But this is only half the story. Lower inflation may mean that what the workers have already earned is better protected, but the policies that are needed to generate this outcome may reduce what they can earn in the future. Why is this? The tight monetary and fiscal policies that are needed to lower inflation, especially to a very low level, are likely also to reduce the level of economic activity, which, in turn, will lower the demand for labour and thus increase unemployment and reduce wages. So a tough control on inflation is a two-edged sword for workers – it protects their existing incomes better, but it reduces their future incomes. It is only the pensioners and others (including, significantly, the financial industry) whose incomes derive from financial assets with fixed returns for whom lower inflation is a pure blessing. Since they are outside the labour market, tough macroeconomic policies that lower inflation cannot adversely affect their future employment opportunities and wages, while the incomes they already have are better protected.
Neo-liberals have made a big deal out of the fact that inflation hurts the general public, as we can see from the earlier quote from Volcker. But this populist rhetoric obscures the fact that the policies needed to generate low inflation are likely to reduce the future earnings of most working people by reducing their employment prospects and wage rates.
Upon taking power from the apartheid regime in 1994, the new ANC (African National Congress) government of South Africa declared that it would pursue an IMF-style macroeconomic policy. Such a cautious approach was considered necessary if it was not to scare away investors, given its leftwing, revolutionary history.
In order to maintain price stability, interest rates were kept high; at their peak in the late 1990s and the early 2000s, the real interest rates were 10–12%. Thanks to such tight monetary policy, the country has been able to keep its inflation rate during this period at 6.3% a year.[17] But this was achieved at a huge cost to growth and jobs. Given that the average non-financial firm in South Africa has a profit rate of less than 6%, real interest rates of 10–12% meant that few firms could borrow to invest.[18] No wonder the investment rate (as a proportion of GDP) fell from the historical 20-25% (it was once over 30% in the early 1980s) down to about 15%.[19] Considering such low levels of investment, the South African economy has not done too badly – between 1994 and 2005, its per capita income grew at 1.8% a year. But that is only ‘considering …’
Unless South Africa is going to engage in a major programme of redistribution (which is neither politically feasible nor economically wise), the only way to reduce the huge gap in living standards between the racial groups in the country is to generate rapid growth and create more jobs, so that more people can join the economic mainstream and improve their living standards. Currently, the country has an official unemployment rate of 26–8%, one of the highest in the world*; a 1.8% annual growth rate is way too inadequate to bring about a serious reduction in unemployment and poverty. In the last few years, the South African government has thankfully seen the folly of this approach and has brought the interest rates down, but real interest rates, at around 8%, are still too high for vigorous investment.
In most countries, firms outside the financial sector make a 3–7% profit.[20] Therefore, if real interest is above that level, it makes more sense for potential investors to put their money in the bank, or buy bonds, rather than invest it in a productive firm.Also taking into account all the trouble involved in managing productive enterprises – labour problems, problems with delivery of parts, trouble with payments by customers, etc. – the threshold rate may even be lower. Given that firms in developing countries have little capital accumulated internally, making borrowing more difficult means that firms cannot invest much. This results in low investment, which, in turn, means low growth and scarce jobs. This is what has happened in Brazil, South Africa and numerous other developing countries when they followed the Bad Samaritans’ advice and pursued a very low rate of inflation.
However, the reader would be surprised to learn that the rich Bad Samaritan countries, which are so keen to preach to developing countries the importance of high real interest rates as a key to monetary discipline, themselves have resorted to lax monetary policies when they have needed to generate income and jobs. At the height of their post-Second-World-War growth boom, real interest rates in the rich countries were all very low – or even negative. Between 1960 and’73, the latter half of the ‘Golden Age of Capitalism’ (1950–73), when all of today’s rich nations achieved high investment and rapid growth, the average real interest rates were 2.6% in Germany, 1.8% in France, 1.5% in the USA, 1.4% in Sweden and -1.0% in Switzerland.[21]
Monetary policy that is too tight lowers investment. Lower investment slows down growth and job creation. This may not be a huge problem for rich countries with already high standards of living, generous welfare state provision and low poverty, but it is a disaster for developing countries that desperately need more income and jobs and often are trying to deal with a high degree of income inequality without resorting to a large-scale redistribution programme that, anyway, may create more problems than it solves.
Given the costs of pursuing a restrictive monetary policy, giving independence to the central bank with the sole aim of controlling inflation is the last thing a developing country should do, because it will institutionally entrench monetarist macroeconomic policy that is particularly unsuitable for developing countries. This is all the more so when there is actually no clear evidence that greater central bank independence even lowers the rate of inflation in developing countries, let alone helps to achieve other desirable aims, like higher growth and lower unemployment.[22]
It is a myth that central bankers are non-partisan technocrats. It is well known that they tend to listen very closely to the view of the financial sector and implement policies that help it, if necessary at the cost of the manufacturing industry or wage-earners. So, giving them independence allows them to pursue policies that benefit their own natural constituencies without appearing to do so. The policy bias would be even worse if we explicitly tell them that they should not worry about any policy objectives other than inflation.
Moreover, central bank independence raises an important issue for democratic accountability (more on this in chapter 8). The flip side of the argument that central bankers can take good decisions only because their jobs do not depend on making the electorate happy is that they can pursue policies that hurt the majority of people with impunity – especially if they are told not to worry about anything other than the rate of inflation. Central bankers need to be supervised by elected politicians, so that they can be, even if at one remove, responsive to the popular will. This is exactly why the charter of the US Federal Reserve Board defines its first responsibility as ‘conducting the nation’s monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates [italics added]’[23] and why the Fed chairman is subject to regular grilling by Congress. Ironic, then, that the US government acts internationally as a Bad Samaritan and encourages developing countries to create an independent central banks solely focused on inflation.
18
On the profit rate data, see S. Claessens, S. Djankov & L. Lang (1998), ‘Corporate Growth, Financing, and Risks in the Decades before East Asia’s Financial Crisis’, Policy Research Working Paper, no. 2017, World Bank, Washington, DC, figure 1.
19
T. Harjes & L. Ricci (2005), ‘What Drives Saving in South Africa?’ In M. Nowak & L. Ricci,
*
Unemployment rates in developing countries underestimate the true extent of unemployment, as many poor people cannot afford to remain unemployed (as there is no welfare state) and, therefore, end up working in extremely low-productivity jobs (e.g., selling trinkets on the street, catching doors for people for small changes). This is known as ‘disguised unemployment’ among economists.