DEVELOPED COUNTRIES: RECENT TRENDS IN INFLATION

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001900030082-5
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 10
• Document Creation Date: December 20, 2016
• Document Release Date: August 18, 2005
• Sequence Number: 82
• Publication Date: September 17, 1974
• Content Type: MF

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CENTRAL INTELLIGENCE AGENCY
WASHINGTON, D.C. 20505
CSA/6 /(5 916 (;0i/70 -
17 September 1974
MEMORANDUM FOR: Mr. Geza Feketekuty
Office of the Special Repre-
sentative for Trade Negotiations
Old Executive Office Building
SUBJECT. Developed Countries: Recent
Trends in Inflation
1. In response to our recent telephone conversation,
we are forwarding the attached draft memorandum on inflation
in developed countries for your and Mr. Eberle's use.
2. The study outlines the three fairly distinct phases
of inflation from 1972 to the present -- from the initial
demand-pull causes, through the oil and other commodity
market disrupticlis, to the wage-push pressures now prevailing.
'Although expected to continue slowing, inflation will remain
a serious problem in most developed countries well into 1975.
Office of Economic Research
Attachment
As stated
Distribution: (S-6470)
Oriq & 1 - Addressee
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DEVELOPED COUNTRIES: RECENT TRENDS IN INFLATION
Introduction
1. Inflation currently is viewed as the chief economic
problem in almost all developed countries. Price increases
began accelerating in mid-1972, gained momentum throughout
1973, and were proceeding at an unprecedented rate by early
1974. By mid-1974, wholesale prices in major OECD countries
were on the average 36% above mid-1972 levels, making the
price spiral the steepest and most sustained in post-war
history. Consumer prices were up 22% on the average.
Although the worst of the price rise is probably over,
inflation will remain a serious problem in all developed
countries through mid-1975 at least.
2. The price spiral has gone through several fairly
distinct phases. The initial phase began in 1972, when
many governments adopted expansionary monetary policies to
spur growth. In that year, the money supply in most major
countries increased at least 50% faster than nominal GNP.
By mid-1973, commodity prices had risen to record levels
and were a prime factor in the continuing inflation. Oil
supply disruptions and the huge increase in oil prices last
winter added impetus to this second round of inflation.
Anatomy of Inflation*
3. From the standpoint of individual countries, price
increases in 1972-73 were the result mainly of rising costs
for foodstuffs, industrial raw materials other than oil, and
imported manufactures. Our analysis indicates that through
1973:
o higher costs for foodstuffs, raw materials, and
imported manufactures accounted directly and
indirectly for more than half of the wholesale
price increase in most major countries;
*To measure the impact of higher input prices on overall
prices, we have used input-output tables for the major
countries. The influence of higher costs for foodstuffs,
raw materials, oil, imports of manufactured goods, and
labor was measured by increasing the relevant rows in
inverted input-output tables by the amount of the cost
increase. In following this procedure, we were assuming
that changes in costs are passed through, dollar for dollar.
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o higher labor costs accounted for 10% to 15% of the
wholesale price rise in most countries; and
o higher profits contributed appreciably to inflation
in almost all major countries because shortages of
many products and a general condition of excess
demand allowed firms to widen profit margins.
4. Since the start of 1974 the primary causes of
inflation have shifted markedly.
o Higher oil costs accounted, directly and indirectly,
for roughly half the increase in wholesale prices
in the first half of the year.
o Higher labor cost:. accounted for one-third o more
of the price rise in most countries.
o Costs of commodities other. than oil played an
important, though declining, role.
o Profit margins generally declined, reflecting
the contractionary impact on aggregate demand of
the oil price hike and of anti-inflation measures
in certain countries.
Inflation from Mid-1972 to Mid-1974
5. The doubling in commodity prices (see Figure I-1)
between mid-1972 and mid-1974 was a global development
resulting partly from national decisions to stimulate demand
and partly from fortuitous factors that hurt supply.
Adoption in early 1972 of expansionary policies -- particularly
in the monetary field -- brought a coincident economic upturn
in major countries. The resulting pressure on prices was
intensified by poor crops in :'ome countries and by last
winter's oil supply disruptions and enormous subsequent rise in
oil prices. Under these circumstances, efforts by individual
governments to control the price spiral could scarcely be
effective.
Causes of Increased Commodity Prices
6. Several factors contributed to the rise in commodity
prices. One of the most important was crop shortfalls in
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several countries. In the crop year. ending in June 1973, world
grain production fell 3%, compared with an average annual
increase of 3.5% in 1960-71. Global demand for food, on the
other hand, increased more than the usual 4%, largely because
of rising demand in Communist countries and the LDCs. Grain
output fully recovered last year, but supplies remained tight
because global demand continued to increase substantially
faster than the 3.0% long-term rate.
