the naïve early stages of economic thought (Pure Theory of Capital, pp. 409–10; also see Economica [August 1931]: 273).
• 26A similar view was put by Professors William Fellner and Friedrich Lutz in W. Fellner et al., The Problem of Rising Prices (Organisation of European Economic Cooperation, 1961).
• 27This stress on the labour side need not imply that established firms (in the Western economies or elsewhere) are never at present protected against actual or potential competition and against actual or potential losses, either by the institutional framework or by economic policy. The Hayekian approach implies that no incomes and assets—whether business or other—be protected against losses. (F.A. Hayek, “Free” Enterprise and Competitive Order’ in Individualism and Economic Order , and ‘The Modern Corporation in a Democratic Society . . .’ in Studies in Philosophy, Politics and Economics ).
• 28Cf. Arthur J Brown, The Great Inflation, 1939–1951 (London: Oxford University Press, 1955).
• 29See J.R. Hicks, ‘Economic Foundations of Wage Policy’, Economic Journal LXV (1955), esp. p. 391:
• 30See W. Beveridge, Full Employment in a Free Society (London: George Allen & Unwin, 1944); M. Joseph and N. Kaldor, Economic Reconstruction after the War (handbooks published for the Association for Education in Citizenship [London, n.d.]); Barbara Wootton, The Social Foundations of Wage Policy (London: George Allen & Unwin, 1955); and, on the present state of the discussion, D.T. Jack, ‘Is a Wage Policy Desirable and Practicable?’, Economic Journal LXVII (1957). It seems that some of the supporters of this development imagine that this wage policy will be conducted by ‘labour’, which presumably means by joint action of all unions. This seems neither a probable nor a practicable arrangement. Many groups of workers would rightly object to their relative wages being determined by a majority vote of all workers, and a government permitting such an arrangement would in effect transfer all control of economic policy to the labour unions.
• 31See, e.g., Barbara Wootton, Freedom under Planning, p. 101:
• 32See Petro, The Labor Policy of the Free Society, pp. 262ff., esp. p. 264: ‘I shall show in this chapter that the rule of law does not exist in labour relations; that there a man is entitled in only exceptional cases to a day in court, no matter how unlawfully he has been harmed’; and p. 272:
• 33The Chairman of the English Trade Union Congress, Mr. Charles Geddes, was reported in 1955 to have said:
• 34Cf. W. Röpke, Welfare, Freedom, and Inflation (London: Pall Mall Press, 1957).
• 35Cf. my essay ‘Full Employment, Planning, and Inflation’, Review of the Institute of Public Affairs IV (Melbourne, Victoria, Australia, 1950); and the German version in Vollbeschäftigung, Inflation und Planwirtschaft, ed. A. Hunold (Zurich, 1951); and F.A. Lutz, ‘Inflationsgefahr und Konjunkturpolitik’, Schweizerische Zeitschrift fur Volkswirtschafi und Statistik XCIII (1957), and ‘Cost- and Demand-Induced Inflation’, Banca Nazionale de Lavoro Quarterly Review XLIV (1958).
• 36J.M. Keynes, A Tract on Monetary Reform (London: Macmillan, 1923), p. 80.
• 37See my essay ‘Monetary Nationalism and International Stability’.
• 38The publication of the new edition of this classic could not have come at a better time, moreover. For it is not merely an outstanding contribution to intellectual history, but also a tract for our times. The U.S. has been mired in an officially-recognized recession for more than a year now with no end in sight. Our current downturn is fast becoming the lengthiest and most severe of the post-World War II era. Entering its fourteenth month, it has already surpassed the average length of the last six recessions and is rapidly approaching the postwar record of sixteen months. The net decline in employment of 2.6 million recorded for 2008 represents the greatest absolute decline in the number of jobs since 1945. With over a half-million workers losing their jobs in December 2008 alone, the unemployment rate unexpectedly spiked from 6.8 percent in November 2008 to 7.2 percent, the highest level in sixteen years. The 4.78 million Americans now claiming unemployment insurance is the highest since 1967, when this statistic began to be recorded and represents the highest proportion of the work force since 1983. Adding to the dismal employment picture, the average work week for the month plummeted to 33.3 hours, the lowest level since 1964, while part-time jobs shot up by 700,000, or nearly 10 percent, from the previous month, indicating that many part-time workers counted as officially employed were either previously terminated from full-time jobs or reduced from full-time to part-time employment by their current employers. Other indicators of the severity of recession besides employment reveal that the current recession has been deeper than the average recession, including industrial production, real income, and retail sales. As one Fed economist concluded, “Main recession indicators tend to support the claim that this recession could be the most severe in the past 40 years.”
