INFLATION, BALANCE OF PAYMENTS AND CURRENCY EXCHANGE RATES;

QUALITY OF GOVERNMENT (national and local);

STANDARD OF LIVING AND WORLDWIDE INEQUALITY;

THE STRUGGLE FOR A BIGGER SHARE

by Manfred Davidmann

Contents

Summary

Balancing Income and Expenditure

Attracting short-term foreign currency deposits
General interest rates, share prices and pensions
Long-term borrowing
Printing more money
Selling gold
Selling assets
Investing abroad and 'invisible' earnings
Balance of payments and currency exchange rates

Rising Prices (Inflation)

Causes of inflation
Effect of inflation on currency exchange rates
Sharing-out the burden
Common myths about inflation

'Price Inflation' and 'Wage Inflation'
Inflation and unemployment

Multinational Operations

Devaluation pricing
Maximising profits

Effect of

1   Importing from low-wage to high-wage country, and
2   Transferring work from high-wage to low-wage country

Transfer pricing

The Struggle for a Bigger Share

Gainers and Losers
Profits and pricing

Quality of Management in Local and National Government

Local government spending
Government income and spending
Quality of management

Differentials between Countries

Appendix: 'Devaluation (Weakening Currency Exchange Rates)'

Inflation and Pricing, Currency Devaluation and Competitiveness
Devaluing to remain competitive
Devaluing to become more competitive abroad

Notes <..> and References {..}

Illustrations

1. Share Prices and Interest Rate changes
2. Making Ends Meet: Balancing Income and Expenditure for Country as a Whole. (Click illustration to see full-size chart.)
3. Causes of Inflation
4. Inflation and Currency Exchange Rates. (Click illustration to see full-size chart.)
5. Worldwide Inequality
6. Inflation
7. Devaluing to Remain Competitive
8. Devaluing to Become More Competitive Abroad

Relevant Current and Associated Works

Relevant Subject Index Pages and Site Overview

Summary

This report describes, reviews and illustrates the underlying relationships between inflation and a country's balance of payments and currency exchange rates. The relationships are illustrated by clear diagrams. Ways of balancing income and expenditure are described.

There is a discussion of the way in which changes in the centrally-determined general interest rate determine share prices, with examples.

Also discussed are the effects of multinational operations such as devaluation pricing and profits maximisation, transfer pricing, importing from low-wage countries, transferring work to low-wage countries.

There are worked examples illustrating the effects of changes in the currency exchange rate on competitiveness, pricing and profits. The effect of a weakening currency is discussed in detail, taking into account differing rates of inflation in different countries. The calculations are simple, straightforward and illuminating. They show, for example, how devaluation (weakening of a country's currency exchange rate) is used to drive up profits instead of resulting in increasing competitiveness and exports.

As share values increased, corporations (companies) have withdrawn corresponding 'surpluses' from their company pension funds and added them, or a substantial part of them, to shareholders' profits. But as share prices fall, pension funds can become underfunded. Companies may then be obliged to make up the underfunding to some extent. The likelihood of this happening may be a factor when companies change, or advocate changing, established company (corporation) pension schemes.

Causes of inflation are described and discussed. Particular attention is given to inflation in relation to pay, with worked examples. The calculations are simple and straightforward, with particular reference to how the burden is shared out between different sections of the community.

As costs increase, bitter confrontation and struggle can develop between those who own and employ, and those who are employed, about how to share out the burden. The report point to the large cost of this way of sharing-out the burden among the different sections of the population.

Also discussed are criteria for judging the quality of government in relation to a country's balance of payments, inflation and the quality of life and living of its inhabitants. As well as objective ways of comparing different countries worldwide.

And this report is one of a series of seven reports which cover, and underlie, the field of General Management, for middle, senior and top management. See

1. Directing and Managing Change
   Includes: Adapting to Change, Deciding What Needs to be Done;
   Planning Ahead, Getting Results, Evaluating Progress;
   Appraisal Interviews and Target-setting Meetings.

2. Style of Management and Leadership

3. Organising

4. Work and Pay, Incomes and Differentials: Employer, Employee, Community

5. The Will to Work: What People Struggle to Achieve
   Includes: Remuneration, Job Satisfaction and Motivation

6. Inflation, Balance of Payments and Currency Exchange Rates

7. Social Responsibility, Profits and Social Accountability

Balancing Income and Expenditure

We all have to balance what we are spending against what we are earning. If we consistently overspend then we either have to earn more or else reduce our spending.

Until we make the necessary adjustments, we can increase our spending money by drawing on savings, by selling jewellery, by short-term borrowing from the bank or friends and perhaps by long-term borrowing such as taking out a mortgage.

For a little while our friends or the bank manager will help us by lending money but the loan has to be repaid and we may have to pay interest. The same applies to a mortgage. The interest we have to pay makes our position worse. As a result of having to pay interest we now have less to spend and overspend more heavily.

If we consistently overspend and cannot increase our income then we are forced to reduce our spending and thus are forced to reduce our standard of living.

