Syndicalism, revolutionary trade unionist movement advocating control of government and industry by trade unions, to be achieved through such direct action as general strikes and sabotage. In another usage, common in France, where the term originated, syndicalism is synonymous with trade unionism, while revolutionary trade unionism is known as revolutionary syndicalism.

In common practice, trade unions are regarded simply as instruments for improving the conditions of workers within an existing social organization. Syndicalism, however, envisions a stateless society in which production, conducted not for profit but in order to satisfy the needs of the community, is administered by a federation of self-governing industrial unions and associations of non-industrial workers. Thus, it accepts the Marxist theory of class struggle culminating in collective ownership of goods and the means of production, while rejecting the Marxist concept of government by proletarian dictatorship. In this respect syndicalism accepts the anarchist concept that centralized government in any form is undesirable.

Doctrines that could be labelled syndicalist were formulated in London in the 1860s by Karl Marx and presented to the first session of the International Workingmen’s Association, or First International, in Geneva in 1866. The Russian revolutionary Mikhail Aleksandrovich Bakunin developed these doctrines and added his own anarchist theories; he was expelled from the First International in 1872. True syndicalism, however, came into being in France later in the 1870s. It was strongly influenced by the writings of the French anarchist Pierre Joseph Proudhon and those of the French social philosopher Georges Sorel, who added a demand for violent revolutionary action. In the 1890s, two French syndicalist organizations, the Confédération Générale du Travail (General Labour Confederation) and the Fédération des Bourses du Travail (Federation of Labour Exchanges), grew in importance; they merged in 1902. The movement achieved its greatest impact in the years before World War I. In England during this period a related movement, guild socialism, had some impact.

The jailing of some syndicalists as pacifists during World War I and the subsequent defection of many syndicalists to Communism through the 1920s reduced the effectiveness of the movement. Only in Spain, where the Confederación Nacional de Trabajo (National Confederation of Labour) achieved a membership of 1 million workers, did the movement grow. Spanish syndicalists supported the Loyalist cause during the Spanish Civil War and were virtually exterminated after the Fascist victory in 1939. Syndicalism then devolved into a kind of vaguely defined intellectual utopianism.

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Wages, in economics, the price paid for labour. Wages consist of all payments that compensate individuals for time and effort spent in the production of economic goods and services. The payments include not only wages in the ordinary, narrow sense—the earnings, computed generally on an hourly, daily, weekly, or output basis, of manual and clerical workers—but also weekly, monthly, or annual salaries of professional and supervisory personnel; bonuses added to regular earnings; premiums for night or holiday work or for work exceeding stated norms of quantity and quality; fees and retainers for professional services; and that part of the income of business owners that compensates them for time devoted to business.

Wages may be reckoned at time rates, piece rates, or incentive rates. Wage earners on time rates may be docked for days, hours, or even minutes of absence or idleness, but salaried workers usually received fixed sums for each pay period, whether or not they are continuously on the job. Workers on piece rates are remunerated uniformly for each unit output. Those receiving incentive wages are paid according to formulae relating output to earnings in ways designed to induce higher production.

A high rate of pay does not ensure large annual earnings. Building workers are paid relatively high hourly rates, but their annual income often is low because of the irregularity of their employment. In addition, nominal wages do not reflect real earnings accurately. During a period of inflation, the real value of wages may fall although nominal wages rise because the cost of living rises more rapidly than monetary earnings. Deductions from wages for income taxes, social security taxes, pension payments, trade union dues, insurance premiums, and other charges further reduce the worker’s take-home pay.


The influences determining wage levels in particular countries at particular times are as follows: (1) Cost of living: even in poor societies, wages are usually at least sufficient to pay the cost of sustaining workers and their children; otherwise, the working population will not reproduce itself and will decline. (2) Standards of living: prevailing living standards influence conceptions of what constitutes a so-called living wage, thus helping to determine wage levels. Improvements in general living conditions generate moral pressures for giving labourers a share of the better life. In the presence of such pressures employers are more inclined to grant wage increases and legislators are constrained to approve minimum-wage legislation and other laws designed to ameliorate the worker’s lot. (3) The relative supply of labour: where labour is scarce relative to capital, land, and other factors of production, as in the United States in the 19th century, employers’ competitive bidding for labour tends to raise the general wage level. Where, as in present-day India, the ratio of labour to other resources is high and where accordingly the supply of labour greatly exceeds demand, competition among labourers for the relatively few available jobs tends to depress the wage level. (4) Productivity: wages tend to rise with productivity. Productivity depends partly on the energy and skill of the labour force and even more on the level of technology employed. Wage levels in developed economies are high largely because workers apply skills of a high order to the operation of an abundance of the most advanced industrial equipment. (5) Bargaining power: the organization of labour in trade unions and in political associations enhances its relative bargaining power and thus tends to win for organized labour, especially in the time of deflation, a larger share of the national income.


The general wage level is an average of widely differing individual pay rates and earnings. The various elements contributing to wage differentiation are as follows— (1) Relative value of the product: an industrious and skilled worker who produces a more valuable output than workers of lesser capabilities is worth more to an employer and usually is paid more. (2) Costs of required capabilities: employers must pay the price of special training if they are to fulfil their need for workers so trained. If engineers did not receive more compensation than building labourers, relatively few people would invest the time, money, and effort required to become engineers. (3) The relative scarcity of specific kinds of labour: common labour is paid poorly because it is common, but entertainers, such as film stars and television performers, who have qualities regarded as unique enjoy very large incomes. (4) Comparative attractiveness of occupations: difficult, disagreeable, or dangerous jobs usually bring higher rates of pay than do more inviting jobs requiring comparable skills. Thus, a lorry driver engaged in moving explosives earns more than one delivering groceries. (5) The mobility of labour: where the working population is immobile, wage differentials are wide. On the other hand, the readiness of workers to change jobs or to move long distances to better-paying positions tends to narrow wage differentials among firms, occupations, and communities. (6) Comparative bargaining strength: a union may lift the wages of its members above the scales paid to unorganized workers of equal skill. (7) Custom and legislation: many wage differentials are rooted in custom or legislation. For example, both custom and legislation are responsible for the fact that black miners in South Africa long earned only a fraction of the wages paid white miners doing equivalent work. On the other hand, governments and unions frequently act to eliminate wage differentials based on race, sex, and other irrelevancies and to promote equal pay.


Most wage theories reflect overemphasis on one or another of the elements determining wages. The first noteworthy wage theory, the just wage doctrine of the Italian philosopher St Thomas Aquinas, emphasized moral considerations and the role of custom. A just wage is defined as that which enables the recipient to live in a manner suited to the person’s social position. Aquinas’s theory is a view of what wages should be rather than an explanation of what they actually are.

The first modern explanation of wages, the so-called subsistence theory, emphasized the consumption needed to sustain life and maintain the working population as the chief determinant of wage levels. The theory was adumbrated by mercantilist economists, elaborated by Adam Smith, and developed fully by David Ricardo. Ricardo argued that wages are determined by the cost of barely sustaining labourers and their replacements and that wages cannot long depart from the subsistence level. If earnings should fall below that level, he contended, the labour force would not reproduce itself; if earnings should rise above it, more working-class children than the number needed to replenish the labour force would survive and wages again would be forced down to subsistence levels by the competition of labourers for the available jobs.

The assumptions of the subsistence theory were invalidated by the facts of subsequent economic history. In advanced countries, the output of food and other consumer goods increased more rapidly than population during the later 19th and 20th centuries, and wages accordingly rose well above subsistence levels.

The wage theory of Karl Marx is a variant of Ricardo’s wage theory. He argued that under capitalism labour seldom receives more than bare subsistence. According to Marx, the surplus remaining is appropriated by the capitalists as their profits. Like Ricardo’s theory, Marx’s view was nullified by later economic experience.