• 39Indeed the dread word “depression” is now being used by some economists and media pundits to portray our current difficulties, conjuring up the specter of the prolonged mass unemployment amidst idle industrial capacity and unsold piles of raw materials that marked the 1930s. For most recognized experts and opinion leaders, how we got into our current difficulties is now a moot question. Everyone is clamoring for a way out. A massive government bailout involving $700 billion to purchase risky assets and to subsidize troubled financial service and domestic automobile firms has proven spectacularly ineffective in reversing or even slowing the contraction of the economy, although it has led to a staggering projected federal budget deficit of $1.2 trillion for the current fiscal year. Accompanying this deluge of red ink is highly inflationary growth in the official Fed monetary aggregates, with MZM shooting up by 10.1 percent and M2 by 7.6 percent year-over-year as of November 2008. Driving this monetary inflation has been the Fed’s expansion of the adjusted monetary base by 76 percent over the same period, which has reduced the target Fed Funds rate from 5.25 percent in mid-2007 to less than .25 percent by the end of 2008.
• 40I cannot help regarding the increasing concentration on short-run effects—which in this context amounts to the same thing as a concentration on purely monetary factors—not only as a serious and dangerous intellectual error, but as a betrayal of the main duty of the economist and a grave menace to our civilization. To the understanding of the forces which determine the day-to-day changes of business, the economist has probably little to contribute that the man of affairs does not know better. It used, however, to be regarded as the duty and the privilege of the economist to study and to stress the long-run effects which are apt to be hidden to the untrained eye, and to leave the concern about the more immediate effects to the practical man, who in any event would see only the latter and nothing else.
• 41The purpose of the Hobart Paperbacks is to discuss, in the spirit of what was once called ‘political economy,’ the influences which affect the translation of economic ideas into practical policy and the economics of government activity. In the first Paperback Professor W.H. Hutt examined the notion that some ideas are not adopted because they are considered to be ‘politically impossible.’ In the second Mr. Samuel Brittan analysed the consistency of British Government economic policy since June 1970. In the third Mr. W.R. Lewis analysed the conflict between ideas and policy in the aspirations of the Treaty of Rome and the performance of its interpreters at Brussels.
• 42As Professor Friedrich Hayek has argued ever since his pre-war disputes with Keynes, the price of maintaining full employment by more and more inflationary public finance is not only accelerating inflation but also a progressive diversion of economic resources into activities favoured by or dependent on inflation. If inflation is to be checked, that structural distortion has to be reversed, which must be painful.
• 43Shortly after the General Theory appeared, Professor W.H. Hutt argued that it was a specific for inflation.
• 44Over the following 25-odd years, the early Keynesian theory was further elaborated and refined and a highly sophisticated series of macro-economic models developed. The 1950s more especially saw the discovery of ‘cost inflation’, in which a rise in wages pushed up the cost level. As prices were determined by costs, and, in crucial sectors of the economy, were ‘administered’ on the cost-plus-mark-up practice, prices rose to protect profit margins. But since wages were also incomes the cost and price increases had no deflationary effect, as effective demand rose simultaneously. In these circumstances a contractionary monetary/fiscal policy would be deflationary: it would lead to socially intolerable levels of unemployment and excess capacity; an alternative measure, directed specifically at rising costs, would have to be devised. If price stability and full employment could both be achieved by keeping wage increases within the limits set by rises in productivity, this implied an ‘incomes policy’. Further investigation into the implications for the price- and wage-level of linking sectoral wage increases with productivity strengthened the case for a nationally-determined ‘wages policy’ covering both relative wage-rates and the general wage level. If wages rose in the sectors where productivity was rising, the result would be a rise in demand for the outputs of other sectors, resulting in a rise in their prices.
• 45Over the following 25-odd years, the early Keynesian theory was further elaborated and refined and a highly sophisticated series of macro-economic models developed. The 1950s more especially saw the discovery of ‘cost inflation’, in which a rise in wages pushed up the cost level. As prices were determined by costs, and, in crucial sectors of the economy, were ‘administered’ on the cost-plus-mark-up practice, prices rose to protect profit margins. But since wages were also incomes the cost and price increases had no deflationary effect, as effective demand rose simultaneously. In these circumstances a contractionary monetary/fiscal policy would be deflationary: it would lead to socially intolerable levels of unemployment and excess capacity; an alternative measure, directed specifically at rising costs, would have to be devised. If price stability and full employment could both be achieved by keeping wage increases within the limits set by rises in productivity, this implied an ‘incomes policy’. Further investigation into the implications for the price- and wage-level of linking sectoral wage increases with productivity strengthened the case for a nationally-determined ‘wages policy’ covering both relative wage-rates and the general wage level. If wages rose in the sectors where productivity was rising, the result would be a rise in demand for the outputs of other sectors, resulting in a rise in their prices.