Hence we aim to increase our income until it more than balances what we are spending and in this way aim to increase our standard of living.

The same considerations apply to countries, as illustrated by Figure 2 'Making Ends Meet' which illustrates what is being said here, which illustrates the balance-of-payments interrelationships.

Take the case where the total cost of a country's imports is more than the value of its exports. This means that more is being spent on imports than is being earned from exports. We see a payments deficit which needs to be made good as imports have to be paid for, and we pay using our money, that is we pay from our foreign currency reserves.

The value of our currency depends on the assets backing it and on the amount of money in circulation.

Included in our assets are our foreign currency reserves. When these reserves drop then the value of our assets drops accordingly, and so does the value of our currency as each currency unit is then backed by fewer assets. Our currency becomes weaker compared with other currencies.

We have reserves which we hold in the form of foreign currency and also in the form of gold. The deficit is made up from the foreign currency reserve. If the deficit persists and we are using up too much of our foreign currency reserve, we can:

In practice any combination of these may be used, dependent on the circumstances the country finds itself in and on its credit worthiness. Each one affects the country's progress and prospects differently, particularly as regards inflation, as follows.

Attracting Short-term Foreign Currency Deposits

Currency is deposited in another country so as to earn interest. The depositor chooses the country to obtain the highest rate of interest, taking into account the effect of likely changes in the currency exchange rate on the purchasing power of the currency, taking into account also the security of the deposited moneys.

Dependent on the general demand for money at the time, which means on the general level of interest rates, one may have to offer a relatively high rate of interest to attract this kind of investment when competing with other countries for whatever money is available.

What attracts deposits is the relative interest rate, and how the currency exchange rate is expected to change. If another country offers more, that is where the deposits are likely to go. So what we are doing is to attract more deposits by increasing our interest rate in relation to that of others. And we adjust our interest rate when other countries change theirs.

As long as the money is needed, interest rates are kept high but when the country's earnings pay, and more than pay, for what it spends and reserves increase, then interest rates can be lowered.

To attract foreign currencies so as to keep one's reserves above a certain level, one has to offer higher rates of interest. Other rates of interest increase accordingly within the country and this increases both the cost of borrowing and the profit from lending. So increasing interest rates increase prices, increase the cost of living and increase profit from lending.

We hear about the effect of changes in the bank rate, in the general interest rate, on unemployment and inflation. I consider that such relationships are at best indirect and theoretical, have not been proved conclusively either way. As regards such matters, however, what I am doing here is to discuss only selected aspects. Inflation and unemployment are discussed later.

An increase in general interest rates increases profits for lenders (within a country and internationally). It also increases costs for borrowers and thus inflation, but only to the extent to which loan interest plays a part in the costs. So inflation increases profits in greater measure than costs.

General Interest Rates, Share Prices and Pensions

Money moves towards a better investment. If interest-paying investments give a better return than dividend-paying shares, people will buy interest-paying investments and sell their shares. Interest-paying investments are then in demand and their prices increase, shares are not in demand and their prices drop. Share prices may then continue to drop until the amount of the dividend payment (in currency units such as USD) represents a return <6> from the share which is the same as the interest paid by interest-paying investments.

So increasing the general interest rate reduces share prices, and reducing the general interest rate increases share prices. The return from shares (dividend payment as a percentage of share price) tends to move towards the new interest rates. As follows:

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This sample calculation illustrates the mechanism. However, share prices also depend on other factors such as the risk associated with the investment, and the country's creditworthiness as reflected in currency exchange rates. Profits tend to increase in measure with inflation and profitability also determines share prices.

So share values may increase steeply, and may be kept up artificially, by reducing interest rates and by keeping interest rates low.

As interest rates were reduced and as share values increased, corporations (companies) have withdrawn corresponding 'surpluses' from their company pension funds and added them, or a substantial part of them, to shareholders' profits.

As share prices fall, pension funds can become underfunded. Companies may then be obliged to make up the underfunding to some extent. It appears that the likelihood of this happening may be a factor when companies change, or advocate changing, established pension schemes.

Long-term Borrowing

One can borrow the money but interest has to be paid regularly and the loan repaid in due course. This is an additional strain on an already stretched economy.

Figure 2 Making Ends Meet

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Britain, for example, had to borrow vast sums annually so as to pay for imported oil until North Sea oil became available. Combined with a considerable increase in borrowing requirements by local government, this materially contributed to the annual deficit. It soon became apparent that it is not easy to reduce one's standard of living, and different sections of the population were confronting each other, struggling to maintain their own level, their own standard of living, struggling for a bigger share of what was available.

Many underdeveloped countries find themselves working to an increasing extent for those who lent them money in the past, or for those who provided essential goods such as oil at high prices, working very hard to export more and more merely to pay interest and repay loans granted in the past instead of bettering their economic capability and the standard of living of the people.