After the decline of the subsistence theory, attention shifted to demand for labour as a wage determinant. John Stuart Mill, among others, propounded the so-called wages-fund theory to explain how the demand for labour, as expressed in the money employers have available to pay for labour, influences wages. The theory rests on the assumption that all wages are paid out of past accumulations of capital and that the average wage rate is determined by dividing the share set aside for wages by the number of employed workers. Wage increases for some workers could mean reductions for others. Only by augmenting the wages fund or by reducing the number of labourers could the wage level be raised.

The wages-fund theorists were mistaken in assuming that wages are paid out of past capital accumulations. Wages actually are paid mainly out of current production. Wage increases, by strengthening buying power, may stimulate production and generate more wage-paying potential, especially if unemployed resources exist.

The wages-fund theory was succeeded by the marginal-productivity theory, concerned mainly with the influence exerted by the supply and demand of labour. Proponents of the theory, which was developed largely by the American economist John Bates Clark, maintained that wages tend to be set at the point at which employers find it profitable to engage the last job-seeking worker, who is called the marginal worker. Because, by the law of diminishing returns, the value of each additional worker’s contribution to production is supposed to diminish, the growth of the labour force depresses wages. If wages should rise above the level assuring full employment, part of the labour force would become unemployed; if wages should fall below that level, competitive bidding by employers for the additional workers would push wages up again.

The marginal-productivity theory is defective in assuming perfect competition and in ignoring the effect of wage increases on productivity and buying power. As John Maynard Keynes, a vigorous critic of the theory, demonstrated, wage increases may bolster an economy’s propensity to consume rather than to save; expanded consumption creates new demands for labour, in spite of the higher wages that must be paid, if higher incomes can arise out of decreased unemployment.

Most economists recognized, with Keynes, that higher wages need not cause reduced employment. A more serious danger that can result from wage increases is inflation, for employers, are inclined to raise prices to compensate for large wage outlays. This danger can be averted only if wages are not allowed to outrun productivity. Because labour’s share of the national income has been virtually constant and is likely to remain so, real wages can rise mainly to the degree that productivity rises.

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Industrial Relations


Industrial Relations, broadly, all dealings, transactions, and activities affecting the determination and enforcement of the terms and conditions of employment. The main parties involved typically trade unions and their employers (or collective representatives), although government also plays an important role via labour legislation.


In the early 19th century, before the growth of the factory system, wages and hours of labour were usually arranged in direct dealings between employers and individual employees, replacing the traditional craft-based arrangement whereby guilds had set the terms of labour. The prevailing legal, social, and economic climate did not favour the development of workers’ organizations. Because the disparity in bargaining power between employers and employees caused many cases of abuse, however, the workers in various industries began to organize trade unions, which demanded better terms of employment. A key to their power was that as a disciplined and unified force they could use threats of mass action such as strikes, or other forms of industrial action, to press their demands. They were helped by the eventual enactment of laws governing conditions of employment, conditions in the workplace, and industrial relations practices such as collective bargaining.

The relationship between employers and employees developed differently in various parts of the world. In particular, the goals and activities of European trade unions differed considerably from those of trade unions in the United States. European trade unions were primarily national organizations traditionally espousing socialism and allied closely with political movements and parties. The typical US trade union evolved as primarily a local organization devoted to the advancement and protection of the economic interests of its members, with national and statewide affiliations but no loyalty to a particular political ideology.

The protective legislation, the earliest type of employment regulation, was enacted principally during the early 20th century. Such legislation regulated areas such as the maximum hours of work and minimum wages of women and children, and hazardous practices affecting them as employees. Under another type of protective legislation, industrial employees became entitled to benefits such as compensation for industrial accidents and income support in the event of illness, disability, or unemployment, and pensions for their old age. In more recent years, many countries have also introduced legislation in favour of equal pay for women and men, and in favour of equal opportunity in the job market by forbidding discrimination by employers on the basis of such criteria as race, gender, and in some cases age.


The larger employers of labour now usually have departments dealing with the negotiation and administration of industrial relations agreements. Such departments are responsible for day-to-day administration of matters relating to employee’s contracts and procedures governing layoffs, promotions, discipline, grievances, and arbitration. Many unions have specialists trained and assigned to deal with management specialists in negotiations and other matters. Collective bargaining can be at a variety of different levels, from an entire industry to a single plant. Recently, however, collective bargaining has become increasingly localized in some countries (such as the United Kingdom), with wages and other terms of employment such as working hours and holidays tending to reflect more closely the performance of particular companies or even plants within companies.

When the employees in a plant are not represented by a union or equivalent association, the terms and conditions of employment are usually determined by direct arrangements between plant management and employee. A union seeking to deal with an employer as the exclusive bargaining representative of its employees may try to persuade the employer to recognize it and institute a closed-shop agreement, whereby only members of that particular union may be employed by the employer, though such arrangements are now illegal in many countries.

Most countries have arrangements, sometimes statutory, for arbitration of industrial disputes by neutral conciliation bodies such as the Advisory, Conciliation and Arbitration Service (ACAS) in Britain. A popular form of arbitration in the United States is pendulum arbitration, where the arbitrator listens to both parties then decides in favour of one or the other, with no compromise allowed. Arbitrators of labour-management disputes are impartial, disinterested professionals. In some instances, arbitration is conducted by a board of arbitrators of which all members except a neutral chair with the deciding vote are interested individuals. Arbitration is conducted either by an arbitrator selected especially for a case or by an umpire, referee, or chair designated for the duration of the collective agreement. Dealings between most modern-day representatives of management and unions have been characterized by mutual respect (however grudging in some cases), the product of years of negotiation and joint administration of agreements. This attitude of mutual confidence has fostered more cooperative labour relations than formerly prevailed. Labour-management arbitration has also contributed to industrial peace because it substituted the binding award of a respected neutral for the exertion of economic force during the term of a collective agreement. Although labour and management continue to differ on various economic problems, they generally realize that neither group can reach its goals without the assistance of the other. Relations between labour and the government can be more contentious, especially with the government as the employer in the public sector or where the government is operating an incomes policy as part of an overall economic policy.

By the mid-1990s the power of organized labour had decreased markedly. Union activists are still faced with jail in China and other newly industrializing authoritarian states when they attempt to form unions outside the state apparatus. Many countries followed the example of Britain by weakening the powers of trade unions through, for example, making secondary picketing (picketing of places other than one’s workplace) illegal, prohibiting the closed shop, and making ballots on strike action compulsory. The result was a remarkable fall in the number of strikes. With more and more people employed in service occupations rather than in manufacturing, union membership declined—and so did union strength in labour negotiations. This process was exacerbated by other economic and political factors held to signal the end of Fordism, the system supposed by some economists to constitute the characteristic form of high capitalism for most of the 20th century.

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Factory System


Factory System, working arrangement whereby a number of people cooperate in the production of items. Today the term “factory” generally refers to a large establishment employing many people involved in mass production of industrial or consumer goods. Some form of the factory system, however, has existed since ancient times.


Pottery works have been uncovered in ancient Greece and Rome. In various parts of the Roman Empire factories manufactured glassware and bronze ware and other similar articles for export as well as for domestic consumption. In the Middle Ages, large silk factories were operated in the Syrian cities of Antakya and Tyre; and in Europe, during the late medieval period, textile factories were established in several countries, notably in Italy, Flanders (now Belgium), France, and England.

During the Renaissance, the advance of science, contact with the New World, and the development of new trade routes to the Far East stimulated commercial activity and the demand for manufactured goods and thereby promoted industrialization. In Western Europe and particularly in England, during the 16th and 17th centuries, many factories were created to produce such goods as paper, firearms, gunpowder, cast iron, glass, items of clothing, beer, and soap. Although heavy machinery, operated by water-power in some places, was used in a few establishments, the industrial processes were generally carried on by means of hand labour and simple tools. In contrast to modern mechanized plants with assembly lines, the factories were merely large workshops where each labourer functioned independently. Nor were factories the most usual place of production; although some workers used their employer’s tools and worked on the premises, most manufacturing was done by workers who were supplied with raw materials, worked in their own homes, returned the finished articles, and were paid for their labour.