• 46Economic policy in the UK and the USA, from 1950 on, reflected the adoption of these views; there was a gradual shift from exhortations, guidelines and pay pauses to more direct attempts to influence and control wages.
• 47That such direct control of wages and prices would be needed to forestall the ‘vicious wage-price spiral’ resulting from full employment had been forecast by Lord Beveridge as early as 1944.
• 48By the late 1960s and early 1970s more economists came to favour an incomes policy, some reluctantly (Robbins, Meade, Paish, Brittan, Morgan), others enthusiastically (Balogh, Streeten, Opie).
• 49By the late 1960s and early 1970s more economists came to favour an incomes policy, some reluctantly (Robbins, Meade, Paish, Brittan, Morgan), others enthusiastically (Balogh, Streeten, Opie).
• 50whatever [wage] rates they succeeded in getting, unemployment would not be permitted to emerge.
• 51He believed, however, that this alternative would be rejected ‘on the ground that in the end its efficient operation would prove to be incompatible with the continuation of political democracy. . . .’ Seventeen years later he argued for an incomes policy as temporary ‘shocktactics’, to afford a ‘breathing space’ in which fundamental monetary-fiscal reforms might be ‘advanced and understood’.
• 52He believed, however, that this alternative would be rejected ‘on the ground that in the end its efficient operation would prove to be incompatible with the continuation of political democracy. . . .’ Seventeen years later he argued for an incomes policy as temporary ‘shocktactics’, to afford a ‘breathing space’ in which fundamental monetary-fiscal reforms might be ‘advanced and understood’.
• 53Despairing of the good sense of union leaders, he sought to bring pressure on them indirectly, suggesting that businessmen be restrained from granting inflationary wage increases by restrictions on aggregate demand, even to the point of precipitating bankruptcies, thus preventing the payment of higher wages that would simply be recouped by higher prices. A suggested alternative or parallel measure would be to tax inflationary wage increases granted by firms. He hoped that union leaders’ expectations of automatic increases in wages would thereby be frustrated. (A similar view is taken by Professors E. Victor Morgan, F.W. Paish, and Sidney Weintraub.)
• 54An alternative type of incomes policy was proposed by Mr. Samuel Brittan. The government would control the level to which wage rates would be permitted to rise while allowing employers short of labour to offer higher rates, but without pretending to determine relative wage rates on the basis of social justice. Such a policy, he said, must be treated as a supplement to monetary and fiscal policies that provide sufficient demand to prevent unemployment, but prevent the emergence of excess demand. He suggested as a stop-gap a temporary price and wage freeze until these policies are implemented.
• 55Secondly, in common with other recommendations for incomes policies, this proposal would perpetuate a given structure of relative wage rates since all the rates to which it applied would be allowed to rise only by a given percentage (save in ‘labour scarcity’). This relative wage structure today reflects not so much the allocative forces of the market but the relative power or ‘pushfulness’ of the different unions. Can we assume that they would be content to retain indefinitely whatever relative positions they had achieved at the moment the incomes policy came into existence?
• 56The common thread running through these discussions is the alleviation of specific wage-rate maladjustments. They have moved some distance from the aggregative analysis. The ‘macro’ problem of adequate demand management has, it now appears, a ‘micro’ dimension: that of establishing (or obtaining) an ‘appropriate’ scale of prices. In other words, from the viewpoint of practical policy, the ‘macro’ problem of a persistent upward push (or pull) on the price ‘level’ is now seen to have ‘micro’ roots, in the specific ‘pricing’ methods used by specific groups of workers. ‘Macro’ measures acting on aggregate expenditure may have allowed us hitherto to ignore this basic micro discoordination, but events seemingly have brought the issue forward unavoidably. ‘Macro’ measures, it would appear, may offset micro problems but are no substitute for appropriate micro solutions.
• 57This ‘Austrian’ analysis constitutes a substantial break with Classical economic theory from Adam Smith to J.S. Mill. It differs also both from the doctrines of the English economists after Mill and from the theoretical preoccupations of the Lausanne School with the conditions of general equilibrium.