Printing More Money

Instead of increasing the interest rate we can pay our debts by printing more money. This increases the amount of money in circulation. As our assets have remained unchanged, each currency unit is now backed by fewer assets. The value of each currency unit decreases accordingly and our currency weakens relative to other currencies. In other words, as the assets of the country remain unchanged this means that each note is backed by less, is worth less.

The resources and the assets and reserves have not changed, each money unit is now worth less than before and buys less and it seems that prices rise accordingly.

The disastrous German inflation which followed the first world war is an example of what happens when one attempts to pay one's way by increasing the amount of money which is circulating. <7>

Selling Gold

Countries sell gold to raise money and this is much like people selling their jewellery. The result is that one has a certain amount of money to spend. But one's assets, and thus in the end one's credit worthiness, are correspondingly reduced.

America, for example, at one time was selling very considerable quantities of gold from its reserves in an attempt to get somewhere near to making ends meet, to approach a balance of payments, to prevent its reserves from being depleted.

Selling Assets

Another way of making ends meet is to bring in foreign currency by selling not just gold but also one's assets, to foreigners. Assets here are land, factories, enterprises, human resources.

Japanese trade surpluses have been used extensively for buying American assets and those of other countries.

Another example is that money earned by the sale of oil at kept-high prices is being used to buy assets of countries which allow this.

Selling one's assets in addition amounts to a loss of earnings as profits may be taken out of the country by the new owner, and also represents a loss of control over one's own destiny.

Further, countries like India and Turkey earn much from the amount of money their citizens send back to their countries, to their families, from employment abroad.

Investing Abroad and Invisible Earnings

One may invest one's money abroad and can indeed borrow the necessary money either at home or abroad. The resulting earnings are part of one's income.

Income from abroad also includes so-called 'invisible' earnings from selling abroad services such as banking and insurance.

A balance-of-payments deficit can be changed from a deficit to a surplus by high invisible earnings. On the other hand one can invest more than the payments surplus by investing abroad, by buying foreign assets.

I have illustrated the factors mainly from the point of view of overspending but the reverse also holds. Spare cash enables one to repay loans, to buy gold, to invest abroad so as to increase one's income, and so on. Also, when considering payments balances, one needs to include profitable oil exports and include oil trade balances when comparing international trade figures.

Balance of Payments and Currency Exchange Rates

When we do not make ends meet we become less credit-worthy, our currency weakens and so does its purchasing power. It buys less and prices increase.

As our currency weakens (devalues) so our exports become cheaper abroad but we have to pay more for imports. This reduces our standard of living relative to others abroad as they find our produce cheaper while we find theirs more expensive.

We now have to produce and sell a greater volume of exports so as to earn as much foreign currency as we did before and have to sell even more if we are to improve our position, if we are to benefit from a devaluating currency.

Rising Prices (Inflation)

Causes of Inflation

We saw in the last chapter that when we spend more than we earn that the country's payments deficit can be paid for by combining a number of different methods such as increasing the interest rate for money deposited from abroad or by long term borrowing, or by printing more money. Figure 3 'Causes of Inflation' shows that each of these methods increases prices and thus causes inflation. It seems that printing more money and thus increasing the amount of money in circulation drives up prices to a greater extent than the other two, dependent on how much additional money is being printed.

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Effect of Inflation on Currency Exchange Rates

Figure 4 'Inflation and Currency Exchange Rates' gives some other causes of inflation and illustrates what happens as a result of inflation when there is a balance-of-payments deficit. Prices increase also in other countries from which we buy, because their inflation increases their prices and thus the cost of our imports. At the same time prices are likely to increase also because our government may be printing more money to cover its own deficit, to cover the amount by which its spending exceeds its income.

As prices increase so do percentage markups such as profits and dividends which in this way increase automatically in line with increasing prices.

The higher prices are felt by wage and salary earners who demand increases in line with increasing prices, in line with the increasing cost of living. Prices increase as a result, the increase depending both on the extent to which wage and salary demands are satisfied and on how much of the price consists of labour costs.

Our prices have increased, our exports have become more expensive, we sell less abroad, our payments deficit gets even worse. When this condition persists and gets worse then we can devalue our currency <2>, the extent of the devaluation depending on whether we are devaluing

(1)   to stay competitive or
(2)   to become more competitive.

As a result of the devaluation our exports become cheaper abroad but we have to pay more for imports. The increased cost of imports in turn increases our own prices but only to the extent to which imports figure in the price. However, this has already been allowed for when deciding the extent to which we devalue.

The devaluation reduces our standard of living relative to others abroad as they find our produce cheaper while we find theirs more expensive. We now have to produce and sell a greater volume of exports so as to earn as much foreign currency as we did before and have to sell even more if we are to improve our position, if we are to benefit from the devaluation.

Sharing-out the Burden

Figure 4 Inflation and Currency Exchange Rates

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It is easier to increase one's spending than to reduce it and one is reluctant to reduce one's standard of living. So one tries to avoid increasing the price of imports and tries to avoid devaluation. Hence one attempts to hold down those price increases which result from incomes rising in line with inflation. In other words, one attempts to absorb rising prices internally by reducing the standard of living. The individual's income does not increase in proportion to increasing prices and this means that the individual sees his own standard of living falling as a result of inflation.

