Stagflation? There are big differences between the 1970s and today
Last week, the World Bank warned the global economy was under threat.
It said Russia’s invasion of Ukraine, surging inflation, and rising interest rates were going to see global growth slump this year.
And it raised the spectre of “stagflation“.
It warned that we were staring down the barrel of years of stagnating growth and above-average inflation (stagflation), a situation the world had not seen since the 1970s.
It wasn’t great news.
It revived painful memories of Australia from 50 years ago, when the governments of Gough Whitlam and Malcolm Fraser struggled to get inflation under control.
But let’s keep things in perspective.
There are big differences between the 1970s and the 2020s that suggest we won’t see a repeat of those days.
If things get worse in Australia from here, it will be for historically different reasons.
We’ve already learned lessons from the 1970s
So let’s focus on the biggest dissimilarities.
And what’s the most obvious one?
Well, we’ve experienced stagflation before, so we know what to expect this time.
In the 1970s, people hadn’t seen the phenomenon before and plenty of people didn’t believe stagflation could happen.
And if you don’t believe something can occur, how do you deal with a world in which it is already occurring?
It took a huge mental adjustment.
Many economists suffered reputational damage in the 1970s because their models suggested stagflation was an impossibility.
Why? Because, according to their way of thinking, if unemployment increased significantly there’d obviously be fewer people in work so there’d be less demand in the economy, and that lack of demand would put downward pressure on wages and inflation.
But in the 1970s, they saw inflation rising quickly, wages rising quickly, and unemployment increasing too. Huh?
It took years to wrap their heads around it.
But we’ve seen it happen before, so it won’t take a dramatic mental adjustment. And economists have studied it forensically.
We’re already living in the neoliberal era
Which brings us to the next dissimilarity.
In the post-war years from 1946 to the early 1970s, Australia’s economy was built on a platform of genuine “full employment”.
It was part of Australia’s social contract.
Labor and Coalition governments would panic if the unemployment rate looked like it was heading towards 3 or 4 per cent in those days, and they kept the unemployment rate averaging below 2 per cent for 30 years.
And that’s why when stagflation hit Australia in the early 1970s, the Labor government of Gough Whitlam tried to keep that full employment model in place for a while.
Why wouldn’t it? In what universe would a Labor government abandon full employment?
But the hands of policymakers were eventually forced by events, and everyone had to begin the very painful process of mentally adjusting to the fact that full employment was going to become a thing of the past.
And, in the middle of that chaotic environment, policymakers started shifting to a new growth model that would have a huge social cost.
Their new growth model eventually accepted a much higher level of unemployment than previously.
That higher level of unemployment would be used to keep a lid on inflation and wage growth, to prevent such high levels of inflation from happening again.
And that’s the model we’ve been living with since the 1980s.
It’s coincided with the rise in underemployment and casualisation in recent decades, an increase in wealth inequality, and a steady decline in the share of national income going to workers.
But Australians have become used to higher levels of unemployment now (which isn’t to say they agree with it).
And that means that if we experience stagflation again, politicians won’t have to tell voters that the old full employment growth model will have to be abandoned.
Why? Because full employment was abandoned decades ago.
We have no expectations to be dashed.
The stagflation decade began with real wage increases
And there’s a third dissimilarity.
The 1970s began with a deliberate increase in labour costs (for employers) for moral and social reasons.
It saw two important decisions to enforce equal pay for women: the “equal pay for equal work” decision in 1969, and the “equal pay for work of equal value” decision in 1972.
Previously, the minimum wage for women had been set at 75 per cent of the male wage rate, but the decisions lifted it to 100 per cent.
And the Whitlam government moved quickly, after its 1972 election win, to introduce equal pay for women in the public service as part of its overall wage push.
Hundreds of thousands of female workers were suddenly eligible for full, male-equivalent pay.
What impact did it have?
In 1977, the economist John Pitchford compared the wage increases for men and women between 1969 and 1974.
He found that over those five years, average hourly wage rates rose for men by 98 per cent, and for women by 142 per cent.
Looking back from the vantage point of 1992, Reserve Bank economist Glenn Stevens (who became RBA governor in 2006) said the impact on aggregate wage costs of those equal pay decisions was substantial.
“Compared to a situation where all wages had risen at the male rate, and given that women comprised about a third of the labour force at the time, the more rapid rise in female wages must have added substantially to aggregate labour costs,” he said.
“Rises in real wages had been seen in the upward phase of previous cycles, but the rise in real wages over several years up to 1974 was unprecedented.”
And this next bit is important.
Those equal pay decisions led to an important and necessary increase in labour costs for the economy.
But that type of “shock” to the economy’s aggregate wage bill could only occur once. It was a one-off event.
It can’t happen in the 2020s because it’s already happened.
And at any rate, real wages have been declining for Australian workers for the last 12 months, so there’s no real wage increase leading into this inflationary episode like there was in the 1970s.
The industrial landscape is very different
And there’s a fourth big dissimilarity.
Australia’s wage-setting institutions in the 1970s were very different from today’s.
When inflation began to gallop higher in 1973 wages grew with it. Average wages grew by about 15 per cent in 1973 and by roughly 28 per cent in 1974.
Can you see that happening again?
In the 2020s, the forces of wage suppression seem too strong and too embedded for that to happen.
And think of the level of union membership today.
At its peak — during the full employment era from the 1940s to 1970s — roughly half of employees were union members.
But from the 1980s, union membership began steeply declining, dropping from 45.6 per cent in 1986 to 14.3 per cent in 2020.
See the graph below.
That decline in union membership has coincided with a real decline in unions’ industrial power since the 1970s.
The ability to command significant wage increases these days, via industrial action, has become really difficult.
In the neoliberal era, Coalition and Labor governments have both chipped away at unions’ right to strike, to the point where the United Nations has repeatedly warned Australia that it’s breaching international labour standards.
The severe restrictions on unions make Australia an outlier among its peers.
See the graphic below.
So, how likely do you think it is that we’ll see the same level of industrial action as we saw in the 1970s?
The financial system is very different
And finally.
The global financial system is really different today.
In the 1970s, Australia’s economy was built on a financial system of pegged exchange rates and capital controls, and policymakers would have to officially devalue or revalue the dollar at intervals to support net exports and control inflationary pressures.
But in the turmoil of the 1970s, the dollar slowly became more flexible.
From being pegged to the UK pound, to pegging against the US dollar in 1971, Australia’s dollar was then pegged against the trade-weighted index in 1974.
In late 1976, that “hard” peg was then changed to a crawling peg, where the value of the dollar was changed daily, and then it finally shifted to a floating exchange rate in 1983.
See the graphic below.
We’re living in an era of floating exchange rates, unlike in the 1970s.
And in 1993, the Reserve Bank of Australia (RBA) adopted an official inflation target, aiming to keep inflation within a range of 2 to 3 per cent, on average, over the cycle.
That’s the world we’re living in today.
Floating exchange rates and official inflation targeting, with a deregulated economy and much lower barriers to trade.
It’s wildly different from the 1970s.
So, while the threat of stagflation may be very real in 2022, it can’t pose the same threat as it did 50 years ago, by definition.
Our economic institutions have changed too much.