• 58In his first English work, the four lectures published as Prices and Production, Hayek questioned the concept of a price ‘level’—i.e., a relationship between the total money stock and the total volume of production, variations in this ‘level’ being associated with variations in aggregate output. He argued that such a concept failed to show that there were specific influences of changes in the stream of money expenditure on the structure of relative prices, and hence on the structure of production. These price and output changes, he maintained, occurred irrespective of changes in the price level. Hayek’s analysis implied that if ‘the’ price ‘level’ is held ‘stable’ by offsetting monetary measures, under conditions where the relative price changes would result in a falling price ‘level’, the real dislocations would be the same as if prices were made to rise by monetary measures, if otherwise they might have remained ‘stable.’ In either case, the outcome is a painful correction of the preceding real misdirection, i.e., a ‘depression’.
• 59In his first English work, the four lectures published as Prices and Production, Hayek questioned the concept of a price ‘level’—i.e., a relationship between the total money stock and the total volume of production, variations in this ‘level’ being associated with variations in aggregate output. He argued that such a concept failed to show that there were specific influences of changes in the stream of money expenditure on the structure of relative prices, and hence on the structure of production. These price and output changes, he maintained, occurred irrespective of changes in the price level. Hayek’s analysis implied that if ‘the’ price ‘level’ is held ‘stable’ by offsetting monetary measures, under conditions where the relative price changes would result in a falling price ‘level’, the real dislocations would be the same as if prices were made to rise by monetary measures, if otherwise they might have remained ‘stable.’ In either case, the outcome is a painful correction of the preceding real misdirection, i.e., a ‘depression’.
• 60. . . up to 1927, I should, indeed, have expected that because, during the preceding boom period, prices did not rise—but rather tended to fall—the subsequent depression would be very mild. But, as is well known, in that year an entirely unprecedented action was taken by the American monetary authorities, which makes it impossible to compare the effects of the boom on the subsequent depression with any previous experience. The authorities succeeded by means of an easy money policy, inaugurated as soon as the symptoms of an impending reaction were noticed, in prolonging the boom for two years beyond what would otherwise have been its natural end. And when the crisis finally occurred, for almost two more years deliberate attempts were made to prevent, by all conceivable means, the normal process of liquidation. It seems to me that these facts have had a far greater influence on the character of the depression than the developments up to 1927, which, from all we know, might instead have led to a comparatively mild depression in and after 1927.
• 61Shortly after the publication of the first edition of Prices and Production, Professor Hayek published (in Economica) the first part of a long, substantive review of Keynes’s Treatise on Money. This provoked a reply from Keynes, followed by a rejoinder, before the publication of the second part of the review. Hayek criticised Keynes for his neglect of the real structure of production, arguing that Keynes’s predilection for concentrating on the immediate and purely monetary phenomena accompanying changes in money expenditure, together with his penchant for aggregative macro concepts (total profits, total investment), had led him into contradictory or untenable conclusions. Keynes apparently held that if there were no entrepreneurial profits or losses in the aggregate, total output would be held constant. Hayek replied that if profits in the ‘lower’ stages of production (nearer consumption) were exactly counterbalanced by losses in the ‘higher’ stages, there would be a contraction in the capital structure and a fall in output and employment—even though there were no aggregate profits or losses.
• 62(b)   To limit price or wage-rate increases by an incomes policy is to freeze a particular set of price and wage-rate interrelationships while underlying circumstances of supply and demand are continually changing. This is like the ‘stability’ of a set of defective gauges perpetually pointing to the same set of readings. It reinforces other institutional factors preventing the specific changes in relative prices and wage rates necessary to the maintenance of ‘full’ employment. Or, to put this same point from a different angle, if ‘full’ employment is to be maintained at union-determined wage rates (which are inflexible downwards), all other prices and wage rates must be adjusted to them: other prices and wage rates must be set at, or reach, levels consistent with this objective. Even if union-determined wage rates were held down to a maximum percentage increase, it still does not follow that the same percentage increase, or a lesser increase, in all other prices and wage rates would suffice to achieve ‘full’ employment. This is why it may be necessary for incomes to rise faster than output, even to secure that increase in output.