The question which then arises is how the burden is shared among different sections of the population. It is more likely to be wages and salaries which suffer as the amount represented by percentage markups, such as profits and dividends, increases automatically. Even when not paid out, profits and dividends can easily be retained in the enterprise and paid out later. Hence an often bitter confrontation and struggle can develop between those who own and employ, and those who are employed.

Common Myths about Inflation

'Price Inflation' and 'Wage Inflation'

When prices of imported goods increase or wages go up, costs increase. Profit is commonly marked-up <4> at a fixed percentage of cost. As costs increase, profits increase automatically.

These profits are paid to shareholders by way of dividends and as capital gains. Part of the profits are paid out as dividends which are annual cash payments. The remaining profits are retained in the enterprise and increase the value of its shares. The shareholder realises this capital gain when selling his shares.

Inflation is an increase in prices, in the cost-of-living. Inflation increases costs. Profits increase correspondingly and automatically. All the profits are given to shareholders by way of dividends and capital gains.

The higher prices are felt by wage and salary earners who demand pay increases in line with increasing prices, in line with the increasing cost of living. Prices increase as a result, the increase depending both on the extent to which wage and salary demands are satisfied and on how much of the price consists of labour costs.

So costs increase, profits increase automatically, prices increase, employees struggle to keep up, wages increase,

so costs increase, profits increase automatically, prices increase, employees struggle to keep up, wages increase,

so costs increase, ......

It does not really matter where you enter the upward spiral to tell the story. Start with wages going up and 'wage inflation' looks like the cause. Start with profits going up and increasing prices ('price inflation') looks like the cause.

So as prices increase, profits increase correspondingly and automatically and are given to shareholders. Wages and salaries increase only after employees struggle to maintain the purchasing power of their take-home pay and then only to the extent to which their demands are satisfied. The reality is that profits are inflation-proofed and that cost-of-living pay increases are achieved only as a result of struggle. <8>

Inflation and Unemployment

Correlations relating unemployment with inflation appear to be inconsistent, apparently depending on how unemployment and inflation are defined, on time and place.

Consider this argument. Say unemployment is low and labour is in demand. 'Free enterprise' competition for labour causes wage rates to increase. Increasing wage rates cause inflation.

The argument then goes that one is fighting against inflation, that low (or falling) unemployment causes inflation so that to keep inflation down one has to increase unemployment or at least keep it above a certain level.

In other words, one is supposed to keep unemployment up, or increase it, so as to prevent free-market competition for labour pushing wages up, as this would reduce profits.

This piece of logical-seeming misleading argument is based on the untrue assumption that inflation is caused only, or mainly, by wage increases.

Conveniently ignored by those putting forward such misleading arguments are all the other causes and relevant considerations mentioned in different places in this report including the effect of a country's balance of payments and consequent economic policies on the exchange rate and the purchasing power of its currency.

MULTINATIONAL OPERATIONS <9>

Devaluation Pricing

The effect of a weakening currency on prices, competitiveness and profits is discussed in detail in the Appendix. The calculations are simple, straightforward and illuminating. They show, for example, how devaluation (weakening of a country's currency exchange rate) is used to drive up profits instead of resulting in increasing competitiveness and output.

As a country's currency weakens, the country's exports need to be increased both in volume and in value by reducing prices abroad and in this way increasing sales. However, there is a strong temptation for manufacturers and exporters not to reduce prices below those being charged by their competitors abroad, but to be more than satisfied with the vast increase in profits which results from sitting back and doing nothing other than increase prices abroad in line with prices charged by one's competitors abroad.

When this occurs then the benefits of the devaluation <2> are lost to the country as a whole and the few gain enormously at the expense of all the rest. In the case illustrated by Figure 8, profits increased by about 90 percent <12>.

The value of assets held abroad, and income from abroad, similarly increase in line with devaluation. Foreign held capital and foreign income appreciate as one's currency depreciates and there is then the tendency for capital to find its way abroad, when such capital should be invested within the country so as to improve its economic potential and for economic growth.

Maximising Profits

Imports are priced at what the market will bear, or just under {7}. The enormous profit margins then cause production to move from high-wage to low-wage countries. The consequence is a lowering of standard of living in high-wage countries to that in low-wage countries, instead of a raising of standard of living in low-wage countries to that in high wage countries.

Effect of
   Importing from Low-wage to High-wage Country, and of
   Transferring Work from High-wage to Low-wage Country

Corporations (Companies)

1.   Import goods and services which originate in low-wage countries, into a high-wage home country.
2.   Transfer manufacturing and service work from a high-wage home country to low wage countries.