The factory system began to develop in the late 18th century when a series of inventions transformed the British textile industry and marked the beginning of the Industrial Revolution. Among the most important of these inventions were the flying shuttle patented (1733) by John Kay, the spinning jenny (1764) of James Hargreaves, the water frame for spinning (1769) of Sir Richard Arkwright, the spinning mule (1779) of Samuel Crompton, and the power loom (1785) of Edmund Cartwright. These inventions mechanized many of the hand processes involved in spinning and weaving, making it possible to produce textiles much more quickly and cheaply. Many of the new machines were too large and costly for them to be used at home, however, and it became necessary to move production into factories.

One of the major technological breakthroughs early in the Industrial Revolution was the introduction of steam engines. When textile factories first became mechanized, only water-power was available to operate the machinery; the factory owner was forced to locate the establishment near a water supply, sometimes in an isolated and inconvenient area far from a labour supply. After 1785, when a steam engine was first installed in a cotton factory, steam began to replace water as power for the new machinery. Manufacturers could build factories closer to a labour supply and to markets for the goods produced. The development of the steam locomotive and steamship in the early 19th century made it possible to ship factory-built products to distant markets more rapidly and economically, thus encouraging industrialization.

The Arkwright method of spinning was introduced into the United States in 1790 by Samuel Slater, who started a factory in Pawtucket, Rhode Island. In 1814, at a cotton mill established in Waltham, Massachusetts, all the steps of an industrial process were, for the first time, combined under one roof; here, cotton entered the factory as raw fibre and emerged as finished goods ready for sale.


Textiles, particularly cotton goods, were the major factory-made products during the early 19th century. Meanwhile, new machinery and techniques were being invented that made it possible to extend the factory system to other industries. The American inventor Eli Whitney, who stimulated textile manufacturing in the United States by inventing the cotton gin in 1793, made an equally, if not more important, contribution to the factory system by developing the idea of using interchangeable parts in making firearms. Interchangeable parts, with which Whitney began experimenting in 1798, eventually made it possible to produce firearms by assembly-line techniques, and to repair them quickly with pre-made parts. The idea of interchangeable parts was applied to the manufacture of timepieces from about 1820 on. Then, in the 1850s, at Waltham, Massachusetts, automatic machinery was used for the first time to make watches by consecutive processes in a single factory. Thus, by the middle of the 19th century, American factories had begun to develop the outstanding feature of the modern factory system: mass production of standardized articles.

The clothing industries were revolutionized by the sewing machine and underwent a tremendous expansion during the 1860s. Spurred by the urgent demand for uniforms during the American Civil War, clothing manufacturers developed standardized sizes, a prerequisite for mass production of ready-made garments. At the same time, the military demand for shoes stimulated the creation of shoe-sewing machinery to mass-produce footwear.


As the 20th century began, the factory system of production prevailed throughout the United States and most of Western Europe. Germany, Britain, the Netherlands, and Belgium became, to a great extent, importers of food and raw materials and exporters of factory-made commodities. In 1913 Henry Ford, the pioneer motor manufacturer introduced assembly-line techniques to motor-car production in the Ford Motor plant. In time the factory system spread to Asia, where cheap labour attracted capital from the industrialized countries of the West. Japan, which had begun industrialization in the late 19th century, rapidly became the foremost industrial power in Asia and a competitor to the Western nations.

As the world economy has grown, factory operations (especially in the developed world) have sought to increase productivity and efficiency through greater use of automation and new technology. This and the closure of uncompetitive factories (often forced by competition from newly industrialized developing countries) has resulted in the phenomenon of de-industrialization in many developed national economies, where the proportion of national output and employment accounted for by industry falls. Some machines, aided by computers, semiconductors, robots, and other technological innovations, are so nearly self-regulating that an entire factory may be kept running by a few people operating sets of controls. This new Industrial Revolution has required much more sophisticated approaches to the management of factories, both in terms of strategy and of day-to-day operations. To stay ahead of the competition, great skill, imagination, and rigour must now be applied to everything from decisions on machinery and equipment purchases to quality control.


The introduction of the factory system had a profound effect on social relationships and living conditions. In earlier times the feudal lord and the guild master had both been expected to take some responsibility for the welfare of the serfs, apprentices, and journeymen who worked under them. By contrast, the factory owners were considered to have discharged their obligations to employees with the payment of wages; thus, many owners took an impersonal attitude towards those who worked in their factories. This was in part because no particular strength or skill was required to operate many of the new factory machines. The owners of the early factories often were more interested in hiring a worker cheaply than in any other qualification. Thus they employed many women and children, who could be hired for lower wages than men. These low-paid employees had to work for as long as 16 hours a day; they were subjected to pressure, and even physical punishment, in an effort to make them speed up production. Since neither the machines nor the methods of work were designed for safety, many fatal and maiming accidents resulted. In 1802 the exploitation of pauper children led to the first factory legislation in England. That law, which limited a child’s workday to 12 hours, and other legislation to regulate child labour that followed were not strictly enforced.

The workers in the early mill towns were not in a position to act in their own interest against the factory owners. The first cotton mills were located in small villages where all the shops and inhabitants depended on a single factory for their livelihood. Few dared to challenge the will of the person who owned such a factory and controlled the lives of the workers both on and off the job. The long hours of work and low wages kept a labourer from leaving the community or being otherwise exposed to outside influences. Later, when factories were located in larger cities, the disadvantages of the mill town gave way to such urban evils as overcrowded sweatshops and slums. In addition, the phenomenon of the business cycle began to manifest itself, subjecting industrial labourers to the periodic threat of unemployment.


By the early 19th century the condition of workers under the factory system had aroused concern. One who called for reform was Robert Owen, a British self-made capitalist, and cotton-mill owner, who tried to set an example by transforming a squalid Scottish mill town called New Lanark into a model industrial community between 1815 and 1828. At New Lanark, wages were higher and hours shorter, young children were kept out of the factory and sent to school, and employee housing was superior by the standards of the day, yet the mill operated at a substantial profit. In Owen’s day, modern trade unions were beginning to develop in the British Isles, and he sought to organize them into a national movement. His aim was to improve working conditions as well as effect basic social and economic reforms. In his concern for the increasing differences between capital and labour, Owen was joined by such economic theorists as the Frenchmen Charles Fourier, Claude Henri de Saint-Simon, and Pierre Joseph Proudhon and the Germans Karl Marx and Friedrich Engels, each of whom analysed the processes of modern industrial society and proposed social and industrial reforms. Meanwhile, the factory reform acts were passed in an attempt to remedy these ills.

In time, organized protest forced owners to correct some of the worst abuses. Workers agitated for and obtained the right to vote, and they established political parties and labour unions. The unions, after a considerable struggle and frequent setbacks, won important concessions from management and government, including the right to organize workers in factories and to represent them in negotiations. Furthermore, issues and problems germane to the factory system came to figure prominently in the formulation of modern political and economic theory as the discipline of labour relations. In the Soviet Union, China, and other Communist states, the factory became a social and political, as well as an industrial, unit. Abuses of the factory system remain prevalent in many developing, and some developed countries.

One important and often overlooked consequence of the factory system was its promotion of the emancipation of women. The factory created wage-earning opportunities for women, enabling them to become economically independent. Thus, industrialization began to change the family relationship and the status of women.


The inspection of factories by state agencies began in England in the early 19th century in response to the public protest against the working conditions for women and child labourers. Today, throughout the developed world regulations exist governing such matters as child labour, working hours, health and safety, and minimum wages. One important early international regulatory agency was the International Association of Factory Inspection, established in 1886 by Canada and 14 states of the United States. After 1919 the International Labour Organisation, acting in cooperation first with the League of Nations and later with the United Nations, correlated the regulation of factory conditions throughout the world, though with no guarantee of enforcement of its standards.