• 63(c)   The major objection to an incomes policy approach is that it merely freezes a given array of prices and wage rates. It does nothing to bring about coordination or to introduce coordinative institutions into the labour sector. So long as the discoordinative potential of such non-market institutions as unions is not tackled, the problem will recur again and again. There may be no substitute for a very painful reshaping of institutions or other means of bringing within the ambit of the pricing system wage rates made impervious to market forces. The alternative is a permanent incomes policy: an all-round fixing of wage rates and prices, i.e., an effectively centrally-controlled economy (with all its problems), although we may, as it were, ‘back into’ this situation unintentionally. This is to say nothing about whether it is desirable politically.
• 64(c)   The major objection to an incomes policy approach is that it merely freezes a given array of prices and wage rates. It does nothing to bring about coordination or to introduce coordinative institutions into the labour sector. So long as the discoordinative potential of such non-market institutions as unions is not tackled, the problem will recur again and again. There may be no substitute for a very painful reshaping of institutions or other means of bringing within the ambit of the pricing system wage rates made impervious to market forces. The alternative is a permanent incomes policy: an all-round fixing of wage rates and prices, i.e., an effectively centrally-controlled economy (with all its problems), although we may, as it were, ‘back into’ this situation unintentionally. This is to say nothing about whether it is desirable politically.
• 65This would follow even if individual unions did no more than prevent any reduction in the money wages of any particular group. Where unions make such wage reductions impracticable and wages have generally become, as the economists put it, ‘rigid downward’, all the changes in relative wages of the different groups made necessary by the constantly changing conditions must be brought about by raising all money wages except those of the group whose relative real wages must fall. Moreover, the general rise in money wages and the resulting increase in the cost of living will generally lead to attempts, even on the part of the latter group, to push up money wages, and several rounds of successive wage increases will be required before any readjustment of relative wages is produced. Since the need for adjustment of relative wages occurs all the time, this process alone produces the wage-price spiral that has prevailed since the second World War, that is, since full-employment policies became generally accepted.
• 66The process is sometimes described as though wage increases directly produced inflation. This is not correct. If the supply of money and credit were not expanded, the wage increases would rapidly lead to unemployment. But under the influence of a doctrine that represents it as the duty of the monetary authorities to provide enough money to secure full employment at any given wage level, it is politically inevitable that each round of wage increases should lead to further inflation. Or it is inevitable until the rise of prices becomes sufficiently marked and prolonged to cause serious public alarm. Efforts will then be made to apply the monetary brakes. But, because by that time the economy will have become geared to the expectation of further inflation and much of the existing employment will depend on continued monetary expansion, the attempt to stop it will rapidly produce substantial unemployment. This will bring a renewed and irresistible pressure for more inflation. And, with ever bigger doses of inflation, it may be possible for quite a long time to prevent the appearance of the unemployment which the wage pressure would otherwise cause. To the public at large it will seem as if progressive inflation were the direct consequence of union wage policy rather than of an attempt to cure its consequences.
• 67In those countries in which inflationary tendencies have operated for some time, we can observe increasingly frequent demands for an ‘overall wage policy’. In the countries where these tendencies have been most pronounced, notably in Great Britain, it appears to have become accepted doctrine among the intellectual leaders of the Left that wages should generally be determined by a ‘unified policy’, which ultimately means that government must do the determining. If the market were thus irretrievably deprived of its function, there would be no efficient way of distributing labour throughout the industries, regions, and trades, other than having wages determined by authority. Step by step, through setting up an official conciliation and arbitration machinery with compulsory powers, and through the creation of wage boards, we are moving towards a situation in which wages will be determined by what must be essentially arbitrary decisions of authority.
• 68All this is no more than the inevitable outcome of the present policies of labour unions, who are led by the desire to see wages determined by some conception of ‘justice’ rather than by the forces of the market. But in no workable system could any group of people be allowed to enforce by the threat of violence what it believes it should have. And when not merely a few privileged groups but most of the important sections of labour have become effectively organised for coercive action, to allow each to act independently would not only produce the opposite of justice but result in economic chaos. When we can no longer depend on the impersonal determination of wages by the market, the only way we can retain a viable economic system is to have them determined authoritatively by government. Such determination must be arbitrary, because there are no objective standards of justice that could be applied. As is true of all other prices or services, the wage rates that are compatible with an open opportunity for all to seek employment do not correspond to any assessable merit or any independent standard of justice but must depend on conditions which nobody can control.
