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Slumpflation or Deflationary Slump?

Hector McNeill1
SEEL

This note is a sequel to the review article in this publication entitled "Slumpflation, the policy-induced crisis". It represents the first article that explains, in more detail, the Real Incomes Approach to economics. Readers are advised that this is a distinct approach to macroeconomics that cannot be summarized in an article as short as this one. The other facets and implications of this policy ( see footnote 2 ) will be covered in subsequent articles.

This was first posted in April 2013 and has been revised.

PLEASE NOTE

The sequel to this essay is Tacit & explicit knowledgege. This is a complex topic and not one normally embedded in macroeconomic theory or accompanying policies. The successful development & application of knowledge requires the type of policy focus provided by the Real Incomes Approach.

Today serious economists and politicians ponder as to whether we are teetering on the edge of a deflationary slump which they consider to be different from slumpflation. Commentators, including economists and politicians, insist that today's challenges facing policy makers are "different" from past crises both in terms of cause and scale of impact. This reflects a deficient appreciation of the stark similarities between all of the economic crises since 1929. The fact that people state otherwise only emphasizes a serious intellectual deficit in macroeconomic theory and practice. Admitting that such a deficit exists we can assume that policy makers are not using the correct decision analysis because the macroeconomic theoretical model is, itself, flawed. As a result policy targets are inappropriate and therefore policy instruments do not gain sufficient traction. We all know that policy-makers the world over are "treading water" hoping that things might improve.

In 1976 supply and demand analysis and assessment of Keynesianism and the then promise of Monetarism were both discounted on the basis that the theory would produce arbitrary impacts on sections of the economic and social constituencies, that is, create winners, losers and those who remain in a policy neutral impact state. These were the source of my criticisms of Keynesianism in the 1970s and it was evident then that the surge of interest in Monetarism was not going to eliminate the collateral and destructive arbitrary and differential constituent impacts. I concluded that both Keynesianism and Monetarism are "fair weather" policies incapable of managing the economy and protecting economic and social constituencies from significant commodity or financial market shocks. Indeed, because of the equivalence of Keynesianism and Monetarism, I dubbed them KM policies. We see today an attempt to apply both approaches in a "co-ordinated fashion" failing as was predicted in 1976.

Why then and now are the same



Real incomes are falling ...
The obvious common economic impact of the slumpflation of the 1970s and early 1980s and what we have now (2007-2013), that is, a deflationary slump, is the fact that real incomes are falling. Falls in purchasing power due to inflation is the equivalent to loss in purchasing power associated with excessive monetary volumes and even zero interest rates. This is because in both cases in an increasingly inter-dependent world, the price of money shows up in the exchange rate of the pound against the currencies of our major trading partners or the common currencies used in transactions. Quantitative easing and low interest rates are the equivalent to devaluation, this raises the relative prices of imported items. This is also a race to the bottom, dressed up as prudential macroeconomic policy, resulting in currency conflict promoted by national central bank decisions, each trying to gain national benefits from export led growth. These benefits will not be fully realized because all are playing the same game. This is a beggar-thy-neighbour approach to macroeconomic policy and undermines the reality of "free trade". It was this sort of mutual irresponsibility in economic governance that undermined the gold standard. No matter what the policy, the eventual symptom of economic crises is that most people face falling real incomes. An addendum to this observation is that it is not only falling real incomes but sharply rising and concentration of real incomes in other segments of the economic and social constituencies.

Such blanket approaches which smother and undermine effective policy traction include trying to control money volumes (quantitative easing), low interest rates and cutting government revenue-supported activities (public services). The fact that savers are seriously prejudiced, that real incomes, as a result of a devaluing currency, drop in proportion to imported items consumed and export led growth falters as a result of currency conflict arising from diametrically opposed national monetary policies that adhere to no central value standard (such as gold), are, by default, considered to be the normal "costs" to be endured as a result of policy-making; very poorly conceived and irresponsible policy-making. The root cause is that economic theory provides no convenient solutions.