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Trade Union


The Trade Union, an association of workers established to improve their economic and social conditions. A trade union represents its members in determining wages and working conditions through the process of collective bargaining with the employer. When agreement cannot be reached, a union may conduct a strike or other industrial action against the employer. In many countries, a union is the economic arm of a broad labour movement that may include a political party and cooperative associations. In other nations where no such formal ties exist, unions themselves may engage in political activities, including lobbying for legislation and supporting political candidates favourable to labour. Many unions also provide employment services, insurance protection, and other benefits to members and their families.

Trade unions are two principal types: craft unions composed of all those performing a specific kind of work, such as electricians, carpenters, or printers; and industrial unions comprising all those in a given industry, such as car workers or steelworkers. Unions also exist among government employees and for such professional occupations as nurses, engineers, and teachers. In some countries, large general workers’ unions include all semi-skilled and unskilled workers in one organization. Unions are often affiliated with a single umbrella organization, such as the British Trade Union Congress (TUC), the French Confédération Générale du Travail (CGT), or the American Federation of Labor and Congress of Industrial Organizations (AFL-CIO).


Trade unions constitute the organized response of workers to the impact of industrialization. The first unions arose in Western Europe and the United States at the end of the 18th century and the beginning of the 19th century as a reaction to the development of capitalism. As the factory system developed, great numbers of people left their rural homes to compete for the relatively few jobs available in urban centres. This labour surplus made the working classes increasingly dependent on their employers. To offset this dependency and to help workers gain a measure of control over their economic lives, the earliest unions were formed among skilled artisans. These groups encountered great opposition from employers and government and were considered illegal associations or conspiracies in the restraint of trade. During the 19th century, many of these legal barriers to trade unionism were eliminated as a result of court decisions and favourable legislative action, but the early unions failed to survive the economic depressions of the first half of the 19th century.

In both democratic and non-democratic European countries, workers’ movements rejected the capitalist system during the 19th century and advocated various substitutes such as socialism, anarchism, syndicalism, and, after the Russian Revolution of 1917, communism. Ideologically motivated trade unions in the United States also formed in the 19th century, usually under the influence of European immigrants. These organizations, however, failed to take permanent root, largely because of the more open political system and the existence of the frontier as an alternative attraction for surplus labour. During the early 20th century, unionism extended to numerous semi-skilled and unskilled workers in coal mines, on the docks, in the transport industry, and in the factories.

For further information on the history of trade unions see Trade Union Movement in Britain.


The most important function of trade unions in democratic, industrialized countries is the negotiation of collective agreements with employers. The subjects covered in contemporary agreements go far beyond the original ones of wages and hours, reflecting the increased complexity of modern society, the strength of unions, and the workers’ rising expectations. In some cases collective agreements specify wages, hours, working conditions, and benefits in great detail. In other cases unions have used their political power to win enactment of laws that provide benefits and protection—increased pensions and unemployment compensation, safety regulations, extended holidays, educational and maternity leave, housing, health insurance, and, perhaps most important, employment tribunals and other grievance procedures to protect workers against any unfair action.

In countries that today are subject to any form of authoritarian government—whether growing out of a revolution, a military or civil coup, or foreign intervention—independent trade unions are not permitted to represent workers. Trade unions in China, for example, have acted as arms of the government, helping to achieve production programmes in the planned economy; many of these unions are also charged with administering social-welfare programmes. Union members are therefore left without the traditional protection against their employer’s actions afforded by their union since both employer and union are limbs of the government.


The earliest international trade union bodies were closely allied to socialist groups, and even today in many important international bodies the bulk of the affiliates are socialist-oriented. As early as 1889 various national printing unions formed the first of the international trade secretariats of workers in a specific occupation or industry. In 1901 several national trade unions established what was later called the International Federation of Trade Unions (IFTU). After World War II the IFTU was dissolved and a new organization, the World Federation of Trade Unions (WFTU), attempted to include both Communist and non-Communist unions. Trade unions from democratic nations soon found it impossible to work with the Communist-controlled bodies and left to form the International Confederation of Free Trade Unions (ICFTU). The ICFTU includes the vast majority of non-Communist unions. The membership of the WFTU now comes from the former Soviet bloc as well as Communist unions in a few democratic countries. A small international body, the World Confederation of Labour (WCL), grew out of a Christian union federation. Now secular, it has affiliates in Western Europe, Latin America, and Africa.

Although international trade unions have little actual power, they serve important purposes in encouraging cooperation and exchange of information. A few efforts have been made to influence collective bargaining among their affiliates and to coordinate affiliate policies. The International Labour Organization, part of the United Nations, also aids in the process of communication and cooperation among unions.


Those trade unions that possess the economic power to threaten continued production of goods or services, and that actually have the political right to exercise such power, have helped to raise the standard of living of both their members and others. Genuine success, however, is ultimately determined by the ability of the employer and the society to absorb the consequences of granting union demands. In democracies, for example, unions have made significant gains during periods of economic expansion; during recessions, however, unions turn to governments for programmes to ensure alternative job opportunities, income maintenance, and other forms of relief. Recently, trade union membership and influence have been declining across the developed world. In developing nations, workers’ organizations are more limited in their influence.

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Taxation, a system of compulsory contributions levied by a government or other qualified public body on people, corporations, and property, in order to fund public expenditure. In deciding whom, what, and how much to tax, all governments have economic and social objectives. Some types of business activity or product, such as cigarettes, may be discouraged by heavy taxes. Other businesses, such as those operating in depressed areas, may be encouraged by tax breaks. Or taxation may be used to bring about social reforms through altering the distribution of wealth.

The effectiveness of any government, at the central or local level, depends on the willingness of the people governed to surrender or exchange a measure of control over property in return for protection and other services. Taxation is one form of this exchange.


In medieval times, taxes were customarily paid not in money but in the form of labour or other payments in kind (such as work on local roads or supplies of grain or other farm produce). As long as the government’s services consisted largely of military actions and the provision of roads and other public works, this form of taxation satisfied most governmental needs reasonably well. Rulers could require feudal lords to provide, as a form of tax, workers or soldiers in numbers that reflected the noble’s rank and wealth. In the same manner, grain levies could be imposed on landowners, both to feed the workers or troops and to provide for other government needs. In modern industrial nations, although taxes are levied in terms of money, the fundamental pattern remains: the government designates a tax base (such as income, property holdings, or a given commodity); applies a tax-rate structure to the base; and collects the tax (equal to the base multiplied by the applicable rate) from the stipulated legal taxpayer.

Tax systems, even today, are as varied as the nations that devise them, ranging in complexity from the most basic arrangements to computerized revenue systems. Simple tax mechanisms are suitable only to the needs of those governments that are extremely limited in scope. When government responsibilities are extensive and diverse (as, for example, when taxes are used to modify economic inequalities and to distribute benefits in ways that are considered equitable), the underlying system of taxes must be sophisticated. Elaborate networks of fiscal reporting become essential, as do legal enforcement and a standard of public education adequate to ensure a high degree of taxpayer compliance.


Tax systems perform differing functions, depending on the responsibilities expected of the enacting government. Local governments traditionally depend most heavily on property taxes and central governments on sales taxes and income taxes. Local governments are required to keep their expenditures within the budgetary limits, determined by their own revenues augmented by payments received from central government, though in some circumstances they can borrow money. The central government, however, can borrow or even create money; it does not have to raise enough from its tax system to balance its budget. Taxation is also the basic instrument of fiscal policy. In concert with its control over the money supply (that is, its monetary policy), the government aims to maintain the stability of the economy. In depressions, for example, taxes may be lowered and budget deficits incurred so that consumers will have money to buy goods and investors will have capital to put into the industry, thus stimulating production. In prosperous times, tax increases may be needed to hold down or prevent the inflation caused by too much money chasing too few goods, or if the government prefers to control inflation through interest rates, taxes may be cut for political or other ends.