• 69The problem of labour unions constitutes both a good test of our principles and an instructive illustration of the consequences if they are infringed. Having failed in their duty of preventing private coercion, governments are now driven everywhere to exceed their proper function in order to correct the results of that failure and are thereby led into tasks which they can perform only by being as arbitrary as the unions. So long as the powers that the unions have been allowed to acquire are regarded as unassailable, there is no way to correct the harm done by them but to give the state even greater arbitrary power of coercion. We are indeed already experiencing a pronounced decline of the rule of law in the field of labour. Yet all that is really needed to remedy the situation is a return to the principles of the rule of law and to their consistent application by legislative and executive authorities.
• 70This path is still blocked, however, by the most fatuous of all fashionable arguments, namely, that ‘we cannot turn the clock back’. One cannot help wondering whether those who habitually use this cliché are aware that it expresses the fatalistic belief that we cannot learn from our mistakes, the most abject admission that we are incapable of using our intelligence. I doubt whether anybody who takes a long-range view believes that there is another satisfactory solution which the majority would deliberately choose if they fully understood where the present developments were leading. There are some signs that farsighted union leaders are also beginning to recognise that, unless we are to resign ourselves to the progressive extinction of freedom, we must reverse that trend and resolve to restore the rule of law and that, in order to save what is valuable in their movement, they must abandon the illusions which have guided it for so long.
• 71It is, however, rather doubtful whether, from a long-term point of view, deflation is really more harmful than inflation. Indeed, there is a sense in which inflation is infinitely more dangerous and needs to be more carefully guarded against. Of the two errors, it is the one much more likely to be committed. The reason for this is that moderate inflation is generally pleasant while it proceeds, whereas deflation is immediately and acutely painful. There is little need to take precautions against any practice the bad effects of which will be immediately and strongly felt; but there is need for precautions wherever action which is immediately pleasant or relieves temporary difficulties involves much greater harm that will be felt only later. There is, indeed, more than a mere superficial similarity between inflation and drug-taking, a comparison which has often been made.
• 72The manner in which inflation operates explains why it is so difficult to resist when policy mainly concerns itself with particular situations rather than with general conditions and with short-term rather than with long-term problems. It is usually the easy way out of any temporary difficulties for both government and private business—the path of least resistance and sometimes also the easiest way to help the economy get over all the obstacles that government policy has placed in its way. It is the inevitable result of a policy which regards all the other decisions as data to which the supply of money must be adapted so that the damage done by other measures will be as little noticed as possible. In the long run, however, such a policy makes governments the captives of their own earlier decisions, which often force them to adopt measures that they know to be harmful. It is no accident that the author whose views, perhaps mistakenly interpreted, have given more encouragement to these inflationary propensities than any other man’s is also responsible for the fundamentally anti-liberal aphorism, ‘in the long run we are all dead’. The inflationary bias of our day is largely the result of the prevalence of the short-term view, which in turn stems from the great difficulty of recognising the more remote consequences of current measures, and from the inevitable preoccupation of practical men, and particularly politicians, with the immediate problems and the achievement of near goals.
• 73The manner in which inflation operates explains why it is so difficult to resist when policy mainly concerns itself with particular situations rather than with general conditions and with short-term rather than with long-term problems. It is usually the easy way out of any temporary difficulties for both government and private business—the path of least resistance and sometimes also the easiest way to help the economy get over all the obstacles that government policy has placed in its way. It is the inevitable result of a policy which regards all the other decisions as data to which the supply of money must be adapted so that the damage done by other measures will be as little noticed as possible. In the long run, however, such a policy makes governments the captives of their own earlier decisions, which often force them to adopt measures that they know to be harmful. It is no accident that the author whose views, perhaps mistakenly interpreted, have given more encouragement to these inflationary propensities than any other man’s is also responsible for the fundamentally anti-liberal aphorism, ‘in the long run we are all dead’. The inflationary bias of our day is largely the result of the prevalence of the short-term view, which in turn stems from the great difficulty of recognising the more remote consequences of current measures, and from the inevitable preoccupation of practical men, and particularly politicians, with the immediate problems and the achievement of near goals.
• 74There is one basic dilemma, which all central banks face, which makes it inevitable that their policy must involve much discretion. A central bank can exercise only an indirect and therefore limited control over all the circulating media. Its power is based chiefly on the threat of not supplying cash when it is needed. Yet at the same time it is considered to be its duty never to refuse to supply this cash at a price when needed. It is this problem, rather than the general effects of policy on prices or the value of money, that necessarily preoccupies the central banker in his day-to-day actions. It is a task which makes it necessary for the central bank constantly to forestall or counteract developments in the realm of credit, for which no simple rules can provide sufficient guidance.