There is an alternative


The British electorate have tolerated widely different conditions on the assumption that our macroeconomic management is sound. To a large degree the instability and precariousness of the economy and prejudice suffered by segments of the community are directly related to flawed macroeconomic theories and inappropriate policies


First of all the very wide range of conditions (
see footnote 3 ) and status of economic & social constituents cannot be accommodated by KM policies because they depend on market manipulation through quantitative control over money volumes and interest rates and across-the-board fixed levies and taxes. As has been explained these have significant differential impacts on the economic and social constituents and therefore traction is eroded. One reason is that these "indicators" have transitory values that are determined by too many factors. As a result policy makers are not only trying to determine the "correct" balance between interest rates, money volumes, government revenue and expenditure they are also attempting to trade these off against unemployment rates, banking credit and loans, saving, investment, exports, import substitution, welfare and a host of other competing demands for attention. To reduce a highly complex picture of de facto confusion that reigns under KM policies the fundamental cause of failure is the lack of accommodation of macroeconomic policies to economic and social constituency preferences. The footnote 3 below provides a short summary of the diversity and complexity of the constituencies which serves to explain why top down monopoly market intervention by governments and so-called independent central banks such as the Bank of England, have to be the most irrational and therefore ineffective basis for administering macroeconomic policies. Since we are dealing with government decision-making and legislative elements and the "beneficiaries" of such policy decisions being the electorate, it is appropriate to question the constitutional rigour of macroeconomics in terms of its accommodation of electorate preferences in government policy-making. (this significant topic has been covered in a general sense in the article: "Constitutional questions arising from macroeconomic management"), here I will focus on the specific solutions to this significant constitutional problem.

The driver of the macroeconomy

The conventional concept of the driver of the economy is market demand and this is perceived to be largely a "pull factor" and expressed in nominal terms. KM policies concentrate a lot of effort in increasing or depressing demand by increasing or reducing money volumes, changing interest rates and changing taxes and levies and public expenditures. The reason these policy targets have no traction is that there is no recognizable measure to guide economic units and individuals as to how to act in their own interests can also support the policy objective. Leaving this to "market forces" is a crude and unpredictable state of affairs given the diversity of conditions facing economic units. Thus policy imposes conditional music and economic units are expected to dance to the new tune. Running the economy as if it were a parlour game of musical chairs is a comical concept but this, unfortunately the reality and it arises from a lack of rigour in aligning macroeconomic logic with microeconomic imperatives.

Setting the course

The predictable outcomes range from severe prejudice to exaggerated benefits. In the end the policy-makers are trying to steer a course between Slumpflation and Deflationary Slump. Thus the objective is to tack to avoid inflation and rising unemployment on one side and falling economic activity and employment on the other. In both cases the extremes represent cases of falling real incomes. In order to attenuate any tendencies towards slumpflation or deflationary slump the economy needs a single objective, that of maintaining or increasing real income levels. Real incomes represent the most appropriate indicator for the macroeconomic policy objective because this can be managed at the microeconomic level by each economic unit following their own interests. The reason this does not happen at the moment is that:
  • real incomes are not the prime policy objective
  • There is a fundamental flaw in the macroeconomic policy models
The main flaw in macroeconomic models is that they consist of a simplistic mechanism consisting of:
  • An overall policy target
  • A policy instrument
As can be seen there is no mention of the measures to be taken and assess performance, of relevance to decision-makers at the level of the firm. This is a direct indication of the essential lack of relevance and practicality such policies have to the social and economic constituencies. Clearly, without reference to such measures the outcomes of policies remain largely unpredictable.

The need for agreed policy packages

Clearly macroeconomic market interventions applying changes in taxation, public expenditure, interest rates and money volumes and the related impacts on exchange rates are never accompanied by a coherent incentive to act in a way that is recognizable by all individuals and economic units as desirable. This is an essential and simple requirement in order to gain traction and deliver policy objectives. The required policy components include:
  • Overall specific policy objective or policy target to which the electorate has agreed
  • A performance measure of some kind to indicate the degree by which individuals and companies contribute to policy target
  • A policy instrument to encourage manipulation of the performance measure to deliver on the policy target
The Real Incomes Approach policy provides these components in a basic policy package consisting of:
  • Overall policy objective or policy target: maintenance or growth in real incomes