The mark-up between buying or producing in a low-wage country, and then selling in a high-wage country, is often enormous <4>. Large additional profits result. Unemployment increases in the home country. There are many costs associated with unemployment such as social security payments to the newly unemployed. {2}

It is accepted as a principle of economics that social costs have to be paid by those causing them, so that the social costs of unemployment have to be paid by the enterprise which caused the unemployment in the first place {4}.

The different costs to individuals and community which result from unemployment are listed in the section on 'Social Cost of Unemployment' of {2}. The total cost to the community is the sum of all the items listed there.

Companies, however, are not made to pay the resulting costs of unemployment, are allowed to pass these operating costs to the community and are thus making large profits at the expense of the community. {2}

In the UK, an individual was in 1998 reported to have been jailed for seven years for only threatening to contaminate a food if the producer did not pay him GBP 30,000 {5}. If he had carried out his threat the social costs would have been considerable and so he was jailed, presumably both as a punishment and to deter others from similar activities.

On the other hand, companies and corporations threaten to make people unemployed, and carry out these threats actually making hundreds and thousands of people unemployed with massive consequential social costs <5>. They also do so for the sake of private profit but no action is taken to prevent them from doing so by recovering the social costs from them, or to punish and deter by punitive sentencing.

All for the sake of profit, for personal gain of wealth, power, influence and control over others, for 'empire building'.

Transfer Pricing

A multinational company can minimise its liability for corporation tax by transfer pricing, that is by making book entries which transfer profits to the country with the lowest corporation tax. This tax avoidance is legal and governments have not legislated to prevent this practice. {6}

Say a multinational has increased its profits by tax avoidance. The government's income from taxation has decreased accordingly. As the government's expenses have not changed it must make up this shortfall elsewhere. Usually from its other taxpayers, say from its citizens. So its citizens pay more tax, the government can now spend the same amount as before, the multinational's profits have increased.

In other words, the multinational's increased profits arise from money which is in effect collected by the government by taxation from its taxpayers.

The multinational, and this means the owners and directors of the multinational, are thus in effect taxing the people and in this way increasing the multinational's profits and thus their own incomes and wealth.

The Struggle for a Bigger Share

Gainers and Losers

Cutting back one's standard of living is not easy and here also the question arises how the burden should be shared. There are those who will attempt not only to maintain but improve their own standard of living while expecting others to bear the economies which have to be made and a harder life, and so conflict develops about how the burden should be shared.

Those who are well paid who gain a percentage increase gain far more in purchasing power than those who are badly paid who receive the same percentage increase and who in any case have to spend any increase on necessities.

This applies equally to percentage markups such as profits and dividends. We need to look at the amounts rather than at percentages.

Inflation is used to concentrate purchasing power into the hands of those who are already well paid, into the hands of those who are already at or near the top, is used to concentrate wealth and power into the hands of a few. In other words, inflation is used to redistribute income from the bottom to the top, concentrating purchasing power at the top and thus increasing differentials.

The country is in difficulties, fighting first for survival and then for economic success and strength. The standard of living is dropping so that attention concentrates on how to share out what is available, between those who run things and those who work. Conflict results.

This attack on the living standards of the working population is misleadingly called a 'fight (or battle) against inflation' to persuade the working population to tighten its belts, to reduce its standard of living.

The arguments by which owners blame the employees' wage and salary demands for inflation while in turn the employees blame the owners' price increases are too often no more than propaganda aimed at increasing one's own slice of the national cake at the expense of the other 'side', at the expense of the rest of the community. <10>

The so-called 'fight against inflation' appears to be an economic deception designed to exploit the working population even further. Just how one-sided this is can be judged by the fight supposedly being against 'wage inflation'. Left out of consideration are excessive price increases, profits, dividends or capital gains. Also more or less ignored is the large top-level remuneration which has been increasing yearly for some years at up to four or five times the rate of inflation, increasing each year by amounts many times exceeding the average income of the working population.

In such circumstances people work against each other instead of working with each other and we see conflict instead of cooperation.

While profits, dividends and 'capital gains' increase automatically in measure with inflation, a bitter struggle develops as owners and employers attempt to use inflation as an excuse for reducing labour costs, that is wage rates, wages and salaries of the working population, so as to increase profits still further. Employees are then not compensated for increased skill, experience and responsibility (increased merit), nor do they receive their share of the increasing national income and wealth (the betterment), do not receive merit increases and betterment increases. Pensioners also stand to lose betterment increases, do not receive their share of the increasing national income and wealth (the betterment) which is being achieved on the basis of their past labours. {7, 8}

Here is an example. UK pensions had been linked to the index of average earnings but from 1980 they were linked to the cost-of-living index. Hence since 1980 the UK government has, for no apparent good reason, withheld from pensioners their share of the increasing national income and wealth, amounting to something like 2 percent of their pension every year. As a result their present pensions are a fraction of what they ought to be, and would now have to be increased by 34 percent just to reach the level at which they should be now. And pensioners would still have to be compensated for the moneys withheld from them without good reason by the government since 1980. {7}

This needs to be compared with the closely knit family which not only weathers the storm but finishes in an even stronger position than before. The way in which difficulties are overcome is very much a question of good household management which shows itself in the way in which people work together. People cooperate with each other for the common good in the knowledge that good and ill are shared fairly among them, it being appreciated that the family exists to meet the needs of all its members and that it does so to the best of its ability. The family weathers the storm and gains strength because its members pull together jointly under the leadership of those most able to deal with the particular problems being encountered. {9}

It is seen that overcoming tough, difficult and challenging problems depends on good leadership and on all cooperating for the common good, depends on sharing not just that which is bad but also that which is good, depends on reward in measure with an individual's contribution towards the common good.