7. Unusually strong demand generated substantial price
increases for numerous industrial raw materials. Demand rose
especially fast last year, when industrial output in the majlor
countries increased 12% -- double the long-term average.
Capacity constraints prevented a corresponding increase in
output of most raw materials. Copper production, for example,
rose only 4% last year, compared with the 8% growth in
consumption (see Table I-1). The resulting inventory
drawdowns left commodity markets tight even before the oil
crisis hit. Commodity prices then surged further, primarily
because of heavy speculative buying to hedge against
'shortages, continuing price increases, and currency changes.
Not until mid-1974, when speculation eased, did raw material
prices generally return to pre-crisis levels.
8. The huge increase in oil prices gave inflation another
hard push (see Table 1-2). As a result of the OPEC countries'
price hikes in October 1973 and January 1974, the delivered
cost of crude oil for most importing countries has at least
tripled. Countries with substantil crude oil production --
the United States and Canada -- have been affected much less
than those with little or no output. For example, average
crude oil prices in the United States are now 90% above a
year ago, while Japan's are up 240%, in terms of yen!.
Some Domestic Factors
9. Lack of surplus production capacity in key industries
contributed to the price spiral in all major countries.
Growth of capacity was slow in the early 1970s owing to the
sluggish growth of investment. Investment in plant and
equipment rose an average of only 3.8% annually in 1970-72,
roughly half the long-term rate. In a few industries, notably
steel and synthetic textiles, strong demand quickly produced
a sellers' market that enabled firms to increase prices and
profit margins.
10. Although investment generally recovered in 1973
(see Table I-3), growth in plant capacit3 apparently has
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conLinued below normal. The lag is explained partly by
the fact that time is needed to complete investment projects.
Another reason, probably more important, is that a growing
share of investment is going into equipment to control
pollution, which yields little or no increase in production
capacity. In the steel industry, for example, an estimated
10% to 15% of fixed investment now i devoted to pollution
control. The Japanese have estimated that as much as 12%
of total investment last year consisted of pollution-control
equipment, possibly tripling the 1970 share.
Current Phase of Inflation
11. Current price pressures in the developed countries
are essentially cost-push in nature. Basically the problem
is that certain industries and labor are determined to
restore their real income, which has been eroded by the
redistribution of income to producers of oil and other key
commodities. The response from labor has been to substantially
increase wage demands. Enterprises are raising prices as
circumstances demand or allow. Governments are avoiding
wage controls, hoping instead to moderate inflation by
constraining aggregate demand. With the slowdown in economic
.growth, national leaders apparently expect business to resist
excessive wage settlements and to absorb a portion of higher
labor costs by reducing profit margins.
Labor Costs
12. Wage rates are already increasing sharply (see
Table 1-4). Settlements negotiated in major West European
countries during the first half of 1974 averaged around 20%,
roughly 50% above last year. By and large, hourly wage rates
during the first half of 1974 kept pace with inflation,
but reduced working hours meant a cut in real income. More
recent settlements call for pay rates to increase slightly
faster than prices are now rising.
13. In contrast to 1973, wage increases this year are
not being offset by productivity gains. With output stagnating
or declining, the growth in output per man-hour has plummeted
over the past six months. A major reason is that firms are
reluctant to reduce their work forces in response to
difficulties that they hope will be short-lived. As a result,
unit labor costs are increasing substantially. In Japan,
unit labor costs rose at a 19% annual rate in the first half
of 1974, ccmpared with only 3% in 1973 (see Table 1-5). The
increases in most other developed countries are smaller, but
still large.
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Other Factors
14. Capacity constraints are still putting pressure on
prices in some industries. The problem is most evident in
basic industries, which are operating near capacity and
enjoying good profit margins. Steel prices, for example,
have generally risen 30% since the start of 1974, while
production costs on the average have risen 20% or less.
Profit margins have narrowed for most other industries
because weak demand kept prices from increasing as fast
as production costs. The profit squeeze is particularly
severe in the United Kingdom and Japan.
Prospects for Inflation Rates
15. Inflation will remain a serious problem in all
developed countries through mid-1975, and probably beyond
that time. We believe that consumer prices in major OECD
countries will on the average increase at annual rates of
16% in the second half of 1974 and 14%.in the first half
of 1975. These rates compare with average annual increases
of 3.5% in 1960-71. Wholesale prices are projected to
rise by roughly 12% from mid-1974 to mid-1975 -- about five
times the long-term annual average. The expected increases
for consumer and wholesale prices are well below the rates
experienced in the first half of 1974.