  • A robust and competitive economy can be sustained as long as participation benefits all on an equitable basis ...
  • A reference index of the degree by which companies contribute to policy target: Price Performance Ratio (PPR) (controlled by each company)
  • Policy instrument: a Price Performance Levy (PPL) which is applied in proportion to PPR value
Real Incomes as policy target

The first step is to make the maintenance or increase in real incomes a microeconomic objective where real incomes are made up of the following components:
  • Owner and shareholders incomes
  • Employee and management incomes
  • Consumer incomes
  • Incomes of the self-employed
  • Incomes of savers
  • Income of the unemployed
The PPR-Price Performance Ratio

Under a real incomes approach the government’s role is to encourage all and different types of economic transactions to be characterized by a general control of the price performance ratio (PPR) (See: The price performance ratio)so that the rate of increase in output prices does not exceed the rate of increase of input values. The real income components, listed above, can be sustained or augmented by the degree to which activities contribute to outputs whose value enhances the real incomes of consumers of the activity output. In general terms a PPR that is less than unity (<1.00) enhances consumer real incomes. A PPR of unity (1.00) is neutral in terms of real income impact and a PPR greater that unity (>1.00) will decrease consumer real incomes.



It is essential that those managing high technology and advanced engineering processes have full command over the way in which they allocate their resources so as to guarantee higher productivity and competitive sustainable prices...
The resources applied by management in managing the PPR include investment, training, the acquisition of tacit knowledge and operational skills in techniques by individuals and work teams as well as through pricing strategies and tactics. In other words there is a range of determinants at the microeconomic level that facilitate the ability to manage price performance ratios. Put another way, by making these determinants supportive of the policy objective each company and individual is free to take decisions according to their specific circumstances, capabilities, resource availability, preferences and objectives.

The price performance levy



In relatively lower technology extractive industries, such as agriculture, the weather and market risks are significant. Securing food, fibre and feedstock security means managers need to be able to plan to allocate their resources as necessary rather than as decreed by macroeconomic policies....
Under conventional tax regimes in free markets, companies with lower PPRs (PPR<1.00) will benefit consumers through a transfer of real incomes (purchasing power) but the profits of the company and wage payments fall. As a result neither the company nor the workforce is compensated for having contributed to the increase in the real incomes of consumers. Conversely, companies with higher PPRs (PPR>1.00) will prejudice consumers by reducing their real incomes (purchasing power) but the profits of the company and wage payments rise. As a result the company and the workforce is compensated for having contributed to the decrease in the real incomes of consumers; this is typical under inflationary conditions. Indeed, many of the perversities that characterize the outcomes of conventional macroeconomic policies can be related to PPR issues including failure to distribute incomes effectively and failure to gain equitable and balanced economic growth.

In order to adjust the desirable distribution of real incomes the Real Incomes Approach aims to compensate companies and their work forces with rises in real incomes in proportion to increased performance and enhancement of consumer real incomes. This can be achieved through a progressive price performance levy (See: The price performance levy)applied according to the PPR bands. This is essentially a tax scheme based upon bands of corporate performance related to their contribution to real incomes. In this way the incentive is for enterprises to manage their resources so as to lower PPR so as to lower the levy. The cumulative outcome is a mutual increase in real income levels arising from physical and pricing performance.

The price performance levy remain as the incentive for encouraging efficiency and performance but there would be no corporation tax. Most taxation would be passed to income tax under a regime of a living wage and circulation taxes such as VAT.

A fundamental difference in macroeconomic management

The fundamental difference between the Real Incomes Approach and conventional policy is that decision-makers are empowered by the fact that they understand what specific actions then need to take to maximize their real incomes, thereby satisfying the macroeconomic objective. This is achived by applying transparent business rules with a specific focus on economic unit maximization of real incomes. Managemnt would remain free to take any decision according to their specific circumstances and be able to allocate resources to set the PPR where they desire to increase their real incomes by reducing the price performance levy, evewn to zero. As a result the policy instrument can support the participants in the economy at the level of the firm and individual to act in their own interests and thereby maintain policy traction and overall success in policy outcome.

Real incomes are determined by a dynamic trade off between nominal prices paid for goods, services and money and nominal incomes. The result of the optional trade-offs is a purchased combination of goods, services and money that is a measure of "purchasing power" or "disposable income". Nominal unit prices are determined by past, current and future trends in productivity and the marketing strategy of a producer in terms of a desire to penetrate markets with lower unit prices or to maintain a less dynamic position of a stable market and higher unit prices.