Profits and Pricing

So profits are apparently being maximised regardless of the cost to others, to the community. Without care or concern for the condition, standard of living or quality of life of the working population. Without being concerned about the in sum-total enormous human suffering which results.

Overall, what we see are consequences of decisions made at the top, and the results of putting them into effect. Results and consequences which at times make the decisions seem so brutal that they appear inhuman.

One of the most effective restraints has been found to be the fear of bad publicity, of public awareness of socially irresponsible company behaviour, with its effect on company image, consumer trust and market share, and thus on profits. Particularly so when publicity names those responsible for making antisocial decisions within the company or for condoning and omitting to restrain the company's antisocial activities.

In the end, it is prices (that is profits) which need to be controlled, as well as unjustifiable items which are charges as costs when calculating profits.

Quality of Management in Local and National Government

Local Government Spending

It is the job of local government to make ends meet and provide the services required by the community including an efficient and effective police force, medical and educational services and amenities. They need to provide a first class service at an economic cost from income provided by local residents and enterprises as well as central government. Local government cannot print its own money and hence finances overspending by borrowing. The increasing cost of debt servicing (interest and loan repayments), which depends on how much has been borrowed, is a danger sign which cannot be ignored.

What stands out is that local government has to borrow and often borrows increasing amounts. If local government is not making ends meet this ought to be clearly appreciated by those living and working in the area and local government's income and expenditure scrutinised in detail.

New York's closeness to bankruptcy accompanied by cuts in essential services is a warning of an increasing threat to the quality of life elsewhere.

Local government is responsible for looking after the short and long term interests of its citizens, backed by central government aid for those with inadequate, less than average, resources and for those which otherwise would be unable to provide average services and amenities as judged by results.

Local government has to make ends meet, has to be effective and this means profitable, where by 'profitable' I mean that it needs to offer a rising standard of secure living and social security, an increasing quality of life, to its citizens.

Government Income and Spending

We can see from Figure 2 'Making Ends Meet' that governments which spend more than they receive, attempt to reduce or to make up the difference by borrowing internally and by borrowing abroad. The remaining difference between what is coming in and the amount they want to spend is then made up by printing more money.

The illustration shows how printing more money increases the amount of money which is circulating and we saw that this causes inflation and how it does so. In such circumstances there is usually much talk about reducing inflation by balancing income and expenditure.

In other words, we are told that to reduce inflation we have to reduce the deficit and that the way to do so is to reduce government spending, that less has to be spent on essential services to the community such as on education, health services, unemployment benefits, social security payments and social care.

But just consider for a moment and look at Figure 2 'Making Ends Meet' (at the top) which illustrates these points, and ask a few questions.

The government spends for the community the money it receives from the community, collecting it through taxation. If it spends more than it collects, then it has to make good the shortage by borrowing and/or by printing more money. Debts have to be serviced and repaid so that borrowing increases future spending, absorbs income, increases the difficulties. But look in more detail at government income and spending. It is clear that to reduce and eliminate the deficit we need to increase income or reduce spending, or both.

We could increase income by increasing taxation but this may be counter-productive. Hence questions which need to be answered are:

'Appropriate Pay' {1} discusses such questions at some length, illustrating them by changes which took place in the United Kingdom over a period of ten years.

It is clear that to reduce government expenditure by cutting social services is one-sided. Why should community services be cut in preference to cutting the vast sums which are collected from the people, that is from the community, and handed over annually to a select few, to owners, shareholders and to those who control financial institutions? These astronomical sums, which are handed over annually, increase the wealth and power of a very small number of people without any corresponding return to the community. They are generally given without obligation to repay, without a corresponding transfer of ownership and control to those who provided the money. {10}

No banker, no financial institution, no shareholder would dream of giving away their capital without making sure of retaining ownership and control over this money, through the transfer of corresponding securities and ownership rights, and of direct and indirect participation in the resulting profits.

Very large sums are involved. The array of investment grants, depreciation allowances, grants in aid, tax allowances, tax-free benefits, tax reductions, loans at favourable terms and other ways of financial support to various enterprises in industry, agriculture and services, speaks for itself. {10, 11}

How come that the people's money is distributed in such a fashion? How come that corresponding ownership rights are not transferred to those who work in the enterprise, on behalf of the community?

