Battling Inflation

These Articles are Abridged Versions of Papers to be Delivered Today and Tomorrow at the Conference on U.S. Competitiveness, Jointly Sponsored by the New York Stock Exchange, the U.S. Senate Subcommittee on International Trade and Harvard University.

U.S. economic progress has slowed, growth in productivity has ceased. Does this mean that we must take a back seat to such countries as West Germany and Japan, or are there policies that can help correct the situation? Economic analyses provide suggestions, particularly in the key problem areas of energy and inflation.

Productivity and Core Inflation

Increases in productivity are one way to offset the inflationary effects of wage increases. The slowing, and then cessation, of productivity growth recently has exacerbated the problem of core inflation that began with the long period of excess demand at the time of the Vietnam war.

Why did Productivity Slow Down?

After 1973 the stagnation of the capital-labor ratio which slows down the changes in methods of production is the largest single cause of the productivity slowdown. If the capital-labor ratio can be made to improve once more, a partial restoration of our traditional productivity performance will be assured.

Baseline Prospects for the Economy:

A Data Resources, Inc. (DRI) model has been used to predict the prospects for the U.S. economy if present policies are little changed but there is a modest tax reform in 1981 reducing personal and corporate taxes. It is not a worst-case model, rather just a trend projection. For 1980-85 it sees GNP growth at 2.7%, productivity growth at 1.4%, core inflation up as actual inflation (CPI) drops, and long-term interest rates at 10.34%--all figures worse than the traditional performance level of the U.S. economy.

The same model indicates that to achieve a dramatically lower core inflation rate by 1985 (say a drop to 6%) by demand management alone would require near depression conditions, e.g. unemployment over 10% for the whole period. That would seriously damage the economy, probably radicalize the electorate, and imperil the capitalist system. Fiscal and monetary policy alone, then, will not solve our problems.

Consider a 3% increase in the effective tax credit and a two year cut in the average tax lifetime of producers' plant and equipment. The DRI model suggests such measures would give a considerable stimulus to investment. By 1985, compared with the baseline case, capital stock would be up 3.1%, level of potential GNP up 2%, productivity up 2.4%, and core inflation improved by 0.8%. This is obviously not the entire solution, but it makes a dent.

Our forecasts assume that the real price of energy will rise by 4% annually. For that, U.S. imports must drop. Even so, projected oil bills will represent a rising burden. Since U.S. industry is unlikely to boost exports by a comparable sum, deficits will grow, and will have to be offset by capital movements.

If real energy prices could be kept stable, greater improvement in the core inflation rate would be possible. A combination of anti-inflationary policies (conservative demand management, tax incentives to investment, conservation and supply policies for energy) would produce a more dramatic improvement in the inflation rate.

OTTO ECKSTEIN is the Warburg Professor of Economics at Harvard University and president of Data Resources, Inc. Productivity Measures for Several Countries Average Annual Percentage Change in Productivity   1950-65  1965-73  1973-78 Japan  7.2  9.1  3.1 West Germany  5.2  4.3  3.2 Italy  5.1  5.6  1.3 France  4.7  4.5  2.8 Canada  2.7  2.3  .8 United Kingdom  2.2  3.3  .9 United States  2.4  1.6  .4

Source--Bureau of Labor Statistics.

Source--Bureau of Labor Statistics.