Physical productivity is based upon the balance between inputs and outputs of economic units. This includes the balance between inputs and outputs handled by individuals working within economic units. It is also based upon the balance of inputs and outputs of people working on their own accord. It is therefore in the area of technology, technique, human learning and innovation that increases in real physical output occur. The short term determinant of the relative benefits to the population of such increases in productivity is unit price setting. Current price setting relates to current unit costs and to expected unit costs. Unit prices also relate to tactics adopted by economic units with respect to a trade off between rate of market penetration and desired margins and cash flow.

The Real Incomes Approach and economic growth



The foundation for growth in the UK economy is a macroeconomic policy that sustains the growth in real incomes.....
A current topic of concern is that in attempting to impose austerity measures as a way to reduce government debt there is a knock on effect that economic growth is weakened or eliminated altogether. However, growth, in the context of the conventional government revenue-expenditure model, is required to raise revenue from taxes to pay off debt. There are many who suggest that growth can be achieved by applying the standard Keynesian approach to public works and investment as a way to increase employment and economic growth.

One of the most drastic outcomes of KM policies and off shore engineering under “globalization” has been an across the board de-skilling of significant segments of the North American and European workforce through a loss of essential tacit knowledge. Thus any growth strategies are seriously constrained by the fact that productive jobs have been exported; they no longer exist in the economy. This state of affairs has significantly reduced growth options that could have become effective within the short to medium term.

Paradoxically Keynesian theory and derived policies do not possess specific reference to the principal sources of economic growth. There exists a persistent confusion between public works to generate employment and sustainable growth. It is well established that some 50%-60% of economic growth in primary, extractive, industrial, manufacturing and service sectors arises from supply side phenomena including technology, learning, technique refinement and innovation. Learning and the accumulation of tacit knowledge are the most important contributors to growth.

Tacit knowledge arises from direct manipulative experience of activities on a repetitive basis leading to significant economies in resource usage and enhanced productivity.


Globalizaion and off shore engineering has exported high technology jobs and de-skilled the workforce. A Real Incomes Approach can sustain the progress in increased productivity and accumulation of tacit knowledge, both essential to recapture growth in highly competitive sectors through a process of investment in onshore engineering....
Therefore to gain such capabilities there is a need to increase the direct exposure of those employed to increasing process throughput in physical terms. The most effective way to achieve this is to have well designed products and services and accessible prices. This can help accelerate sales and take up through market penetration. As a result of increased direct experience of managers and work forces based on the higher throughput, tacit knowledge is increased and continues to accumulate.

The perception of many in government is that anything involving innovation, technology, learning and technique will require a medium to long term investment programme including research and development initiatives, more access to university, technical and online courses and large investments. This naturally causes many to therefore not see this area as a short to medium term solution to growth.

The Real Incomes Approach, through a process that raises the direct impact of individual decision-makers on the movement of the economy towards increased real growth in incomes also enables managers to optimize their investments applied to low cost growth pathways suitable for their enterprises. A key factor is pricing policy and manipulation of the PPR and an ability to recover investment costs. Although medium to long term investments are, indeed, important for future growth a considerable amount of growth can be obtained by applying state of the art technologies. Managers can identify growth elements in an enterprise that can be self-supporting through the management of the PPR and net of price performance levy positions. This also signifies that a significant annual growth can be obtained without requiring loan finance (debt). Above all, pricing can help gain market penetration extending the operational experience of employees and managers leading to quantifiable economies in resource usage through enhanced capabilities in the application of technique. The annual gains arising from this learning process and accumulation of tacit knowledge can exceed 15% each year, depending on the type of process.

By distributing the initiative for such innovation to the population of economic units as opposed to trying to lead from the front through centralized initiatives, the impact on national growth can be significant. The issue is to integrate the combined efforts of what are growth opportunities that are distributed throughout the economy but each needs to be applied according to the conditions of each economic unit. The Real Incomes Approach supports this foundation for enterprises to act in a more proactive manner reducing the need to require loans and the attendant risks.