Hence there are further questions which need to be considered:

1. Can we afford to give away such large sums to enlarge the wealth, power and patronage of a very small section of the population at the expense of the whole population?
2. Can we continue to afford to do so at a time of crisis?

The crisis is likely to have been caused or aggravated by inadequate management and administration, so resources including capital are being used ineffectively and are often wasted. In such circumstances one looks closely at the quality of the leadership, of those who direct, of those who manage, one looks at the way resources are being used. Reducing wages (cutting essential community services) merely makes the workforce pay the bill for inadequate management, allows the management to carry on just as wastefully as before at the expense of the standard of living of the workforce.

Demanding a fair return for one's investment (shareholders' investment, bank loans, money provided by the community in various ways) wakens up management to its responsibilities, encourages and rewards good management.

Hence while on the one hand one can consider cutting essential community services, on the other hand one can also cut the flow of capital from the community to the select few and in any case can expect a fair commercial and social return to the community for the enormous sums which are annually handed over in this way.

Quality of Management

Just like any enterprise or local government, so national government has to make ends meet, has to bring about a rising standard of secure living and social security, an increasing quality of life to its citizens.

Failure to do so is just as directly and surely the result of bad leadership and management as it is in any commercial enterprise. It is a severe criticism not only of those who lead and manage but also of the kind of experts and consultants they use. Leadership and the quality of one's experts and whether and how their expertise is used and applied, are of determining importance <11> and this applies to central as well as to local government.

Differentials Between Countries

At this point in time the inequalities between countries <3> are of course appalling, as can be appreciated from the following Figure 5 which compares the developed countries looked at in some detail in the report on 'Style of Management and Leadership' {3}, but also includes Switzerland which is the country with the highest national product per person, and a few of those at the bottom end who are underdeveloped, poor and in great need.

Figure 5 shows how income and production are distributed among them. It shows how big a part of the world's population lives within the country's borders and what part of the world's goods and services they produce for themselves and for others. At one end of the scale 0.18 percent of the world's population who live in Switzerland generated and benefited in 1978 from about 1 percent of the world's production, while at the other end of the scale about 18 percent of the world's population who live in India generated and benefited from roughly the same amount. About the same output is derived from and shared by 106 times more people in India, the Indian's share being roughly a hundredth part of that of a Swiss person.

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Column (3) of Figure 5 makes this point. What is listed here is the ratio of the gross national product per person for the country to the gross world product (GWP) per person, that is to the amount which each person would have produced and benefited from had world production and its resulting benefits been spread equally among all the world's population.

This ratio measures inequality between countries. For example, it shows that the Swiss received about 5.6 times their 'equal share' while Indians received only 6 percent of the equal share and this illustrates the drastic way in which the higher living standards of rich and developed countries are parallelled by extreme poverty, starvation and need, the extent to which they have been accompanied by unacceptable extreme differentials.

Column (4) illustrates this point by listing the relative inequality, which is the inequality between countries, by listing the ratio of the share received by each country to that received by the poorest country <3>, namely India.

It is the democracies which assist those who are underdeveloped and who do not as a rule attempt to use aid and assistance as a lever or as stepping stones towards control and take-over. But there needs to be control of the way aid and assistance is applied and of who benefits, and one would expect some sort of return, namely some sort of lasting commitment to democracy and to the application of democratic principles. There needs to be some sort of indication that the people are interested in making the effort, that they wish to work their way up and struggle for democracy and freedom, both internally and by international cooperation and commitment to democratic principles.

Appendix

Devaluation (Weakening Currency Exchange Rates)

Considering competitiveness abroad, we have seen that our export prices can rise to the extent that increasing prices are not absorbed internally by a lowering of the standard of living of some or all of the population.

Hence we become less competitive and may then have to devalue or allow the exchange rate to adjust itself so as to stay competitive in the short term and to become more competitive in the long term.

In this way we reduce our prices abroad and become more competitive but as we now get paid less for each item sold we must now sell more items so as to earn as much as we did before.

Not only is it essential that we sell more so as to make ends meet but it is also essential that we fully utilise the opportunity presented by being more competitive so as to sell much more. We need to do this so as to end up with a balance-of-payments surplus in order to regain economic strength and power so that we in due course once again increase our standard of living compared with others.

We have seen that currency devaluations <2> adjust the rate of exchange so as to reduce the prices of our exports so that they remain competitive and perhaps become even cheaper. This helps us to sell much more. We have also seen that the price paid for this is a lowering of the standard of living of the population as a whole, so that it is important to do all one can to make full use of the opportunity presented by a devaluation so as to regain one's strength through selling far more than before. This means that we need to lower the foreign currency prices of our exports accordingly.

Only too often do producers and exporters charge abroad what the market will bear, charging the highest price their goods will fetch, without reducing prices when their currency is devalued. The result is that the producer's and exporter's profits increase enormously but at the expense of a general lowering of the standard of living of the country as a whole, because they sell the same volume as before but make a far greater profit on each sale. In this way they use devaluation to increase their profits but from the point of view of the country as a whole production does not increase as the number of items sold does not increase. Prices have not been lowered, there is no corresponding gain in the volume of production, that is in economic growth.