Among the tax systems of different nations, wide variations exist in how money is raised and spent. Tax and expenditure policies reveal the fundamental ideology of a government and a political system. Most democracies today derive their general notions of what constitutes a good tax system from four principles enunciated in the 18th century by the Scottish economist Adam Smith.

A Fairness

Of fundamental importance is that any tax must be fair—that is, citizens should be taxed in proportion to their abilities to pay (a concept that Smith defined somewhat ambiguously as “in proportion to the benefit they derive from the government”). A tax is considered fair if those who have the means to pay are assessed either in proportion to their capacity to pay or, depending on the situation, in proportion to what they receive from the government. Both “ability to pay” and “benefits received”, therefore, are criteria of fairness. When government services confer identifiable personal benefits on some individuals and not on others, and when it is feasible to expect the users to bear a reasonable part of the cost, financing the benefits, at least partly, by taxing the people who benefit is considered fair, as in the repayment of loans to students by subsequent taxation. (Obviously, this method does not apply to such services as public welfare payments.) Taxation in accordance with appropriately applied standards of ability to pay or of benefits received is said to meet the requirements of vertical equity (because such taxation exacts different amounts from people in different situations). Just as important is horizontal equity—the principle that people who are equally able to pay and who benefit equally should be taxed equally.

B Clarity and Certainty

The application of a tax should be clear and certain. This principle, considered very important by Smith, has often been underestimated in modern tax systems (in which open and impartial administration usually can be taken for granted). Where the application of taxes is uncertain and arbitrary, however, the public can have no confidence in the system. The old British tax on numbers of house windows was disliked and widely resisted partly because its rationale was unclear; likewise, windfall taxes introduced by a government on gains produced by the policies of a previous government can appear uncertain.

C Convenience

Taxes should be easy to calculate and collect. Compliance with income tax laws increased dramatically where a system of deducting tax from earnings before they are paid has been introduced.

D Efficiency

A good tax system should be structured so that it can be administered efficiently and economically. Taxes that are costly or difficult to administer divert resources to non-productive uses and diminish confidence in both the levy and the government. Worse still, waste can also be created by excessive tax rates; economic efforts are then shunted from high- into low-yielding activities, from productive enterprises into tax shelters, and from open, above-board transactions into hidden, off-the-record participation in the underground economy. When this happens, the important principle of tax neutrality (which maintains that a tax should not cause people to change their economic behaviour), implied by Smith, is violated.

Smith’s tax maxims have stood the test of time remarkably well. Other basic principles have been added to the list, but some have occasionally been proven counter-productive. An example is the desirability of tax elasticity—that is, the automatic response of taxes to changing economic conditions without adjustments in tax rates.


In designing tax systems, governments customarily consider three basic indicators of taxpayer wealth or ability to pay: what people own, what they spend, and what they earn. Historically, agriculture, as the fundamental basis of the subsistence economy, became the earliest lucrative tax base. Thus, among major revenue sources, the property tax on land and its produce is the oldest of modern taxes.

The movable property was somewhat harder to tap as a source of taxation, but as marketplaces developed, taxes on the sale or transfer of goods became productive sources of revenue. International commerce gave rise to customs duties, levied both to yield revenue and to control the amount and kind of imported merchandise. Domestic trade spawned a variety of taxes, ranging from excises on specific commodities (such as the ancient salt tax) to levies aimed at taxing designated transactions. An example of the latter, still widely used in some parts of the world, is the stamp tax on bills of sale and other legal and financial documents. (The stamp tax levied by the British government on American colonists became so prominent as a symbol of tyranny—of “taxation without representation”—that it helped trigger the American War of Independence.) Also widely used today are excise taxes of many kinds, especially on luxury items and on goods such as alcohol and cigarettes, the use of which governments wish to regulate. Many countries levy sales taxes at the retail level. To lighten the burden on the poor, countries exempt necessities such as food and prescription drugs. European Union countries use a value added tax, levied on goods and services, at each stage of production, on the value added at that stage.

Although the value added tax is comparatively new, taxes on what people own, buy, transfer or use have a far longer history than doing taxes on what people earn or otherwise receive in income. A personal income tax was first used in Britain in 1799. It was dropped for a time and then revived, and has been in continuous use in Britain since 1842. Because an individual income tax is complex and difficult to administer, this kind of tax was slow to take hold. By the end of the 19th century, however, a number of countries in Europe and elsewhere had adopted it. In the United States, the 16th Amendment to the Constitution (ratified in 1913) was needed to establish the legality of a federally imposed income tax.


Because no single form of wealth is a perfect indicator of taxpayer ability to pay, most modern nations try to diversify their tax systems. Many people think of the ability to pay largely in terms of income. This assumption, however, is losing ground as the inequities in modern income tax systems become increasingly apparent. Inheritance tax on bequeathed wealth has also come under considerable criticism. A comprehensive form of taxation on consumption expenditures has gained support among tax specialists, but public acceptance has been lacking.

No tax is levied with perfect evenness or on a completely comprehensive base; its burden inevitably falls more heavily on some taxpayers than on others: this unfortunate fact exacerbates the basic unpopularity of taxes per se. The exemptions, exceptions and other loopholes in tax laws are partly the result of humanitarian concern for those who might be overburdened; partly, they reflect political pressures; and partly, they come from administrative inefficiency or inability to deal with the extremely complex tax structure, or to foresee all possibilities for tax evasion. By using a variety of taxes, governments can attempt to ensure that the tax burden falls fairly across all taxpayers.

As governments find it ever harder to finance all their commitments, and as taxpayers grow ever more resentful of the taxes they are asked to pay, interest has grown in levies designed to achieve fairness in terms of benefits received. Aside from simple user charges such as those on public leisure amenities (which may be thought of more as prices than as taxes), the benefits standard is apparent in many major levies. These include petrol taxes that are earmarked principally for road maintenance and construction; business levies collected to provide unemployment insurance; and social security taxes allocated to worker casualty insurance and retirement funds. The effectiveness of earmarking is a much-disputed issue, but it tends to appeal to politicians, though in fact all revenues are generally pooled regardless of national earmarking. Although earmarking can make raising new revenue easier, it can also create budgetary distortions, especially in times of economic stress, when the general fund may be in need while special funds are more than adequately filled.


The effects of taxation are difficult to judge. Even personal income tax, which is presumed to fall entirely on the legal taxpayer, has indirect consequences in the economy; it influences decisions to work, save, and invest, and these decisions affect other people. Corporate income tax may in some cases simply result in lower corporate profits and dividends; in other cases, it may broadly reduce the incomes of all owners of property and businesses. To the extent that corporations compensate for the tax by raising the prices of their products, the tax burden may simply be shifted on to consumers. To the extent that tax-reduced corporate profit margins hold down wages, the incidence of the tax is shifted backward to workers.

Similar disagreements arise over the incidence of local property taxes and over the employers’ share of social security payroll taxes. Even the long-established view that retail sales taxes are shifted forward from retailers to consumers is challenged in a world in which wages and government transfers (that is, income payments such as social security) are indexed, or automatically adjusted upward, for inflation. The inclusion of the sales tax in the Retail Price Index insulates recipients of indexed incomes against inflation-induced tax increases and therefore puts the burden of those increases on the recipients of non-indexed incomes. As awareness grows of the difficulties in pinning down the burden patterns of various taxes, the old distinction between direct and indirect taxes becomes relatively meaningless.