In terms of the current urgent need for economies to secure growth impacts within a short period of time, the Real Income Approach provides a basis where by managers can secure short and medium term results in the form of real growth. Once the Real Incomes Approach is introduced the benefits from real incomes growth should accelerate according to the rate of diffusion of the impact of the policy throughout the economy.

The Real Incomes Approach has a direct impact through inflation reduction, economic activity stimulation and therefore promotion of employment based on more productive and sustainable activities. As a result the economy can follow a steady course that can avoid slumpflation and deflationary slump.


Footnotes:

1 Hector McNeill is diretor of SEEL-System Engineering Economics Lab.

2. The above article is a bare summary of some of the aspects of how the Real Incomes Approach works. However, as a distinct approach to macroeconomics the Real Incomes Approach has specific implications with respect to a range of significant processes, resources and groups within the UK constituency of which the following is an incomplete list. Readers are invited to send in requests for analysis of how the Real Incomes Approach affects issues of interest to them:

Accounts, Aggregate supply cost curve, Aggregate national purchasing capacity, Aging population, Agriculture, Aid, Alternative energy, Audit, Automation, Banks, Bio-energy, Caring sectors, City of London, Civil servants, Commodities, Competition, Complexity, Conservation, Constitution, Constitutional economics, Consumers, Cooperatives, Credit, Debt, Decision analysis, Democracy, Derivatives, Development economics, Dynamic equilibria, Ecology, Education, Employment, Energy, England, Environment & ecology, ERM, Euro, European Union, Exchange rates, Exports, Extension, Extractive sectors, Equity, Fair trade, Finance, Fisheries, Freedom, Futures, Gold, Government revenues, Green, Growth, Health, Hedging, ISO (process standards), Import substitution, Income, Industry, Inflation, Innovation, Innovation cycles, Interest rates, International relations, Investment, Investors, Labour, Learning, Learning curve, Life stages (infancy, childhood, youth, adult, elderly), Local authorities, Management, Manufacturing, Microeconomics, Minority principle, Money volumes, More for less, Mutual organizations, National Health Service, Natural resources sectors, Natural resources preservation, Northern Ireland, Options, Optimization, OQSI (Open Quality Standards Initiative), Pensions, Performance Levy, Petroleum, Political parties, Poverty, Preferences, Preservation, Price Performance Ratio, Primary sectors, Professions, Public Limited Companies, Public sector, Real incomes, Real time audit (RTA), Reconfiguration of processes, Restructuring administrations, Role of the state, Savers, Scotland, Self-employed, Service sectors, Social, Stakeholders, Stock markets, Subsistence to cash transition, Substitution, Supply & Demand, Supply Chain, Tacit knowledge, Technique, Technology, Time base, Trade, Training, Unemployment, Universities, Wales, Water resources.

3. Economic units, depending upon the sector and technologies applied, all lie on different positions in relation to their investment cycles which can involve periods of between 2 to three years to approaching 25 to 30 years. The status of corporations in relation to capacity for production, capacity utilization, production run durations, production yields, cash flow, indebtedness, liquidity, size of order books, pricing strategies, labour conditions and human resources capabilities are amazingly different even for companies within the same sector deploying the same technologies and plant. It is therefore more than evident that the relevance of finance and interest rates to such a range of operational conditions is not obvious. On the social constituency side the distribution of income and the state of employment combined with many different domestic circumstances related to age, family size and outgoings, again creates a situation where the relevance of finance and interest rates is also not obvious. Because KM policies do not aim to stabilize the differentials between the real income components of corporate profits, employee incomes, saver and investor incomes, policies have serious differential impacts. If one adds to this vast array of reasons for diversity and therefore complexity of the economic and social constituencies, considerations of corporate objectives, strategies, tactics and people's needs and preferences the dynamic of this diversity increases and a rational analysis of this complexity becomes a serious intellectual challenge. Trying to "manage" such a complex through singular market interventions as practiced by KM policies is clearly not a serious pursuit.




Revisited and updated 5th September 2014 (mainly typos and formatting). Please note that this essay will be updated within the next 20 days to comply with the current standards of clarity of expression and the latest findings and terminology applied within the Real Incomes Approach to Economics.

Updated: 16th September, 2015.