We saw that as our currency weakens (devalues) so our standard of living is reduced relative to others abroad. So these greater profits are made at the expense of a general lowering of the standard of living of the country as a whole. And as prices have not been lowered, there is no corresponding gain in the volume of production, that is in economic growth. And the greatly increased profit redistributes income and wealth from the general population whose standard of living is falling, distributing it to those at the top who benefit from such profit increases.

The calculations are simple and straightforward, as can be seen from the following examples.

Inflation and Pricing, Currency Devaluation and Competitiveness

An article contains imported items (see Figure 6 'Inflation') and column 1 shows that 25 percent of the price is for imported items, that internally produced items amount to 65 percent of the price, the remainder being a clear profit of 10 percent. Assuming that the price of the article is GBP 100 at the beginning of the year, column 2 shows how the price is made up.

Assuming an internal rate of inflation of 25 percent and an external rate of inflation in other countries of 5 percent, then the price after one year is that shown in column 4. The imported price component is increased by 5 percent, while internal price component and clear profit have each increased by 25 percent.

As inflation abroad is much less than the internal rise in prices, 25 percent of the price of the article being for imported items, the overall increase in price (20 percent) is considerably less than the internal rate of inflation (25 percent).

Assuming that the same article is being exported to and sold in Germany and that the currency exchange rate is 4 DEM/GBP, then the article which sold for DEM 400 at the beginning of the year would have to be sold for DEM 480 at the end of the year. But, during this same period, prices increased by only 5 percent in Germany and the cost of the equivalent German article increased as a result of their inflation from DEM 400 to DEM 420.

It is seen that we have become less competitive abroad as the article we previously sold at DEM 400 in competition with an equivalent German article also selling at DEM 400, is now being sold by us at DEM 480 while the competing German article now sells for only DEM 420.

Devaluing to Remain Competitive

Similarly we can follow what happens when we devalue so as to remain competitive (see Figure 7).

Here we continue the previous example by devaluing to remain competitive, that is by adjusting the currency exchange rate from 4 DEM/GBP to 3.36 DEM/GBP, which has the effect of reducing the price abroad of our own article from DEM 480 to DEM 420.

As a result of this devaluation we now have to pay more for our imports. The imported items cost DEM 105 which at the old exchange rate of 4 DEM/GBP amounted to GBP 26.30. At the new exchange rate we have to pay GBP 31.30 for the same imported items. The new exchange rate of DEM 3.36/GBP already allows for this.

The overall effect is that our price has increased internally from GBP 120 up to GBP 125 as a result of the higher cost of imports and that we have reduced the price of the article abroad from DEM 480 to DEM 420.

Devaluing to Become More Competitive Abroad

If we devalue further so as to become more competitive by lowering our price abroad below that being charged by our competitors, then our internal price again increases a little because of the higher cost of imported items. This is illustrated by Figure 8.

Continuing with the same example, it is seen (column 2) that if we devalue our currency so that the exchange rate becomes 3 DEM/GBP then the internal price increases to roughly GBP 129 which at the new exchange rate amounts to about DEM 386.

This devaluation thus reduced our price abroad to DEM 386, this being about 8 percent below our foreign competitor's price of DEM 420 (see Figure 6: Note 4). Our price is 8 percent below our competitor's, a very useful competitive advantage.

However, this competitive advantage has been gained at a very considerable drop in the standard of living of the population, compared with others abroad, as we devalued by about 30 percent.

Figure 8 also illustrates what happens if the manufacturer or his agents do not reduce the price abroad but charge the maximum they can persuade people to pay (Figure 8, column 3). In this example this price would be DEM 420 which is the price of the equivalent German article.

At the new exchange rate of 3 DEM/GBP, they now receive GBP 140 for each article. As internal costs and the cost of imported items remain unchanged, all the extra money collected is clear profit.

As can be seen in Figure 8 (column 3) the remaining profit amounts to GBP 23.70 and this means that profit has increased from GBP 12.50 to GBP 23.70, an increase of about 90 percent.

The country's exports need to be increased both in volume and in value by reducing prices abroad and in this way increasing sales. However, there is a strong temptation for manufacturers and exporters not to reduce prices below those being charged by their competitors abroad, but to be more than satisfied with the vast increase in profits which results from sitting back and doing nothing other than increase prices abroad in line with prices charged by one's competitors abroad.

When this occurs then the benefits of the devaluation <2> are lost to the country as a whole and the few gain enormously at the expense of all the rest.

Notes <..> and References {..}

Notes

References

Relevant Current and Associated Works

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Relevant Subject Index Pages and Site Overview

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RELEVANT SUBJECT INDEX PAGES

• Press Notices
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• Community
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Other Subjects; Other Publications

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Copyright    ©    Manfred Davidmann    1981, 1982, 1989, 1995, 2006
ISBN 0 85192 030 6    Second edition 1982, 1989
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