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Keith Rankin's Thursday Column: Shocking Prices?

Keith Rankin's Thursday Column
Shocking Prices?
31 August 2000

Retail petrol prices are up 50% since around this time last year. It's just one issue behind the malaise that's going round. It seems such a pity to waste the year 2000 - the millennium year - worrying about the kinds of price change that represent no more than the ebbs and flows of the marketplace.

We should know by now that the market economy works. Not the pure market economy; that's a not uninteresting abstraction that academic economists overinvested their human capital on. The pure market economy is a flawed ideal that big business interests use as camouflage for exploitative practices. The pure market model assumes both that all goods are private and that perfect knowledge is supplied as a free public good.

No, it's the impure market economy that works. Commodity prices go up and down, currencies rise and fall, inflation waxes and wanes, governments get involved, adjustments take place over time. These phenomena are not problems; they are the system working as it should work. It's when nothing changes, when we really do have certainty, that we should start to worry.

Increases in petrol prices are not some kind of economic dragon that must be slain by a modern St George. Rather they are a result of restricted supply and/or increased demand. We are free to respond. The consumption of petrol is not compulsory.

Some of us are already responding to higher oil prices. I heard on Morning Report that the chief economist at the BNZ now catches the train to work. And Auckland's motorways were somewhat less congested than usual yesterday evening.

Of course, when a particular commodity's price changes, and changes for at least the medium-term, then there are losers and winners. Some people are worse off than before, but that's life. Other's are better off than before. In the case of oil prices, society as a whole is better off if we create less carbon dioxide. Society is not enhanced by the use of Nissan Patrols, complete with anti-pedestrian bull-bars, to get the groceries home and to take kids to school.

Much of our concern about oil prices dates back to the myth that the economic "golden weather" of the 1950s and 1960s ended as a consequence of the oil price shocks of the 1970s. It might just be a good time to reflect on the 1970s.

The first oil price shock (1973-74) was one of a number of commodity price hikes in that decade. Before the escalation of oil prices were the beef, wheat and wool shocks. They gave the New Zealand economy a real boost in 1972/73.

Relative prices changed markedly in 1974. Primary produce prices remained static while oil prices took off. That certainly had a marked short-term effect on New Zealand; out terms of trade halved in 24 months. We had not been a winner for long.

But what changed the world macroeconomy were not the oil prices but the political responses to them. Indeed the 1970s' experience does give credence to the public choice theorists who claim that government failure is invariably worse than market failure.

Just when Friedmanite monetarism was becoming trendy in academic circles, politicians saw the oil price increases as harbingers of inflation. Ironically, the monetarists were equally wrong in their view, that inflation had nothing to do with oil prices and everything to do with the money supply.

Western politicians had become sensitised to inflation; the beef and wheat boom had coincided with a war (Vietnam) that, like all wars, had caused inflation. So, in 1974, they adopted the monetarists' remedy for inflation, without taking on board the monetarist analysis. While Friedman's policy prescription had nothing to do with interest rates - he prescribed an annual 3% rise in the quantity of money - in practice attempts to implement restrictive monetary policies equated to the pushing up of interest rates.

The effects of the oil price rises were important, but confined to the realm of microeconomics. New energy sources became important. Energy conservation became an industry in itself. New industries emerged, and the United States motor vehicle industry waned.

The economic crises of the 1970s - stagflation (simultaneous inflation and unemployment) and the productivity slowdown - were a result of macroeconomic policies that should never have been pursued. Nevertheless, by 1976-1977, the world crisis was over. Western economies had recovered and restructured. In 1977, the Lib-Lab pact had restored pragmatism to economic management in Great Britain. Employment picked up through 1978, while inflation decelerated markedly.

The second oil crisis of 1979 coincided with the arrival of Margaret Thatcher in Britain and Paul Volker as Chairman of the US Federal Reserve Bank. These people had monetarist agendas that were to be implemented without regard to events in the wider world. It was these "class war" policies that consigned the developed world in the early 1980s to its worst depression since the 1930s. The carry-on in Iran, which led to oil price rises, was really just a convenient coincidence to the arrival of hard-core monetarism.

Raising interest rates - as Thatcher and Volker did - is just another name for raising the "wages of capital"; of raising the incomes of the owners of capital in absolute terms, and relative to the wages of labour. Not surprisingly, the policy of raising capital costs in capital-intensive economies had a marked effect on firms' costs. Stagflation took off only after the policy that was supposed to end stagflation was implemented. Eventually, mass unemployment in North America and Western Europe lowered the wages of labour and reduced aggregate demand, preventing small businesses from raising prices. Stagflation came to an end although the costs of the "cure" proved higher than the costs of the problem.

Overall, the 1970s' oil price shocks themselves did no damage to the world economy, and indeed induced a number of conservation-oriented responses that made the world a better place. The real problem was our over-reaction to the oil price hikes, and the opportunity the confusion gave to a few well-placed capitalists to implement a political agenda that really was damaging to those of us who depended on our labour and our wits rather than our private property.

So today, I get twitchy when we overreact when certain vicissitudes of supply and demand are assumed to represent some sort of crisis. Rather, price movements represent the normal workings of the impure market economy.

© 2000 Keith Rankin

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