Despite the difficulties of precise measurement, governments are appropriately concerned with the vertical pattern of the tax burden: does it fall proportionately more heavily on the rich than on the poor (progressive taxation)? Does it burden everyone to the same degree in relation to taxpaying ability (proportional taxation)? Or does it place a relatively heavier burden on the poor (regressive taxation)? In most modern nations, a generally progressive tax structure is considered desirable for two reasons. First, a progressive tax is considered more equitable (because the wealthy have more ability to pay). Second, extremes of wealth and poverty are considered injurious to the economic and social well-being of a society, and a progressive tax structure tends to moderate such extremes.

On the other hand, tax rates that are too progressive—that rise too steeply—may discourage both work and investment by removing much of the reward. In the early 1980s concern about this problem attracted the attention of policymakers to so-called supply-side economics—to economic theories emphasizing the importance of ensuring that taxes do not drain away incentives to investment, either by individuals or by businesses.

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Market Forces

Market Forces, underlying influences on the operation of the economy. They boil down to supply and demand, which determine price and the allocation of resources. In a pure free market economy, market forces are unrestrained. However, in all countries, governments to a greater or lesser degree restrict the operation of the free market and therefore distort (even negate) the effect of market forces through economic policy. In the former communist countries the system of central planning left no room for market forces to operate. In other parts of the world governments have often, for different reasons, sought to override market forces through such actions as the granting of subsidies to firms or services that (it is judged) could not survive in a free market, or the imposition of tariffs or quotas on imports. Increasingly, however, countries are moving towards a position where market forces are allowed to operate more and more freely. A market revolution is taking place in the former communist nations, but changes have also taken place all over the world—from South America to Southern Africa. An open market in which market forces are allowed to operate freely is at the heart of the single market programme of the European Union. However, the principle has never been applied to farming in the EU, which is governed by the Common Agricultural Policy under which prices for agricultural produce are guaranteed, thus encouraging overproduction.

Market forces vary from market to market and derive their power from the individuals who make up a market and on whose lives they have enormous influence. They are determined by such factors as wealth, consumer taste, regulation, and taxation. Stringent safety requirements may push up the cost (and therefore the price) of a potentially desirable product beyond that which a sufficient number of consumers can afford (or are willing) to pay. Tax differentials on alcoholic drinks have encouraged thousands of Britons to make day trips to France in order to stock up with beer and wine.

Contributed By:
Wilfred Beckerman

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Inflation and Deflation


Inflation and Deflation, in economics, terms used to describe, respectively, a decline or an increase in the value of money, in relation to the goods and services it will buy.

Inflation is the pervasive and sustained rise in the aggregate level of prices measured by an index of the cost of various goods and services. Repetitive price increases erode the purchasing power of money and other financial assets with fixed values, creating serious economic distortions and uncertainty. Inflation results when actual economic pressures and anticipation of future developments cause the demand for goods and services to exceed the supply available at existing prices or when available output is restricted by faltering productivity and market constraints. Sustained price increases were historically directly linked to wars, poor harvests, political upheavals, or other unique events.

Deflation involves a sustained decline in the aggregate level of prices, such as occurred during the Great Depression of the 1930s; it is usually associated with a prolonged erosion of economic activity and high unemployment. Widespread price declines have become rare, however, and inflation is now the dominant variable in macroeconomics affecting public and private economic planning.


When the upward trend of prices is gradual and irregular, averaging only a few percentage points each year, such creeping inflation is not considered a serious threat to economic and social progress. It may even stimulate economic activity: the illusion of personal income growth beyond actual productivity may encourage consumption; housing investment may increase in anticipation of future price appreciation; business investment in plants and equipment may accelerate as prices rise more rapidly than costs, and personal, business, and government borrowers realize that loans will be repaid with money that has potentially less purchasing power.

A greater concern is the growing pattern of chronic inflation characterized by much higher price increases, at annual rates of 10 to 30 percent in some industrial nations and even 100 per cent or more in a few developing countries. Chronic inflation tends to become permanent and ratchets upwards to even higher levels as economic distortions and negative expectations accumulate. To accommodate chronic inflation, normal economic activities are disrupted: consumers buy goods and services to avoid even higher prices; property speculation increases; businesses concentrate on short-term investments; incentives to acquire savings, insurance policies, pensions, and long-term bonds are reduced because inflation erodes their future purchasing power; governments rapidly expand spending in anticipation of inflated revenues; and exporting nations suffer competitive trade disadvantages forcing them to turn to protectionism and arbitrary currency controls.

In the most extreme form, chronic price increases become hyperinflation, causing the entire economic system to break down. The hyperinflation that occurred in Germany following World War I, for example, caused the volume of currency in circulation to expand more than 7 billion times and prices to jump 10 billion times during a 16-month period before November 1923. Other hyperinflations occurred in the United States and France in the late 1700s; in the Union of Soviet Socialist Republics (USSR) and Austria after World War I; in Hungary, China, and Greece after World War II; and in a few developing nations in recent years. During a hyperinflation the growth of money and credit becomes explosive, destroying any links to real assets and forcing a reliance on complex barter arrangements. As governments try to pay for increased spending programmes by rapidly expanding the money supply, the inflationary financing of budget deficits disrupts economic, social, and political stability.

A historically important form of inflation in the days of bimetallism or the gold standard was currency debasement when a ruler reduced the amount of precious species metal in coins. This secured short-term profits for the state, which could use the same amount of precious metal to mint more coin, but drove up prices in the long term, under Gresham’s law whereby “bad money drives out good”. Such debasements frequently funded government war efforts, partly explaining the correlation of inflation with political upheaval. The flow of silver from the New World into Europe from the 16th century has also been linked with the gradual rise in inflation from that time, as the value of the precious metal tended to diminish, but this view is not universally accepted. Modern governments effectively perform similar debasement when they print more money or otherwise modify its value.


Examples of inflation and deflation have occurred throughout history, but detailed records are not available to measure trends before the Middle Ages. Economic historians have identified the 16th to early 17th centuries in Europe as a period of long-term inflation, although the average annual rate of 1 to 2 per cent was modest by modern standards. Major changes occurred during the American War of Independence when prices in the United States rose an average of 8.5 percent per month, and during the French Revolution, when prices in France rose at a rate of 10 per cent per month. These relatively brief flurries were followed by long periods of alternating international inflations and deflations linked to specific political and economic events.

By historical standards, the post-World War II era has been characterised by relatively high levels of inflation in many countries, and by the mid-1960s a chronic inflationary trend began in most industrial nations. For example, from 1965 to 1978 American consumer prices increased at an average annual rate of 5.7 percent, including a peak of 12.2 percent in 1974. In Great Britain, inflation also peaked in 1974, following the quadrupling of world oil prices, at over 25 per cent. Several other industrial nations suffered a similar acceleration of price increases, but some countries, such as West Germany (now part of the united Federal Republic of Germany), avoided chronic inflation. Given the integrated status of most nations in the world economy, these disparate results reflected the relative effectiveness of national economic policies.

This unfavourable inflationary trend was reversed in most industrial nations during the mid-1980s. Austere government fiscal policies and monetary policies began in the early part of the decade combined with sharp declines in world oil and commodity prices to return the average inflation rate to about 4 percent.


Demand-pull inflation occurs when aggregate demand exceeds existing supplies, forcing price increases and pulling up wages, materials, and operating and financing costs. Cost-push inflation occurs when prices rise to cover total expenses and preserve profit margins. A pervasive cost-price spiral eventually develops as groups and institutions respond to each new round of increases. Deflation occurs when the spiral effects are reversed.

To explain why the basic supply and demand elements change, economists have suggested three substantive theories: the available quantity of money; the aggregate level of incomes; and supply-side productivity and cost variables. Proponents of monetarism believe that changes in price levels reflect fluctuating volumes of money available, usually defined as currency and demand deposits. They argue that to create stable prices, the money supply should increase at a stable rate commensurate with the economy’s real output capacity. Critics of this theory claim that changes in the money supply are a response to, rather than the cause of, price-level adjustments.