16. Japan, Italy, and the United Kingdom face the most
severe continuing inflation. Higher labor costs alone will
boost Japanese wholesale prices by an estimated 11% through
mid-1975. Consumer prices will rise even faster, as previous
cost increases are passed along to final consumers. Growing
labor costs will be the chief cause of Italy's expected 20%
rise in wholesale prices and Britain's expected 12% increase.
West Germany's inflation rate probably will reach only about
8% because wage settlements have been more moderate than in
other European countries.
17. Tight monetary and fiscal policies promise only
limited success in curbing. inflation. Constraints on aggregate
demand can limit price increases only to the extent that
business is induced to absorb cost increases. Profit margins
in many industries have already been squeezed by the fall-off
in demand in the first half of 1974. With costs continuing
to rise, many firms will be inclined to reduce output rather
than profits. Relaxation of demand-management policies would
ease cost pressures by permitting higher production and more
rapid productivity gains. If demand increased very much,
however, production bottlenecks would surface fairly rapidly
in certain inoustries.
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18. Price increases are likely to erode a large part of
recent wage hikes. Indeed, in Italy, real wages are expected
to decline through mid-1975, and in the United Kingdom real
wages will increase only by an estimated 3%. Accelerating
wage demands could given considorable stimulus to inflation.
In most devoloped countries, a 5% increase in unit labor
costs would boost wholesale prices by about 2%.
19. Crop shortfalls this year threaten another round
of exogenous price increases. Prices of most US farm
commodities entering international trade have strengthened
recently, following several months of decline from record
highs. The London Economist index of prices for 16
internationally traded fooastuffs increased 3% in August
alone. Low world stocks, withholding of commodities by
farmers, and speculative buying prompted by adverse weather
are contributing to the pressure on supplies and prices.
Prices o.!:' industrial raw materials, on the other hand, are
continuing a downward trend.
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Table I?1
GrolAill Of World Coillpf
of S:lectecl
P0r4:0111 Nen:act'
Tal,:e 1-2
Impact of Oil Price !likes
Percent
Increa..: in
Delivered Price
Average.
1967-72
1973
of Crude Oil
Increa,:e in
Oct 1973 to
Wholesale
Aluminum
8.1
13.1
Jun 19741
Prices
C.;prer
5.4
8.0
Cotton
1.2
2.9
France
200
3.6
Niel:el
1.7
11.6
Ha!).
225
12.0
Tin .
0.6
6.7
Japan .
240
8.5
Zinc
5.2
6.9
Uniteel Kingdom
16,5
5.0
Uniud States
90
4.6
West Germany
165
5.9
J. in terms 01 natior.31ClIfTti..y.
_Table 1-3
Developed Countries: Growth in Gross Fixed Investinentl
Percent Inclease
Average
1960-70
Average
1970-72
1973
France
9.0
6.7
6.6
Germany
73
2.3
1.8
Italy
.4.9
0.6
12.0
Japan
15.4
' 4.5
19.3
United Kinf,dom
3.0
? -3.2
12.0
United Slates
5.1
4.1
12.8
1. At corstant icsu!:ntial conOruclior...
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able 1-4
Developed Conn% Increase in I lowly Wage Rates
Percent
First
Half
Second
Half
First
Half
Second
Half
First
Half
1972
1972
1973
1973
1974
Canada
5.6
9.9
4.7
9.3
12.3
France
11.1
11.8
14.4
15.4
20.0
Italy
9.7
13.1
24.7
28.9
22.0
Japan
12.5
12.8
21.4
28.4
25.4
United Kinzdont
12.3
193
' 6.4
16.8
16.0
West Germany
10.4
6.2
? 12.4
8.2
14.0
? Table 1-5
? Developed Countries: 1ncrea3-: in Unit Libor Costs
Percent
First
Half
1972
Second
Half
1972
First
Half
1973
Second
Half
1973
First
Half
1974
Canada
2.8
5.7
1.1
9.6
4.9
France
3.9
5.2
6.1
11.9
16.0
Italy
5.8
0.3
1.2.2 '
21.5
17.0
Japan
2.5
2.15
,0.4 ?
7.8
19.0
Uni. 4 Kingdom
8.0
10.0
-0.3
14.5
16.0
Vest Germany
1.1
?
3.9
2.7
8.0
8.2
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