Stagflation Afflicts the Nation

Frank deJong

[ GroundSwell, July-August 2008]

Inflation and economic stagnation are mutually exclusive, according to reigning conventional neo-Keynesian economics.  Nonetheless, it's here, and the G7 leaders and the national banks are at a loss: Either raise interest rates to stop inflation and kill jobs and production, or cut rates to spur growth and cause inflation.

Stagflation is no mystery, however.  Baffled economists need only re-read Canada's own John Kenneth Galbraith.  In his 1972 "Annals of an Abiding Liberal," he explains that stagflation results when central banks set the bank rate to fight inflation, knowingly deepening a recession or forestalling a recovery.

Galbraith explains that roughly half the economy is made up a small number of large corporations, and the other half comprises many smaller businesses, which he calls the entrepreneurial sector.

The corporate half of the productive economy causes the inflation in stagflation, since it is mostly immune to bank rates.  That's because large corporations have preferential access to capital, can often self-finance, have direct lines to resources and suppliers, and can use their influence to control prices.

The entrepreneurial sector causes the stagnation in stagflation, since it must borrow on the daily market, doesn't own resources, can't command prices from suppliers, and must sell products and services for what the public can afford. When capital is scarce, smaller businesses must lay off employees, cut production or go bankrupt, waiting for interest rates to come down.

Galbraith advocated wage and price controls, which Canada and the USA both briefly implemented at the time. But a better remedy would be for governments to remove taxes from incomes and businesses and instead collect the unearned income in the economy, what 19th-century economist David Ricardo called an "economic rent."  Economic rent, which makes up about 30% of the economy, is the societal surplus that accrues to desirable, finite assets like resources (oil, coal, gas, trees, water), land, the electromagnetic spectrum, drug patents, the stock market, and the permission to pollute.

Presently, large corporations command the lion's share of the societally-generated economic rent, so a move to shift some of the tax burden onto that portion of the economy would remove their unfair advantage and equalize the effect of central bank rates changes on both large corporations and small businesses, and thus address stagflation.