The aggregate level of income theory is based on the work of the British economist John Maynard Keynes, published during the 1930s. According to this approach, Keynesianism, changes in the national income determine consumption and investment rates; thus, government fiscal spending and taxation policies should be used to maintain full output and employment levels. The money supply, then, should be adjusted to finance the desired level of economic growth while avoiding financial crises and high-interest rates that discourage consumption and investment. Government spending and tax policies can be used to offset inflation and deflation by adjusting supply and demand according to this theory.

The third theory concentrates on supply-side elements that are related to the significant erosion of productivity. These elements include the long-term pace of capital investment and technological development; changes in the composition and age of the labour force; the shift away from manufacturing activities; the rapid proliferation of government regulations; the diversion of capital investment into non-productive uses; the growing scarcity of certain raw materials; social and political developments that have reduced work incentives; and various economic shocks such as international monetary and trade problems, large oil price increases, and sporadic worldwide crop disasters. These supply-side issues may be important in developing monetary and fiscal policies.


The specific effects of inflation and deflation are mixed and fluctuate over time. Deflation is typically caused by depressed economic output and unemployment. Lower prices may eventually encourage improvements in consumption, investment, and foreign trade, but only if the fundamental causes of the original deterioration are corrected.

Inflation initially increases business profits, as wages and other costs lag behind price increases, leading to more capital investment and payments of dividends and interest. Personal spending may increase because of “buy now, it will cost more later” attitudes; potential property price appreciation may attract buyers. Domestic inflation may temporarily improve the balance of trade if the same volume of exports can be sold at higher prices. Government spending rises because many programmes are explicitly, or informally, indexed to inflation rates to preserve the real value of government services and transfers of income. Officials may also anticipate paying larger budgets with tax revenues from inflated incomes.

Despite these temporary gains, however, inflation eventually disrupts normal economic activities, particularly if the pace fluctuates. Interest rates typically include the anticipated pace of inflation that increases business costs, discourages consumer spending, and depresses the value of stocks and bonds. Higher mortgage interest rates and rapidly escalating prices for homes discourage housing construction. Inflation erodes the real purchasing power of current incomes and accumulated financial assets, resulting in reduced consumption, particularly if consumers are unable, or unwilling, to draw on their savings and increase personal debts. Business investment suffers as overall economic activity declines, and profits are restricted as employees demand immediate relief from chronic inflation through automatic cost-of-living escalator clauses. Most raw materials and operating costs respond quickly to inflationary signals. Higher export prices eventually restrict foreign sales, creating deficits in trade and services and international currency exchange problems. Inflation is a major element in the prevailing business cycles of booms and recessions that cause unwanted price and employment distortions and widespread economic uncertainty.

The impact of inflation on individuals depends on many variables. People with relatively fixed incomes, particularly those in low-income groups, suffer during accelerating inflation, while those with flexible bargaining power may keep pace with or even benefit from inflation. Those dependent on assets with fixed nominal values, such as savings accounts, pensions, insurance policies, and long-term debt instruments, suffer erosion of real wealth; other assets with flexible values, such as property, art, raw materials, and durable goods, may keep pace with or exceed the average inflation rate. Workers in the private sector strive for cost-of-living adjustments in wage contracts. Borrowers usually benefit while lenders suffer, because mortgage, personal, business, and government loans are paid with money that loses purchasing power over time and interest rates tend to lag behind the average rate of price increases. A pervasive “inflationary psychology” eventually dominates private and public economic decisions.


Any serious anti inflation effort will be difficult, risky, and prolonged because restraint tends to reduce real output and employment before benefits become apparent, whereas fiscal and monetary stimulus typically increases economic activity before prices accelerate. This pattern of economic and political risks and incentives explains the dominance of expansion policies.

Stabilization efforts try to offset the distorting effects of inflation and deflation by restoring normal economic activity. To be effective, such initiatives must be sustained rather than merely occasional fine-tuning actions that often exaggerate existing cyclical changes. The fundamental requirement is a stable expansion of money and credit commensurate with real growth and financial market needs. Over extended periods the central bank can influence the availability and cost of money and credit by controlling the financial reserves that are required and by other regulatory procedures. Monetary restraint during cyclical expansions reduces inflation pressures; an accommodative policy during cyclical recessions helps finance recovery. Monetary officials, however, cannot unilaterally create economic stability if private consumption and investment cause inflation or deflation pressures or if other public policies are contradictory. Government spending and tax policies must be consistent with monetary actions so as to achieve stability and prevent exaggerated swings in economic policies.

In particular, large government budget deficits have to be financed either by borrowing or by printing money. If the latter route is adopted, inflationary pressure inevitably develops. Effective stabilization efforts require a sustained application of consistent monetary and fiscal policies.

Important supply-side actions are also required to fight inflation and avoid the economic stagnation effects of deflation. Possible supply-side initiatives include increasing incentives for savings and investment; enlarged spending for the development and application of technology; improvement of management techniques and labour efficiency through education and training; expanded efforts to conserve valuable raw materials and develop new sources; and reduction of unnecessary government regulation.

Some analysts have recommended the use of various incomes policies to fight inflation. Such policies range from mandatory government guidelines for wages, prices, rents, and interest rates, through tax incentives and disincentives, to simple voluntary standards suggested by the government. Advocates claim that government intervention would supplement basic monetary and fiscal actions, but critics point to the ineffectiveness of past control programmes in industrial nations and also question the desirability of increasing government control over private economic decisions. Future stabilization policy initiatives will likely concentrate on coordinating monetary and fiscal policies and increasing supply-side efforts to restore productivity and develop new technology.

All national questions of inflation, deflation and associated policies were given additional weight by the mobility of investment and speculation in the deregulated, globally linked markets of the late 20th century. When international finance can change the value of a currency in minutes, or plunge a country into the recession by fleeing inflationary measures, firm management becomes essential to economic stability.

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International Monetary Fund


International Monetary Fund (IMF), the specialized agency of the United Nations, established, along with the International Bank for Reconstruction and Development (the World Bank), at the UN Monetary and Financial Conference held in 1944 at Bretton Woods, New Hampshire. The IMF began operations in 1947. Its purpose is to promote international monetary co-operation and to facilitate the expansion and balanced growth of international trade through the establishment of a multilateral system of payments for current transactions and the elimination of foreign trade restrictions. The IMF is a permanent forum for consideration of issues of international payments, in which member nations are encouraged to maintain an orderly pattern of exchange rates and to avoid restrictive exchange practices. It also provides advice on economic policy and fiscal policy, promotes world policy coordination, and gives technical assistance for central banks, accounting, taxation, and other financial matters. Membership, comprising 184 countries as of 2005, is open to all sovereign nations.


Members undertake to keep the IMF informed about economic and financial policies that impinge on the exchange value of their national currencies so that other members can make appropriate policy decisions. On joining the fund, each member is assigned a quota in special drawing rights (SDRs), the fund’s unit of account since its establishment in 1969, whose value is based on the weighted average value of five major currencies. (In October 2001 the SDR was worth US$1.27557.) This replaced the old system whereby subscription of members was to be 75 percent currency and 25 percent gold. The total quotas at the end of June 2001 were SDR 212.4 billion (US$272 billion). Each member’s quota is an amount corresponding to its relative position in the world economy. As the world’s leading economy, in 1997 the United States has the largest quota, some SDR 25.5 billion; the smallest quota is about SDR 3.5 million. The amount of the quota subscription determines how large a vote a member will have in IMF deliberations, how much foreign exchange it may withdraw from the fund, and how many SDRs it will receive in periodic allocations. Thus, the European Union has almost 30 percent of the voting strength, while the United States has slightly more than 17 percent (2001).

