UK: THE HABITS OF A LIFETIME OF INFLATION DIE HARD.

UK: THE HABITS OF A LIFETIME OF INFLATION DIE HARD. - Businessmen remain wary of predictions that inflation is dead.

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Last Updated: 31 Aug 2010

Businessmen remain wary of predictions that inflation is dead.

The idea that we are in for an prolonged period of low inflation has been gaining ground among economists. Few, however, have gone as far as Roger Bootle, chief economist at Hongkong & Shanghai Banking Corporation, who has announced (notably in his book The Death of Inflation) the beginning of an era in which zero inflation will be the norm. In future, Bootle predicts, prices will fall as often as they rise. So what do businesses think about this prospect? And, if the forecast seems reasonable, how do they intend (in the words of Bootle's subtitle) to 'survive and thrive'?

If companies have accepted an age of low inflation, the fact is not evident in their anticipated rates of return on investment. Firms are still expecting far too high a return, argues Bootle. This means that they have been 'setting much higher real return requirements than in the past'. The Bank of England endorses this view and has criticised businesses for seeking rates of return of 20% or more, while inflation remains below 5%.

A senior corporate planner in one of the big UK-based oil giants is not overly impressed by Bootle's thesis. 'I don't think there is enough evidence to suggest that we have moved into an era of zero inflation,' he says.

'We are going through a period of exceptional change, with costs being taken out all along the production chain.' Nevertheless, he believes the threat from inflation is exaggerated by a failure to measure significant quality improvements and the introduction of new products. And the fact of low inflation means that business forecasting is now more likely to be accurate. 'You can make your projections without accounting so much for inflation because your margin of error is not as great.'

In huge multinationals, only the rate of global inflation (or deflation) will have much impact on overall strategy. Smaller groups are necessarily more concerned about regional - or sectoral - conditions.

'We certainly don't believe there will a recurrence of the high inflation seen in the 1970s and 1980s, although we don't believe in massive deflation either,' says Andrew Robb, finance director at Pilkington. Given its impact on pricing structures, deflation is a problem that Pilkington has been grappling with for some time. 'If you're involved with supplying the automotive industry, as we are,' says Robb, 'then price is being driven down by the enormous power of your customers, the global manufacturers. So providing glass with increased capabilities, for example tinted glass, is one way to recoup lost revenue.' The key to surviving in an era of low or no inflation, he thinks, will be to 'restructure business on the basic belief that we can't rely on price to bail us out. To maintain our margins, we have had to become absolutely efficient, drive costs down and increase yields.'

Smaller firms are more locally focused, and if anything more vulnerable to inflation. Martin Siner, economist at the Federation for Small Businesses (FSB) remarks that 'whether inflation is dead or not, the right policy systems need to be in place in order to keep inflation down. What small businesses are worried about is the interest rate, which the Government is trying to use to keep inflation down. Because there is a very high exposure of small business to long-term lending, any hike in interest rates means that a lot more money needs to be paid out.'

Meanwhile, at the London School of Economics, David Metcalf, professor of industrial relations, has a different angle on the subject. He believes that an era of zero inflation will increase the likelihood that companies move away from the ritual of the annual pay round. 'Once you are out of an annual pay round system, then pay based on performance is much more likely,' he says.

Bootle could be right. Inflation has been consistently lower over the past three or four years than most forecasters would have dared to predict.

But most businessmen remain wary. It will take several more years of low or no price increases to convince them that inflation is indeed dying - and not just resting.

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