Reaganism and Thatcherism were Intellectually Dishonest – Heiner Flassbeck on Reality Asserts Itself (1/5)

The Real News Network has an interview that starts with this first segment Reaganism and Thatcherism were Intellectually Dishonest – Heiner Flassbeck on Reality Asserts Itself (1/5).

This should prove to be an interesting series. In the first one there is a good discussion of what happened in the 1970s with the oil driven inflation.

JAY: And why do you think these ideas became dominant? And what changed? You talked about this moment after World War II that was kind of desperate, and so, you know, the elites around the world bought into this Bretton Woods idea. What changed?

FLASSBECK: I think the main thing were the oil price explosion, what is called the oil price explosions in the middle of the ’70s and the end of the ’70s, where we had hikes in inflation all around the world, in the industrialized world, in the United States and Europe, everywhere. Inflation went up because wages were on the rise. There was full employment everywhere. So the unions were strong about pushing for higher wages–.

JAY: But inflation also went up because oil prices went way through the roof.

FLASSBECK: Yeah, yeah, but in–the second round was–this is really what economists call a second-round effect. And they were right at that point of time that wages were creating a second-round effect for inflation, and this was a lasting effect on inflation. And then monetary policy stepped in, and monetary policy harshly broke, so to say, this circle of rising wages and rising inflation.

JAY: By raising interest rates through the roof.

FLASSBECK: And then raising interest rates through the roof, and then by creating unemployment. This was the time when unemployment, so to say, entered the Western world. This was the first time.

And this conflict between inflation and unemployment was taken by the monetarists, by the neoclassical economists, to say, you see? Keynesianism is wrong because Keynesianism always produces inflation; in the end they produced inflation. It was good with high employment for a time, but then it overshoots. So we need more objective steering of monetary policy. We should not allow these bouts of inflation, and we should stop it early on, and this can only be done by an independent central bank. And then–so monetarism took over. And academically they were also quite successful at convincing, so to say, most economists that only a neoclassical theory, a neoliberal theory, would be a scientific approach to economics.

JAY: But weren’t they right in terms of the levels of inflation? Weren’t they right?

FLASSBECK: No, no, for the moment they were right. For a moment it was right. If you take Europe or Germany or the United States, it was right at that moment of time: it was not correct and it was not reasonable to increase wages in response to the higher inflation that came from oil price explosion. This is, so to say, a supply-side effect, this is really a supply-side effect where inflation rises, and this cannot be taken from the companies at home, because we have to give that income, so to say, to the producers of oil. We have to send it over to Saudi Arabia. So it was no longer there. And then to fight for something that is no longer there, that’s not very reasonable. That leads to inflation. But that was only the first round. In the second round, the second oil price explosion, wage increases were much lower, much lower. But nevertheless, monetary policy–.

JAY: But the wages had to go up to keep up with the inflation from the oil prices.

FLASSBECK: Yeah, but that’s a very open question. There I’m not of that opinion, because what happens if–what you should get always: you should have wages following, so to say, a normal inflation rate. But if the inflation rate, for external reasons that you cannot influence (something like the oil price hike), increase, then the internal fight doesn’t make sense, because it’s gone. This income is gone. The inflation, the higher rate of inflation shows that income has gone elsewhere.

As is typical of Paul Jay, he fails to get the point, but if you have an open mind you do not have to suffer the same fate. What I get from this whole interview (not just the excerpt above) is an explanation of how the inflation problem was correctly although painfully solved by Reagan/Thatcherite policies (which were really German policies). Also that the correctness of those policies was limited to the situation of an exogenous driver of inflation. What we are experiencing in the world economy today is nothing like the issue in the 1970s, so supply side solutions are totally inappropriate to the current situation.

Actually, supply side economics might seem to be a good idea when there is more demand than supply. However, it fails to take into account that when there is already full employment, there is no more supply to be had. When there is not enough demand to use what could be supplied, then there is no sense in increasing supply which is already too big for the demand. The only insight during the period of the 1970s and 80s was that when demand exceeds supply under full employment, you have to cut demand. The Reaganites never admitted that was what had to happen. That is what they did, but they pretended it was something else.

Doing the right thing for the wrong reasons is what has lead to the ensuing decades of doing the wrong thing for the wrong reasons.

I suspect that all these issues will be treated in more depth in the later segments, if only Paul Jay will stop interrupting the interviewee.

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