Members who have the temporary balance of payments difficulties may apply to the fund for needed foreign currency from its pool of resources, to which all members have contributed through payment of their quota subscriptions. The IMF may also borrow from official institutions, and the General Agreement to Borrow of 1962 gave it the right to borrow from the so-called “Paris Club” of industrialized countries, which have undertaken to make up to US$6.5 billion available if needed (this sum was raised to US$17 billion). The member may use this foreign exchange for a certain time (up to about five years) to extricate itself from its balance of payments problem, after which the currency is to be returned to the IMF’s pool of resources. The borrower pays a below-market rate of interest for the IMF resources it uses; the member whose currency is used receives almost all of these interest payments; the remainder goes to the fund for operating expenses. The IMF is thus not a bank but sells countries SDRs in exchange for their own currency.

The IMF also supports economic development, such as the establishment of functioning free market economies in the former Warsaw Pact countries. This includes a special temporary fund, established in 1993, to offset trade and balance of payments difficulties experienced by any member country abandoning artificial price control policies. Its Enhanced Structural Adjustment Facility (ESAF) assists developing countries with economic reform. By the end of April 1998, it had provided SDR 6.4 billion to 48 countries. Loans under IMF terms frequently have stiff clauses attached regarding domestic economic policy: these have been the cause of some friction between the IMF and its debtors in the past.


The IMF commenced operating in 1947. It initially aimed to confine exchange rate fluctuations between member currencies to within 1 percent of a par value quoted in terms of the US dollar and hence linked to gold; 25 percent of members’ subscriptions were to be in gold. The first major change in policy was the General Agreement to Borrow, concluded in 1962 when it became clear that the fund needed increasing. The 1967 IMF meeting in Rio de Janeiro led to the creating of the Special Drawing Right as a standard international unit of account.

In 1971 the IMF’s par value system was renegotiated to allow a 10 percent devaluation of the dollar and a broadening of fluctuation ranges to 2.25 per cent. The sharp oil price rises after 1973 severely affected member countries’ balances of payments and led effectively to the end of the Bretton Woods agreement to restrict exchange rate fluctuations. Revision of the fund’s articles in 1976 ended gold’s role as a basis for the IMF and hastening the demise of the gold standard, which the dollar left in 1978.

From 1982 the IMF devoted much of its resources to the resolution of the worldwide debt crisis, caused by excessive lending to developing countries. It assisted indebted members to devise programmes of economic adjustment and has backed this assistance with massive lending. In conjunction with its own loans, it encouraged additional lending from commercial banks. As the realization grew that the problems of its members involved long-term structural inadequacies, the IMF established new facilities, using funds borrowed from better-off members, to provide money in larger amounts and for longer periods to members that seek to reorganize their economies.

The IMF acquired an important new remit at the end of the 1980s with the implosion of European Communism and the appearance of a host of European states determined to join the global capitalist system. This role was initially met through a series of new funds for overhauling the former command economies of Central and Eastern Europe. The debt crisis by this time had largely abated.

The IMF has to some extent lost its original form and purpose, since exchange rates are now largely left to the currency markets to determine. Modern regimes that control exchange rates, such as the European Exchange Rate Mechanism, are usually tied to convergence programmes design to produce international currencies, and the ERM’s breakdown in 1992 demonstrated the IMF’s relative impotence when confronted with currency problems in modern developed economies. The financial crisis in Mexico in 1995 showed once more that IMF funds are now unequal to the vast amounts of private capital circulating in the world economy. The financial crises in Mexico in 1995, and in Asia and Russia during 1998, showed once more that IMF funds are now unequal to the vast amounts of private capital circulating in the world economy. In November 1998 it agreed on a rescue package for the Brazilian economy that helped to forestall the threat of a global financial collapse due to economic turbulence in Asia, Latin America, and elsewhere. In April 1999 the IMF introduced stricter lending measures designed to allay crises like those that devastated many Asian countries in 1998. It established a pre-approved line of credit for qualifying countries to draw upon when international financial conditions threaten their economic well-being. Conditions included a positive economic review from the IMF, use of internationally accepted practices of disclosing economic data and statistics, good relations with private creditors, sound debt management, and a viable economic programme. The policies were aimed at bolstering investor confidence before a crisis develops, and the IMF believed that the system would prevent crises by providing incentives to follow sound economic policies.

In the 1990s high levels of external debt among developing nations were increasingly being recognized as a major threat to sustainable development and the reduction of global poverty, and in 1999 a major review of the Highly Indebted Poor Countries (HIPC) debt relief programme was announced. The HIPC programme had been established in September 1996 by both the IMF and the World Bank to ensure that countries would no longer face a debt burden they could not manage, and to provide exceptional assistance to countries following “sound economic policies” to reduce debt to sustainable levels. The review, known as the HIPC Initiative, was designed to place debt repayment within an overall framework of poverty reduction and economic growth and allowed eligible countries more control over their own finances. The following year, the IMF indicated that it intended to respect to a greater degree the individual economic, political, and social profiles of countries requiring assistance and that it would move away from endorsing free market economics as a prerequisite for assistance. By 2004, 27 of the world’s poorest nations had had their total debt reduced by more than US$34 billion. In order to meet the programme’s original target of a reduction of US$100 billion, leaders at the 2004 G-8 summit agreed to extend the initiative until December 2006.


The board of governors, made up of leading monetary officials from each of the member nations, is the highest authority in the IMF. Day-to-day operations are the responsibility of the 24-member executive board, which represents member nations individually (for larger countries) or in groups. The managing director chairs the executive board. The main headquarters is in Washington, D.C.

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Commodity, economic term with two meanings: in economic theory it is a tangible good or service that is the result of a production process; in general terms it is a primary product (or raw material) that is grown, such as coffee, tea, rubber, or cotton, or an extracted mineral resource, such as gold, copper, or tin; it may also be something that is (in effect) reared, such as wool. Here we concern ourselves only with the second meaning.

Countries that are rich in commodities or natural resources have the advantage over others that are not so well endowed in that their economies are (up to a point) less dependent on the ingenuity and effort of their inhabitants. They are, however, dependent on the market for commodities, which determines price. Experience has shown that commodity prices are more vulnerable to dramatic price shifts than are manufactured goods. In the past two decades many commodities, including oil, tin, copper, and coffee, have been subject to huge price fluctuations, that were often not foreseen or prepared for by both producers and consumers. Some of these price increases were to a large extent the result of natural conditions that have resulted in crop failures or crop surpluses. Other price shifts have resulted from one or other of a combination of politics and changing markets.

Because, on balance, consumers and producers have tended to be in favour of more stable commodity prices, attempts have been made to achieve commodity price stability through agreements that have involved export and/or production quotas; intervention in the market by buying a commodity when the price is falling (which helps slow or reverse the fall) and storing it until the price has recovered; and long-term contracts between suppliers and purchasers. None of these have worked consistently well, and there have been some serious failures, notably the dramatic collapse of the tin agreement in the mid-1980s. Increasingly, international organizations such as the International Monetary Fund (IMF) have been using other ways to help those developing countries whose commodity exports are crucial sources of foreign exchange earnings.

There are a number of commodity markets in the world, most of which concern themselves primarily with rights of ownership rather than physical possession. A “spot” price for a commodity is the current price. A “future” price is one agreed for the transfer of ownership of a specified quantity of the commodity on a specific date in the future (perhaps a month, perhaps a year). The futures market allows buyers to know in advance what they are going to have to pay for a commodity and protects them from unforeseen fluctuations in the spot price. It also offers speculators opportunities to profit from price fluctuations they have foreseen (or have been prepared to gamble on) but which the market has not. Suppose you judge that the spot price will be 5 per cent higher in 30 days’ time than the current (30-day) future price for a commodity, you will (if your judgement is correct) make a 5 per cent profit (less commission costs) by buying at the future price and selling the commodity on the spot market in 30 days’ time. However, if the spot price has fallen below the future price you paid, you will have incurred a loss.

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