New View of Prices

Whenever the experts look at inflation, the general assumption is that the cost-price spiral is an economy-wide phenomenon to be blamed on all industry. This assumption, says Professor Charles L. Schultze of Indiana University, is a mistake, and is one reason why the U.S. knows so little about inflation; economists do not study it closely enough. In a report issued last week by the Committee for Economic Development, Economist Schultze goes after the inflation problem industry by industry with prices, cost and output data for each. His conclusion: sharp inflationary pressures in only a few industries were responsible for most of the inflation in the U.S. economy during the 1947-57 period.

Schultze isolated six major industries in which soaring demand far outstripped the rest of the economy. They are:

Construction

Durable Goods

Finance and Insurance

Transportation (other than railroads)

Communications

Public Utilities

The Big Three. During the decade, the combined output of these six jumped 66% v. a rise of 42% for the economy as a whole. In some of the six, notably utilities, which posted a 128% gain in output with only an 18% price rise, productivity rose fast enough to counteract the usual price increases that accompany soaring demand. But in others of the powerful six, productivity fell behind. Productivity did not keep pace with costs in construction and durable goods; added to a seventh burgeoning industry, services, which by its very nature does not increase productivity rapidly, they were enough to overpower all other sectors of the economy and lead the way into inflation (see chart). Says Schultze: "If durable goods, construction and services are combined, the total accounts for roughly 15.5 [percentage] points of the 29% rise in the overall price index, even though these three represent less than one-third of total business output."

The study goes on to explore another economic problem of the 1947-57 period: steadily rising prices even during recession when dropping demand should cut prices. Economist Schultze does not explain it in the usual terms of a wage push by hourly workers. Instead he cites businessmen themselves: in expectation of growing long-term demand, they loaded on new plants and machines, more nonproductive salaried engineers and managers, all heavy overhead items of fixed cost. When recession came, the businessmen were stuck; they could lay off hourly workers, but they still had to pay their fixed costs for plants and highly trained white-collar staffs. As sales dropped and earnings were squeezed, the tendency was to hike prices in hopes of maintaining profits. Says Schultze: By insisting on immediate returns on their investment "instead of writing it off against the future, they showed a little bit of a lack of imagination."

The Ratchet. Moreover, inflation may well be here to stay. Says Schultze: "A massive depression like that of the 19303 would surely break through the rigidities in the price-cost structure and force wage and price declines." But the U.S. economy of 1960 is so strongly committed to full employment and has so many built-in stabilizers that there is little chance of a big enough drop. The U.S. has managed to even out the sharpest swings in its economic cycle, but in so doing it has also put a "ratchet" under prices and costs, thus preventing them from going down.

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